Panera Bread's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.19.14 | About: Panera Bread (PNRA)

Panera Bread Company (NASDAQ:PNRA)

Q4 2013 Earnings Conference Call

February 19, 2014 8:30 am ET

Executives

Ronald Shaich – Chairman, Chief Executive Officer

Roger Matthews – Executive Vice President, Chief Executive Officer

Michele Harrison – Vice President, Investor Relations

Analysts

Brian Bittner – Oppenheimer

Joe Buckley – Bank of America Merrill Lynch

John Glass – Morgan Stanley

Matthew Difrisco – Buckingham Research

Jeffrey Bernstein – Barclays

David Tarantino – Robert W. Baird

Jason West – Deutsche Bank

Sara Senatore – Sanford Bernstein

Chris O’Cull – Keybanc Capital

Keith Siegner – UBS

Sharon Zackfia – William Blair

Nick Setyan – Wedbush Securities

Bob Derrington – Wunderlich Securities

Steve Anderson – Miller Tabak

Operator

Good day everyone and welcome to the Panera Bread Fourth Quarter 2013 Year-End Earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Michele Harrison, Vice President of Investor Relations. Please go ahead, ma’am.

Michele Harrison

Thanks Lynette. Good morning to everyone and welcome to Panera Bread’s Fourth Quarter and Fiscal 2013 Earnings call. Here with me on the call this morning are Ron Shaich, our Chairman and Chief Executive Officer, and Roger Matthews, our Executive Vice President and Chief Financial Officer.

Before we begin this morning, let me cover a few regulatory matters. I’d like to note that during our opening remarks and in our responses to your questions, we may make forward-looking statements regarding future events or the future financial performance of the company. Any such items, including targeted 2014 results and conditions and details relating to 2014 performance and beyond should be considered forward-looking statements within the meaning of the Private Litigation Security Reform Act of 1995. Such statements are only predictions and actual events or results could differ materially from those predictions due to a number of risks and uncertainties. I refer you to our documents the company files from time to time with the Securities and Exchange Commission, specifically the company’s last filed annual report on Form 10-K, which was filed on February 15, 2013. This document contains and identifies important risk factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

With that, I’ll turn it over to Roger.

Roger Matthews

Thanks Michele and good morning everyone. Yesterday after the market closed, we reported Q4 EPS of $1.96, in line with our expectations and up 12% versus our reported EPS in Q4 2012. These Q4 results include a benefit of approximately $0.13 from the extra week in the period. Today, Ron and I will provide more detail for you on our Q4 results as well as put this quarter’s performance in the context of our broader initiatives to drive enhanced customer experience.

Our revenues for the fourth quarter increased 16%. This was a result of increases in comparable bakery café sales, the addition of 63 new company-owned bakery cafés since the fourth quarter of 2012, growth in franchise royalties, sales of fresh dough and other products to our franchisees, and the additional 53rd week. Excluding that 53rd week, our revenues were up approximately 10%.

On an adjusted 14 week over 14 week basis, our comparable same store sales growth was 1.7%. Our franchisees experienced comparable same store sales growth of 0.5%. Given the weather in December, we were pleased with the overall results. Ron will speak to this in more detail.

Now let me take a few minutes to talk about margins and the trends that we saw in the quarter. Our fourth quarter operating margin declined 170 basis points versus last year. The majority of this decline was expected as we made key initial investments in our cafés to improve our capabilities and ultimately the quality of our customer experience. Bakery café margins de-levered by 100 basis points compared to the prior year. The biggest driver of this decline was labor expense, increasing by 60 basis points versus the fourth quarter of last year. This higher expense reflects the implementation of an additional 35 hours per week in each of our cafés beginning in late October, and to a much lesser degree additional planned training costs resulting from increased hiring incurred to bolster the size of our café rosters from which our managers deploy labor in their cafés.

In addition, other operating expenses de-levered 40 basis points as we made a series of one-time investments to begin to ready the cafés for increased traffic. These investments included new bakery racks designed to better display our assortment and allow managers to better manage against waste, as well as accelerated maintenance in our cafés. While none of any one of these initiatives was significant by themselves, in total these added close to $2 million of incremental expense to the quarter.

The margin de-levering was partially offset by a modest decrease in food and paper costs, approximately 10 basis points, primarily the result of product mix as well as the lapping of the packaging upgrade rolled out in Q3 of 2012. Consistent with the second and third quarters, we had approximately 1.8% of price during the quarter.

Let’s talk about growth in depreciation, amortization and general administrative costs in the quarter. This was an important theme for this quarter and will also be important for 2014 and beyond. D&A de-levered by 50 basis points in Q4 on an increase in dollars of 20%, excluding the impact of the extra week in the quarter. G&A saw a similar increase in dollars of over 15% in Q4, again excluding the impact of the extra week in the quarter, and de-levered by 30 basis points. Our growth in these two line items was a step function increase rather than linear, a direct result of the investments we are making to greatly enhance the customer experience.

The increase in depreciation and amortization reflects several factors. First and most significantly to the P&L in Q4, several projects designed to improve throughput in our cafés and enable improved operational capabilities rolled out at the end of the third quarter and during the fourth quarter. For example, we accelerated replacement of older Panini presses in the cafés given their higher use from strong customer demand. We completed the rollout of the updated KDF system and we began installing equipment to alleviate potential capacity issues. Second, we increased our IT spending net of capitalized. These technology investments included IT infrastructure for our cafés and support centers as well as customer-facing applications that we look forward to discussing in detail at our upcoming investor day in Charlotte at the end of March. Remember that the capitalized IT expenses are amortized generally over five years instead of 10 years, normal for our bakery café investments, so the expense portion of capitalized spending on IT hits our P&L quicker than usual.

Similarly, the increase in G&A reflects the building of IT capabilities specifically but also more broadly enhancing organizational capabilities across the company. We have significantly increased the size of our IT team at Panera to reflect our belief in how critical it will be to our future. This increase was partially offset in Q4 by a decrease in incentive compensation. As I said earlier, we expect these trends in D&A and G&A to continue into 2014.

