CKE Restaurant, Inc. Q3 2008 Earnings Conference Call Transcript

CKE Restaurants, Inc. (CKR)

Q3 2008 Earnings Call

December 13, 2007 9:00 am ET

Executives

John Beisler – Vice President Investor Relations

Andrew F. Puzder – President, Chief Executive Officer & Director

Theodore Abajian – Chief Financial Officer & Executive Vice President

John J. Dunion – Executive Vice President Supply Chain Management

Analysts

Anton Brenner – Roth Capital Partners

Brian Moore – Wedbush Morgan Securities, Inc.

Steve Weiss – JP Morgan

Rachel Rothman – Merrill Lynch

Dean Haskell – Morgan Joseph

Lee Lignos – Lakeway Capital Management

Conrad Lyon – FTN Midwest Securities Corp.

Keith Siegner – Credit Suisse

Presentation

Operator

Good day ladies and gentlemen and welcome to the CKE Restaurants Third Quarter Fiscal 2008 Conference Call. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of today’s conference. If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. I would now like to turn the presentation over to your host for today’s conference Mr. John Beisler, Vice President Investor Relations. Please proceed sir.

John Beisler

Thank you Brandy. Good morning and thank you for joining us. My name is John Beisler, Vice President of Investor Relations for CKE Restaurants. CKE Restaurants is hosting this conference call to discuss our results for the 12 weeks ended November 5, 2007. Yesterday, CKE issued a pair of press releases announcing it’s financial result for the 12 weeks ending November 5, 2007 and it’s same store sales for the four week period ended December 3^rd. Both releases are available on our website www.CKR.com. CKE has also filed it’s Form 10Q with the SEC. This call will reflect items discussed within those press releases and Form 10Q. CKE management will make reference to them several times this morning.

Speaking on today’s call are Andy Puzder, President and Chief Executive Officer, Ted Abajian, Executive Vice President and Chief Financial Officer. Andy will begin today’s presentation with a few comments regarding our third quarter and period 11 same store sales results as well as provide an update on several important initiatives. Ted will then review our third quarter results with you. Andy will conclude today’s presentation with comments on the strategic direction of the company. Andy and Ted will then take calls from callers.

Before we begin, I’d like to remind you of our disclosure regarding forward looking statements contained in Form 10Q and earnings release. Our disclosure regarding forward looking statements can be found within Form 10Q under item two, management’s discussion and analysis of financial condition and results of operations. Matters discussed during our conference call today may include forward looking statements relating to future plans and development, financial goals and operating performance and are based on management’s current beliefs and assumptions. Such statements are subject to risk and uncertainties and actual results may differ materially from those projected in the forward looking statement. I introduce you now to Andy Puzder, President and CEO.

Andrew F. Puzder

Thanks John and good morning everybody. During the third quarter we continued to execute both strategically and operationally on our plan to position our company for long term sustained growth and to improve near turn profitability. Strategically, we repurchased a significant amount of stock materially reducing our outstanding share count. During the third quarter we repurchased $4,796,899 shares of our common stock at a total cost of $80.1 million. Through the first three quarters of fiscal 2008, we repurchased 13,199, 219 shares at a total cost of $233.7 million dollars. Since the end of the third quarter we repurchased an additional 447,700 shares at a total cost of $6.7 million. Since the inception of our stock repurchase plan in April of 2004, we’ve repurchased approximately $19.1 million shares or approximately 32% of our fully diluted share count for a total investment of $331 million. We expect our share repurchases to be accretive to EPS in fiscal 2009. We’ve updated our investor presentation and it can be accessed at www.CKR.com. You click on the investor tab and then on presentations and at pages seven and eight of the updated presentation we summarize our shareholder distributions over the past four years and our diluted share count history dating back to fiscal 2001.

During the third quarter we also refranchised 16 Hardee’s restaurants. Since the end of the third quarter we refranchised an additional 30 Hardee’s restaurants in the Kansas City market giving us a total of 126 restaurants refranchised year-to-date. The development agreements we entered into in connection with our refranchising program obligate the purchasers to build an additional 59 restaurants over the next five years. While refranchising reduces our gross revenues and adjusted EBITDA it also provides us with cash for debt reduction, share repurchases or funding of our capital plan. It reduces our capital expenditures, increases are adjusted EBITDA minus capital expenditures and increases our pre cash flow. Refranchising is also expected to increase our company operated restaurant averages and volumes as these market generally have average unit volumes below the system averages. We’ve included an analysis on page 50 of our updated investor presentation quantifying the benefits of refranchising on pre cash flow.

As we have no plans to build new units in these markets and the acquiring franchisees are agreeing not only to remodel these restaurants but also to build new units under developing agreements, this is clearly the right move for our company and the Hardee’s brand short term and long term. In addition, as we execute on our new unit development in selected Hardee’s markets and at Carl’s Jr., we will offset at least a portion of the near term reduction in revenue from our refranchising efforts. In this respect, it is my pleasure to announce that for the first time in eight years, or in this decade, we are opening more restaurants than we are closing. As of the end of the third quarter, we and our franchisees operated 3,036 Hardee’s and Carl’s Jr. restaurants, an increase of 43 restaurants since the end of fiscal 2007. Year-to-date both Hardee’s and Carl’s Jr.’s have had positive growth as brands and both we and our franchisees have had positive unit growth.

While the increase in restaurant count is not a large number in absolute terms, it is a significant achievement as it demonstrates we are now in a fluxion point with respect to our unit growth. This will be the first year since 1999 that our brands will have more units opened at the end of the year than they did at the beginning. In other words, it should be our first year of positive net unit growth. Going forward, new units will become a more significant driver of our adjusted EBITDA and our EPS growth. There is a new unit growth summary on page 12 of the updated investor presentation.

At the operations level, we implemented certain cost reduction initiatives during the third quarter to offset rising commodity costs and the impact of the increases in the minimum wage. These initiatives combined with an improvement of 40 basis points in workers’ compensation expense made Carl’s Jr.’s third quarter food and packaging and labor and employee benefits consistent as a percentage of company operated restaurant revenue with the prior year quarter. At Hardee’s we actually saw a 20 basis point improvement in labor and employee benefits as a percentage of company operated restaurants revenue versus prior year quarter. But, a 210 basis point increase in food and packaging costs. An increase in dairy and biscuit ingredient costs negatively impacted Hardee’s operating costs due to strength of its breakfast day part. Occupancy and other restaurant operating cost increased by 110 basis points over the prior year quarter due primarily to higher depreciation related to our new point of sale system at Carl’s Jr.’s and the ongoing remodel program at both brands. To date, we’ve remodeled 133 Carl’s Jr. restaurants or 33% of the system and 63 Hardee’s restaurants or 11% of the system.

Despite the fact that our first price increase impacted only the final period or 1/3 of the third quarter and our second price increase took affect after the end of third quarter, our efforts to mitigate the impact of rising restaurant operating costs began to have a positive impact in the third quarter. In second quarter, our restaurant operating costs were 300 basis points above the prior year quarter. Of this 300 basis points increase, 90 basis points were due to an increase reserve for a very old and very large workers’ compensation claim. All other restaurant operating cost were 210 basis points above the prior year for the second quarter. In the third quarter, despite continued increases in certain commodity costs, particularly biscuit ingredients, diary, potatoes and cooking oil, we reduced the gap between last year and this year to 190 basis points. We’re working diligently to reduce that gap even further for the fourth quarter when both price increase will have their full impact.

With respect to fourth quarter, we’re continuing to experience high costs for certain commodities and scheduled increases in various state minimum wage rates will impact our labor expense. Nonetheless, we continue to work diligently to narrow the gap versus the prior year. One other expense worth noting is a $1.8 million charge we took in connection with our interest rate swap agreements. As Ted will discuss in more detail, we incurred this charge because interest rates declined after we entered into our interest rate swap agreements. Similarly, if interest rates increase in the future, we would expect to record a benefit to earnings. However, for the third quarter that charge reduced both net income and EPS. The after tax impact of this charge was approximately $0.02 per diluted share and we had calls yesterday after we released our earnings from some of our shareholder assistants, who we always appreciate, asking that we emphasize that our 13% EPS would actually have been 15% without this charge and, of course, that’s true and we did try and put in there that it was a $0.02 charge. But, on the other hand we do have to absorb that charge.

