Einstein Noah Restaurant Group Inc. Q3 2008 Earnings Call Transcript

| About: Einstein Noah (BAGL)

Einstein Noah Restaurant Group Inc (NASDAQ:BAGL)

Q3, 2008 Earnings Call

November 6, 2008 5:00 pm ET

Executives

Rick Dutkiewicz - Chief Financial Officer

Paul Murphy - Chief Executive Officer

Analyst

Michael Podhorzer - Sidoti & Company

Jake Bartlett - Oppenheimer

Paul Westra - Cowen and Company

Matthew DiFrisco - Oppenheimer & Co.

Todd Cohen - MTC Advisors

Operator

Welcome to the Einstein Noah Restaurant Group 2008 third quarter earnings conference. During today’s Presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) As a reminder, this conference is being recorded today, Thursday, November 6, 2008.

I would now like to turn the conference over to our host, Mr. Rick Dutkiewicz; please go ahead sir.

Rick Dutkiewicz

Good afternoon, and welcome to the Einstein Noah Restaurant Group 2008 third quarter conference call. I am Rick Dutkiewicz, Chief Financial Officer and with me today is Paul Murphy, President and Chief Executive Officer.

Let me start by covering a few regulatory matters. I would like to note during our opening remarks and in our responses to your questions, certain items may be discussed which are not based on historical fact. Such items, including statements indicating our belief, trends, plans, expectations, assumptions, anticipation, guidance, projections, estimates and the like should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially. For more details please refer to our news release issued today and to the risk factors in our SEC filings.

Now for a brief review of our third quarter financial results. Overall we were pleased with our performance and we feel that our results underscore our ability to execute our plan successfully in an otherwise very tough consumer and economic environment.

Total revenue growth was 0.5% to $100.9 million from $100.4 million in the prior period. While we had price increases in place for the quarter, plus 34 more locations across the company versus a year ago, the unit volume of products sold adversely affected the top line.

Company owned restaurant sales fell marginally to $92.4 million from $93 million, while comparable store sales were down 1.7% versus 5.2% growth in the same quarter of 2007. Comparable store sales were comprised of 5.8% in price increases and 4.3% in positive product mix shift, offset by a decrease of 10.7% in units sold.

The reduction in units sold volume was due to several factors; first it was a result of our conscious decision to reduce hours of operation at all company owned locations by at least one hour per day. As we’ve discussed before, however the reduction had no adverse impact on the operating profit of the restaurants themselves.

Second, volume reductions were due to a decrease in the breakfast day-part and more broadly, a drop off in add on orders, particularly beverages and sweets. Finally, this all occurred against the backdrop of the credit crisis and all time lows in consumer confidence which most certainly affected results.

At the end of the third quarter of 2008 AUV for the trailing 12 months was $919,000, based on total store weeks of 5,439, the weekly per store sales average for all of our company-owned restaurants in the third quarter was $16,990, while the average check was $7.45.

Please note that we have a significant presence in states that have been most impacted by the sub-prime mortgage crisis, namely Southern California, Arizona, Florida and Nevada. If we exclude these most troubled markets, as well as adjust for the reduction of hours, our overall comps were actually positive.

Furthermore, hurricane Ike directly affected five of our Houston locations, which were partially or fully closed for several days. The storm cut a 200-mile path, so it’s fair to say that it affected a much broader radius in the region. That all being said the key take away is that we were pleased with our sales numbers, particularly when one adjusts for all the noise in the quarter.

Taking a peek at Q4, October comps were down 2.6%, this is obviously below our third quarter performance, but considering what we’ve been hearing from many others in the industry, we believe we are actually holding up pretty well on a relative basis and I think this speaks to the value proposition we bring to our customers and the strength of our breakfast day part.

Company-owned restaurant gross profit was $17.2 million in the third quarter of 2008, compared to $18.5 million in the same period last year. The spike in utility costs negatively impacted us year-over-year by approximately $400,000. Although we look forward to some relief in 2009, as energy costs continue to fall.

