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P.F. Chang’s China Bistro (NASDAQ:PFCB)

Q4 2008 Earnings Call

February 11, 2009 1:00 pm ET

Executives

Mark Munford – CFO

Richard Federico – Co-CEO

Robert Vivian – Co-CEO

Analysts

Steven Kron - Goldman Sachs

David Tarantino - Robert W. Baird

John Glass - Morgan Stanley

Matt DiFrisco - Oppenheimer

Jeff Farmer - Jefferies & Company

Joe Buckley – Merrill Lynch

Jeffrey Bernstein - Barclays Capital

Destin Tompkins - Morgan Keegan

Mitch Pfizer - Buckingham Research

Brad Luddington - Keybanc Capital Markets

Fitzhugh Taylor - Thomas Weisel Partners

John Ivankoe - JPMorgan

Brian Elliott - Raymond James

Sharon Zackfia – William Blair

Keith Siegner - Credit Suisse

Nicole Miller - Piper Jaffray

Tom Forte - Telsey Advisory Group

Larry Miller - RBC Capital Markets

Howard Penny – Research Edge

Greg Ruedy - Stephens Incorporated

Operator

Welcome to the P.F. Chang's China Bistro fourth quarter 2008 earnings release conference call. (Operator Instructions) I would now like to turn the call over to Mr. Robert Vivian, Co-Chief Executive Officer of P.F. Chang's China Bistro; please go ahead, sir.

Robert Vivian

Good morning everyone, thank you for joining us today. With me are Richard Federico, our Chairman and Co-CEO, and Mark Munford, our Chief Financial Officer. Many of our comments today will be forward-looking in nature and as such will involve risks and uncertainties.

We recommend that all investors thoroughly review our quarterly and annual filings with the SEC before taking a financial position on our company. We intend to file our 10-K later on today.

I trust that everyone has had an opportunity to see our press release this morning. Our comments will be fairly brief. It doesn’t take me very long to say that we believe sales are going to remain soft which is going to lead to margin pressure. So once I finish with that, we will open up the call and Richard, Mark, and I will try to help you with your questions.

So let’s start with the fourth quarter, sales trends last October and November continued along roughly the same rocky path that we saw in the third quarter, but then the lights went out in December. Historically we tend to sell a fair amount of Chinese food in the weeks surrounding the Christmas holiday season.

This past season was no different, we were still very busy. However we clearly felt the decline in activity from 2007. No geography was spared. We suffered year-over-year declines across our entire system. On a brighter note, our team did a very good job of managing their business during the quarter. Consequently our restaurant operating margins only suffered a slight decline despite our diminished traffic at both brands.

As we mentioned on our last call we closed 10 Pei Wei restaurants in the fourth quarter. Now that the restaurants have been closed the cost associated with those restaurants have been moved to discontinued ops. In addition our G&A in the fourth quarter was higher then normal due to Pei Wei related severance payments.

When it was all said and done earnings from continuing ops declined 22% year-over-year, which unfortunately leads us to our thoughts for 2009. While we remain hopeful that sales trends will improve from 2008 we do not place great odds on that happening.

For the year we expect negative sales trends at both concepts. Our forecast calls for a 6% to 7% decline year-over-year in average weekly sales. We expect sales trends to be worse in the first half of the year then the second half. In total we are forecasting revenues to be roughly flat versus 2008.

Now as of today, our sales plan have proven to be directionally correct, however, sales to date are slightly ahead of our forecast. If we are right about sales this year then we will suffer a decline in operating margins as our fixed costs primarily labor and depreciation, work against us. While pre opening costs will decline considerably due to our reduced development schedule, the operating margin pressure will be too great to overcome.

Consequently we expect earnings from continuing ops to decline about 20% in 2009 versus 2008. Now as bad as all that sounds, there are a few small rays of sunshine. We have two balance sheet goals this year, one is to reduce our long-term debt and the second is to end the year with fewer shares outstanding.

Notwithstanding our other dour view on our business, we expect to generate free cash flow of approximately $80 million this year which gives us great confidence that we will be able to accomplish both of our goals.

Another little shining nugget, is the progress our Pei Wei team is making at improving their business. Granted we have a long ways to go and believe me we understand that. However, our fourth quarter shows some nice sequential trends.

And finally our recent management realignment puts Richard Federico closer to our day to day operations and if history is a guide, that spells good things for our future.

With that, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Kron - Goldman Sachs

Steven Kron - Goldman Sachs

Just to make sure that I understand your comments on so far to date, you are slightly ahead of forecast, is that the forecast that the first half would be worse, is that an internal forecast or is that your forecast of down 6 to 7 average weekly sales?

Robert Vivian

That’s our internal forecast and again, we expect sales trends in the first half to be worse then the second half.

Steven Kron - Goldman Sachs

Taking a step back, as you’re looking or expecting for continued pressure in your business and as you think about changes that the consumer is making in their behavioral patterns, and others have talked about this being a little bit more on the back end, can you talk about the strategies that you are employing on positioning of the brand, on assessing the store portfolio, on changing cost structure at the Bistro on a go forward basis, how are you thinking about those things.

Richard Federico

Obviously we’ve got very different strategies going on at the respective brands. At Pei Wei we are spending an awful lot of time tugging on the three levers that we think are going to help improve that business, obviously one being cost and one being margins and the other being sales. We’re starting to look at the Pei Wei business through slightly different filters.

One of the things that I think Pei Wei has suffered from in hindsight is it has tended to look at its value equation and its positioning in relationship to being an alternative to casual dining and may not have been as focused on its relationship within its competitive set within the quick serve segment.

