Burger King F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

Nov. 5.07 | About: Burger King (BKC)

Burger King Holdings, Inc. (BKC) F1Q08 Earnings Call November 5, 2007 10:00 AM ET

Executives

Amy Wagner - Senior Vice President, Investor Relations andGlobal Communications

John W. Chidsey - Chief Executive Officer, Director

Ben K. Wells - Chief Financial Officer

Russell B. Klein - President- Global Marketing Strategy andInnovation

Analysts

John S. Glass - CIBC World Markets

Joseph T. Buckley - Bear Stearns

Glen Petraglia - Citigroup

Steven T. Kron - Goldman Sachs

John Ivankoe - JPMorgan

Jeffery A. Bernstein - Lehman Brothers

Mark Wiltamuth - Morgan Stanley

Jeffrey F. Omohundro - Wachovia Securities

David Palmer - UBS

Matt Difrisco - Thomas Weisel Partners

Operator

Good day, ladies and gentlemen. Thank you very much for yourpatience and welcome to the Burger King Holdings first quarter fiscal 2008earnings conference call. My name is Bill and I will be your conferencecoordinator for today. (Operator Instructions) I would now like to turn thepresentation over to your host for today’s conference, Ms. Amy Wagner, SeniorVice President of Investor Relations and Global Communications. Please proceed,Madam.

Amy Wagner

Thank you, Bill and good morning, everyone. Welcome toBurger King's first quarter fiscal 2008 earnings conference call. We haveprepared an earnings call PowerPoint presentation to assist in presenting ourfirst quarter performance. These slides, as well as the audio broadcast of thiscall, may be accessed through our investor relations page on our website atwww.bk.com. Both the audio portion and the slideshow will be archived on ourwebsite where it will be available for future reference.

Presenting on the call today are John Chidsey, ChiefExecutive Officer, and Ben Wells, Chief Financial Officer. Also with us on thecall is Russ Kline, President, Global Marketing Strategy and Innovation, whowill be here and available to answer any questions you may have about ourmarketing, advertising and products during the Q&A portion of the call.

We’ll spend about 20 minutes today discussing our firstquarter results before opening the call up for questions.

Before we begin today, I would like to remind everyone thatthis conference call includes forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995. These statements reflectmanagement’s current expectations based on currently available data. However,actual results may be impacted by future uncertainties and events and coulddiffer materially from what is discussed today. More detailed information aboutthese uncertainties is contained within the Safe Harbor statement included inthis morning’s earnings release.

The presentation also includes non-GAAP financial measuresas defined by Regulation G. The reconciliation of these non-GAAP financialmeasures to their most directly comparable GAAP financial measures and otherinformation required by Reg G are included in the appendix to thispresentation.

Before turning the call over to John, I want to announcedthat we’ll be hosting our first analyst investor day on February 27th, 2008, at our headquarters in Miami, Florida. You will have the opportunity tohear from our top executives, including our division presidents from around theworld. And on the following day, we’ll take a few of you down to Mexico to tourrestaurants so that you can experience the global reach of our brand.

We are excited about this first ever event and look forwardto hosting you. Formal invitations will be sent out in December.

And with that, I’ll turn the call over to John.

John W. Chidsey

Thanks, Amy and thank you for joining us this morning.During today’s call, we will discuss our strong first quarter performance andcomment on the outlook for the full year. After which, we will open up the callfor questions.

Our worldwide momentum continued as evidenced by our strongquarterly results across all key financial metrics, and the team’s focus on theexecution of our global go forward plan and our strategic growth opportunitiesdrove strong quarter-over-quarter performance, once again demonstrating that wehave the right formula to deliver best-in-class results.

All business segments contributed to top line expansion,yielding significant earnings improvement over the prior year period. Worldwiderevenues increased to $602 million, up 10% compared to $546 million in the samequarter last year, and I am pleased to share that we recorded our 15thconsecutive quarter of positive worldwide comps of 5.9%, the best level of compperformance in 10 quarters.

Our robust comps benefited from our barbell menuarchitecture strategy of offering premium and value products, from the strengthof leveraging our marketing alliances worldwide and from extended hours in theU.S. And once again, our strong EMEA APAC comps were led by the U.K., whichposted double-digit performance.

In the U.S. and Canada, we recorded our 14th consecutivequarter of positive comps of 6.6%. During the period, we drove incrementalsales and traffic with our premium BBQ Bacon TenderCrisp Chicken Sandwich andthe Spicy Chick'N Crisp sandwich, our newest addition to our p.m. Value Menu.

Our successful Simpsons movie tie-in drove sales of theUltimate Double Whopper and our Transformers and NFL alliances drove trafficand created brand relevance. We also continued to promote our breakfast valuemenu and our extended late night hours in the U.S. and we realize theforecasted improvements in both of these day parts.

Restaurant growth continued on an upward trend. Oursystem-wide net restaurant count increased by 146 as compared to the sameperiod last year. During the fiscal year, the U.S. is expected to post positivenet restaurant growth for the first time in six years. And approximately 80% ofgross openings will come from international as we continue our expansion in newand existing profitable markets around the globe.

We anticipate significant net restaurant growth in oursecond quarter, especially in our Latin America and EMEA segments. In Octoberalone, we opened approximately 20 restaurants and that trend is expected toaccelerate throughout the quarter.

