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Panera Bread Company (NASDAQ:PNRA)

Q4 2008 Earnings Call

February 12, 2009 10:00 am ET

Executives

Michele Harrison – Vice President Investor Relations

Ronald M. Shaich – Chairman of the Board & Chief Executive Officer

Jeffrey W. Kip – Chief Financial Officer & Senior Vice President

Analysts

Steven Rees – J. P. Morgan

Sharon Zackfia – William Blair & Co, LLC

John Glass – Morgan Stanley

Robert Derrington – Morgan, Keegan & Company, Inc.

David Tarantino – Robert W. Baird & Co., Inc.

Joseph Buckley – Bank of America Merrill Lynch

Jeffrey Farmer – Jefferies & Co.

Jeffery Bernstein – Barclays Capital

[Bill Solanic – Private Investor]

Operator

Welcome to today’s Panera Bread Company 2008 fourth quarter and fiscal 2008 earnings call. Today’s call is being recorded. At this time I would like to turn the call over to the Vice President of Investor Relations and corporate development Ms. Michele Harrison.

Michele Harrison

I’m Michele Harrison Panera Bread’s Vice President of Investor Relations and Corporate Development. Here with me this morning are Ron Shaich, Chairman and CEO and Jeff Kip, our Senior Vice President and Chief Financial Officer. First, let me cover a few regulatory matters. I’d like to note that during our prepared remarks and in our responses to your questions certain items may be discussed which are not based on historical facts.

Any such items including targeted 2009 results or conditions and details relating to 2009 performance should be considered as forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995. All such forward-looking statements are subject to risk and uncertainties that could cause actual results to differ materially.

I would now like to ask Jeff to review Q4 and full year 2008 with you. Ron will then provide some colored commentary on our strategic plans to move forward. Jeff will then provide you with our targets for Q1 and full year 2009 and lastly Ron will close with a few comments.

Jeffrey W. Kip

Yesterday afternoon we released earnings for the fourth quarter and full year 2008. We’re pleased to deliver diluted earnings per share of $0.84 in a difficult environment, net of about $0.03 in charges. These charges were associated with first a write off related to our Columbia strategic cash investment with Bank of America, secondly the right off of assets associated with the roll out of our new coffee program and finally an increase in reserves associated with legal settlements.

The fourth quarter diluted EPS of $0.84 and the full year EPS of $2.22 represent year-over-year growth of 50% for the quarter and 24% for the full year. Exclusive of the charges for the quarter, the quarter would have grown 55%. Fourth quarter operating profit grew by 35% to $41.7 million and operating margin expanded 130 basis points from 10.3% to 11.6%. For the full year operating profit grew 26% versus the prior year to $112.7 million and operating margin improved 30 basis points for 8.4% to 8.7%.

Let’s now walk through some of the details of our results starting with revenues. Our fourth quarter revenue increased 19% to $358 million versus $301 million in the comparable period for 2007. Let’s now look at the components of revenue growth. Net bakery café sales were up 18% or to $303 million in the fourth quarter and comprised about 85% of total revenues. Net bakery café sales for the full year 2008 grew 23.6% versus 2007 to $1.1 billion. The increase was driven by comp store sales growth and bakery cafes opened in the trailing 12 months and the impact of the 53rd week. The impact to the extra week was 6.8% of sales growth for the fourth quarter and about 2% of sales growth for the full year.

In terms of new units, we opened 32 new bakery cafes during the fourth quarter, eight of which were company owned stores and 24 of which were franchise operated including our first two stores in Canada. Fourth quarter AWS for new units opened in 2008 grew 6% versus the prior year to $36,943. For the full year, new unit average weekly sales finished at $36,694 and in line with our target of $36,000 to $38,000 for the year.

Let’s move on to comparable bakery café sales growth. First, company owned comp store sales growth for Q4 2008 which was 14 weeks versus the fourth quarter of 2007 which was 13 weeks was up 9.8% on the fiscal basis. 7.9% came from the extra week. On an apples-to-apples basis, comp sales for the 14 weeks of the fourth quarter 2008 versus the corresponding 14 weeks of 2007 and that’s the 13 weeks of the fourth quarter 2007 plus the first week of the first quarter of fiscal 2008, grew 1.9%. This is the most stable underlying comp sales growth number.

The components of the fourth quarter company comps of 1.9% included about 6.1% of price, approximately 100 basis points of negative mix impact and negative transaction growth of -3.2%. Let me note that we estimate the impact from severe weather in December on the fourth quarter transactions and comp growth to be approximately 80 basis points negative. This is based on looking specifically at the sales fall off versus run rate of specific days and geographies where there was actual severe weather.

So, all in we believe our comp growth excluding weather impact was nearly 2.7% in the fourth quarter and our core transaction growth netting out the weather impact was -2.4%. Numbers, we’re very happy with.

It’s worth noting as you look at our period-by-period breakdown of comp stores sales growth in the fourth quarter that Thanksgiving flip between period 11 and period 12 in the two years. Adjusting for this flip would render all three periods’ very stable around 2% comparable stores sales growth. On the face of it, it’s a little misleading, it’s not nearly that volatile, it’s very stable at 2%.

Our franchisees experienced similar sales growth in the fourth quarter driven by comp stores sales growth and new store openings in the trailing 12 months. Franchise operated sales growth drove our royalty revenue and fees up 19.8% to $21 million for the quarter and 11.3% to $75 million for the year. Franchise comp sales grew 10.7% on a fiscal basis for the 14 weeks of the fourth quarter of 2008 versus the 13 weeks of the fourth quarter 2007 and 5.3% for the 53 weeks of fiscal 2008 versus the 52 weeks of fiscal 2007.

