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Tim Hortons Inc. (NYSE:THI)

Q1 2008 Earnings Call

May 1, 2008 2:30 pm ET

Executives

Scott Bonikowsky – Internal Relations

Donald Schroeder – President, Chief Executive Officer

Cynthia Devine – Chief Financial Officer

Analysts

Winston Lee - Credit Suisse

Irene Nattel - RBC Capital Markets

Adina Bloom - TD Newcrest

Jim Durran - National Bank Financial

David Hartley - BMO Capital Markets

[Matt Sheehan - Flosha Capital]

[Mike Peterie] - CIBC Capital Markets

John Ivankoe - J.P. Morgan

Steve Kron - Goldman Sachs

Keith Howlett - Desjardins Securities

Operator

Welcome to the 2008 first quarter Tim Hortons earnings conference call. (Operator Instructions) It is now my pleasure to turn the conference call over to Scott Bonikowsky, Vice President of Investor Relations at Tim Hortons.

Steve Bonikowsky

Yesterday we released our results after the markets closed. Coinciding with our earnings release, we announced important changes to streamline and strengthen our executive structure as well. We will be discussing both topics on the call today. If you've not yet had the opportunity to review this material, you can access the information on the Investor Relations section of our website at TimHortons.com. All other material I reference today associated with our call is also located on the same website in the Investor Relations section.

Joining me on the call this morning are Don Schroeder, our President and Chief Executive Officer, and Cynthia Devine, our Chief Financial Officer. Our Executive Chairman, Paul House, will also be joining us for the questionand-answer period.

We have posted slides on our website in connection with today's call which we will refer to. You can find these slides under the Presentations tab. This discussion is also being webcast and will be available on our website under the Audio Archives tab for a period of one year. After our remarks, we will be pleased to take questions.

Before we begin the formal presentation, please refer to the safe harbor statement which is included in the earnings release today. The Safe Harbor Statement can be found on the third slide of our presentation.

Certain information that we discuss today will be forward-looking, including discussions about future performance such as financial expectations, goals, plans, and developments. Various factors could affect the company's results and cause those results to differ materially from those expressed from our forward-looking statements. Therefore, you should not place undue reliance on forward-looking statements, which are effective only as of the date and the time they are made. We undertake no obligation to update these forward-looking statements to reflect the occurrence of future events.

Some of those factors are set forth in the safe harbor statement that is included in the earnings release, and additional factors are set forth in our public securities filings and in our 2007 annual report Form 10-K. You may access the full text of the safe harbor statement on our Form 10-K in a report on our website under the SEC Filings tab.

All Tim Hortons results, I'll remind you, are presented in accordance with U.S. GAAP and they are reported in Canadian dollars. In the event we reference non-GAAP financial information that we've not already reconciled in the press release issued earlier today, we will post a reconciliation to the most directly comparable GAAP financial measure on our website as mandated by Regulation G.

And finally, on a disclosure housekeeping note, I draw your attention to the same-store sales section of the earnings release. Please note that in the first quarter, as we previously disclosed, we did change the same-store sales calculation methodology in Canada to be consistent with our U.S. segment and industry practices. Same-store sales for both segments now include restaurants beginning their 13th month of operations, and I would note that this change had virtually no impact on the actual recorded same-store sales performance in the quarter.

So with that, it's my pleasure to turn the call over to our President and CEO, Don Schroeder.

Don Schroeder

I'll start with a discussion of the executive structure changes we announced yesterday, and then I will focus on the quarter.

If you turn to Page 6 of the slide presentation, you will see a summary of the major changes. When I assumed my new role as President and CEO, my approach was and continues to be to evaluate all aspects of our business to determine opportunities for growth and performance improvement. We have proven strategies, an exceptional leadership team, and a business model that continues to position the company among the leaders in the quick service restaurant sector. However, as a company we have never believed in good is good enough, so we will continue to keep pushing to get better.

It is this spirit that I undertook a comprehensive review of our structure, leading to the decision to realign executive oversight for key areas of our business. Two primary factors drove my decision to put in place the new structure. First, I wanted our most capable senior executive to have focused mandates and accountabilities for the most important parts of our business.

For example, we now have clear accountability among our two most experienced operations executives for the growth, development and strategy of our Canadian and our U.S. and international markets. We also have aligned our research and development agenda with our overall brand activities under one executive and our manufacturing operations under another.

Second, it was very important to me that we better leverage our senior management team who work with this group, as I believe they are exceptionally talented leaders. I also wanted a more streamlined management structure. As a result, we have changed roles and mandates for a significant portion of our senior management team to make the best use of their talents, and at the same time we have implemented decisions to streamline our structure.

