California Pizza Kitchen Inc. Q4 2008 Earnings Call Transcript

California Pizza Kitchen Inc. (CPKI)

Q4 2008 Earnings Call

February 12, 2009 4:30 pm ET

Executives

Rick Rosenfield – Co-Chief Executive Officer

Larry Flax – Co-Chief Executive Officer

Susan Collyns – Chief Financial Officer

Analysts

Matthew Difrisco – Oppenheimer & Co.

David Tarantino – Robert Baird

Brad Ludington – Keybanc Capital Markets

Nicole Miller – Piper Jaffray

Destin Tompkins – Morgan, Keegan & Company

Lawrence Miller – RBC Capital Markets

Steve Anderson – MKM Partners

[Bryan Vicara] for Bryan Elliott – Raymond James

[Bryan Wayne]

Presentation

Operator

Good afternoon. My name is [Crystal] and I will be your conference operator today. At this time, I would like to welcome everyone to the California Pizza Kitchen fourth quarter earnings conference call. (Operator Instructions). Thank you. Mr. Rick Rosenfield, you may begin your conference.

Rick Rosenfield

Thank you, operator and good afternoon everyone. Thanks for joining us on our fourth quarter and year end 2008 earnings call. I'm Rick Rosenfield, Co-CEO of California Pizza Kitchen and with me on the phone today is my Co-CEO Larry Flax, and Sue Collyns, our Chief Financial Officer and newly appointed Chief Operating Officer.

Before we begin, I need to remind everyone that part of our discussions this afternoon will include forward-looking statements. They're not guarantees of future performance, and therefore, undue reliance should not be placed upon them.

We refer all of you to the filings with the Securities and Exchange Commission for a more detailed discussion of the risks that may have a direct bearing on our operating results, performance, and financial conditions.

I'm going to start today with a discussion addressing the question that I suspect is on everybody's mind, and that I'm asked about every day from investors, analysts, friends, and acquaintances. How are you guys doing in this economy?

I think that in order to understand my answer to that question, you have to go much deeper than our quarterly or yearly numbers, and try to understand the fundamental nature of our brand and business model.

First, I'm very confident in our strengths. We've always said that we're not recession proof, but we are more recession resistant than many of our peers and competitors. That resistance stems in part by the core of our customer base and where our restaurants are located.

We know that our frequent customer skews highly toward upper income and education level demographics. While as we know, even these higher income consumers have cut back on their expenditures, nevertheless, they do have more discretionary income at their disposal, and a meal at CPK is certainly an affordable item.

Moreover, it's our perception that while retail sales at our centers are certainly off, and that loss of traffic certainly impacts us, people are still going to the malls and centers and even if they don't purchase as much, they will eat.

An old saying that a major developer told us 20 or so years ago, still holds true, "At least will all have good Saturdays." And it is still true, even in this economic environment. We also know there's been a concern expressed that CPK is highly exposed to the weakened economy in California, where indeed we do have 42% of our base, but as I have emphasized before, despite this softness, California remains our strongest profitable market, with average unit volumes and profit margins well in excess of the rest of our restaurant base.

And with the strength of our brand identity here, the strong labor pool, virtual lack of seasonality, and the attendant weather factors, our presence in California is far more a strength than a weakness.

In addition, when one considers our positioning in the current environment, one should focus on our ancillary revenue streams with Kraft and our franchising, which we'll discuss at length in a moment. However, I must tell you what gives us the most overall confidence is the strength of our team.

I've mentioned before that we now have 33 regional directors with an average tenure at CPK of 14 years, terrific store level management teams, and very committed people here at our restaurant support center in California.

It is in times like this that we're able to draw on their experience and loyalty to adapt to the current environment, and what we've been doing and I think it shows in our results, is managing our business in real time. We say that we have to manage the business we have now, not the business we had last year.

All in all, we're very confident in CPK's market position and strategy. Specifically, we feel very comfortable about our relative price point, while our innovative menu and our attentive service consistently deliver higher customer satisfaction scores.

This to me underscores the value proposition of our brand, which together with our people, is what will carry us through these tough times.

Before specifically discussing the fourth quarter, I think it's important to briefly review our accomplishments for the full year.

First, we opened 13 full-service CPK restaurants, while our franchise partners opened two domestic airport locations and eight international locations, bringing our year end total to 252 CPK restaurants around the world. This is an increase of 10% year-over-year.

In 2008, total revenues grew 7% to $677 million, including 6.6% growth in restaurant sales, 40% growth from Kraft frozen pizza sales, 12% growth from HMSHost franchises, and 53% growth through international franchising.

Comparable sales were in line with revised expectations, down 2% against a positive 3.8% comparison with the sequential slow-down in 2008, most pronounced in the fourth quarter.

