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Panera Bread (NASDAQ:PNRA)

Q1 2014 Earnings Call

April 30, 2014 8:30 am ET

Executives

Michele Harrison - Vice President of Investor Relations, Corporate Development & Treasury

Roger C. Matthews - Chief Financial Officer and Executive Vice President

Ronald M. Shaich - Co-Founder, Executive Chairman and Chief Executive Officer

Analysts

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Alexander Slagle - Jefferies LLC, Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

David E. Tarantino - Robert W. Baird & Co. Incorporated, Research Division

John S. Glass - Morgan Stanley, Research Division

Sara H. Senatore - Sanford C. Bernstein & Co., LLC., Research Division

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

Keith Siegner - UBS Investment Bank, Research Division

Jason West - Deutsche Bank AG, Research Division

Jeffrey D. Farmer - Wells Fargo Securities, LLC, Research Division

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Operator

Good day, and welcome to the Panera Bread First Quarter 2014 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Michele Harrison. You may begin.

Michele Harrison

Thanks, Kim. Good morning to everyone, and welcome to Panera Bread's first quarter 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 Securities 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 the 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 20, 2014.

This document contains and identifies important factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements.

With that, I'll turn the call over to Roger.

Roger C. Matthews

Thank you, Michele. Good morning, everyone. Yesterday, after the market closed, we reported Q1 EPS of $1.55, which was at the high end of our target range. Recall that last year's first quarter results had a truly one-time $0.05 benefit from the favorable outcome of legal and sales tax matters in the quarter. Taking that one-time benefit out from last year, our year-over-year EPS decline was 2.5%.

Today, Ron and I will provide you more detail on our Q1 results, as well as put this quarter's results in the context of the broader, long-term initiatives we outlined in detail at our Investor Day in Charlotte a month ago. We will also provide perspectives on our targets for Q2 and the full year 2012.

Our revenues for the first quarter increased 8% to $605 million. This was primarily the result of new company-owned bakery-cafes, as well as growth in franchise royalties and sales of fresh dough and other product sales to our franchisees.

Now I'll spend a couple of minutes looking at our comps. While the number itself is always interesting, more important is to put that number in the context of the underlying trend and try to see the real trajectory of the business. So how do we make sense of a comp of 0.1%? First, let me note, fiscal comps ran 0.7%. However, we will use the relatively weaker calendar comps for our discussion today and going forward, as we believe the calendar comp are a lot more meaningful than fiscal comps. It matches the days up with the same day from the prior year, not with the random day that happened to fall on the same spot in a fiscal calendar that shifts as a result of the 53rd week. We then try to disaggregate both the weather impact, as well as the shift of holidays. Our approach on weather is conservative. We look to see if the store had a named storm in the region and then look for negative 10% or greater decline in sales on that day, only then do we exclude the store on that day for this year and last year to create a clean comp.

Using this methodology, we believe the impact of severe weather cost us something like 150 to 200 basis points in transactions for the full quarter. So let's use a midpoint of 175 basis points. We know the severe weather was heaviest in January and February, with the first month of the year being the worst. Then we focus on the Easter shift, which we believe resulted in an extra 150 basis points of transaction and comp in P3 or approximately 50 basis points of comp and transaction in the first full quarter.

Taken together, the net impact of the unfavorable weather and the Easter shift created a headwind of roughly 125 net basis points to transactions and comp growth in Q1. So to give context, that means our weather and holidays adjusted comparable sales growth for the first quarter was roughly positive 1.35%.

Now let's break apart the pieces. From the transaction growth before that weather and holiday adjustment, our transactions declined by 2.8%, while our check combining price and mix was up 2.9%. On a weather and holiday adjusted basis, transactions were down approximately 1.6%.

Now we should look at the period-by-period data for further insight. On the company side, we reported January calendar comps of down 3.1%, February comps up to 0.2% and March comps up 3%. And finally, let's now focus into the first 27 days of period 4 where our comps were up 0.4%.

We know that Easter was a 150 basis point headwind this period, so the weather and holiday adjusted comp for April to date was more about like 1.9%. And while we don't disclose the components of a 27-day comp, I can tell you that our transactions for the first 27 days have been better than Q1 on a reported basis, on a weather and holiday adjusted basis and on a 2-year run rate.

Finally, one last bit of perspective on how we hold our Q1 transaction performance. As in prior quarters, we measured ourselves against the black box index. As the quarter progressed, after a difficult-to-read and negative January, we saw sequential improvement in our transaction growth differential to black box in February and, again, in March.

Now let me take a few minutes to talk about margins and the trends that we saw in the quarter. Our first quarter operating margin declined by 250 basis points versus last year. This was frankly in line with our expectations, albeit at the higher end given the severe weather. Contributing factors included lower comp growth and related weaker flow-through, as well as the investments we made to enhance our corporate and café foundational capabilities, as well as to improve the quality of the customer experience. Bakery-cafe margin delevered by 130 basis points compared to the prior year.

The primary components of the decline were comprised of the following: Food cost increased 30 basis points in the first quarter, primarily the result of higher waste created by the sales volatility introduced by inclement weather. Additionally, paper cost trended slightly higher than last year driven by investments to improve our packaging, which we see as a key component of the customer experience in our cafés. This also reflects higher input prices around paper and packaging.

Let me add that we saw and we'll be seeing more commodity inflation for the year than originally expected. We're seeing this in several areas, but in particular in produce, such as avocados, bacon, where the antibiotic-free market has been impacted by the much discussed virus at farms, and butter. We continue to expect to take only modest price later this year, but we will continue to watch inflation. We now expect food inflation to be approximately 125 basis points this year and frankly would have been higher were not for the good work of our supply chain team to lock in prices in key raw inputs months ago. At this time, we are well over 80% locked on all our commodity inputs.

Labor expense increased by 40 basis points versus the first quarter of last year. This higher expense reflects the implementation of the additional 35 hours per week in each of our cafés in late October and additional planned training cost resulting from increased hiring and incurred to bolster the size of café rosters. This deeper bench strength allows our cafés to better maintain proper staffing levels in the event of a random employee being sick or not showing up for work. And given the volume in our cafés, inability to fill a vacant slot on short notice can have a major impact on lunch productivity. This increase in labor expenses were partially offset by lower manager bonuses due to softer weather impacted sales this quarter.