Rent charges rose by approximately $700,000 compared to the third quarter of 2007, as we had several new stores in the early stages of their life cycle where fixed costs exceeded their associated sales volumes. Commodity costs were also higher, about $700,000 versus last year, but we are managing our exposure well in the current environment.

With respect to 2009, we have locked the cost for over 60% of our major agricultural commodities at prices that are virtually flat to 2008. We believe that we have some potential savings on the remaining items that would actually reduce our spent on these items on a year-over-year basis.

In fact, we’ve locked in the majority of our wheat and coffee, and are waiting patiently to take positions on the balance of our cheese needs, as well as butter which is the proxy for cream cheese. All in all we believe we stand to benefit from the burst of the commodity bubble.

Manufacturing and commissary revenues increased 18.3% to $7 million in the third quarter of 2008, compared to $5.9 million in the same period last year. Commissary comps were up in the 5% to 6% range and we did well selling to third party customers, as well as to franchisees and licensees. Inclusive of the pricing we took to restore profitability we are confident that our pricing is compelling and therefore are selling more products.

Of course, our commissary business should grow in tandem with the growth of our franchise and licensed business as well. Manufacturing and commissary gross profit saw a $1 million swing to a $400,000 compared to a $500,000 loss in the same period last year, so we clearly executed well here.

Our general and administrative expenses decreased $2.1 million compared to the same period in 2007. The overall decrease was primarily due to a reduction in corporate compensation and benefit costs, lower spending on travel, reduced sales and use tax and a reduction in non-cash stock based compensation expense.

For the full year we are projecting $35 million to $36 million in G&A expenditures, excluding stock based compensation and as a percentage of sales expect to be below 9% versus above 10% at our highest levels.

We also recorded a charge in operating expenses during the third quarter for $1.9 million to satisfy two California wage and hour settlements. This represents our current estimate of the aggregate amount, although the final liability will be subject to court approval and the actual number of claims made.

Deprecation and amortization expenses increased $800,000 in the third quarter of 2008 from the same period last year, due to additional costs related to our new corporate headquarters that became our home base in May of 2007.

Depreciation and amortization was also affected by upgrades at our existing restaurant base made since the second quarter of 2007. Based on our current purchases of capital assets, our existing base of assets and our projections for the new purchases of fixed assets, we believe depreciation expense for 2008 will be approximately $14 million.

Overall our core earnings from operations grew significantly. Excluding the previously mentioned California wage and hour settlements of $1.9 million, our non-GAAP income from operations was $7.9 million, up 16% from $6.8 million in the third quarter of 2007. Including the California wage and our settlements, our GAAP income from operations was $6 million, down $800,000 from the third quarter of 2007.

Likewise, excluding the California wage and hour settlements, which again would suggest a non-GAAP financial measure, diluted EPS would increase by $0.11 to $0.39 per share. On a GAAP basis, net income was slightly below last year’s third quarter at $4.5 million versus $4.9 million, while diluted EPS was $0.28 per share compared to $0.30 last year. Again, as I have indicated, GAAP results include the aforementioned California wage and hour settlements.

Our streamlined operating activities for first nine months of 2008 resulted in a 74% year-over-year increase in net cash provided by operations to $33.7 million. As of the end of the third quarter, this helped build unrestricted cash and cash equivalents balance to $22.2 million.

We continue to be focused on generating free cash flow and building our unrestricted cash balance from now, until June 30, 2009 which is the date our $57 million Series E preferred stock matures.

As I stated earlier, we have generated approximately $14 million of free cash flow in the first nine months of 2008 and if we were to assume similar performance for the next nine months, our unrestricted cash balance would increase by an additional $14 million by June 30, 2009.

During that time we anticipate repaying approximately $8.5 million of our senior notes, due to normal scheduled principal reductions and a required excess cash flow payment in the first quarter of 2009. While that payment will reduce our unrestricted cash, it will also reduce our leverage ratio on a dollar-per-dollar basis. In essence, we should have approximately $80 million of senior debt outstanding by June 30, 2009.

If you recall we have an accordion feature in our senior credit facility that allows us the opportunity to borrow the additional funds necessary to repay the Series E on June 30, 2009, subject to continued compliance with our covenants and subject to successful syndication and while the credit market has deteriorated in the past few months, we are thankful that there are signs of easing, and that our facility includes some very healthy institutions such as Wells Fargo Foothill, Bank of America, etc.