In line with previous guidance, we are on track to openapproximately 300 net restaurants this year, meaning we will have more BKrestaurants operating than ever before in the brand’s history at some pointduring this fiscal year.

Worldwide average restaurant sales of $327,000 for thequarter are a 9% improvement over the prior year. Trailing 12-month worldwideARS was $1.22 million and the U.S. trailing 12-month ARS was $1.21 million,both a new record high, exceeding the $1.2 million ARS mark for the first time.

Turning to page four, our strategies remain on course,effectively delivering profitable results in every reporting segment. Thisquarter, EBITDA was $117 million, representing a significant 13% improvementcompared to EBITDA of $104 million in the same quarter last year.

And earnings per share were up 17% to $0.35 compared toearnings per share of $0.30 in the same quarter last year, benefiting from ourde-leveraging initiative. Our effective tax rate for the quarter was 38.8%,higher than last year’s first quarter tax rate of 37.5%.

Tax rates were higher this quarter due to a statutory taxrate change in Germany, partially offset by the reversal of some valuationallowances in Canada, negatively impacting EPS by $0.02. Ben will provide youwith more details later in the presentation.

During the quarter, we also used our strong cash flow for avariety of purposes. We paid down an additional $25 million in debt. Wedeclared and paid our third quarterly dividend as a public company, and werepurchased 252,000 shares for a total of $6 million through our previouslyannounced $100 million share repurchase program.

Our cash flow generation remains strong. It affords us theopportunity to return value to our shareholders while at the same time derivingfuture profitability by investing in our brand, making it a win-win for allstakeholders.

On page five of the presentation, you will find keyworldwide quarterly highlights. Again, total revenues were up 10% for thequarter to $602 million, led by a 16% increase in franchise revenues.

As we forecasted, worldwide company restaurant margin camein flat at 15.3%. Robust comp sales worldwide offset higher commodity costs inthe U.S. and Canada, utility cost increases in Latin America and throughoutEMEA, and lower margins from the underperforming restaurants acquired in theU.K.

On a positive note, even with significant commodity costpressures in the U.S. and Canada segment, we were still able to increasemargins by 50 basis points quarter over quarter through strong comp sales,savings derived from the completed rollout of the flexible batch broiler, andeffective labor management.

We continue to aggressively manage our G&A. Our G&Acosts are actually down 1% net of foreign exchange impact of $3 million andincremental equity compensation expense of $1 million. Even with theseadditional costs, G&A is up just 3% versus prior year, in line withguidance and at a significantly less growth rate than our overall revenueincreases.

As we continue to drive top line growth, our highlyleveraged business model, both at the restaurant and at the corporate levels,will enable us to deliver bottom line expansion at a much faster rate thanrevenue growth.

Now, I want to briefly mention the progress we have made inthe U.K. market. Consumers continue to respond favorably to our brandrevitalization efforts that we kicked off last October. Sales and trafficcontinue to strengthen and we now have 11 months of positive comps. We continueto rationalize our restaurant portfolio and are committed to operating onlythose restaurants that are or can become profitable.

On the last call, we made reference to additional U.K.restaurant closures as part of our strategy to better position that market andto strengthen our overall financial performance. This quarter, we closed anadditional 35 restaurants, the majority of which were located in high rentdistricts and had limited earnings potential.

We do however remain confident in the market’s long-termpotential and in our strategies currently in place to generate growth. We haverefranchised 24 restaurants to existing franchisees in the past year and wehave secured new franchisee development commitments to open new restaurants inlocations that are expected to deliver higher returns.

On page six, you will find quarterly financial highlights bysegment. Worldwide revenue and income from operations improved substantially asour top line momentum continued and as we leveraged our highly franchisedbusiness model and our G&A to drive profits.

U.S. and Canada revenues grew by 8% and income fromoperations increased by 11%, driven by very strong comps of 6.6% compared to 2.6 in the same quarter last year. Awinning combination that featured products and promotions drove sales andtraffic. Premium and value offerings included the BBQ Bacon TenderCrisp ChickenSandwich, the Ultimate Double Whopper, and the BBQ Spicy Chick'N CrispSandwich.

Our Simpsons and Transformers movie tie-ins and NFLpromotions delivered the forecasted results, creating significant brandrelevance and incremental traffic. And we also continued to promote ourbreakfast and late night day parts, producing the expected improvements inthose day parts.

Company margins improved 50 basis points to 15.3% from14.8%. Increased food costs, primarily in beef, chicken, and cheese, negativelyimpacted margins by 200 basis points. However, our robust comps, benefitsderived from the completed implementation of the flexible batch broiler, andcost management drove meaningful margin expansion in spite of these pressures.

EMEA APAC revenues grew by 15% and income from operationswas flat. Revenues were boosted by 97 net new openings and the acquisition of15 restaurants, predominantly in the U.K., during the 12 months ended September30, 2007.

Revenue growth was also aided by strong comps of 4.6% versus1.1% in the prior year, led by double-digit comps in the U.K. and strongperformance in Germany, Spain, and Australia markets.

During the quarter, we featured a variety of premiumproducts, including the limited time offer Smokey Blue Angus Burger in the U.K.and the Whopper BBQ Sandwich in Spain. We also drove traffic with the launch ofthe BK Fusion’s Real Dairy ice cream offerings in the U.K. and we leveraged thestrength of our marketing alliances with The Simpsons in many countries withinthis segment.