So if you look at the way the menu is structured, the way the food is designed, the way its priced, the way its presented, it tends to have a little bit more of feel of a casual dining experience then a little bit less of a quick casual and I think in that, we’ve created a bit of a competitive disadvantage. So we’ll be focused on being able to accelerate our menu innovation. We’ll be focused on accelerating the value equation within the brand whether it be through introduction of new product or reformulation of existing product.

We will be focused on targeted real estate. We learned an awful lot during the course of 2007 and 2008 with regards to where the best places are to build this brand and we’ll be tugging on all levers I think in the Pei Wei business in relatively short order. On the Bistro side, I expect to see a continuation of really a reflection of a process. If you look at the improvements that the brand made from a margin perspective, we definitely saw the benefit of that in the fourth quarter and that was really work that had started in the latter part of 2007 and into 2008 and we’re starting to see the benefit of it.

Part of it is generated from the fact that we are building fewer restaurants which allows our operation teams to be more intently focused on the existing business. It’s the continuation of improving processes in the stores, where we’ve been able to actually increase our speed of execution. We’ve been able to increase our product quality. We’ve been able to reduce the amount of waste that we have in the business.

We’ve been able to streamline some of our back of the house operating efficiencies in a way that we’ve made a very meaningful difference in the cost that it takes for us to operate the business while at the same time, we have not made adjustments to the front of the house. Our servers, our bartenders, our host, those folks that have that direct contact with the guests, we’ve kept those in tact and so from a value perspective we believe that the consumer is actually getting a better product in a more timely sequence and getting service that we’re very proud of.

Steven Kron - Goldman Sachs

Is there a need to take a fresh look at your portfolio of stores, particularly at the Bistro in certain geographies where perhaps development five years ago would have warranted that capital investment but looking at the wealth destruction around the country and certainly in certain geographies like Florida and California where maybe those stores were built in areas that might not see that consumer demand pick back up any time soon.

Richard Federico

That’s clearly been how we’ve approached real estate all along. Its an opportunity, you’ve heard Robert say in the past when talking about the Bistro businesses that we don’t expect a whole lot of additional capital flowing to new development in California right now. We tend to be focused in other areas of the country. I think with the brand that has what I would say limited number of great opportunities on an annual basis ranging somewhere between 10 to maybe up to 20 businesses, we can be very selective in terms of where we choose to go.

Now one of the governors that we’re all faced within this business is there’s just fewer and fewer developments getting financed. There are fewer other lifestyle retailers that are developing right now so I would expect for obviously in 2009 and probably into 2010 that we would be on the very low end of our development expectations.

Steven Kron - Goldman Sachs

I was thinking more in terms of store closures.

Richard Federico

We do not have any plans for additional store closures. We don’t have any Bistros that would warrant that kind of consideration at this point in time.

Operator

Your next question comes from the line of David Tarantino - Robert W. Baird

David Tarantino - Robert W. Baird

Just on the guidance you mentioned that you expected better trends in the second half relative to the first half just wondering why that assumption, is it the easier comparison or it is something else that you have planned.

Robert Vivian

No I think its eternal optimism in the sense that we’re hopeful that the, all of the activity that’s going on from a macro standpoint will begin to have some sort of traction by the end of the year and that perhaps the consumer will emerge from a very dark clouded psychological perspective that they have currently. We may be wrong about that. But it has a little bit less to do with our micro business and more to do with just kind of a view that we believe things will get a bit better.

David Tarantino - Robert W. Baird

On the trends to date and the first quarter, perhaps you can give some directional guidance on whether that’s better then what you saw in December or even in Q4 as a whole.

Robert Vivian

It wouldn’t take much to be better then December. Our business was down 10% in December so yes, that’s a fair statement. And that’s probably about the only color I will give you with respect to our trends thus far. Again, we expected for the year, again we are forecasting sales levels that we’d never seen for this extended period of time and I’m talking about down 6% or down 7% for the entire year.

And as I’ve said we’ve expected a worse first half on a sales comparison year-over-year then a second half which would imply again that we are, that the first half of the year is something greater then down 6% or 7% and the back half is slightly better then that. Right now we’re ahead of our internal forecast.

David Tarantino - Robert W. Baird

What tax rate are you assuming and if you could give some idea of whether a buyback is imbedded in that guidance.

Mark Munford

Our tax rate for 2009 somewhere between 25% and 26%. Its probably going to be a bit lower then we saw in 2008 simply because our earnings expectation right now is a bit lower and as far as our guidance being reflective of any buybacks, no it doesn’t consider that.

Robert Vivian

When we talk about 20% down year-over-year we’re talking about on a continuing ops basis.

Operator

Your next question comes from the line of John Glass - Morgan Stanley

John Glass - Morgan Stanley

I understand the concept of deleveraging just generally and how you talk about 20% decline, but in the fourth quarter you’re averaging [inaudible] fell by 9% at the Bistro and your restaurant margin was essentially flat, and so how does that translate into 6% down AUVs next year with 20% declines in profits, are there step functions in labor which you can’t cut any more out but you could cut last year and maybe talk a bit about food cost assumptions, maybe there’s something in there that was different then we last expected.

Robert Vivian

Again, in terms of trying to lay out guidance for 2009 I will tell you that it’s a crapshoot. Most companies are deferring from stepping out on this limb. We felt it was appropriate to try and give you some flavor for what we were thinking internally. With that as a preface let me say that any time you have declining sales trends, it is very difficult to maintain margins and I think our team did a fabulous job last year of battling their way through some very difficult sales trends. As we look into this year I expect as Richard mentioned, this is a long process for us in terms of continuous improvement. Our goal in 2009 is to continue to improve our game at both concepts, but I’m speaking specifically to the Bistro.