For fiscal 2013, our operating income was $310 million, up approximately 10% relative to the prior year, and our EBITDA, or earnings before interest, taxes, depreciation and amortization, for the year ended at roughly $420 million, up 12% relative to the prior year. We estimate that the 53rd week in 2013 added approximately 220 basis points to these year-over-year growth rates.

Now I’ll spend a minute on our sources and uses of cash. We generated approximately $136 million of cash flow during the fourth quarter, resulting in $68 million of free cash flow after $68 million of capital expenditures. For the year, we generated approximately $348 million of cash flow before capital expenditures. After $192 million of capital expenditures, we generated net free cash flow of $156 million. During the quarter, we deployed just under $140 million of capital for share repurchases, bringing that total for the year to $332 million. For the fourth quarter, we believe that shares repurchased during the quarter contributed roughly $0.04 to our reported EPS.

As we stated on our last call, our goal going forward is to have a proactive and consistent approach around our use of capital and deployment of our excess free cash flow, primarily for share repurchase. Equally however, maintaining financial flexibility and excess capacity to be opportunistic will always govern our long-term goals around our capital structure.

To wrap up our discussion on Q4, we were pleased with our results: comp growth, EPS growth and new unit opens, which were in line with our expectations despite the volatility created by December’s weather. But our actions this quarter were only steps in a broader plan to greatly enhance the customer experience at Panera.

With that, I’ll turn it over to Ron to provide color commentary relative to the plan throughout our next year. Ron?

Ronald Shaich

Thank you very much, Roger, and good morning everybody. I’d like to begin by providing some perspective on how our efforts in Q4 2013 and our direction in 2014 were developed and came to form the long-term strategic plan we are now executing at Panera. Allow me now to put that strategic plan into context.

Back in early 2011, we began brainstorming relative to how to enhance the customer experience at Panera. Yes, that vision was rooted in technology, but it was about so much more than technology. For the last several years, we’ve been working to bring our vision for enhanced customer experience to life. We’ve been prototyping, testing and evolving that vision over the last 18 months. I will share a bit of that vision for an enhanced guest experience today, and we will talk about it in much greater detail at our analyst meeting in Charlotte next month.

I’ll start by providing a bit of perspective. We have traditionally viewed Panera as an eat-in business. Sure, we understood that there were customers who would come in and order a meal for take-out, but we never, never provided them a different ordering process or pick-up process; that is to say, one appropriate to their needs. See, historically we at Panera have operated a one-size-fits-all model. Ultimately, we came to understand that our take-out customers and indeed each of our customer segments would benefit if we offered that segment the specific order, payment, execution and consumption system appropriate to their needs. As we explored and developed that system, we began to call this an enhanced customer experience. Hopefully, you’ll soon have the chance to see it at our upcoming analyst meeting.

At that meeting, you will also see and learn about our efforts to enhance the customer experience for the eat-in guest and for the large order delivery guest. I’m sure some of you listening to this call will want to jump to conclusions. You might want to conclude that this is yet again another mobile app in the food industry. Yes, there will be meaningful technology components to what we reveal in Charlotte, but what we’re talking about is far more. It’s an end-to-end system that provides an enhanced order, payment, execution and consumption experience, specifically designed for the particular needs of our eat-in and to-go guests as well as our delivery customers.

Let me now share with you something else about the development of our strategic plan. By 2013, we had reached the conclusion that our vision for enhancing the customer experience at Panera offered us enormous opportunity, but we also came to believe our ability to truly benefit from our vision for an enhanced customer experience would be constrained unless we also upgraded our operational capabilities. As a result, we began an intense focus on making the changes necessary to ensure we had the operational capabilities required to meet the accuracy need of an evolving customer and existing and future production demand.

In parallel to these efforts, we’ve continued to remain focused on providing our guest with a better alternative through innovative food and potent marketing. Taken together, these initiatives which internally we refer to as Panera 2.0, will if they are successful ultimately lead to expanded growth opportunities for our company. As a result, they represent the strategic plan we are executing to drive Panera into the future.

Okay, let’s now drill down into the specifics relative to our performance in Q4 and then we’ll return to provide a brief update on our strategic initiatives. Let’s start with comp store sales. In Q4, our company comps ran 1.7%, which was near the upper end of our previously indicated range. This fourth quarter comp performance equates to two-year comps of 6.8%. For the first 48 days of Q1 2014, our comps were negative 2.2%.

Now it’s probably worth noting that for the first quarter and for the first 48 days of the first quarter of 2014, our business was marked by substantial fluctuations week to week and month to month, which were reflected in our comps. To that end, let me just aggregate our performance month by month with you.

In October, company comps were up 1.9%, adjusting for the shift in the Thanksgiving holiday. In November, we registered comp growth of 3.7%. I must tell you, I remember feeling pretty good around Thanksgiving; but then in December, we saw our comps drop to negative 0.4%, and this rollercoaster ride extended into 2014. January and the early part of February were characterized by days of comp growth generally consistent with Q4 interspersed with days with dramatic negative comps as bad weather rolled through. In fact, seven of the 48 days in Q1 to date had comps of negative 10% or greater.

Okay, so here’s what we think is going on. A disproportionate number of Panera cafés are in the Midwest and the mid-Atlantic northeast corridor that was hit with the worst weather these past 10 weeks. For Q4, we estimated that the inclement weather had a roughly 50 basis points to 70 basis points negative impact on our comps, which translates into $0.03 to $0.04 impact on our earnings per share. In the first quarter for the first 48 days, the impact has been more severe and we estimate the impact on our transaction growth and comps has been approximately 250 basis points to 300 basis points, which in turn we estimate will reduce EPS by $0.07 to $0.09 per share.

Let me now break down the fourth quarter company comps for you. In the fourth quarter, price growth was up 1.8%, reflecting modest commodity inflation, and mix was up 0.7%. Our transaction growth for the quarter was negative 0.8%, but what we care most about is traffic and as we’ve said in the past, our growth in entrée may be a better proxy for the true measure of traffic, so we were encouraged to see that year-over-year entrée growth came in positive at 0.2% in Q4. In fact, in every quarter in 2013, and for that matter in every quarter in 2011 and 2012, we saw positive entrée growth.