Among the most important changes, the following executives on our team are assuming new roles. Roland Walton has been appointed Chief Operations Officer - Canada. Roland will also be assuming responsibility for operations training and operations standards for the Tim Hortons brand. David Clanachan has been appointed Chief Operations Officer for the United States and International.

These changes strengthen executive oversight and accountability for the growth of our core Canadian businesses while focusing full-time attention at the senior executive level for our growing U.S. and international businesses. David's appointment also enables focused senior executive oversight of the development of our international growth strategy, an area of increasing priority for the company. Real estate development will now report directly to Roland and David, serving the respective needs of the businesses they are leading.

Bill Moir has been appointed Chief Brand and Marketing Officer and is President of the Tim Horton Children's Foundation. As part of our executive structure changes, we have also positioned research and development with overall brand building under Bill's leadership to achieve better synergies and alignment.

Cynthia Devine, our Chief Financial Officer, will have her role expanded to include oversight of our manufacturing operations and vertical integration strategy. Prior to joining Tim Hortons in 2003, Cynthia had significant leadership experience in manufacturing settings, and we believe this change will create even greater focus on vertical integration opportunities and manufacturing effectiveness.

We have also appointed Bruce Wallace as Executive Vice President - Supply Chain. Bruce is a highly capable leader on our team who previously managed our five distribution centers, which he will continue to oversee. In addition, Bruce will oversee all of the company's purchasing functions. His appointment reflects the importance of our supply chain to our store owners and to our success.

As a result of employees leaving the organization under various retirement and other arrangements, the company will incur a restructuring charge of approximately $3.8 million in the second quarter of 2008. We expect future annualized savings of approximately $1.5 million as a result of these changes to our structure.

Let me be clear, we have continued confidence in our ability to meet our operating income growth target of 10%, but this target excludes this one-time charge of $3.8 million.

I believe these changes to our executive structure leverages the significant capabilities of our senior executives while creating clear accountabilities and operating mandates for key areas of our business. I am looking forward to working with and supporting our team in their new roles.

Turning now to the quarter, Tim Hortons continued to execute our growth strategy in the first quarter by focusing on a combination of menu innovation, initiatives focused on operational excellence, and unit growth in both the Canadian and U.S. markets.

On Slide 7, you will see that our menu program included the introduction of the Bagel B.E.L.T Breakfast Sandwich in Canada, which we had introduced previously in our U.S. markets. We promoted Toasted Almond Flavor Shots, Tuscan Vegetable Soup, and larger-size Gourmet Cookies.

Late in the quarter we also introduced a new hot signature Slow Roast Beef Sandwich in both markets. This product leverages the equipment in place to deliver the hot breakfast sandwich and fill the key gap in our lunch day [part] menu by appealing to a core group within our customer base who appreciate a hearty and filling hot sandwich for lunch. While too early to determine the potential of this sandwich and too late in the quarter to contribute significantly to our sales performance, we were very pleased with customer reaction to our soft lunch. Media in support of the Slow Roast Beef Sandwich started in April.

During the quarter we also ran our highly popular Roll Up the Rim contest, which provides millions of food prizes and TimCards, as well as grand prizes including Toyota Matrix vehicles, Bayliner boats, and Garmin navigation devices.

On Slide 8 we outline our sales performance during the quarter. The combination of some higher pricing in Canada, which contributed approximately 2.5% to Canadian same-store sales growth and our active menu and promotional program was enough to mitigate some of the impact of a very challenging sales climate in the quarter, resulting in same-store sales growth of 3.5% in Canada and 1% in the U.S. Pricing did not contribute to results in our U.S. business.

The most significant factor moderating sales growth in the first quarter was substantial snowfalls in key markets across Canada and in the Northeast and Midwest U.S. Ordinarily I would not focus on weather as a factor for discussion in any given quarter, but the amount of snowfall was extraordinary and certainly impacted our customers' ability to get out as frequently to our stores.

Sales in Canada were also impacted by the introduction of new statutory holidays in the provinces of Ontario and Manitoba and the timing of Easter in 2008 compared to 2007. We estimate these two factors had an impact of up to 1% on Canadian same-store sales growth in the quarter. Our U.S. sales were also affected by the timing of Easter.

Finally, unlike some of our peer group, we did not benefit from an extra trading day from leap year as we report on a 13week quarter. Our same-store sales performance in the quarter was below our targets of 4% to 6% in Canada and 2% to 4% in the U.S. respectively for the full year, however we expected somewhat of a challenging first quarter. The perspective we communicated when we announced our full targets in February was that we expected to see strengthening as the year progressed.

In April price increases were implemented in certain Canadian and U.S. markets. Pricing increases are generally taken to help our franchisees offset higher commodity and labor costs. The impact of these price increases is included in our full year targets. We anticipate these price increases will help offset some of the impact of continued economic weakness in the U.S. markets, and overall challenging sales climate.