We expect to make continued improvements in our processes, in how we manage our business. I will tell you that I simply don’t believe that as we sit here today if you’re talking about down 6% or 7% that we will be able to have the same type of performance in 2009 as we did in 2008 from a margin standpoint.

I think its going to be very, very tough to do. I hope I’m wrong, frankly I hope I’m wrong on sales, I hope I’m wrong on the margin assumptions. But at this point in time where we sit today in February of 2009 with all that’s going on around us I think we need to be pragmatic about what’s in front of us and frankly its going to be a very tough year.

As we simply look at our business while we do expect improvement there are certain things we just don’t think you can do from a margin and from a deleveraging standpoint. Labor is going to be tough. Everyone in this industry is going to be faced with increasing wage rates this year, so that’s another headwind that we’re going to have to battle. Its going to be difficult for us to do anything with labor other then deleverage.

And you’re correct, there are certain step functions as you move down the volume scale that it becomes very, very difficult unless you begin to reduce your management across systems and that’s not something that we’re prepared to do at this point. I think that as you go down our income statement labor is going to be the one that we’re going to talk about for most of the year, depreciation by its nature is fixed and again to the extent that we have a decline in sales trends, you are going to see deleverage there.

Cost of sales, historically we just don’t move around that much. I think if you go back, three, four, five years, you’ll see the total, our bandwidth is almost probably like 50 basis points. I think that year-over-year we might see a bit of pressure and that pressure is primarily going to come from chicken, which sounds kind of strange given where chicken pricing is, but we had a very good chicken year in 2008.

On a year over year basis my guess is we’re going to see a slight tick up there. We’ll see a slight tick up in oil and in rice, and so I think that by and large we’ll have a bit of pressure on cost of sales but I can assure you that will not, we don’t believe that will be the line that will cause the greatest amount of conversation this year.

John Glass - Morgan Stanley

Can you speak about the Pei Wei margin structure in 2009, I thought closing stores were going to give you 60 or 70 basis points and you had this plan for between 200 to 300 basis points of savings with cost of goods and the labor management, does a lot of that get wiped out by the new view on AWSs or can you give some directional guidance on the Pei Wei margins.

Mark Munford

Let me just add some clarification on the discontinued ops or those 10 closed Pei Wei stores, what we’ve done is we’ve gone back and we restated all the comparable periods so the numbers that you’re looking at on a historical basis are already sans those 10 stores pulled out.

John Glass - Morgan Stanley

So there’s still some other initiatives in place to improve the labor productivity and the cost of sales at those remaining Pei Weis?

Richard Federico

Absolutely if you look at the trends through the last year one of the things that we saw in the fourth quarter was the benefit of a lot of work that had been done leading up to that. As you recall the original targets were to first get our turnover under control, try to increase the tenure of our general managers and our partners that are running our businesses and the good news is mission accomplished at least in terms of hitting our first targets.

You saw a continued improvement on the labor line in spite of some of the sales pressures that we saw during the course of the year. We expect to see a continued improvement on both of those initiatives in Q1 and into Q2 of 2009 and the team is now working on the next round of efficiencies and candidly concept development that will hopefully enhance both the labor and the product innovation lines.

John Glass - Morgan Stanley

Net, net do you expect Pei Wei margins to improve in 2009.

Richard Federico

Over 2008, imbedded in the forecast, slightly down due to increased marketing spend.

Mark Munford

One of the things that you [inaudible] visibility to, obviously we’re not giving you a detailed forecast, is on the Pei Wei side in 2008 we spent about 90 basis points of, as a percentage of sales on marketing and we’ll be ramping that up to 1.5% in 2009 so that will give us a bit more pressure.

John Glass - Morgan Stanley

Is 2009 a 53rd week year?

Mark Munford

Yes it is, 53rd week, it will give us probably a few pennies of benefit in Q4.

Operator

Your next question comes from the line of Matt DiFrisco - Oppenheimer

Matt DiFrisco - Oppenheimer

Looking at the reference to 20% decline in consolidated operation income, is that an EPS reference or a net income reference.

Robert Vivian

That’s a dollar reference.

Matt DiFrisco - Oppenheimer

Dollar EPS or dollar net income.

Robert Vivian

Dollar continuing ops. Its not an EPS reference.

Matt DiFrisco - Oppenheimer

You expect G&A and absolute dollars to be relatively flat I would assume then?

Robert Vivian

Yes we do.

Matt DiFrisco - Oppenheimer

Turning to some of the initiatives that you’ve done in 2008 on the labor side, I would presume you still have some of that benefit that you sustained margins and prevented deleverage in the fourth quarter to continue through much of the first half, or at least the first quarter, so inverted to the revenue falloff would the margin, I guess you could see actually sales improve but maybe margins or the lack of the benefit from some of these labor initiatives wane as we get through 2009.

Robert Vivian

Most of the things that we are doing are not one-time events. It’s a long process, we are going to continue in this process in terms of trying to find every manner that we can to make our operations more efficient. Now on a year over year basis will the delta be greater in 2009 then 2008? No, it will not.

Matt DiFrisco - Oppenheimer

I’m specifically talking about the reduction of the [Wok] cook at the Pei Wei, a labor scheduling system being rolled out, things like that though are, they had a dramatic impact in year one and then as you cycle that obviously its going to wane.

Robert Vivian

I don’t recall us reducing a Wok cook at Pei Wei but nonetheless—

Richard Federico

We started the project evolution work at the beginning of 2008, most of the pieces of the puzzle were rolled in Q4 of 2008 and we expect to see a continuation of those trends into the first and second quarter this year.

Matt DiFrisco - Oppenheimer

On the Pei Wei income statement it looks on a comparable basis you had operating expenses come down 100 basis points despite the down 6% same store sales, was that just the marketing differential in that you had greater marketing dollars, absolute dollars in 4Q of a year ago, or was there something else going on there.