One last thing to remember, we have approximately $13 million of borrowing capacity on our revolving credit facility and fully expect that to remain largely unchanged on June 30, 2009. Therefore with our unrestricted cash balance as of today, plus the added cash from the next nine months, as I just described along with the $13 million in excess borrowing capacity under our revolver, I’m confident that we can work with our lenders to maintain our flexibility through the redemption.

A couple of last points with regard to the balance sheet; during the third quarter we locked in some fixed interest rate on $60 million of our first lien term loan at 3.52% plus an applicable margin. We will also benefit from being able to choose between the lower of LIBOR plus 200 basis points, or prime plus 100 basis points, which we see as a significant benefit in a volatile environment for the remaining balance of the debt.

Let me also mention another future event, in December we expect to release a significant portion of our valuation allowance, which currently reserves 100% of our deferred tax assets. As we have previously disclosed, we consider cumulative income before tax for the last three fiscal years and the level of historical and projected future taxable income in assessing the realization of our deferred tax assets and with the completion of fiscal 2008 we expect to attain positive cumulative income before tax for the fiscal years 2006, 2007, and 2008.

Consequently the final determination of the amount to be released will be largely dependent on the final approved 2009 plan. So the take away here is that you may see a large non-cash gain in the fourth quarter. We will update you on this matter on our fourth quarter earnings conference call.

That’s a summary of our financial results for the quarter. As usual, I’ll be available to answer more in depth questions during the Q-&-A session, following Paul’s remarks. With that, I’ll turn the call over to Paul Murphy.

Paul Murphy

Thank you Rick, and good afternoon everyone. Today’s environment is perhaps as challenging as it’s ever been, but despite the environment, we continue to focus on what is best for the long-term health of the business, namely serving fresh, great tasting food at a great value and with superb convenience.

Consumers today are looking for quality, cravable meals and quick portable options, but also seek premium beverage offerings such as specialty coffee and frozen blended drinks. Our wide range of both food and beverage selections enable us to make our neighborhood friendly, fast, casual concept, both distinctive and superior to our peers and.

While we appreciate the severity of the economy and are certainly not immune from its affects, as Rick said we do compete in a defensive day part and have a solid pricing strategy.

Therefore we are very focused on controlling what we can within the four walls of operation and ensuring that nothing we do undermines our close relationship with our customers. We hope you all agree that our efforts, particularly around commodities and G&A, are proving effective in these unprecedented times.

On August 19, we celebrated a company milestone, Noah’s Bagels 19, anniversary and offered our guests a 12-ounce cup of our famous Anniversary Blend coffee for just $0.19 as a token of our appreciation of their loyalty for almost two decades.

Noah’s was instrumental in bringing the taste and quality of New York bagels to the San Francisco Bay area and in fact Noah’s first location, on College Avenue in Berkeley, is still open and thriving today.

While we are certainly proud of our heritage, we are not simply resting on our laurels, but rather building a strong foundation, which enabled us to realize growth of our concepts in a prudent, judicious manner balancing the near-term economic climate with the full opportunity we have ahead of us.

During the third quarter we saw three company-owned locations, one franchise location, and 10 licensed locations, open for business. Although three company-owned and two franchise locations were also closed as we rationalized our portfolio of under performing locations.

In 2008 we now plan to open at least 17 new company-owned restaurants, one shy of the 18 that we had discussed previously due to an unforeseen permitting delay. Through the end of the third quarter we have opened nine company-owned restaurants. We have opened two franchise restaurants in 2008 and the remaining three are currently under development and are expected to open in early 2009.

On the heels of agreements with operators such as Aramark and SSP America, we have caught the attention of America’s top dining management groups. Through September 30, 20080 we have opened 22 Einstein Brothers licensed restaurants. We anticipate opening an additional 10 to 13 units in the fourth quarter.

