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Panera Bread Company (NASDAQ:PNRA)

Q3 2011 Earnings Call

October 26, 20118:30 AM ET

Executives

Michele Harrison – VP, IR

William Moreton – President and CEO

Jeffrey Kip – SVP and CFO

Analysts

David Tarantino – Robert W Baird

Joseph Buckley – Bank of America/Merill Lynch

Matthew DiFrisco – Lazard Capital Markets

John Glass – Morgan Stanley

Michael Kelter – Goldman Sachs

Jeff Bernstein – Barclays Capital

Christopher O’Cull – SunTrust Bank

Brian Bittner – Oppenheimer

Jason West – Deutsche Bank

Nicole Miller – Piper Jaffray

Sharon Zackfia – William Blair

Phillip Juhan – BMO Capital Markets

Mitchell Speiser – Buckingham Research

Nick Setyan – Wedbush Securities

Stephen Anderson – Miller Tabak

Robert Derrington – Morgan Keegan

Bart Glenn – DA Davidson

Operator

Good day, and welcome to today’s Panera Bread Company 2011 Third Quarter Earnings Call. Today’s call is being recorded. At this time, I would like to turn the call over to Michele Harrison. Please go ahead.

Michele Harrison

Thanks, Celia. Good morning to everyone, and welcome to Panera Bread’s third quarter earnings call. I’m Panera’s Vice President of Investor Relations and Corporate Development. Here with me on the call this morning is Bill Moreton, our CEO and President; and Jeff Kip, our Executive Vice President and Chief Financial Officer.

Let me cover a few regulatory matters, before we begin our call today. I’d like to note that during our opening remarks and in our responses to your questions, certain items may be discussed, which are not based on historical fact.

Any such items, included targeted 2011 and 2012 results or conditions and details relating to 2011 and 2012 performance, should be considered forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995. All such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially.

I’d like to now turn the call over to Bill. Bill?

William Moreton

Thanks, Michele. Good morning, everyone. The third quarter was another very strong quarter for us. We delivered $0.97 earnings per share, which represents 29% growth over the prior year. In fact, this marks the 13th out of the last 14 quarters we have had 20% or greater EPS growth.

Our revenue grew 22% to 453 million during the quarter and was driven by our strong same-store sales and new unit development. Our company-owned comparable bakery-cafe sales were up 6% this quarter, which was above our previous expectation based on stronger transaction and mix growth.

So far, in the fourth quarter to-date, our company comp store sales are up 6.7%. As a result, we’re raising our fourth quarter comp store sales target to 5.5 to 6.5%. I should also mention, we are maintaining our fiscal year 2012 comparable store sales target of 4 to 5%.

In addition to our sales results, we continue to be pleased with the performance of our new bakery-cafes. Our new unit average weekly sales volume is a proxy for our customers’ affinity for our concept as well as for the level of the financial return we’re getting on our capital investments.

Our AWS also reflects the real estate disciplines we put into place a couple of years ago. Our company new unit AWS is $41,470 on a year-to-date basis, which is up versus last year’s record pace of $40,950. We are raising our 2011 new unit target to 110 to 115 units, which is a 10 to 15 units more than our original range.

And we’re also today raising our 2012 new unit expectation to the same 110 to 115 units. The key driver of increased production has been our franchise community, and it’s a great sign of confidence in the concept, when our franchisees increase their own pace of capital investment.

We are also pleased that we were able to deploy nearly 90 million of capital in this quarter by buying back approximately 850,000 shares at an average price of $103.62 per share. The buyback resulted in $0.01 of accretion in our Q3 earnings and will result in approximately $0.04 of accretion in Q4. This will in turn result in an incremental $0.09 per share of accretion in 2012.

I would now like to spend a little time discussing our sales results and key initiatives with you. By components our Q3 comps of 6% consisted of 2.6% transaction growth and 3.4% average check growth. Looking first to transactions, our 2.6% transaction growth in the third quarter follows up on a strong 2.9% transaction growth in the second quarter, and we think is demonstrative of the resiliency of our concept in more challenging economic times.

We are expecting transaction growth to flatten out in the fourth quarter and into 2012 as we anniversaried a significant contribution to incremental transaction growth we saw with the rollout of the MyPanera loyalty program in 2010. Our targets for transaction growth in Q4 and in 2012 accordingly are flat in Q4 and zero to 50 basis points positive in 2012.

