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Executives

Rick Rosenfield - Co-Chairman, Co-President & Co-Chief Executive Officer

Sue Collyns - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Analysts

Lloyd Connor - Connor Capital Management

Jonathan Coppin - Robert W. Baird

Matthew DiFrisco - Oppenheimer & Co.

Charlie Miller - R.W. Baird

Nicole Miller - Piper Jaffray

Brad Ludington - KeyBanc Capital Markets

Mitch Speiser - Buckingham Research

Destin Tompkins - Morgan Keegan

Lawrence Miller - RBC Capital Markets

Steven Rees - J.P. Morgan

Steve Anderson - MKM Partners

Tom Forte - Telsey Advisory Group

Tony Brenner - Roth Capital Partners LLC

Analyst for Matthew DiFrisco - Oppenheimer & Co.

California Pizza Kitchen, Inc. (CPKI) Q2 2009 Earnings Call Transcript August 6, 2009 4:30 PM ET

Operator

Good afternoon. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the California Pizza Kitchen second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Rosenfield, you may begin your conference.

Rick Rosenfield

Thank you, operator and good afternoon, everyone. Thanks for joining us today on our second quarter 2009 earnings call. I am 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 Chief Operating Officer.

Before we begin, I need to remind everyone that part of our discussions this afternoon will include forward-looking statements. They are 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.

Our second quarter was truly best in class and a tribute to the hard work that everyone on the CPK team put forth in delivering strong results during another difficult period. Similar to nap track industry trends, our sales were sequentially down from the first quarter and from what we can see, the economic recovery is mixed with all parts of the country particularly California still facing significant challenges.

Total revenues for the quarter fell $5.7 million to $170.9 million for the period and our full service comparable sales of negative 6.5% were at the low end of our original guidance. As I stated California was under pressure for the quarter and with roughly 40% of the store base. It has a material impact on overall results. In terms of our other large states, Texas, Illinois and New York also slipped sequentially from the first quarter but were not as pronounced as California while Colorado and Florida improved versus earlier in the year.

Our ancillary revenue growth including domestic/international franchising and Kraft sales increased 3.5% in the second quarter. The global recession adversely affected our international franchises while airline traffic trends negatively impacted our HMS host franchise operations. Despite the economy, our franchisees are committed to growth and we expect to open approximately eight international and two domestic franchises next year.

Additionally, we are very excited about our announcement yesterday regarding the signing of a development and franchise agreement for India. Finally, on August 17th, we will be opening a franchise kiosk unit at Hofstra University in Hampstead, Long Island which could prove to be a promising new channel for us. Our Kraft business continues to be a bright point and despite challenging competition this year, was up 22% year to date. We remained very encouraged about our prospects here.

During the second quarter of 2009, we opened one Company-owned full service restaurant in Norcross, Georgia which is a suburb of Atlanta and two locations in California, Sacramento and Valencia which is just north of Los Angeles. In addition, our franchise partners also opened a full service restaurant in Guadalajara, Mexico. The increasingly competitive casual dining environment has become a market share play and we believe that the best plans win that game and get stronger over time.

Against this backdrop, we are confident of our business approach which ensures every CKP dining experience. It is innovative, distinct and value oriented. We responded to market conditions during the April to June timeframe with a relaunch of our successful Thank You Card program and are following up with several new strategic initiatives designed to build the business and our brand for the long term by fostering loyalty and increased frequency at our full service restaurant.

Similar to what we have done in prior years, we rolled out new menu items in June. This year, we had reached our long list of innovative pizzas with a new Meat Cravers Pizza and Cheeseburger Pizza. Also included were two new twists on our most popular pizza, the original Barbeque Chicken which was introduced on our first menu in 1985. Kids can now order the Hawaiian Barbeque Chicken pizza with fresh pineapple and the Barbeque Chicken with apple with smoked bacon bits. We also augmented our salad offerings with our fresh new Moroccan Chicken Salad.

We have also prided ourselves as having category leading salads within casual dining and this new addition to our menu helps reinforce that point. On a related note, a recent readers' poll in the Honolulu newspaper named CPK as not only having the best American menu and pizza menu but also the best salad menu in Honolulu. While we have generally taken pricing in conjunction with every new menu introduction, we did not do so this year given the fragile state of the consumer.

Instead of trying to hold our margins through modest price increases, we are working even harder on containing the cost side of our business. Specifically we are protecting our margins by focusing on a series of operational and waste elimination efficiencies. Our strength in implementing these items stems from the new actual to theoretical food cost system launched in March combined with the talents of our strong operating team with significant tenure at CPK.

They are also supported by a terrific store level management team and of course a topnotch group here at our restaurant support center. At all levels of our Company, we are passionate about the task at hand and I think that has been quite apparent in our results. Other initiatives we are working on being rolled out in the back half of the year including a catering and upgraded wine program. These initiatives did not impact our Q2 results but will have an effect starting in August. Again, we are building our business for the long term and adopting a strategic approach while homeruns are nice, they are the exception and as the combination of these singles and doubles and we believe are sustainable and will help our business grow consistently over time.