Some of our license partners have experienced delays in either construction or budgetary funding. Recent license agreements have added new locations in high traffic venues, including airports, hotels, supermarkets, hospitals, colleges and universities. We are creating brand recognition across numerous venues and driving home the point that our concepts are easily accessible and fit our consumer’s active lifestyles.

In addition to the momentum behind the licensing program, we expanded our franchising strategy this past summer to include the Midwest, New England and the Southern United States. Initial franchise sales began last year and focused on the southeast, where several franchise agreements have already been signed.

This year we signed franchise agreements with experienced operators for 19 locations to be developed in Augusta Georgia, Frisco Texas, Tyler Texas and most recently San Antonio Texas. The acceptance of our brand in the franchise community is something we will continue to capitalize on as we expand our footprint nationwide.

Given the state of the credit markets, as well as our own capital structure we will place prime importance on our cash generation capabilities and allocation of capital. We are therefore disciplined in our growth strategy and will not pursue expansion at any price, but rather only when the unit economics justify it.

To that end we have significantly scaled back our development for 2009 and are now planning on opening six to eight company restaurants next year, which is down some 50% from 2008. By limiting CapEx we will be able to strengthen our balance sheet and pay down debt, which we feel is our best course of action today.

Finally, on our last conference call we talked about a series of marketing and advertising initiatives, we started testing in the second quarter, including broadcast advertising in some markets, outdoor advertising and newspaper FSI’s. We have carefully monitored the results so far and have found a mixture of outdoor and FSI’s are the most impactful. Based on focus group research, we have heard that among some existing customers there has been some reduced frequency as well as trading down in price point.

In summary, we are focused on what we believe are the keys to creating shareholder value and building our brand equity and to understand that that root of our success is predicated upon taking care of our customers and not sacrificing any part of their experience for the sake of short-term expediency.

As always, none of our efforts would be possible if not for all of our employees, whose continued support, effort and commitment to each of our customers makes everything else possible.

Operator, you may now open the call to questions. Questions may be addressed to either Rick or myself.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Podhorzer - Sidoti & Company.

Michael Podhorzer - Sidoti & Company

Good afternoon guys, and thanks for taking my questions. How have you guys been able to cut G&A expense so drastically and should we expect the mid $7 million level each quarter going forward?

Rick Dutkiewicz

Hi Mike, it’s Rick Dutkiewicz. I think the key for us frankly, is we took a long hard look at the level of support necessary here within the support center, the amount of travel and the benefit that we were getting from that travel. Frankly we also had a pretty substantial reduction on non-cash stock based compensation expense.

That all being said, it had a fairly profound impact on G&A for the quarter and as I stated in my opening comments the expectation ought to be for this year, somewhere between $35 million and $36 million excluding non-cash stock based comp.

Michael Podhorzer - Sidoti & Company

Okay, what about looking toward 2009?

Rick Dutkiewicz

At this time, Mike, we’re not giving any guidance specifically with respect to 2009. I think you just need to keep mindful that a key focus for us is certainly continuing to generate cash flow from operations. So we’re going to be measured in terms of what our spending is going to be at the corporate headquarters.

Michael Podhorzer - Sidoti & Company

How about the rise in operating cost, was that basically higher utility costs? What exactly was in that?

Rick Dutkiewicz

Predominantly utilities and rent, Mike.

Michael Podhorzer - Sidoti & Company

One last thing, are you seeing any impact on potential franchisees in the credit crisis?

Rick Dutkiewicz

That’s a great question. I think you step back to a couple of issues that are happening there. Number one, we’re continuing to see new franchisees and hosting, what we refer to as discovery day here at the corporate headquarters, but they’re running into kind of a combination of two issues, the first of which is as you recall, the way our concept works. We generally go into a structure that may in fact be a new complex.

So there are some delays in terms of new construction, in terms of facilities that are actually being constructed. Those delays may in fact be to the effect that the landlord’s got to get that facility leased at a far higher level than he may have had to do historically, and the second one and we all know this, for a period of time there frankly the credit markets literally shut down and so an awful lot of loans were kind of put in limbo.

I think what we’re most encouraged about, is the balance sheet of the franchisees we have are strong since they are already existing operators.