Adjusting for the extra week as we did with the company comp stores sales growth, franchise comp store sales grew 3.3% for the 14 weeks in the fourth quarter 2008 versus the corresponding 14 weeks of 2007, that is the 13 weeks for the fourth quarter of 2007 plus the first week of 2008 and 3.4% for 53 weeks versus the corresponding 53 weeks of 2007. Again that’s the 52 weeks of 2007 plus the first week in 2008. We estimate weather had approximately the same impact on franchise operated comp stores sales growth as it had on the company.

To close out our comp store sales growth discussion for the quarter, system wide comparable bakery café sales growth was 2.7% for the 14 weeks of the fourth quarter of 2008 versus the comparable 14 weeks of 2007.

Moving on to the final component of revenues, fresh dough sales to franchisees. These grew 24% to $33.7 million in the fourth quarter including about a 2.1% impact for the extra operating week. As a percent of total sales fresh dough sales to franchisees were 9.4%, up 30 basis points year-over-year.

Let’s now move on to the fourth quarter expenses and profit margins. Bakery café operating profit dollars increased 21.6% in the fourth quarter and restaurant margin as a percent of sales improved by 50 basis points year-over-year driven by the company’s margin improvement initiatives. Within restaurant margin cost of food and paper was favorable by seven basis points year-over-year reflecting approximately 150 basis points of benefit from category management initiatives offset by about 80 basis points in wheat inflation.

The cost of labor remained essential flat as a percentage of sales. 100 basis points of improvement on the labor line we had originally forecast given the removal of the crisping labor was about half offset by deleveraging on -3.2% transactions and half offset by both higher manager and joint venture bonus payouts due to better performance and higher medical self insurance costs given the inflation in medical costs overall.

Let’s now look at key costs and expenses below restaurant margin. The fresh dough cost of sales to our franchisees improved 360 basis points in the fourth quarter as dough prices fully offset wheat costs increases in the quarter. With inflationary costs upset we are once again seeing the benefit of operating leverage in our fresh dough facilities as our margins return to historical levels.

G&A expenses as a percent of revenues were up 60 basis points in the fourth quarter versus the prior year, both due to the aforementioned legal settlement accruals and because corporate bonuses were up significantly in 2008 versus a year ago when minimal or no bonuses were paid out. We’re paying approximately target this year. For the full year G&A expenses as a percent of revenue were essentially flat year-over-year.

Below operating margin in the fourth quarter effective tax rate was approximately 37.5% versus 40% for the year ago period when higher tax expenses driven by a FIN 48 tax reserve. Let me also note that in the fourth quarter the company wrote off the book value of all its coffee grinders as it rolled the new coffee program with centrally ground coffee to improve quality and consistency. The impact of this charge was about $0.01 per share and the expense hit the other operating line.

Let me now conclude with a few key cash flow and balance sheet items for the fourth quarter and full year. Operations and employee stock options exercises generated cash flow of approximately $58 million in the fourth quarter and $174 million for the full year 2008. We ended the year with approximately $75 million in cash on our balance sheet. This excludes the Columbia strategic cash fund investment which I will discuss momentarily and zero debt. I can’t lie, it’s great to be a CFO with a clean balance sheet in these times.

Capital expenditures for the fourth quarter were $13.1 million and $63 million for the full year 2008. During the quarter we again adjusted the net asset value of our investment in the Bank of America Columbia strategic cash fund from $0.80 on the dollar to $0.65 on the dollar. We ended the year with about $4 million of book value of these investments on a little more than $6 million of face value compared to the 2007 yearend book value of $23 million and the original $26.6 million principal value. That original value is November 2007.

Subsequent to the end of the year we received an additional redemption of about $900,000 bringing total redemptions to more than 80% of the original holdings at about $0.96 and leaving us with a little more than $3 million of the original $26 million on our balance sheet. Our current expectation based on Columbia’s guidance is about 50% of the remaining holdings will liquidate in 2009 and the remainder thereafter.

Finally, on average for the quarter there were approximately 30.6 million fully diluted shares outstanding including the impact of 1.5 million stock options outstanding with an average exercise price of $40.73. Let me now turn it over to Ron to discuss key initiatives.

Ronald M. Shaich

For the past year we have told you about our plans to move the business forward by improving margins, by growing sales and by strengthening return on incremental invested capital. As ever, we remain committed to delivering on these initiatives. As we 2009 however we will adjust the language of our initiatives to more precisely align external language with our internal focus.

In 2009 our team will be intensely focused on growing gross profit dollars per café, driving operating leverage and using our capital smartly, all while putting in place the drivers of long term earnings growth with particular emphasis on impacting competitive advantage and concept differentiation. In other words, we intend to continue to compete in the face of the recession as a concept that people are willing to walk across the street to visit and pass competitors to reach. This has long been the key to Panera’s success and it will continue to be the key to Panera’s success.

I’d now like to walk you through the progress we have made on each of our initiatives in Q4 2008 and on our key projects to deliver on those initiatives in 2009. Let’s begin with our initiative to grow gross profit dollars per bakery café. Gross profit dollar growth is important because it is the key driver of bakery café operating profit. I should note that our focus on growth profit dollars in full year 2008 helped drive operating margin up 30 basis points year-over-year in the face of 120 basis point negative impact from wheat and diesel inflation.

Integral to our improvement in gross profit dollars was our growth in gross profit per transaction. This has been coordinated by our category management function to great success. Panera’s ability to drive gross profit per transaction through a profitable product mix fueled by a new menu structure through the high low pricing strategy we rolled out in 2008 and through the effective introduction of new products with a higher gross profit is a testament to category management work in 2008.

I should note category management led a successful system wide change in soup size in Q4 2008 which is also helping us build more gross profit per transaction now. As you know, in mid November 2008, we added a 12 ounce soup to our menu. This larger bowl replacing the 8 ounce soup which is now only available as part of a you pick two combination. The larger soup portion has also helped us to drive more soup in a bread bowl sales which is offered at the same price point as the 12 ounce soup.