Richard Federico

It was marketing.

Operator

Your next question comes from the line of Jeff Farmer - Jefferies & Company

Jeff Farmer - Jefferies & Company

On your value comments at Pei Wei I’m just curious if that, are we to infer from that you are thinking about rolling back price points or if you’ve already done that or what your experience has been with that in terms of making it a bit more palatable for the consumer right now and then on the Pei Wei margins, as you look at this business for the longer term and assuming you can get your average weekly sales to stabilize in the mid $30,000 range, do you ultimately see yourself able to get Pei Wei margins at the restaurant level back over 15% or over the longer term closer to what the Bistro is delivering at 18%.

Richard Federico

We are looking at price and value from a product perspective a couple of different ways at Pei Wei. We’re looking at offering some of the existing products in a smaller portion, smaller price opportunity. We are looking at the possibility of doing some more all inclusive dining opportunities. And then we are also evaluating the general format of the menu as it sits today in relationship to its current price.

If you went down each individual menu item at Pei Wei and you said for what I get with this experience and what I pay, is it a great value, the answer would be yes. If you look at it in relationship to a quicker casual experience it may not be structured exactly the way that it could be or should be and so we’re in the process of running a couple of different scenarios on menu adjustments and menu developments.

Mark Munford

As far as margins and where we expect to be long-term I think we saw some good direction trends as we looked at 2008 and what we’re forecasting in to 2009. What we ended up with in 2008 in Q4 we were roughly 330 basis points different then from the Bistro. And that’s really our barometer right now as you think about the pressures at both concepts and our entire industry is under, we said all along that we would like the Pei Wei margins to be within 150 to 200 basis points of the Bistro at maturity and the reason that we can get the returns that we’re looking for at that lower operating margin is simply the differential in the investment.

So we saw some improvement in those trends in 2008 and we’re hoping to continue that trend as we look at 2009.

Jeff Farmer - Jefferies & Company

Did you give an updated CapEx number for 2009 reflecting the lower unit count.

Robert Vivian

You’re talking about roughly $35 million.

Operator

Your next question comes from the line of Joe Buckley – Merrill Lynch

Joe Buckley – Merrill Lynch

Just to follow-up on that $35 million, is that down from the most recent guidance of as much as $60 million.

Robert Vivian

Yes it is, the expectation in terms of both Bistro and Pei Wei I think in our press release we talked about four to six units, and on Pei Wei a couple of units. That certainly drives that lower CapEx number.

Joe Buckley – Merrill Lynch

Is there anything else being cut out of the CapEx budget to get it down that much?

Robert Vivian

No, we continue to spend, there’s always a bit of spending from an infrastructure support standpoint and we are certainly not reducing our maintenance CapEx at the restaurants.

Joe Buckley – Merrill Lynch

Where did you end the year with cash, where did you end the year in terms of long-term debt and if you can fill out your comments on lower long-term debt and fewer shares, any additional color would be helpful.

Mark Munford

We ended the year with roughly $40 million of cash, and $80 million of debt on the revolver. To finish off the conversation of free cash flow when we think about 2009 cash from operations should be somewhere in the neighborhood of $110 to $120 million and as mentioned on the CapEx we are forecasting $35 to $40 million which should give us free cash flow of somewhere in the neighborhood of $70, $75 million.

I think in our prepared comments we said we wanted to do two things as far as the balance sheet is concerned. We want to end the year with less debt and we want to end the year with fewer shares so we don’t have a whole lot of particulars past that, those are the framework that we’re working under and we do have an authorization of $40 million that right now expires in July but could be extended.

Joe Buckley – Merrill Lynch

You mentioned the advertising budget for Pei Wei what are you thinking for the Bistro in terms of marketing and maybe in conjunction with that, could you take about gift cards, how you faired with gift cards in the fourth quarter and whether you’re seeing faster redemption of them in 2009 so far.

Mark Munford

On the Bistro in 2008 we spent roughly $7 million in advertising marketing which is 70 basis points of sales and as we’ve talked about we’re targeting 1% in 2009 and on the Bistro that marketing in 2008 is roughly up $3 million from where we were in 2007 so it was an investment year and will continue to be so as we look at 2009.

As far as gift cards, on a year over year basis we were up about 39%, 40% year over year on gift cards and in Q4 that was up about 20%. I don’t have detail for you on the redemption rate that we’re seeing on that.

Operator

Your next question comes from the line of Jeffrey Bernstein - Barclays Capital

Jeffrey Bernstein - Barclays Capital

On the mention of G&A earlier I think you had said you thought on a dollar basis it would be flat in 2009, just wondering if you could talk about the cost cutting opportunity and whether there’s a chance for more significant leverage as a percentage of sales, and I think you said G&A was up in the fourth quarter but that was more of an anomaly, could you talk about the cost cutting opportunities within G&A as it relates to corporate for 2009.

Robert Vivian

We’ve already gone through our support structure in terms of evaluating it in light of our business today. I think our forecast contemplates those savings, or any potential savings we may have in the future. At this point I’m not going to offer any more color with respect to that.

Jeffrey Bernstein - Barclays Capital

And then the commentary on Pei Wei marketing obviously it’s a big uptick, wondering if you could talk about marketing for the brand, what’s worked, what hasn’t worked, what you’re thinking about 2009 as it relates to pushing more value and competing more with fast casual rather then casual dining.

Richard Federico

We’ve actually got a couple of initiatives and we’re front loading, we just did an introduction of a new product, the Tia Mango Chicken. We’re supporting that with the marketing dollars specifically in our three largest markets in Houston, Phoenix and in Dallas. That initiative just started last week. We’ve put into test as I mentioned a couple of different value propositions, we have it in nine different restaurants.

