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Executives

Cheryl A. Bachelder – Chief Executive Officer, Director & President

H. Melville Hope, III – Chief Financial Officer

Cheryl Fletcher – Direct of Finance and Investor Relations

Analysts

Michael Gallo – C.L. King & Associates, Inc.

Mickey Schleien – Ladenburg Thalmann & Co.

Dan O’Neill – Prospector Partners

Kenneth Smith – Lenox Equity Research

AFC Enterprises, Inc. (AFCE) F1Q08 Earnings Call May 29, 2008 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the first quarter 2008 AFC Enterprises, Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Cheryl Fletcher, Director of Finance and Investor Relations. Please proceed.

Cheryl Fletcher

Good morning everyone. Before I begin I would like to read the following forward-looking statement. Certain statements made on this call regarding future events and developments and our future performance as well as management’s expectations, beliefs or projections relating to the future are forward-looking statements within the meaning of the Federal Securities Laws. These forward-looking statements are subject to a number of risks and uncertainties.

Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: Competition from other restaurant concepts and food retailers, our ability to franchise new restaurant units and expand our brand, increases in food and labor costs, effects of increased gasoline prices and other general economic conditions and the risk factors detailed in our 2007 annual report on Form 10K and other documents we file with the Securities & Exchange Commission. You should not place undue reliance on any forward-looking statements since those statements speak only to the date they are made.

During this call references may be made to non-GAAP terms of EBITDA and free cash flow. The company defines EBTIDA as earnings before interest expense, taxes, depreciation and amortization. The company defines free cash flow as net income plus depreciation and amortization plus stock compensation expense minus maintenance capital expenses. The company’s computations and reconciliation to GAAP measures of the numbers referred for these terms are contained in our earnings press release that can be found on the company’s website at www.AFCE.com.

I would now like to turn the call over to our CEO and President Cheryl Bachelder.

Cheryl Bachelder

Thank you and good morning everyone. We’re delighted to be on our first quarter earnings conference call with you this morning. Today I’m going to review our first quarter financial and operational highlights and update you on the progress made against our four pillars of our new strategic plan outlined on our last conference call in March. Mel Hope, our CFO, will then review the first quarter financials in more detail and provide you an update on our 2008 fiscal guidance.

We are pleased with our earnings performance for the first quarter of 2008 at $6.4 million or $0.24 per diluted share. EPS included a benefit of $1.3 million or $0.03 per share primarily from a favorable settlement from an insurance claim and one-time gain from the sale of real estate. We now expect our full-year earnings to be $0.66 to $0.71 per diluted share which includes the $0.03 from other income we realized in the first quarter.

We continue to generate solid cash flow from our highly franchised business model and our EBITDA margins remain one of the industry leaders at 28.9% for the first quarter. During the first quarter we opened 37 restaurants compared to 29 restaurants in the first quarter a year ago. The openings included 17 domestic and 20 international restaurants in existing markets. With this new opening development progress year-to-date we are confident in our full-year guidance of 115-130 global openings.

We had 32 closures in the first quarter which included 17 domestic units and 15 international units. In 2008 we expect our closures to be similar to the past few years. As a result net openings for fiscal 2008 are expected to be consistent with previous guidance of 5-15 units.

International same-store sales were positive 3.5% in this quarter representing the sixth consecutive quarter of positive same-store sales. We are pleased with the continued progress of our international operations.

Our total domestic same-store sales were negative 1.8% for the quarter. For perspective, this trend has improved compared to negative 3.4% a year ago. It is comparable to our 2007 same-store sales which were negative 1.6%.

According to the most recent Crest Data Popeye’s is out-performing the competition. Crest cites chicken QSR traffic as being negative 4%. Popeye’s is negative 2%. We believe our marketing and messaging is helping us withstand this weak economy and the effect of price increases to offset rising commodity costs. Nonetheless, Crest also reports that the percentage of people eating out less often has grown by 15 percentage points in the last six months. Also, lunch and dinner, our primary day parts, are the weakest segments of the QSR category.

This environment we are in makes it difficult to predict exactly when we will see positive same-store sales. Our business plan has significant new product news in the second half and we expect to see our sales turn positive late in the year.