Following on the appointment of a director of operational efficiencies in the first quarter, we made another key appointment in June, a director of sales. He is working with Larry, Sue and me to drive revenue per employee through various initiatives and across all channels. In late July, we began print and digital advertising in all major markets launching a CPK adventure card which promotes new menu items through September 15th by giving 20% off on only those items. Of course you are all welcome to register for an adventure card on our website.

Additionally, this month, we launched a loyalty program with American Express aimed to driving traffic. Finally, in September, we are launching a business-to-business program across the country and we are testing our call centers to drive takeout sales which represent 14% of our restaurant sales. Our customers have always had high expectations for great dining experience in our restaurants that is probably more true today than it has ever been.

We are confident that we are effectively reaching out to them through all our many touch points and rightfully earning their patronage. Before I turn it over to Sue, I would like to give you an update on our development of Company-owned restaurant which of course is a key driver of long-term growth. I am happy to say that we are able to see at least one silver lining in the cloud of current economic conditions. While the development of new projects had slowed to a trickle in the United States, the shakeout in retail and restaurants in mature properties is providing an opportunity for us particularly because we are able to leverage long standing relationships with the largest developers.

We are also able to take advantage of a very flexible footprint that allows us to capitalize on retail space as small as 3500 square feet although 4500 square feet is a more efficient minimum for us. As of today, we are planning to open at least eight new full service restaurants and ten franchises units next year and the message that we are sending is very clear, we are very confident in our future and are accelerating growth albeit in a disciplined manner.

Incidentally of the eight anticipated Company locations for 2010, five are in former retail space and three are new construction at highly successful mall. Additionally, later this year we expect to convert one ASP in Kailua, Hawaii to a small full service restaurant. We think there are additional conversion opportunities for us. We will keep you advised of our plans as they develop and with that, I will turn it over to Sue, our Chief Operating Officer and Chief Financial Officer.

Sue Collyns

Thanks, Rick and good afternoon, everyone. Our total revenue for the second quarter fell 3.2% to $170.9 and that included a 3.3% decrease in our restaurant sales to $168 million. Our royalties from Kraft increased by 16.2% to $1.8 million, but international franchise revenue did fall 18.3%, and that was due to timing associated with initial franchisee payments to new stores related to last year and on domestic franchise revenue from reduced airport traffic declined 5.1%.

Our full service CPK restaurant second quarter comp sales fell 6.5%, and included approximately around 3% of price along with negative 8.5% of traffic and negative 1% of mix shift. As you can see from the programs Rick described above, we are very serious about arresting the traffic decline and are excited about the strategies to build sales and our guest counts.

Moving on to monthly comps, April was down 6.5% and that was on top of the positive two-tenths of 1% in the previous year. May was down 7.6% compared to a full 0.1% comp in May of 2008 and June was down 5.6% compared to three-tenths of 1% last year.

Our Companywide, full service CPK restaurants delivered a weekly sales average of $64,171, which was down 6.6% from the previous year. In terms of cost, our food, beverage, and paper supply for the quarter was 23.9% of restaurant sales, which was 100 basis points better than the previous year. We continue to make progress on improving our activity related to food cost narrowing the gap and reducing waste and we saved over $700,000 in the three months period through this initiative while also benefiting from a $200,000 reduction in fuel surcharges.

We feel we have made the actual and theoretical food cost part of our culture now and these improvements are sustainable. We also benefited from favorable price movement in the produce category and specifically in the cheese category which had an average price of around $1.50 per pound in the quarter compared to around $1.88 per pound last year. You may recall that our cheese means are 50% hedged. During the second quarter, we benefited by approximately 20% reduction in the cost of a pound from $1.88 to $1.50.

Our labor expense increased 40 basis points to 37.3% of sales and improved by 120 basis points from the first quarter. Our year-on-year drivers included first and foremost the decrease in comp sales and the associated deleveraging of those fixed cost and second, the high minimum wage rate in all 27 states with the federal minimum moving up 12% to $6.55 during the period. As a side note, I am sure you all know that the federal minimum wage rose again on July 24th of this year by 11% to $7.25 and of course this will impact our Q3 results.

We have been able to mitigate the full impact of these minimum wage increases by managing our labor more efficiently though. Our labor was actually down 30 basis points through more effective time management associated with meal break and the new technology that we put in and saved us about $300,000 in the second quarter. We have also become more adept with allocating management resources to individual stores and ensuring that the number of managers per restaurant is properly aligned with their associated revenue.

I would also like to add that we are in all time low for management hourly turnover at CPK. Normally, our hourly turnover tracks around 75% which is below the industry average but right now, we are seeing around a 50% turnover rate for our hourly employees. From the management line where we usually track in the 25% range for turnover, which incidentally is again more favorable than the industry average, we are seeing around a 14% turnover rate right now. This trend is benefiting every store in our system from the standpoint of service, lower training cost and ultimately, high guest satisfactions.

Moving on to the direct operating and occupancy costs, our cost here rose by 180 basis points to 21.4% of sales compared to the prior year and improved from the sequential quarter by 50 basis points. The increase against the second quarter last year is mostly a function of our decision to move our depreciable assets from 10 to a 15-year life, which we spoke about in our first quarter’s earnings call. This change caused us to recalculate the amortization of occupancy charges to include rent escalations that extended that five-year timeframe.

