Restaurant Brands International Inc. (QSR) Q1 2018 Earnings Report, Transcript and Summary

Good morning and welcome to the Restaurant Brands International First Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] All callers will be limited to one question. Please note, this event is being recorded. I would now like to turn the conference over to Markus Sturm, Head of Investor Relations. Please go ahead.

Thank you, operator. Good morning everyone and welcome to Restaurant Brands International's earnings call for the first quarter ended March 31, 2018. A live broadcast of this call may be accessed through the Investor Relations webpage at investor.rbi.com and a recording will be available for replay. Joining me on the call today are Restaurant Brands International’s CEO, Daniel Schwartz; and CFO, Matt Dunnigan. The team will be available to answer questions during the Q&A portion of today's call. Today's earnings call contains forward-looking statements, which are subject to various risks set forth in the press release issued this morning and in our SEC filings. In addition, this earnings call includes non-GAAP financial measures. Reconciliations of non-GAAP financial measures are included in the press release available on our website. Before outlining the agenda for today’s call, we wanted to briefly highlight the recent implementation of two new accounting standards since both of them impacted our first quarter 2018 results, specifically the two new standards are revenue recognition and hedge accounting. As previously indicated on our fourth quarter 2017 earnings call, we followed a transition method for the new revenue recognition accounting standards under which our retained earnings adjusted was recorded at the beginning of 2018 to reflect the cumulative impact of transitioning to the new standards as if the standard had always been in place. Under this transition method, we will not be restating results prior to 2018 to reflect the new accounting standards. The most significant changes of this adoption that effects comparability of our results of operations between 2018 and 2017 included change in the timing of franchise fee revenue recognition and the reflection of advertising fund contributions and expenses on a gross basis. To allow for comparability with 2017 results, we have provided in the earnings release a reconciliation of 2018 results under previous accounting standards and will continue to do so for the remainder of the year. Also, for comparability purposes, organic revenue and organic adjusted EBITDA growth are calculated based on 2017 and 2018 results under previous accounting standards. The results presented in our earnings release indicate which revenue recognition methodology applies in each respective period. Additionally, in the first quarter of 2018, we adopted new guidance related to hedge accounting. Under the new guidance certain amounts pertaining to our cross-currency rate swaps that were previously recorded in other comprehensive income will not be included in net interest expense. As a result, we expect to recognize a benefit in net interest expense in our consolidated statement of operations, which primarily reflects the positive interest rate differentials on our Canadian dollar and euro cross-currency rate swaps. Additional details about these new accounting standards can be found in our Form 10-Q, which will be subsequently filed. Now, let's quickly review the agenda for today's call. Daniel will start by discussing highlights for the first quarter and our 2018 priorities at Restaurant Brands International and will then discuss the performance of Tim Hortons, Burger King, and Popeyes Louisiana Kitchen. Matt will then review consolidated financial results for the quarter; following which, Daniel will share some concluding remarks before opening the call up for Q&A. I'd now like to turn the call over to Daniel.