Now, I highlight this because I think it serves as a backdrop for a fourth quarter performance that while in absolute terms was more modest than we were shooting for, was still in line with our expectations and represented an improvement in relative performance for Panera. Indeed, the good news is that our transaction growth relative to the industry improved in Q4.

As we’ve discussed on prior conference calls, we have begun benchmarking our performance against the Black Box index, a measure of the U.S. restaurant composite. We do this because it gives us a baseline to understand relative performance, particularly during periods of volatility, weather, or weather impact. So here is what our analysis of Panera performance versus Black Box indicates. In Q4, our transaction growth ran 160 basis points better than the all industry composite. This is our best performance relative to the all industry composite in 2013, and it compares favorably with our performance in Q3 when we ran 80 basis points better than the all industry composite.

Let’s now turn our attention to development. In the fourth quarter, we opened 18 new bakery cafés while our franchisees opened 24 new cafés. At the end of 2013, we had 1,777 total cafés operating system wide. The demand we’re seeing at these new locations, which has always been the best gauge of strength for the Panera brand, tells us that the Panera experience continues to resonate deeply with our guests. Indeed in 2013, we saw another year of record-setting opening (indiscernible). To be specific and to make an appropriate apples-to-apples comparison, when you adjust out urban cafés, we saw average weekly opening volumes grow to $43,810. Let me add that we also opened three new catering hubs – or as we call them, deliver hubs – in Q3, bringing our total to seven hubs as of the end of fiscal 2013 and providing capability for out-of-café delivery to more than 30 cafés. By the end of 2014, we’re anticipating that we’ll have opened more than 20 hubs, providing support to over 100 cafés.

Let’s now speak to the initiatives that underline our strategic plan. Since the focus of our last earnings call was on operational capabilities, let’s begin by discussing that. We’ve a lot to share with you. Last quarter, we added 35 hours to our cafés, and that has had real impact. We have upgraded equipment to grow capacity. We added a new kitchen display system, and we worked hard at driving proper staffing and proper process discipline. As a result of these efforts, we’ve already seen a material improvement in our metrics that tell us how well our cafés are deployed and how quickly our guests are being served. As well and as I indicated earlier, we have begun to reduce the complexity of running our cafés by rolling out our catering hubs, an initiative that is met by applause by just about every Panera general manager we encounter.

Let me share one final thought relative to our efforts to improve operational capabilities. To be clear, our initiatives to improve operational capabilities are designed to clear the runway, if you will, so when we layer in volume drivers like advertising and an enhanced customer experience, our cafés can deliver against the demand. The improvements in operating capabilities just described are the elements of our strategic plan meant to reduce friction at Panera. Other efforts are in place to create a better competitive alternative to inventive foods and potent marketing. I believe these efforts are every bit as significant as our initiatives around enhancing the guest experience and operational capabilities because ultimately the quality of our food and the effectiveness of our marketing drive the desire part of the equation for Panera.

So let’s now talk about what you can expect in the coming months in terms of food at Panera. Starting this week at a Panera near you, we’re celebrating our classics; that’s to say we’ll be focusing our attention on a number of long-time customer favorites. Specifically, we will be highlighting a you-pick-two that includes our chipotle chicken Panini and broccoli cheddar soup. Both are among the top-selling products at Panera. In April in keeping with the favorites theme, we’ll be celebrating a you-pick-two consisting of our bacon turkey bravo sandwich and mac-n-cheese, two more Panera classics.

We thought it was important to focus on our customers’ favorites for these celebrations as a way to energize our base, if you will, and stimulate that craveability around our offerings. Our thinking is not unlike a Bruce Springsteen concert in which he mixes in his classics with some of his newer songs. To that end and as I mentioned on our last conference call, we’ll be introducing new flatbread sandwiches to our menu in the spring.

We’re very excited about this as our version of the flatbread will be unique to Panera. With fresh, baked in the café artisan bread in the style of an India tandoori, these sandwiches will feature quality proteins and bold flavor profiles that allow us to better experiment with new seasoning and new spices. Our flatbreads provide customers the option to choose their portion size, which supports the broader perception of value on our new menus. We believe this could also serve to open up a more robust snacking platform for Panera and add some muscle to our gathering place business, which runs across multiple departs. Moreover, flatbreads will allow us to better tap into growing interest in international and regional cuisines, and we believe that they will resonate with a younger audience, particularly among millennials and Gen-Xers. Initially, we’re going to start with varieties such as high chicken, Mediterranean chicken, and southwestern chicken.

I’d also like to spend an additional minute or two addressing how we’re evolving our offerings. Specifically I point to what we’re doing with our soup and with our proteins. We’ve been very excited about the success of our squash soup and the ABF turkey chili, both of which were big winners. These two soups really underscore an ongoing push at Panera as we seek to differentiate our offerings by delivering an ever-higher quality of product.

As for proteins, let me note that we’ve been able to use our scale to leverage our sourcing capabilities, which makes it possible to bring things like antibiotic-free turkey and antibiotic-free chicken to more products, and which enables us to transition from nitrate-laden roast beef to grass-fed steak throughout our menu.

Okay, let’s now turn our attention to marketing. As you know, we’ve been testing low weight to national media buys since last year, and over the past few years our media spend has grown from 1.4% of sales in 2012 to 1.7% of sales last year. In 2014, we expect to spend approximately 1.9% of sales on advertising with significantly more of our buy going to national media. That national media effort began several weeks ago at a modest level and will step up again modestly in March and as the year unfolds. I should also add we were very excited about the campaign which features Panera’s favorites and speaks to the quality and integrity of our ingredients as part of an effort to drive guest engagement.

However, I would advise investors not to expect the step function change in sales as a result of national media. This is partly because of the nature of the message, the relatively modest weights of the campaign, and our sense that the impact of our national media buy will be variable by market depending on whether or not we already have a considerable presence as an advertiser in that market, as we do in certain mature markets like Chicago and St. Louis. Similarly, we do think that our advertising will have its greatest impact in more expensive but less market intense markets for Panera, markets like New York, Boston, Atlanta, Dallas and Los Angeles, where we historically had a very limited advertising presence.