We have continued confidence in our ability to meet our same-store sales targets for 2008 despite challenges we continue to see ahead.

During the quarter we actively rolled out our reloadable cash-less TimCard in the U.S., which was implemented in the back half of 2007 in Canada. By the end of the quarter most of our U.S. restaurants had implemented the TimCard program.

As you can see on Slide 9, we began to see very strong redemption of the TimCard in the quarter in Canada following extensive purchases of the cards over the holiday season, resulting in a reduction of the float to about $18 million in restricted cash at quarter end. However, TimCard activations and reloads did achieve very positive traction, creating incremental growth above our successful gift certificate program, which the TimCard's replaced. By March, we believe we reached a more normalized purchase redemption rate. We now have over 1 million reload transactions, either in a store or over the Internet, in the first quarter of 2008.

While it is very early in the life cycle of our launch, we are pleased with the implementation of the TimCard. We are beginning to focus now on implementation in nonstandard restaurants both in Canada and the U.S. and on point of sale integration which will further increase speed of service. Speed of service is one of the key drivers behind our TimCard launch, and point of sales integration is an important opportunity to deliver further customer benefits.

Turning to store development on Slide 10, I mentioned at the outset that we continued our store expansion activities, which helped contribute to our system wide sales growth. We opened a total of 25 restaurants in the quarter, with 22 of those in Canada and 3 in the U.S. Our real estate development activities are typically backend loaded and our expectation is that 2008 will be no exception to that pattern. This year represents our most ambitious store development agenda in several years, with a target of approximately 210 to 250 projects planned, including 120 to 140 restaurants in Canada and 90 to 110 projects in the U.S.

Our U.S. store development targets include expanding the self-serve platform we have successfully developed internationally. On Slide 11 you can see an image of this offering. Our platform provides a very high quality beantocup coffee offering and a limited assortment of pastry and baked good products. We continue to look at innovative ways to seed and extend our brand in certain U.S. markets, and the self-serve kiosk strategy is one of the ways we are working to accomplish this goal with limited capital requirements.

As part of this strategy we announced an agreement in the fourth quarter of 2007 that resulted in the Tim Hortons self-serve platform being implemented at 15 Shell stations in the U.S. These sites opened in December and received very positive customer response in the quarter.

On balance, the first quarter created some challenges but we remain confident in our ability to hit our full year sales growth targets and in our ability to continue to successfully execute our long-term strategy for growth and performance.

And with that, I'll turn it over to Cynthia.

Cynthia Devine

I'll provide some color on our financial performance for the quarter and some of the underlying trends in the business.

On Slide 14 we outline revenue for the quarter. Revenues increased just over 8% in the quarter to $460 million. Sales, which consist primarily of warehouse sales, were $306 million, an increase of about 10%. There were 26 fewer corporate stores in the quarter as we transitioned to owner-operator models in some of our developing markets. The impact on revenues from the lower number of corporate stores was offset in part by a higher number of stores consolidated under FIN 46R.

Rent and Royalties grew just under 7%, fairly consistent with system wide sales growth, and were offset in part by higher relief mainly related to U.S. corporate stores that were transitioned to owner-operator arrangements.

Franchisees were about 6% lower year-over-year and were impacted in the quarter by lower resales and replacements than the comparable period, offset in part by a higher number of new units and higher renovations.

With respect to expenses, we continued to manage expenses fairly well in the quarter. Turning to Slide 15, you can see that cost of sales rose 10% in the quarter, consistent with growth in our sales line, including the impact of higher distribution expenses related to the higher costs of handling frozen and refrigerated products.

Now that the transition to three-channel delivery is complete, warehouse sales and cost as a percent of revenues should begin to stabilize by the third quarter of 2008 considering the facility achieved full three-channel operations to our targeted Ontario restaurants in the third quarter of 2007. Please remember, though, that distribution revenues, costs and margins can be affected quarter to quarter by changes n the underlying cost of key commodities.

First quarter operating expenses were up a modest 6% in the quarter compared to the same period of 2007 due primarily to higher number of restaurants in the system and related property costs.

G&A expenses were up 7.4% to support the needs of the business but remained below revenue growth in the first quarter.

Equity income was down close to 25% due to a tax benefit in 2007 that did not reoccur, a product supply issue and commissioning costs for a new pastry line installed at our bakery joint venture. This new pastry line will supply our restaurants with high quality European pastries, including Danish, croissant, and puff pastry.

Turning to the earnings on Page 16 of the slides, you can see that operating income for the first quarter was just about $96 million, up 2.4% year-over-year. The lower franchise fees and significantly reduced equity income offset most of the benefit from higher same-store sales and increased number of restaurants in our system.