Despite the increase in revenues, company restaurant marginsdecreased 80 basis points to 14.4% from 15.2% in the year-ago period. Theselower margins were the result of operating under-performing restaurants thatwere acquired in the U.K. Company restaurant margin was also impacted by higherutility costs throughout all major EMEA markets. These decreases were partiallyoffset by improvements from sales of higher margin products.

In Latin America, revenues grew by 8% and income fromoperations increased 13%. Our results were favorably impacted by 88 newrestaurant openings over the past 12 months and positive comp sales of 3.8%versus 6.1% in the prior year.

Last year’s robust comps were the result of our verysuccessful Whopper 15th Anniversary promotion in Mexico. However, we continueto post strong comps this quarter with our featured products and promotions,including the Angus Mushroom Swiss, BK Stacker Sandwich, and the BK SpicyChick'N Crisp, and our worldwide Simpsons and Transformers movie promotionaltie-ins.

Company restaurant margins decreased 150 basis points or$20,000 due to higher utility costs and expenses related to the rollout of newPOS systems, which are expected to improve restaurant efficiency. Thesedecreases were partially offset by sales of higher margin products, laborefficiencies, and new restaurant openings.

On page seven is our company scorecard. Our continuingmomentum and maniacal focus on executing our global go-forward plan drovestrong results across the board. I will now take a few minutes to discuss eachone of our multi-faceted growth opportunities.

Page eight illustrates our robust worldwide comp salestrend, closing in our fourth full year of strong black-on-black results. Thisquarter was a very powerful comp quarter for us. Our menu management strategy,product innovation, marketing alliances, and extended operating hours drovesolid results and continue to build brand relevance.

For example, we created The Simpsonizeme.com website as partof our movie tie-in with The Simpsons, allowing consumers to turn digitalphotos into animated yellow versions of themselves. Almost 40 million photoshave been uploaded with over three-quarters of a billion hits to date, evidencingour marketing leadership in creating brand awareness using innovative andcutting-edge advertising media.

And I’m excited about our second quarter’s new productofferings and promotional lineup. In October, we featured both our A.M. andP.M. value menus and for Halloween, super fans every enjoyed being the King. Wesold tens of thousands of King costumes and masks through our online store andat various retailers, creating an even higher level of brand awareness in themarketplace.

This month, we will launch homestyle melts in the U.S. andCanada, a product with both a breakfast and lunch version that has been verysuccessful in our test markets. We also expect to drive family traffic throughour SpongeBob SquarePants and Viva Piñata promotional tie-ins.

I am confident that our positive comp trend will continuethis second quarter, even as we lap last year’s very successful Microsoft Xboxholiday gaming promotion.

Before turn the call over to Ben, I would like to reiteratethat our development plan is on track. This quarter’s net number again wasimpacted by the 35 planned U.K. closures that I mentioned earlier. However, weare off to a great start this quarter with approximately 20 net new restaurantsopen in the month of October. Our new unit worldwide development pipeline isstrong and we expect to open approximately a net 300 restaurants during thisfiscal year. Expanding our brand globally is a top priority and focus of theentire BK management team.

I’ll now ask Ben to update us on the rest of our metrics.

Ben K. Wells

Thanks, John and good morning, everyone. Our momentumremains strong and we are confident in our ability to continue driving strongworldwide growth by delivering on our multi-faceted opportunities. Let me nowturn your attention to page nine of the presentation.

Our sequential ARS improvement continued, making our ARSstronger than ever. Since the revitalization of our U.S. business in ’04, wehave grown ARS by 25%, getting us closer to our $1.5 million new interim ARSgoal. Worldwide, we exceeded the $1.2 million ARS threshold for the first timein our brand’s history, generating greater profitability given the inherentleverage of our business model.

A good example of our leverage can be seen through the charton the left side of this slide. U.S. company restaurants with a trailing12-month ARS of $1.9 million or above generated a best-in-class margin of25.5%.

Potential and existing franchisees are recognizing thesuccess of this business model and are seeking development opportunities in theU.S. and internationally. We expect the U.S. to be a net unit grower this yearfor the first time in six years, a meaningful milestone as we continue to rampup development worldwide.

U.S. company restaurant margins of 15.8% improved 50 basispoints compared to the same period last year. As John mentioned, due to ourrobust comps, we were able to leverage our fixed costs at the restaurant leveland deflect commodity cost pressures. We also saw our first full quarter ofexpected energy savings from the completed rollout of the flexible batchbroiler.

On another note, we also saw quarter-over-quarter progressin the percentage of U.S. restaurants above the 4% royalty rate. We now haveabout 30% of the U.S. restaurants above the 4% mark.

Turning to page 10, we actively delivered on our commitmentto enhance shareholder value through a variety of initiatives. We used ourstrong, consistent cash flow to pay down an additional $25 million in debt,bringing our net debt to adjusted EBITDA ratio to an historical low of twotimes.

Our current outstanding bank debt is now at $846 million. Wedeclared and paid the third cash dividend as public company of $0.0625. Inaddition, we used $6 million of our cash to repurchase 252,000 shares of ourstock as part of our previously announced share repurchase program. Finally, wespent $20 million this quarter building new and refurbishing existingcompany-owned restaurants.