While not readily apparent on the surface, we did benefit from a $460,000 in utility cost savings and more importantly, our companywide energy management program which we rolled out in March of this year. Our energy program consisted of a three part strategy that incorporated behavioral changes, best practices and pricing optimization. We also saw a 10% reduction in janitorial usage per store per week and our percent rent decreased in line with reduced sales.

Finally, we focused on repairs and maintenance and are on joint benefit that comes from pricing efficiency and vendor consolidation on that line as well. Moving on to G&A, our G&A was $13.1 million this quarter, which is basically flat with last year and includes $11.4 million of what we call core G&A and that was $119,000 lower than the prior year. This saving was driven largely by less activity in our manager and training program which was also helped by the lower turnover I referenced earlier.

Depreciation charges totaled $9.3 million and with an improvement of 50 basis points to 5.4% of sales due to the accounting change I referenced a few moments ago. That was partly offset by the addition of eight new full service stores that have been opened since the second quarter of last year. Our pre-opening cost totaled $972,000 compared to $958,000 last year and included approximately $82,000 in phantom rent charges.

We incurred interest expense of $188,000 this quarter compared to interest income of $179,000 in the second quarter of last year and $309,000 of interest expense in the sequential quarter. We benefited from effective treasury management, low-debt levels and more favorable interest rate. Our effective tax rate is 29.5% for the second quarter and was 280 basis points lower than last year but inline with our expectations and that resulted in net income number of $6.1 million or $0.25 per share which was around 25% above the high end of our guidance for the period and at the top end of our more recent expectations of $0.24 to $0.25 per share.

We ended the quarter with $13.7 million of cash and $50 million of debt and you recall I am sure that our debt is funded by $150 million line of credit that we secured last year, which also has a $50 million accordion feature that is in place until May the 7th of 2013.

In the second quarter, we paid down $17 million of debt and have paid down $24 million year to date and we anticipate making further progress in the back half of the year. Our second quarter capital expenditure totaled $8.7 million and included about $5.5 million of new restaurants and remodels and our CapEx plans this year are rather modest and are mostly geared toward our new store opening as we referenced in previous calls. We expect CapEx for the full year to be between $26 million to $28 million and that balance will be further improved by approximately $2 million of tenant improvement allowable.

In terms of share repurchases, we were not active during the second quarter although we do have approximately $14 million remaining on our $50 million buyback authorization.

Moving on to forecasting for the third quarter, we will continue our practice of providing forward-looking updates for the perspective quarter only. So for the third quarter, we are projecting comparable restaurant sales of between negative 6.5% and negative 7.5%. For the month of July so far, full service comps are down 9% and that is against a negative 1.3% from last year. We believe the drivers behind this negative comp include no incremental pricing on our June menu rollouts, a relatively strong July 2008 comp that we are lacking and the significant decline in July delivery comp.

Our modeling assumptions behind the negative 6.5% to negative 7.5% for the full quarter include easing comparison in August and September. Additionally, we expect to benefit from the new programs that Rick referenced earlier, most of which were rolled out last and this week. We are forecasting third quarter EPS of between $0.19 to $0.21 which includes one full service CPK opening, one international franchise opening, one domestic franchise kiosk and an ASP conversion to a full service store.

To recap our 2009 development schedule, we will open five CPK full service restaurants this year that were new. We expect one conversion from an ASP to a full service and we have actually opened four of those five new stores, we will open the fourth next week in Cherry Hill, New Jersey. We also anticipate opening up five international franchise locations of which our partners have already opened three and expect two domestic franchise locations, one this quarter and one next quarter, one kiosk and one in the airport.

That concludes my financial update and now I would like to turn the call back to Rick for closing comments. Rick?

Rick Rosenfield

Thanks, Sue. Larry and I are confident that we have the right strategy in place to sustain and cultivate our brand both through this interim period and well into the future. For 2009, let me remind you that we have already launched the following seven programs; our adventure card advertising program, our improved wine list, our loyalty program, the introduction of an off premise call center, catering and the sales tool to increase check averages and suggested sales and finally, a nationwide business-to-business program.

In addition to this unprecedented level of traffic building initiatives, it is worth noting that our price points are very competitive within casual dining. In fact, almost 50% of our menu is less than $10 and almost three quarters of our menu items are less than $12.50. Our menu was innovative, unique and varied which connects with our core customer and builds brand loyalty.

Over the past few quarters, CPK has proven its ability to execute like never before and this can-do attitude is driving our financial success and moving our business forward. This was seen as a successful cost management over the first half of the year and as we move into a period where same store sales comparisons become more favorable, we are targeting similar progress with meaningful initiative to drive the top line. Ultimately as tough as this recession has been, capacity is coming out of the system and Larry and I firmly believe that weaker concepts will continue to face further challenges.

That sets the stage for the best most trusted brands to gain strength and we already know that CPK is on that short list. With that, I would like to open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Lloyd Connor - Connor Capital Management.

Lloyd Connor - Connor Capital Management

Actually I did not have question. I did not click in.]

Operator

Your next question comes from the line of Jonathan Coppin - Robert W. Baird.

Jonathan Coppin - Robert W. Baird

This is Jonathan Coppin for David. Could you maybe quantify the benefit you received from the Bounce Back promotion in the Q2 comps number?