Thanks, Markus, and good morning everyone. Thanks for joining us on today's call. I'm pleased to provide an update today on our first quarter 2018 results. This quarter we were pleased with the double digit systemwide sales and adjusted EBITDA growth that we achieved for our Burger King and Popeyes brands. However, we are not happy with our sales growth and overall financial results at Tim Hortons. On a consolidated basis, this quarter we grew our adjusted EBITDA to $498 million or $506 million under prior revenue recognition standards, which represents 5% organic growth versus the prior year's combined results of RBI, including Popeyes. As Marcus highlighted, for year-on-year comparability purposes we are presenting organic growth both on a constant currency basis, as well as under previous accounting standards in both periods. Continued growth in our topline, combined with the redemption of our preferred shares in 2017, and a favorable tax rate due to stock option exercises in the quarter led to adjusted diluted EPS of $0.66 per share for the quarter, up from $0.36 per share in the prior year period. Continued momentum at Burger King in the first quarter led to systemwide sales growth of 11%, which was a result of net restaurant growth of nearly 7% and comparable sales of 3.8%. Our BK comparable sales results this quarter were driven by notable strength in the U.S. and continued growth in many of our larger international markets. At Popeyes, systemwide sales grew by 11%, driven by net restaurant growth of nearly 7%, and comparable sales of 3.2%. Comparable sales this quarter were driven by improved results in the U.S. and continued sales momentum internationally. At Tim Hortons, systemwide sales grew by 2%, driven by net restaurant growth of 2.8% and flat comparable sales. Our Tim's comparable sales this quarter reflects flat results in Canada and softness in the U.S. Today, we’re going to share with you much more details than we have provided historically about our plans to improve our overall results at Tim's. This is one of the most important focus areas for me personally and for my team, but before diving into the details of our results across the three brands, we thought it would be helpful to first highlight aspects of our business that we believe uniquely position us for long-term growth and then to outline our priorities for 2018. We know and openly admit that we operate our business a little different than other companies. For example, we do not provide forward-looking guidance. This stems from our view that its true owners of the business with long-term mindset focusing on quarterly forecast is not a priority for us, instead we believe that time is more efficiently spend when it is focused on executing against sound strategic priorities, which will in turn produce favorable results. Another thing that is a little different about us is that even when things are going well we don't like to promote our results. We keep our heads down and we focus on driving strong sustained growth. Because of that, we have not historically dedicated much time to media relations to tell our story. Unfortunately, this has resulted in the publication of several articles, particularly related to Tim Hortons in Canada that mischaracterize our intentions that often cite inaccurate information and that usually reflect a purposefully negative tone dictated by a group of dissident franchisees. Needless to say, we’re not pleased with the narrative in the media. These misrepresentations undermine the good honest intentions of our franchise restaurant owners, their team members, and our employees, all of whom worked tirelessly every day to do their best for our guests and for our great Tim Hortons brand. We’ve already made changes to our communication strategy and we’re committed to doing a better job of communicating our story based on observable facts. We should have done a better job communicating with our Tim Hortons franchisees in the past and there were certainly opportunities for us to improve going forward. But we're proud that since acquiring the Tim Hortons brand we in partnership with our franchisees have been successful in increasing average revenue per store, unit economics, and overall systemwide sales in Canada. The brand remains very strong and we think it will only get stronger as we continue to work even more closely together. While our approach to investor and media relations may be a little different, we firmly believe that we are uniquely positioned to create long-term sustainable value for all of our stakeholders and would like to outline why we believe that and what our key priorities are to accomplish that. First, we owned three iconic brands, each of which we believe has a rich heritage, a unique value proposition, and significant growth potential. The strength of each brand is demonstrated by the average returns our franchisees are experiencing and the correspondingly high demand that we see from franchisees to grow our brands all around the world. And on that point of growth, we have a very large opportunity to grow each of our brands for many, many years to come. Burger King is not number one globally in the burger category. Popeyes is not number one globally in chicken, and while Tim Hortons is number one in Canada it too is not number one globally in coffee, but this positions us as a strong challenger with a very large opportunity to grow each of these great brands all around the world for many years. It will take a lot of hard work and dedication, but we are long-term oriented and are willing to work tirelessly toward our bold growth ambitions. A second unique aspect of our business is our people. Each of our brands benefits from great franchisees who together with their team members are the true heroes of the business working hard day-in and day-out to deliver the best possible experience for our guests. Over the years we’ve focused heavily on building a team of employees comprised of top talent. Our culture resonates well with employees who are hungry, who are humble, who are extremely hard-working and who have a true ownership mindset, particularly since our compensation structure is highly indexed to long-term performance and the ultimate achievement of our bold growth ambitions. Most of the senior leaders of our business are large equity owners in Restaurant Brands International and over the past few quarters you’ve witnessed these leaders converting their options largely to shares in lieu of cash reflecting their long-term confidence in our business. We believe that the combination of our great franchisees and our great employees who are both committed to working together to achieve our shared growth objectives uniquely positions our business for long-term success. Leveraging our foundation of great brands and great people, late last year we worked closely with our partners around the world to develop our priority initiatives for 2018. Our resulting priorities for this year are as follows. Number one, improve comparable sales for Tim Hortons, particularly in our home market of Canada. Number two, built on our systemwide sales momentum at Burger King and further accelerate growth of the brand all around the world. Number three, established partnerships to meaningfully accelerate net restaurant growth for Popeyes, including through new international master franchise arrangements. Number four, leverage technology to enhance our guest experiences for all three of our brands and number five, maintain a balanced approach to capital allocation to maximize value creation for all of our stakeholders. When discussing our quarterly results this year, we intend to provide you updates on our efforts to achieve these priorities. We’ve already made good progress on priorities 2 through 5, but we will spend more time now talking about how we intend to achieve priority number one. In the first quarter, Tim Hortons adjusted EBITDA was $245 million or $251 million under prior accounting standards, which represents a year-on-year organic decrease of 6%. The year-on-year decrease is largely driven by our supply chain business, including lapping of last year's roll out of espresso-based beverage equipment and related espresso inventory, which benefited our results in the first half of 2017. The supply chain decreases were partially offset by continued growth in our franchise business, driven by systemwide sales growth. First quarter comparable sales at Tim Hortons wed negative 0.3%, driven by relatively flat comparable sales in Canada and softness in the U.S. Our first quarter results in Canada reflect softness in coffee, partially offset by growth in breakfast foods. Softness in coffee was a result of heightened competitive activity during the quarter, as well as a weaker execution of our rollup the rim promotion. We are encouraged by the results of some of our new lunch products introduced this quarter including our turkey bacon club, our bacon artisan grilled cheese and more recently our signature melts platform. As you would have observed over the last year, our relationship with our restaurant owners hasn't been as strong as we would like it to be. Over the last few quarters, we have significantly improved the dialogue and the relationship with many of our franchisees, but we realize that we still have more work to do. To be clear, the small group of dissident franchisees who have been the driving force behind negative media coverage does not represent the voice of the whole franchise system or of the company. Unfortunately, this continued media coverage has negatively impacted our guests’ perception of our brand and our community roots. The elected franchisee advisory board and most Canadian franchisees are engaged and they are working with us to drive the business forward. In fact, just last week the elected franchisee advisory board openly spoke out to their fellow franchisees with their support of the Tim Horton’s management team that we have put in place to drive long-term growth. To be clear, we are not pleased with how our Tim Horton’s business is performing. As a result, we have developed and begun to implement decisive and urgent actions and created a long-term plan to address the causes of our underperformance. Recently, you saw us appoint a new Tim Hortons brand President Alex Macedo, who is previously the President of our Burger King North America business. At Burger King, Alex led a successful turnaround of the brand in the U.S. after we acquired in 2010. Alex brought with him additional talented team members to oversee the Tim Hortons brand, including Axel Schwan. In Axel's former role as CMO for Burger King he was responsible for rolling out an improved Burger King brand positioning, including new restaurant designs, menu layouts, packaging, and creative marketing campaigns, which have each contributed to Burger King's success over the last several years. We also just announced a relocation of our head office to downtown Toronto for a number of reasons, including our belief that this will help us attract even more top talent. However, while we believe these decisions will help position Tim’s for their future success, it is clear that things will not be fixed overnight. And that’s why together with our restaurant owners we have developed the winning together plan, which is focused on three key pillars, restaurant experience, product excellence and brand communications. Restaurant experience encompasses interactions with our guests both inside and outside of our restaurants and includes key priorities such as becoming increasingly more digital through our Tim's mobile app and modernizing our restaurant image. In March, we announced a new Tim Hortons restaurant design called the welcome image, which entails a redesign natural, more modern, and more inviting image, while