Our strong free cash flow generation gives us theflexibility to invest in the brand, driving future growth and value to ourshareholders. On our last 32 remodels, we realized a rate of return of 16%. Onour last 16 scrapes and rebuilds, a rate of return of 36% was earned. Ourremodeling and rebuilding initiative is on track.

We have solidified our capital spending plan for 2008 fiscalyear and expect to continue this initiative in the second half of the year. Weare using our strong balance sheet to enhance shareholder value, investing ininitiatives that align with our overall growth plan.

I also want to mention that Fitch upgraded our debt ratingsduring the quarter. Our long-term issuer default rating was upgraded to DoubleB Minus from B Plus, and unsecured credit facility was upgraded to Double BPlus from Double B. The agency noted our significant profile improvement,including our comp sales momentum, increased ARS, and improved margins.

Turning to this quarter’s effective tax rate, our tax ratewas 38.8%. This is higher than we had originally forecasted and higher thanlast year’s first quarter effective tax rate at 37.5%. As most of you areaware, and as John noted, many countries are in the process of revising theirstatutory rates, which in turn impacts our effective tax rate each quarter asthese changes become law and we make the appropriate adjustments.

Even though we do anticipate our full fiscal year effectivetax rate to be 37.5%, based on what we know today, we will continue to seevariability in our effective tax rate quarter to quarter.

Before turning the call back to John, I want to mention thatwe have included additional company data and reconciliation in the appendix ofthis presentation, and again, thank you for your interest and participation onour call.

John W. Chidsey

Thanks, Ben. In summary, I am confident in our businessmomentum. We have the right resources, strategies, and multi-faceted growthopportunities to carry the brand forward. We are executing on our globalgo-forward plan, delivering best-in-class results as demonstrated by our strongfirst quarter performance.

We remain on course, building profitable restaurants indomestic and international markets, improving operations excellence, continuingour best-in-class innovative marketing and advertising campaigns, andcontinuing product development and menu management. We believe that our intensefocus in these areas will yield incremental growth and in turn create value forour shareholders.

We are thriving in a challenging economic environment asconsumers take advantage of our value and convenience. I am confident in ourability to execute on our strategic growth opportunities and deliver solidresults.

On a separate note, subsequent to our earnings announcementthis morning, we issued a press release regarding our sponsors, Goldman, TPG,and Bain’s intent to sell 23 million shares of BKC stock. We anticipate filingan S3 within 24 hours that will outline the specifics of the deal. Until thatdocument is filed, I am not at liberty to discuss any details of the proposedtransaction.

We will now open the call for questions as they pertain toour earnings. Again, I am unable to answer any questions surrounding oursponsors’ intention to sell shares, so please limit your questions to ourearnings release. Thank you for your time and continued interest. Operator, youmay now open the call for questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes from theline of John Glass with CIBC World Markets. Please proceed, sir.

John S. Glass - CIBCWorld Markets

Thanks very much. John, at one time you talked about anoperating hour deficit with McDonald’s of about 30 hours a week. With theupdated or extended operating hours this summer, what do you think that deficitis today?

John W. Chidsey

It actually, John, it was 20 is what it was previously, andthen we talked about the fact on the last call that we mandated that you mustbe open until midnight or later starting on May 17th, so the deficit now issomewhere between 13 to 14 hours. If you’ll recall, we said about every fivehours is worth a comp point.

John S. Glass - CIBCWorld Markets

Okay, and that in fact was the case this quarter then? Youbelieve you got that incremental -- the amount of incremental comp that youthought you should?

John W. Chidsey

Yes.

John S. Glass - CIBCWorld Markets

Great, okay. And then, you didn’t talk about the food costoutlook for the United States. Do you have any update from last quarter, givenwhere commodities are today?

Ben K. Wells

We basically, along with everyone else in the industry, iswatching it very, very closely. I’ll tell you, we think that if beef continuesto moderate as it currently is, all things being equal, and we get the compsthat we anticipate, we are going to be able to continue to deflect thecommodity pressures inside our P&L.

John S. Glass - CIBCWorld Markets

Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Joe Buckley of Bear Stearns. Please proceed.

Joseph T. Buckley -Bear Stearns

Thank you. Give us an update, a little bit more of an updateon the U.K. You mentioned you closed 35 restaurants this quarter. Are the storeclosures behind you at this point? And maybe just talk about some of the thingsyou’ve done as you’ve taken over some of those under-performing franchisestores, the kind of operating changes you’ve implemented.

John W. Chidsey

I think as we said, Joe, on the call the previous quarter,we had this last batch to go of what I would consider traditional restaurants.I think we are basically done. I’m not saying you’re not going to have a fewstragglers here and there but nothing in this size range.

In terms of the restaurants that we’ve taken over, I thinkit is very similar to what we’ve done in the U.S., which is put money back inthem because they were traditionally under-invested in from an image standpoint.They were not run incredibly well with the right amount of labor, things ofthat nature.

Obviously the overall work that the marketing and the newproduct teams have done over there, that’s been a benefit not just for thecompany restaurants we took over but for the system as a whole, whether it wasice cream, whether it was the Angus Burger and a lot of the great work we’vedone on that front. So it was really no different than what we would have donein this market.

Joseph T. Buckley -Bear Stearns

Okay, and the margin pressure there, is that likely tocontinue for a while longer? Obviously the comps sound like they are doing verywell. At what point do those two lines cross, do you think?