Sue Collyns

Sure, Jonathan. Bounce Back was very successful for us and we anticipate that the benefit was approximately 1.5%.

Jonathan Coppin - Robert W. Baird

Okay, that is helpful and then looking forward to the new adventure card program, can you give a little more color on your expectations for that program and maybe try to quantify what type of lift you might have assumed in the Q3 guidance that you gave?

Sue Collyns

Well I think the third quarter comps that we anticipate now in that negative 6.5% to negative 7.5% then as we mentioned, it is largely built around the fact that we do not have any pricing in there right now and we do anticipate comps that we are running up against for the months of August and September being easier to last. So, I mentioned that as a starting point because Rick also mentioned seven new sales initiative, most of which only just again either last week or this week. So in terms of the adventure card, it is a little too early to anticipate or build in expectations because they have not happened yet but we do hope that at least, one or two or three of those seven initiative hit and start to make an impact in our third quarter comps.

Jonathan Coppin - Robert W. Baird

Okay. So it is safe to say that you are at least expecting some sort of a lift from those programs.

Rick Rosenfield

We are.

Jonathan Coppin - Robert W. Baird

Okay and then just one last question, just looking at the Kraft business, it looks like year over year growth rate has slowed for several quarters now. I am just wondering if you can give a little more color on what is driving them.

Rick Rosenfield

Well, I think what it is driving it is that it was not that the kind of growth rates we were talking about were simply not sustainable. It was a great growth rate off a smaller base. So, now we are doing $200 million approximately in business this year. So the other issue is that that definitely impacts it is that the competitive environment in the frozen pizza is greater than it has been before. On the plus side of that for us is we have a great reliance on Kraft and a belief in their ability to defend our position. They are experts in what they do and we are an important brand to them.

So, we intend to grow it. They are very innovative. Larry and I are constantly working with them on new and innovative products and we feel great about our ability to grow albeit naturally not as the kind of not sustainable growth rate we have seen in the past.

Operator

Your next question comes from the line of Matthew DiFrisco - Oppenheimer & Co.

Matthew DiFrisco - Oppenheimer & Co.

Just I guess touching on a little over the commentary that you said about the regional same store sales, are you seeing anything also as far as I guess with California settling back and maybe some of the rest of the country hanging there a little bit better is what I sort of gleaned from your comments. What does that look now on the return basis? I know historically you have always argued that you have been roughly about 300 basis points higher in California. What is that relationship now inside California versus outside California?

Sue Collyns

California still delivers high weekly sales average as well as the high EBITDA per store and that relationship has not changed despite the comps that are falling off.

Matthew DiFrisco - Oppenheimer & Co.

Okay. Then also just turning to your comp, I think one of your peers reported earlier today was stressing that July is a very profitable month for them and the integral swing month for basically the profitability of the overall third quarter. I would presume that is shared by a lot but probably to a lesser degree. In what context is July I guess weighted as far as top line sales in that looking at your degree of improvement, I would assume you are looking at about, you need to put up about down five comps or better in order to get to the lower end of your, or the higher end, the negative 6.5 range for the overall quarter. Is it correct to assume that July is away to your sales month and most likely on a historical basis more profitable month as well out of the third quarter?

Sue Collyns

Well, I guess mathematically, July for us represent the five-week month out of the quarter. So, it is weighted toward the month of July but I will just tell you this year, we are spending around 5% more in our advertising and promotional spend and as we mentioned with those seven programs that Rick referenced, most of them actually only just started so the month that we expect to see increased activity in the month of August and September but just proportionate to previous years.

I think the other thing that might be affecting comp estimate for again August and September is the amount that we are lapping. We are lapping a negative 2.2 from last year and lapping a negative 4% comp in September and on stock basis, it is rare. We might have had the odd week lift but basically we have not really had a stock comp to speed in excess of negative 10%. So, again mathematically, just based on that that gave us the confidence to project a negative 6.5% to negative 7.5% comp for the quarter.

Rick Rosenfield

Another aspect that we see coming up that will start lapping what I called some of the CNN events of the Olympics, the opening and closing ceremony and then of course both of the Republican and Democratic National Conventions in the quarter.

Matthew DiFrisco - Oppenheimer & Co.

Right. Just to follow on your comment about the marketing spend by month, can you put that in context how that looks as far as the third quarter of 2009 versus the third quarter of 2008 or maybe the back half of 2009 versus the back half 2008 as far as are you spending absolute dollars more in those 2009 periods?

Sue Collyns

Yes, we are. There is an increase in our 2009 expenditure compared to 2008 expenditure and basically what we are doing is reallocating money that we would have otherwise geared toward new store openings to what we consider to be more effective and measurable activities that will drive traffic.

Matthew DiFrisco - Oppenheimer & Co.

And that would be an in-store margin, in-store cost or the G&A line?

Sue Collyns

No, that is actually what we call the direct operating and occupancy line.

[Operator

Your next question comes from the line of Charlie Miller - R.W. Baird.

Charlie Miller - R.W. Baird

I did not have a question actually. Thank you though.]

Operator

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

Nicole Miller - Piper Jaffray

I just need to clarify; will the conversion happen in the third quarter or the fourth quarter, the ASP conversion?