staying true to our Tim Hortons values and heritage. We and our restaurant owners have set a bold target of rolling out our new welcome image to a majority of restaurants across Canada over the next four years. Our new international restaurants and 10 restaurants in Canada are under this new image already and we have been testing the effectiveness of the image using both quantitative and qualitative research. Through that research we gathered feedback directly from our guests in Canada and here is what they told us. Approximately, 95% of our guests said they completely agree that the new interior design looks modern and up-to-date as compared to less than 60% in our prior image. Approximately 85% of our guests said that they perceive our new image as better than that of our competitors in Canada and approximately 75% of our guests said that they were more likely to become repeat customers of the restaurant design in the new image. What most excites us is that just in the first few weeks of announcing the new welcome image to our system, our franchisee partners in Canada have shown their support for the initiative and have already signed up hundreds of restaurants for renovation within the next two years. The current pace of signups puts us in line with our bold target to have most of the restaurants in Canada with a new image by 2021. We still have a lot of work to do and we normally wouldn't communicate statistics like these this early on but we felt it was necessary to share the level of support we are receiving from our restaurant owners and our guests on this key pillar of our winning together plan. The second pillar of our plan, product excellence involves a focus on offering products that our guests love. One component of this is furthering our coffee leadership in Canada, including through our espresso-based beverage platform that we rolled out last year. A second component is improving the quality of our lunch products, which we already started, including through our turkey bacon club, our artisan grilled cheese, and our new signature melts platform. We also plan to improve our products packaging and other visual cues, which will roll out in Canada later this year. We will have more progress to share with you on that front in the coming quarters. On the third pillar, brand communications, we are focused on launching impactful marketing campaigns, which highlight the great values that define us was Tim Hortons brand. We recently launched our neighbor’s campaign in which we encouraged guests throughout Canada to go out and meet their neighbors over a cup of Tim Hortons coffee. We’ve already heard some great stories from our guests about how they’ve used this campaign as an excuse to meet a new neighbor if they’ve just moved in or otherwise just simply say thank you to neighbors for helping to shovel their side of the driveway. A sense of community is an integral aspect of the Tim's brand and bringing Canadians closer together over Tim Hortons coffee is something we are proud of. We also recently launched a new musical advertising campaign, which highlights the quality and production process of a cup of Tim Hortons coffee all the way from the farms where we hand select our beans to the fresh cup of coffee served to our guests in our restaurants. Together with our franchisees, we continue to invest in the local communities that we serve, including through our Tim Hortons Children's Foundation, which raised nearly CAD31 million last year. Regional community spend on initiatives such as Timbits Minor Sports Programs has also increased significantly since we acquired the brand. This pillar also encompasses having our brand team more openly and more proactively speaking with the media to tell the great story that Tim Hortons has to offer. We admittedly should have done more of this in the past and are committed to being more proactive in our communications in the future because we believe that we have a great story to tell. We believe that focusing on each of these three pillars, restaurant experience, product excellence, and brand communications will help us drive our core strategy of enhancing guest satisfaction and franchisee profitability for the long-term. We’re confident that this plan will help us achieve long-term sustainable comparable sales growth for Tim's, particularly in the home market of Canada. Our priorities continue to center around driving enhanced guest satisfaction and franchisee profitability. Working together with our restaurant owners, we have managed to increase average franchisee profitability in Canada by a significant amount since we first acquired Tim Hortons. This strong franchisee profitability and returns for the Tim Hortons franchisees in Canada speaks to the strength of the brand and the hard work of our franchise partners. Although our franchisees are facing headwinds this year we are committed to successfully delivering on our winning together plan with our partners and continuing on this path of long-term franchisee profitability growth. Now in terms of development we grew our Tim Hortons restaurant count by 2.8% year-on-year, which reflects growth in Canada, as well as growth in our new international markets. Our partners in each of the Philippines, the U.K., Spain, and Mexico continue to open great looking restaurants under our new model and welcome image. Our Tim's international growth story is still in its early days, but we remain encouraged by the results and by the guest feedback that we’re seeing all around the world. We’re also making good progress with other partners to grow the brand in additional international markets and hope to provide updates on this later this year. Before I move on, I want to re-emphasize that we don't think the current challenge is that Tim Hortons can be addressed with a series of short easy fixes. Like our restaurant owners we are focused on the long term and on executing with excellence on our three-pillar winning together plan, simply put, we are as passionate about this iconic brand as our franchisees and our guests and we know we are accountable for its success. That’s why you have my commitment it will continue moving with speed and determination to improve its performance. Let’s now review the results for our Burger King business. Systemwide sales growth of 11% during the first quarter was driven by continued momentum in both net restaurant growth of nearly 7% and comparable sales of 3.8%. Growth in the topline resulted in BK adjusted EBITDA of $214 million for the quarter or $215 million under prior accounting standards, which represents the year-on-year organic increase of roughly 12%. Our comparable sales was driven by continued momentum in the U.S. with first quarter U.S. comparable sales of 4.2%, and continued strength in our large international markets. In the U.S., our sales growth was a result of impactful marketing, product innovation, and our consistent strategy of maintaining a menu that is balanced across price points. Innovation included the launch of our double quarter pound king and the launch of our spicy crispy chicken sandwich, an evolution of our improved quality crispy chicken platform that we launched last year. Both products contributed positively to our sales growth this quarter. Internationally, our comparable sales were strong in many of our largest markets around the world, including Brazil, Russia Spain and the UK, which was driven by a balance of compelling value offerings as well as innovative limited time offers that resonated well with our guests. This was partially offset by continued softness in Australia and Korea both a result of broader industry softness, as well as not having the right balance between value and premium offerings, which we’re working with our partners to improve upon. On the development front, we grew restaurant count by roughly 7% year-on-year, which reflects continued growth from our partners all around the world. As highlighted earlier, having the best franchise partners is a critical success factor to our long-term growth. Our acceleration of net restaurant growth under our franchisee led development model from approximately 170 net stores in 2010 when we first acquired Burger King to nearly 1,100 in the last 12 months is proof of that. Our accelerated store growth also highlights the power of our master franchise development model, which we have also been deploying at Tim's and more recently at Popeyes. As demonstrated over the past few years at our Burger King business, we believe that the establishment of these partnerships will set the foundation for meaningful growth in the topline of each of our brands for many, many years. We’ve stayed through to our 2018 priority of building on our systemwide sales momentum at BK and is further accelerating growth of the brand all around the world. We’ve also made good progress on our priority to leverage technology to enhance the guest experience for BK. This quarter, we began testing delivery in the U.S. across several hundred restaurants and numerous markets. We’re encouraged by the results so far. Though it is still early, delivery has been successful for us in many of our international markets, including places like China and Spain and we intend to further expand our test in the U.S. over the coming months. Now, let’s review our results for Popeyes. Systemwide sales growth for the first quarter was 11%, which was driven by net restaurant growth of nearly 7%, an improved comparable sales of 3.2%. Growth in our topline combined with integration synergies resulted in Popeyes adjusted EBITDA of $39 million or $41 million under prior accounting standards, up 81% organically versus the prior year period. Comparable sales for the quarter were driven by an improvement in U.S. comparable sales to 2.3%, combined with significant strength in comparable sales and international markets. Our results in the U.S. reflect a better balance between value and premium offers than we had during prior quarters. Consistent with our priority to use technology to enhance guest experience we’re also testing delivery at Popeyes in the U.S. and currently have several hundred restaurants in various markets across the country that are participating in the test. Our results thus far have shown that consumers have particularly enjoyed using the delivery channel to purchase Popeyes products for the dinner and for the late-night day parts, which are day parts that typically involve larger check sizes. As with BK it is still early, but the results have been encouraging so far and we intend to meaningfully broaden our test in the coming months. In terms of development, we grew Popeyes restaurant count by nearly 7% year-on-year, primarily driven by growth in the U.S. Our continued growth in North America, will be further supported by several multi-year development agreements that we signed in the first quarter. We also announced our first master franchise agreement to grow the Popeyes brand in Brazil. We’re very excited to be working with our partners in Brazil who are also our partners responsible for successfully growing our Burger King brand in the country. Through their understanding of local tastes and preferences in the market, as well as many years of experience in the QSR industry, we are confident that we have the right partner to bring Popeyes to this exciting new market. Brazil is a strong market for chicken consumption, which has grown to be the leading protein in the country and we look forward to introducing guests all over the country to our unique menu offerings in the coming months. We are also in discussions with several other partners to accelerate the development of our Popeyes brand all around the world and we look forward to updating you on our future progress. With that, I'd now like to turn the call over to Matt.