John W. Chidsey

Until we lap taking over these company restaurants, whichwe’re going to have the impact of that in our numbers for another two quarters,until you lap that, you are going to have some pressure there. I think you willcertainly expect to see it next quarter. I can’t remember exactly at which pointwe then start to comp over comparable numbers, so to speak, from a marginbasis.

Joseph T. Buckley -Bear Stearns

Okay. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Glen Petraglia of Citigroup. Please proceed.

Glen Petraglia -Citigroup

Thanks. Good morning. John, the comment was made in yourprepared comments about labor management in the U.S. Obviously you’ve gottensome benefits from the batch broiler. I’m wondering if you can give us anupdate on kitchen minder and the labor schedule and where you are in terms ofthe rollout of that to the company owned restaurants in the U.S.?

John W. Chidsey

Well, kitchen minder comes really as a package with the newbatch broiler, so if you order this new batch broiler, you must order a kitchenminder. And so I would say that we have gotten a fair amount of the benefit, ifyou will, that we are seeing on the broiler from not just an energy efficiencystandpoint, as Ben mentioned, but also from a waste and a consumer perceptionfrom kitchen minder.

From the labor management scheduling, while we rolled it outin some of the company restaurants, we’ve got a ways to go there, so I wouldsay we’ve barely begun to feel the benefit of labor management. Most of thatimprovement would have come from the broiler and kitchen minder.

And on the franchise side, it would be even more skewed interms of the labor management being rolled out.

Glen Petraglia -Citigroup

Okay, and then Ben, if you could -- I didn’t see it anywhereand perhaps I just missed it -- impactfrom currency in the quarter.

Ben K. Wells

Currency was negligible during the quarter. It was less than$1 million on the bottom line.

Glen Petraglia -Citigroup

Okay. Thanks.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Steven Kron of Goldman Sachs. Please proceed.

Steven T. Kron -Goldman Sachs

Good morning. A couple of questions; I guess first just on acapital structure, I mean, you guys are now at the somewhat targeted two timesdebt, net debt to EBITDA range that you guys talked about a while back. Youcontinue to generate great free cash flow. I’m just wondering how you arethinking about the capital structure going forward since you’ve been able topay down debt so effectively.

John W. Chidsey

I think, as we said on our last call, Steve, our number onedesire is to reinvest back into the brand, whether that’s building new companyrestaurants, whether that’s being more aggressive, as long as we continue tosee the results we expect to see on scrapes and rebuilds and remodels, I thinkthe second way to reinvest back in the brand is some of these negotiations thatwe’ve mentioned that we have underway to potentially acquire franchisees, againto either fold into our company portfolio or to break up and spin them backout, and we have those discussions going on both in the U.S. and outside theU.S. You can obviously only play the cards you are dealt on that front but Ithink that would be a great use of our capital.

And then, after those initiatives, which again I view asreally helping to grow the brand long term, then whatever cash flow you haveleft, your ability is in either to buy shares back in the open market or atsome point, depending on how the debt markets, in what shape they are in,levering up and buying shares back directly from the sponsors.

And the last use would just be your ordinary quarterlydividend.

Steven T. Kron -Goldman Sachs

Okay, that’s helpful, thanks. And then, just on the marginfront, clearly it seems as though on the company margins, you’ve gotten thebenefit of having the batch broiler rolled out for the full quarter now andoffsetting the commodity cost headwind to a large extent.

Can you maybe just talk about what margin realization youare actually getting from the batch broiler? Can you quantify that a little bitfor us?

And then secondly, certainly the next step is forfranchisees to start to order these products, batch broiler and kitchen minder.Can you talk about the adoption rate here going forward?

John W. Chidsey

I can’t take it down because in my head I’m not fast enoughon the margin standpoint, but the $500 to $600 that we talked about a month inanticipated savings is absolutely what we are seeing. And as Ben said, thefirst batch has been there for well over a year now that we started out with,so we have enough data to know. So I feel good about the $500 to $600 a monthin savings.

In terms of franchisee adoption, I’m looking around the roomhere. I’m going to say we are somewhere between 750 to probably 850 broilersthat have been ordered by franchisees and that continues to go well, in termsof them being [inaudible] -- we’re more up to like 1,000 now, so we’ll go with1,000.

Steven T. Kron -Goldman Sachs

Okay, great. I’ll leave it at that. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of John Ivankoe of JPMorgan. Please proceed.

John Ivankoe -JPMorgan

Thanks. Actually, just a quick follow-up on the batchbroiler; has the company begun to take it abroad in some of the European storesor the EMEA stores?

John W. Chidsey

A little bit in very selected markets. I think we were firstof all sticking closer to home in terms of Latin America, Puerto Rico, placesthat are really in this general vicinity. But w have done a few company marketsover there. Germany, as an example, but again we want to get the U.S. donefirst and then really go after Europe.

John Ivankoe - JPMorgan

Okay, so that might be a couple years out still?

John W. Chidsey

I think over the next 12 to 24 months is probably areasonable guess.

John Ivankoe -JPMorgan

Could you comment on the pricing environment, just kind of-- I mean, we’re beginning to hear specific numbers from a number of differentquick service companies in terms of the pricing that they are running. If youcould help us think about straight pricing and then whether you are seeing theaverage ticket go up or down relative to that pricing?