Not only does soup in a bread bowl have a higher perceived value to the customer but it also offers us a very high relative gross profit per transaction. Looking forward in to 2009, our category management team is committed to continuing to drive gross profit per transaction through the continued execution of our high low pricing strategy. Our intent is to match price increases to cost inflation.

To that end, we took a $0.05 per cup increase with the roll out of our new coffee. In addition, we’re planning to take a 1% price increase in mid Q2 and are considering an additional 1% in late Q4 2009. With only these modest price increases planned for 2009, we do not expect the new price increases will be a key driver of gross profit per transaction improvement at Panera in 2009 rather, you will see us driving gross profit per transaction by continuing to work the change mix by driving sales of higher gross profit items like our signature salads and like our you pick two and by initiating new products to increase add on sales, to increase bulk bakery purchases and to increase sales of seasonal bread items.

To that end, you’ll see us testing initiatives like the you pick four. With you pick four a customer who orders an entrée that is to say a soup, a salad, a sandwich or a you pick two and also orders a beverage will the offered the opportunity to purchase a baked good to complete their meal at a very attractive price. Since our costs on a marginal baked good is relatively low this is potentially a real gross profit per transaction booster.

In addition, we’re testing bulk baked goods as an add on or gift purchase. Not only are we offering bulk bagels but we are in test on four packs of muffins and scones. You will see us focus on selling more seasonal breads at retail. We will regularly celebrate our gift worthy breads, things like Panettone, holiday bread, Irish soda bread, hot cross buns and a variety of sweet breakfast breads. We will also merchandise our breads to our guests for everyday use.

To that end, we will feature breads like the white wholegrain and the honey wheat. To help support our retail and impulse business we’ve added a merchandising function to our team. This team will be responsible for helping us structure, merchandise and communicate our add on and impulse products. In a nut shell we will drive gross profit per transaction in 2009 by focusing on programs that provide add on, bulk and impulse opportunities for our guests.

The second key element to achieving growth in gross profit dollars per café is holding transaction fall off to a minimum. In 2008 we were able to offset the leakage in our transactions by winning new transactions with the introduction of our breakfast sandwiches, with the strength of our media and with continued operational improvements. Taken together, these positive transaction builders blunted significant transaction losses that Panera could have experienced if it followed a pattern similar to so many in our industry and what they experienced in 2008.

In 2009 we are again committed to executing programs that serve to blunt the impact of the recession and build transactions. Our share the warmth breakfast celebration in late January 2009 was an example of such an effort. As you may know, we celebrated our new light and dark coffee roast. Dressed in new packaging we celebrated a new strawberry granola parfait. I will add it’s really just strawberries and low fat Stoneyfield Farm organic yogurt and a homemade granola and we also celebrated our breakfast sandwiches served on our fresh grilled ciabatta bread on January 28th by giving away free samples all day.

In lieu of purchasing the products, our guests in conjunction with Panera helped raise over $180,000 in that one day for our operation donation charitable partners across the country. The result was over 550 hits with various media. News of our share the warmth day aired on the country’s most listened to morning program as well as LA’s largest radio station and New York’s largest radio station.

More importantly, the result was the opportunity for so many customers to experience these foods themselves. We were so pleased with this initial celebration that you can expect to see similar integrated food trial campaigns throughout 2009.

We are also focused on growing transactions across all day parts through new products. At breakfast we’re testing a spicy breakfast sandwich. We’re also testing a healthy power breakfast sandwich and we’re testing steel cut oatmeal which we hope to roll out later in the year. At lunch we expect this summer to introduce new and differentiated products like the chopped cob salad, like the Santa Fe salad and an improved chicken salad made with fresh grapes, antibiotic free all natural chicken and almonds. Finally, we are testing new entrees like oven backed macaroni and cheese and an open face beef brisket sandwich.

To support these products we are also reengineering our supply chain and hope to improve both the quality of our lettuce and the mechanism in which we make our Paninis. Simply put, the goal of all of our food development and equipment projects is to continue to raise the competitive anti by offering a higher quality differentiated dining experience for our guest.

Let me note that media will also be integral to our plans for minimizing transaction fall of in 2009. Our focus over the last three years has been in testing media in such a way that we can prove to ourselves that it provides a real return on investment. We are pleased that again in 2008 the media we tested paid for itself in less than 12 months. Based on the results of our 2008 media program we will be utilizing increased media exposure, that is to say radio and billboards in 2009.

As our number of cafes per market has grown and because the price per media impression is falling significantly in 2009, we expect to generate significantly more media impressions per café in 2009 for modestly more dollars. In addition, in 2009 we will test our first TV advertising in three markets as well as an online advertising effort. We also have a loyalty program in the works that we expect to pilot later in the year. In sum, we expect media and our marketing efforts to be another tailwind for transaction growth for Panera in 2009.

Let me also talk about operations as a means to build transactions. For Panera, operations mean speed, accuracy and a further improved customer experience to increase differentiation. This is certainly not a sexy program but is one that really matters maybe more than anything else. The good news is that our stores on an internal operating metrics continue to rise.

The result is once again Panera was a top performer on [Sandlin] & Associates 2008 National Evaluation of Customer Satisfaction in the Restaurant Industry. 54% of Panera’s customers told [Sandlin] that Panera was excellent, top box on their last visit. In sum, we are confident that operations will also help to build transaction growth at Panera in 2009.

As you well know, neither product or development nor media nor operations will single handily improve our transactions in the face of a consumer meltdown. But, taken together we are hopeful that they’ll be strong enough to blunt much of the recessions impact and to help us beat our gross profit dollar targets.

Let me now move on to the second initiative in our plan, driving operating leverage and thereby improving our operating margins. As we all know operating leverage occurs when we’re able to build gross profit dollar per day without incremental costs. I’ve reviewed our efforts to drive gross profit dollars per transaction already so I won’t repeat myself now. However, operating leverage also incurs when we’re able to drive efficiencies through scale and through the utilization of our scale to effect better purchasing efficiency.