Okay, so now I’ll provide a quick update on the My Panera loyalty program which ended 2013 with over 16 million members and with approximately half – and I repeat that, half – of all of our transactions being done by My Panera customers. Over the next 12 months, we’ll be looking to upgrade the program in a number of ways. For instance, we’re going to make it easier for My Panera members to know both when they receive a reward and when it set to expire, as we believe this could drive incremental frequency. We’re also going to utilize CRM campaigns – customer response marketing – that more effectively personalizes the incentives for our guests to better influence their purchasing decisions. You can also expect to see us use the My Panera data to develop propensity models that will enable us to identify new customers whose profiles match up to our very best customers.

Okay, now I’d like to discuss pricing. In the coming weeks, you’ll notice a new structure to the menus at Panera. The intention of our new menu structure is to make it easier for guests to understand our product offerings and at the same time to offer greater visibility to the range of price points on our menu. We believe we’ve accomplished that with a revised menu structure that groups items and offers individual prices by item for a whole serving, a half serving, and as part of a you-pick-two. While our goal with our new menu structure was to provide more clarity, which we think can only help throughput, we anticipate that another benefit will be the perception by customers of more lower priced options. As well, we think this new menu structure will enable guests to pick and choose and personalize their orders in a way that may better suit their cravings or health needs.

To close, I think it’s worth reminding everyone what we discussed in the third quarter conference call, which is that long stretches of Panera success generally have been preceded by step function investments that move the concept to a new and different vision. These investments marked by temporary periods of recalibration generally have occurred every five years or so, but have served to create new inflection points for sustained earnings growth. As I look back at the last 16 weeks, I’m encouraged by the early traction we’re seeing, although the positive trends in Q1 are likely buried somewhere in the snow.

Let me be clear on where we go from here with our strategic plan – we’re excited to be rolling out our vision of an enhanced guest experience that better serves the specific needs of to-go, eat-in, and delivery customers. We know our efforts to strengthen operational capabilities will have an impact as we’ve seen material improvement in operational metrics that we believe are leading indicators, and we expect we can continue to drive innovation in both our food and our marketing in an effort to generate desire, engagement and affinity. Indeed, we are ever more confident that these initiatives taken together will lead to expanded growth opportunities for Panera well into the future.

Let me conclude by noting that I have personally been working on elements of our strategic plan for the last three years, and I want you to know how excited I am to have the opportunity to share with you the specifics of that plan at our analyst day in late March.

Now let me turn it back to Roger to discuss our guidance for Q1 and full-year 2014.

Roger Matthews

Thanks Ron. Now let me spend a few minutes reviewing our targets for the full year and the first quarter of 2014. As we have discussed, we believe that 2014 will be a year of meaningful investment for Panera. It is also a year in which we hope to see tangible evidence around success in our efforts to increase transaction growth and thus our comps in 2014 and well into the future.

To truly set up our company and cafés for success over the next five years, we must improve the customer experience in our cafés as well as enhance Panera’s positioning as a better competitive alternative. This will require meaningful structural change, many of which are sequential in nature and will take our customers some time to see the full benefits of these changes, and these changes require meaningful expense in capital to get it right. As a result, we expect that 2014 earnings growth will be modest until these step function investments are offset by increased top line growth over time.

For fiscal 2014, we expect comp growth of 2 to 4% and positive transaction growth building through the year as a result of the timing of the initiatives and their related impact on the business. Given very modest food and packaging inflation expected, price for us will be less than in prior years. The severe weather to date in January and February also significantly moderated our views on the first quarter comps and the resulted expected earnings growth.

Let me talk about a few of the investments. The impact of adding 35 hours per week per café will increase labor expense by as much as $15 million on an annual basis. We will not lap this expense until late October 2014. In addition, we have seen minimum wages rise in some states which will likely result in some expense pressure for our cafés as we seek to maintain a premium wage for our associates relative to minimum wage. We also will see modest pressure from anticipated rollout of ACA as we intend to remain committed to offering our associates healthcare alternatives.

Food costs as a percentage of sales will moderate slightly as we lap last year’s introduction of pasta and shrimp, which were higher cost food items. As I mentioned when discussing Q4, in 2014 we anticipate D&A and G&A will be a source of de-leveraging as these P&L lines are most impacted as we continue to build our IT capabilities and enhance our operational capabilities in the bakery cafés. In 2014, we expect depreciation and amortization expense to grow in the low teens as a percentage over 2013, with IT capitalized expenses as the primary driver. Over the past 18 months, we have made increasing investments in our IT platform to support our initiatives around a greatly enhanced customer experience and ultimately build and then maintain IT as a competitive advantage.

Our investments in a better guest experience enabled by technology and access will add on a layer on ongoing expenses that will need to be leveraged over time. To give this context, this spending essentially doubled in 2013 and will be up 64% in 2014. It is important, though, to note that these increases are off a small base for a company our size.

Similarly, we anticipate G&A to increase by slightly over 20% in dollars in 2014, driven by IT, additions to our executive team to explore growth opportunities that would leverage the Panera brand in new formats and serving new customer needs, and the lapping of lower incentive compensation expense in 2013, specifically in the back half of the year. Just to give you context on the magnitude of the increase we’re expecting, total G&A dollars spent on IT grew 38% in 2013 over the prior year and are expected to be up approximately 30% in 2014.

At the end of 2012, we talked about $20 million in investments for 2013. As we’ve refined that view of the year, we realized that while some of these investments were one-time in nature, many were layer investments that are ongoing in nature and will increase that level of D&A and G&A in 2014 and beyond. As indicated on the last call, 2014 EPS growth will be modestly below the low end of our guidance long term target. Specifically, we expect 2014 EPS of $6.80 to $7.05, up between 5 and 8% compared to our 52-week EPS in 2013 of $6.50, which is net of the extra week and the one-time tax benefits of $0.18 we called out during last year. Q1 EPS is expected to be $1.49 to $1.55. This number was clearly negatively impacted by weather in the first quarter in January and February to date, as Ron gave color to.