Russell B. Klein

We continue to see the very healthy blend in terms oftraffic and check, in terms of our contribution to sales growth and then insideof check, we’ve had a real nice balance of both pricing power with productinnovation and mix management, and then also nominal price increases that ouroperators we’ve seen out in the system.

The company took price increase in July of about 1%, so wecontinue to see the ability to thoughtfully take price and in fact, one of thekey focuses of the company is to refine our pricing model so that we can reallywring out those opportunities on a restaurant-by-restaurant basis.

So there absolutely has been the ability to try to outrunsome of the cost pressures on F&P with pricing.

John Ivankoe - JPMorgan

Let me follow up on that; so you took a price of 1% in July,so is that your cumulative price increase? Do you know what I’m saying? Wasthere any more taken before July that is currently in the numbers?

Russell B. Klein

No, just anything that would have occurred from mixmanagement, improvements in value meal incidents and that sort of thing.

John Ivankoe -JPMorgan

Okay, and secondly, it sounds like you are actually going tobe doing location-based pricing. How far along are you in that initiative andwhen might we see that at the store level?

Russell B. Klein

We, we are pretty far along. We have a cascading strategythat we are in the midst of rolling out. I would say by the time we are full to[bright], it will be 12 to 18 months and we do see this as a importantopportunity for us.

John Ivankoe -JPMorgan

Okay, absolutely. And finally, Ben, if I may, and if Imissed this, I apologize; could you update us on the fiscal ’08 CapEx and taxrate guidance?

Ben K. Wells

On the CapEx, we are going to, as we said before, we aregoing to spend approximately 140 to 150, perhaps 120 to 150, but inside thatbroad range. The actual tax rate for the full year, as I noted in the script,was 37.5%. That’s with the discrete items that we included. Obviously it willbe less if you started stripping out all the statutory changes that are takingplace.

John Ivankoe -JPMorgan

And going forward, fiscal ’09, should we still be thinkingthat tax rate dropping a point or so a year or something --

Ben K. Wells

Absolutely. In point of fact, the noise you are seeing hereis people are lowering their tax rates, which requires us to make theappropriate accounting. So in the outer years, we feel very comfortable thatour rate will continue to drop by about a point a year.

John Ivankoe -JPMorgan

Okay, perfect. Thanks.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Jeffery Bernstein of Lehman Brothers. Pleaseproceed.

Jeffery A. Bernstein- Lehman Brothers

Great, thanks. Good morning. First, a follow-up question onthe U.K.; I think last quarter you were able to strip out what your acquiredunits did to margins. I think you said it was 140 basis point impact. I’m justwondering what you view the impact was to this quarter’s company-operatedmargins in terms of the European market.

John W. Chidsey

It’s about 80 basis points.

Jeffery A. Bernstein- Lehman Brothers

And then going forward, you’d expect that to continue tolessen over the next quarter or two until you are net neutral?

John W. Chidsey

Correct.

Jeffery A. Bernstein- Lehman Brothers

And then specific to the U.S., you had mentioned breakfastand late night were producing the expected improvement in day part sales. Isthere any way to quantify where you are in terms of either the breakfast menuor the value menu or the late night in terms of as a percentage of comp orpercentage of the system?

John W. Chidsey

I think that Russ can jump in after I’m through here, Jeff,but I think what we meant is we talked about it a lot on the previous callsthat we’ve been able to grow those day parts at a faster rate than we had ouroverall business, somewhere between 1.5 to 2 times our normal growth rate.

Russ can give you some more highlight in terms of how we’vebeen able to move breakfast or value in terms of what percentage of our menu itwas a year or two ago versus where it is today.

Russell B. Klein

Just to John’s point, even overall on multi-faceted leversfor growth, I mean, we’ve seen a real nice balance and certainly contributionfrom a day part standpoint is equally balanced. We see some expecteddisproportionate growth in A.M. and P.M. parts of our business. The value menu,which is an A.M./P.M. offering for us, has continued to grow as a percentage ofsales, particularly with the kick we got from Spicy Chick'N Crisp. Yet we stillsee opportunities there.

Obviously our breakfast represents a big part of the gapversus our key competitor and when you look at the value menu as a percentageof sales mix, we remain underdeveloped versus our two key competitors and stillpossess a superior blended margin, so we’ll continue to use that as a strategicadvantage.

Jeffery A. Bernstein- Lehman Brothers

But no specifics in terms of where you are on an actualpercentage basis of the total menu?

Russell B. Klein

It’s around 13%, the value menu is.

John W. Chidsey

With both of our competitors being well over 20%, so againto Russ’ point, we think we have a lot of room to run there.

Jeffery A. Bernstein- Lehman Brothers

And then just lastly, there’s been talk on the U.S.company operated margin, obviously up nicely despite the commodity pressures.I’m just wondering, as you look at the comp needed to maintain the margin inthe current environment, do you have a sense as what do we keep going forward?I know you mentioned that you thought momentum was continuing into thisquarter. I’m just wondering what it really takes to maintain that margin.

John W. Chidsey

You’re talking about the U.S. specifically? Because in thecall, we obviously said we felt good about, as Ben said, even if we see somecontinued pressure, given the flow-throughs from increased comps and what weare seeing with the batch broiler, which mostly that’s in the U.S., that weremain confident that our margins would stay flat again on an overall basis.