As we get a bit more color on the impact and we get the feedback, we’ve allocated some dollars for that in the middle part of the year and then we’re holding back the balance of the back half of the year based on some of the other initiatives that we’ve talked about with regards to either menu development and/or other opportunities for the brand.

So we’re committed for the first part, we’re evaluating the second part and we’ll be making decisions on the third part as we get to the middle part of the year.

Jeffrey Bernstein - Barclays Capital

I think you had mentioned previously some inclusive dining options, is that what you’re talking about, a package deal of drink and a combo meal type thing.

Richard Federico

We are going to try a couple of different scenarios that look like that. It could include a drink, it could include a cup of soup, it could include a side salad, or a single spring roll, we’re formulating those as we speak. Right now what we have in place in those nine restaurants is if you think about the menu and the signature entrée section, the very large plates, we have created bowl versions of those plates and introduced those into nine restaurants through a POP marketing.

Jeffrey Bernstein - Barclays Capital

In terms of unit openings, could you give the timing of the openings and then can you talk about landlord receptiveness broadly speaking in terms of renegotiating terms, I’m hoping that 2009 terms are perhaps more favorable then 2008 but just in terms of your existing properties, have you had success in terms of approaching the real estate ownership about reductions or changes in the structure.

Robert Vivian

Insofar as the development plan is concerned, both the Bistro and Pei Wei will open one restaurant in the first quarter, Pei Wei is going to open another restaurant in the second quarter. The Bistro will open two to three restaurants in the third quarter and then finish up the year with a single restaurant in the fourth quarter. That’s roughly five restaurants for the Bistro and a couple for Pei Wei.

In terms of our conversations with developers, they are in a bit of a pickle themselves these days and so I would describe our relationship with our developers as being very good. We’re both trying to work our way through this morass and obviously we would like to pay less, obviously they would like for us to pay more, again we want to have good relationships as we exit. Hopefully this economic dilemma that we’re in and therefore we continue to work hand in hand with all of them.

Operator

Your next question comes from the line of Destin Tompkins - Morgan Keegan

Destin Tompkins - Morgan Keegan

My question is on your efforts to stabilize the sales trends and specifically on the Bistro you have talked about in the past your struggle to change the order preference, the top 10 items have been the same today as they were 10 years ago, and you have introduced a lot of new menu items to the Bistro, are you coming up with any new thoughts or ways to market new items or to change that order preference and freshen up the Bistro experience for existing customers.

Richard Federico

I would say there’s good news and bad news in the fact that people really like and come back to the things that are most popular. And from an opportunity to be able to expand our audience base we are trying a couple of different things. We have just introduced a traditional eggroll which is not something that we’ve had on the menu in the past. I think you will find that because it tends to be a bit more prototypical but a very outstanding product that that will move to the top of the class.

We are getting some really good feedback there. We will continue and have just added another fresh seafood dish, we just added a grilled mahi-mahi and again as we start to expand the selection of lighter, fresher, offerings I think we’ll continue to gain some traction there. But I think the [tenants] and the basic premise of utilizing what we have and expanding those items I think will serve us well.

But it will take us a bit of time to get more guests to appreciate the fact that we have a little bit more variety then we’ve had in the past. But we may never move the Chang’s spicy chicken person off of Chang’s spicy chicken and as long as they keep coming back every once in a while for it I’m okay with that.

Destin Tompkins - Morgan Keegan

On the menu pricing, I think you’ve said in the past you didn’t have plans for menu price in 2009, I assume that’s still the case at both brands and then on the potential for menu mix do you think we could see negative menu mix on top of traffic declines as we look at sales in 2009.

Robert Vivian

You’re right with respect to the pricing assumption for 2009, neither brand is going to be taking price. In terms of menu mix I think that, more to the point let’s talk about our average check, we expect our average check to decline in 2009 versus 2008 at both brands. At Pei Wei for all the things that we talked about in terms of possible initiatives, but also at the Bistro. We expect that many of you who have seen or know about the fact that we’ve introduced a dinner for two at the restaurant that’s priced at $40. It’s a great offering and if you get out your sharp pencil and calculator you’ll find that that is a slight discount from what you would pay if you ordered the items separately.

That’s okay. The fact of the matter is that we think it’s a great introduction to our brand. For those people who haven’t been to our restaurant lately or even those that have, it allows them to enjoy our concept in a manner that we think puts our best foot forward. You have appetizers, you have soup, you have entrées, you have dessert. It’s just a great way to course your way through our menu and I think again it highlights what we’re strong at and our hope there is once going through that experience people realize that even though they may have been Mongolian beef or Chang’s spicy chicken fans in the past, that it does offer, they begin to taste a little bit broader depth in terms of the menu.

And again they get to experience the whole dining experience that we would like for them to have. Again all of that is baked into our thoughts with respect 2009.

Operator

Your next question comes from the line of Mitch Pfizer - Buckingham Research

Mitch Pfizer - Buckingham Research

First on Pei Wei is the average weekly sales target still about $36,000 and I ask that because it seems like I think almost every class is now below that level and if that $36,000, is it changed and if it isn’t does that imply that there might be additional store closures at Pei Wei if that level is not met over the next year or so.

Mark Munford

We are currently not planning any additional store closures, however it sales continue to deteriorate it could raise some additional issues that we may need to address. Also on a quarterly basis we perform an impairment analysis and at year end we didn’t have any additional stores that required us to take an impairment charge, but once again if things continue to deteriorate we could need to address that again and take additional impairment reserves.