Other operating expenses deleveraged 50 basis points due to a number of factors. The largest change was increased media expense, as we flexed up the weights of our national bodies [ph] late in the quarter. Second, the bad weather hit us in the utility line in other operating expenses. We saw nearly a 20% year-over-year increase in utility costs in our cafés as a result of both increased unit -- usage given higher temperatures, lower temperatures and higher rates. We anticipate utility rates to remain higher than last year for the rest of the year. We also incurred an incremental expense in Q1 to bring the Panera family together to provide our operators and franchise community with an update on the future vision. This event was a lot like the Investor Day we did with you all in Charlotte and is something we try to do to every 18 to 24 months. The only difference is that this update was broadcast to movie theaters in all the different regions of the country, and we paid roughly 5,000 managers and assistant managers for their time to join us for the half-day event. Apologies, we couldn't pay all of you for attending the Investor Day. The cost of putting on the event and broadcasting appears in this line, and the labor line itself shows modest deleveraging from the cost associated with attendance.

Finally, partially offsetting these increases in other operating expenses were lower multi-unit manager bonuses and savings gained from small wares including supplies. This is the benefit of the moves we made to replenish small wares at the end of last year.

Let's now talk about the growth in G&A and D&A in the quarter. G&A and D&A delevered by approximately 80 and 60 basis points, respectively, in the quarter. The increased in expense reflects the planned investments in Panera 2.0, IT infrastructure and other functional capabilities that we have previously discussed. The increase is in line with the yearly guidance that we provided, and we expect these 2 line items to ramp throughout the year.

Moving down the P&L, other income was approximately half the level it was in the first quarter of 2013. The $0.05 sales tax reversal from last year showed up in this line item. Our effective tax rate of 37.3% for the quarter was lower than last year's Q1 level. This is an area where we should spend some time. As most of you know, our tax rate can move around quarter-to-quarter and can differ year-over-year without the annual tax rate differing much. This quarter's level was actually right in line with our effective tax rate from the full year of fiscal 2013. More importantly, we continue to believe we will end the year with an effective tax rate below 38%. We've been doing some work in the tax area to modestly lower our effective tax rate and are beginning to see the signs of success. Nothing aggressive, but in upgrading the talent in our tax area, we've been able to pursue opportunities across our diverse business units and geographies to realize tax efficiencies. In fact, we experienced a modest benefit this quarter from the early stages of these tax planning efforts. So as we think about the quarter, there's probably $0.02 of EPS benefit that could be considered onetime in nature. But all of the tax beat was the result of better tax planning, and we will see continued benefit throughout the year as we move towards a sub-38% effective tax rate for the full fiscal year. And this will be our on-going forward run rate.

Let's now talk about the use of cash. We continue to prioritize the deployment of our cash to the construction of new bakery-cafes. During the quarter, we opened 27 new bakery-cafes systemwide, 16 company-owned and 11 franchise operated, bringing our systemwide café count to 1,800 at the end of the quarter.

You might have noticed that we added some additional disclosure to our press release. If you didn't, let me point you to Schedule II. We will now be breaking out the number and average weekly sales for our traditional units, as well as our non-traditional units. This is consistent with our commitment to provide great disclosure on our business as it evolves. Traditionally, units are easy. These are the suburban bakery-cafes with at least 4,200 square feet that we've been building in suburban locations for years. Non-traditional units will allow us to more deeply penetrate existing and new markets, while providing an opportunity for high return on investment deployment of capital. The non-traditional units will be in the range of sizes and layouts and may include urban, takeout and delivery and smaller footprint stores in non-suburban locations. Let me note that these units are a much more recent phenomena with a lot less history, and they don't compare easily to our traditional stores. So I wouldn't read too much into the year-over-year comparison.

New company-owned cafés had year-to-date average weekly sales of $55,230 versus $61,912 last year. As we indicated last year in our call, last year's number was somewhat inflated as it reflected only a modest number of operating weeks, driven essentially by only 4 cafés. And you will remember, we didn't change our outlook on café volumes for the year in Q1. We're very pleased with this year's opening levels as it's the second highest in the company's history until last year and represents a much larger sample of cafés matching more than twice the number of operating weeks for the quarter compared to last year.

Breaking this down further into traditional and non-traditional units, we saw an AWS for traditional cafés of $56,737 versus $64,593 last year. Again, 2013 was skewed by the small number of operating weeks from that handful of stores. Non-traditional unit AWS was $35,901 for the first quarter of '14 versus $52,779 in the first quarter of 2013. The 13th -- 2013, we had 1 urban café opened in D.C. midway in the quarter versus 2 urban stores and 1 smaller footprint store opened late in this year's first quarter. Given the small comparison set of 3 stores versus 1 last year and the different formats, any year-over-year comparison is not meaningful. Suffice it to say, these units are performing well relative to our expectations. Our newly opened franchise cafés had year-to-date average weekly sales of $58,891 versus $51,543 last year. This was a record for our franchisees. The split between traditional and non-traditional units are less meaningful as, this year, our franchisees opened up 1 urban unit and last year did not open up any non-traditional units. We will continue to break out the split between traditional and non-traditional units for you in the future quarters.

Turning to the balance sheet. We ended the quarter with just over $100 million in cash and no funded debt. We generated approximately $64 million of cash flow from operations during the first quarter after $42 million of capital expenditures. We continue to return cash to our shareholders and repurchased approximately 50 million of shares during the quarter. We now have just under $200 million remaining on our current share repurchase authorization. To wrap up our discussion on Q1, our comp growth, EPS growth and new unit opens were all in line with our expectations, despite the volatility created by weather. But this quarter is only one step in our plan to significantly bend the trajectory of our business.

With that, I will turn it over to Ron to provide his color commentary on the quarter, as well as the coming year. Ron?