Equity income may change quarter to quarter and does not always grow at the same rate as the rest of our business. Net interest expense was $4.4 million in the quarter. This compares to $3.6 million in the first quarter of 2007. The increased expense relates primarily to higher interest on a greater number of capital leases and on external debt.

Net income for the first quarter increased just over 4% to approximately $62 million. Net income growth was positively affected by a lower tax rate in the quarter of 32.9% compared to 34.6% in the first quarter last year. This benefit was partially offset by the higher interest expense as I previously noted.

EPS was $0.33 per share compared to $0.31 per share in the first quarter last year, an increase of 7%. A 2.5% reduction in the weighted average shares outstanding in the quarter to about 186 million shares benefited our EPS growth.

On a segmented basis, Don already mentioned the challenging sales climate and the impact of our sales performance in both Canada and the U.S., so I will focus on the financial performance.

The Canadian segment had operating income of $106 million, which was essentially flat year-over-year. Performance improvements realized through increased chain sales which impact our warehouse and rents and royalty lines were most offset by lower contributions from franchise fee income and from the reduction in equity income I outlined previously.

In the U.S. business we had a loss of $2.9 million in the quarter. Improved operating performance at our coffee roasting facility year-over-year and the positive impact of foreign currency translation were the two main factors leading to the improvement in our operating loss versus the first quarter last year, helping reduce the impact of a challenging sales environment.

On Slide 17 we highlight major balance sheet items. We ended the quarter with $78 million of cash and equivalents on hand. You will note that the restricted cash line under the current assets went down from approximately $38 million at the end of 2007 to about $18 million. This line represents the cash float from our TimCard program and reflects the active redemptions Don noted earlier.

I would reinforce, as we have communicated before, that interest earned from the restricted cash will be contributed to the advertising fund to help pay for operational costs of the program. The contribution of this interest income to the ad fund is expensed through G&A.

Turning to cash flow and liquidity, we spent a total of $51 million in the quarter to purchase about 1.5 million shares as part of our share buyback program. Our capital expenditures, which are weighted heavier to the back half of 2008, resulted in spending of about $32 million in the quarter, with the majority of that focused on store development and renovation activities. Depreciation and amortization for the quarter was $21.9 million versus $19.8 million a year ago.

Long-term debt and capital leases on our balance sheet continued to stand at just over $380 million at the end of the quarter. We continued to enjoy good liquidity, including $300 million between two revolving lines of credit in Canada and the U.S.

One final note regarding the restructuring that Don discussed at the outset of the call, as Don mentioned, we will incur a restructuring charge of approximately $3.8 million. While there will be offsetting sustainable future annualized savings of approximately $1.5 million, the impact of the restructuring charge was not reflected in the company's operating income target.

On Page 18 we outline our operating targets for 2008. Our operating income target of 10% growth, which we continue to have confidence that we will meet, did not anticipate and therefore excludes the onetime restructuring charge. Our other targets remain unchanged.

On balance, we faced some challenges in the quarter but still delivered sales growth due to the strength of our menu and promotional programs. Additional pricing in place in April reflected within our original targets should help offset the continued macro pressures, and we remain focused on executing our growth strategy.

With that, I will turn it back over to Scott.

Steve Bonikowsky

We'll now begin our Q&A session.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Winston Lee - Credit Suisse.

Winston Lee - Credit Suisse

U.S. relief, could you remind us where that sits in the P&L? I think it's just in the royalties and revenue line, but is it also in the franchise cost, too?

Cynthia Devine

U.S. relief is offset primarily against rents and royalties.

Winston Lee - Credit Suisse

So it's not in the franchise costs at all?

Cynthia Devine

No, it doesn't relate to the franchise fee revenues.

Winston Lee - Credit Suisse

As you look at inflation and cost, commodity cost, how do you mitigate the risk in Canada versus the U.S.? Is it different? And could you just outline that again for us? I know do forward purchasing. Maybe you can talk on how far you've purchased.

Don Schroeder

With respect to the commodities, coffee, of course, is our primary product. We try to stay purchased out at least six months. For this year we're covered almost to the end of 2008. And the other major commodities we are covered through 2008 for sugar and for wheat and oils.

Cynthia Devine

Winston, I'm not sure, with respect to your question on how it's treated differently between Canada and the U.S., there aren't really a lot of differences. For example, though, there are some foreign exchange implications for items that are produced and manufactured in Canada. Obviously foreign exchange would be an impact to some extent on our U.S. business there but other than that, there aren't really any differences between how we treat our store owners in Canada versus the U.S.