I would now like to give you a little color and a little update on our key initiatives underlying this transaction growth. The first area of investment to drive transaction growth is in the quality of our food. This investment shows up in the strength of our celebrations and in the ownership of certain categories in our customers’ minds. Most of the third quarter was spent on our Celebration Three, which focused on our summer salads and finished with the kickoff of our celebration four, which is focusing more on our hot sandwich platform and our bakery goods.

Looking first at Celebration Three, our Signature Salads continue to do exceptionally well, led by our Strawberry Poppyseed Salad, and a category as a whole was up 10% versus 2010. Another key driver of Celebration Three was our breakfast sandwiches, which were up 18% compared to the prior year. This is another indicator of the improved quality that our new Panini grills are producing. Celebration Four, which started in mid-September marked the introduction of our Turkey artichoke Panini, which has helped grow the signature Panini category 35% since the start of the celebration. This sandwich features our new higher-quality turkey, utilizing the sous-vide cooking method that we’ve rolled out throughout the system.

Additionally, with our bakery focused as celebration our cookie sales led by our iced pumpkin cookie have increased 41% over the prior year. Finally, our new chocolate vodka specialty bread has been a big success and we are very pleased with it.

Celebration Five which will launch in mid-November will feature our new Steak Balsamico Panini and our new Sonoma chicken stew. Both of these entrées worked well at both lunch and dinner as we continue to build leadership in the hot sandwich and soup categories.

As we look ahead to 2012, we will continue to pursue our strategy of category ownership and we will see the return of some old favorites like a salmon salad and the Cuban Panini as well as continued innovation with items such as the turkey cranberry Panini that will roll out next year. The next key area of investment in our transaction growth is our media program. When we continue to believe the dollars we are investing are returning better than one to one in a 12 month period. We were pleased to outperform our transaction growth target in the third quarter and we believe the improvement of our messaging with the “Make Today Better” campaign and our continued learnings on how to optimize our media spend were key contributors.

We anticipate that 2012 will be another year of increased media spending as we continue to focus on increasing the quality awareness of our points of competitive differentiation. In 2012, we expect media spending to increase by approximately 25% from our still low base, which would represent an increase as a percentage of sales from 1.3% in 2011 to approximately 1.5% in 2012. We expect a portion of this increase to go towards our first national cable TV by next year, which we are very excited about.

Additionally, we will also continue to expand our digital media presence, particularly in connection with our catering business. The next key investment I’d like to discuss is our loyalty program, which has now seen its membership grow to over 8.3 million registered users. We are very happy with this program’s size and the position it puts us in to understand and communicate with our customers to drive deeper relationships. As an example of the impact we are starting to see, we enjoyed a nice jump in our comps in September as we rolled out our celebration for, and we believe it was in part due to our ability to communicate the start of the new celebration and our new products to our loyalty program members ahead of time instead of just allowing them to discover the new celebration as they visit the cafes.

Further, as we mentioned on the Q2 call, after testing program changes and analyzing the data we have moved the rewards towards both lower costs and greater customer relevancy, and we’ve seen consistent visit frequency increases at reduced discount expense levels. We are also now beginning to leverage the data we’ve gathered from our program members to understand the general buying patterns, reactions to product launches, promotions and price. And we have plans to use it to help us understand a range of issues going forward.

Again, this is a tremendously powerful tool for us that we are just scratching the surface with. As we anniversary the program’s rollout, we now see loyalty folding into our ongoing operations and customer experience. As a transaction driver and no longer see it as something we would call out separately. In fact, we think we will actually at least see some transaction compression over the next few quarters, most significantly in Q4, 2011 as we compared to the outsized transaction lift we got when we rolled out the program last year driven by the redemption of introductory rewards. I would now want to conclude my discussion of transaction growth drivers without mentioning the last key driver. That is the quality of our operations.

We continue to see the quality of our people improve which is a key contributor to the improvement of our overall customer experience. Our joint venture program at our GM and multiunit level continues to provide us a point of competitive differentiation as we move ownership type thinking closer to the customer. Let me now briefly touch on average check growth in the quarter before turning the call over to Jeff to discuss margins, operating leverage, uses of cash and our guidance for Q4 and 2012. In the third quarter, we saw 3.4% check growth on price of approximately 2.5% and positive mix of 90 basis points. Our check rebounded after a difficult Q2 with strong celebrations in celebration three and celebration four mixed performances.