Our Q1 EPS is expected to be lower than last year’s EPS as a result of de-levering in margins from weaker comps coupled with the continued investments in labor, IT and operational capabilities. Given uncertainty around how these investments will play out, we are providing annual guidance on comps, operating margin and EPS, but for the quarters going forward we will only be providing EPS guidance.

New unit development for 2014 will be in the target range of 115 to 125 units with company openings representing a higher percentage of total system growth in 2014 relative to 2013.

Now let’s cover our capital deployment plans for 2014. We continue to believe that the best use of capital is to build new bakery cafés that generate attractive long-term returns. This clearly remains our priority. We expect our 2014 total capital expenditures to be approximately $225 million to $250 million. This increase over 2013 levels reflects an increase in new unit development and relocations, continued investments in our cafés for operational efficiencies, and enhanced technology. Additionally, we will also need to spend more capital expanding our fresh dough facilities to further leverage them as points of distribution for our fresh dough and fresh produce. These investments are cyclical in nature and occur as we grow our cafés naturally and then fully leverage existing facilities, resulting in the need to either expand or build new facilities.

Even with this increased CAPEX, we will continue to deploy capital in a consistent fashion for share repurchases given the strong cash flow generation of our business, probably less than 2013 levels given we deployed excess cash on the balance sheet that year, but still meaningful. These repurchases are layered into our guidance. While preserving financial flexibility will ultimately be our first priority, we believe consistent share repurchase is important and continue to review our optimal capital structure with our board.

Let me conclude this portion of our prepared remarks with a reminder about our upcoming investor day in Charlotte, North Carolina on March 25. The investor relations section of our website features details on the event, so please don’t hesitate to reach out to Michele should you wish to attend. We are very excited to share with you our vision for Panera’s future and have you meet other members of the management team. We believe we’ll be able to tangibly show you how our strategy is designed to change our customer experience and capture the demand for Panera food which will manifest itself in increased transaction growth and give you a better understanding of who you are choosing to invest against this great brand for long-term earnings growth.

With that, we’re now going to open the line for questions. As has been our policy, I would ask everyone to limit themselves to one question to be considerate to all those who wish to ask questions. Operator?

Question and Answer Session

Operator

Thank you, sir. [Operator instructions]

We’ll take your first question from Brian Bittner from Oppenheimer.

Brian Bittner – Oppenheimer

Thank you very much. Good morning. I’m wondering if you can just give us a little more detail, make us feel a little more comfortable in the 2 to 4% full-year comp guidance, because obviously it does assume a very large acceleration in sales from where the comps are today, even excluding the weather impacts. I think we all know that it’s tied to these initiatives that you’re going to talk more about at the analyst day, but maybe you can elaborate a bit more on the timing and maybe the impacts of some of them, like maybe what you’re seeing in test markets with technology or what have you.

Roger Matthews

Sure. If there’s two important themes that I’d leave you with, one is that 2014 won’t be a series of step functions on comps but a nice, slow, steady, gradual build because I think we firmly believe as we look at test results that it’s going to be the totality of these initiatives that we’re doing that are going to really produce a result. I think secondly, we’ve given you a sense there’s a whole series of initiatives. We’re not going to probably go into the specific timing of each of them and the impact of them. All I would say is obviously given what’s been a weaker start to the year given the weather, we tried to lay out a guidance target we felt comfortable with in terms of the totality of our initiatives.

Brian Bittner – Oppenheimer

Okay, thank you.

Operator

We’ll move next to Joe Buckley from Bank of America Merrill Lynch.

Joe Buckley – Bank of America Merrill Lynch

Good morning. Could you give us the status of these changes in the service equipment and processes, the KDF’s, et cetera, that you’ve discussed? Are they in all the company-operated cafés at this point or are they in some stage of rollout, and is there more to come or have the operational changes been put in place already?

Ronald Shaich

I think, Joe, as you know, there are a number of different elements to it, and I think as we delineated on the last call there were a number of elements. Certain things have been done. We’ve improved the capacity in roughly 75% of the company stores, the KDF has been rolled out. Other things have not been done. We are looking at a number of initiatives to drive the accuracy, customer-facing displays and the like. We have not fully completed the discipline we want to bring around process metrics where we actually have complete clarity relative to them.

What I would say to you and I think it’s important to get is that this isn’t—like many things, it isn’t a single light switch that we turn on, but it’s really about a commitment to operating discipline, an commitment to being fully staffed and fully deployed, and to actually have the operational capabilities to do what we expect. So I think what I really am trying to say to you is we’ve gotten a bunch of it done, we’ve already begun to see improvements in our process metrics, which we know are leading indicators, and yet we have a significant amount yet to do, much of that around bringing to bear the level of discipline we want in the system.

Roger Matthews

I guess, Joe, the only thing that I would add is implicit in the guidance we gave are really the bulk of the initiatives that Ron is talking about to come.

Joe Buckley – Bank of America Merrill Lynch

Okay, thank you.

Operator

We’ll hear next from John Glass from Morgan Stanley.

John Glass – Morgan Stanley

Thanks. Can you talk about the capital budget for ’14, and is this a step function as well that you’ll remain more capital intensive given the technology elements of the business, or is it more of a one-year spend? And in answering that, can you also just talk about the pace of development? I think ’14 plan is a little lower than what you did in ’13 – maybe you’re just being conservative, but are you making those trade-offs? And then finally can you also just weave that into your buyback plans for ’14? I know you’re not disclosing it, but—

Ronald Shaich

That sounds like a three-hitter!

John Glass – Morgan Stanley

I know, but after all these years! Can you knit those three things together in terms of how much you’ve got to build?

Ronald Shaich

Every 10 years you’ve been covering us, you get an extra question.

John Glass – Morgan Stanley

Thank you!

