Tim Hortons Inc. Announces 2008 Third Quarter Results

Tim Hortons Inc. (NYSE:THI) (NYSE: TSX:) (NYSE:THI) today announced operating results for the third quarter ended September 28, 2008.

Systemwide sales(1), which include sales from Company-operated and Franchise restaurants, grew 7.8% in the third quarter compared to the third quarter of 2007. Canadian same-store sales increased 3.8% and U.S. same-store sales were down 0.6%. Total revenues rose 3.8% to $509.0 million compared to $490.5 million in the same period last year. Operating income increased 12.7% to $122.1 million compared to $108.3 million last year. Net income was up 16.9% to $78.8 million compared to $67.4 million in the third quarter of 2007. Earnings per diluted share were $0.43, up 20.2% compared to $0.36 in the third quarter of last year.

"Our earnings performance and positive same-store sales growth in Canada demonstrates our brand strength in the face of unprecedented economic and consumer challenges," said Don Schroeder, president and CEO. "While our brand in the U.S. is less developed and we faced sales and earnings challenges due in large part to the current economic conditions, we delivered strong consolidated performance in the third quarter."

Consolidated Performance

The Company opened 49 restaurants during the quarter, compared to 40 units in the same period of last year.

During the quarter, promotional programs included Chocolate Brownie and Hazelnut Iced Capp Supremes, Gourmet Cookies and the Bagel B.E.L.T. Various baked goods featured during the quarter included Strawberry Blossom Donut and European Style Pastries. In the U.S., promotional activities also included Iced Coffee and a new Combo program called "Fresh Choice Sides" which included combos of apples, hashbrowns, muffins and donuts as part of a hot breakfast sandwich Combo program. In September we also featured Hearty Potato Bacon soup and Italian Wedding soup in the U.S. market.

Total revenues were $509.0 million in the third quarter, up 3.8% compared to $490.5 million in the third quarter of 2007. Sales, consisting primarily of distribution sales, increased 2.0% to $333.6 million compared to $327.0 million during the same period last year. Underlying product demand, excluding the impact of pricing, increased but year-over-year growth comparisons were impacted by specific sales items in 2007 that did not recur including a new uniform program. Total revenues and sales growth were both affected by our continued initiative to convert Company-operated restaurants to an owner-operator model, reducing revenues from Company-operated restaurants. There were 27 net fewer Company-operated restaurants at the end of the quarter versus the prior year, bringing the total number of Company-operated restaurants in the system to 43 compared to 70 in the same period of 2007. Revenues from Company-operated restaurants were down a corresponding 30.4%, or $3.9 million compared to last year, offset in part by sales increases related to restaurants consolidated in accordance with FIN 46R. A total of 98.7% of the systemwide restaurants are now franchised.

Revenues from rents and royalties were up 8.2% in the third quarter to $155.2 million, consistent with systemwide sales growth, compared to $143.4 million in the third quarter last year. Franchise fees were flat at $20.2 million in the quarter compared to $20.1 million last year. Increased openings and franchise renewal fees were mostly offset by lower resales and replacement fees and fewer equipment sales recognized from our U.S. franchise incentive program.

During the third quarter franchise fee costs decreased 2.9% compared to last year. Lower franchise fee costs resulted from fewer resales and replacements with lower associated costs per unit, and lower equipment costs recognized under the U.S. franchise incentive program. These factors were partially offset by higher costs from the increased number of restaurant openings and higher support costs associated with establishing a franchisee's business.

Cost of sales increased modestly, growing 1.7% in the quarter on a year-over-year basis. Warehouse cost of sales was the primary driver of the increase coupled with an increase in FIN 46R consolidated restaurants. These factors were partially offset by a decrease in Company-operated restaurants. Operating expenses increased 3.8% in the quarter compared to the third quarter of last year. The increase was mainly due to the increased number of restaurant openings and higher variable rent on existing properties due primarily to growth in the Canadian business, offset by the timing of certain expenses incurred in the prior year.

General and administrative costs were $30.0 million in the third quarter, down 2.5% from 2007 costs of $30.8 million. The year-over-year decrease in general and administrative costs was due primarily to a range of factors in the prior year that did not recur, the most significant of which was costs incurred in 2007 for the Company's franchisee convention.

Equity income was $9.4 million in the third quarter, a decrease of 4.4% compared to the same period of 2007. The Company had slightly higher earnings contributions from both of its largest joint ventures in the third quarter. An asset disposition in the third quarter of 2007 that did not recur reduced equity income on a year-over-year basis.