G&A improvements, in addition to our efforts to reduce the impact of increased commodity and labor costs, we also focused on G&A reductions as a way to improve earnings. As Ted will discuss in more detail, we’ve seen significant G&A reductions throughout the year. For third quarter, even without the reductions related to the sale of La Salsa, which appear in discontinued operations, we were below not only the prior year but our internal forecast which contemplated the refranchising of Hardee’s units. We achieved this improvement despite increase in G&A expense with respect to certain departments such as our real estate and construction and training departments as we gear up for growth.

Both brands experienced positive same store sales in the third quarter despite rolling over strong results in the prior year. Same store sales at company operated restaurants increased 7/10 of a percentage at Carl’s Jr., on top of positive same store sales of 6.2% last year for a positive two year total of 6.9%. Hardee’s same store sales increased 2.7% on top of positive same store sales of 5.6% last year for a positive two year total of 8.3%. As of the end of the third quarter, Carl’s Jr.’s average unit volume was $1,486,000, a $46,000 increase since year end and rapidly approaching the $1.5 million mark. Hardee’s average unit volume was $945,000, a $29,000 increase since year end and, again, rapidly approaching the coveted $1 million mark.

As we announced yesterday, same store sales improved for both brands in period 11 with Carl’s Jr.’s up 2.5% and Hardee’s up 3.2%. We achieved these sale gains despite two price increases and the onset of winter weather during the final two weeks of the period in the Midwest and southeast. As of the end of period 11, Carl’s Jr.’s average unit volume was $1,490,000 and Hardee’s average unit volume was $949,000. The accumulative result of our cost reduction initiatives and our positive same store sales offset by commodity costs and depreciation expense increases and the $1.8 million charge in connection with our interest rate swap agreement was third quarter income from continuing operations of $7.5 million or $0.13 per diluted shares. As stated earlier, we repurchased a significant amount of stock.

During the first three quarters of 2008 we’ve added $198 million in debt to our balance sheet such that at the end of the third quarter, our total outstanding debt is now $376.1 million. At the end of the third quarter our debt to adjusted EBITDA ratio was approximately 2.25:1. Although our debt to adjusted EBITDA ratio has more than doubled since the end of fiscal 2007, our ratio still remains towards the bottom of our group of peers. As of today, we have a $269 million balance on our term loan, of which we have effectively fixed the interest rate for $200 million of the borrowings with the interest rate swap agreements, as I mentioned earlier. We currently have $37 million outstanding on our $200 million revolving credit facility and our total bank debt is $306 million. The bottom line is in a challenging environment we’ve reduced our restaurant operating costs, reduced G&A expense, had positive sales and continued to make necessary investments in our businesses while returning capital to our shareholders and positioning ourselves for improved growth and profitability.

I will now turn the discussion over to Ted Abajian our Chief Financial Officer for his discussion of the financials.

Theodore Abajian

Thank you Andy. Good morning everyone. Before I get started I need to make you aware that during this conference call we may refer to certain non GAAP financial measures as explained in our earnings release issued yesterday and in our report on Form 10Q for the 12 weeks ended November 5, 2007. Also, our reported financial results have been adjusted to reflect the sale of our La Salsa Fresh Mexican Grill change which has been classified as discontinued operation within our consolidated financial statements. I will now take you through our third quarter results.

Consolidated revenue for the third quarter was $351.6 million, a $2.8 million or .8% decrease from the prior year quarter. The decrease in revenue reflects the impact of our refranchising efforts, partially offset by our same store sales growth and new unit development. Third quarter operating income was $19.5 million, a $7.3 million decline from the prior year quarter operating income of $26.7 million. The year-over-year decline in operating income is primarily attributable to a 110 basis point or $2.9 million decline, I’m sorry $2.9 million increase in food and packaging costs and a 110 basis point or $2.9 million increase in occupancy and other restaurant operating costs. I will comment further on both of these areas when I address our performance at the brand level.

Third quarter G&A costs which include an $841,000 increase in share based compensation expense declined by $1.9 million or 40 basis points as a percent of total revenue as compared to the prior year quarter. G&A cost excluding share base compensation expense were down $2.7 million for the quarter. Facility action charges were $.3 million for the quarter as compared to a credit of $1.4 million in the prior year quarter. The prior year results included gains on the sale of surplus properties that did not recur in the current year quarter.

Interest expense was $7.7 million for the third quarter, an increase of $3.9 million as compared to the prior year quarter. The increase versus the prior year quarter is due to a combination of higher overall debt balances resulting from our share repurchase activity and, as Andy mentioned, a $1.8 million non cash charge we incurred during the third quarter to adjust the carrying value of our interest rate swap agreements. You may recall that during the third quarter we entered into interest rate swap agreement which effectively fixed the interest rate on $200 million of our term loan debt at 6.22%. These agreements expire in March of 2012. Subsequent to entering into these agreements, both current interest rates and expected future interest rates declined. As of the end of the third quarter we were required to record a $1.8 million charge to account for this decline and interest rate. Since the charge we recorded as the effect of resetting our interest rate to the current market rate, we would expect to begin recording interest expense at the then current market rate from that point forward. However, future declines in interest rate yield curves would require us to record additional charges. Different interest rates, or more specifically if forward looking interest rate yield curves should increase we would reverse a portion, all or potentially more than all of the charge we have recorded in the third quarter. However, since the end of the third quarter rates have continued to decline. If interest rates were to remain at current levels which we updated as of yesterday, we would expect to record an additional charge of approximately $3.5 million in the fourth quarter to reflect the impact of this decline in interest rates on the fair value of our interest rate swap agreements.

Third quarter income from continuing operations was $7.5 million or $0.13 per diluted share and include the aforementioned adjustment to interest expense which equates to approximately $0.02 per diluted share.

I’ll now briefly discuss third quarter results at both Carl’s Jr. and Hardee’s. At Carl’s Jr., third quarter same store sales increased .7% rolling over a 6.2% increase in the prior year quarter. Restaurant operating cost increased from 130 basis points to 78.8% of company operated restaurants revenue. The increase in restaurant operating cost was driven by a 140 basis point increase in occupancy and other expense over the prior year quarter due primarily to an 80 basis point increase in depreciation expense arising from our increased remodel activity and the roll out of new point of sale software and related hardware. Both food and packaging costs and labor and employee benefits were relatively flat versus the prior year quarter. Higher direct labor expense related to minimum wage increases at the federal and state levels were offset by a reduction in restaurant level manager bonus expense and a 40 basis point decrease in workers’ compensation expense from favorable adjustments to our workers’ compensation claim reserves.

Moving now to Hardee’s, third quarter same store sales at company operated Hardee’s restaurants increased by 2.7% rolling over a 5.6% increase in the prior year quarter. Restaurant operating costs increased 260 basis points to 84.3% of company operated restaurants revenue. The increase in restaurant operating cost at Hardee’s was primarily driven by a 210 basis point increase in food and packaging costs. A substantial portion of the increase in food and packaging costs is due to higher commodity prices for biscuit ingredients such as floor and buttermilk, as well as dairy products overall. These items have a much greater impact on Hardee’s business than Carl’s Jr. as a result of significantly higher breakfast sales. Occupancy and other expense increased 70 basis points over the prior year quarter due primarily to general liability insurance expense which was 50 basis points unfavorable to the prior year quarter as a result to adjustments to our claim reserves. Labor and employee benefits decreased 20 basis points versus the prior year quarter primarily as a result of a 50 basis point reduction in workers’ compensation claims expense resulting from favorable adjustments to our workers’ comp claim reserves and a reduction in restaurant level manager bonus expense. These favorable items more than offset higher direct labor expense related to minimum wage increases at the federal and state level.

Before Andy wraps up our prepared comments this morning, I’d like to comment on our general expectations with respect to a few key fourth quarter metrics. While we continue to experience commodity cost pressures, we do believe the actions we have taken over the past several months should continue to benefit restaurant level operating costs such that fourth quarter year-over-year, such that the fourth quarter year-over-year increase in restaurant level operating costs as a percent of sales should be lower than the year-over-year increase in the third quarter. With respect to refranchising and the associated decrease in G&A spending, we expect to see additional G&A spending reductions versus the prior year during the fourth quarter as compared to the third quarter run rate. A significant portion of our refranchising activity occurred during the third quarter and early in the fourth quarter. Specifically, of the two most recent transactions covering a total of 56 restaurants, one closed during the last week of the third quarter and the other transaction closed four weeks into the fourth quarter. Finally, our estimate for weighted average diluted shares outstanding for the fourth quarter is 56.8 million shares, a 20% reduction from the prior year fourth quarter diluted weight average share count of 71.2 million shares.