Jeffery A. Bernstein- Lehman Brothers

I didn’t know if there was anything specific to the U.S.

John W. Chidsey

No, not really. I think as long as our comps continue inthat 2% to 3% range which we forecast for the year, we feel pretty good that wecan continue to maintain the margins that we see today.

Jeffery A. Bernstein- Lehman Brothers

That’s great. And just one last question; I know a couple ofcompetitors have spoken about a slowdown mid-September through the present,tougher, perhaps more elevated consumer environment pressures. I’m justwondering if you guys have seen any directional trends in terms of thingsgetting better or seeing some pressure the past 30, 45 days.

John W. Chidsey

Well, obviously as we said, that was our best quarter for usin 10 quarters, and we said we’d -- in the script, which I’ll reiterate, wefeel really good about October. We got off to a great start and I think thewords in there specifically were we feel confident about positive comps in thesecond quarter, so we haven’t really noticed any particular slowdown per se interms of consumers.

And as we said on the last call, we still run, if you lookat our comps, we are probably two-thirds traffic driven, one-third check, maybeeven slightly above that a little bit, so that’s not something we really noticeto date.

Jeffery A. Bernstein- Lehman Brothers

Great. Thank you very much.

Operator

Thank you very much, sir. Ladies and gentlemen, your next questioncomes from the line of Mark Wiltamuth of Morgan Stanley. Please proceed.

Mark Wiltamuth -Morgan Stanley

Good morning. Just to check in on how the franchisees aredoing. I’m curious if you think their restaurant margins are also up. And ifyou could give us an indication on the rate at which the franchisees aresigning up to build new units.

John W. Chidsey

Okay, I’ll go in reverse order. In terms of -- you’retalking about U.S. franchisees building?

Mark Wiltamuth -Morgan Stanley

Yes.

John W. Chidsey

Well, obviously we didn’t break down this year for ourguidance, we didn’t break down specifically by market, but suffice it to saythat again, if the U.S. is going to be a net grower for the first time in sixyears, we did talk about the fact that they are building more certainly thanthe previous year, so we feel good about -- it’s probably double to triple --no, it’s more than double. It’s probably triple what they built two years agoand we continue to see more and more momentum. They continue to come in -- Idon’t think we put it in the script this time, but they are still coming in ata 1.5 million basically when they’ve been open for 13 months, so that momentumreally continues to fuel itself, so to speak.

In terms of your first question, I would say franchisees maybe doing even slightly better, simply because they’ve been more aggressive onprice actually than we have. If you think about commodity costs and all theother issues they face, they’d be the same as what we face in our companyrestaurants, but again I’d say they are slightly more aggressive on takingprice so they should be not that dissimilar but slightly better than us.

Mark Wiltamuth -Morgan Stanley

And they should still have more to go with the batch broileras they get more of those out there.

John W. Chidsey

Exactly.

Mark Wiltamuth -Morgan Stanley

Okay, thank you very much.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Jeffrey Omohundro of Wachovia. Please proceed.

Jeffrey F. Omohundro- Wachovia Securities

Thanks and good morning. Just a question about brandpositioning and thinking about the broader menu strategy, how you might bebalancing that effort with your success appealing to the core heavy user?

John W. Chidsey

Well, we definitely embarked on an act two to our growthstrategies this last May when we kicked off into our new fiscal year and beganto introduce what we call white space strategies, which is simply the idea thatour ability to democratize what our limited markets in food to go with qualityand innovation that you see in fast casual and to deliver it at a value for themoney and convenience and speed of service that we can do within our business model.

So products like the Angus, products like the wrap products,our Hold’ems products that are in test market, are two examples where we cancontinue to push into what we consider to be white space and we’ve recast ourconcept of our super fan to actually be a little more complete around the conceptof a super family, which obviously the parties with kids segment is a largecontributor to our business and so products that have somewhat more femaleappeal and also kid friendly or family friendly appeal with some of the themesthat are in the marketplace, maybe best demonstrated by a product we have intest market now called Apple Fries, which is a fresh cut apple in the shape ofa french fry that’s in test market and we’re very excited about.

So we are continuing to balance those white space strategiesagainst what also works for us, which is focus on our core customer, new LTOsaround our Whopper product and our TenderCrisp product and our value menu.

Jeffrey F. Omohundro- Wachovia Securities

Thanks.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of David Palmer of UBS Investments. Pleaseproceed.

David Palmer - UBS

Thanks. Congrats on your quarter, especially the U.S. Myquestion is on your international. I think you had something like $1 million ofincremental profit growth from non-U.S. markets out of the $14 million or sothat you had this quarter, and obviously this stands in contrast to some ofyour big cat peers and restaurants, which have been doing big numbers in termsof incremental international non-U.S. profitability.

I’m wondering what you are thinking is the big picture herein terms of inflection points from -- that those profit growth in terms ofdollars really picking up and in answering this, perhaps you can comment onanything that might be masking your progress this quarter. This could includeabove average reinvestment you made and perhaps if you feel like puttingdollars on the U.K. closures, what that might have done to your profit? Thanks.

John W. Chidsey

I think it’s a couple of things, David. I think one thingthat you had last year is you had -- I don’t remember which quarter it’s in, Iapologize, but I think it was this quarter, we had a $5 million gain as we gotout of a joint venture in New Zealand and Australia, and so that you’relapping, so that obviously was a one-timer, so that is certainly masking it.