Ronald M. Shaich

Good morning. Yes, great. Thank you very much. Thank you, Roger. It's barely been a month since I saw most of you at our Investor Conference in Charlotte. So you'll have to excuse my candor when I say that after 8 hours together, just 30 days ago, there's little new to add today. However, I would like to take this opportunity to highlight for those of you not in attendance in Charlotte certain elements of the plan that make up our long-term strategy and to provide to all of you color commentary on our key initiatives based on what we've learned in quarter 1 and in the first 27 days of quarter 2. Just as I did in Charlotte, it's worth restating Panera's key objectives. Simply put, we are focused on enhancing our competitive position, and we're focused on expanding our growth opportunities.

To enhance our competitive position, we're implementing 3 key strategies, including the rollout of Panera 2.0, operational excellence and further innovation in food and marketing. Relative to expanding our growth opportunities, we are utilizing several key strategies, including traditional store growth, the development of new formats for Panera and the rollout of Panera to You, which consist of Large-Order Delivery, which we formally call catering and small order deliveries. The intent of each of these strategies is the same. We're dedicated to restaging Panera and in putting Panera on a course for expanding growth in sales and EPS growth well into the future.

Let's now begin by discussing our efforts to enhance Panera's competitive position. To help provide some context, let me first explain something that I spoke about in Charlotte, which we refer to as the desire friction ratio. As core, this is how we view our consumer proposition. We seek to encourage and drive our customers' desire for what we offer, which is to say, we want our guest to walk past the competitors to choose us. At the same time, we want to reduce the friction with the level of resistance that stands in their way. Those of you who've had a chance to see and feel Panera 2.0 recognize it's an enhanced customer experience powered by technology and enabled by operational excellence. It's a vision for how Panera listen to a digital future and an on-the-channel world. Panera 2.0 is an end-to-end system that provides an enhanced order, an enhanced payment, an enhanced execution and enhanced customer experience, specifically designed for the particular needs of our eat-in and our to-go guests, as well as our delivery customers. It's meant to create a truly frictionless and personalized experience for each of our guests in all of their need states.

The elements of Panera 2.0 include in-café kiosk, they include a new website, they include new mobile ordering app, they will make it easier for customers to place, customize and pay for orders. And it includes a range of operational improvements. Perhaps less obvious but no less critical will be other new elements in our cafés that go with Panera 2.0, including a special to-go area, featuring dedicated seating and order status monitor and shelf space, all to facilitate easy access for our rapid pick-up customers.

After several years of developing and testing the technology and defining the necessary operational improvements, the full Panera 2.0 experience is now up in 2 markets in 15 -- in 14 cafés. By the end of 2014, we expect Panera 2.0 to be up and running in nearly 150 cafés. In 2015, we expect we will see the bulk of the company cafés implement the full suite of 2.0 elements. And we expect that in 2016, we will see substantially all of the system adopt Panera 2.0.

Rapid Pick-Up, which is just one element of Panera 2.0, is being rolled out to substantially all of our cafés systemwide in the coming months. Given that we discussed this roll-out plan just 4 weeks ago, there's little new news to report other than to tell you, we continue to like what we see from Panera 2.0, and we are on schedule for the rollout of Panera 2.0 into Dallas. While our conviction behind 2.0 and its potential impact grows by the day, it's also important to remind investors again that the impending rollout of Panera 2.0 is not without real investments and near-term pressure on earnings. Panera 2.0 requires both upfront capital investments and an upfront investment in people and operational capabilities, if we hope to meet the increased demand, while delivering an ever better customer experience. As a result, the rollout of Panera 2.0 will dampen earnings at an individual café in the first 6 months after launch and, in turn, will make planning and specifically quarterly guidance more volatile in the near term.

Second among our strategies to enhance Panera's competitive position is our commitment to operational excellence. On our past 2 earnings calls, we focused on some of the projects we've taken on in this area and detailed a number of our programs. These are all part of the strategic plan we detailed in Charlotte, as ops excellence is a necessary foundation required to enhance our competitive position and drive sales. And as I've noted, Panera 2.0 requires enhanced operational excellence for success. Indeed, when volume is no longer throttled by a limited number of open registers, our cafés must have the operational capabilities necessary to keep up with the unrestricted inflow of digital orders. To be specific, we've now invested to update our kitchen display system. We're in the process of introducing a first-generation auto load-balancing system, and we are making plans to install a new centralized phone system. Moreover, last October, we provided our operators with an additional 35 hours per week in each of our cafés, and we took out additional recruiting and training cost to bolster the number and scale of our café associates. The truth is, it's still too early to see the full impact, but we're seeing our efforts pay off. Our sandwich production times have improved materially since the summer. Indeed, production times are down by over 35 seconds on average.

Last summer, nearly 60% of orders at company Panera cafés had production times exceeding 3 minutes. In Q1 2014, fewer than 40% of orders at company cafés had production times greater than 3 minutes. And yet, this is only the beginning. We have not attained the level of operational excellence we desire nor what is necessary to materially drive sales. Our ultimate intention is to have all production times under 3 minutes in a Panera café and to have no guest leaving a Panera because they grow tired of waiting in the line. At Panera, we know how to get the job done, but it will require capabilities and systemic changes before we can fully operate at the levels we aspire to. Likewise, I should note, there's a lag before guest proceeds or reduce friction that ultimately leads to higher customer frequency. And I say that because our average customer visits 1 of our cafés only once every 5 to 6 weeks. It takes time for them to experience the change, it takes time for them to fully appreciate the change and it takes time for them to build those changes into their perceptions relative to their next visit.

Third, in our plan to enhance Panera's competitive position are our efforts to bring renewed innovation to our food, our environment and our marketing. This is the desire component of the desire friction ratio we're trying to impact.

Let's start by talking about food innovation. On our last call, I mentioned that we'll be introducing flatbread as a new platform. And in several weeks, we'll launch 3 varieties of flatbread, including a Southwest flatbread, a Thai flatbread and our Mediterranean chicken flatbread. Those of you who attended our Investor Day were able to try the flatbreads ahead of the system-wide rollout, and I saw more than a few of you going up for seconds and thirds. Frankly, they're pretty good, aren't they?