Mitch Pfizer - Buckingham Research

On the guidance for down 20% for income from operations that does include interest expense I believe any guidance on interest expense and I guess that does get into how much you think, how much debt you think you’re going to pay down in 2009.

Robert Vivian

Yes it does and we are not giving any guidance on it. Just one point of clarification in your question you made the statement that you thought no Pei Wei class has sales in excess of $36,000, looking at our press release it looks like we have five classes that are above that number.

Mitch Pfizer - Buckingham Research

On the revenue assumption of a flat does that include the extra week?

Robert Vivian

Yes it does.

Mitch Pfizer - Buckingham Research

In terms of Pei Wei because it seems like you might be moving more toward a fast casual positioning with that imply that you might want to hire somebody in the QSR space to help you out with, or the fast casual space to help you out with that repositioning.

Richard Federico

We will be reaching out to folks that specialize in that as a support for some of the decisions that we are making internally.

Mitch Pfizer - Buckingham Research

I believe in 2008 management was compensated on earnings per share targets is that different now that you are not providing earnings guidance and if so what are the compensation criteria?

Robert Vivian

I think we have given you earnings guidance for 2009. I think you can do the math on that but to your point are we changing our viewpoint on our incentive compensation at the senior level, the answer to that question is yes. You will see us moving away from a forecast of earnings per say, to more of a look at how our return on invested capital relates to our weighted cost of capital and then again how our return on invested capital how we are performing from year to year.

Operator

Your next question comes from the line of Brad Luddington - Keybanc Capital Markets

Brad Luddington - Keybanc Capital Markets

Back to the dinner for two for $40 that you are doing right now first off my waiter couldn’t tell me how long that’s going to last, he thought it was just for the month of February is there a time limit on that and then along with that do you attribute like you said you were beating your plan on sales right now to that promotion at all.

Richard Federico

That’s just recently been introduced to the bulk of our stores, we’ve had it in about 40 or 50 restaurants now for maybe 30 to 45 days so it’s probably too early to tell what the impact is of it and at this point in time it has not been designed as a limited time offer.

Brad Luddington - Keybanc Capital Markets

In your guidance do you have any earnings benefit from the 53rd week built into that?

Mark Munford

Yes we do, it’s a few cents of benefit in Q4.

Brad Luddington - Keybanc Capital Markets

Is there any way you can quantify, it’s kind of impressive that you’re beating plan with those a winter storms that we saw in January, is there anyway you can quantify what that might have done to same-store sales.

Robert Vivian

Yes there is a way to quantify it but no we are not going to share that with you.

Operator

Your next question comes from the line of Fitzhugh Taylor - Thomas Weisel Partners

Fitzhugh Taylor - Thomas Weisel Partners

Can you remind us what you are spending on pre-opening for both brands per unit.

Mark Munford

It’s roughly $400,000 at the Bistro and $140,000 at Pei Wei.

Fitzhugh Taylor - Thomas Weisel Partners

And then you said expected negative mix and check this year from a pure pricing standpoint is that flat as you enter the year.

Robert Vivian

Yes that’s our intent, we will see how it all shakes out, but yes that is our intent.

Fitzhugh Taylor - Thomas Weisel Partners

Could you just briefly comment on manager turnover just as you have kind of scene of the struggles as of late, any pressure or any frustrations at that level?

Richard Federico

We have actually seen stabilization in one brand and a reduction in the other in terms of overall management turnover.

Robert Vivian

The nice thing right now and again it’s the silver lining in a very dark cloud but we are seeing some great people come knocking on our door to ask if we have any positions available. It’s incumbent upon us to do everything we can during this time frame to improve the level that we have at our management teams of both brands and I can assure you that we are doing everything possible to do that.

Operator

Your next question comes from the line of John Ivankoe - JPMorgan

John Ivankoe - JPMorgan

I’m just curious on your comments that you expect that Bistro average ticket to be down in 2009 just as I guess I would think that Chang’s for two would actually be additive to your average ticket because most people wouldn’t order that much food unless you gave them a price pointed option, and if you could discuss any changes that you may be doing to the lunch bowls including promoting those that may be affecting your average ticket on that way.

Robert Vivian

I hope you’re right, as Richard mentioned we just introduced to the system last week or maybe two weeks ago the dinner for two. I hope it’s a hit, I hope that people spend more money than they normally do but again hope is not a strategy and I will tell you that as things play out this year and again it’s very difficult to talk about increasing your check in a period where we are looking at potentially double-digit unemployment. We hope that happens.

John Ivankoe - JPMorgan

Any changes to lunch, regarding lunch bowls or anything else.

Richard Federico

We’ve been really happy with the introduction of the lunch bowls, as you will recall we put those in place basically in light of having a single menu for both dayparts, we were concerned that we might get a little out of whack from a lunch perspective. The lunch bowls currently mix somewhere in that 10% range of total lunch sales and so for the folks that are looking for a more individual experience they seem to be pretty popular at this point. We do not have any new lunch bowls in development that I am aware of right now.

Operator

Your next question comes from the line of Brian Elliott - Raymond James

Brian Elliott - Raymond James

The commentary about the down 20% from continuing operations that refers to $35 million, that’s the base?

Mark Munford

Yes.

Brian Elliott - Raymond James

I think you meant your CapEx budget and the changes in the development world etc. are you anticipating any TI money in your cash flow from Ops projected range that you gave>

Robert Vivian

A modest amount yes.

Brian Elliott - Raymond James

How do you think about Valentines Day being that it’s on a Friday or Saturday, is that, how big a risk do you think that is to first quarter or February numbers.

Robert Vivian

Bryan, you're a very influential guy. More so than I am. So I would appreciate it if you would write your congressmen and senators and offer the suggestion to the Obama administration that as part of the stimulus plan we should just go ahead and fix the second Wednesday of every February as Valentine's Day.