Thanks, Daniel. Systemwide sales growth across each of our brands combined with the inclusion of Popeyes in our results, partially offset by declines in Tim Horton supply chain related revenues and expenses led to adjusted EBITDA of $498 million or $506 million under prior accounting standards, up 5% organically versus the prior year combined results of RBI, including Popeyes. Our first quarter adjusted net income increased to approximately $313 million or $319 million under prior accounting standards. This compares to prior year results of $171 million and the year-over-year increase is attributable to adjusted EBITDA growth, the redemption of our preferred shares in 2017 and a favorable tax rate due to stock option exercises in the quarter. This led to adjusted diluted EPS for the quarter of $0.66, up over 80% from $0.36 in the prior year period. As a reminder, neither adjusted net income nor adjusted diluted EPS include Popeyes for the prior year results, since we acquired the business in March 2017. Before discussing capital allocation, we thought it might be helpful to point out three relevant considerations for investors looking to update their forecast based on first quarter results. First, as Marcus highlighted at the beginning of the call, starting in the first quarter of 2018, we implemented new revenue recognition accounting standards. It is important to note that the impact of the new standards on our first quarter results is not necessarily an indication of the expected impact to the remaining quarters in 2018 for two main reasons, shifting from previous accounting standards where franchise fees where fully recognized at the time of opening to instead amortizing them over the life of the contract, means that the impact of revenue recognition for franchise fees will implicitly have a larger impact on periods in which more openings occur, since we tend to open a majority of our restaurants in the second half of the year. This means that we anticipate the impact of the new accounting standards will be larger in the back half of the year. Additionally, our advertising fund contributions and related expenditures tend to be seasonal, especially given these revenues are structured as a percentage of sales. Second, Markus also highlighted at the beginning of the call that this quarter we implemented new hedge accounting standards. The adoption of the new standard resulted in a $3.6 million positive impact on our net interest expense for the first quarter of 2018. Since our re-designation date was in March we only recognized a partial benefit in the first quarter, and accordingly we expect the benefit to be larger in the remaining quarters of 2018. However, the ultimate amount is subject to foreign exchange rate movements. And finally, our first quarter 2018 adjusted effective income tax rate was materially lower than the range we had provided earlier this year, but it is important to remember that the timing and amount of stock option exercises can vary materially quarter-to-quarter and can thus have a much more material impact on a particular quarters rate than the full-year rate. Investors should accordingly expect meaningful quarter-to-quarter volatility in our tax rate related to the unpredictability of stock option exercises. Now let’s discuss our cash generation and capital allocation during the quarter. In the first quarter, we had net free cash outflow of approximately $109 million calculated as the sum of cash flows from operating activities and cash flows from investing activities. This free cash outflow includes sizable one-time cash tax payments, including taxes accrued in the fourth quarter of 2017 related to the redemption of our preferred shares, as well as seasonal timing of working capital outflows such as gift card redemptions. We also paid a total of approximately $97 million in common dividends and partnership exchangeable unit distributions this quarter. As of March 31, 2018, our ending cash balance was approximately $850 million. Our total debt balance was $12.3 billion, and our net debt was $11.4 billion. This quarter we announced that together with our franchisees, we plan to invest a combined total of roughly CAD700 million over the next four years in relation to our important rollout of the Tim Hortons welcome image. While we have not disclosed exactly how this amount is split between us and our franchisees, consistent with our long-standing practice for the Tim Hortons brand, for restaurants where we either own or lease the real estate we contribute 50% of the front of house renovation costs. While this represents a very important investment for our business and stays true to our balanced approach to capital allocation, our rollout of the welcome image represents a relatively immaterial incremental impact to our cash flows for the next four years. This morning we announced that on April 24, 2018, the RBI Board of Directors declared a dividend of $0.45 per common share and partnership exchangeable unit of RBI LP, payable on July 3, 2018, which is consistent with our previously announced target of $1.80 in total dividends to be declared in 2018 and with our strategic priority of maintaining a balanced approach to capital allocation. I now like to hand the call back over to Daniel for concluding remarks.