Further, as we’ve reached the anniversary of the loyalty program rollout, we’ve seen a positive impact on check as we compared to the modest check compression we saw last year at rollout.

Recall that in Q3 of last year, the loyalty program was in approximately one third of our company-owned stores on a weighted-average basis. As a result we will continue to see a mix benefit in our check from this impact in the fourth quarter of this year, and rolling into 2012.

Finally our catering business continues to make a strong contribution to our comp store sales, showing up in our check growth. Our combined catering initiatives drove 31% year-over-year growth in the catering sales in the third quarter and that brings our year-to-date catering sales increased to 29%.

You have to remember this comes on top of our 24% growth last year. We continue to feel that off premise sales is a very large opportunity and a multi-year opportunity for us, and we expect to see our catering sales continue to grow at a similar level as this year as this year-to-date through the fourth quarter and into next year.

On an overall basis we expect the growth in our average check to continue in Q4 and 2012 as well. In the fourth quarter, we expect check growth of approximately 6% on 3.5% price, which is up from Q3 on the 1% price increase we took in late September, and 2% to 3% makes impact on check.

Mix benefit will accelerate as we compared to the full loyalty rollout in Q4 2010. Finally in 2012, we expect 4% to 4.5% check growth on 3% price and mix of a point to 1.5 driven by the same factors we are seeing now.

With that let me turn it over now to Jeff. Jeff?

Jeffrey Kip

Thanks, Bill. Good morning, everyone. As you read last night in our release we enjoyed another quarter of great operating leverage as our operating margins improved 80 basis points versus the prior year in the third quarter to 10.5%.

The key to the year-over-year favorability was 160 basis points of positive leverage of bakery-cafe margin, offset modestly by the net impact of 250 basis points of year-over-year unfavorability in our cost of sales to franchisees margined, driven by food and diesel cost inflation in our FDS system.

Our strong bakery-cafe margin performance broke down as follows; while food and paper margin deleverage 160 basis points primarily on 4.5% food inflation, our labor margin improved to 210 basis points year-over-year from structural changes in benefits and labor discipline. And we enjoyed 110 basis points of leverage combined on our occupancy and other operating lines from strong sales results in both our existing and new bakery-cafes.

More importantly, we’ve been able to drive margin improvement while reinvesting in our concept and our infrastructure for growth to set ourselves up to drive continued sales growth and profit growth. We’ll continue to pursue this strategy in the fourth quarter and fiscal year 2012 and beyond.

In the fourth quarter however we actually expect negative operating leverage for the first time since the first quarter of 2008 in the form of 50 to 100 basis points of operating margin on favorability year-over-year. Why?

Well, first food inflation in both our bakery-cafes and our supply chain will reach its highest point of the year, approximately 5% in our bakery-cafes and 20% in our dough facilities.

Secondly we’ll anniversary the launch of our structural labor initiatives and see labor margin where we’ve really been offsetting our food costs unfavorability during the first three quarters of flat year-over-year.

We anticipate the fourth quarter will be a bit of a blip than our record of steadily improving our operating margin however and in 2012 we expect flat to modestly improved operating margin overall as modest leverage from sales is offset by food and paper inflation of approximately 4% versus year-over-year pricing in 2012 of approximately 3%. One final margin related note, our tax rate in the third quarter was 38.1% and we expect an effective tax rate of about 38.25% in both the fourth quarter and fiscal year 2012.

Let me now move on to uses of cash. As you know in 2010 we deployed $205 million of cash which had and will have a positive impact on both the third quarter and full year 2011 EPS. The $205 million of cash consist of 150 million of share buyback and our $55 million acquisition of the New Jersey market.

Thus far in 2011 we’ve deployed an additional $132 million of capital through our $41 million acquisition of the Milwaukee market and $91 million more of share buyback, $88 million of which we completed this past quarter and $3 million since the close of the quarter, that’s $337 million of capital deployment to drive earnings growth over the last 18 months or so.