Don Schroeder

The purchasing is all done from Canada for the entire chain. And, of course, as Cynthia said, we have the U.S. dollar factored into there, especially with respect to the coffee purchases.

Operator

Your next question comes from Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

Just wondering, if we could please spend a moment talking about that 10% EBIT guidance for the year, clearly there are headwinds in the form of slower consumer spending. And although commodity costs to a significant degree is a pass-through to the franchisees, nonetheless you do have some corporate restaurants, and there's inflation in your own business. And so I was wondering if you could just talk through what gives you the confidence both at the revenue line and also at the expense line that you're going to be able to contain things to deliver that 10%?

Cynthia Devine

Well, Irene, with respect to our first quarter performance - I think I would start with that - the performance was below our expectation, but not that far below where we were expecting to be for the quarter because we had anticipated a softer first quarter. So while it may not look like it to you, we still remain very confident in our ability to hit the 10% because we had anticipated a softer first quarter because of some of the things that we've talked about previously.

With respect to equity income, we did have some surprises there, but the commissioning of the pastry line and the reversal of the tax benefit were things that we had anticipated in our first quarter and so therefore remain confident in the balance of the year and the plans that we have in place.

Irene Nattel - RBC Capital Markets

You did allude to the price increases that lie behind some of the same-store sales assumptions. Could you just talk a little bit about what things are within your control to help drive the sales, promotional items, that sort of thing, are you looking at a more aggressive menu?

Don Schroeder

We have a very strong promotional calendar for the balance of 2008. We believe that will serve our store owners very well.

In terms of the pricing, again, the store owners have been very responsible in looking at pricing. There have been significant costs that they face with respect to rising minimum wages and so on.

In Ontario, the store owners have just recently taken a price increase, a little less than 4%. Quebec, it'll go into effect on Monday and it's just under 2%. And that's to reflect those increased costs, so that's been factored in.

And again, with respect to the commodities, for 2008 we are covered already for the most significant ones for the balance of the year.

Operator

Your next question comes from Adina Bloom - TD Newcrest.

Adina Bloom - TD Newcrest

Just on the same-store sales growth in pricing, what impact are you expecting pricing to have on same-store sales, both in Canada and the U.S. next quarter?

Cynthia Devine

With respect to next quarter, I think as Don just outlined, probably what we're prepared to talk about is pricing that's in place in the markets right now. And as Don mentioned, we have Ontario that represents approximately 40% of our chain that has slightly less than 4%, and Quebec, which is slightly less than 2%. So that's really at this point as far as we're willing to communicate on pricing.

Adina Bloom - TD Newcrest

So there's no price increases so far in the U.S.

Cynthia Devine

Yes, sorry. And I was just going to add one thing and that's with respect to Canada. With respect to our U.S. business, on April 21 we took approximately 3% pricing. And it varied by region, but across the U.S. as a whole it was approximately 3%.

Adina Bloom - TD Newcrest

And just on the $3.8 million severance charge, it seems a bit high. I'm wondering if you could provide a bit more detail on it, and should we expect an increase in G&A as a result of the new executive appointments going forward?

Don Schroeder

As part of the review when I took over the position, there was a detailed evaluation of the entire company. And the company has grown significantly over the last number of years, and with that growth there tends to be a little creep sometimes in terms of responsibilities and reporting moving.

And what the objective here was to just get clear alignment and clear accountabilities in the various sectors of the business, and I believe we now have that with respect to the U.S. operation, the Canadian operation, the marketing and brand, as well as finance and the vertical integration.

But as part of that, there were some senior people in the company that were looking at retirement and together we worked out an arrangement whereby for the benefit of the company a number of these people did leave, and the entire amount of the restructuring charge is attributable to those people leaving the company.

But there is a net saving to the company of approximately $1.5 million per year going forward. So we achieved the objectives in terms of getting a more lean operation and streamlined.

Operator

Your next question comes from Jim Durran - National Bank Financial.

Jim Durran - National Bank Financial

Going back on the U.S. business, you were indicating that it was largely a function of transitioning stores from corporate to owner-operated?

Cynthia Devine

That represented a large portion of the increase in relief. I think we talked about it in the first quarter of 2007 as well. A lot of the new stores that we bring online in the end of the year, the first quarter is one of the toughest quarters and then when you have weather factoring in, we typically have helped out stores in the first quarter disproportionately more compared to the balance of the year.

In addition to that, though, as we move stores over from corporate stores into owner-operator arrangements, a number of those stores, while we've reduced our corporate store losses, we've now put the operator in place, but we have helped those operators out in the form of relief. So that's what we were referring to there.

But it's a combination of new stores and the corporate store transition.

Jim Durran - National Bank Financial

And so it's not reflective necessarily of trying to deal with a more competitive environment?