Thanks Matt. We continue to grow systemwide sales all around the world for each of our three iconic brands. Tim Hortons, Burger King, and Popeyes Louisiana Kitchen, which drove adjusted EBITDA growth for the quarter. We have established our primary priorities for 2018 and developed strong plans with our partners all around the world to deliver on those priorities. At Tim's, we have absolute confidence that our three-pillar winning together plan will allow us to overcome the challenges that we face and to improve sales growth in Canada. For Burger King, we have plans in place to build on our comparable sales momentum in the U.S. and internationally and to also further our net restaurant growth. At Popeyes, we are highly focused on continuing to sign impactful development agreements both in the U.S. and internationally to fuel significant acceleration of net restaurant growth and long-term systemwide sales growth. Our great franchisees and employees all around the world are working hard to deliver against these priorities in 2018 and we look forward to providing you another update in the second quarter. Let me close by reiterating that our top priority, systemwide is to deliver the absolute best experience for our guests and to drive profitability for our franchise partners. I want to thank everyone for joining us this morning and for your ongoing support. We’ll now open up the call for Q&A. Operator?

Thank you. [Operator Instructions] The first question comes from Nicole Miller with Piper Jaffray. Please go ahead.

Thank you. Good morning. And thanks for the comments on the call today. My question is in regards to Tim Horton, in conjunction with the remodels, would it be possible that they might be extending the terms, the lease terms that they have? So, just wondering on average may be where does the systems fit in the term with the extent that and then what the impact or contribution would that have to revenue or cash? And then just a second part to Tim’s, in the U.S. specifically their peer group is suffering in terms of PM business, so AM comps are up and PM comps are down, are they seeing the same types of trends or something different going on? Thanks.

Thanks Nicole. It’s Daniel. We’re excited about the restaurant experience of the three-pillar plan and we're really excited to roll-out the welcome image in Canada. As you know, and as is typical at the time of renovation, we would look to extend property control and we would look to enter into a new or extended franchise agreement. So that’s typical across our brands and that’s generally how our Tim's brand works and with respect to the business in the U.S., I think we saw they have a softer result, it was a little bit more competitive and I think it’s on us to make sure that we bring back the right balance between value, premium, and limited time offers, which I think we have done a better job with in prior quarters.

Our next question comes from John Glass of Morgan Stanley. Please go ahead.

Thanks very much. Daniel, and just in the spirit of talking about sort of investments in the business, when you talked about the Canadian Tim's business being some remodel CapEx, how do you see the overall need for investment though at the business, and I'm talking about it I guess on a global basis across all three brands, you’ve talked about technology in delivery and that sort of something newer to you, your competitive brands have been investing longer-term in some of those initiatives, do you see a need to step-up investment across the brands to compete more in technology, do you see other brands needing to – for example go through some of the reimaging that you are seeing at Tim's, can you talk about that holistically as you think about the business over the next year or two?