In the fourth quarter, we're pleased to exceed bottom line expectations and during the period we opened our second L.A. Food Show Grill & Bar in Beverly Hills, while our franchise partner, Global Restaurant Concepts added their seventh full-service CPK restaurant in the Philippines.

HMSHosts also opened two new airport locations in the fourth quarter, in the Raleigh Durham International and Las Vegas International Airports. The Las Vegas location is actually a full-service CPK, which could open up the opportunity for other full-service franchise restaurants in the future.

So far in the first quarter of 2009, we opened one company owned full-service restaurant in Wellesley, MA, and relocated one in Natick, MA. Our CPK brand also expanded to the Middle East, with our first location in that region in Dubai. The restaurant is owned by our franchise partner, Gourmet Gulf Company and is located in the new 12 million square foot Dubai Mall.

Switching gears to matters here in the U.S., new product development is an ongoing journey at CPK, and we are pleased to have had a number of introductions recently to propel our brand. Within the restaurants themselves, we rolled out our new menu in November, which includes four cheese ravioli, asparagus soup, chicken pesto pizza, and for dessert, sticky toffee pudding and a kid's M&M sundae.

Our Kraft relationship has also enabled us to take our creativity to a new level. As a follow up to our Pizza For One launched last spring, we have now collaborated with Kraft on our first non-pizza item, called flatbread melts.

This is a single-serve, handheld microwavable product that is similar to the Pizza For One, in both size and price. The flatbread melts are being introduced in four flavors; five-cheese and spinach, chicken Santa Fe, carne acada, and chicken and bacon club.

Our CPK branded Kraft products can now be found in 20,000 locations in 50 states, up from the 17,000 we've previously discussed.

We have a wonderful partnership, which has been a win/win for each company for ten years, and the numbers back that up. In 2008, Kraft royalties, as I mentioned earlier, grew almost 40% to $6.6 million. In the current environment, consumers are obviously more cautious, eating at home more often, and as I mentioned previously, we are seeing the benefit of this in our frozen pizza sales.

Moving on to a subject that I know you're all interested in; I'd like to give you some color on how the fourth quarter – I'm sorry, how the first quarter of 2009 is unfolding so far. Bear in mind that our comps were negatively affected in Q4 by the loss of a week of shopping days between Thanksgiving and Christmas.

With our family-orientation, the kids weren't out of school as many days at the end of 2008. However, that flip came to benefit us in the first week of this year. The result is that for the month of January, comps were negative 3.3%, however, this does not account for two store remodels in the Boston area, which negatively impacted us by 7/10 of 1%, which brings the normalized January results to negative 2.6%.

However, adjusting for the strong first week in January, as best we can normalize it, we would estimate that comps in December would have been negative 5.9%, and in January would have been negative 5.3%.

As we look ahead, we think there are a number of key drivers that will help us move forward during what is expected to be a challenging year. At our company-owned restaurants, we're working on strategies that defend and protect our formidable brand.

We will limit our capital expenditures on new restaurant development by opening only five new full-service CPK locations, less than half of 2008. We'll protect margins by focusing on operational and cost efficiencies, taking expenses out of the business. In fact, our weekly discussions with CPK regional directors, has been very productive, identifying numerous savings opportunity both at our restaurant support center and in the field.

I do want to emphasize that in discussing taking costs out of the business, we are expressly not cutting any portion size or doing anything that would potentially lower our quality. What we're trying to do, is right-size the business in every manner.

We're going to also leverage our online ordering platform, which was launched in the fourth quarter, and drive curbside, regular takeout service, as well as catering orders. Next, we will devote greater attention towards insuring that our newest stores reach their optimal performance levels.

With regard to our high margin ancillary revenue streams, we're going to keep doing what we've been doing, and within the same bucket of high margin opportunities, we will continue to increase our brand presence both internationally and domestically through our many relationships with experienced franchise operators.

And with that, I'll turn it over to Sue.

Susan Collyns

Thanks Rick and good afternoon everyone. I'd like to go through our quarterly high notes that we issued today in our press release, and I'll get into it.

The total revenue for the fourth quarter fell 0.7% to $161.8 million, and that consisted of 1.2% decrease in restaurant sales to $158.3 million, royalties of Kraft increasing by approximately 40.4% to $2.3 million, and franchise revenue from both domestic and international, growing at approximately 12.4% to $1.2 million.

Our fourth quarter comp sales fell 7.2% and included 3.4% of price, negative 10.4% of traffic, and negative 0.2% of mix. Our monthly comps broke down as follows; October was down 7.3%, and that was on top of the positive 2.8% the previous year, November was down 5.7%, compared to a positive 1.7% last year, and December was down 8.5%, versus a positive 0.7% in the same period of 2007.