Cynthia Devine

Not necessarily but the first quarter, as we talked about, is always a tough quarter. But obviously, with same-store sales of 1%, some of the stores that we would have hoped would come off of relief with slightly more robust sales growth didn't come off relief as quickly as we had hoped. So part of that is in relation to the economic situation in the U.S. as well.

Operator

Your next question comes from David Hartley - BMO Capital Markets.

David Hartley - BMO Capital Markets

The average basket or average ticket in Canada and the U.S. Could you give us some indication as to where that's going and maybe the success of some of your products over others?

Cynthia Devine

We typically have not broken out average check in that we do give, details on pricing and what we've taken there, and that's really where we keep it. But what we have talked about before, as we expand into the breakfast sandwiches, as we move into the Hot Roast Beef Sandwich, those things are obviously higher ticket. But in terms of any specifics around average check, that's not something we're prepared to talk about.

David Hartley - BMO Capital Markets

Well, are you seeing any changes in consumer behavior around, incremental purchase around core product items? Are consumers starting to, if they're buying a coffee and a Timbit, they're not buying the Timbit anymore? Or they're adding a Timbit?

Don Schroeder

Customers habits change all the time, but the great news in our restaurants are as their habits change, there's a great variety of products to choose from and we satisfy their needs on an ongoing basis.

Operator

Your next question comes from [Matt Sheehan - Flosha Capital].

Matt Sheehan - Flosha Capital

Regarding pricing in the U.S. you took some price here for the first time in just over a year, and obviously U.S. franchisee margins are probably getting squeezed a little bit. I'm wondering if you can describe the impact that squeezed margins can have on franchisee support. Are you seeing any impact at all?

Don Schroeder

Well, there's no question the increased costs are going to squeeze their margins and that's why we do a detailed review with them to assist so that when it's time to take pricing that they can do it in a responsible way. The store owners in the U.S. completed that exercise during the first quarter and as we indicated a moment ago, they made the decision that they were going to take prices of just approximately 3% for this year.

Matt Sheehan - Flosha Capital

What about in terms of your backlog of franchisees, and is that changing at all? Is the tougher economic environment hampering that at all?

Don Schroeder

Not really, we have always had tremendous interest in people acquiring franchises, whether it's here or in various parts of the United States.

Cynthia Devine

Also with respect to the franchise incentive program that we have in place, that really has - and that's been a program that we've had in place for a long time and helped people get into the system without worrying about financing upfront.

Don Schroeder

And in a recessionary time, you find more candidates coming forward who have been displaced out of their jobs and so forth. So in fact you find the reverse that you do during better times.

Operator

Your next question comes from [Mike Peterie] - CIBC Capital Markets.

Mike Peterie - CIBC Capital Markets

Could you give us a little more detail on the performance of the hot sandwich and specifically if it's giving you any traction into the dinner [inaudible]?

Don Schroeder

No, not at this point. I don't think we have released any information with respect to the performance. We're very happy with what happened. It's been well received by our customers, and I think that's all we would say at this point.

Mike Peterie - CIBC Capital Markets

And are you contemplating further additions to the hot sandwich menu at this point?

Don Schroeder

Yes, we're constantly looking at expanding that. We have the equipment in place as a result of introducing the hot breakfast sandwich, and any further opportunities that we can have to leverage the use of that equipment we would like to do to benefit the store owners.

Operator

Your next question comes from John Ivankoe - J.P. Morgan.

John Ivankoe - J.P. Morgan

I'm just sitting thinking about the U.S. business and the U.S. comps of 1% in the first quarter, and I'm just trying to put that in the context of your new unit volumes in the United States which, for years have run well below Canada. The thought is, lower new unit volumes and given the fact of a relatively rapid rate of development, I would have expected a lot more structural comps as those new stores begin to ramp over time towards a higher average.

So as you think about the maturation of the United States business in terms of bringing up those lower new unit volumes to higher average unit volumes even towards Canada, when do you think that might happen and what do you think you'd have to do to get those significant increases in both new unit volumes and average unit volumes in the United States?

Don Schroeder

Well, again, we've been in the U.S. for a number of years. If you look at Buffalo, Buffalo's the perfect example that with time and you get the proper number of stores within the market, the performance in the Buffalo market in particular is very comparable to what happens in Canada. It did not happen overnight. We are looking and we continue to look at how can we speed up the timeframe within which you do get the stores to the performance at the same level in Canada, and we see that happening in Michigan and Ohio very well, and we'll continue to do that.

But the pattern that we see in all of those markets is exactly the same as in Canada. We did not always have high unit volumes in Canada in each of the regions. Each time we went into a new market it took time to develop the habit and get the awareness and get the average unit volumes up to where they are today.