Michael Podhorzer - Sidoti & Company

Moving on to your debt covenant, how close are you? Are you guys still comfortable, I know I spoke with you a couple of weeks ago about this.

Rick Dutkiewicz

Let me give you two specific numbers that are important, the one we most look at is the ratio of debt to EBITDA and the ceiling on that, if you recall from our debt agreement which has been filed in fact with the SEC, is 2.75 times. At the end of the third quarter we were less than 2.2.

Michael Podhorzer - Sidoti & Company

And there was another number you had mentioned?

Rick Dutkiewicz

No, I think kind of the key metric there is the relationship of debt to EBITDA. So the top number, the ceiling on it is 2.75 and we were at less than 2.2.

Operator

Our next question comes from Matthew DiFrisco - Oppenheimer.

Jake Bartlett - Oppenheimer

Hello, this is Jake Bartlett in for Matt. Rick I had a question about the comp trends, you mentioned in the fourth quarter you’re looking at negative 2.6. I’m trying to get an idea whether that’s decelerating throughout the month or how you feel comfortable with that kind of persisting in the fourth quarter or possible improving, or getting worse.

Rick Dutkiewicz

Jake what we’re seeing more than anything else is that seems to be leveling out at this point. Not necessarily on a week-by-week basis, but more on a period-by-period basis. So we’re seeing some level of moderation coming in that. There are some weeks where that thing moves up to be a little bit better and there are other weeks that it then tails off. So it’s not been anything consistent, but when you average all that noise in, it appears to be relatively flat.

Jake Bartlett - Oppenheimer

In November and December of last year were there any anomalies that we should think about as we try to figure out what the rest of the quarter is going to look like?

Rick Dutkiewicz

No, I wouldn’t really look to last year of having anything unique. Other than, you have to recall that and you can look at a prior transcript that we had a pretty substantial pickup in terms of gift card breakage last year. We’ll have that again this year, but it will only be the normal recurring annual piece and that information was disclosed at our fourth quarter call last year.

Jake Bartlett - Oppenheimer

Just on franchise store openings, I want to be clear on that. Did you mention that three are going to be pushed into 2009?

Rick Dutkiewicz

Yes, they’re at various stages of development, some actually under construction, some getting finalization on loan approval, some getting finalization of permits and there are multiple of those. I think fundamentally what happened more than anything else is you had the slowdown with respect to the construction of the facility they were going into, that was pretty enlarged measure due to what the developers themselves had to deal with.

We see a lengthening out more than we had on a historic basis with this and we think that’s a combination of all these events, really focused for lack of better words around the issue with obtaining credit, both for the developer of the center as well as, shall we say the more guarded approach by a lot of lenders out there.

Jake Bartlett - Oppenheimer

Do have kind of an early estimate of how many you expect to open, your total franchise stores in 2009, with the three be incremental to that, to what you were thinking about before. Is it more --?

Rick Dutkiewicz

I think what we want to look at more than anything else, is we started a new process with them by which we’re having weekly calls and so what I’d like to do at this point is kind of defer that question into the first quarter. I’m going to get my hands a little bit more, and we want to see really how this credit crisis or how for a lack of better words, this thawing and this unclogging of the credit pipes works out in terms of their ability to access capital. Not only theirs, but more importantly the developers of the centers.

Jake Bartlett - Oppenheimer

Then the last question; licensed stores, I think you’re expecting a couple less than I think you previously expected for fourth quarter. What does that mean for 2009? Should we be pulling down our expectation to below 2008 or should we feel comfortable with saying even or up?

Rick Dutkiewicz

I’m going to make two comments there, is really what we ran into versus anything else is that the projects were frankly approved, set for commencement of construction and a lot of these are in colleges, universities and state governments. They are acting not unlike anybody else in the space, they are conserving cash and pushing off CapEx projects into 2009 and so while it’s a disappointment for us, it doesn’t mean that the project was aborted, but rather means it was deferred until such time that they can get a better handle on their cash flow.

We continue to have a great relationship with both Aramark, SIDEXO and also with our relationship with SSP Creative Host and so when you kind of aggregate all those pieces, we feel we’ve got the right partners there, that there’s a lot of opportunity, but again this is outside not only our control, but in large measure their control.