I'd like to spend a few minutes discussing flatbreads because I think they offer the potential to materially differentiate Panera in the broader marketplace. We're doing flatbreads in a way that only Panera can. The flatbread itself will be baked in the café from fresh dough and created in the artisan style of the Indian tandoori. These breads provide a platform designed to allow our guests to experiment with new seasonings and new spices and will allow Panera to offer our target customer an elevated experience with innovative new flavors.

As we talk about food innovation, let me also note that we'll be formally announcing our food policy this summer. I don't want to go into any details just yet. But let me be clear, our aim in articulating our food policy publicly will be the giveaways to what is at the very core of our consumers' trust and confidence in Panera. Since its founding several decades ago, Panera has stood for making a positive difference in the lives of our guests. And we believe that by sharing our food policy with the world now, we will provide our customers even greater transparency relative to what is in our food leading to greater choice in what they choose to eat. As well, we believe our ongoing commitment to simple and understandable ingredients serves as a foundation for food that taste better and is better for you. Specifically, the food policy we will roll out this summer will further strengthen the trust customers have in Panera.

Let's now discuss marketing innovation. In late February, our national advertising campaign went live. I want to reiterate what I said on our last earnings call. This marketing effort was not intended to be a step-function sales driver. Rather, we are implying -- we are employing continuity advertising that will extend throughout 2014 and into 2015 in an effort to drive deeper engagement with our target customer. In addition, our national advertising campaign provides access to more expensive metro markets where we have historically had limited advertising presence.

Let me provide a little color on what we are seeing from our advertising efforts. In markets like Los Angeles, where we historically had modest impressions, our comps are outperforming the rest of the country. On the other hand, in markets like Chicago, where we had previously had heavyweights in local advertising and where year-over-year impressions are actually down, we're experiencing weaker comps. I tell you this because it illustrates clearly that our national marketing effort will affect different markets differently based on their relative growth and impressions year-over-year. Having said that and thinking about the country as a whole, we expect our national marketing effort will generate a positive impact and provide a real return on investment, particularly, as the year unfolds. However, we wanted to be clear that given the nature of a long-term continuity campaign, we believe it's highly unlikely we will see a step-function jump in sales, but rather a sustained build in sales.

Let me quickly comment on our loyalty program before I conclude our comments on marketing innovation. In previous earnings calls, we told you that nearly half of our transactions at company cafés are linked to a MyPanera card. We are in the process of evolving the MyPanera program to further capitalize on that adoption rate, which we believe to be the best in the restaurant industry in an effort to provide even more personalized and relevant guest for -- more personalized and relevant benefits for our guests and in an effort to continue to drive frequency.

I'd also note that we believe MyPanera will play an important role within our Panera 2.0 effort, as we utilize our high utilization rate to create greater benefits for those customers ordering digitally at Panera. As I noted when I began my comments, our second key objective in 2014 is to expand opportunities for growth. As part of this initiative, we're exploring several strategies including continued traditional suburban growth, new non-traditional formats and building the capabilities to better compete in adjacent businesses like Large-Order Delivery, which we formerly refer to as catering and small order food delivery. To help appreciate our thinking around this initiative, it helps to understand the concept of hoovering which gives voice to our desire to maximize our sales per capita in a given market. Effectively,we want to use our soup, salad and sandwich credibility to serve more people in more ways. And to do that, we want to vacuum out every high ROI opportunity that exists for our brand.

Roger discussed our continued traditional café growth goals and touched a bit on our non-traditional format initiatives. So I'd like to focus on the evolution we are driving in our Large-Order catering business. Here is the facts. Over the past year, our catering growth has flattened out. Why? One only have to spend a morning calling up hundreds of our cafés, which I've done, in different markets and trying to place a catering order with relatively short lead time to get the answer. All too often, our cafés don't accept the order or could not commit to our customers' desired timings. Indeed, our research leads us to conclude that our catering business is essentially limited by many of the same capacity constraints confronting our cafés during weekday peak hours. While catering limitations are certainly problematic for our catering sales growth, especially considering the role catering has played in driving overall comps at Panera over recent years, we also recognize that freeing up the catering governors provides a powerful opportunity for Panera.

Let me now talk to that opportunity. As we've discussed in past earnings calls, a number of delivery hubs have been in place in Panera for several years. Indeed, we noticed that when we created these delivery hubs, both catering sales and retail sales at the stores catering we're taking from, sales in those stores went up significantly and in a rate faster than the rest of the market. Folks, focus works. So does having a dedicated production line and the necessary management and driver capabilities to do a Large-Order Delivery right. And we also came to another realization. We realize that with delivery hubs in place, we would have the opportunity to enter the small order delivery market, as well as a thinner -- tweener market that we define as being smaller than our traditional catering order, but larger than one-off delivery. Many ways to think of it is your typical 2-, 3- or 4-person business lunch on demand. It's exciting stuff and all of our test and experience tells us it will work. Thus, you can see why we're rolling out delivery hubs wherever we can and as quickly as we can. Indeed, we now expect to have better than 10% of our custom -- 10% of our company system utilizing delivery hubs by year end. However, it is also important for investors to appreciate the nature of our investment in delivery hubs. We make the capital and managerial investment in these hubs in advance of their generating the sales and returns that will ultimately be produced. Indeed, hubs incurring material upfront expense and then generate a material payback that matures over time. To that end, we like to encourage our investors to think of our delivery hubs as an investment that must be analyzed like a project and essentially net present value back based on a multi-year IRR. Obviously, the investment nature of a hub stands in stark contrast to planning for a café that generally takes stable ROI almost immediately upon opening. While I know you appreciate that the short-term impact from opening delivery hubs can be negative, we believe that and we know you understand the delivery hubs we are opening will set the stage to contribute materially to our results in 2015, 2016 and out years beyond that. To conclude my comments, let me reiterate our commitment to restaging Panera for expanded sales and expanded earnings growth well into the future. Panera has done just that several times in the past, and we intend to do that yet again. While we expect the cost of restaging the company will result in relatively modest earnings growth in the near term, we believe the investments we're making will materially enhance our competitive position and provide expanded opportunities for growth. And we know that if we execute our strategy successfully, this in turn will lead to expanded earnings growth well into the future. That is our mission and that is where our energy is focused.