And so we're working to try and speed up the process in the U.S.

John Ivankoe - J.P. Morgan

Could you care to put a little bit more meat around the progress that you've made in Michigan and Ohio on an average unit volume and comp front?

Cynthia Devine

We don't usually break out regional differences, but as Don said, we're continuing to do the same things that we've done in Canada and it's no one thing that's going to move the comps significantly. It's always a combination of things. It's through product innovation. It's through store-level execution and promotional activities and all those same types of things over time are what are going to grow those average unit volumes.

But again, as Don also said, because we're trying to fast forward something that took a long time in Canada, we are adding a lot of units to the market and so sometimes that takes your overall average unit volumes down and it takes a little time before you start to see the whole market continue to grow.

Operator

Your next question comes from Steve Kron - Goldman Sachs.

Steve Kron - Goldman Sachs

The U.S. business and maybe a little bit more on the profitability side. You're at around 400 units right now. It's clear that the 40 units or 40 or so units that you have left on the company owned side is really dragging down the profitability. First, Don, how are you thinking about the path to profitability as it relates to the U.S. business? Are there timetables that are set? And is there any way to give some level of granularity parsing out maybe what the drag from the company operated side is to give people comfort that in those franchise markets the profitability is high, which would encourage further development?

Don Schroeder

We're continually looking at new ways of driving unit volumes in all of the areas in the U.S. There's no question that the corporate stores, we have reduced the number of corporate stores that we have in the U.S. over time and it's our goal to continue to do that and move them through the various programs into the hands of franchisees. But we'll only do that when it makes sense economically for them.

So in the meantime, again, we just continue to focus on improving in any area that we can through products, operations and so on, as Cynthia said.

Steve Kron - Goldman Sachs

And are the new stores that you're building, my understanding is that most of it's in existing markets. Are you entering new geographies? I think in the past you've talked about development in the Pittsburgh region or other areas. Are there other geographies that we should be looking at?

Don Schroeder

Yes, Syracuse is on the books for this year. We will be opening a number of stores in the Syracuse market. But again, that's consistent with our plan of just expanding out from Buffalo to Rochester, now to Syracuse. And also in Michigan, in Lansing.

Operator

Your next question comes from Keith Howlett - Desjardins Securities

Keith Howlett - Desjardins Securities

I was just trying to figure out how Good Friday and Easter Sunday impacts you. Do any of your franchisees close or is it just that people aren't out and about so they don't go to your units? And similarly, for the two statutory holidays in Manitoba and Ontario, what is the mechanism of the impact on you?

Don Schroeder

The restaurants are open, but the volume of traffic out and about on those days is greatly reduced. And the new statutory holidays in Ontario and in Manitoba, everything was closed. So there's just no one around. The restaurants are open, but the traffic out on the streets and on the road is greatly diminished.

Operator

Your next question comes from Winston Lee - Credit Suisse.

Winston Lee - Credit Suisse

You mentioned that there was within the equity income an impact from I think you talked about some efficiencies or execution. Could you elaborate on what that was and whether that's now resolved?

Cynthia Devine

Which, commissioning of the pastry line?

Winston Lee - Credit Suisse

No, you had mentioned three things. Pastry line, tax and there was one other.

Cynthia Devine

Okay, a product supply issue.

Winston Lee - Credit Suisse

Yes, the product supply issue.

Don Schroeder

Yes, we did have an ingredient issue at the bakery. That has now been satisfactorily resolved so that issue disappeared.

Operator

Your next question comes from Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

Just to stick with the equity income, I know that the year-over-year shift wasn't that big but still there are a lot of questions around, of the decline year-on-year, how much of that would have been related to the absence of the tax refund. That's the first thing.

And the second thing is, as we move through 2008, how should we think about the impact of the commissioning of that additional line on the contribution from Maidstone?

Cynthia Devine

The answer to the first quarter question is that the tax impact was about $1 million last year, okay? And that was something that we anticipated that we would not have in the first quarter of this year.

With respect to the commissioning of the pastry line, we're starting to ship product, obviously, to stores, but continuing to tweak the line and various things. Any start up that you have of a significant line like that is going to have an impact on your business, and that was contemplated in our target for the year.

Don Schroeder

Yeah, but it will be fully commissioned, we anticipate, in the second quarter so that the full product range that's available to us will be produced there within the second quarter.

Operator

Your next question comes from Jim Durran - National Bank Financial.

Jim Durran - National Bank Financial

As far as price increases, the ones that have already been taken, right, so in this quarter you had 2.5% contribution of price inflation. That should be falling off now as we progress into the next quarter, I believe?

Cynthia Devine

Correct for the most part. Some of it will remain.