Roger Matthews

All right, so let me take them in a slightly different order. On at least a unit construction, so just to be really clear, number one, we usually start the year with pretty conservative guidance because we never know exactly how things are going to turn out – I think that’s been our history. Secondly, company unit development will be a much larger percentage of the total target for the year, so I would tell you we feel as confident as ever and I think we’re very comfortable in the returns we’re generating, so there’s no change to our level of confidence or our desire to be aggressive on unit construction.

On the CAPEX, I’d say you’re partially right and other parts again are one-time. So as I mentioned, we will spend significant capital this year on our FDF facility. We’ll do the same next year as well because, again, those 25 roughly facilities, they just hit a certain point over time where we’ve leveraged them so extensively that we have to expand the facilities. We’re at that point now, and so while this year and next will be higher, I will tell you the prior years were quite low and the next few years after 2015 will be lower.

But you’re right in that IT is going to be a larger ongoing component of our spending, and the reality is to do this right, to do IT in a way where you build a function, maintain it, and then ongoing maintain and support it for our stores and our franchisees and continue to upgrade it. The reality is the costs of this are expensive, and so that’s why our goal is to leverage this over time with increased transactions.

I’d say lastly on share buybacks, again we are blessed with a business that generates tremendous free cash flow, so again even though we will have to be deploying more CAPEX this next year, our goal is to be a meaningful repurchaser of our shares. Again, I won’t be more specific than to say we’ll be below probably the levels we did in 2013, but I think the levels will still be substantial, and obviously we always want to be opportunistic and when opportunities present themselves.

John Glass – Morgan Stanley

Okay, thank you.

Operator

We’ll hear next from Matthew Difrisco from Buckingham Research.

Matthew Difrisco – Buckingham Research

Hi there. My question—I do have a question and then I just wanted to clarify. The Black Box data, did you also infer also that you’re continuing that pace, or is that 1.6 only confined to 4Q, the 160 BPs above Black Box?

Roger Matthews

That 160 BPs is confined to Q4. It’s 161, to be specific, for Q4 and we don’t have data for Q1 yet.

Matthew Difrisco – Buckingham Research

Okay. Can you give us some color on what you’re seeing as far as—it’s pretty impressive that half of your customers’ transactions are coming in as the My Panera members. What are you seeing in the characteristics currently between the check and the frequency from that customer? What can we learn from that customer and assume the benefit could be as you win over more of your transactions towards that?

Ronald Shaich

Well, I don’t have the check data on the top of my head. I can tell you their frequency is significantly higher. I think that here’s what we learn. As consumers use Panera for multiple departs, their frequency goes up and their check goes down. Generally, that tends to be our best customers and the folks that are in My Panera, so I think that ultimately what we take away from it and therefore what you can learn from it is that the potential to drive Panera’s increased frequency through My Panera is the opportunity to engage people in ways in which they get more connected with Panera, use it more frequently for the departs they presently use, and in which they step up to use it for additional departs.

Matthew Difrisco – Buckingham Research

That’s interesting. I guess that correlates well with your commentary about the entrée growth as well as the percentage of sales moving towards My Panera that it would correlate with.

Ronald Shaich

Exactly, you’re right on. Okay, thank you, Matt.

Matthew Difrisco – Buckingham Research

Thank you.

Operator

Moving on to Jeffrey Bernstein from Barclays.

Jeffrey Bernstein – Barclays

Good morning, thank you. Actually just two clarifications, which hopefully equates to one question. First, a clarification on the unit growth. I think you said it’s now skewing more heavily or significantly more heavily company operated. I’m just wondering if you could talk about maybe why that is, whether the franchisees are slowing it because they’re making significant investments, or whether we should assume that rate accelerates again in ’15 and beyond. The other thing was I think you mentioned in your prepared remarks—you were talking about using cash for share repurchase and other things, and I think you said you review your optimal capital structure periodically. I’m just wondering if and when leverage would ever fit into the model more materially than it does today. Thanks.

Roger Matthews

Sure. So I wouldn’t read anything into the franchisee mix skewing lower this year. You look at the fourth quarter, franchisees built 24 cafés out of a total of 70 for the year, so some of it is just the timing of franchisees just got a lot of units done in the fourth quarter and let flow through into next year. So nothing to read into that, and again for us, we just continue to be pursuing the development plan based on the returns we’re getting, which are quite attractive.

I think on leverage, it’s something we continue to look at and think about and ultimately review with our board. I think for now at least, what we’re very focused on is becoming a consistent repurchase of stock, doing that steadily on a basis quarter-by-quarter over time, and we’re going to continue to evaluate what the benefits of leverage could be.

Ronald Shaich

Thank you. Next?

Operator

David Tarantino from Robert W. Baird, your line is open.

Ronald Shaich

Good morning, David.

David Tarantino – Robert W. Baird

Hi, good morning. My question is on the earnings outlook for 2014 and really related to margins. It looks like margins came in weaker than you had anticipated in Q4, and even though comps were at the high end of your plan, so my assumption is that the costs ran ahead of your initial assumptions. The question I guess related to this is how confident are you that you’ve got your 2014 guidance embedding the right assumptions on the cost side, or maybe asked differently, do you think you have enough conservatism in your cost lines to be comfortable in delivering the earnings outlook you’ve laid out?

Roger Matthews

Sure. So I guess as it relates to the fourth quarter, I’ll be honest – we don’t really see it as the margin having been significantly weaker than expected. I think the reality is, and we’ve seen a lot of folks publish some notes before the call – I know folks called out the lower tax rate and what could be a $0.03 impact. Conversely though, when you look at the impact that Ron alluded to of weather, we’re pretty conservative in how we’ve talked about the EPS impact on weather. It’s ultimately—I would say that number was at least what Ron said, if not higher. The reality is that December volatility dramatically not just hurts comps but it throws off the whole labor and scheduling portion. So again, I think we felt pretty good about where actually the margins came out on the store level and for the cafés.

I think in terms of the guidance for next year, we have, I would say, the cost pretty well mapped out for 2014. As Ron said, the initiatives we’re rolling out are part of a very long-term plan, so I’d say a fair amount of methodical planning in terms of how we are going to roll out things to the cafés and the costs associated with it. So look, we feel very good about it. We’re obviously sitting here in Q1 and 24 hours ago, having seen another snowstorm roll through the northeast, our hope is that we’ve built in the right level of conservatism into Q1. We feel good about it, and again as we put out our estimates for Q1 EPS and the rest of the year, we feel these are targets that are achievable.