And yes, you’ve got those U.K. restaurants, which have hadsome effect, so I think those would be the two biggest anomalies, if you will,so I think you will see -- I think you will definitely see acceleration in thenext quarter. Because again, if you look at Latin America and use that as aproxy, last year we opened 96, 97 restaurants, we closed three. As you continueto see things like that, you are obviously driving incremental revenues becauseyou are not having to add heads. Most of those restaurants, whether it’s LatinAmerica or EMEA, are franchise, so -- someone just scribbled me a note thatsaid at the end of the year, you could expect to see 33% increase --

Ben K. Wells

That’s if you adjusted it for the JV.

David Palmer - UBS

Is there anything else you would add to give a longer termfeel? I know that you’ve said that you want to have most of your growth on alonger term basis come from international. Is there anything that can kind of-- I mean, in terms of perhaps the fact that you are going to be building moreand having more net new unit growth within existing markets, is there any sortof timing around this, even to the quarter or to the half of the year that wecan think about in terms of modeling international?

John W. Chidsey

Well, as I just said and Ben jumped in, again, if you backout the TPF gain and you are at a 26% increase in terms of operating income, soI would say the international segment is growing much faster than the U.S.segment, which you would expect to see. If you took out, which I can’t do themath right here on the fly, if you took out again those U.K. restaurants, itwould be more than 26% growth, so I think it’s absolutely playing out as youwould expect. That if 80% of our growth is coming from outside the U.S. and ifwe don’t need to add costs, you should continue to see this sort of 30%-plusgrowth outside the U.S.

David Palmer - UBS

Okay. All right, thanks very much.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Matt Difrisco of Thomas Weisel Partners. Pleaseproceed.

Matt Difrisco -Thomas Weisel Partners

I just have a couple of questions; with respect to thecampaign that we are seeing now in the U.S. market, I guess the homestylecampaign, what’s the schedule for this running? Is this going to run throughChristmas as well and through the holiday season?

John W. Chidsey

No, the homestyle campaign will take us into December andthen early December, we’ll be switching over to basically a Whopper campaign.

Matt Difrisco -Thomas Weisel Partners

It seems like you’ve invested a little bit more, or at leastthe image is building with have the moms on the advertising and everything. Iguess you are going to lose that image or are you going to try and carry thatinto the Whopper campaign?

John W. Chidsey

I wouldn’t say that the homestyle advertising is someinflection point in terms of how we are going to market. The advertising youare seeing is aimed at positioning this particular product as one that is asgood or better than mom could make and we are having some fun with that. Butyou’ll continue to see us draw from a play book over our calendar, targeting ourcore customer and managing all of the segments, whether it be parents, partieswith kids, the white space strategies I spoke of earlier. So certainly thehomestyle advertising isn’t some new era of work for us.

Matt Difrisco -Thomas Weisel Partners

Secondly, just following up a little bit on theinternational margin question, if you could just simplify it and look at it interms of is it the -- are the margins something that would improve quicker ifit was -- is it a source of you need more sales through those stores or arethere some out-of-control costs that with better practices, now that some ofthese stores will be company-owned stores, that will improve the margins andsee it through cost controls or whether it’s something cyclical, like you mentionedutilities in I believe Latin America. Or is it just a pure you need more salesvolume through these stores?

John W. Chidsey

I don’t know -- they’re not out of control, that’s for sure.What you are seeing going through the international margins is currency, andyou have to take a look at the revenue is way up because of currency, then thecosts that are going to go through the P&L are going to be way up, or visaversa.

The same metrics that we operated inside the U.S. applythere and obviously when you have a highly fixed cost or leverage model,anything that goes through the top is going to come back down to the bottom, soobviously higher comps always helps.

But I want to stress that currency inside this model is onethat comes down to the bottom with essentially a non-starter, it’s less than $1million, it’s de minimis, but if you picked out each line, you are going to seecurrency flowing through and having its obvious effect, depending on what itis.

Matt Difrisco -Thomas Weisel Partners

I understand, okay. And then last question, can you give usan update if there’s any change to the investment cost of the kitchen minderand the batch broiler as it rolled out now associated with the $500 to $600monthly savings?

John W. Chidsey

No change. That’s absolutely as advertised.

Matt Difrisco -Thomas Weisel Partners

So the investment cost is still around $16,000 for afranchisee?

John W. Chidsey

No, it’s about $5,600 to $6,000 depending on where you infreight, et cetera. So it’s still about a one-year payback.

Matt Difrisco -Thomas Weisel Partners

On the broiler and the kitchen minder?

John W. Chidsey

No, for the broiler. With kitchen minder, it’s slightlymore, it’s like another $1,000, I want to say, so call it $7,000. So still,when you are comparing $500 to $600 a month, maybe a 15-month payback for both.

Matt Difrisco -Thomas Weisel Partners

Perfect. Thank you.

John W. Chidsey

I believe that was our last question, so again, we want tothank you very much for your participation today. Thanks for your interest inour story and we look forward to speaking to you next quarter. Thanks a lot.

Operator

Thank you very much, sir, and thank you, ladies andgentlemen, for your participation in today’s conference call. This concludesyour presentation for today and you may now disconnect. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!