Operator

Our next question comes from Paul Westra - Cowen and Company.

Paul Westra - Cowen and Company

I wish I could follow up a little more on your G&A for the year. Can you give us a little bit more specific, what your non-cash stock comp expense expectations were at the beginning of the quarter and what they changed to for the year and then sort of what was perhaps the catch up feature in the third quarter? Did you sort of over expensed hindsight in the first half.

Rick Dutkiewicz

Paul is Rick Dutkiewicz, is that versus where we had been tracking it was really only a little over $100,000 to $200,000. It’s actually a relatively modest amount. What happens to stock based comp [Inaudible] is once the options are vested the charge disappears off the books and so a large measure of the early options are now fully vested. So that’s what’s causing that dynamic.

Paul Westra - Cowen and Company

So what is your non-cash stock comp expectations for 2008?

Rick Dutkiewicz

In terms of 2008, the way I kind of look at non-cash stock-based comp, I’d be dealing with it viewing it with an eye that to date, we’ve had roughly 900,000 and you’ll get that, certainly out of the release and we may have between another 100,000 to 200,000 for the balance of the year. Does that help?

Paul Westra - Cowen and Company

Really I was trying to get -- what if any, the one-time nature helped that G&A line. Was clearly well below I think everyone’s expectations. I was trying to gauge the --.

Rick Dutkiewicz

The G&A, there is nothing to do with the item as it relates to the California wage and hour in that G&A line. So, what I would probably characterize more than anything else, G&A for the quarter actually contracted and a lot of that wasn’t just necessarily any one item or items that we don’t expect from an ongoing basis.

Now, the third quarter tends to be lower for us, just in general terms. That’s why we really thought it was important to let you guys know that we think that G&A, for the year X the $1.9 million, will be between 35 and 36 and that excludes about $1 million of non-cash stock-based comp.

Candidly Paul, in an environment like this, it’s critically important that we manage the business as tightly as possible and we think to that end we’ve made a lot of the tough decisions. We’ve looked as to where we can sit there and pull back some spending and we don’t think it has adversely impacted the guest’s experience at the store.

Paul Westra - Cowen and Company

Moving on to the question on the wheat. Did you say you locked half of your wheat needs for the first six months of the year or for the entire year?

Rick Dutkiewicz

We’ve locked in the majority of the wheat, Paul. In round numbers it’s about 80%. Now, what I want to share with you is, we’ve locked wheat but not necessarily basis. As you recall, when you deal with the, for lack of a better word I call it the calculus around the cost of flour, you deal with the cost of the wheat crop, you deal with the credit of mill feed and you deal with basis.

From our standpoint in working with our advisors, we’re feeling that there’s probably an unwarranted premium in basis at this point. So, we considered that in terms of figuring where we’re going to be at for 2009, but we think there’s opportunity there.

Paul Westra - Cowen and Company

With respect to your wheat purchases, I know you bought extraordinarily well in 2008. So, you won’t see as much year-over-year drop, potentially given the drop in overall wheat prices. So I guess my question is that you’ve locked in 80%. The prices you’ve paid for ‘09 that you contracted. How do they compare to sort of today’s wheat price?

Rick Dutkiewicz

We locked some in earlier in the year and certainly the ones we took earlier in the year are in advance of what this is and you can pick that up, certainly by just looking at a chart.

We were also patient on a fair measure of it. By being patient, we actually were able to pick up some wheat that frankly is below today’s price, but all in all in aggregate, I think I want to kind of come back to this thing and say, look commodities is from our standpoint frankly a non-issue on a year-over-year basis, with some opportunity to actually reduce that spend.

I think we did a pretty credible job in 2008, in terms of how we managed agricultural commodities. We had a lot of discipline and I think we’re exhibiting that same discipline here for the 2009 spend.

Paul Westra - Cowen and Company

Two remaining questions; given your outlook for commodities looks to be flattish for next year, have seen then better. Your pricing outlook, if that’s the case, if say commodities are very reasonable next year, your relatively high pricing in ‘07, ‘08 falls off, what kind of pricing would you assume you’d be taking? I assume moderate or positive?