David Tarantino – Robert W. Baird

Thank you very much.

Operator

We’ll hear next from Jason West from Deutsche Bank.

Jason West – Deutsche Bank

Yes, thanks. Just a question on the rollout of some of the initiatives and what’s embedded in guidance. I know in March, we’re going to go down to Charlotte and probably see some of the new access initiatives that you guys have been testing. Just wondering, is a rollout of that program—you know, some of the new technology and ordering options, is that contemplated in the guidance for this year at some point in terms of the cost and the sales lift, or is that something that you’re looking at for next year?

Roger Matthews

Elements of it will roll out as we march forward this year; other elements will roll out over a longer period of time. The elements that we imagine that will roll out this year are embedded in the guidance.

Jason West – Deutsche Bank

Okay, but the large chunk of the expense increase this year is not really related to that, or is a lot of this related to that initiative?

Roger Matthews

Obviously the expenses we expect are built into our guidance.

Jason West – Deutsche Bank

Okay, thanks.

Operator

Sara Senatore from Sanford Bernstein, your line is open.

Sara Senatore – Sanford Bernstein

Thank you very much. I just wanted to sort of get a sense of—you mentioned that the initiatives that you’re seeing in terms of additional labor is really helping, but if I look at the January-February trends, even if I adjust for weather, it still looks pretty choppy. So it looked like, as you were saying, November was strong – I would have attributed that to maybe some of the benefit from labor, and then the underlying ex-weather trends have kind of flowed. So can you just help me understand what was in there in terms of the benefit from throughput and labor, as well as if there was any benefit from, you said, periodic testing of national marketing, whether that was in there. I’m just trying to get a sense of the degree to which you really can see some improvement based on some of the initiatives you’re undertaking.

Ronald Shaich

Sure. I’d share with you this – what we saw improvement in is the operational metrics we utilize – speed of service, throughput. That’s what we saw. Those are typically leading indicators. They are not something that affects performance, shall I say, in the last two weeks or four weeks. It doesn’t work that way, and when you understand the average frequency in Panera, you can fully understand that many of these initiatives can trail by as much as three to six months. It’s not unusual to see that when you impact an operating system, so I would advise you and other analysts not to have a perception that you take an action across a 2,000-store system, near-2,000 store system on one day, and that somehow it changes in some byproduct metric like transaction growth or comps the following day.

I would say that we’re 48 days into P1. We have a—we’re basically giving you our comps as they come in every morning. I think you’ll certainly hear what other people are saying – we think that January has been very tough for a lot of people. I think we’ll better understand our relative performance and what is really going on in the business as the snow melts and as we have a perception relatively on how we’re doing.

But I think our basic assumption without full knowledge – with no more knowledge than you have – is that the underlying trends are still pretty good in P1, and we’re feeling optimistic and positive about the impact we’re having, understanding it all a long-term play here.

Sara Senatore – Sanford Bernstein

Thank you, understood.

Operator

Chris O’Cull from Keybanc Capital, your line is open.

Chris O’Cull – Keybanc Capital

Thanks. Good morning guys. Ron, the company’s used national advertising at various times in recent months, but there hasn’t been a meaningful transaction lift. What are you seeing in these tests that gives you confidence greater national advertising this year will drive transactions and earn a return?

Ronald Shaich

Yeah, good question, Chris. One never knows. That’s why we don’t basically pull apart all of these different initiatives. Having said that, we’ve run modeling relative to advertising over a number of years multiple different ways. We actually have conducted testing control to see what happens when we advertise versus when we don’t market by market, and we’ve actually used two different econometric modeling mechanisms to determine what the impact is.

In all cases, it’s come back indicating to us it more than pays for itself. It’s not a black-white thing. It depends on the message, it depends on the kind of campaign and whether you’re doing a brand campaign or a campaign that’s meant to drive short-term transactions. Our efforts are generally more brand-oriented than they are trying to be promotional. Having said that, we have significant analytical data that supports the idea that this has impact. What the actual impact of what we do and what will happen in the future, I don’t think we’re going to know until after the fact and after we’re able to go back and do the post mortems.

Chris O’Cull – Keybanc Capital

Great, thanks.

Operator

We’ll hear next from Keith Siegner with UBS.

Keith Siegner – UBS

Thanks. Before I ask a question, Roger, can I just ask for a clarification? When you talked about D&A growing low teens versus 2013 and G&A up 20%, and both of those in dollars, is that against the as-reported 53-week numbers in 2013?

Roger Matthews

Yes, it is. Yes.

Keith Siegner – UBS

Okay, thank you. The question, then, is with a full year in the books now, when you look back to the 2012 urban openings, they’ve all anniversaried now and hit the 12 months. What have you learned about that urban opening class? What are the urban unit ROICs and how do you think about that with a little bit more perspective now? Thanks.

Roger Matthews

Wow, there’s a lot there. You know, it’s interesting, Keith – first, I would say to you this. The buy-ins are extraordinarily high. The operating environments are difficult, certainly more difficult than a suburban kind of environment. The R is because the buy-ins are high, is very significant. The I in the ROI – because that is even higher – basically means that the ROIs themselves when you net it all out are more modest than our suburban stores, at least at this point, but produce significantly more profit dollars. It’s the nature of big capital expenditures.

I think the more important learning for us is that the opportunity is very real, but it may not be simply applying the way we do a suburban store. So I think that you’re going to hear us talk about how we approach and go forward in urban marketplaces based on a lot of what we’ve been doing working on this strategic plan we have called now, Panera 2.0, and I think the application of some of what you see in Charlotte will make a great deal of sense as we march further into the urban environment.

Keith Siegner – UBS

Thank you very much.

Operator

As a reminder, it is star, one if you have a question or a comment. We’ll move next to Sharon Zackfia from William Blair.