Now I'd like to turn the call back to Roger, who will review with our -- review with you our quarter 2 and 2014 full year guidance. Thank you, and I'll give you Roger.

Roger C. Matthews

Thanks, Ron. Let me now spend a few minutes reviewing our targets for the full year and the second quarter of 2014. As you know, we made the decision to clip off the very top end of our targeted fiscal 2014 EPS range. Why? The short answer is our desire to communicate our perception of what we now consider a modestly greater degree of difficulty in 2014, given the first 4 periods. To that end, we narrowed our fiscal 2014 target comp range to 2% to 3.5%. As we've discussed, we continue to believe the success of our initiatives will be seen in the back half of 2014 and into '15. You heard me walk through the comps and all the complexity around seeing a trend. We believe we are seeing the makings of a positive trend. However, in fully digesting the weather from the first quarter and continued week-to-week volatility in the comps around the Easter shift and the related vacation weeks, we felt the uncertainty around how our initiatives play out in the near term should be reflected in the degree of difficulty in our guidance. We continue to expect our operating margin will delever by 75 to 125 basis points over the course of the year, with more significant delevering in the front half of 2014. We continue to invest in foundational capabilities and ending the year with modestly improving margins year-over-year as the initiatives take effect, and we see the impact of stronger comps.

As a result, we narrowed our expected 2014 EPS to $6.80 to $7, up between 5% and 8% compared to our 52-week EPS in 2013 of $6.50, which is adjusted for the extra week and the one-time tax benefits of the $0.18 we called out during the year. The second quarter, we expect EPS to be $1.70 to $1.76, which will represent a decrease of 2% on the low end of the range and an increase of 1% on the high end of the range versus our actual results in the second quarter of 2013. This is consistent with the trajectory of results that we talked about at the Investor Day with momentum we're heavily seeing in the back half of the year. We continue to expect the unit development for '14 will be in the target range of 115 to 125 units with higher company openings in '14 versus '13. The average AWS for these units is targeted at $41,000 to $43,000. In summary, let me conclude our formal presentation by reiterating our belief that all investors will benefit from this strategic plan we are now executing and our efforts to enhance our competitive position and expand opportunities for profitable growth.

With that, we will now open the line to questions. [Operator Instructions] Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Brian Bittner of Oppenheimer & Co.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

With this 2Q EPS guide below where we were expecting it, it does mean -- as you said, it does mean we need to see a major acceleration in the sales and the margins in the second half. So can you, again, help us understand the exact drivers for this because it does make the full year guidance appear aggressive as we sit here today, especially with where sales are running today on an underlying basis and where the margin trends have been in the first half?

Roger C. Matthews

Yes. Sure. Let me talk about it. And again, this is why we went in so much detail in the comps because I think, for us, we're really trying to see and talk and share with you our thinking on the trends we are seeing. I think, for the first 27 days, we are continuing to see the strengthening trend. And so, as we look into the back half of the year, the whole story for '14 was going to be steady, continued investments on these initiatives, coupled with an improving top line same-store acceleration. So I think the reality is, for us, nothing's really changed from the Investor Day, when we talked about that upward sloping and back half waiting. We always knew the back half of the year was going to be where the proof of a lot of our efforts were going to be seen, that into '15. So I guess -- although when you step back, while the guidance for Q2 may have been a surprise relative to you all who will develop your own model for Q2, the reality didn't really surprised us, and it was in line with the trajectory we were expecting.

Ronald M. Shaich

And I'd also add -- and we're very much trying to give you this communication I think you pick it up. Our ability and given the nature of the business to predict or guide relative to very individual quarters is, should I say, a higher degree of difficulty than it might have been a year or 2 when we were simply opening more of our conventional stores. So we have much more uncertainty and volatility. Having said that, where we're focused and what we actually know is that the initiatives that we're rolling out, the strategic plan that we laid out in Charlotte that we talked about again today, we completely get that and we believe in it. What we can't give voice to completely is, as we move different pieces around and as timing plays out, how it's going to affect an individual quarter, an individual period or even an individual week.

Operator

And we'll take our next question from Alex Slagle of Jefferies.

Alexander Slagle - Jefferies LLC, Research Division

Roger, just had a question. I want to clarify a couple of moving pieces in the guidance. First, regarding the expected tax rate in '14, so what's the full year EPS impact of that benefit baked in the guidance and what are the offsetting declines in the expectations? I guess, a little bit more food inflation and slightly lighter comps? Could you talk to that?

Roger C. Matthews

Yes. I mean, look, I think you start with a slightly lower comps. And again, I think what's important is to use the term we really feel like we narrowed our ranges on comps and guidance. This was not in any way about trying to lower the bottom end. We feel very comfortable as we have more information frankly. We owe it to you all to narrow our thinking, not to kind of try to expand the range. So I think one is the comps now narrowing to that 2% to 3.5%. Two is food inflation. We'd always express upfront our desire. This year, we -- our plan was not to take meaningful price. And as food inflation is now playing out, we're seeing it. And frankly, it's playing out in a lot of the things like butter, for example, where we can't really lock in, in advance. We know that will weigh on us and that's something we're kind of evaluating. And then, I think, lastly, you touched on the tax rate. The tax rate, we do believe we were going to end up with an effective tax rate of something below 38%. I think the reality is, we're not being specific on where the tax rate ends up because the reality is, there's a range of options as to where the tax planning we're doing will play out. It really is a whole series of smaller initiatives. I wouldn't want to leave anyone the impression we are working on some grand master plan on tax. The reality is just we have a pretty diverse business in geographies and business units. And as we've added some extra fire power to our tax team. They've been able to look for opportunities frankly to bring that tax rate down. So this is something we've been working on now for some time, and we're starting to see the efforts. So all in all, again, I don't think we have a point estimate on exactly where it ends up, but I think we do believe we will be sub-38% in terms of tax rate.