Yes, sure John. Thanks for the question. I mean, you know the way our business operates is a little different than some of our peers and that we are structured with – we are largely a fully franchise system with master franchise operators in our largest markets around the world and while we might have not been talking about it all that much, we have been renovating and our franchise owners have been renovating their restaurants every year for the past many years both in the U.S. and all around the world. And the fact that we are building a whole lot of restaurants relative to the base of restaurants that we have that put us in a position where we have a pretty good image globally with our brands. With respect to technology, we have made this a bigger priority and I think the first thing that you saw us do earlier this year is when we appointed Josh Kobza, who was our previous CFO to oversee in addition to his role of overseeing development to oversee all of technology and we are building out a team and we are more actively working with renders all around the world to help accelerate our use of technology to enhance our guest experience. We don't see this as something that’s going to require a meaningful amount of capital and I think we see opportunities to better leverage technology like we’re already doing around the world so in places like China and Spain were delivery is a really big portion of our business. We talk about testing delivery across the Burger King system in the U.S. which we’re already doing, we’re testing delivery in the Popeyes system, and we’re looking at a whole different variety of things, and we are already investing in the most important element, which is having the best people working on the project internally.

The next question will be from Dennis Geiger of UBS. Please go ahead.

Great, thanks and thanks for all the details on the winning together plan, very helpful. Can you talk a little more though about how much of the plan perhaps is currently in place and rolled out, and then how much perhaps is coming just so we can think about maybe the timing of some of the benefits from the initiatives if that’s possible? And then kind of following up on John's question, is it fair to think then that this plan beyond what you have already kind of announced with remodels that it doesn't really require any kind of significant step-up in CapEx G&A spend et cetera. And then if I could just relate to that, sneak one more in, anything that this does for you from a development perspective within Canada or maybe it’s too early, but you know just how you're thinking about that as this becomes a success? Thanks.

Yes, thanks. Thanks for the question. I think with respect to the - kind of what’s in place and the benefits and we just announced this quarter, I mean just within recent weeks we crafted this plan together with our restaurant owners, the Tim's winning together plan that centers around restaurant experience, product excellence and brand communication. And a restaurant experience, we talked about the fact that we really want to work with our owners to accelerate the pace and the quality of the pace of renovation, and the quality of the restaurant image in Canada. We're really encouraged by the initial results that we have had both quantitative and qualitative testing with our guests. We’re also encouraged by the support and the feedback that we’ve already gotten from our restaurant owners just a few weeks into having announced the welcome image we have. Several hundred restaurants who have already indicated to us that they plan to renovate their restaurants. Ad as Matt had mentioned in his prepared remarks, we were already renovating our restaurants and while the cost of the welcome image is slightly more expensive than the previous image, we were already contributing to renovations in Canada. So, the incremental component in the scheme of things won't be material for us, but we do believe it will materially – it will positively impact the guest experience. With respect to product excellence this means analyzing every single one of our products to make sure that they are absolute best in their categories and that is our commitment. And we’ve already started doing this by elevating the quality of the lunch platform with some of the new products that we have launched including turkey bacon club, artisan grilled cheese, the new signature melts, and lastly on brand communications, which is launching impactful marketing campaigns we just started doing this with the neighbor’s campaign that we launched. The musical campaign that we launched that highlights the quality of the cup of coffee that we offer at Tim Hortons all the way from bean to cup. And lastly, as I mentioned, it means being way more proactive with the media going forward, and telling our own story, our own positive story, and it’s early, it’s still very early and there is no, like, we have said this before and you probably have heard me saying this before five years ago at Burger King, there is no silver bullet, but we think that the focus on restaurant experience, product excellence, brand communications, together with our restaurant owners if we do this, we execute on this and we will, we are confident that this is going to drive the brand in the right direction.

The next question comes from John Zamparo of CIBC.

Thanks, good morning. I appreciate the color at the top of the call. I wanted to ask about the Tim's mobile app, you have got a few quarters with it under your belt now, what can you share with us about the pace of customer signups or frequency of use and potentially higher checks and you mentioned the goal of furthering your copy leadership in Canada, do you view the app as being a meaningful part of that? Thanks.

Yes, we’re still excited about the, or we are still excited about the potential for the Tim's mobile app and how our guests are interacting with us digitally. We’ve now included this as kind of more broadly part of our overall restaurant experience pillar of the winning together plan. We’re learning more about how our guests are interacting with us on the app, we're making changes and we’re evolving the app to kind of be better tailored to what our guests are – or how our guests are using it. We see this longer term as a tool that will enable us to see all sorts of things, including direct marketing and a variety of other ways to ultimately just improve our guests access to the brand and it’s still early for us, but we’re excited about the long-term potential for this, especially for the Tim's brand.

Our next question comes from Brian Bittner of Oppenheimer & Company. Please go ahead.

Thanks, very much. Just sticking with the Tim Hortons, with the sales trend in Canada, how do you guys parse out what you believe is coming from the effects of the negative media coverage? Is it a deterioration in the [indiscernible] or some other measure and how are you convinced that the weakness there may not be more attributable to some other headwinds going on in the Tim’s business?

Yes, it’s Daniel and thanks for the question. Look, it is both. The environment is competitive and the fact that there is a ton of negative media created by this group of franchisees, it is also hurting the guest perception and they are both contributing to the performance, which is why we had to take a step back and work with our advisory board and work with our restaurant owners to craft kind of bigger bolder plan in our winning together plan to move the business and move the brand forward. And that’s our agenda now and that is the top priority we are encouraged by the fact that we have a bunch of support very early on from a meaningful number of restaurants and owners and I think we have the right team, the right plan and the right support from the owners to drive the business forward.