Sue Collyns

It is a third quarter event. We anticipate it as being converted in the month of September.

Nicole Miller - Piper Jaffray

And then it was at rate of five international which is two domestic or five franchises, excuse me for the year, two domestic and three international?

Sue Collyns

For the full year, it is going to be five full service. It will be one ASP conversion so a total of six full service if you like then we will also have five international, three of those have already opened and we will have one international that will also open in the month of September and the last one is anticipated for the fourth quarter at this point and then we also have two other domestic franchises, again one that is the Hofstra University actually opened August 17th and then second domestic franchise anticipated for the fourth quarter.

Nicole Miller - Piper Jaffray

Okay, I apologize. I did not hear that correctly and then, next year, the eight companies and I did not catch how many franchises but what will be the approximate timing and then the split for franchise between domestic and international?

Sue Collyns

Yes, Rick actually announced eight domestic full service stores and then ten franchises. He did not really give the split between international and domestic at this point but really wanted to emphasize the fact that we are reramping our growth and we have not really given the timing of that at this point in the call. We will phone that up in the third quarter call I think.

Nicole Miller - Piper Jaffray

Okay and in the third quarter, you said you did not take price on a June menu so can you give me the price again that it was in the second quarter and then what price will be in the third quarter.

Sue Collyns

Yes, with second quarter I think we had around 3% of price. Third quarter, just because of roll over pricing from last year will have around 2% that will carryover and then the third quarter; I think it will be around 1.3%.

Nicole Miller - Piper Jaffray

Okay great, so then bigger picture, with this adventure card and I did sign up. I should be getting mine any day, I am actually excited. Are you actually, it seems to me like you are actually capturing my information so like are you going to be able to track these people, these loyalists,VIPs whatever you want to call them and then what influence is that going to have on the way you advertise and promote?

Rick Rosenfield

Great point, Nicole. Yes, we will have that information and you will be in our base of customers to whom we will be communicating frequently and very much part of our plan is building our database of people who are interested in us.

Nicole Miller - Piper Jaffray

So that is a change. I mean, you do not have that information as it stands today, is that right?

Rick Rosenfield

No, we have yours I guess.

Sue Collyns

Well, we do already have a significant database so that is actually being built over the last five years in particular from the, much of which has come actually from the kids birthday cards and the forms they have filled out for that. So, we have grown our database to a very substantial number and this will enable us to enhance that in the marketing efforts around that execution.

Rick Rosenfield

And while we do not have any purchasing activity yet because the cards are going out, we are pleased with the amounts of people who are registering at this point.

Nicole Miller - Piper Jaffray

Could it be more incremental than the Bounce Back program?

Rick Rosenfield

I do not know if we are ready to say that.

Nicole Miller - Piper Jaffray

Okay fair enough. Last question, can you just give us a few data points or a little bit more detail on the internal field program?

Rick Rosenfield

On the..?

Nicole Miller - Piper Jaffray

You made mention here in the press release and internal sales program to drive the average revenue per employee.

Sue Collyns

Alright, this is largely the result of our Director of Sales, the new appointment, so just to clarify that, in the first quarter; we brought a Regional Director from the field to work as the Director of Operational Efficiencies. In the second quarter, we brought in another Regional Director from the field to work with Rick, Larry and I on a number of sales building initiatives that affect our existing store base and this is actually a sales optimization tool that was built. It will help us track suggestive sales on appetizers and desserts as well as bucket, check average and service tips and a number of metrics that really help us identify by store, by server, by day if it is lunch or dinner how they are tracking relative to each other in that store and to the average for that region as well as how they compare to the set of goals that we have for them.

So, each manager will be out to give each server very specific feedback to help them manage their sales and their check averages and ultimately their tips.

Operator

Your next question comes from the line of Brad Ludington - KeyBanc Capital Markets.

Brad Ludington - KeyBanc Capital Markets

I wanted to follow up on the conversion of the ASP in September. Is that going to be the conversion of an open store sales go down from nine to eight units then or is that one of the ones that was already close?

Rick Rosenfield

That is correct. It is at existing store that will reduce the ASP count by one and will increase the full service by one.

Sue Collyns

We have always had great safe success in Hawaii, Brad and this particular store is a market that we anticipate fairly not conversion rate from an ASP to a full service.

Brad Ludington - KeyBanc Capital Markets

Okay. Looking at the comps across, you talked about how the Texas and some of the other states that have declined, I mean, have they gone measurably lower or is it just a slight decline sequentially in same store sales rate?

Sue Collyns

I am sorry, could you repeat that?

Brad Ludington - KeyBanc Capital Markets

Okay, there were comments I believe about how Texas, Illinois and New York had sequentially decline on a same store sales basis from the first quarter. Was that a measurable decline or just a slight decline quarter to quarter or can you comment on that?

Sue Collyns

I do not think we commented in our prepared remarks on any of the results by state.

Rick Rosenfield

We have a comment on, what we did not do is break it out and we are disinclined to do that because we never have broken out things like that.

Brad Ludington - KeyBanc Capital Markets

Okay and can you give us reminder what the impact of Hurricane Ike was on you guys last year in September?