Operator

And we'll take our next question from Joe Buckley of Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

I jumped off the call for a minute, so forgive me if this is something you -- that was crystal clear to everybody else. But I guess I'm a little confused why you are trimming the guidance. Are the costs related to the 2.0 rollout coming in a little greater than you expected? I think you used the phrase, ramping up as the year progresses. Is that part of the reason to be a little bit more conservative on the EPS guidance?

Roger C. Matthews

No. I mean, to be honest, the cost side really -- nothing's changed. I mean, we knew all along the timing of how this would play out and the dollar amounts. I mean, the reality is, with more information and having now digested the first quarter and then seeing P4, we want to continue to narrow in the guidance. And so, the reality is, this was really about giving more precision as we're able to, but it's also digesting. And again, I think we walked you through the comps and shared with you as much detail as frankly we're seeing. We do see glimmers of hope, but -- and the reality is, P4 is quite promising. We talked about the fact that transactions are better. But the reality is, there's a tremendous amount of volatility around that Easter shift and how the vacation week surrounding it settled out. So as we sit here today, this is really about trying to be more precise for you all with frankly more information in our disposal.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. Are sales so far about where you thought they'd be? Or I guess you narrowed the guidance. So I guess you thought they'd be a little stronger at this point?

Roger C. Matthews

I apologize to you, but you may have heard one question. We'll take your question at the end [indiscernible] second question. Okay?

Operator

We'll take our next question from David Tarantino of Robert W. Baird.

David E. Tarantino - Robert W. Baird & Co. Incorporated, Research Division

My question is about the comp trends you're seeing in March and April and how it relates to the marketing spending. So could you maybe give us a sense for how you're viewing the impact of the national media spend and whether the sales reaction to that spending has been in line with your expectations? And maybe, on a related point, you didn't talk about same-store entrée trends, which you've talked about in the past as a better measure of your traffic. So maybe, could you update us on that?

Ronald M. Shaich

I think that's 1.5 that rounds to 2. But I'll try to take it and link them together and simply say, relative to the advertising, I mean, it's -- this is a continuity campaign. It's way too early to read into it. We don't have any of the analytics that we used the kind of metric modeling to fully appreciate it. Having said that, I think we can clearly see, when we correlate the data against year-over-year growth and impressions by market in certain markets, as we said, like L.A., where we had greater growth in impressions, we're seeing more impact. In other markets, as I mentioned, like Chicago, we're actually seeing the impression down. We're seeing the fact that comps are actually relative to the rest of the company worse. And so, you can clearly see that this advertising is having an impact. I think we're comfortable based on our historic analysis and all the work we've done in the past that this is paying for itself, giving us a reasonable return on investment. But ultimately, how the cumulative effect of it works, I think that's going to take some time to play out and I know you and I, several years ago, we're talking about advertising in some of your own expense with BMG and how the nature of the kind of advertising we really want to be doing plays out over 6 months, 1 year, 2 years. That's what we're paying for when we talk about a continuity strategy, not a sort of Super Bowl ad. Relative to the entrées question, the trends were essentially the same, which is to say, entrée growth is growing more rapidly than transaction growth. The reason that we have given voice to that in the past is just to say, internally, we think it's a better metric than transaction growth, at least, as you're thinking about demands on the system because one of the quandaries we had earlier in the -- I'd say last year, is we would have transaction growth that was relatively flat, while we have entrée growth that was up. And you all were saying, "Well, why are we investing in ops if transactions aren't growing?" And the reality is, the demands on the system are up. It shows up as mix. It doesn't show up as more people. And that's why we wanted to talk about transaction growth -- or entrée growth. As long as you have that principal, we're all set. It's continuing to play out that way.

Operator

[Operator Instructions] And we'll take our next question from John Glass of Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

There's -- you've mentioned delivery hubs versus catering hubs. And I think this is a possible area of confusion. It certainly is for me. Can you maybe just distinguish, which ones are in the unit base, which ones are -- I think the catering is not. And, Ron, you mentioned, like, you needed some sort of project finance analysis to really understand the IRR. How do we from the outside understand that because I don't think we're ever going to get the kind of level of detail that you would [indiscernible] contributing or not to the business?

Roger C. Matthews

Yes. It's Roger. So just to be very clear, the catering hubs -- and again, we're referring to catering now as Large-Order Delivery, so if that creates any confusion. Catering hubs are not part of our unit mix. We specifically have said in the footnotes at Schedule II that that's not going to be part of the mix, and we will separately disclose them, so you'll understand. And that's the number we've thrown out of wanting to build 25 this year of catering hubs. Now we refer to them as delivery hubs, more broadly defined. So that's that. I think more broadly, the analysis that Ron was referring to and I will say upfront, this is analysis that will be impossible for people from the outside to fully do is -- and this is what we alluded to at the Analyst Day around the -- frankly the benefits of what we will call smart cannibalization. We have markets where -- for example, we know that, that catering, there's more demand than we can fulfill and that catering is specifically weighing on the café's ability to meet the lunch demand. So by pulling out that catering from those couple of stores and concentrating it in a production hub that is focused on catering, that's what they do, that they're use to the ebbs and flows of that business, what we know is over a 3- to 5-year period, you generate a tremendous return on that cluster, and that's a term we'll often use internally as we evaluate markets because, as Ron said, what you see is as you move the sale, the catering sales out, the catering sales at the hub grow faster and the retail sales at the stores where you took catering out then grow faster. But if all you narrowly looked at was a 1-year impact, this would be dilutive to ROI and, frankly, to earnings because, by definition, you're setting up a brand-new production facility that day 1 is just handling sales you're already handling at those other cafés. So it's -- to be honest, I think it's an area that will be very difficult for you to evaluate. I think it's -- the key is for us to make sure we're disclosing the number we're doing so that you see it. We will try to -- each kind of year take a stop for you all and talk about how we're thinking about cannibalization and then looking at overall returns. But again, this is one that I think will be difficult from the outside looking in to fully evaluate.