I’ll now turn the call over the Andy for closing remarks.

Andrew F. Puzder

Thanks Ted. Despite all of the cost issues facing our business, on an EPS and an adjusted EBITDA basis we expect this year to be the second best year we’ve had since our team took over management of the company, exceeded only by last year which was a perfect storm of low costs and high sales. A series of charts featuring our EBITDA EPS and adjusted EBITDA growth are located on pages 51-53 in our investor presentation and I think it really puts this in context. We also expect that as we begin to reap the benefits of our capital plan and our strategic initiatives, both EPS and adjusted EBITDA will continue to improve. We expect adjusted EBITDA to grow an average rate of 11-13% over the next five years.

I will now address a couple of questions that seem to occur in investor meetings and in these conference calls. First, investors have been asking how much we spent with respect to our previously announced capital plan and what kind of returns we’re seeing? We’re now about 21 months, or 23 accounting periods into our $650 million capital plan which we disclosed in April of 2006. In our current investors presentation we’ve updated that plan to factor in certain changes in our underlying assumptions including, an increase in the costs of our remodels and the sale of Hardee’s units. This update is available on pages 9-11 in our investor presentation.

Since the beginning of our last fiscal year through the end of third quarter of fiscal year 2008 we’ve expended $178.4 million of our projected capital expenditures. Of this, $120.3 million has been non discretionary spending which includes remodels, repair and maintenance expenditures and investments in IT and our distribution center. The remaining $58.1 million has been discretionary spending which includes new unit growth and dual branding of our restaurants. As we previously indicated, our initial capital spending will be weighted towards non discretionary projects as we invest in areas where capital spending has been deferred for some time and where we need to rebuild our infrastructure as required for growth.

As expected, our refranchising of more than 100 Hardee’s units this year has reduced our capital spending needs over the coming years as we no longer need to commit remodel and repair and maintenance capital for these stores. In addition, because we are in some instances simultaneously dual branding stores as they are being remodeled, we’ve reduced the amount of capital allocated for the dual branding program. Partially offsetting these items is an increase in the projected cost of our remodels and an increase in IT spending due to higher implementation costs of our POS system as well as a new distribution management system installed in our Ontario distribution center.

In all, we’ve reduced our five year capital spending by $32.5 million to $617.5 million with approximately $439 million to be spent over the next 3 ¼ years. Since our capital expenditure plan is back loaded with discretionary expenditures, if we fail to experience acceptable returns going forward we will reduce this amount or extend the time period as we deem prudent. The bulk of our capital spending to date, for which there is a measurable return on investment, has been our remodels. Although this is a non discretionary investment as we would have to remodel our restaurants even if there were no measurable returns on the funds we invest, we do expect a return from our remodels and we do everything we can to increase that return. Remodels are simply a cost of doing business. To date, we’re experiencing an 8% return on our Carl’s Jr. remodels and about a 16% return on our Hardee’s remodels. This disparity in returns is due to a number of factors including higher averaging volumes at Carl’s Jr.s and a greater need for remodel at Hardee’s. In addition, we never really saw a decrease in sales at Carl’s Jr. even though there was the remodels and as we may not be seeing an increase of sales once we complete the Carl’s Jr. remodels although, we are seeing an increase. We are examining exterior elements that may help improve the remodels at both brands.

To date, about 2/3 of our capital spending has gone into investments we needed to make to support future growth and for which it is difficult to measure a return on investment. Our remodels which have a lower return on investment than dual branding or new units, as such, our capital expenditure budget is front loaded with non discretionary expenditures for which it is difficult to measure a return on investment, or which have a lower return on investment than the expenditures such as dual branding and new units which have a higher return but, are back loaded in the budget. This obviously results in lower initial returns and higher returns as we proceed through the plan.

With respect to our discretionary capital spending we completed operator Green Burrito conversions in the third quarter. We now have a total of 191 Carl’s Jr. Green Burrito company operated restaurants and 179 franchised units for a total of 370 dual branded units or 33% of the Carl’s Jr. system. We expect to dual brand approximately 20-25 company operated restaurants with Carl’s Jr. and Green Burrito this year. We’ve opened nine company operated Carl’s Jr. restaurants through the first three quarters of fiscal 2008 and, we intend to open 18-20 new company operated Carl’s Jr. restaurants for full fiscal year.

On the Hardee’s side, we completed 12 company operated Red Burrito conversions in the third quarter and now have a total of 63 company operated Hardee’s Red Burrito dual branded units and eight franchise units for a total of 71 dual branded units or 4% of the Hardee’s system. We expect to dual brand approximately 35 company operated restaurants with Hardee’s and Red Burrito this year. We’ve opened five company operated Hardee’s through the first three quarters of fiscal 2008 including, a total of two dual branded locations and, we intend to open six to eight new company operated Hardee’s for the full fiscal year. While we remain encouraged by the results of these units, we will build a very limited number of future units if the results do not justify the investment.

Another question that investors have raised to us, is why we waited to the end of third quarter to take a price increase to offset commodity and labor costs increases at both brands. While we did take pricing early in the year, to some extent, I believe, we were a little behind the curve and initially a little timid with respect to our price increases. However, there were reasons for our delay which were unavoidable. First, we do take pricing where and when we can on a regular basis. At the highest priced brands in our segment, we cannot take large price increases until our competition does so or we further separate ourselves from the pact on price, on a price valued basis which would negatively impact our transactions and sales. The reality is that because of our premium quality, higher priced positioning we will always be somewhat behind our lower priced competitors from a timing perspective on large price increases.

Second, when we increase prices we do take the time to evaluate where in the menu we can increase prices most effectively with the least amount of consumer reaction. And, finally, we try to time these increases to proceed seasonal run ups in restaurant traffic such as the beginning of summer and at the beginning of the holiday shopping season since traffic gains tend to reduce the potential for sales and transaction losses resulting from higher prices. Consequently, we targeted October and November for our price increases. We certainly seem to have accomplished our objective with our two price increases as we have yet to see any price related impact to our sales trends in periods 10 and 11 while preliminarily we have seen a positive impact on our operating results. We’ll know more about the impact of these price increases by the end of the fourth quarter.

Finally, investors ask why the increase in commodity and labor costs seems to have impacted our brands more than some of our competitors. Well, first, for the reasons stated above certain of our competitors took price increases before we did. More fundamentally however, such costs increases impact us more because we own a greater percentage of our restaurants than our competitors. This means, when costs go up, our profits go down to a greater extent than is the case with competitors having a higher mix of franchise restaurants. This is because franchisors get royalties based on gross revenues not bottom line profits. If in fact, a franchisee increases prices to offset increased costs, royalties could actually go up if revenues increase. On the other hand, there is substantial benefits to owning more restaurants when restaurant level costs declined as occurred last year because, we get a huge benefit versus the competition as our restaurant level profits improved with decreased costs even if revenues are stagnant. We believe we can address, and in fact, we are addressing the current commodity and labor cost increases in the short term with certain actions including the price increases I discussed earlier. We also believe that due to our restaurant ownership mix, in the long run we will benefit to a greater extent than most of our competitors, when following these price increases commodity prices declined.

Now, I hope that answers some of your questions. While always looking to improve, we do feel we’re on the right path in addressing both the short and the long term issues that we’re facing. We’re focused, we’re determined and I remain very optimistic about our company’s future and I look forward to taking us into the New Year. We will now take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen if you wish to ask a question, please press star followed by one on your touchtone phone. If your question has been answered or you wish to withdraw your question, star two. Press star one to begin and we’ll stand by for first question. And, your first question comes from the line of Tony Brenner of Roth Capital Partners.

Andrew F. Puzder

Good morning Tony.

Theodore Abajian

Good morning Tony

Anton Brenner – Roth Capital Partners

Good morning. I have two questions.

Andrew F. Puzder

Could you get closer to the phone?

Anton Brenner – Roth Capital Partners

Yeah, I’m sorry.

Andrew F. Puzder

That’s okay.