The impact of these uses of cash on our third quarter EPS was an incremental $0.06 or 8% impact on EPS growth of which a combined $0.02 came from our acquisitions, $0.03 from the 2010 share buyback and we’ve got 1% incremental EPS out of the share buyback we just completed. The impact in the fourth quarter is $0.07 incremental of EPS and that’s a 6% impact on EPS growth, $0.03 came from our acquisition and $0.04 will come from our incremental 2011 buyback.

So for fiscal year 2011 in total we’ll see $0.24 impact on EPS, 7% on EPS growth and for 2012 our EPS target includes an incremental $0.04 from the Milwaukee acquisition and an incremental $0.09 on top of 2011 for our recent share buyback.

Please remember that our EPS targets do not assume any buybacks beyond what we have actually completed. We had 29.8 million fully diluted shares outstanding in the third quarter. We project 29.5 million in the fourth quarter and 29.7 million in fiscal year 2012. Finally, even with all these uses of cash we ended the third quarter with $181 million of cash on the balance sheet.

Let me wrap up with our EPS and EPS growth targets for the fourth quarter and fiscal year 2011 and 2012. First, we are raising our fourth-quarter EPS by $0.04 to $1.39 to $1.41 to reflect the impact of the third quarter’s incremental share buyback.

We are not modifying our EPS target due to our increased Q4 comp’s guidance however which Bill noted earlier but because we plan to accelerate the timing of certain targeted investments in our concept and infrastructure for growth thus our Q4 operating margin will be unfavorable to our previous expectation. In terms of 2011, we are targeting our EPS to $4.63 to $4.65 to reflect our third-quarter actual results and the impact of our recent buyback.

Finally we are today setting our 2012 EPS target at $5.38 to $5.48 per share, which is 16% to 18% growth from the midpoint of our fiscal year 2011 range. Also reflecting the impact on 2012 of our recent share buyback. Please remember our long-term EPS growth model is to drive 15 to 20% earnings growth through 12 to 17% operating growth with an additional 3% of earnings growth driven by use of capital. We’re pleased not only to be delivering 2011 well over the high end of our range, but also to have confidence in delivering 2012 right in the middle of the same range. Thanks to everyone for dialing in and listening this morning.

I would like to now turn it back to our operator so we can take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to David Tarantino with Robert W. Baird.

David Tarantino – Robert W Baird

Hi, good morning. And congratulations on great results. Bill, just a question may be high level question about the traffic outlook or the transactions outlook for Q4 and 2012 and I recognize that you are cycling some benefit from the initial rollout of the loyalty program, but could you talk about, sort of, the puts and takes on the traffic outlook especially in light of the increased media spending and the benefits you might see from that and also perhaps the experience you have with some of the targeted marketing to some of the loyalty customers and talk about the benefits from those and maybe what you are assuming as offsets? Thanks.

William Moreton

Yeah. Sure, David. You know, you look at the last couple quarters of traffic at 29 last order and 26 this quarter and we are very much. We are very pleased with that. As you said, the biggest single thing that we are going over now in Q4 in the beginning part of next year is the loyalty launch from last year. Through the third quarter about a third on a weighted average number of our cafes were rolled. So really the majority of them rolled in the fourth quarter, and you know it was a big transaction increase. There was typically an introductory reward and there was a lot of excitement that brought people to the cafes.

So we would tell you that what rolling over that we think is going to make the transaction comparison very difficult in the fourth quarter, which is why we are looking for about flat. To me that’s really positive. What that means is that our other initiatives around media and the quality of the celebration and the quality of the ops are really doing quite well to be able to maintain flat transactions compared to the rollout the year before. And what I would tell you, David, is simply is we’ve been going forward.

We are very pleased with our media and we really feel confident that it’s repaying more than one-to-one. I think we are getting better at determining the types, the different types of media and how it works by market and then in terms of the loyalty program we are still seeing – it’s difficult to project in what that benefit can be. As I said, in my remarks, we are very pleased that we saw at the beginning of celebration for a jump in comps by being able to communicate to our customers directly about the products and get an excited before the celebration actually hit.

As we move more-and-more to soft rewards and we move more towards really being able to target groups of customers whether by frequency band or interest by purchase , if they are specialty bread purchasers we have the ability to talk more directly to them. We think that will have a very positive effect next year but at this point it’s very difficult how to project that. So we are not really projecting anything specific for that and we’ll see how that goes and how it drives transactions as we move through the year.