I’d now like to comment on several projects in place to utilize our scale and to effect better purchase efficiency. The first and most significant project was our effort to lock in wheat for 2009. As you know this effort will pay huge dividends in 2009. I know Jeff will review it with you when he discusses our targets and most of you understand its implications already so I won’t add to the discussion. I do however, want to comment on our efforts to improve our purchasing.

During the last 18 months our purchasing systems have been completely rebuilt. We had two intents in mind when we rebuilt our purchasing. Our first intent was to allow us to have time to adjust retail prices in the face of the extraordinary volatility we now see in so many commodities. Our second intent was to execute a laddering approach that allows us to minimize the length of our commitments.

Let me note it is our belief that none of us, none of us in Panera let me say, knows where the commodity markets are going and if we did we’d be running a commodity trading firm and not a restaurant concept. Rather, our goal is to minimize the risk of taking big bets on the direction of commodities while being certain we have the time to adjust our retail prices to our costs.

Relative to the purchasing we made a lot of progress. Specifically, we now believe we will be able to hold our cost inflation at retail in 2009 to less than 2.4%. Please note the less cost inflation we experience, the less transaction growth or gross profit per transaction is needed to deliver a certain level of gross profit dollars.

Let me also mention that another mechanism for driving operating leverage and improving operating margin is managing the growth of controlled expenses. In 2009 we’re aiming to hold growth and controllable expenses to a rate significantly less than the growth of our gross profit dollars. To do so our team is looking in to many potential areas of savings from uniforms to utilities to office supplies.

Additionally, we’re looking in to a number of green initiatives. Yes, green is the right thing to do but it’s not the right thing to do simply because of its impact on the earth that we all inhabit but as well because green offers material opportunities for waste reduction and material opportunities for reduced energy consumption and therefore improves operating margin.

Finally, we have begun to apply internal discipline to overhead. Our goal is to hold overhead growth rates to 75% of revenue growth. This also drives operating leverage. Taken together, these many initiatives offer us opportunities to drive operating leverage and ultimately our operating margins.

Let me now turn to the third initiative in our plan, smartly deploying our capital. Simply put, we delivered on our ROIC commitments in 2008. We know the average weekly sales of our new bakery cafes is a key driver of our return on capital and as Jeff told you our AWS, that is to say our average weekly sales in the class of 2008 continued to be significantly stronger than the prior year’s.

Expect to continue to see high ROI cafes in 2009. With the weakening commercial real estate market we are already seeing better deals that ultimately delivers higher returns. Historically, some of Panera’s highest return cafes were built during prior recessions. It makes sense, rent is priced at the spot market rate but is locked in for 10, 15 or 20 years. So, for a company with a strong balance sheet like Panera, this is the ideal time to make good deals.

Let me add that we’re also working on materially reducing our investment per bakery café and we will begin testing a smaller store prototype that will reduce our capital investment by approximately $200,000. This also offers the potential to drive improved return on investment and represents an additional means to improve our use of capital.

Taken together, I think you have to agree that Panera has much in place to deliver on its key 2009 initiatives. Those initiatives being driving dollar growth through improved gross profit per transaction and transaction growth, improving operating margins through operating leverage and smartly investing our capital.

With that, I’d like to turn it back to Jeff who will take you through our targets for Q1 ’09 and full year 2009. I’ll then return for some closing reflections.

Jeffrey W. Kip

I’m now going to lay out for you our financial outlook and targets for the full year of 2009 and the first quarter as well. In our press release yesterday afternoon we reaffirmed our previously issued EPS target range of $2.55 to $2.71 which represents 15% to 22% growth over 2008 EPS.

Let me walk you through our key initiatives and their corresponding metrics to understand what assumptions we used to create our targets. First let’s start with our focus on growing gross profit dollars in our bakery cafes. As Ron discussed, we plan to grow gross profit dollars by driving gross profit per transaction reflected in both mix and price growth and also growing our holding transaction fall off to a minimum.

We utilize several metrics as proxies so you can see our progress in this area. Among our key metrics are transaction growth and the impact of price and mix on comps. Taken all together, we believe comps are valuable proxy for gross profit growth. Given that price is largely in place and simply rolling in from 2008 we can hope to exceed our total gross profit growth target by either generating greater mix impact on gross profit per transaction or through transaction growth. The two initiatives are interchangeable as gross profit dollar drivers and we have significant initiatives against both as Ron has already described for you.

Let me now review our comp assumptions that root our target for you. Our 2009 full year target presently assumes comparable company owned bakery café sales growth of 0.5% to 2.5% consisting of positive mix growth of 1% to 1.5% approximately 3% of year-over-year price consisting primarily of roll in pricing and transaction growth of -3.5% to -2%. All of these comp numbers assume the 52 weeks of 2009 are compared to only the first 52 weeks of 2008 to provide the true stable comparison.

Discretion is the better part of valor and we believe it’s wise to build our transaction assumptions conservatively in the face of uncertainties created by the recession of 2009. Please note that our traffic does not have to improve from the modest levels experienced thus far in 2009 to date for us to hit our target. More on this shortly. Also remember that neither our media nor our transaction or mix building initiatives have yet come to bear on 2009 results.

Let’s now discuss our operating leverage initiative. The best metric for operating leverage is operating margin. Based on our gross profit per transaction initiatives, purchasing initiatives and cost discipline, the company is targeting approximately 75 to 125 basis points of operating margin improvement for the full year 2009.

Let’s now review some of the key operating leverage assumptions. First, as Ron mentioned, the company is now projecting bakery café and food inflation for 2009 excluding the impact of wheat and diesel fuel at approximately 2.4% below our full year-over-year price increase of 3%. In addition, as you know the company has locked in wheat for 2009 at approximately $9.5 per bushel. This is all in including both futures and bases which is approximately $5 per bushel all in favorable to the average price we paid in 2008.