As such we believe it is prudent to adjust our domestic same-store sales guidance to negative 1-2% for the full-year 2008. As you saw in our first quarter results we are aggressively managing our cost structure to hold our earnings plan for the year. You can expect this disciplined approach to continue through the balance of the year.

I would now like to update you on the progress made against our four pillars of our strategic plan that we announced in March. These four pillars are; building a distinct and relevant brand, running great restaurants, strengthening our unit economics and aligning our people and resources to deliver results.

First, building our brand. Our marketing initiatives and new menu platforms are being built around Popeye’s distinct competitive advantages of superior quality food and our flavor profiles from our Louisiana heritage. In March we introduced Popeye’s Bonafide Chicken which brands our core bone and chicken products and reminds consumers of our clear competitive advantages; prepared fresh, marinated in Louisiana seasoning and hand-battered.

Same-store sales during this launch period were slightly below our expectations. However, as I mentioned earlier our sales out-performed the chicken QSR category during this time period. Our marketing team has revamped the balance of the year marketing calendar to offer more everyday value offerings. In May we are offering a high quality portable snack with a value price point; our Marinated Buffalo Nuggets. Eight pieces for $2.99.

Over the next few months our marketing plan will focus on providing consumers portable snack foods at competitive price points in the $3-5 range that can help to drive traffic during lunch and snacking day parts.

As I mentioned on our last call we have developed an arsenal of products against three new menu platforms. Portable snacks, value offerings and quick lunches. We will be launching items from these new menu platforms later this year.

Now to speak to running great restaurants. Starting in January we began implementing new Popeye’s operating systems and routines; routines already proven in the QSR industry to help improve the consistency of our restaurant operations across the system. On the last conference call we mentioned that we were shifting our guest satisfaction measures from the mystery shopper approach to the new guest experience monitor survey we call “GEMS.” Currently 2/3 of our restaurants in the system have adopted the new program. We are extremely pleased with the franchisee response. The adoption rate is more than double what we had expected by this time. Based on their response we now anticipate we will have all Popeye’s restaurants being measured by GEMS by the end of the summer. As we discussed earlier we are definitely seeing a significant correlation between our top 10% GEMS score restaurants and higher same-store sales performance.

Our field operations reorganization is also complete. Our goal is to have at least two in-store quarterly assessments completed for all domestic restaurants by the end of this year. Since restructuring the team in February we have completed approximately 30% of the first round of these back-of-the-house assessments. The issues we identified in these visits are promptly retrained in the restaurant and then revisited 30 days later to monitor improvements made.

During the first quarter we also held six Operations Conferences around the country focused on training our operations teams. Those conferences were extremely well attended. Our attendance was triple last year’s attendance. I think that evidences our system’s new commitment to training our team to run great restaurants.

Now to speak to strengthening our unit economics. Rising commodity costs continue to challenge our industry. In the first quarter our bone and chicken prices for the domestic system increased approximately 7% year-over-year and other food costs increased 9%. This increase in food costs translates to 200-250 basis point impact on our restaurant level operating profit margins before any pricing action. This is in line with what other QSR chains are experiencing.

We expect to see continued cost pressure through the balance of this year with commodity costs projected to be up 7-9% on a full-year basis. This will translate to 200-300 basis point impact on restaurant operating profit before pricing action. I expect most of our operators to price to recover at least half of that cost increase.

As discussed on our last call we have assembled a team to attack the cost structure of our restaurants to help improve this restaurant operating profit. This team has already identified tools to better manage our food costs, assist in labor scheduling and to manage controllable expense items like maintenance agreements, utilities management and oil pick ups. Our goal is to help our small and medium size operators find at least 2 percentage points of profit margin in the second half of this year to help offset those 2 points lost to commodities year-to-date. Our field operations team is rolling out these initiatives at the end of June.

New unit openings. Our pipeline remains sound for the year and our guidance is firm on new unit openings. Our focus is to deliver 2008 unit growth, simultaneously to strengthen our 2009 pipeline through improved unit economics, new site modeling tools and better prioritization of the development market. These steps are essential to our long-term growth expectations as we aim long-term to deliver 4-6% average annual growth in net units.

Now talking to aligning our people and resources to deliver results. As announced on our last call the company is working to identify experienced and qualified franchisees to purchase our company-owned restaurants. This strategic move allows us to shift G&A resources towards initiatives that drive sales and profitable growth for our franchise owners.