The next question comes from Andrew Charles of Cowen and Company.

Great, thanks. Two questions from me. So, for Tim’s, can you talk about the decision to just remodel the interiors of restaurants just given the heavy use of drive-through and off-premise for the brand and then I appreciate the detail on the winning together plan, you guys previously talked about how the remodels will be recording incremental TI associated with the [indiscernible] plan, are you expecting incremental cost or CapEx associated with any of the new Tim's initiatives that you guys outlined today?

I will comment, thanks for the question. I am going to comment on the image and I will let Matt, if you want to comment on the – how it is going to be accounted for and all that. Sorry if this wasn't clear. The welcome image, the restaurant exterior and interior will both be redesigned. And so, I think from the exterior it is going to have more of a natural-looking lighter, more inviting materials. Inside, we're going to have things like artwork that reflected Tim Hortons values and history’s, commissioned portrait Tim Horton, Mosaic, iconic brand images, walls that feature our unique coffee sourcing, so there is a whole variety of components to the new welcome image and including upgrading the quality of seating that fosters a sense of community inside the restaurant. So, it is so full scope inside and outside. Matt, if you have any follow-ups on this financial side?

Yes. Just to touch on the investment question, as Daniel mentioned, a really important piece of the winning together strategy here is the welcome image, which we rolled out and this is a very important initiative for us, and we think that it will help us drive significant re-imaging of our system in Canada and as part of our historically balanced approach to capital allocation, we’ve been maintaining a very healthy pace of remodels over time, and so as it relates to overall cash flows, the remodel initiative represents a relatively immaterial incremental impacts to cash flows over the next four years in capital investment. And as it relates to the broader winning together plan there is no material investment to otherwise speak off.

Thank you. Our next question comes from Peter Sklar of BMO Capital. Please go ahead.

In your commentary, when you were talking about the coffee performance in Canada, I believe you said, in addition to competitive issues, there were some issues related to the execution of the roll up to win to rim, which has been a long-standing promotion on the calendar of Tim Hortons. Could you just explain a little bit what happened there?

Yes, thanks for the question Peter. With respect to roll-up during the quarter, we did miss an opportunity there, partly due to an unfortunate error with one of our suppliers who we had been using for decades. So that coupled with the increasing competition led to some softness in coffee during the quarter.

The next question comes from Gregory Francfort of Bank of America.

Hi guys. I've got two questions, Matt, one for you. Just can you help maybe gross out the revenue impact of the accounting changes, I think the $182 million in revenue and 191 on SG&A, is that 191 also what the impact was in advertising fund revenue, so it was like a $9 million drag from the fees? And then Daniel, a bigger picture question on delivery for Burger King in the U.S, how do you envision quick service delivery playing out? I think the economics to make it work probably is, maybe high teens in terms of total checks and are you going to shift your marketing to maybe address bundle of orders or bundle, bundle, I'm just sort of curious how you plan to address delivery and how you think the market evolves?

Hi, thanks for the question. It’s Matt here. I will touch on the accounting and then I will pass it over to Daniel. So, on the revenue recognition accounting, again, two main impacts to our financials, the first being to franchise fees, where we are – previously we were recognizing upfront the franchise fees when the restaurants are opened or the agreement was renewed. Starting in 2018, these will be amortized over the life of the agreement. And the second, as you pointed out, it was related to ad fund. Under the previous standards of the advertising fund that positions were recorded on the balance sheet and had no P&L impact. Beginning this year, we are consolidating the full growth P&L impact of the advertising funds that we managed both revenue and expense, and this resulted in the year-over-year increase in revenues. And then additionally, I would say, on a net basis, the close to $9 million impact was approximately half related to the amortization of franchise fees and the other half related to the consolidation of advertising funds in the quarter.

Thanks, and then with respect to the delivery question, we have seen delivery be quite impactful in some of our international markets, I think we had mentioned on the prepared remarks places like China and Spain, and also Turkey has been a long user of delivery in terms of impactful sales. With respect to the U.S., it’s early, I mean our initial results are encouraging. We have rolled it out – delivery out to several hundred restaurants with the Burger King brand and several hundred with the Popeyes brand, and I think we’re still in the phase where we're seeing good results so we want to continue monitoring it and adjust accordingly before we could kind of come back to you and have definitive plans on how we want to adjust or how we want to reprioritize marketing, but I would say it is too early for that, but I think, look this is just one good example of us being able to kind of quickly move fast to use technology to enhance our guest experience and really just to provide more channels for the guest to access the brands.

The next question will be from Will Slabaugh of Stephens Inc.

Thanks guys. I had another question on Tim's. In just sort of getting our gauge in terms of where you feel like you are from a product innovation standpoint and then sort where you need to be, so if you could just talk about the espresso platform, I guess it is number one and then some of the other lunch items in coffee that you mentioned earlier, in terms of how impactful you feel they have been in the past as you’ve launched and as you’ve initiated some changes? And then what needs to be changed either from a product or from a marketing standpoint, just from a high-level standpoint? And then also, if I could also ask about the supply chain, you mentioned that revenue at Tim’s were down, I think it was 6.8% on a like-for-like basis due mainly to the supply chain. I know you mentioned espresso and lapping over that in terms of inventory just part of that, I wonder if there is anything else going on there or if that was the big reason? Thank you.