However, on a normalized basis, as Rick mentioned, excluding the calendar shift, December was actually down only 5.9%, and as Rick mentioned, we also had a five week versus a six week sprint from Thanksgiving to Christmas in 2008, and that would have brought the costs of quarter on a normalized basis, from negative 7.2 to negative 6.3.

Company wide, our full-service CPK restaurants delivered a weekly sales average of $61,034, which was down 8.1% from the prior year of $66,438. Our food, beverage, and paper supplies for the quarter were 25.3% of restaurant sales, which was 30 basis points higher than last year.

Sales deleveraging due to our lower comparable sales results, coupled with higher grocery costs, were the primary drivers of the variance.

Our cheese price in the fourth quarter averaged approximately $1.80 per pound, which was 10% better than last year's fourth quarter of approximately $1.99 per pound, and we expect that there will be additional favorability in this item as we move through 2009.

In fact, cheese prices have fallen rather dramatically in the last few months, and we expect to benefit from this trend, as well as the proactive hedging that we've undertaken.

Based on continuing cost of goods improvements since our last call, we now expect our cost of goods to rise by only an additional 20 basis points in 2009, compared to 2008 and we've adjusted our contractual positions with vendors to take advantage of a more purchaser-friendly environment since the last time we spoke in November.

Our labor expense increased 60 basis points to 36.9% of sales, and was the result of two key drivers, first, the decreasing comp sales and associated deleveraging of fixed costs, and second, the higher minimum wage rates in all 27 states, with the federal minimum wage moving from $5.85 to $6.55. We estimate that this cost us an incremental 20 basis points in the fourth quarter over last year.

Importantly, the effect of incremental labor deleveraging was limited by having opened only one location in the fourth quarter, compared to opening seven full-service restaurants in the fourth quarter last year.

Direct operating and occupancy costs rose by 220 basis points to 23.3% of sales, compared to the prior year. This is mostly a function of our decision to move many of our depreciable assets from a ten year life to a fifteen year life, which caused us to recalculate the amortization of occupancy charges to include rent escalations over a new timeframe.

This basically had a two-pronged effect by raising our occupancy costs by $3.8 million in the period, while consequently lowering our depreciation costs by the same amount. In addition, we experienced an increase of 8.5% or $340,000 in utilities costs in the fourth quarter, which as I'm sure you can appreciate, had a deleveraging affect when comp declined.

Excluding the $3.8 million affect the change in life, would have resulted in this line item at approximately 20.1% compared to 21.1% last year, and even with utility pressures, demonstrates solid cost control and management of this line item.

Our G&A ended at $12.9 million or was 8% of total revenue, compared to 7.1% last year, and this includes 7% of what we call core G&A, and 90 basis points of stock option expense, which totaled approximately $1.5 million.

Compared to the third quarter, our core G&A fell $252,000, which reflects our heightened focus on controlling T&E and other discretionary expenditures. Depreciation was $7.8 million and fell 140 basis points to 4.8% of sales. It's usually the accounting change I described moments ago, and it was offset by the addition of 11 new full serve – 12 new full service stores opened since the fourth quarter of last year.

Our pre-opening costs totaled $766,000 this quarter, compared to $2.6 million last year, and included one L.A. Food Show restaurant that we opened in the fourth quarter, along with expenses for pre-opening on two remodeled stores, rent on the Linden Square location we opened in the first quarter of this year, as well as approximately $70,000 in phantom rent charges.

As we made reference to in our preliminary sales release on January the 14th, we incurred a total of $13.3 million of non-cash impairment charges related to ten restaurant locations, and that included three CPK ASAPs that were all in California, and seven full-service CPK restaurants, which amounted to a $0.55 before EPS charge, before income tax.

Moving on to interest; we incurred interest expense of $555,000 this quarter, compared to $209,000 in the fourth quarter of last year. We ended the quarter with $14.4 million of cash, and $74 million of debt, and our debts funded by the $150 million line of credit that we secured back in 2008, which also has a $50 million accordion feature and is in place until May the 7th of 2013.

There is justifiably a lot of attention being given to capital structure these days, but we have a very solid and conservative balance sheet. We believe the terms we've secured are far more favorable than would have been negotiated today, both on the rate and length of the facility.

We're well within our debt covenants and we have a diversified lending group, which offers us added flexibility in this market.

On a GAAP basis, we benefitted from a 21.7% tax rate for the full year which resulted in our fourth quarter EPS of negative $0.22 inclusive of the asset write-down detailed above. Excluding the $3.3 million of non-cash impairment charges and the $194,000 of closure costs related to a store closing in November, our full year tax rate would have been closer to 32.3%, not 21.7%.

We have included a reconciliation table at the back of today's earnings release to highlight this difference between the GAAP and the pro forma numbers and as you can see, the net income pro forma numbers for the quarter is around $0.13 with a tax rate of 37.6%. This is above the range of the $0.08 to $0.10 on our January 14 sales preannouncement.