Anton Brenner – Roth Capital Partners

I have two questions. One is, Andy, you seem to be edging more than I’ve heard you before on your intention of opening new restaurants. On the restaurants that have opened this year are the sales trends less than you would look for? Is there some other reason you went out of your way to mention that you won’t, you won’t open new stores if the trends are disappointing?

Andrew F. Puzder

No. If I gave that impression, I apologize. We’re opening as many new Carl’s Jr.’s as we can find reasonable sites to open them on and, our new real estate department which , you know, we’ve really invested in over the past 18 months is doing a spectacular job of coming up with sites. We’re going into some new markets and we’re going to be developing a lot of Carl’s Jr. restaurants. On the Hardee’s side I want to make sure that, we’re still at that $950,000 average unit volume on the company stores and the new units that open up substantially higher than that but, I want to make sure we get the metrics right before I do the same kind of aggressive development at Hardee’s that we’re currently doing at Carl’s Jr. And, all I meant to emphasize in the script was, if we don’t, while the capital plan contemplates that we will get that formula and I believe that we will get the formula for the metrics on the new Hardee’s units, that if we don’t get it, I have, we have the discretion not to build as many new Hardee’s and that’s really my only point. We fully intend to develop a lot of units. That really is, as we go forward and look at our EBITDA on our earnings per share in coming years, really a big part of our growth in those areas is going to come from these, this new unit development that we’re contemplating and we are aggressively pursuing that.

Anton Brenner – Roth Capital Partners

Okay. My second question relates to your share repurchase program. I’m wondering if given your potential discretionary cap ex spending, if you intend to remain aggressive on share repurchase. And, I’m curious what you compute your rate of return on share repurchase as being.

Andrew F. Puzder

Well, the computation on the rate of return, that’s not something that we’ve made public or that we’re going to make public. But, we do expect it to be accretive next year. On the issue of how much, how aggressive we’ll be, I think, going forward we’ll be more opportunistic. We’ve done, I’m really, I think, we’ve done about as much as we can do with bank debt and, you know, I’m happy, really happy that we were able to accomplish what we did accomplish with traditional bank debt which we can repay and we can get interest rate locks in it and it can be very advantageous to us. I think, if we did something meaningful going forward we’d have to finance it different and, at the moment, I think we’re going to and, we have our non discretionary program which is still in place and we do have dry powder if a good opportunity presented itself. But, I don’t think we’re going to be as aggressive over the coming year certainly as we were this year.

Anton Brenner – Roth Capital Partners

Thank you.

Andrew F. Puzder

Thank you.

Operator

Your next question comes from the line of Brian Moore of Web Bush Morgan.

Theodore Abajian

Good morning Brian.

Andrew F. Puzder

Good morning Brian.

Brian Moore – Wedbush Morgan Securities, Inc.

Good morning. I’m a little rusty on my floating the fixed swap accounting. I’m hoping you can talk to me about, I guess, maybe the up front payment associated with that and then, how much of the interest expense line they’re charging top out as cash.

Andrew F. Puzder

It’s tough to tell you. This isn’t very intuitive so I’m going to turn you back over to Ted.

Theodore Abajian

Thanks Andy, I was perfectly prepared for that one. No, Brian the, well, first of all, the $1.8 million charge during the quarter, none of that is cash during the quarter. And, what is effectively happening here is we entered into these swap agreements that fixes our interest rate at a point and time for, at the time was a 4.5 year term. If, as interest rates change you have to mark that instrument to market much like an investment security. Since interest rates went down from the time we entered into the agreement until at the end of the quarter they were lower than when we entered the agreement in the middle of the quarter. You effectively are required to take charge for the difference between the rate you’re locked in at and the then current rate as of the end of the fiscal quarter which is a charge based on the entire 4.5 year term remaining which makes the assumption interest would stay at that level at the end of the quarter. If interest, as I mentioned earlier, if interest rates change going forward, you take additional charges if they go down further. Or, if interest rates were to go up, you would actually reverse a portion or potentially all, or even more than all of that charge that you’ve taken previously. It is complicated, I wish it’s.

Brian Moore – Wedbush Morgan Securities, Inc.

There was an upfront payment, Ted? I’m sorry.

Theodore Abajian

No. There is no upfront payment. It’s a fixed rate swap with no upfront payment.

Brian Moore – Wedbush Morgan Securities, Inc.

Okay. Fair enough. Perhaps a question for Andy, could you maybe speak to the divergence and two year comp trends in recent months, perhaps from a geographic product or competitive standpoint?

Andrew F. Puzder

Well with Carl’s Jr. we ran an ad, it was called Teacher which met with some, I guess, unfavorable reaction from some teaches. And, you know, while normally I’m willing to defend our ads right to the limit, I didn’t think fighting teachers was a particularly good idea so, we backed off the ad and I think it had an impact on Carl’s sales during the third quarter. So, I think that, more than anything else, you see that. Although sales were still positive we did have to pull our ad which we felt would be driving sales that quarter off the year.

Regionally, you know regionally things have been fine. I mean, the Midwest and southeast has been great. Now, I will tell you in the last, the last week or two of period 11 and part of period 12 and, I don’t know what part of the country you’re living in right now but, you know, there are , we just had severe ice storms up through Oklahoma reaching up into Missouri and parts of the Midwest and southeast. And, you know, we get these things every year but, they rarely fall at the same time. So, you know, that can impact your same store sales certainly more than, more than anything else. But, I mean, we’re seeing, we’re seeing absent weather, absent the weather and even in, even after our pricing increases and I know people say the way your prices went up, you know, your sales should go up. Well, that’s not necessarily, if that were true, you know, we’d raise them a whole bunch everyday. You know, at some point your prices go up enough that it drives business away and you have to be careful not to do that.

But, even with two good pricing increases in periods 10 and 11, we haven’t seen negative impacts to the trend. So, you know, I think on a, I think a lot of the articles you read about how people may be trading down to fast food and, we’re in a particularly good situation with our quality message to intercept some of that trade down, I think we’re seeing, we’re seeing good trends pretty much across the brands. And, you know, we always, we’d love to be up 5% a year, that’s not realistic. That’s not going to happen. But, sales have been good. I mean, it’s not, I’m not, I can’t tell you in any part of the country I’m seeing any really major declines. I’m looking at Ted and he’s shaking his head no too. So, we’re not seeing any declines geographically or by product mix.

Brian Moore – Wedbush Morgan Securities, Inc.

Alright. And maybe, one final question. I guess, given your comments about parody in terms of pricing, I guess first, do you believe you’re at parody with some of your, you know, lower price competitors? And then secondly, to get maybe the willingness to take additional pricing, the timing, you know, particularly given the two step minimum wage increase here in California.

Andrew F. Puzder

Yeah. You know, there are, we emphasize pricing because that’s something we can talk about. There are also other things we do to improve the cost structure which, you know, really are competitive related and we don’t talk about in these conference calls. But, with respect to being in parody on pricing, I think everybody’s continuing to raise their prices. The impact of the dollar on the industry, on commodity costs, the weakness of the dollar on commodity costs continues and it affects our competitors as much as it affects us. And, we keep an eye on what they’re doing, particularly the franchisees of some of the larger, our larger competitors. You know, you can’t, when you’re a franchisor, you can’t tell your franchisees what to charge. So, when you’ve got a large franchise system as some of our competitors, you know, you watch the franchisees, you know, to see where the prices go because, they’re going to mark to market, to use a phrase we’ve used already today.

So, we keep an eye on them and, I think, people continue to raise prices and we will as well. You know, we’re going to do what we need to do to make sure that our margins go where they need to go and stay where they need to stay. Although, as was the case when beef went up back in, was it 2004? You know, we may be, we may be a quarter behind or a few periods behind our competition but, we’re not going to be much behind.

Brian Moore – Wedbush Morgan Securities, Inc.

So would that be fair to say, I’m sorry to interrupt.

Andrew F. Puzder

That’s alright.

Brian Moore – Wedbush Morgan Securities, Inc.

There’s a willingness to see something before the typical summer and, you know, or shopping season type periods you referenced earlier?

Andrew F. Puzder

Well, we normally take price increase at the beginning of the year in first quarter and I expect that we’ll do that again this year. What I was talking about seasonally is when you take really major pricing. You know, we took two substantial price increases in periods 10 and 11 before the shopping season. We will continue to take pricing throughout the year and we may, we may take even more substantial pricing just before the summer hits. We’re, we don’t believe we’re done with this yet. We can’t be done adjusting our prices until the economy adjusts and, that doesn’t look to be happening in the short term.