As we’ve discussed in the past, every dollar movement in the price of wheat per bushel impacts the P&L by approximately $3 million which 60% going to fresh dough costs of sales to franchisees and 40% to the retail cost of food line. Additionally, we have approximately 5% dough price rolling in from our 2008 dough price increases adding a benefit of about $5.5 million on profit of fresh dough sales to franchisees. This also drives up leverage and shows up as operating margin.

Between the wheat cost benefit and the full impact of the 2008 dough prices increases, we expect cost for fresh dough sales to franchisees to return to historical levels as a percentage of fresh dough sales to franchisees. Historically, we ran with costs in the low to mid 80% before depreciation and G&A, margin levels that provide us with a fair and appropriate return on the capital investment we made in our fresh dough facilities.

Moving on we also intend to hold overhead discipline. As Ron indicated for 2009 we’re targeting our overhead growth at about 75% of our revenue growth including the impact of the 53rd week in 2008. This means that total G&A dollars year-over-year will grow in the mid single digit percent in 2009.

Let’s now discuss our initiative to use our capital well. As we’ve discussed in the past we allow only 15% of our total capital in a given year to be non-ROI capital, that’s test or infrastructure capital. We set a hurdle of 15% return all in, that’s free cash against investment on the other 85% of capital expenditures. For our new stores our hurdle is a 15% all in cash return net of the royalty we would have earned anyway had we invested no capital in franchised the location.

Our 2009 target for company owned new store average weekly sales is $36,000 to $38,000 or enough to earn the 15% net return. This is also about the same sales level that we ran in 2008. We’re targeting 80 to 90 new stores in 2009 split 40/60 between company and franchise. Just as a side note, with the current market conditions we expect that development will be skewed to the back half of the year.

In terms of capital outlays we expect to spend the following: new store capital of approaching $40 million; remodels and maintenance capital of approximately $20 to $25 million; and fresh dough facility and corporate infrastructure capita of approximately $10 million. In addition, we expect to spend approximately $20 to $25 million for the acquisition of the remaining 49% of Paradise bringing total capital expenditures to roughly $90 to $100 million including the acquisition.

Let’s now talk specifically about the first quarter targets. For the first quarter of 2009 the company is targeting earnings of $0.53 to $0.59 per diluted share versus $0.41 per diluted share in the comparable period of fiscal 2008, up 29% to 44%. The first quarter 2009 EPS target has the following key assumptions: first, Q1 company owned comparable bakery café sales growth is targeted at -0.5% to 0.5% consisting of negative mix impact of -1% to -0.5%, approximately 4% of price rolling in from 2008 price increases and transaction growth of between -3.5% and -3%.

As noted in the press release we released yesterday afternoon, company owned comparable bakery café sales declined 2% in the first fiscal period of 2009. That’s the first 28 days in the fiscal year. These results were impacted by severe winter weather in the company’s core Midwestern and Eastern markets which the company estimates had approximately a -1.5% impact on comparable bakery café sales growth in the period. Again, we calculate that number by looking at sales performance versus the stable run rate in the market given the days and geographies that we know extreme weather hit.

Company owned comp stores sales turned in grew 0.9% in the first 15 days of the second fiscal period of 2009 so quarter-to-date our comp store sales growth including the impact of weather is a -1%. This breaks down in to approximately 4% roll in price, -2% mix impact and -3% transaction growth.

Let’s look a little more closely at the steady state mix and transaction growth components. As I just stated transactions declined -3% year-to-date but growth has been impacted approximately -1% for the quarter-to-date by severe weather. So, the underlying steady state traffic growth number is -2% well ahead of the high end our guidance for the quarter and at the high end of our guidance for the year. Remember that Panera has run no media in 2009 to date.

This brings us to the mix impact percent. As I noted, price has been 4% greater than last year in the first quarter to date and check growth has been about 2% meaning our mix impact is -2% as just mentioned. However, our check growth and thus our mix impact has been pulled downward by two factors. First, week one of fiscal 2009 ended January 6th, so it was the first week of January while week one of 2008 ended January 1 so it was that week between Christmas and New Years.

The week ending January 1 typically each year has a much higher check because of the nature of holiday transactions. The net effect of this fiscal comparison was a period one check growth was lower by approximately 1% versus what we would have seen had we done a straight calendar comparison. Secondly, our coffee celebration in week one of period two which Ron discussed drove a lower check in period two because of the nature of transactions in the period to date by an estimated 1% plus.

Taking both impacts, our steady state check growth has been excess of 3% and with 4% price, thus our steady state mix impact has been a little better than -1%. Pulling it all together, in the first quarter year-to-date we have price of 4%, steady state mix impact of -1% or better net of calendar and promotion impact and steady state transaction growth of -2% of weather impact. The mix impact is in line with our first quarter guidance and the transaction impact is favorable to our first quarter guidance by a full point. Given all the factors present in the first quarter, we believe our underlying results are doing well for 2009.

Let’s move on to operating leverage metrics for the first quarter. We’re targeting 125 to 200 basis points of operating margin expansion as a byproduct of the initiatives Ron discussed earlier and the year-over-year benefit of wheat and diesel costs. The benefit from wheat and diesel costs will be approximately $3 million in the first quarter split 40/60 between retail cost of food and paper and fresh dough cost of sales to franchisees. Profit on fresh dough sales to franchisees will prove approximately $3.7 million additional in first quarter from the roll in of 2008 dough price increases.

Finally, in terms of uses of capital the company is targeting approximately five to 10 system wide new unit openings in the first quarter of fiscal 2009 with average weekly sales for company owned new units consistent with its full year target of $36,000 to $38,000. With that, I’d like to turn it back to Ron for some closing remarks.