Sue Collyns

I do not have that data at my fingertips. Let me just see here. In the third quarter, I have got 18 days of closure dates from weather but I am not quite sure if it is related to Hurricane Ike in particular but it seems that we would potentially be remapping inside benefit this quarter as well.

Operator

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

Mitch Speiser - Buckingham Research

Sue, I noticed the mix piece of the comp did slow a bit to down 1%. I just like to maybe have some further commentary on that and maybe it relates to this but there has been some talk that parties with kids are underperforming. You are very kid friendly. I was wondering if you have noticed that trend in your stores.

Sue Collyns

Sure Mitch. I guess I have not really noticed a decline associated with traffic with children in particular. What we have seen is that lunch has been affected because everyone is obviously competing at lunch and there have been tremendous amount of discounting going in that sector. The other area that we noted in our prepared remarks related to delivery and that is an area that has been very important to CPK and just to clarify that, we have 14% of our sales to takeout and 4% of delivery and it does not sound like a lot but it had seen a precipitous decline in the third quarter which is really unprecedented and that does seem to be affecting traffic.

So, again we actually have a strategy that we put into place recently as recently as in the last month to really work with our delivery companies, marketing on our website, we will be working with mining the data essentially with the database and scripting some outbound calls with Bergman, also expanding some of those regional boundaries and increasing the competition to help drive activity in that area. So, I think those are the key touch points for us rather than children per say. That has always been an area of strength for us. It is really focusing on lunch and focusing on delivery.

Rick Rosenfield

And just a quick note to Sue's comment about delivery, one aspect that softens the blow even though deliveries off significantly is that that is the least profitable channel of our business because of the significant fee that we pay to the outside delivery companies.

Sue Collyns

That is right. So, it hurts the income but from a margin perspective, it is not that meaningful.

Mitch Speiser - Buckingham Research

Got it and if could slip just a second question there, in your comps, you are guiding it down pretty significantly. Your earnings, you are guiding to flattish. Just in general, I just want to get some comfort how confident you are to drive flat earnings on down 7% or so comps.

Sue Collyns

No, I think it is coming as a result of many of the cost management initiative that we put into place in the first half of the year. We said that many of those costs include initiative specifically the actual or theoretical were sustainable. We also got the benefit of the technology rollout in the labor area and meal breaks and managing that line so we feel quietly confident about holding that line at a comfortable level notwithstanding decelerating comps and I guess the other thing that is really impacting us is in this quarter, we will only have one new store opening compared to four new store openings in the third quarter of 2008.

So, you are getting the benefit of a fairly efficient group of stores compared to the deleveraging effect of new store openings there.

Operator

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

Destin Tompkins - Morgan Keegan

First question, I do not want to be the dead horse but some of the other restaurant companies commented that when they have talked about July trends that the early part of the month was noticeably weaker than the later part of the month. Can you comment on your trend?

Sue Collyns

I think it was fairly flat for us all the way along. That 4th of July kicked in and basically, the Friday was stronger because of the flip in the 4th of July but the Saturday was weaker. We thought it might normalized after that and it never really did and then again when we looked in at the day part mix between lunch and dinner, as well as dine in, take out and delivery, we really saw that delivery was more of a culprit than we had anticipated and that is what led us to feel very good about all of the dining in strategies that we have in place to drive traffic; the new wine menus, the loyalty program, the introduction of catering programs together with the adventure card program but then we also looked at ways to drive that off-premise activity through the introduction of the off-premise call center together with working with our delivery companies. So, it was pretty flat for us.

Rick Rosenfield

Just to add my own anecdote to this and I do not know if anybody else has comment on, but I have heard, I know I have said in the past that good movies and by that I mean successful box office movies, are very good for our business. We have 40% or more of our restaurants are associated in some fashion with movie theaters and the beginning of the year, the movie theaters were having very, very good comps and I read recently in the last five week, they have had negative comps because they are lapping some big blockbuster movies of last year.

So, I think that negatively affected us particularly on the weekends as July developed and that matters to us.

Destin Tompkins - Morgan Keegan

That is a helpful color. Looking at the new restaurants you are going to open in 2010, you mentioned that you seen a little bit more attracted in development cost and the footprint gives you a lot of flexibility. Can you comment maybe on the return expectations or maybe the delta between what you have been, some of the newer stores you have open in the last couple of years. Do you think you could see returns that are maybe 200 or 300 basis points better or have you look at that much?

Rick Rosenfield

Well, we are looking at it. I am not sure we are prepared to comment other than to say with the smaller footprints and reduce building cost, not only because of the square footage but just because of the environment. We think we will be able to achieve the kinds of returns we wanted with the smaller restaurants and smaller average weekly sales. So, we are not modeling them in our mind to do the kind of super volumes and we would be presently surprise some of them of course will. But we think it is a model that we are really working in this and in future environment.

Sue Collyns

And I think just to amplify that for our class of stores in 2009, the three that we have opened, the average cost have come in significantly lower than previous years and that certainly meeting the weekly sales average hurdles that we expect them to meet. So, we are very happy with that and I think long term, feel very good about the prospects we are increasing return on investment and shareholder value.

Destin Tompkins - Morgan Keegan

Okay great. A couple more if I may, on the cost of goods for the quarter, 23.9%, could we see a similar number sequentially as we go through the year or do you expect that to come back up? How should we look at cost of sales?