Bryan Elliott

I'll ask for Monday.

Robert Vivian

It would cost the government absolutely nothing to do that and it would be a huge benefit to the restaurant industry.

Bryan Elliott

Well, ask for Monday and settle for Wednesday.

Robert Vivian

Thee you go. See you're better at this than I am.

Rick Federico

If you do it on Monday they may go out on Saturday anyway.

Robert Vivian

The answer to your question is is that it’s bad for us being on Saturday. We essentially lose, with Valentine’s Day is essentially a Saturday and so we like for that to occur on Tuesday or Wednesday. Our restaurants will be busy this weekend at least I hope they are. In fact on a year-over-year basis it hurts us.

Brian Elliott - Raymond James

Essentially on a comparative basis we lose a Saturday year on year for the month.

Robert Vivian

That is correct.

Brian Elliott - Raymond James

You talk about the one timers in a fourth quarter Q&A I wondered if you could give us a quantification on that and I assume that you’re generally flat guidance would be ask those one timers.

Mark Munford

In our Q4 inherent within the all of our accounting processes we have estimates, we true up those estimates at the end of each period and we’re trying to get better and better at that as we go along so we did have some things like group health insurance and Workers’ Comp and so forth that gives us a little bit of a benefit, that cut for us, we had some things cut against us in Q4 and net net actually on a one-time basis in Q4 it was actually down a penny. So there wasn’t a whole lot of benefit in Q4 related to what I will call catch up type adjustments.

Brian Elliott - Raymond James

I was actually referring to the Pei Wei closure costs that I thought you said were some in there or did I misinterpret that.

Robert Vivian

There is in the G&A line there is roughly about $2 million of expense yes.

Brian Elliott - Raymond James

Are you saying that that $2 million was offset by benefits from the list you just went through or is that independence of, that they offset the inflation in G&A.

Mark Munford

Yes net net in all what we will call quarterly type adjustments is a negative a penny.

Brian Elliott - Raymond James

That’s before we look at the one time Pei Wei issue.

Mark Munford

Yes.

Operator

Your next question comes from the line of Sharon Zackfia – William Blair

Sharon Zackfia – William Blair

On Pei Wei for the bowls what is the timing on deciding whether or not that is something to be rolled out to the rest of the system.

Richard Federico

We haven’t put a fixed time on it yet, we are running through like I mentioned a couple of different scenarios to see which ones work best. My expectation is that that process would take us another 60 days or so.

Sharon Zackfia – William Blair

On Pei Wei if I am doing the math correctly where the 10 locations that were closed where they losing around $6 million a year, is that right?

Mark Munford

About $2 million a year.

Sharon Zackfia – William Blair

Did you have a penalty in the fourth quarter from New Years shifting at the Bistro.

Robert Vivian

No we saw the same thing last year.

Operator

Your next question comes from the line of Keith Siegner - Credit Suisse

Keith Siegner - Credit Suisse

I definitely applaud the margin progress that we have gone through in a number of questions but just to go back to the sales for a second and I also appreciate all the detail on some of the product development but if you think about it with the [inaudible] 2009 with average weekly sales the lowest they’ve ever been on an annual basis, you had the earlier class years with the lowest it’s been since 2002, have you done customer surveys or studies to find out exactly what consumer perceptions are the brands and how they are using and how they are influencing it, and just to get a sense of what may be some of the cost reduction efforts have done to the overall perception.

Robert Vivian

I will say that some of this I am sure is at our doorstep but it is a little tough environment right now so I think it’s a combination of those two things. To your question have we done things that compromise the guest experience in order to improve our margins—

Keith Siegner - Credit Suisse

What are the customers telling you about their perception of the brand right now and what they want and what they use it for and of the experience and just kind of a general sense of what you are hearing from customers about the experience.

Robert Vivian

Our experience is as good or better than it has ever been and that’s what we are hearing from our guests. They also in the same breath tell us that things are a little tough at home, we don’t go as often as we’d like to go.

Keith Siegner - Credit Suisse

You mentioned chicken before have you set chicken contracts for 2009 and if you have are there any changes in clauses, do you now have price escalation clauses based on corn and or grain prices things along those lines.

Robert Vivian

Yes we have our chicken in place for 2009 and on a forecasted basis we expect to be slightly up versus the prior year.

Keith Siegner - Credit Suisse

And that’s a fixed fixed price or are their escalation costs.

Robert Vivian

No we have pluses and minuses in a contract and we’ll see how they play out through the course of the year.

Operator

Your next question comes from the line of Nicole Miller - Piper Jaffray

Nicole Miller - Piper Jaffray

What was CapEx in 2008.

Mark Munford

It was $87 million. Cash from operations in 2008 was roughly $140 million so it gave us free cash flow in 2008 of $53 million.

Nicole Miller - Piper Jaffray

Is my math right if you are looking at overall food inflation of 2% to 3% is that like 50 basis points, is that right.

Robert Vivian

Yes I think as we look into 2009 we expect a little bit of pressure but not a lot.

Nicole Miller - Piper Jaffray

I know you addressed the question earlier about what preopening is per unit is there anything you can do to address bringing that down even though you’re not really obviously not accelerating development right now as a priority but what are your thoughts on that.

Richard Federico

I think it will generally be in that range, you might be slightly better but not meaningfully.

Operator

Your next question comes from the line of Tom Forte - Telsey Advisory Group

Tom Forte - Telsey Advisory Group

On sales you’ve talked before about trends as far as California, Florida, Arizona, Nevada, I was hoping he would update that information as well as a number of states that comped positive in the quarter also if you are seeing anything different in Texas and then lastly for the fourth quarter specifically what was the year-over-year change in food costs.