Ronald M. Shaich

Before we turn it over to your questions, I’d like to share a few closing thoughts. The last 12 months have been very, very good for Panera. We were the best performing stock in 2008 in the restaurant industry. In fact, 2008 performance topped off a decade in which we have been the best performing restaurant stock, that is to say the best performing restaurant stock among companies with a market cap over $250 million. In fact, over the last 10 years Panera’s stock has appreciated at an annual rate of growth north of 31%.

So here, is the question an investor has to ask, does Panera remain a top performing company going forward? To be frank, we recognize how hard it is to continue generating the kind of success Panera has had. Having said that, we believe that recognizing that difficult is actually fundamental to delivering a strong performance going forward. Because we recognize this, our focus is not only on short term initiatives of driving gross profit dollar growth per bakery café, not only improving operating leverage and not only on utilizing our capital smartly but also on insuring we have the means to expand our earnings well in to the future.

To that end, we spent a fair amount of time trying to understand how we utilize this recession and how we utilize our scale to build a stronger company for the longer term. So, how do we do that in the face of this recession? We start by staying committed to strengthening our concept. It is our belief that if ever there is a time to drive differentiation, it is now. We are contrarians and we don’t respond to the flavor of the month.

While the rest of the world discounts and while the rest of the world competes with fast food to offer a $3.99 salad we focus on delivering a $12 salad for $5.99 to $7.99. That to us gets to the core of our value proposition. This is why during this recession we will be focused on differentiation to improved lettuce, improved salads, testing a new way to make paninis fresh without waste, a loyalty program through disciplined media strategies and through an ever improving operation focus including greater delivery on our metrics of speed of service and accuracy and know that this recession will end and when it does it we will come out of that recession much stronger than competing concepts.

This recession also offers an opportunity to build highly productive bakery cafes. While the rest of the world closes stores and shuns development in the face of the recession we will take advantage of the lack of demand for new real estate and build bakery cafes. Finally, we want to use this recession to strengthen our organization capabilities. So, while the rest of the world lays off employees and shrinks there organizations, we will continue to build our organization.

People are worn down by store closures and they’re worn down by organizational cut backs. They have been seeking out strong companies like Panera like we have never before seen in our history. Thus, we will continue to select the best and hire people who will be real assets to Panera in the future. Panera is one of the 10 largest food service companies in America today. As a result we have spent a fair bit of time considering how to derive benefit from size and scale that Panera offers a relatively large company.

Typically size is the enemy of special. In fact, too often size is the forerunner to mediocrity. The reason for this is that size and scale are typically used simply to take cost out of the value chain. Eventually optimization and efficiency alone lead to a poor guest experience, they lead to a lack of differentiation and they ultimately lead to transaction fall off and transaction fall off is the long term kiss of death for shareholders.

It is our intent though to follow a different path. Yes, we want to use the strength that comes with being a $2.5 billion brand but to us that means asking of our organization not simply cost reductions but sourcing and equipment development that allows us to do things for our customer experience no one else has been able to do today. When a company becomes larger, marketing become a strategic weapon that is more economically viable. Typically, this is seen as one of the real benefits of size and scale.

Unfortunately, this has led to the commercialization of many brand and again a reduction in what originally made it special. In contrast, as Panera moves forward with more aggressive marketing, it is our intent to use our marketing to enhance our guest experience and build deeper relationships with our target customers.

Let me conclude with this commitment to our team members and our investors. Know that we fully intend to utilize Panera’s size, Panera’s scale and Panera’s balance sheet to boost our competitive advantage through an ever improving customer experience particularly in this recession as a means that ultimately drives earnings expansion well in to the future.

At this time we’d like to stop. We’re open to your questions. We’ll stay on the line for a full 20 minutes. As is our custom, we request that you ask only one question at a time in order to give as many of you on the call an opportunity to weigh in. If you have additional questions we ask you to return to the queue. As I said, we’ll stay on operator until 9:40. Operator, we’re ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven Rees – J. P. Morgan.

Steven Rees – J. P. Morgan

I appreciate all the detail on the call on the negative mix and so far in the first quarter but I guess based on your promotion and prices strategy when should we expect this mix to reverse and be a positive contributor to same store sales growth in ’09?

Jeffrey W. Kip

Steve, essentially what we’re saying is we’re going to experience some of it during the first quarter, we stated that in our guidance and since we expect it to finish positive for the year we obviously expect it to turn and help in the second, third and fourth quarters.

Ronald M. Shaich

Steve, I’ll through something out at you as well. I think Panera probably is given more detail relative to its targets and what underlies them, its assumptions than I think at this point almost anybody out there. I think one of the risks in that is becoming tied to an individual metric, and now we’re discussing mix as a subset in comp and what data is going to change.

My suggestion to investors is hold us to our target, hold us to our EPS guidance and understand that these things will move around there will be ups, there will be downs. I think what we’re trying to indicate to you is that we at Panera feel completely comfortable with our guidance and our guidance for the first quarter and the year.

Jeffrey W. Kip

Just to add to that we have initiatives up against both transactions and mix. For us, we want to move both of them but they functionally work the same as part of comps.

Operator

Your next question comes from Sharon Zackfia – William Blair & Co, LLC.

Sharon Zackfia – William Blair & Co, LLC

I have a really quick question, have you thought about in any way hedging fuel given the pull back in diesel?

Jeffrey W. Kip

Yes, that’s something we’ve definitely thought about. It is an interesting discussion given the depth and liquidity in various markets and all of the accounting considerations probably a fun offline conversation when you’re feeling better. It’s something we look at and continue to look at to be honest. It could happen.

Operator

Our next question comes from John Glass – Morgan Stanley.

John Glass – Morgan Stanley

You can’t get off that easy on the comments about mix. I guess the real question is gross profit per transaction is a very important part of your gross profit strategy. You say in the release and on the call the best proxy for that is the average check growth and price is price so that’s fairly mechanical but mix is the other important component of that. So, maybe the question really is what has driven mix negative to date? What are the factors you see there and what changes that? Maybe not when but what changes that over the course of the next several quarters to make that a positive gross profit contributor?