Sharon Zackfia – William Blair

Hi, good morning. So I’m going to keep it to one question even though I’ve been following you more than 10 years. Just a question when you think about how you compensate your managers. I think historically it’s been more cash flow based, the unit level cash flow. I’m wondering if you’re thinking about adding more top-line incentive to the managerial compensation and just how that fits into this plan.

Ronald Shaich

Great question. We’ve been one of the leaders—I think we were one of really the originators of what much of the industry now uses, called joint venture programs – a fraction of the action, as an example, went through Outback. We developed it now, I think a decade and a half ago. It’s served us very, very well. Basically, it means that our managers sign up and make a commitment to the store for a period of time, and then essentially we see compensation based on the productivity of the—based on the outcomes of the store, and they have ultimately a buyback or an opportunity to receive a large payment at the end of their agreement, and that large payment is based on the trailing EBITDA, some multiple of the trailing EBITDA for the last two years of their agreement. Obviously, that big payment that they see out there, which can be significant, is important to them and important to us in motivating them to stay focused on building customer satisfaction.

Having said that, I think you’re wise enough to know we’re continually looking at everything and continue to look at how do we adjust our compensation schemes to get the right kind of attention. I think that the important thing you should hear from us when we talk about operational capabilities, and it goes right back to Joe’s question, is physical capacity is one thing but maybe more important is managerial motivation skill and discipline. We’re very focused on trying to free our managers up to stay focused on running process discipline.

Going to the urban store question, we have stores where we’re producing an entrée every six seconds. Imagine what that’s like and what that means to produce, and it requires a level of operating commitment and discipline that’s rooted in proper staffing and high quality people. So in many ways, what you hear us talking about in operational capabilities is not simply a single element but a commitment to really deliver in a serious way not against simply hours versus chart, which is a metric that often gets used in restaurants, but more importantly actually worshipping customer experience and delivering the Panera experience.

Sharon Zackfia – William Blair

Okay, great. Thank you.

Operator

We’ll hear next from Nick Setyan from Wedbush Securities.

Nick Setyan – Wedbush Securities

Thank you. My question is around the franchisees and what their response has been with respect to a lot of the initiatives that we see going on, and in terms of the cadence as well, are they lockstep as the company implements some of these initiatives? Are they in terms of timing doing the same, or is there a little bit of a delay? Do they have a choice in what they can implement and what they can’t, or if they can choose to implement some and not implement others? Just some color around some of that would be helpful. Thank you.

Ronald Shaich

Yeah. I mean, Nick, I met with our franchise great council yesterday around some of these issues, and to a person they are excited. They’ve been part of both the development of this and they have been part of along the way understanding what’s going on, so generally I would say our franchise community is excited about the progress and the direction.

I would say this as well – our franchisees have generally done extraordinarily well. There’s been a great deal of net worth been created. There is tremendous goodwill between the company generally and our franchisees, and a high degree of connection. I think what our franchisees and I assume you have is that over the last couple of quarters since we have pushed on this operational capability effort and begun programming some of this, our comps have actually grown at a faster rate than our franchisees’, and I think they obviously see that and that gives even more incentive. It both gives support to what we’re doing and gives incentive for them to join us as we continue to try to do an ever-better job for our guests.

Nick Setyan – Wedbush Securities

Thank you.

Operator

Bob Derrington from Wunderlich Securities, please go ahead.

Bob Derrington – Wunderlich Securities

Thank you. Ron, based on one extra question per decade, I think I’ve got three coming at you, but I won’t torture you with that.

Ronald Shaich

All right. Save two for the next meeting, Bob.

Bob Derrington – Wunderlich Securities

Specifically Ron, around the success you’ve had with your pasta program and as we look at the depart sales across your business, how do we think about further evolution in the menu, especially as you’re rolling out some of these new service initiatives? That’s question one. Question two is—

Ronald Shaich

You’re pulling your 30-year card! Go ahead.

Bob Derrington – Wunderlich Securities

Well, specifically on the menu test that you’ve had, we know in some different markets, do we need to be concerned about a check average trade-down as consumers have looked at these new menu boards?

Ronald Shaich

Great – okay. Let me take the second question first and simply say we have not seen in any of our testing check averages descending, so nothing indicates to us that. Rather, we see it as a potential frequency builder, so nothing indicates to us we’ll see it. Obviously as you go national, things have a way of having a life of their own, but nothing indicates to us that we should expect that.

Relative to depart, I think in the core Panera is a—has 80% of its volume after 11:00. It’s basically a lunch gathering place and lunch in the evening, with a breakfast component. Those are the businesses that we compete in. Those are the businesses you expect us to compete in. What I think you’re hearing us talk about is how do we take—how do we continue to build differentiation within the worlds of soup-salad-sandwich and products like our mac-n-cheese and pasta? How do we continue to build differentiation within those products and how do we then take that differentiation and make sure we’re serving in a way that’s distinctly appropriate for that eat-in guest, for that to-go guest, and for that guest that wants delivery, that wants the food delivered to where they are. I think that what you hear us saying is we bring all this together – you’ll be hearing us talking about it in Charlotte – is we’re about getting better at what we do, not about doing a lot of new things differently.

Bob Derrington – Wunderlich Securities

Very good. Thank you.

Roger Matthews

So Operator, we probably have time for one more question.

Operator

Your last question will come from Steve Anderson from Miller Tabak.

Steve Anderson – Miller Tabak

Good morning. I know you talked a lot about throughput initiatives. The one thing I haven’t heard you discuss on this call in particular is the drive-through lanes, and particularly as that starts to become over time an increasingly important part of your unit mix. Have you done anything specifically to increase throughput times to reduce times there?

Roger Matthews

We’re looking at it. There’s nothing specific we’re going to comment on at this point.

Steve Anderson – Miller Tabak

Okay, thanks.

Operator

That does conclude our Q&A session. I’d like to turn the conference back over to your hosts for any concluding remarks.

Roger Matthews

Great. Thank you all for joining, and we do hope everybody will take advantage of the investor day March 25 in Charlotte, North Carolina. Hope to see you all there.

Operator

That does conclude today’s teleconference. We thank you all for your participation.

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