We repurchased and retired approximately 677,000 shares in the fourth quarter at an average price of $9.07 under our $50 million buyback authorization and we have already repurchased 10.7 million through December under this particular authorization. However, we intend to be very cautious in this regard going forward.

Our fourth quarter capital expenditure totaled $10.4 million and included approximately $7 million for new restaurants and remodels. Our total CapEx for 2008, including our new stores, the remodels and the capitalized maintenance, was $55 million before tenant improvement allowance and that was around $7.1 million.

With a modest capital expenditure plan for this year of approximately $30 million, we'll be placing greater emphasis on paying down our outstanding debt and improving our already solid financial condition. In fact so far this quarter we've already paid down $5 million of debt and expect to make further progress in this regard as we progress throughout the year.

Moving on to 2009 we have five full service CPKs planned, two domestic franchises and eight international stores and expect Kraft to grow at approximately 12% for the full year. We also have lease required remodels in four of our stores and another remodel in a company-owned store which will result in approximately 20 loss weeks during the year which will cost us around $0.03 EPS. In fact, 10 of the 20 weeks I just referred to are in the first quarter with the remodel of our Prudential store in Boston, and that is actually around half or around $0.015 of the $0.03 EPS I just mentioned.

So other broad numbers we thought you might be interested in for 2009 are as follows. Two thousand and nine will be a 53-week year for us and in terms of an effective tax rate for you to think about we're using 32%. We're also anticipating our core G&A will be flat with 2008 at approximately $47 million, and in addition to the core G&A our stock option expense is anticipated to be approximately $6.8 million and shares outstanding for the full year are estimated at 24.5 million shares.

While we don't plan to give our annual comp or earnings guidance in 2009 at this time, we thought that these broad metrics would be helpful and what we'd like to do is continue our practice of providing forward-looking updates during our earnings calls, but only for the prospective quarter.

So in line with this new practice for the first quarter as outlined in our press release, we're modeling a negative 5.5 to negative 6.5 decline in comps and a third quarter EPS of between $0.03 to $0.05 based on a diluted share count of approximately 24 million shares. This factors in one full service CPK opening, which is already opened, and two remodeled stores that will be closed for 10 weeks as well as two international stores.

And that concludes my financial update and now I'd like to turn the call back to Rick for closing comments.

Richard Rosenfield

Thanks, Sue. Let me leave you with the following thoughts. We think CPK is a unique brand capable of extending itself in both the U.S. and internationally. We are consciously balancing our portfolio towards a high margin low CapEx strategy through Kraft and franchising, although we will always look at and develop high quality full service locations.

We also expect to generate high levels of free cash flow that protects our balance sheet and enables us to opportunistically buy back stock and keep our debt levels manageable. Larry, Sue and I are working as a team and are in constant communication with the field to ensure that we protect shareholder value and customer satisfaction on every touch point.

Overall, we think this combination of attributes positions us to weather the storm and make us well poised when the economy turns. So with that I'd like to open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from David Tarantino – Robert Baird.

David Tarantino – Robert Baird

Sue, I know you don't want to make any bold predictions about 2009, but just wondering if you could give us some direction on the earnings sensitivity to the various levels of comps, and in particular maybe if you extrapolate that down 5% or 6% for the rest of the year, kind of what the ballpark range might be?

Susan Collyns

I think what we're prepared to do right now, David, is really just reflect on the first quarter and pull from some of the comments I made as well as some of the comments Rick made. Right now in January we're tracking a rather negative 3.3, but that also includes the impact of these stores, these 10 weeks that we're losing from remodels which are costing us around 0.7%. So on a normalized basis January look disproportionately solid but that's because of the significant sales numbers in the first week of 2009. So if you normalize that as Rick said, we're tracking a January number that's closer to around 5.3%.

I think it's really in terms of a broader amount by quarter we're not really in a position to say. I think it depends on a number of factors in the economy; the unemployment rate stabilizing, inflation moving back to a level that we understand and not moving into a deflationary environment and the housing market stabilizing. So at this point we're really only prepared to talk about Q1 and feel reasonably comfortable that a negative 5.5% to negative 6.5% comp number is the right place to refer to.

David Tarantino – Robert Baird

And just so I understand the comp guidance, in terms of why would you project something for the balance of the quarter that's worse than what you've seen already on a normalized basis? I guess it has to get even much worse given that the positive first week's in there. Is there something about the comparison that you're worried about or is this just general conservatism?

Susan Collyns

Well, I think we obviously see the events of the month of February unfolding and if January normalizes out to a negative 5.2%, we also have a lot of gift card redemptions occurring in the month of January and that's consistent with prior years' experience. And so February is tracking less well at this point than January but nothing that's concerning. And again, within that negative 5.5% to negative 6.5% range is where we think things will settle out.