Ronald M. Shaich

I will deal with part of it and Jeff will take it from there. I just want to say average check is the one we have. It’s got a correlation of about 60% which is to say gross profit per transaction is a reflection of what is left after the customer leaves. Average check unfortunately just is simply a reflection of what they bring in the door but it’s what we’ve got to use as a metric to discuss this. Jeff, do you want to talk about the counter balance forces?

Jeffrey W. Kip

Listen, let me just start, you can build your profit per transaction two ways John. You can improve your margin within the transaction or you can actually grow the sales of the transaction within the transaction, you can grow the size of the check. What I would tell you is that in 2008 we weren’t focused on add ons, growing the size of the check and bundling. We were focused on getting our menu oriented, moving people in to higher profit per transaction items, better margin items and taking price that we had previously left on the table.

We were never worried about check growth and in the fourth quarter what I’d tell you is we hit our profit per transaction targets and our margin targets. We hit the middle to high end depending on how you account, of our original guidance with lower transactions so we were fine there and weren’t particularly worried about mix. This year, we’re not that focused on price, essentially all of our price is coming from roll in and what we’re really looking at is a set of initiatives Ron described to build the profit per transaction through growing breakfast transactions, through growing lunch transactions, through growing bakery add ons either at the counter or impulse buying.

This is something we haven’t done before. These programs are rolling in, their just happening in the first celebration, they’re going to build through the year so it’s a different headset we bring to the metric in both years.

Operator

Your next question comes from Robert Derrington – Morgan, Keegan & Company, Inc.

Robert Derrington – Morgan, Keegan & Company, Inc.

Ron, could you give us a little bit of color on the development cost that you see currently in the marketplace? You know, the combination of land, what lease rates look like, are you seeing some benefit, are construction costs coming down? And, how does that affect your franchisees’ plans to develop restaurants? Are they financially healthy, are there any kind of problems there?

Ronald M. Shaich

Let me start and talk about our franchisees then I’ll talk about the real estate market. Our franchisees are to a group healthy. We have probably the best group of franchisees you could want. We have 35 franchisees, they have on average 20 stores, they are small to midsized businesses in their own right. Some of them are in excess of $100 million. Because, there are very few negative cash flow stores in the entire system, they have very strong cash flow. They have typically in their own right significant serious lines of credit.

So, I would say to you in a world in which there is an intense credit crisis, our franchisees in our communities the least have the affect of that. It is not been a major area of discussion shall I say within our community. In fact, I will tell you that on our last franchise round table it didn’t even come up until the second day and it came up at a dinner when we were discussing what was happening to other franchisees.

Panera is the kind of company that lenders that are still in the business want to lend to. Strong, stable with no weakness, that’s desirable. Relative to real estate, I would say the real estate markets are in stagnation, essentially very similar to what I think we saw play out in the residential real estate market. Simply put I think that the developers are in a quandary. There is less and less demand, most people are not growing, there are only a couple of people that are growing. The banks aren’t growing, the cell phone stores aren’t growing, most restaurants aren’t growing. There are very few people that are like Panera that are still out there looking for locations.

As the demand has come down, likewise, the developer on the other side of it is still saying to people like us or many times they’ve been saying to us, “I want the rate on a location that I penciled in when I went for my financing.” “I want the rate I penciled in, the kind of returns I penciled in six months ago, or a year ago, or two years ago when we first talked about the deal.” We’re saying it’s a different world and we’re not going to pay that. We want 10% or 20% less.

With a AAA balance sheet like we have and the strength of our franchisees that they bring to it. It’s an interesting discussion. Some are willing to do it because that’s the real rate today, others aren’t and that’s the kind of stagnation that occurs. The other factor that I think is relevant in the real estate markets is that for a number of developers they’re losing our big box retailers. That means that on one hand they can’t complete the center or they’ve lost their financing and that affects development so that drives the stagnation that occurs.

On the other hand that provides an opportunity. Most of our leases have co-tenancy clauses in them, it allows us to get out if we so wish. Now, that may mean that we drop the store but it also means we can speak with the developer about a different deals. In many cases that may be good for us because there’s more parking which was always a problem during the good days. So, there are a lot of forces that are at work.

I think that right now we’re in a bit of a stagnation. I think we’ll come out the other side over the next six months in which the development community will reset itself to a new reality of the economic realities and I think there’s going to be a lot of opportunity for higher return locations.

Operator

Your next question comes from David Tarantino – Robert W. Baird & Co., Inc.

David Tarantino – Robert W. Baird & Co., Inc.

Ron, just a follow up on the development, with the returns starting to improve pretty dramatically at what point do you think it’s appropriate to maybe accelerate the growth rate? Or, are you thinking that way at this point? Any color you could offer there.

Ronald M. Shaich

Our criteria for development isn’t a number, it’s driven by our return on investment hurdles that Jeff defined. We will only spend your money well. Having said that if the opportunity to spend your money go up we’ll try to take advantage of it. I think there is that desire that exists by us and in many cases our franchisees to take advantage of those opportunities.

Having said that, that’s offset by the stagnation that occurs, some of the drop out in projects that you’re starting to see, the slowdown in projects you’re starting to see. So, I think I can tell you there’s an intent to do that. I think it’s a question on the timing of that and how it plays out and what it really means over the next couple of years.

Jeffrey W. Kip

We’ll do as many as we can as long as we earn the appropriate returns.

Operator

Your next question comes from Joseph Buckley – Bank of America Merrill Lynch.

Joseph Buckley – Bank of America Merrill Lynch

Ron, a question on the gross profit per transaction focus, [inaudible] effectively in ’08 and I think how you appropriate it in ’08 is you were trying to rebuild margin. As you go in to ’09 obviously you’re keeping the same focus. Do you think about trading some of that off to focus on transaction counts or is the environment so ugly that you kind of accept there will be transaction counts and you think the gross profit focus is the way to go?