Ronald M. Shaich

And I'd just simply say, this is early in the cycle relative to some of this. We're sharing with you the direction where we're going. But our maturity of very deep financial information, we certainly have multiple years of experience with it. But our ability to be able to inject it into our guidance and share with you is, by its very nature, limited. This is not the same as building, as I said, the 1,700 cafés. It's different. It has a different investment nature to it. It has a different level of clarity. So we're very straight in saying to you what we're doing, why we're doing it, what we've seen in the past. And yet at the same time, saying, we're going to have to be filling you in, as we get large scales of these up, what they're, shall I say, mature investment pattern ultimately is.

Operator

We'll take our next question from Sara Senatore of Sanford Bernstein.

Sara H. Senatore - Sanford C. Bernstein & Co., LLC., Research Division

I wanted to ask a little bit about the sort of the competitive environment. You mentioned that your gap to black box is maybe widened a bit. But certainly, it seems like breakfast have gotten much more competitive and catering -- a lot of people, a lot of your peers have entered into that market. Is there any potential that the issue that we're seeing is not so much of what's going on in your stores' operations throughput, but has just gotten more competitive, particularly in those 2 day-parts and, in particular, around the value proposition? So if you could just talk about generally and then maybe the day-parts, breakfast and catering in particular?

Ronald M. Shaich

Sure. I mean, I'm going to -- I'd say more generally, Sara, that the competition has always been a part of the game, and that's why we would say job #1 for Panera is building competitive advantage, competitive authority, driving that desire. It's been since the day we started the company job #1. It's been the job over the last 30 years. It's the focus on key objective, certainly, objective #1, along with the expanding growth of this strategic plan we laid out for you. Having said that, success breeds flattery. We got a lot of people going in the catering business. That's a reality. It's not I think -- in my view, relative to our organization, how I hold us accountable, which is I believe you hold us accountable as a management team is competition is a reality. It's not an excuse. And so everything we've got to do is to figure out how to recognize what's going on out in the marketplace and do a better job. It's as simple as I can put it. And I guess I would say to you, competition was here, is here, will be here. We accept it and we still think we've got to do a better job in there.

Operator

We'll take our next question from Matt DiFrisco of Buckingham Research.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

I have a question and I just want to hear if I -- just make sure my notes are correct here. But the -- I don't think you said anything on the ad spend. But previously, you were saying maybe targeting about 1.9% of sales for '14. I'm just curious how that was in 1Q? And then, when you mentioned the franchise driving volume, I didn't catch if you said all of those, on a comparable basis, were drive-in versus drive-in. Is there anything where the franchise out-performance might be attributed to more drive-ins this year than they had last year, or is that not the case?

Roger C. Matthews

Yes. There's no -- I mean, again, look, the franchisees, just like us, continue to build increasingly more drive-thrus, but there's nothing dramatic about the year-over-year comparison on that, when that would -- I think that's just great performance and continued strength for frankly us and them. I think on the 1.9%, I mean, that's still our target for the year. Nothing has changed. The ad spending, frankly a lot of that gets locked in months in advance. So nothing has really changed there as the kind of target we're marching towards.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

But I guess, when you said the ramp, was that 1.9% as quarterly pace, or was there a little bit more, little bit less spend in 1Q on a relative basis?

Roger C. Matthews

I don't think we've actually -- we're not really giving out the quarterly guidance on that. I think we said where we'd end up for the year, I mean, I think the reality, as Ron said, is this is a -- this continuity approach was a slow, steady build over the year. So I think at this point, really, what we've given out is the 1.9% for the year, and we're actually still on target for that.

Operator

We'll take our next question from Keith Siegner of UBS.

Keith Siegner - UBS Investment Bank, Research Division

Especially considering that it sounds like catering had flattened out a little bit this quarter, when you look at what was still a very strong mix, I was wondering if you could talk a little bit more about where the mix is coming from. Is this higher price point, people moved up the menu, especially considering that you've launched the new menu now? Or is this add-ons, or is this particular day-part? If you could add some color around where the mix strength continues to come from, that would be very helpful.

Roger C. Matthews

Yes, sure. I think, as Ron said, in answer to the earlier question that David asked, we have seen entrees per transaction continue to grow, and that just continues to be a positive tailwind for us on mix. I think the other is we did roll out the new menu, again, I think as folks who had a chance to kind of see the pre versus post. Yes, we think that was -- we did think that was going to be additive to us because we thought it's simplified and made the customer experience a little easier, reduce the number of price point categories. And it was not meant to take or decrease price, it was more meant to just clarity and create clarity and it had that benefit. So -- and then lastly, obviously, we're lapping the full launch of pasta. So again, we've got pasta now fully for the whole quarter and the mix and doing well. So I think there's no one big story, it's just a whole series of smaller stories that have played out. Again, I think the good news is, because it was fairly modest price, I would just tell folks there was a nice mix between check and price, and that's part of our overall goal is to create that more balanced profile of comps. It will come from positive transactions, price and mix. So all in all, it's kind of story of several components, all of which moved positively.

Keith Siegner - UBS Investment Bank, Research Division

Just to be clear then, it sounds like the new menu was not check dilutive, is that right?

Roger C. Matthews

Was not what?

Keith Siegner - UBS Investment Bank, Research Division

Check dilutive?

Roger C. Matthews

No, we do not believe it was.

Operator

We'll take our next question from Jason West of Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just trying to understand the trajectory, again, on the earnings and the margins. I know, in the first half, you've got down margins. You're making these investments. And in the back half, you'll start to see some payoffs and some sales improvement. But my understanding was most of the big investment in the 2.0 is going to happen next year because this year, it's a fairly small investment to get up the Rapid Pick-Up running. So just trying to understand, do we see some pickup in the back half and then another big investment next year as that bigger wave rolls out? Or is that not the right way to think about it?