Brian Moore – Wedbush Morgan Securities, Inc.

Great. Thank you very much.

Andrew F. Puzder

You’re welcome.

Operator

Your next question comes from the line of Steve Weiss of JP Morgan.

Steve Weiss – JP Morgan

Hi. Thanks. I wanted to ask about your margin expectations going forward. I know the goal in the fourth quarter is to further reduce the gap. But, at this point, as you’re looking to 2009 given the pricing and other margin driving initiatives and just generally easier laps, how should we be thinking about restaurant level margins to progress in the year?

Andrew F. Puzder

Well, you know, there’s obviously two elements to that. One is what will you do if the pricing situation stays stagnant or continues to escalate. You know, we need to do what we need to do to stay, to improve our margins and to stay current with the changing economy. Now, if commodities start to come down, and they will at some point come down, just as interest rates will at some point will go up. Commodity costs will at some point come down. And, at that point, given the pricing we’ve taken and our premium positioning, we’re going to reap substantial benefits just as we did last year when commodity prices went down. So, a lot of it depends on the economy but, I’m going to let, having said those general things, I’m going to turn it over to Ted to see if he wants to say anything.

Theodore Abajian

Yeah, I would add a couple of things to that Steve. First of all, if you recall last year towards the end of our first quarter which our first quarter ends the end of, the middle of May is when we began to see the commodity price increases. So, a good portion of our first quarter last year didn’t have the impact of the kinds of commodity escalations that we’ve seen for the remainder of this year. And so, we’re still, you know, fighting a bit of a head wind in terms of the rollover even in terms of the first quarter. But, as Andy said, you know, look, our expectations are at some point we want to rebuild our margins to a level, you know, back to some historical normalized levels. And, that’s going to be a function of continued price increases on our part and other adjustments we can make within our brand as balanced against what may happen in the commodity environment overall. And, again, we do, at some point commodities are going to break and, if we knew the answer to that, you know, it would be a different ballgame completely. But, I don’t think anybody has a good, clear crystal ball on that matter.

Brian Moore – Wedbush Morgan Securities, Inc.

Okay. And Ted, can you just help us understand what you may have contracted from a commodities standpoint as you look out over the next, you know, next fiscal year. We have John Dunion with us, our head of supply chain management. I’ll let him comment on that topic.

John J. Dunion

Yes, thank you. We typically stay out ahead in forward coverage on most of the major commodities and actually, the four that Andy spoke to being oil, cheese, wheat products and dairy products. So, we’ll typically keep coverage in place at various levels three to four months out in the future.

Brian Moore – Wedbush Morgan Securities, Inc.

Okay and the general pricing that you’re seeing on what you do have under contract. Can you comment on that?

John J. Dunion

Yes. I mean, we’ve got , we’ve got a situation which is basically driven by a weak dollar and is accentuated by the funds coming in and buying the futures and having very heavy net positions and futures contracts.

Brian Moore – Wedbush Morgan Securities, Inc.

Okay. And then, just finally, Andy I know you’re working on a lot of things beyond pricing to improve the overall picture. And, I know, you probably don’t want to talk about a lot of it just from a competitive standpoint but, can you give us some sense of the opportunities you see in the brands to improve margins beyond price?

Andrew F. Puzder

We, we’ve got actually some substantial things in the works. But, you can make ingredient changes, you can make product mix changes, you can try and make day part changes, all of which can impact your restaurant level operating costs. So, to some extend you’re sort of guessing at where prices are going to go on different commodities. But, you know, John does a very good job at that for us. And, we think we’ve got , we got some, I think, we’ve got some very interesting things we’re working on that I think can make a big difference for us. And, we’re day and night working on these, and talking about these margin issues to get them more and more under control going forward without, again, getting so far ahead of our competition that we damage our price value, our price value impressions in the market. We want consumers to, they realize we’re higher priced, we want them to continue to know that we’re higher value as well. So, we’ve got , I know I’m being very vague about this but, I have to be but, we’ve got some good stuff going on.

Brian Moore – Wedbush Morgan Securities, Inc.

Okay. Thanks very much.

Operator

And, your next question comes from the line of Rachel Rothman of Merrill Lynch.

Andrew F. Puzder

Hey, Rachel, how are you?

Theodore Abajian

Hey, Rachel.

Rachel Rothman – Merrill Lynch

Hi. Good morning guys. Can you tell us how much price you did take in period 10 and period 11?

Andrew F. Puzder

Well, actually, I had that in the script and then we took it out because, we don’t want, we don’t want people kind of guessing how much of the pricing we’re going to get. So, we’re not going to comment publicly on how much pricing we took. Unless, Ted, you’ve changed your mind and want to comment? No, he’s shaking his head no. So, no we’re not going to.

Rachel Rothman – Merrill Lynch

Would you, is it low single digit, mid single digit? I mean, I guess we’ll get the average check at the filing of the K but, that isn’t going to be for quite a while.

Andrew F. Puzder

Rachel, this one comment I would make, if you recall back when beef prices spiked and we took large price increases in the beginning of fourth quarter back in, I think, it was fiscal 04.

Rachel Rothman – Merrill Lynch

Okay.

Andrew F. Puzder

You know, at that time at Carl’s and Hardee’s we took between 3-4% in price. And, you know, that was a single price increase and, you know, I would consider that on a historical basis to be a very significant price increase. And, you typically wouldn’t take a single price increase of that magnitude absent an event driven situation like we had back then with beef. So, and typically, you know, you would be in a position where, you know, in a normal year you would take a couple, you know, two or three price increases that might aggregate to, you know, a couple of percent. Maybe 2.5-3% in a year when you’ve got commodity inflation. So, normally wouldn’t have individually taken a price increase the magnitude of the 3-4% increase that we took back in fiscal 04. But, it was, meaningful in order to combat these commodity increases.

Rachel Rothman – Merrill Lynch

I guess, can you give us some comfort when you talk about the traffic trends not having fallen off. I can appreciate that but, it seems as though, from the data in the queue, the transactions are already negative at Carl’s. So, is it just that they’re not becoming more negative? Or, that you actually saw a rebound in traffic?

Andrew F. Puzder

No, we didn’t, I think what we said in the press release, and it’s true, we did not see a change in the trends.

Rachel Rothman – Merrill Lynch

Okay.

Andrew F. Puzder

So, and really, that’s between you, when you increase your prices what you’re looking for as well, is it materially impacting your sales or your transaction trends and so, at least as of the date of that press release we had not seen such a reaction. You know, it gets hard to tell in the, you know, with Hardee’s right now it’s hard to tell because you don’t know what is impacting. You know weather is having an impact so, it’s a little tougher to see what’s going on right now. But we’ll know once the weather normalizes out there.

Rachel Rothman – Merrill Lynch

Yeah. The saddest part is we use to think about the option on the company really being the Hardee’s turnaround and that seems like it’s really worked out well but, it’s happening at the same time Carl’s is posting softer results than we’ve seen in a number of years and, I think that kind of puts some pressure on the story. Maybe you could just segway that into really what you think has lead to the kind of lower performances that we’ve seen out of Carl’s this year versus historically. And, I know you mentioned the teacher ads but, is it maybe a [inaudible] new product news or has it been just significant capital reinvestment on the part of your competitors in the market? Is it the economy in California? Or, what do you feel is hindering your ability to kind of drive, I don’t know, call it 4% comp.

Andrew F. Puzder

You know, if you look back, if you look in the shareholder presentation, and I’m leafing through quickly here. You can see that in fiscal 02, sales were up 2.9% at Carl’s and then the next year they were up 7/10 of a percent. Then the next year 2.9 and then .77 and then 2.2, then 4.9 and then this year we’re up about a percent. You know it does, you know, in years when you have a large average unit volume and you have a very good year then, next year you’re happy to be positive. I mean, we’re not going to be up, we probably average, if you average these numbers out we’re up about 3% a year maybe 3.4, 3.3. So, you’re not going to get, you’re not going to get 4% every year, you’re going to average around 3.3-3.4. And, we’re not, the only thing, I mean, we’ve had a couple of things happen at Carl’s this year but, really nothing that’s decreased average unit volume, nothing that’s caused us to decide that we need to change our marketing direction or what we do with our products.