In recent months we have continued to invest time and resources towards a strong partnership with our franchise owners. We are meeting often with our leaders to align on marketing, menu and operations initiatives needed to “wow” our guests. We remain intensely focused on building a strong brand that will deliver steady sales and profit growth to our owners.

I want now to touch on international briefly. In the first week of May I was able to attend our international operations meeting in Istanbul, Turkey. The meeting brought together our key leaders from Turkey and all of the Middle East, Saudi Arabia, Bahrain, Kuwait, Jordan, UAE and Qatar. For two days we worked on operational matters, shared marketing updates, met with our suppliers and certainly discussed food costs.

I was pleased to observe the strong working relationships we have with our operators in Eastern Europe and in the Middle East and the quality of these operators. Since we last talked I’ve begun working closely with our international team on a long-term plan for accelerated unit growth around the globe. We are excited by the brand’s opportunity for expansion in the years ahead.

In closing, Popeye’s is focused on implementing the new strategic plan we outlined in March to deliver a better experience to our guests, to build our brands through menu innovation and to drive improved profitability of our restaurants. While our sales may take until later in the year to turn positive given the market environment we are confident in our full-year EPS guidance as stated here today. Our new unit openings guidance is also firm.

The long-term goals of our strategic plan are to target 2-3% same-store sales growth, 4-6% growth in net units and 12-15% EPS growth. With a strong franchise model which continues to generate solid cash flows and EBITDA margins, among the highest in the industry we remain confident in Popeye’s plans which will deliver strong and improved returns to our shareholders.

I thank you for this opportunity to update you on our performance and I now turn the call over to Mel Hope.

Mel Hope

Thanks Cheryl. Good morning everybody. As Cheryl indicated we are pleased with our 2008 first quarter earnings performance of $6.4 million or $0.24 per diluted share. First quarter earnings included the favorable effects of $1.3 million of other income. Excluding these non-operating items our first quarter earnings would have been $5.6 million or $0.21 per diluted share.

Total revenues for the first quarter were $53.3 million versus $51 million in the first quarter last year. During the first quarter sales from company operated restaurants were $26.4 million representing an increase of $1.9 million over the first quarter last year. This increase was primarily due to a $1.6 million increase in sales generated from new company operated restaurants opened in the Atlanta and Tennessee markets and a $1.6 million increase from the timing of re-openings of temporarily closed restaurants in New Orleans. This increase in total sales was partially offset by $1.3 million from negative same-store sales in our company stores.

Franchise revenues, which are the revenues realized from royalties and fees paid by Popeye’s franchisees, were $25.8 million in the first quarter compared to $25.1 million last year. This increase was due to the opening of new franchise restaurants which was partially offset by a decrease in domestic same-store sales.

G&A expenses for the first quarter were $16.8 million versus $14.9 million last year. This increase was primarily due to the costs associated with the recruitment and hiring of new management and non-recurring marketing and menu professional fees.

Other expense and income reflected net other income of $1.3 million in the first quarter which was comprised primarily of an insurance claim settlement and a gain on the sale of property previously leased to a franchisee.

Our EBITDA in the first quarter was $15.4 million with a margin of 28.9% which continues to rank among the highest in the industry. Operating profit in the first quarter was $13.3 million versus $13 million last year.

First quarter interest expense was $2.8 million for 2008 and $2.5 million for 2007. Because of favorable interest rates in the current market we entered into an interest rate swap effective June 30, 2008 through June 30, 2010 on a notional amount of $100 million. The effect of the interest rate swap is to limit the interest rate exposure on this portion of our 2005 credit facility to a fixed rate of 4.87% compared to our current interest rate of 6.4%. We expect to see the benefit of these interest rate savings in the second half of 2008.

Our tax provision of $4.1 million reflects an effective tax rate for the quarter of 39%.

Let’s talk about how we are using our cash. Our highly franchised business model continues to generate solid free cash flow at $8.8 million during the first quarter. On March 12 of the quarter the company entered into a $15 million accelerated stock repurchase program to take advantage of market conditions and retire 2 million shares of our common stock. Year-to-date including the accelerated stock repurchase program we have repurchased a total of 2.1 million shares of common stock for $16.6 million.