Yes. I will take the first one and I will pass it on to Matt to talk about the supply chain, but I would say, as it relates to the winning together plan and the two pillars that you mentioned and frankly the third pillar as well, I would say early on all of them with respect to product excellence we have made some progress elevating the quality of our lunch sandwiches including the turkey bacon club, the artisan grilled cheese, and we’ve gotten good feedback and seen some good results with that. We are encouraged by the success we have had in the rollout of our espresso-based beverages in giving us another way to innovate around coffee and we did some of that this quarter, but as I said earlier, we’re going to analyse every one of our products and making sure that absolute best in each of their category, that is a firm commitment that we are making. So, I think that is a whole lot more to come there. And on brand communications, I think it is about elevating the quality of our communications and constantly being more open to kind of proactively speak with the media and more proactively telling our own story. And I think you're going to see us doing a lot more both of them, but as it relates to the winning together plan, your impact of product excellence, impact of brand communications I think it’s still very early. And Matt do you want to follow up.

Yes, just to follow-up on your question related to the supply chain performance. The organic year-over-year decline in EBITDA and revenues for Tim’s this quarter, primarily reflected two impacts on the supply chain business. First, as you mentioned, in the quarter we lapped the rollout of our espresso program that was completed in the first half of 2017. Secondly, as highlighted over the past few quarters we passed on some supply chain savings to our franchisees through a reduction in pricing in the second half of last year. We continue to maintain this pricing for franchisees. So, margins in the supply chain business in the first quarter of 2018 are relatively consistent sequentially with the margins in the second half of last year. And looking ahead, as we no longer lap these two impacts, we expect the organic growth profile at Tim’s to improve throughout the year. Overall, a variety of moving pieces. We highlighted here some of the largest. Had it not been for these issues, the business would be roughly flat in overall organic EBITDA growth in Q1.

The next question will be from Karen Holthouse of Goldman Sachs.

Hi. So, you have mentioned your changes to communication in Canada as part of the strategy, if that’s not ultimately successful and starting to improve brand perception, is there anything you are most focused on for more of an operational, maybe a spending perspective that you think would be most helpful or most effective as – for lack of a better term [indiscernible] branch to maybe Canadian consumers or franchisees?

Yes, thanks for the question Karen. We've made good progress on building a strong and positive agenda with the restaurant owners. The relationships with the owners weren’t where they needed to be, but we have been making improvements. We are very excited about the winning together plan, and as I had mentioned in the prepared remarks, we already have several hundred restaurants were signed up, which indicates the support and the enthusiasm. Just last week, our advisory board openly spoke out to the entire system and this is the advisory board that’s elected by the franchisees, they openly supported our management team, they supported our plan and they spoke out against some of the actions of some of the franchisees who have been creating some negative media coverage, and look we do have a lot to improve, but we have the right team. We have the right plan. We have the right support from our restaurant owners to drive the business forward. And I am confident that with the right brand communications, you know coupled with acceleration and restaurant, image renovation and new product introduction and product renovation that we will drive the brand in the right direction.

The next question will be from Jon Tower of Wells Fargo.

Great, thanks for taking the question. Just one more on Tim Hortons Canada and then another on BK U.S. First on the Canada business, can you give us a little bit of information on where the customers are going, if they are not going to Tim’s? Are they are staying at home or if they are going to the competitors, what’s driving them to the competitors? And then on the BK U.S. business, can you talk about whether or not you are attracting new customers to the brand or you're just seeing increased frequency of existing customers with those strong same store sales? Thanks.

Yes. Thanks. On Tim’s, and you this has been the case in the past. We don't comment on specific competitors, but we can say and we have said, it has been competitive environment and that coupled with some of the negative brand coverage has impacted our sales, which is why we put together the winning together planned, together with our restaurant owners to drive the business in the right direction. And then on the Burger King's side, we had a good quarter, especially in U.S. and we continue to innovate around some of the existing platforms, we saw some success with the double quarter pound king, we saw success with the spicy chicken sandwich platform that we launched which was built, which was built on the crispy chicken sandwich that we had launched last year. And I think the other thing that’s positively contributes to the same store sales growth that we’ve experienced over time at the Burger King brand is the fact that if you go back in time, 5, 6 years ago, we had one out of ten restaurants renovated. And now after working closely with our franchise restaurant owners in the U.S. over the last 6 plus years, we have renovated the vast majority of the system, which has helped. And if I had to jump back to Tim Mortons, one of the things that gives us confidence that renovating restaurants, positively in the long run contributes to one's ability to drive improved sales.

The next question will be from Matt McGinley of Evercore ISI.

Thanks. On that last point, I believe that the typical remodel cycle for Tim Hortons is usually done around the franchise term every 10 years, but it may have gone a little bit longer than that as you finalise that new welcome image, I am curious that if that means if a typical Tim’s Restaurant is just a little older in terms of remodel cycle then we have seen in the past. And then as far as how the franchisees will fund that, I believe you negotiated a preferred lending agreement with some of the banks in Canada for the franchisees that makes it faster to get capital to do a project and I'm curious if those lines are still available to the franchisees?

Hi, it’s Daniel. So, yes, the that typical renovation cycle with the Tim Hortons restaurants is 10 years, and we’re working with our restaurant owners to accelerate the timing to kind of bring forward the renovation such that we will want to be able to achieve the majority of the restaurants under new image by 2021. That will be our combination of new builds and renovations. And yes, we did range for this preferred lending terms for this system to be able to access that to finance renovations.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Daniel Schwartz for any closing remarks.

Thanks everybody for joining us today and we look forward to updating you on our progress next quarter. Thanks a lot.

And thank you sir. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.