David Tarantino – Robert Baird

And then just a quick question on the D&A versus occupancy trade, is that something that's going to happen every quarter now going forward or was that a one-time shift?

Susan Collyns

Well it was a one-time shift for 2008, but it will result in a continuing change going forward so direct operating and occupancy costs will be higher as a result of the increase in rent with those escalation points being met over a 15-year time horizon whereas depreciation will actually come down conversely. So right now in terms of a depreciation number for 2009 it should be at a minimum the same level as it was in 2008. So it should not exceed that level. So you'll get a benefit there whereas in the past depreciation had obviously risen every year. You're not going to see that in 2009.

David Tarantino – Robert Baird

And then you would see an equal offset in occupancy or is this a benefit?

Susan Collyns

It is actually a net benefit. It didn't quite play that way in 2008 because of some other depreciation charges we needed to incur, but there should be a marginal benefit on a go forward basis and that will commence in 2009.

Operator

Your next question comes from Matthew Difrisco – Oppenheimer & Co.

Matthew Difrisco – Oppenheimer & Co.

I'm just trying to find, did you guys mention price? I might have missed that on the call. If you could just tell us what the price overall factor was in the quarter and what you expect embedded in that 5.5, 6.5 guidance? And then also can you just give us an update on the trends given your California skew; if the world is flat now or is California still on the lower end of the same store sales spectrum relative to the nation?

Susan Collyns

I'll talk about pricing and I'll let Rick take California. In terms of price we generally make our decision on price in May of each year because we have two new menu rollouts, one in June and one in November. So the June rollout and the pricing associated with that is important. I think it's fair to say in this environment it's very difficult for any brand to consider taking pricing, so we're looking at it seriously.

We haven't decided on a final pricing number, if there will be an increase this year, but I'll just tell you directionally even if we were to take no pricing in period six, we would still have approximately 2.4% of price in our numbers for the full years because of the carryover from 2008.

And I'll just give you a sensitivity that might be worth thinking about and that is if we were to take a 1% pricing increase in period six then that would average out a price, full year pricing number, of 3%. So we're going to be somewhere from 2.4% to a maximum of 3% this year and I think that's a good way to look at it right now.

Richard Rosenfield

And on the comp, or in California, I think it's fair to say California is still soft and frankly we're still seeing the softness that we saw last year, too, in the high construction states with the same thing in Nevada and Arizona. We saw – and Florida doesn't appear to be getting the kind of robust season of traveling that they would have expected to get. And that's just sort of an anecdotal feel as to where it's at right now.

Matthew Difrisco – Oppenheimer & Co.

Okay and then also just lastly, can you give us what your frozen pizza wholesale sales were? I think you were targeting around $175 million or so for the year? Or, I'm sorry, $170 million for the year? What did you come in in the quarter?

Susan Collyns

We can talk about the Nielsen number and it was at approximately, well, actually I don't have the quarterly number in front of me. I know that the annual number was around $160 million and that's publicly reported by Kraft.

Operator

Your next question comes from Brad Ludington – Keybanc Capital Markets

Brad Ludington – Keybanc Capital Markets

I wanted to ask you a couple of questions on, first off, when we do a pro forma number in the fourth quarter is there some level – is there any kind of level of dilution we should factor into the share count when you get a positive earnings number?

Susan Collyns

I'm sorry, Brad, are you talking about the fourth quarter of 2008 or 2009?

Brad Ludington – Keybanc Capital Markets

Two thousand eight, shifting from a loss to a pro forma gain of $0.13.

Susan Collyns

Have you had a chance to look at the reconciliation table on the last page?

Brad Ludington – Keybanc Capital Markets

I had a quick glance and there probably is a share number in there that I just didn't see.

Susan Collyns

Yes. It says it's 24,050. It's actually on there, the diluted share count number, right?

Brad Ludington – Keybanc Capital Markets

Thanks. I figured I probably missed that. Talking about the second quarter you'd announced that you're probably going to do the bounce back program again. Is there – what kind of margin impact might that have on the restaurant level margins if you do run that promotion again?

Susan Collyns

I don't think we're in a position to comment on that. We know that it lifted comps last year by over 2% and are hoping it'll have a favorable impact on comps and margins ultimately in the second quarter this year. We are comparing apples and apples fortunately in the second quarter, given that we ran this program last year, so it effectively amounts to a discount on sales for the most part of it because that's where we weighted the prizes.

Brad Ludington – Keybanc Capital Markets

And I did miss, how many remodels did you say you were going to do in '09?

Susan Collyns

There are four lease required and then there's one other internal remodel. It's actually an ASAP that we're converting into a full service store. We're just doing that discretionarily. And as I said it basically results in closure weeks of 20 weeks in 2009 and 10 of those 20 weeks will be in the first quarter.