Sue Collyns

Well, as I said at this point, I think I am quietly confident saying that the actual theoretical food cost initiative that we put in place are sustainable. It is something we measure every week and we have talked about every week on our regional director call that Rick and Larry host each Wednesday and obviously we have received some tailwinds on the cheese and on fuel surcharges and I guess I have seen recently that cheese has moved up from $1.12 to I think this week have currently tracking $1.25 per pound. So, it may not quite get that benefit in the same way for Q3 and Q4 but we are sure to take doing everything we can to manage that line item.

Destin Tompkins - Morgan Keegan

Okay and then lastly on the interest expense, you have seen some nice sequential improvement or lower in the interest expense last couple of quarters and it sounds like you are going to continue to pay down debt with the free cash flow. So, is that a reasonable run rate? Should we expect that to decline or is there anything unusual that might be slowing through that line and making it look artificially lower than it should?

Sue Collyns

No, it is not artificially low. We are playing out plus 125 right now managing our cash flow very, very seriously and anticipate that continuing to move down from $50 million toward the end the year.

Operator

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

Lawrence Miller - RBC Capital Markets

Most of my questions were asked and answered. I just want to ask you about sort of a longer term amortizing strategy. There is a lot of competitors out there running a lot of discounting programs and when do you think that, I am not saying you should be discounting or running those kinds of programs but when do you think you might have the aptitude to hit the national program and I will have a follow up list.

Sue Collyns

Sure, Larry. I guess it is fair to say that we also recognize that we are in the environment where acute consumer seems to be responding to incentive but feel that there is big difference between across the board blanket discounting and targeted promotion. I guess that would be the first comment. The second comment is that advertising is still less than 1% of our total revenue and we have reallocated our spending and looking at it very, very carefully moving at from new store openings and other areas that were perhaps less quantifiable to what we consider to be higher return on investment activities.

We have increased the total spend which probably going to be around 5% higher than it is last year and the other comment I would make is Kraft. We all spend approximately just I think just shove around $10 million this year advertising the brand and Rick and Larry had been working very specifically with them on different initiatives to increase the brand winners and promote traffic and looking at ways to complement not just our off-premise sales of the frozen product but also tying that with in-house promotion and that would be unprecedented for us so I think there is opportunity to leverage their dollars going forward in a way that we have not up until now.

Lawrence Miller - RBC Capital Markets

Thanks and then you guys have, you have a hosted initiative out there and you are forecasting since your sales improved in the second half of this quarter. I guest at least in your comparisons. Have any of those initiatives, things you have done before or things you have tested that we should feel more comfortable that even against those easier comparisons if it does not happen, there might be some improvement?

Sue Collyns

Well, right now, I mean just mathematically if you look at the comps that we are mapping up again, again I am sort of using that. We have not done worth the negative 10% on the stock basis so I have not actually built into a forecast number the fact that one of these might hit and they might hit big time. We would like to think that again, views of Rick's sinology of the singles and doubles that some of them hit. We are not quite sure when so we are seeing some very encouraging results so far in few of those areas but again, with one or two weeks under our belt, I guess that fide the range of what I would consider reasonable to lay that into the forecast.

But if I do continue then we might see a comp number that is better than that negative 6.5% to negative 7.5%.

Operator

Your next question comes from the line of Steven Rees - J.P. Morgan.

Steven Rees - J.P. Morgan

I just wanted to ask about the decision to accelerate unit development action because I think you are one of the very few companies that are growing units next year and most were quarter after closing and one of the benefits for 2008 was the fact that your development was low. I think you cited this as a margin benefit. So, how can we be I guess confident that you have risk adjusted your site selection criteria next year that these are lower risk unit that they will deliver the sales part and the margin expected necessary for the property earned?

Rick Rosenfield

Well I think in term with, we pulled back not because we were not opening profitable restaurants. We pulled back because of the environment and capital allocation issues as everybody did. But on the other hand, we are in the business that have always been in the business of building profitable restaurants and as we said and we will carry today and we say, "Wait a minute. Our business is not as good as it was a year ago but we have a really good business with really healthy restaurants." And so we are not afraid to build healthy restaurants with good returns. We love the fact that the costs are coming out of these restaurants. We love the fact that we are building smaller footprints that can make the returns even on lower expected volumes and then last but not the least, we have been picking restaurant sites for 25 years, Larry and I and we have very good people involved in it and Larry and I or I and mostly both of us see and approve every site and I like the sites that we are seeing.

I like the markets we were entering. I like going into some of the mature centers were there is a little competition when they were built. They were built with food courts and not with full service restaurants and there is ample opportunity for full service restaurant so I feel lot of opportunity that I did not see a year ago and I think we are positioned well for it.

Sue Collyns

I would also add to that Steve and you may have missed this in Rick's prepared remarks but five out of those eight are actually in former retail spaces which a couple of years ago clearly would not have been available and the benefit of that is that we are able to get very good quantitative data on the adjacencies of other retail outlet in that space to assess the success of that location and again, so you have that comment and then I think the final comment I would make is because we can move to as low as the 3500 square foot, although ideally 4500 to 10000 square foot is certainly a more efficient minimum for us, it gives us the level of flexibility that many of our competitors do not have.