Ronald M. Shaich

Joe, I think you get it real clearly. They’re not one or the other, it’s this constant balance that you’re trying to do to drive gross profit dollars. Either way get’s you there. I think those folks that are out there that are in desperation mode driving transactions at any costs and cutting quality, optimizing, cutting their portions, they’re selling off their future and in the interest of driving transaction count.

I think on the other hand those folks that are simply squeezing margins, that did it in the best of times, that got their prices too high, got out of alignment, got their values out of alignment, they ultimately see the transaction fall off that’s the long term kiss of death. I think our view is continuing to be as we have over the long term to balance it. One of the things that we look at with great intensity is our value ratings.

Our value ratings have continued to remain stable with 80% saying that Panera is a top box, is a good or great value. That’s the way that we look at it. The other thing that I think we try to think about very intently is not to raise prices or to assume all consumers are the same. Our intent is to try to create real value for consumers appropriate to what they want.

That’s what the genesis of our high low pricing strategy is and that’s why we understand we have to protect the ability for certain of our consumers to use Panera on an everyday basis while offering opportunities as I like to tease Jeff, for rich guys like Jeff Kip here, opportunities to leave a little bit more if they so wish. Think of it like the deluxe membership at the health club or the regular membership.

My point to you which I think you get is it is this continued balancing act and we’re going to continue to deal with that balancing act trying to be intelligent and smart about it and building the business with focus on both delivering in the short term while taking care of this brand and differentiating it over the medium and long term and always protecting our relationship with our consumer.

Operator

Your next question comes from Jeffrey Farmer – Jefferies & Co.

Jeffrey Farmer – Jefferies & Co.

I’m just looking for a little bit of color on the size of the traffic benefit you guys have seen in the past when you do flip the switch on advertising?

Ronald M. Shaich

I mean it’s turning on the switch. I think it tends to be it builds, it’s not promotional at all, it’s generally brand and its celebratory around the food. So, I would say to you that anybody who thinks that the day we turn it on there’s a 300 basis point or 200 basis point jump doesn’t understand it. What it is, is it will run I believe from early March through November. It will be an underpinning to what we do and I think you will see it not reflected in a singular event but in the overall underlying transaction growth that we produce.

Operator

Your next question comes from Jeffery Bernstein – Barclays Capital.

Jeffery Bernstein – Barclays Capital

Actually I have a two part question, the ’09 guidance of 15% to 22% earnings growth, unchanged from last quarter, I’m just wondering if you were to strip out the benefit it looks like wheat prices being down 35% or so, if you were to strip out wheat and I guess perhaps diesel, what would you see the normalized earnings growth rate to be kind of excluding that anomaly? Secondly, as it relates to the balance sheet you guys highlighted $75 million in cash already, you’ve got slow on cap ex, you’ve got no debt. I think you mentioned that the board would consider share repurchase at some point. I mean, how else do you use that cash? What kind of free cash are you expecting in ’09 and do you just plan to stockpile or are there other alternatives to us it?

Jeffrey W. Kip

I think the second question of your two parts is one we get most quarters. The answer to it is we’re going to use cash in a way that yields effectively our targeted market being returns and at some point we’re going to hit a level of cash where we’re going to really talk about returning it to shareholders whether it be using balance sheet capacity or taking cash straight off the balance sheet.

Our board elected to do it about 15 months ago when we did a $75 million share repurchase in the 30s. We think that was very effective. That could happen again. Obviously, they’ve decided to do it before, I think we’ll talk about a range of options. This year to the extent we’re generating cash more than our ability to build more stores and find other higher return projects is an unusual year. We see it as a year where we want to preserve a little more balance sheet flexibility for opportunities that may arise and just simply to protect the company.

So, I think the answer is we think about this pretty simply, we’re going to build new stores with a higher return. We’ve obviously done some franchisee acquisitions at higher returns in the past. We’ve done acquisitions of related concept, Paradise obviously we did part of and we’re looking to do the other part this year which is essentially the same concept under a different name. It was an acquisition of a market. We would be willing to do something again and then we’re going to look at opportunities to return cash to shareholders appropriate to the risk levels and the credit markets and our opportunity to access cash if we need it.

In answer to your first question, obviously we’re getting a nice pick up, we went through the math on the call on the wheat and it is given us a nice level of earnings growth in an environment where everyone in the industry is having a reasonable high level of transaction loss. So, it’s a nice thing for us this year. We’re looking forward to having a good year on operating leverage that to a certain extent comes from that pick up.

Ronald M. Shaich

I’ll cut through it and add this and Jeff, correct me if you’ve got it differently. But, basically this year will get made on the wheat pick up, our EPS growth assuming we hit no worse than -3% transaction fall off. Anything that we pick up above -3% will drive us above the low end of our EPS guidance. So, the real play, the wheat is done, the real play is where do transactions fall for the full year? If they run -3% we’ll come near the low end. If they run better than that and that’s where the swing will be you’re going to move up the guidance curve. That’s the year in a nutshell.

Operator

Your next question comes from [Bill Solanic – Private Investor].

[Bill Solanic – Private Investor]

Ron, would you mind characterizing the company’s experience in opening and operating stores in dense urban settings like Chicago’s loop and Manhattan and the strategy to penetrate these kinds of markets going forward?

Ronald M. Shaich

Sure. We continue to look in all kinds of markets. People have long confused Panera as a simply suburban concept. As you know Bill, because you’re in the real estate business and a broker if I’m not mistaken, we have a number of stores in downtown Chicago, downtown St. Louis, downtown Minneapolis, downtown Boston and you’ll continue to see Panera do cafes wherever there is the opportunity to deliver high returns. That’s the criteria, you know it better than anyone.

Operator

That is all the time that we have for the question and answer session. That will conclude today’s conference. Thank you all for your participation.

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Source: Panera Bread Company Q4 2008 Earnings Call Transcript

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