Brad Ludington – Keybanc Capital Markets

And then finally can you comment on what Valentine's Day falling on a Saturday versus a weekday last year, what kind of impact that could have on comps just by itself?

Susan Collyns

That's not something that we're terribly concerned about. We've been tracking everything recently from Obama's address to the nation Monday of this week to a whole range of must see TV options, but where we look at our Valentine's Day results and we do actually do quite well on Valentine's Day and based on previous year activity and we expect to have an uptick this Saturday as well.

Operator

Your next question comes from Nicole Miller – Piper Jaffrey

Nicole Miller – Piper Jaffray

On the remodels is it $0.03 it'll cost you, Sue?

Susan Collyns

Yes, $0.03 in total, $0.015 of that will be in Q1.

Nicole Miller – Piper Jaffray

And I think someone asked earlier, but I missed it, too, the actual price and traffic for the fourth quarter? I'm sorry.

Susan Collyns

Sure. Q4 price was 3.4% and traffic was negative 10.4 and mix was negative 0.2%.

Nicole Miller – Piper Jaffray

Thank you. And the Kraft total, you always give us to tie out, so is it, when you said the 160 is that the $40 million then that we use? That's the whole full number that ties out to your P&L that you get paid your royalty on?

Susan Collyns

We get paid – that's right. We get paid on the wholesale number but we've been in dialogue with Kraft and what they'd prefer us to refer to publicly is the Nielsen number and that's externally reported by them. So to respect their wishes that's all we're commenting on, but I think the bigger issue for us is that our royalty increased over 40% in 2008 over the previous year. I mean you can obviously back into it based on the escalation points and do it yourself, but we're not authorized to comment on that.

Nicole Miller – Piper Jaffray

And then just a last question, how are you providing value to consumers? Some of your peers are actually starting to discount different types of advertising coupons, well, just a lot of stuff out there. So how do you plan to provide value in 2009?

Susan Collyns

I think it's through traditional methods whether it's the menu or whether it's our service levels. I know from a marketing perspective there are significant opportunities helping local communities in fundraisers. In fact we just did a big one this week in California with a Florida police officer who passed away toward the back end of January and community outreach exceeded our expectations. So I think there are different ways to drive traffic and support the community.

Rick Rosenfield

I think our branding has always been that we focus even more than ever on the quality of experience, quality of service, on the substantial dollars that we have invested in our remodels and our new prototype. And then again, coming up we have our bounce back in Q2 which is a great value. But it is not – we don’t feel good about the positioning, discounting and couponing, and it's just not a direction we're comfortable with.

As Sue said, though, we really do focus on store level marketing and becoming part of the community because at the end of the day it's that customers feeling good that makes them come back and that's what we're going to drive in this environment or in any environment.

Operator

Your next question comes from Destin Tompkins – Morgan, Keegan & Company.

Destin Tompkins – Morgan, Keegan & Company

Thank you. Sue, I don't know if I missed it. Did you say what CapEx guidance for 2009 was and if not can you give it to us? And then additionally trying to get back into a free cash flow number, can you give us some parameters there as well?

Susan Collyns

I'm happy to reflect on CapEx and I outlined that in the script and we referred to a modest spend for this year of around $30 million. In fact it may not even reach that but that's the number we're targeting right now and that is a growth number. That doesn't include any tenant improvement allowances on a net basis it would be lower than that.

On a free cash flow basis, not really in a position to give you that number because that would imply that I was able to give you an EBITDA number for the full year and we'd prefer not to do that at this point. We obviously have an internal number. I think we mentioned on our Q3 call that we've suspended

the budget process toward the back end of last year and during the week of January 5th this year moved toward budgeting again.

So we’ve obviously got those numbers internally. We’re working very hard. There’s a number of cost saving initiatives and areas of opportunity that we’re focusing on, everything from food costs to labor to a utilities program to try to manage that line item. We’re excited about driving all of those initiatives and we’ll let you know as the year progresses how we’re doing, but you’ll get a better idea of free cash flow as the year progresses.

Destin Tompkins – Morgan, Keegan & Company

Okay. And then looking in your guidance that you gave for both Q1 and a little bit for 2009, the share count numbers for Q1 were lower than for the full year so it implies that maybe you’re not expecting to buy back much stock later on in the year. Am I interpreting that correctly?

Susan Collyns

I think that is the assumption at this point in time. Our goal this year is to pay down our debt and to use excess capital to do that. That’s based on the current environment and what we see today. If things change, we obviously want to reserve the flexibility to make an adjustment, but that’s the current plan.

Operator

Your next question comes from Larry Miller.

Lawrence Miller – RBC Capital Markets

Can I just ask, Sue, what cheese assumption you’re using in Q1 of ’09, I think you have a contract in place for about half the year. And further, what other contracts you might have in place that gets you to that 20 basis point run rate over 2009.