So, I think those are the real differentiating points that give us the high degree of confidence that makes us feel very good about those eight stores for next year.

Rick Rosenfield

And I might add it is a very good waiver market for us right now. It did not exist.

Steven Rees - J.P. Morgan

Okay that is a very helpful color and then just a couple of housekeeping, do you have an expected total comp X for 2010 yet, Sue?

Sue Collyns

No, I do not.

Steven Rees - J.P. Morgan

Okay and then I may have missed this but just, you said the comparisons got a lot easier on August and September. What were they in a one year basis?

Sue Collyns

Sure, it is negative, so July was negative 1.3%, August was negative 2.2% and September was negative 4%.

Steven Rees - J.P. Morgan

Okay and then just finally, your increasing investment, digital and print media here in the second half, do you have a quantification of that that you can offer?

Sue Collyns

No, just up 5% basically for the year.

Operator

Your next question comes from the line of Steve Anderson - MKM Partners.

Steve Anderson - MKM Partners

Just a follow up on the new unit that you guys will open in fiscal 2010, I just wanted to ask if you are going to see any cost savings from moving into these ground deals or retail sites or what you call on that and if you expect both from a new unit opening cost as well as any at least allowances that you made having them.

Rick Rosenfield

Well, we are seeing, as I said we are seeing a very favorable real estate environment and the deals that we are signing, I would say TIs are consistent with what we have seen in the past which is good under these circumstances but rents are definitely better. We are just making overall better real estate financial deals and again the costs have really come out. We feel good about it.

Sue Collyns

Yes, I guess I would add to that by just saying, it was on the east coast because of weather variations as well as unions, cost tend to skew higher compared to the west coast and the other biggest driver for it are these cost savings and the different models that we had come up with over time. We have an A, B and C internally and we are building more Bs and Cs. The As are the free standing for the 6000 square foot prototype and that the Bs and Cs are the smaller square footage packages with more flexible and modular kitchen parts that are lower cost and gives us more flexibility and that has really helped reduce our cost over the last couple of years.

Rick Rosenfield

Just again as a quick note, these restaurants are sort of scattered across the country next year and none of them are in California and that is not as a matter of choice but just as I have said to you before, we are happy to build in California or anywhere else that we find sites that we think are opportunistic and good for us.

Operator

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

Tom Forte - Telsey Advisory Group

I wanted to know if you could comment first on the performance of the flat bread. I think you had a full quarter versus one month and then I have a second question.

Sue Collyns

Okay. We do not actually split out sales of the cross product but I can tell you that directionally, it is certainly doing well and we are happy with the performance.

Tom Forte - Telsey Advisory Group

And then as far as level of investment, when we think about converting an ASP versus building a new full service restaurant, how does it compare?

Rick Rosenfield

Well there is no comparison. This is just literally putting a covered add-on and then some minor other changes in this case.

Sue Collyns

Changes for the bar area actually creating a bar, increasing the number that are feasible all year round with the patios, so it is a very minor, I think it is a $250,000 investment is very modest.

Tom Forte - Telsey Advisory Group

And then last question, of the other existing ASP, should we think that all of them have the potential to be converted?

Rick Rosenfield

No, they do not all happen to that potential but a couple of them probably do.

Operator

Your next question comes from the line of Tony Brenner - Roth Capital Partners LLC.

Tony Brenner - Roth Capital Partners LLC

In the first half and especially in the second quarter, your same store sales were at the bottom of your guidance range and you beat your earnings forecast based on a number of the cost efficiencies and steps that were implemented during the period. At this point, listening to what you are saying, it would appear that at least in terms of sequential improvement and sequential earning surprises is going to have to come from a top line beat, not a margin beat, was that fair?

Sue Collyns

I think that is fair and I think we mentioned timely that we really did not layer in a success of one of those seven programs that was material into the comp number. So we are hoping that one of them or two of them or even three of them do hit and do may come out for us in the third quarter but even if we do not get a lot of traction in the third quarter, we definitely anticipate some more success in the fourth quarter.

Tony Brenner - Roth Capital Partners LLC

Okay, which one do you think will be above the expectation?

Sue Collyns

Well…

Rick Rosenfield

We think they all will; hopeful I should say.

Operator

Your next question comes from the line of Matthew DiFrisco - Oppenheimer & Co.

Analyst for Matthew DiFrisco - Oppenheimer & Co.

This is Rachel Shakarin for Matt DiFrisco. How much do you expect to benefit from the extra operating region fourth quarter and also what do you anticipate the tax rate is going to be for 2009?

Sue Collyns

Fourth quarter gross a couple of years ago when we had that 53rd week benefited about around 8% EPS. So, I do not think I would forecast that at this point for Q4 of this year but directionally that might be a market that is worth looking at and in terms of tax rate, again based on the second quarter that we just went through, it looks like our tax rate is going to be closer to 30% somewhere between 29.5% to 30%.

Operator

(Operator's instruction) I would now like to turn the call back over to Mr. Rosenfield.

Rick Rosenfield

Great. Well, thank you for joining us in the call and we look forward to talking to you on the next call.

Operator

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

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