Jeffrey Kip

Thank you, David.

Operator

We will go next to Joe Buckley with Bank of America/Merrill Lynch.

Joseph Buckley – Bank of America/Merill Lynch

Thank you. You mentioned that franchising expansions is what’s driving up the overall targeted expansion numbers for 2011 and 2012. Could you talk about what mix of company versus franchise cafés you expect those expansion numbers to include and maybe if you would just type some discussion of Paradise it looks like there are some changes going on there and how you see Paradise fitting into the picture near-term and long-term?

William Moreton

Sure. Hey, Joe, we see the mix as roughly half and half. We may end this year a little better on the franchise side actually as we’ve seen a little acceleration but I think we generally see the unit expansion is gravitating in a 50-50 range one year and maybe 45 to 55 and the other year 55, 45 and again we think this year we may actually see franchise production exceed company production by a couple of stores.

Jeffrey Kip

And then to Paradise, Joe, the comments that we made again remember when we originally bought Paradise the idea was that’s how we would compete in the soup salad sandwich category in Phoenix because of how firmly they were entrenched. What we are doing now is we are moving Paradise to be a little closer to the Panera menu still retaining those things that make Paradise special and connect so deeply into the Phoenix market. But as we’ve done that we’ve taken the opportunity to clean up certain of the franchise relationships where there is overlap between Panera and Paradise. So our idea is Paradise is a vehicle for us to compete in Phoenix where there aren’t Panera to complete in Salt Lake City Utah where we have a franchisee of Paradise where we don’t have Panera bakery-cafes and in those overlapping markets really we were trying to kind of clean up our agreements and really have Panera be the vehicle through which we compete. So we are very much trying to get the efficiencies of Panera on the menu, keep the things that make Paradise a special and it really is our vehicle to compete in certain limited markets and that’s how we are viewing Paradise.

Joseph Buckley – Bank of America/Merill Lynch

Thank you.

Operator

We will go next to Matthew DiFrisco with Lazard Capital Markets.

Matthew DiFrisco – Lazard Capital Markets

Thank you. I just wanted to go a little bit further into those development numbers I think it’s pretty impressive you guys are moving up not only the store number, but also the volume that you are getting off that new store. Can you describe what could be behind that is it, I’m wondering is it a brand equity or are you just knowing more supported by the advertising when you go into markets or is it also may be locations that you are picking maybe more mature developed trade centers and bigger DMA’s ?

Jeffrey Kip

Hey Matt, it’s Jeff. I mean I think if you look at our new unit volumes ‘08, ‘09, ‘10 and now ‘11, you see it’s been increasing every year. And what we did several years ago was we put in several initiatives, starting with a more powerful data analysis team in-house and then moving up the quality of our real estate managers and our disciplines. And we think you’ve just seen the results in terms of quality and trade area selection and returns on the stores. And you look at that over time, and it’s just – the results have been great.

William Moreton

Right. And just to add what Jeff said some people ask us why we don’t grow more quickly. The truth of it is we do think it’s the best return on our capital is to put a new dollar and a new Panera bakery-cafe but because of the disciplines Jeff described, we’ve been very careful about the sites that we pick and we don’t break that discipline. And I think that that’s really raised our higher average weekly sales and what we’re seeing now is there’s a little bit more opportunity, some of the dislocation we’ve talked about in the past between the landlord, their lender and the tenant that’s in troubled, is starting to clean up a little bit and we continue to see very high quality opportunities on the real estate front.

And with our franchisees, we really should emphasize that. Again, one of our greatest strengths, we only have 33 franchise owners that are all well capitalize , very well operated groups. And they see the returns are generating on Panera versus the other concepts they may be involved in. And they clearly are continuing to put a disproportionate amount of their capital towards growing out Panera and they are seeing the increasing real estate opportunities as well. So I think it’s all that, Matt.

Matthew DiFrisco – Lazard Capital Markets

Thanks.

Operator

We’ll go next to John Glass with Morgan Stanley.

John Glass – Morgan Stanley

In the past I think you had commented about your concerns about relying too heavily on check and pricing and needing to really drive traffic particularly as the consumer becomes more value conscious. But here we are in the fourth quarter and next year really relying entirely on check to drive the comps and 6% to boot.