Rick Dutkiewicz

Paul, we haven’t made a final decision on pricing. We want to kind of look at all the other elements that come into our cost inputs and then we’ll use it from a measured standpoint.

I think, from our standpoint we feel really blessed that we don’t have a gun to our head, for lack of a better word, of dealing with a substantial commodity cost increase in ‘09 that would force our hand to do substantial pricing.

Paul Westra - Cowen and Company

Okay and final question; I know you talked a little bit about your marketing efforts. Can you a talk a little bit about, maybe some product promotions or tests that you are looking into, not just for the fourth quarter but maybe some bigger picture ideas for 2009?

Paul Murphy

I mean, one thing that we’re doing right now, as you kind of see what’s going on, especially in the [Inaudible], there’s some pretty aggressive discounting going on out there, especially in terms of the dollar menus as such.

I think one thing that we have done is we’ve taken a little bit of a different approach, over the last month. Really kind of a few things we’re doing now that, as we move forward. Right now, I know we have a deal going on where, if you come in and you spend $6, you get $3 off a bucket sale and what our premise is on that, is that we’re not discounting the base business. We’re getting incremental top line off that and also protecting the bottom line margin and we’ve been pleased with the results of that.

The next thing as we move forward into 2009, we’re taking a very hard look at bundling with our beverages, both in the morning and the lunch day part, but always with the mind not to erode kind of the base sale in the store, because we’re traditionally not discount-driven.

We want to promote incrementally to any price relief that we get, but we are also looking at new menu items that we’ll be able to discuss on the next conference call, on the fourth quarter call and we’ll have that a little bit better fleshed out and be able to, I think, speak a little bit clearly to that.

Operator

(Operator Instructions) Our next question comes from Matthew DiFrisco – Oppenheimer & Co.

Matthew DiFrisco - Oppenheimer & Co.

Thanks, most of my questions were answered. I just had one last one. With respect to the third quarter, I jumped on the call a little late also. Was there any benefit from reducing hours on the margin front as you had in Q2 opportunistically and what can we expect going forward as far as something that might be an outlier unique to your situation, where you could continue to optimize the hours for a couple of quarters to drive margins?

Rick Dutkiewicz

I think the biggest takeaway to have from this, if you kind of look at the cost of sales in relation to sales on a quarter-over-quarter basis, you saw that the two prime items, your prime costs that you really get impacted with that change, food costs and labor costs remain relatively flat. So, our thesis earlier on that we really weren’t getting any margin off these products, held true.

Now, I don’t think there’s any big number in terms of incremental benefit to be had from that. We’re always mindful of taking a look at hours. We don’t really see that as being another lever that we would be pulling here, in the short-term.

Matthew DiFrisco - Oppenheimer & Co.

But does that affect your comp at all?

Rick Dutkiewicz

Absolutely did. It’s well over 1% and so, as we said early in the call, if you adjust for those markets that were dramatically impacted by the sub-prime mortgage crisis, namely Southern California, Arizona, Nevada and Florida and adjusting for those comps actually would have been positive.

Matthew DiFrisco - Oppenheimer & Co.

So adjusting for the hours, is what I’m asking about. Is that --?

Rick Dutkiewicz

Adjusting for the hours got to almost flat.

Matthew DiFrisco - Oppenheimer & Co.

In all markets or are the markets excluding those mortgage-affected markets?

Rick Dutkiewicz

In all markets.

Operator

Our final question comes from Todd Cohen - MTC Advisors.

Todd Cohen - MTC Advisors

Actually the question was answered. Thank you.

Operator

Thank you. Mr. Dutkiewicz, at this time there are no further audio questions.

Rick Dutkiewicz

Well, thank you very much. We appreciate your time today and we look forward to catching up with you on our year-end conference call.

Operator

Ladies and gentlemen, this does conclude the Einstein Noah Restaurant 2008 earnings call. At this time, if you would like to dial in for the replay, you may dial 303-590-3030 or 1-800-406-7325 and enter the access code 3934899. I would like to thank you for your participation and you may now disconnect.

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