We’ve got some ideas how to drive sales over the coming year and, you know, we think we’re going to continue to do that as we have in prior years. You know, you’re going to be running over some softer numbers this coming year so, absent some macro economics circumstances, you should see Carl’s Jr. to continue to be as strong a performer or stronger performer than it has been in the past. So, it’s not, it’s very difficult to judge a brand by a quarter or two. I think, you have to look over the history of the brand and look at the strength of the brand and at Carl’s we continue to have, even with these pressures, still the margins are very strong or, I should say, the operating expenses are low in comparison to the competition and our average unit volumes are approaching $1.5 million. New units continue to do extremely well so, I’m not, in the short term I’m not, I guess I’m not feeling as concerned about the future as maybe I’m intuiting that you are. It’s, you know, Carl’s is doing real well. When you look at what sales we just had in period 12, we were up, what 2.5?

Andrew F. Puzder

2.5

Theodore Abajian

Period 11, excuse me, we were up 2.5, you know it was over 5/10 of a percent increase last year. But, you know, you’re going to do better when you roll over those lower numbers. So, we love to see Carl’s up 2.5, 3, 4% this year. But, it was up 5.1% last year, so. You know, we’re not discouraged and we have plans to try and continue building it going forward. One of the things we need to do at Carl’s that I’m kind of excited about and we’re actually going to be within the next two periods, we’re going to be putting more of an emphasis on breakfast which I think is a huge, huge opportunity at Carl’s. And, there are some other day parts and segments that we can concentrate on competitively that Carl’s hasn’t concentrated on in the past that I think can drive business in different parts of the day. You know, I think that’s a big factor at Carl’s because, obviously, we’re open all day and we need to make sure that we’re doing as well at breakfast, or late in the day as we’re doing at lunch.

Rachel Rothman – Merrill Lynch

I guess, just ask the question a different way. When I look at your five year same store sales growth from calendar 02 to calendar year 06 which excludes this year, I have Carl’s at 3.7%. Given that the volumes are high but, I mean, that’s just a constraint that exists, is there any reason that we should think about that not being your, kind of average or normalized rate going forward?

Theodore Abajian

No, I think in the 3% range is what we’re willing to think of as over time what we’re going to do. You know, 3.7, 3.5, 3.4, whatever the number turns out to be. I know if you’d have taken it back one more year it goes down because 01, we were only up 1.8%. But, you know, we, you know, that’s within the range of where we look to grow with the brands.

Rachel Rothman – Merrill Lynch

Okay. Great. And then just finally, I’ve had a number of chains like Jack In the Box, McDonalds, [inaudible], IHop, they’re all pursuing the refranchise of their company operated stores and one of the key drivers they highlight which you highlighted today was the opportunity to materially leverage their G&A. Can you talk about how much you think you can leverage your G&A? How we should think about that? I know, I think Ted gave some context about fourth quarter seeing more leverage than third quarter but, is that on a percentage of revenue? Is it on a dollar basis? You know, really what opportunities are there for you to lower your G&A as you shed a third of your Hardee’s? You will have shed a third of your Hardee’s, and in terms of dollar amount, how should w think about that? And then, as a follow up to that, I guess, it also frees up your time, right? Because, you don’t have to worry as much about the operations. Can you just kind of characterize where you’re spending that extra time? What you’re focused on?

Theodore Abajian

While Andy thinks about the answer to that question, you know, the G&A side is obviously, something we’re living through real time right now. I will say, you know, one metric that I haven’t even gone over in any great detail with Andy, frankly, is we look at our incremental spend per store in the neighborhood of, I’m going to give a range here $20-$24,000 per year per stores. So, you know, I think that’s, you know, a realistic expectation and obviously, we’d like to do better than that and take more overhead out than that but, right now it’s kind of, while I believe we can take that out, the incremental on top of that is a function of, you know, living for a period of time without the stores and then making adjustments corporately to staffing to improve upon that number.

Rachel Rothman – Merrill Lynch

So, the $24,000 is G&A overhead?

Theodore Abajian

$20-24,000 I think, is a safe range. And, I think as we get, you know, keep in mind half the refranchising has occurred in the last six weeks frankly. So, as we get a little deeper into this, I think, we’re going to have even greater clarity on our ability to take additional G&A out.

Rachel Rothman – Merrill Lynch

And, is that the net? Meaning, the transfer from company operated to franchised? Or, is that just the amount that you would expect to save? Because, obviously, they’ll be some G&A costs associated with the incremental franchise store.

Theodore Abajian

Yeah. That actually, that actually is the amount that comes out directly related to refranchising. There is some incremental amount that comes back in but, that is not a very significant amount. Very, I mean, very minimal in comparison.

Rachel Rothman – Merrill Lynch

And then, just finally, as a follow up, can you just talk about why the franchise margins deteriorated so much in the quarter? I know there’s all kinds of things that impact that but, I guess, conceptionally, I would think that as you add more franchise stores you’d be able to get pretty substantial leverage in that category?

Theodore Abajian

Yeah. There’s really a couple of things. One, first of all, we did have collections, again, in the prior year last year at Hardee’s related to bad, essentially collection of previously bad debt expense, amounts that had been previously written off of about $1.8, $1.9 million dollars last year at Hardee’s that did not recur this year. So, that’s one item. The other item, and I’m not certain exactly how you’re calculating it, our distribution revenues which were very low margin to begin with are actually up and part of the reason they’re up is we’re having franchisees.

Rachel Rothman – Merrill Lynch

Great. Thanks so much guys.

Theodore Abajian

Okay Rachel.

Operator

Your next question comes from the line of Dean Haskell of Morgan Joseph.

Andrew F. Puzder

Hey, Dean.

Theodore Abajian

Morning Dean.

Dean Haskell – Morgan Joseph

Good morning gentlemen. Congratulations on a great operating quarter taking out the discontinued items and that swap charge, a good number $0.15 well above the consensus. I did miss one of the comments on the charge expected for the swap in the fourth quarter.

Theodore Abajian

Yeah, Dean that was.

Andrew F. Puzder

That’s assuming interest rates stay where they are.

Theodore Abajian

Yeah, as of yesterday based on, you know, interest rate expectations yesterday which changed throughout the day, would be $3.5 million. But it, and I look at that regularly, it’s amazing how much that can change in any given day.

Dean Haskell – Morgan Joseph

And, what are you using? A T note four or five years out for the term of the loan?

Theodore Abajian

No. No, it’s actually, I mean, actually the counter parties that we have the swap agreement with literally provide a valuation, you know, at any point and time that we ask. It’s based on the five year forward swap curve.

Dean Haskell – Morgan Joseph

Okay.

Theodore Abajian

The LIBOR swap curve.

Dean Haskell – Morgan Joseph

Great. Second question, for Andy, do you plan on emphasizing anything else accept for anything other than breakfast, perhaps value for the next couple of months as we go through the traditionally seasonally weak period?

Andrew F. Puzder

When you say emphasize, we’re not going to go onto TV with a value message. We do have value in the restaurants and, I think, that the consumers, at Carl’s in particular, now, we are doing a, right now, a bacon cheddar double burger at Hardee’s right now on the two for $3 message as we do our double cheeseburger normally and also bacon cheddar fries. Which, by the way, if you can get out to Hardee’s are spectacular. And, that’s as close as we get to a value message.

Dean Haskell – Morgan Joseph

Okay. Great. Yeah, I’m going to have the bacon cheddar fries this afternoon.

Andrew F. Puzder

Great. Let me know how they are.

Operator

As a reminder, that’s star one to ask a question. Your next question comes from the line of Lee Lignos of Lakeway Capital.

Theodore Abajian

Hi Lee.

Andrew F. Puzder

Good morning Lee.

Lee Lignos – Lakeway Capital Management

Hey, good morning. How are you guys doing?

Andrew F. Puzder

Good.

Lee Lignos – Lakeway Capital Management

A couple of things. First, as a shareholder, I’d like to, you know, acknowledge the fact that you guys have done a very good job at providing more understanding in terms of the numbers and guidance and kind of what’s going on. I just wanted to tell you that it’s a show that we do appreciate that. I know, it’s a very difficult company to look at from a modeling perspective and you guys finally, I think, got it right this quarter.