During the first quarter the company also repaid $8.3 million of our long-term debt which included a $7.7 million mandatory prepayment. At the end of the quarter our long-term debt including $25 million in borrowings against our revolver was $144.4 million.

Under the terms of the company’s share repurchase program we expect to continue to repurchase shares opportunistically in the open market. Our current credit facility provides we will be able to repurchase more than $20 million of our shares during the balance of 2008 if we choose to do so.

So what do we anticipate for the balance of 2008? As Cheryl mentioned we adjusted our domestic same-store sales to negative 1-2% compared to our previous guidance of flat to positive 1%. We expect our total new restaurant openings for 2008 to remain consistent with our previous range of 115-130 units. Throughout 2008 we expect our closures to be similar to the past few years. Therefore net openings for fiscal 2008 are expected to be in the range of 5-15 restaurants, consistent with previous guidance.

For 2008 we expect our earnings per share to be in the range of $0.66 to $0.71 per diluted share including the $0.03 of the other non-operating income we realized in the first quarter and to which I referred earlier.

This earnings guidance also reflects the benefit of the lower interest rate on our 2005 credit facility and the company’s plans for continued management of its G&A expenses to help offset softer same-store sales expectations. We expect our G&A expense as a percentage of system-wide sales to be consistent with our previous guidance at 3-3.1% of system wide sales. As we begin to realize our growth initiatives the company expects to see that percentage return to a trend below 3% of system wide sales in future years.

As a reminder, our first quarter includes 16 weeks versus the other quarters of the year which include 12 weeks. For the next two quarters we expect our G&A run rate to be slightly lower than our first quarter and in the fourth quarter we expect an up tick in our G&A expenses due to the timing of our international franchise business conference and year-end expenses like accounting and other professional fees.

The company is continuing its identification of experienced and qualified operators to purchase the company operated restaurants as part of our strategic initiatives. If we were to complete transactions for the sale of all the company operated restaurants we would expect to realize sale proceeds of $38-42 million. Net gains associated with the sale are expected to be at the lower end of our previously announced range of $0.08 to $0.14 per diluted share. We made that adjustment due to the capital we have or need to invest in several restaurants in which we have had fires during the first quarter as well as the completion of new restaurant construction and other maintenance capital invested in the restaurants.

Thank you and we’re now going to open the lines for your questions.

Karen?

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Michael Gallo – C.L. King & Associates, Inc.

Michael Gallo – C.L. King & Associates, Inc.

First I just wanted to start on international. Really for the first time in a long time I’m hearing you talk about the longer-term acceleration of international. I was wondering if one we were getting to the point where we are through the closures in Korea that have obviously been significant for the last couple years, two what markets you are beginning to target internationally and three, how long do you think it might be before we start to see more significant acceleration in international?

Cheryl Bachelder

I appreciate your question. I do think international represents a significant future growth opportunity for Popeye’s and I am just starting to invest my time and attention to that plan beginning with this first trip to the Middle East and to Turkey. As to the countries that we see opportunities in we see ourselves kind of growing out from the bases we have set today in the Middle East, Eastern Europe and Southeast Asia in particular. Strong opportunities to enter countries that are adjacent to the ones we are in to continue our growth. For example we are in the process of opening up Egypt. We have had strong success in Jordan for example. I think you will see that as to continue to push out from our base where we have people on the ground to support that growth.

Your comment on Korea I do think is fair to conclude that Korea has stabilized. We have been seeing solid same-store sales growth from Korea up until recent weeks and so I think it is fair to say the Korea issues we talked about some years ago are pretty much behind us.

I will also tell you there is a lot of excitement in restaurant tours around the globe and the Popeye’s concept. We are finding good alliances with other restaurant operators and companies that run, for example, Burger King’s around the globe and finding those alliances as very strong ways for us to enter markets with established, strong operators. So I am excited about the future of international.

Michael Gallo – C.L. King & Associates, Inc.

The second question I have is around the additional implementation of guest measurement. I know you don’t have a complete picture yet but I was wondering if you can give us some additional color on what you are finding as the result of those surveys and some of the things you are doing to address those.