Jim Durran - National Bank Financial

Yes. But you'll still have the new price increases obviously kicking in. On the TimCard, I'm just trying to understand how we should look at this. The $17 or $18 million that's booked on the balance sheet right now, that's purely just dollars sitting there waiting to be spent by consumers, and so therefore we use that as a percent of sales, a proxy for penetration of how successful the card's been so far? Is that a fair way to look at it?

Don Schroeder

I don't know whether I'd say that. There was certainly tremendous activity in December around Christmas and so on. And the positive news is that there's been significant reloads and activations since then. We see very positive things happen around special occasions with the card, Valentine's and so on. So it's very positive. And again, the use of the card is there, it's consistent and we've got that $18 million, as you say, just sitting there waiting to be spent.

Keith Howlett - Desjardins Securities

I would assume that that number is also a much larger number than what you realized on gift certificates historically.

Don Schroeder

We saw a real bump, that's right, compared to the gift certificates, which the gift card has replaced.

Operator

Your next question comes from David Hartley - BMO Capital Markets.

David Hartley - BMO Capital Markets

I wanted to ask about Dave Clanachan's new role. You have international next to his name. Could you talk a little bit about what your plans are for international and if it relates to kiosks, maybe I can appendage a subpart to the question and ask about the plan with kiosks, whether it be in the U.K. or Europe or Ireland - sorry, or the U.S.  is it a leading or following implementation, like before or during or after you get into a market? Could you flesh that out, what the plans are for that?

Don Schroeder

Well, David Clanachan has been very actively involved in the development of the strategy that's in place now in Ireland and in England with the kiosks there, and that was the way of introducing it into the market with the specialty coffee, the bean-to-cup program, and a limited assortment of baked goods. But that is the way it's been developed there.

Now in David's new position he can focus even greater attention on the development of that. It's been received very well in Ireland and England. We want to expand the opportunity, and there's literally a world of opportunities out there internationally and David now has the time to focus on those and to evaluate them on behalf of the team.

David Hartley - BMO Capital Markets

So there's no plan as to where you're going to go next with this or will you just continue to build out these existing markets in the U.K. and Ireland?

Don Schroeder

Well, we'll continue certainly to build out in Ireland and England and then evaluate any other opportunities that present themselves.

David Hartley - BMO Capital Markets

And in the U.S., with this kiosk program, are you entering a market, say, Syracuse, for example, with a kiosk program, seeing how that goes, and then building the restaurants, or are you doing this in step with new stores or do you put the kiosks in after the stores, the full stores, go into the market?

Don Schroeder

Well, again, we opened the fifteen Shell locations at the end of 2007. It's now within our portfolio of options. We like to think we fit in anywhere, so going forward, whether it's Syracuse, existing markets or any other new market, it'll be a combination of traditional stores and where it makes sense to use the kiosk as part of the penetration strategy.

David Hartley - BMO Capital Markets

Are you profitable on these kiosks right now?

Don Schroeder

Well, it's been very well received. The Shell operators are very pleased with what they've seen since taking them over and introducing them in December.

Operator

Your next question comes from Keith Howlett - Desjardins Securities.

Keith Howlett - Desjardins Securities

I'm not sure if you talk about same-store traffic. I'm just wondering in Canada, the 1%, would it indicate traffic was positive or negative on a same-store basis.

Don Schroeder

From a traffic standpoint, we don't break that out. But I can tell you given the very severe weather that we had both in Canada and in the U.S. in the quarter, obviously, when you have bad weather like that, the traffic count is down and when you lose that traffic, you never get it back. So I would say definitely there was a negative impact on traffic during the quarter.

Keith Howlett - Desjardins Securities

And if I can just tuck one in here on the Buffalo market, are you seeing any impact from the increased number of Dunkin' Donuts units in that market or does it really show up at all in your numbers?

Don Schroeder

Dunkin' is there. We're there. There's no question it's a good market for us and we'll continue to expand there.

Operator

Your last question come from Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

You have a very experienced management group. This isn't the first time that you have been through a consumer spending slowdown. Is there anything that you're seeing out there right now, either in terms of consumer behavior or competitive behavior, that is different or that gives you pause?

Don Schroeder

No, everything that's out there now we have seen before; we've lived through to varying degrees over the years. So we've seen it. As you say, we have an experienced management team and they've got the experience to deal with it going forward.

Operator

There are no further questions at this time.

Steve Bonikowsky

Thanks to everybody for joining us today for our first quarter Tim Hortons earnings conference call. If you do have any additional questions or topics that you wish to discuss, please feel free to give me a call as always at 905-339-6186 or alternatively by e-mail at investor_relations@timhortons.com. Thanks and have a great day.

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Source: Tim Hortons Inc. Q1 2008 Earnings Call Transcript
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