Operating income was up 12.7% to $122.1 million, compared to $108.3 million in the third quarter of 2007. Higher rents and royalties driven by increased systemwide sales was the most significant contributor to strong operating income growth. Other positive contributing factors included higher other income, higher franchise license renewals and lower general and administrative costs due to some costs in 2007 that did not recur in 2008. These positive factors were partially offset by lower equity income.

Net interest expense was 24.1% higher in the third quarter at $5.3 million, compared to $4.3 million in the same period of 2007. The increase in net interest expense was due primarily to lower interest income as a result of rate reductions and lower cash on hand.

Net income grew 16.9% in the quarter to $78.8 million, compared to $67.4 million in the third quarter of last year. The higher growth was the result primarily of a lower effective tax rate during the quarter of 32.5%, versus 35.2% in the comparable period of 2007. The decrease in effective tax rate was due primarily to a lower Canadian statutory rate in the third quarter as well as items that impacted the effective tax rate in 2007 that did not recur this year.

Diluted earnings per share (EPS) grew 20.2% to $0.43 compared to $0.36 last year in the third quarter. EPS growth was due primarily to higher net income and lower weighted average shares outstanding, which decreased 2.8% to 182.7 million shares due to the Company's share repurchase program.

Segmented Performance

Same-store sales in the third quarter for the Canadian segment were up 3.8%, most of which was due to previous price increases. The Canadian segment lapped very strong same-store sales growth of 7.7% in the comparable period of 2007.

Segment margins in Canada increased during the quarter primarily due to growth in rents and royalties from systemwide sales growth, higher franchise fee income and higher distribution income. Canadian operating income was $132.9 million, an increase of 11.6% compared to $119.1 million in the third quarter last year. A total of 30 restaurants were opened in Canada, bringing the total to 75 restaurants opened on a year-to-date basis.

Compared to the third quarter of 2007, U.S. same-store sales declined 0.6%, which includes the impact of about 3.2% of previously introduced pricing. The U.S. segment had a loss of $2.1 million in the third quarter. Higher franchisee relief accounted for most of the year-over-year change, more than offsetting the positive impact of the higher number of openings in the quarter.

A total of 19 restaurants were opened in the U.S. this quarter, and 30 units year-to-date. The Company has opened several new restaurants as part of its planned Syracuse expansion and is making substantial progress in opening locations as part of its recently announced agreement with Tops Friendly Markets. Under terms of this agreement, Tim Hortons sites, which will be primarily self-serve units, will be established in about 80 Tops stores in western and central New York, and northern Pennsylvania.

Based on year-to-date same-store sales performance of 1.2%, and continued economic weakness in the U.S., the Company does not expect to meet its 2008 same-store sales target in the U.S. of 2% to 4% growth. The Company does expect to exceed the restaurant expansion target of 90-110 locations, with a stronger orientation toward non-standard restaurants in the U.S. and self- serve kiosks consistent with the Tops Friendly Markets agreement.

The Company's focus on U.S. profitability has resulted in several proactive initiatives including conversion of Company-operated restaurants to the owner-operator model, seeding the brand through less capital intensive means including strategic alliances, and recently introducing product bundles with various value price points. As part of its profitability focus, the Company plans to rationalize some underperforming Company-operated restaurants in southern New England between the end of 2008 and early next year.

"Our brand has experienced tremendous systemwide growth in the U.S. over the past several years. The plan to close underperforming restaurants is consistent with management's efforts to improve profitability in the U.S. segment. We expect rationalization of underperforming restaurants will ultimately contribute to improved profitability, and improve sales performance at our remaining restaurants nearby," said Don Schroeder, president and CEO.

The Company's operating income performance to the end of the third quarter was generally consistent with its annualized expectations for operating income growth of 10% excluding the $3.1 million charge in the second quarter. While rationalization of some underperforming restaurants in southern New England will contribute to future earnings, the 2008 operating income target did not contemplate a charge for closed restaurants that will likely occur in the fourth quarter.

As part of its international platform, the number of Tim Hortons licensed sites in the Republic of Ireland and the United Kingdom has expanded to 261 locations.

Capital Expenditures

The Company invested $46.0 million in capital expenditures in the third quarter, and $112.1 million year-to-date, primarily on its restaurant expansion program and renovations. Due primarily to a higher number of leased restaurants versus owned restaurants and a higher mix of non-standard restaurants, the Company does not expect to spend the targeted 2008 capital expenditure range of $200 million to $250 million.

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