Theodore Abajian

Oh, thanks Lee. We appreciate that.

Lee Lignos – Lakeway Capital Management

That said, as an investor [inaudible] the stock has come in a lot and when you look at the valuation relative to the rest of the universe, it trades at a pretty significant discount and I think one of the things that a lot of investors are confused about is, you know, obviously this was a year of transition. You guys are doing a lot to clean up the company for future growth, you bought back a lot of stock which, I think, is definitely a boldish sign. But, as you look out to next year, I think there’s a little bit, I guess, I don’t want to say concern but, it’s really just more people are really trying to figure out what the growth trajectory is for the business. And, I was hoping, you know, you kind of touched upon this in pieces of lower expenses here and taking price there. But, can you kind of give us a better framework for how to think about the growth for the earnings of the business? And, I guess, one of the points to that is that’s there’s always been a weird disconnect between the valuation of the company on an EBITDA basis versus and earnings basis. And, I think, right now the company is positioned to start growing the earnings and I was just hoping you could try to give us a little bit of framework to try to figure out how we can look at that growth going forward.

Theodore Abajian

Hey Lee, this is Ted. Obviously, you know, we’re very focused on the overall share price and what we can do to grow that over time. And, you know, this is a down year, there’s no question about that and nobody at this table or in the company is the least bit satisfied with that and, you know, we’re working very hard to make, you know, as much as this year was a disappointment, or a declining year, to make next year kind of an outsized growth year. But, I would say we’re operating in an environment that we’re not, that we haven’t operated in consistently previously. IN other words, in a commodity environment and labor cost environment that is a bit, has a bunch of wild cards in it, not to mention a consumer and, you know, all the other issues affecting the economy that are a little unusual. Having said all of that, we’re certainly internally working to make next year, you know, a better than average growth year. And, I think to make that happen, you know, we’re going to need to be able to take additional price increases which we’re planning to do. Whether or not commodities, you know, commodities could be a big help or a big hindrance in that regard. Whether they’ll help out at all or not, right now many of the forecast we see suggest that they’re going to continue to escalate. So, you know, I think we’re very bullish on those prospects but, frankly, our business plan is based on, you know, looking out four or five years and achieving over that time period, you know, as I think Andy [inaudible], you know 11-13% EBITDA. We’re still committed to that. Obviously, this year being a down year means we’ve got some ground work to make up frankly.

Andrew F. Puzder

Well, let me, I’ve had time to think while Ted was talking so maybe I can add a little to that. I think the way I would look at it is, if commodity cost continue to increase and labor cost continue to increase at the rate that they’ve been increasing, we’re going to be continuing to increase prices as are all our competitors and take other actions internally to maintain margins and profitability, you know, where they are or better than where they are.

You know, we’re trying, we’re closing that gap on last year. We’re very focused on doing that and we’re doing whatever we can to minimize that gap and will continue to do that going forward. If prices stagnate, if they stop increasing that will be a much easier job for us because we’ve already done a lot of the actions we need to get caught up and we can do more. And, if commodity prices come down, you know, labor is going to be what labor is going to be, you know how its staged in. And, a lot of what’s happening in that respect depends upon the next election. But, if we’re looking at a time period where our commodity prices are going to decline, we’re going to get big benefits from that, huge benefits because of our restaurant ownership and our actions we’re taking now. So, it’s, you know, I would look at it in kind of that three pronged way whether if commodities and labor continue to go up, which is hard to image they would but, if the Fed keeps lowering the interest rate then, the dollar keeps weakening, then our goods are going to be very desirable over seas and that’s going to create issues for us. But, it’s hard to believe they would continue that for much longer but, if they did we’re going to continue to work very hard to continue to improve those margins. If they stabilize, you know, a lot of the work will be done for us because, we’re already taking those actions. And, if they actually improve, we’re going to get big benefits. And, I think that is mainly the kind of three pronged approach we have been looking at without giving you any particular percentage or dollar numbers to fill in. But, I think, that’s how we view the business.

Lee Lignos – Lakeway Capital Management

Fair enough. I appreciate the insight.

Andrew F. Puzder

Thanks Lee.

Operator

Your next question comes from the line of Conrad Lyon at FTN Midwest.

Andrew F. Puzder

Good morning.

Conrad Lyon – FTN Midwest Securities Corp.

Hey, good morning everybody. Hey, let me go back to Carl’s and kind of the sales outlook. You know, this might be helpful, I think. In terms of the best volumes that you see, can you give us kind of an idea perhaps maybe where the top 10%, top 5% of your stores lay?

Andrew F. Puzder

Well, if you’re talking about franchise and company, you know, Mexico got, God it’s got to be close to $1.8 AUV now. You know, Mexico just kicks butt. We just opened a restaurant in Pango Pango, American Samoa which had the record opening for a first week at a Carl’s Jr. I think they did like $115,000 in week one. So, there’s some real strength over seas and we are, although we didn’t put it in this presentation, in our next presentation we’re going to give you guys a little more insight to what we’re doing internationally and we think we’re making some very positive and meaningful moves internationally. Domestically, for company owned stores or for franchise stores, our best market would probably be Los Angeles, Orange County where we average, we’ve got to be hitting close to $1.7 there now.

Theodore Abajian

I don’t have the exact numbers.

Andrew F. Puzder

I don’t have it either but, it’s got to be close to $1.7. You know, incredibly strong markets for us. And then, you’ve got your outer markets, the reason you franchise in your outer markets is because you want the franchisees to go out and develop them because they start a little slower but, I would say we do extremely well in Southern California where we have, you know, we have, I don’t know, I want to call them TPGs but, that’s not the right thing. We have enough advertising dollars that we’re competitive with even our major competitors. So, that makes a huge difference and we’ve got a big focus in increasing our advertising dollars in every market, that’s part of the development plan because, the more advertising dollars you have when you have a strong brand with great food, good service, and remodeled restaurants, if you’ve got those advertising dollars you’re going to drives sales. So, is that the answer you were looking for?

Conrad Lyon – FTN Midwest Securities Corp.

Yeah. That’s the first part. I want to see where you typically top out and then, I don’t know if that’s even topping out but, the next question is, is really how, what is the demand like at during your peak hours? Do you feel like you have ability in some of those better units to increase sales? Or, do you feel that the number of transactions during your peak hours are more difficult to increase at those hours?

Andrew F. Puzder

Well, it’s a question that’s sort of a restaurant by restaurant basis. You know, we have restaurants, you know, I’ll give you an example of a specific one. We have a restaurant on Santa Monica Boulevard just, west of the 405, you know, and they’ve got to be doing, you know, $2.5 million there and quite honestly I’ve been there at lunch and dinner and unless I make a bigger building or a bigger parking lot, you know, at lunch I can’t really do a lot more business in that unit. Now, that’s an unusual unit and I would say 90-95% of our units we could still grow lunch/dinner. But, there are some units, and it’s particularly true in high density areas where real estate is expensive. We’ve got some leases that Carl himself, you know, originally set up, you know, back in the day where you know, you really can’t increase the size of your unit or the size of your parking lot and you may have lunch issues with respect to growing the business. But, again, you don’t have breakfast issues and you probably don’t have late night issues so, you can grow business that way. But, that’s a very small percentage. You know, if it was 10% of the units I would be astounded. I’ve got to believe that it’s much lower than that.

Conrad Lyon – FTN Midwest Securities Corp.

Okay. Let me go a different direction. I think you mentioned that you’re going to be pushing some new items out in different parts. Does that also entail wider operating hours?

Andrew F. Puzder

You know, we look at operating hours a little bit differently than some of our competitors do. We have expanded operating hours because, for example, let’s use breakfast at Hardee’s. You know, if you open at six o’clock, you do a certain amount of business between six and seven. If you open at five o’clock you may not do as much business between five and six but, it turns out you do more business between six and seven because you were open five to six and, you know, the floors are cleaned and the people are working and everybody knows you’re there. So, we, and, you know, the end of the day is true too. If you’re closing at 11 o’clock, at 10:30 your guys got the mop buckets out and, you know, they’re ready to go. If you’re closing at midnight well, they’ve got the mop buckets out at 11:30. So, there are, we look very closely at hours because we want to be open hours were the restaurants are profitable. Now, if your franchisor principally, and we’re 70% franchise but, we still have a higher percentage of company restaurants and they’re a very significant impacter of our EPS and EBITDA. But, if you’re more of a franchisor than you are a company restaurant operator, really you want to be open 24 hours because you’re getting paid on the top line not on the bottom line. The reality is with us, we don’t want to be open hours where we’re not making a profit. And so, while we do look very closely at what the hours should be, we have recently expanded hours at Hardee’s. We also did an expand hours test at Carl’s by the way, and decided that maybe we didn’t need to be opened to the expanded hours we were open because the business wasn’t there and we kind of cut it back a little bit. I’m talking about half hour increments here so, don’t get excited it’s not like we’re closing down at nine o’clock at night or something. But, it’s something we look at very closely but, if you’re not open certain hours there’s probably a reason and the reason probably is you don’t make money during those hours and we’re a very profit oriented organization. So, we look at it in that perspective not simply a sales generation view but, a profit view.