Susan Collyns

In terms of cheese, I just want to clarify a couple of points that perhaps I hadn’t had the opportunity to beforehand. The average price of cheese for us in 2008 ended up at around $1.88 per pound. So far in 2009, we’ve actually only contracted nine months at 50% and in fact we have none of the first quarter contracted at all.

And what we contract is the Class III milk future, so to cut a long story short, we basically only have around 37.5% of our cheese purchases contracted for 2009 at $1.70 per pound. So we get the balance at, obviously, the current favorable prices. As an example, I think the January price per block was $1.54 per pound, and in February right now my procurement team told me this morning it was running at around $1.13 per pound. So we’ll see the full benefit of that in our results in the first quarter.

Lawrence Miller – RBC Capital Markets

Also, can you help me understand, I think I’m missing something, if you’re extending the life of your depreciable assets by a third, why is D&A not down year-over-year by that amount? And following up on that, if we don’t have the rent rolls that you would have in the backend of the leases, it does seem possible to me that they could be going up at the same rate that the D&A could be coming down. So if you can kind of help me flush out those two counterpoints.

Susan Collyns

Philosophically, you’re exactly right, and I think I mentioned in a previous question, that 2008 the depreciation went down by around 3.8 million and direct operating and occupancy went up by the same amount. So we didn’t see a pick up in 2008 because we had some other assets that needed to be trued up. However, in 2009 we do expect a benefit going forward and I just haven’t quantified that at this point.

Lawrence Miller – RBC Capital Markets

Two quick ones, you said gift card sales were good this year, any commentary on what gift card sales were and then secondly, you mentioned a few areas that you could take out costs. Can you give us a little more color on what programs you’re putting in place so that you might be able to do to attack those costs?

Susan Collyns

Gift cards sales were actually relatively strong in 2008. They’re actually up 20% over the previous year in terms of sales, and redemptions also were very strong. In fact, in the fourth quarter the redemptions equaled approximately 1.8% of the comp number compared to 2007 where the gift card redemptions equaled approximately 1.6% of the comp number.

Just to wrap a number around that for you from a full year perspective, our gift card sales in 2008 totaled around $12.2 million compared to the previous year of $10.2 million. But in the fourth quarter, our gift card sales were actually down 11% from the previous year, and that was to do with one particular vendor ordering a tremendous amount in 2007, which actually carried them for not just ’07 but ’08 as well. So hopefully that gives you enough color on the gift cards.

Lawrence Miller – RBC Capital Markets

It does. Can you talk about the areas of cost savings and what you’re programs are?

Susan Collyns

Well, we have three key areas of attack right now that we’re focusing on from an operations perspective that I’m working with a team on. One relates to energy efficiencies. Another one relates to food cost initiatives, and we’re actually working with one of our exceptional regional directors who has a high level of talent in this area.

And he’s coming in and he’s going to be heading up an area called operational efficiencies, and we’re going to be working with him on a whole series of theoretical to actual food cost initiatives that we plan to rollout companywide, together with some repairs and maintenance opportunities that we have and we’re centralizing the management of that particular area, and anticipating saving at least a 5% target going forward.

So we’re very focused. We’re very targeted. It’s not rocket science it’s focusing on all the basics that make us great restaurateurs and help us manage the business in a very challenging time.

Rick Rosenfield

And just a footnote too, also the same regional director that we’re bringing to work on the food costs and operation efficiencies will focus on best practices on the waiver line too.

Susan Collyns

I think it’s worth saying that while we have spoken about it and we’ve been able to achieve our own level of successes a team over the last couple of years, we’ve been doing that without having one person thinking about it 24/7. And, again, in challenging times you think differently and we’ve decided that if we’re really going to make a difference and guarantee these results for our shareholders this year in a world where, obviously, things move.

But to try to shore these up as much possible it made sense to dedicate that headcount, and we’ve been able to do that without adding a headcount, which is the best thing. We’ve divided up this regional director’s stores amongst other regional directors that we have in the company, and he will be coming in here working directly with me and working under me and to secure these savings.

Operator

Your next question comes from Steve Anderson – MKM Partners

Steve Anderson – MKM Partners

Just quickly do you have a high number to calculate the 53rd week how much of that you think would add to your fiscal ’09 EPS number.

Susan Collyns

The 53rd week will be significant, but I guess I put that under the bucket of saying that would be a forward-looking estimate that, at this point in time, we’re not really comfortable giving. I’ll just refer you back, I guess, to a couple of years ago. I think the 53rd week contributed approximately $0.08 to our EPS and so that might be a starting point for you to think about.

Steve Anderson – MKM Partners

My next question is, in visiting several restaurants during the weekday luncheon I noticed they have rolled out a $7.95 lunch special. Can you tell me how many stores you have that in right now and if you plan to expand that because I noticed that it’s only on a store by store basis.