Robert Vivian

With respect to the year-over-year change in food costs, I think you can get that directly from our press release.

Mark Munford

About 50 basis points favorable so in Q4 on a consolidated basis we were and 27% cost of sales, Q4 2007 we were 27.5%.

Robert Vivian

In terms of geography I think we stated earlier that the fourth quarter was at two different than it has been in the past. December was a tough month for us. Every geography was negative so it makes it real easy. There was nothing positive about December. We haven’t moved any of our restaurants, we still have great exposure in California, Arizona, Florida, Nevada, and Colorado. If you look out on a total sales basis that somewhere between 35% and 40% of our sales.

Operator

Your next question comes from the line of Larry Miller - RBC Capital Markets

Larry Miller - RBC Capital Markets

Are you thinking about any other value promotions at the Bistro, and are you getting any thoughts to actually taking prices down at this point on any of your entrées.

Richard Federico

At this point in time we do not have any new value ideas being tested in the system and we are not contemplating lowering prices.

Operator

Your next question comes from the line of Howard Penny – Research Edge

Howard Penny – Research Edge

When you look at the big picture are there any macro statistics or economic specifics that you are looking at that might drive the business higher or lower other than the obvious ones and as a note if I use the prepared remarks indicator to determine where we are in the cycle we would be closer to a bottom—

Robert Vivian

I hope you are right, I am not so sure I would necessarily draw that conclusion. In terms of macro there is nothing that we look at that everyone else doesn’t look at. Our business is pretty simple. When there are stress on the consumer there is going to be stress on our business and when and if there is relief there I think that we will share on any increase that might come to casual dining. I will tell you that I think our team said again have done a great job of becoming more efficient and if, underline the word if, if things get better from a consumer standpoint I think we will be very efficient should the sales winds turn for us.

Operator

Your next question is a follow-up from the line of Matt DiFrisco - Oppenheimer

Matt DiFrisco - Oppenheimer

Did you take any price in Pei Wei in the fourth quarter?

Mark Munford

No.

Matt DiFrisco - Oppenheimer

Is that the sequential improvement on relative COGS on a year-over-year basis, has that been a reflection of going forward new contracts a little bit better proxy for 2009 or did something go there—

Richard Federico

A combination of a couple of things but predominantly it was the, some of the shifts that we made in the menu as part of project evolution. That eliminated a couple of higher cost items and I think we are seeing the benefit from in cost of sales.

Mark Munford

We sort of recognized in the chicken rebate in Q3 and then had some more in Q4. Obviously it’s an annual contract and you don’t have enough visibility to start to book some of those rebates into you get into the latter part of the quarter so that is why you saw some favorability start in Q3.

Matt DiFrisco - Oppenheimer

But doesn’t that rebate stop with year end and not continue into 2009.

Mark Munford

That’s right.

Matt DiFrisco - Oppenheimer

But then the good things of the reducing the food costs of the lower margin items, that continues.

Richard Federico

Yes.

Matt DiFrisco - Oppenheimer

Have you looked at or done any analysis or measured how many potential co-tenants issues you might have as far as potential retail neighbors that might be closing in certain locations that you have or is that not picked up yet but you have modeled that in your conservative guidance for the comp.

Richard Federico

One of the, particularly around the Bistro, is a fundamental belief in how we position ourselves within retail centers tends to be we want to be more of a freestanding option. We tend to be a little bit more destination and probably don’t gain as much benefit from the co-tenancy. So we have not spent a whole lot of time focused necessarily on who is going dark and who is not.

Operator

Your next question comes from the line of Greg Ruedy - Stephens Incorporated

Greg Ruedy - Stephens Incorporated

Other casual diners have mentioned that smaller more efficient development may be the wave of the future with enhanced focus on ROIC, is 250 still the number for the Bistro And what adjustments do you maybe have to make to the prototype when development picks back up.

Richard Federico

One of the beauties of the Bistro and if you look at us historically is we have been able to modify the size of the building a couple of different ways. We have developed a freestanding, a couple of versions of the freestanding proto Z restaurant which is a 6200 square foot to 6400 square foot restaurant. Our system average is probably in the neighborhood of 7200 to 7500 square feet.

If you recall that several years ago we have opportunities to take be Bistro into markets that we didn’t necessarily think were the types of places we would end up but it turned out to be very very good locations for us with that prototype, places like El Paso, Texas, and McAllen Texas, and Wichita so we tend to take each specific location, tend to look at what we think the potential of the market is and then craft our building size and our investment accordingly.

Greg Ruedy - Stephens Incorporated

So 250 is still in play.

Richard Federico

Right now we have not changed our assumption.

Operator

Your next question is a follow-up from the line of Mitch Pfizer - Buckingham Research

Mitch Pfizer - Buckingham Research

Just on the January trends that you mentioned you did say that it’s doing better than your internal expectation, is that better then be 6 to 7 or better than the, your view that the first half is going to be slower than the second half, or is that nitpicking.

Robert Vivian

I think I said that we were ahead of our internal plans. But the fact is we are ahead of our internal plans for January.

Mitch Pfizer - Buckingham Research

Just on the alcohol mix has there been any changes in trends in alcohol purchases.

Robert Vivian

Not significantly, there are certain states in our country where we’ve seen a decline due to some of the DUI laws that are in place now but overall for our entire system there hasn’t been any dramatic change in alcohol consumption.

Thanks to everyone for their patience and for tuning in today. Just to give you a heads up we will be releasing our first quarter earnings on April 22. We look forward to talking to you then, thank you.

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Source: P.F. Chang’s China Bistro Q4 2008 Earnings Call Transcript
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