Conrad Lyon – FTN Midwest Securities Corp.

Okay. Last question, coupons. Just curious to see how, what your coupon sales are like and what the redemption trend has been?

Andrew F. Puzder

You know, I don’t know how much.

Theodore Abajian

We don’t, we don’t give anything specific out in that regard. I mean, our couponing hasn’t been materially changing over the last couple of years. I know from time to time, especially when you launch a new product; we always do some kind of couponing. That’s consistent year-to-year.

Conrad Lyon – FTN Midwest Securities Corp.

And, kind of what I’m getting at is I’m curious to see if consumers are gravitating more towards those things these days than not.

Andrew F. Puzder

We’re not, you know, we really haven’t, I don’t think we’ve materially changed it in either brand so, I’m not. You know, that’s a way, again, that might be a franchisor or franchisee thing. But, you know, you can drive business, I can drive transactions to Carl’s Jr. tomorrow if I wanted to. You know, it just won’t make us as much money. So, it’s, you know, it’s kind of a balance.

Conrad Lyon – FTN Midwest Securities Corp.

I hear you. Okay. Thank you very much.

Andrew F. Puzder

Okay. Thank you, Conrad.

Operator

Your next question comes from the line of Keith Siegner of Credit Suisse.

Theodore Abajian

Hey Keith.

Keith Siegner – Credit Suisse

I just wanted to follow up a little bit on the advertising. When I look at Hardee’s and what the spend was for the quarter it’s a little bit lower in dollars but also in percent than we’ve seen kind of recently and below what I expected. Was this kind of related to the pulling of the teacher ad? Is it partially timing? Or, could we see a ramp again in fourth quarter? If you could just help me understand that.

Andrew F. Puzder

If there’s a change, it’s timing. It’s not, it’s not anything. And, the teacher ad wouldn’t have impacted it because, even though we pulled the ad we still ran different ads, they just weren’t new ads or as effective of an ad. But, we still ran ads the same as we would have. If there was a difference it was a timing.

Theodore Abajian

Yeah. It’s entirely a timing issue.

Keith Siegner – Credit Suisse

Will we be above kind of a normalized run rate in the fourth quarter due to the timing? Or, just kind of go back to a normalized spending, a little over 6%?

Theodore Abajian

It’s a little bit tough to say Keith because, sometimes the year-over-year change is a result of adjustments to non media spend, okay? Within the prior year we had, you know, an adjustment to increase our production costs, for example, to account for additional spending. So, you know, our media spending tends to remain relatively constant as a percent of sales, you know, with a little bit of seasonality depending on the quarter we’re in.

Andrew F. Puzder

A lot of this is, they do this on a DMA by DMA basis but, a lot of it is they’re trying to project what sales are before they know what sales are so they know what to spend on advertising which is a percentage of sales. So, you know, sometimes there’s catch up and sometimes you’re holding back because you overestimated. So, it’s a, it is a timing thing.

Keith Siegner – Credit Suisse

Okay. [Inaudible] you mentioned how new unit Hardee’s are better than the average. What metrics do you need to see or would you like to see for maybe feeling comfortable with accelerating the new units?

Andrew F. Puzder

You know, at Carl’s we know where to build, we know how big to build, we know, I mean, we’ve got it all down. And, you know, that’s because even in the 97, 98 period we opened 100 plus restaurants and there are still people in the company who, you know, we’ve been opening Carl’s all along. We never really stopped. With Hardee’s, we just stopped. I mean, there hadn’t been, there was a period where there wasn’t a new Hardee’s for 10-15 years on the company side. And, we changed the brand. You know, it use to be this brand you opened in little towns and, you know, you were the burger place, the roast beef place, the fried chicken place and the breakfast place. Well, you know, now we’re the thick burger place and we’ve got this great breakfast. So, it’s trying to determine where, what size and also, if there’s also operations issues. Your guys need to know how to open new restaurants and it’s different than operating a restaurant where you know what the average unit volume is.

When you open a new restaurant you have to plan for the future. So, we’re actually bringing some of our Carl’s guys over to the Hardee’s side to work on new unit openings with the Hardee’s people. We’re looking at different restaurant sites, we’ve got, you know, within the last 18 months we brought Rich Buxton on to head real estate. We’ve really got a far more sophisticated system for looking at the different metrics that we need to look at to decide where to open, what time, you know, when do we open? How do we open? So, while we do get, the new units as you would expect, you’ve got a beautiful new restaurant in a place that you believed it would work and you’ve got this great food and good service and smiling faces. You do much better than you would at an older site on an average unit volume basis. You know, that’s not really, AUV really, opening AUV really isn’t the issue. The question is how well do you hang on to that business and how much profit you make from that business. And, you know, we want to see those metrics be very solid before I commit to really kind of blowing out development at that brand as we’re blowing it out at Carl’s. And, while I think we’re going to get there and I’m seeing progress ever day in those respects and we’ve got a lot of focus on that, that next to getting margins under control, that’s probably our biggest focus and it’d be hard for me to tell you which is bigger because it may be even a bigger focus than margins. But, while we’re very focused on getting that right at Hardee’s. I’m just not willing to commit in any of these calls or investor meetings yet that we’re there.

Keith Siegner – Credit Suisse

No, that’s actually very helpful in terms of gaining an understanding about how you’re approaching it. So, I appreciate that. One last question, the remodel cap ex that Carl talked about, the increased cost of remodel, is the cost coming from a change in how you’re implementing the remodel? Is it just higher costs of construction?

Andrew F. Puzder

Well one was when we started out I was really, I was really hammering these guys to keep the costs down and they did. But, they were doing some things like, they wouldn’t put in a new floor. You know, floors a big expense. Well, you know, a lot of these restaurants I went and visited and they did the remodel and didn’t do the floor, it didn’t look like it was remodeled. So, I realized, I had to let them do more floors. Or, they wouldn’t remodel the bathrooms. They’d remodel just the public areas and then you’d go into the bathroom and it would kind of ruin the image of the whole. So, there were some things they weren’t doing at first because of pressure to keep the cost down that I’m letting them do now. So, I think we’re looking at about $150,000 a unit initially and now it’s up to $185,000.

Theodore Abajian

$185-$190,000 depending on the floor.

Andrew F. Puzder

So, it’s, you know, I’ll take the blame. I mean, I think we needed to do more so, we’re doing more.

Keith Siegner – Credit Suisse

So you’re seeing the sales commensurate to keep the returns roughly similar?

Andrew F. Puzder

You know, actually, I did this pretty early on so, I can’t tell you but, I can tell you the early remodels were not as happy with the sales or the reaction as I am now. And, I think, we took the research out of our updated investor presentation because it didn’t make sense to keep including it. On our website you can go back and get the old presentations if you want to see the research and, it hasn’t changed. But, the research on the remodels came back incredibly good. So, we are looking at some exterior elements to give it more of a pop so people as you drive by see that it’s remodeled. Right now, most of the work’s being done on the interior where it needed to be done. But, we are looking at an extra element which would be a little more money but, if it, you know, if it improves the return then it’s worth the investment. So, we’re taking a look at that as well.

Keith Siegner – Credit Suisse

Okay. Thank you very much.

Theodore Abajian

Thank you.

Andrew F. Puzder

Thank you.

Operator

You have no questions at this time. I would now like to turn the call back over to management for closing remarks.

Andrew F. Puzder

Well, thanks everybody. Thanks for being on the call and I look forward to addressing you in the New Year. Have a wonderful Christmas, a great holiday and a happy New Year. Thanks very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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