Ronald M. Shaich

I think you got a -- we're projecting to do and have -- is nearly 150 done by the end of the year. That's a substantial investment and particularly, if they come, again, in the third or into the fourth quarter, as you think about the way these get started off, you have the investment capital, you get hit instantly with the depreciation, you have the dislocation as you make the changes in the café, you have the staffing, the operational intensity that has to be brought to bear, you have to give people time, which means extra labor to get their muscle memory back in place. So I would say Panera 2.0 represents, as we roll out in each case, that individual café at that moment and for 2 months before and 4 months or whatever it is afterwards, a net negative. As we move -- as many as upwards of 150 of these, and we shift them into and they're occurring in the third quarter and the fourth quarter, you'll feel the hit of that. I think that's more dramatic, shall I say, than Rapid Pick-Up, which we referred to. Rapid Pick-Up is a subset of the Panera 2.0 element. All it really represents is a bookcase and the national expansion of our mobile app. It doesn't have material economic impact at the investment level. It doesn't have major operational impact. So I would not expect much of a burp from Rapid Pick-Up. I do think that as you take on Panera 2.0s, given the comprehensive nature of it, it could represent a burp per café multiplied by the number of cafés per quarter.

Operator

[Operator Instructions] And we'll take our next question from Jeff Farmer of Wells Fargo.

Jeffrey D. Farmer - Wells Fargo Securities, LLC, Research Division

I did hear what you just said about Rapid Pick-Up. But I'm still curious that as you guys roll this out in coming quarters, how are you planning to promote it in these new markets? And in the markets where you found Rapid Pick-Up for a while, what type of adoption rates have you seen?

Ronald M. Shaich

Yes. Two comments. First, I would say to you that -- let me just take the second part first and I apologize, I forgot the first part of the question. But I would say to you, relative to the data on it, we've only had 1 market up now for 3 or 4 months. So it's really too early for us to know what the impact of it is. I will say to you this so we make sure that we're in the same ballpark here. It's modest. This is isn't going to be a blowout. It will be in the low-single digits. We would estimate the percentage of transactions that occur on it. We're still trying to figure -- at this moment, we're still trying to figure out how much of it is incremental. I think it's going to take us some time to really have an answer to it. And so, if you think about Rapid Pick-Up, I wouldn't assume it's going to materially move the comps or the transactions, particularly in the first 2 months after the rollout. I think it's the right thing to do. Over time, it will build -- and frankly, the reason we're putting it out is everybody is so enthusiastic about the full Panera 2.0 package. We have this available. It's the first chunk of it, but it's not fully the comprehensive solution. I would say to you, relative to how we're going to be communicating it, for competitive reasons, I don't want to go into it in too much detail, but we've had very positive impact with in-store communications, you'll see us doing that. Secondly, we're using MyPanera as a powerful vehicle to essentially move people into downloading the app and more importantly, utilizing the app for Rapid Pick-Up purposes. And then, potentially, in Quarter 4, still under consideration, maybe some external communication or advertising. That advertising could take form as online advertising, which you would see as digital advertising. And we are in some testing of and are making final judgments whether we'd use any mass media relative to this. So still in evolution in terms of communication relative to its impact, it's modest.

Operator

Let's take our next question from Bob Derrington of Wunderlich Securities.

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Ron, this restaging of the company's business that you talked about, every 5 years, basically, a lot of these programs that we're talking about are considerably more complex than just some of the relatively -- bringing in a new line of salads for example. What is it at the core that really gives you confidence this is the right way to go? Is it your consumer feedback and from some of the early stores? Are you locked in your belief that this is clearly the right thing to do for the future of the business?

Ronald M. Shaich

Yes. We wouldn't be doing it -- I wouldn't be putting my reputation on the line if I didn't believe that. That I promise you, Bob. Look at it, Bob, this is actually less complex than some of the things we did. Now if you go all the way back, I'll answer [indiscernible] remember when we first did fast casual. I can remember being out there for 5 years trying to raise money on Wall Street. And I wanted to make the bet on Panera, and The Street was saying to me the only 2 business that exist are something called fine dining and fast food. There's no market for people that want to pay a little bit more for something better. That was a big transition, and that was a huge transition when we restage the company and bet the whole thing on this. You saw the results. I mean, when we were in the -- in the middle of the recession, we expanded the growth rate by 50% and invested resources into the customer experience. That had a lot more friction against it, shall I say. People thought we were crazy. When we did antibiotic-free chicken, we were the first people to do naturally-raised chicken. I mean, that was -- those were tough things because the market -- it was very expensive back then. And today, we created a market for antibiotic-free chicken because the antibiotic-free or chicken raised without antibiotics has come down. So we would have -- it happens every time. And the trick in what you pay us to do is to try to figure out where the world's going and to deal with how we're going to compete into that world. It is very clear to me that -- and I think we're seeing it in a plain face way, is Panera has got to drive up -- it's got to reduce its fiction. There's too much of friction in the Panera at the buy-ins we're running. So we got to reduce the friction, that's a lot of what Panera 2.0 and OpEx excellence is about.

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Quick follow-up, Ron. Could you gives us some...

Ronald M. Shaich

Let me finish, Bob. The desire side of it, if I may just say is got to happen and that's why you see us pushing up the innovation in food and marketing. Having said all that, Panera is a powerful platform and as important as driving the competitive position is, the desire friction ratio, every bit is important is the opportunity to take on these adjacent businesses. And these are multibillion-dollar businesses that Panera has the opportunity to capture. We got to get there, it's not going to happen overnight, but we got to position ourselves to get there. And so, that's how I hold it. Got it, Bob. I'm sorry.

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Will we see the franchisees begin to embrace some of the pieces of this program?

Ronald M. Shaich

They're embracing it now. The reason -- I mean, let me just -- but the reason we're rolling out Rapid Pick-Up is because the franchise community so much wants it. I mean, the -- I think we all want it yesterday. The problem it is doesn't work like that, and we devastate our earnings that we try to do it all in one shot. It takes a -- things of value, raising my son. These things take time, and they don't occur in 20 minutes. Things of value will take time. And we're clear on what we're doing. We're clear on how to get there. We're going to get there.

Well, thank you, everybody, for joining the call and appreciate your time this morning. Thank you.

Operator

That does conclude today's conference. We thank you for your participation.

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