Susan Collyns

That’s right. It is only on a store by store basis and for very select stores and we’ve studied the results and, at this point, we don’t anticipate it rolling out beyond the current group that it exists in.

Rick Rosenfield

And that is a small number of stores.

Operator

Your next question comes from Bryan Elliott – Raymond James

[Bryan Vicara] for Bryan Elliott – Raymond James

This is actually [Bryan Vicara] filling in for Bryan Elliot. Just a real quick question on the 53rd week I was wondering if you could give us a sense of what costs you’re accruing on a monthly versus weekly basis where you might be able to get more leverage from that 53rd week.

Susan Collyns

Sure. I think the biggest line item you’ll see the difference in will be the rent line, so that’s in the direct operating and occupancy, also the labor line, as well as G&A. Those will be the three big drivers that are going to impact you on that 53rd week. Obviously, cost of goods comes into play but that’s a variable expense in line with that additional revenue week.

[Bryan Vicara] for Bryan Elliott – Raymond James

And is D&A accrued for on a weekly basis then? So you wouldn’t have the incremental leverage there.

Susan Collyns

We should see some moderate incremental leverage in D&A, as I said, over 2008 and I don’t know what that is for the 53rd week at this point.

[Bryan Vicara] for Bryan Elliott – Raymond James

And also just one other quick question, with the thank you card program that you’re running in Q2, is there any thoughts on potentially running that for a longer period than you ran it in the Q2 of ’08 or any thoughts around that?

Susan Collyns

I think we assess that as the year plays out and as each of these years plays out. When we initially rolled it out last year it was ten years between…

Rick Rosenfield

Ten weeks.

Susan Collyns

Ten years between the last time we did it, and we ran it for approximately a ten-week period of time. This year we actually anticipate running for a little bit longer than that, pretty much the whole quarter of Q2 rather than that abbreviated time period, and we’ll asses 2010 when it rolls around.

Operator

Your next question comes from [Bryan Wayne].

[Bryan Wayne]

I just had a quick question on the Kraft, I believe you gave the Kraft royalty guidance is about 12%, is that correct?

Rick Rosenfield

Say it again?

[Bryan Wayne]

The Kraft royalty guidance, I believe you gave for all of ’09 I believe the guidance was 12%?

Susan Collyns

It was an increase of 12% over the previous year I think is what we tried to say.

[Bryan Wayne]

And I guess just looking back over the last couple of years you’ve been growing at almost 30% and almost 40% in ’08. I guess the CPK for one doesn’t lap until I guess the second quarter. You have these new flatbread melts, which will be fully accretive, I guess, incremental to this year. So I guess just curious is that just conservatism with the 12% guidance there or is it something else?

Susan Collyns

I guess there are a couple of comments I’d make on that. One, is obviously the base is much higher now, it’s still a double-digit increase, but to secure the previous increases that we had is probably not a realistic base.

The other comment I’d make is that our ancillary revenue stream in 2008 grew 17% over the previous year and we still expect that kind of a 15%, 16%, 17% increase in 2009 for that entire group. So Kraft is clearly an important part of that, but it’s not the sole driver. I guess I would ask you to reflect on the group itself rather than one metric.

[Bryan Wayne]

One other question, I guess, on the food costs I believe at a January conference I believe you mentioned, I think, about 4% increase in total cost of goods sold. And, I guess now you’re saying the 20 basis points haven’t kind of backed into it with the pricing and whatnot yet. Is that 4% still a valid number?

Susan Collyns

Well, 4%’s being taken down now so it’s probably closer to a 2% or 3% increase in line with the moderation that we’ve seen and also some of the renegotiation that we’ve had and the dialogues that we’ve had with our vendors.

[Bryan Wayne]

Then other than cheese, could you just discuss some of the other contracts you have in place. I think on the 3-Q call you said you had about 60% locked in for ’09, if you could just update that number, please.

Susan Collyns

Sure. In the high level seafood I guess we have around 25% of our seafood locked into December of this year, meat we have just about all of that locked into December. I think we have around 50% on our grocery locked in. I think I refereed to cheese we’ve got around 37.5% locked in at $1.70 per pound and it’ll get the upside of the balance.

I think we have 100% of all of our bread and all of our dough locked in. And produce is variable as the year goes on, and I think that’s another swing factor that we’re unsure about at this time because, obviously, if there’s a natural disaster that will impact the produce prices countrywide and that’ll impact our results.

Operator

(Operator Instruction) At this time I’m showing there are no further questions.

Rick Rosenfield

Thank you all for joining and look forward to talking to you next quarter.

Susan Collyns

Thank you very much.

Operator

This concludes today’s conference call. You may now disconnect.

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