Cheryl Bachelder

I do think that is one of the exciting initiatives we have quickly established at Popeye’s to give visibility of our restaurants and our restaurant managers to what their guests are saying so that they can promptly focus on making adjustments. As I said we are well ahead of plan in getting that tool in place across the country. We have also just begun to get enough surveys per store in some restaurants to start looking at analysis, Mike. I think I mentioned in the Q&A of the last call that I would expect a few points of same-store sales to be kind of lying on the floor of restaurant operations and in fact that appears to be true. As I get larger survey counts I’ll start to talk more about that data to you. But I can tell you the first putt of it indicates that there are in fact a few points of same-store sales in improving our restaurant operations. Our top 10% performing stores so far are certainly demonstrating that.

What we actually do to follow up on those is when we are in stores doing back-of-the-house ops assessments we often see the correlating factors with those guest scores such as speed of service, quality of operation opportunities, and we train on site as we do those back-of-the-house ops assessments. We also direct those restaurant managers to other training opportunities we offer regionally that they can attend and then we follow-up with our franchise business consultants to address the things identified and the opportunities identified from those visits. So it is an entirely new discipline at Popeye’s to do that on a quarterly basis. We’re going to get to every restaurant twice this year and then our goal is to quarterly be in our restaurants going forward.

So I think we are off to a great start at putting those disciplines in place.

Operator

The next question comes from the line of Mickey Schleien – Ladenburg Thalmann & Co.

Mickey Schleien – Ladenburg Thalmann & Co.

I just have one quick question. I wanted to know whether there would be any impact on the royalty payments you make now that Mr. Copeland has passed away. I’m referring to the recipe.

Cheryl Bachelder

You are referring to our spice royalty?

Mickey Schleien – Ladenburg Thalmann & Co.

Yes.

Cheryl Bachelder

No. We do not anticipate a change in our spice royalties. They people we are operating with or discussing our business with have not changed and in fact Al Copeland’s son is now involved in that operation so it is pretty much the same.

Operator

The next question comes from the line of Dan O’Neill – Prospector Partners.

Dan O’Neill – Prospector Partners

Could you talk about the level of non-recurring expenses incurred in the quarter and how that is expected to progress throughout the year?

Mel Hope

We’ve said that for the full year there is about $3.5 million of one-time investments that we are making toward the strength of the brand. During the quarter we certainly incurred some of those. I’m thinking it is probably relative to the $3.5 million…probably a little bit heavier towards the first half of the year than the second half.

Operator

The next question comes from the line of Kenneth Smith – Lenox Equity Research.

Kenneth Smith – Lenox Equity Research

I was wondering if you can give a little more color on the process of selling the company units. What level of interest are you seeing? Is there a date that the interested people have to reply by? A deadline? If you could just give us some idea. I was wondering if the performance of the company units is having any effect on the marketability of those units.

Mel Hope

The process is ongoing right now. We haven’t put a timeline on it. There has been a fair amount of interest in each of the markets that we discussed. But we are continuing the process of identifying qualified operators. In terms of the performance of the restaurants the answer to that is of course the performance of any business is an indicator of pricing and we are sorting through that as we get it through the process. At this point we’re just not far enough along to give any more of an indication of how the process is rolling out.

Cheryl Bachelder

Ken I would just add it is on track from our perspective.

Kenneth Smith – Lenox Equity Research

Cheryl, is there something about the markets in which the company units are located in that you can point to to explain their relative performance compared to the rest of the system?

Cheryl Bachelder

The one thing I would point you towards is we have not taken aggressive price increases in our company restaurants. A lot of the same-store sales in the industry right now is being driven by pricing to offset rising commodity prices so I just share that perspective with you.

The second thing is the only other kind of real impact is that New Orleans we have obviously been re-opening some very large volume restaurants in the last several quarters so that is making the same-store sales not fully reflect what is happening in that market.

Operator

This concludes the question-and-answer session of your call today. I would now like to turn the presentation over to Ms. Cheryl Bachelder for closing remarks.

Cheryl Bachelder

Thank you Karen. I simply want to thank you for the opportunity to update you on our performance today. I hope we have answered your questions. We thank you for your continued support of Popeye’s as we put our strategic plan in place to grow the returns to our shareholders. Have a great day.

Operator

Thank you for your participation in today’s conference call. You may now disconnect.

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Source: AFC Enterprises, Inc. F1Q08 (Qtr End 4/20/08) Earnings Call Transcript
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