So how do you feel about that as you think about, is that the right combination particularly given that high-level of check increase? And if I could just throw in a second question is, I think there has been some discussion, at least informally, about maybe thinking about things like table service in the cafes, can you talk about what – how – if you’ve tested it and what your thoughts are for 2012 on that? Thanks.

Jeffrey Kip

Sure. John, very sneaky way to ask two at once.

William Moreton

You start, and I’ll...

Jeffrey Kip

I want to make a couple comments. Just to reiterate what we were saying earlier, we see – it’s not a bet on the check. We’ve got a little bit of a mathematical thing going. Whereas loyalty rolled out with introductory rewards, you get an incremental number of low ticket transactions because people are essentially redeeming their welcome awards, right? And if you think back to the fourth quarter last year, that’s where our check really compressed in terms of showing mix growth.

So what we’re seeing right now is a comparison to a rollout period. So I don’t want to say it’s an anomaly, but the fourth quarter is actually affectively doubled the guidance on mix that we’re giving for next year. It’s 2 to 3 and next year is 1 to 1.5. So you’re looking at a little bit of a bubble in terms of how we look at that.

And you know our bet really isn’t on retail mix. If you think about 1 to 1.5 mix growth in 2012, we’re really getting a significant portion of that from catering. And in terms of growing, when you’re growing catering in the mid-20s you’re going to get point or something like that, a comp contribution.

So there’s actually almost no bet in 2012 on the mix and our big initiative continues – big initiatives continue to be around driving transactions with the additional color that built through and in response to David’s question earlier.

William Moreton

Yeah. And then just to table service, John, that is a something that we have in about 100 bakery-cafes across the system, company and franchise. We are continuing to experiment with that. We will test some more bakery-cafes next year. We’re refining the table locator system and really understanding what that means. We think long-term that it really does position us well in terms of how we compete, but that’s something we continue to look at cautiously test and continue to read. So that’s really where we stand with table service.

John Glass – Morgan Stanley

Thank you.

Operator

We’ll go next to Michael Kelter with Goldman Sachs.

Michael Kelter – Goldman Sachs

I wanted to follow up, it seems like you guys have found a kind of a new leg of growth investing in media and loyalty, which really are completely new and different capabilities for you guys in the way they are playing out. So, I guess, I’m curious with the media budget of what will almost be 70%, 80% in two years and your first national cable by the loyalty program going away from discounts more towards some of the new wants offerings, what internal capabilities do you have and what types of things do you need to maybe bring in from the outside and how do you think about what your capabilities are today versus feeling it out as you go?

William Moreton

Okay, Michael. Let me take a shot at those questions. First let’s do media first. To your point, media actually has been a four and half, almost five-year journey for us so far. And you know we started very modestly as we do and Panera we like to iterate – learn, iterate, test again, learn iterate test again and go forward that way.

When we talk about the media going up, you are right it has gone up and we said it will go up 25% next year. But you have to remember what a low base that’s off of. I mean we’ve talked about it being 1.3% of sales this year moving to 1.5% next year. There are many national competitors that are in the 3% to 5% range. So kind of think of it as an S-curve, right, whereas you’re going up that S-curve your return is very good on the dollars you spend and eventually there is a time where your return isn’t as good at the hook of the top of S.

We are just in the very early innings of media. So, I would tell you we have a combination of we brought some tremendous in-house talent, led by Michael Simon, our Chief Marketing Officer and Chris Hollander our VP of marketing. Very talented people so we have a great capability inside. And then the different agencies that we work with outside in terms who places our ads and own creative, I think, it’s a really nice mix today. And what you see is us going up that S-curve continuing to learn what the optimal mediums are by market and their effectiveness as we go forward.

So we view both of these initiatives, but just stay with media now, it has several years of runway left as we kind of cautiously go up that curve and learn where we are at. So, we would say although the dollars are big compared to the year before still relatively small in total basis.

And then as it relates to loyalty, I would tell you it’s a mix again of in-house skills and talents with an outside partner as well that helps us think strategically about the program and how we move forward. And what I would tell you with that is we have a multi-year strategy of how we attack loyalty and look at it, and really what we went through last year is operationalizing it and getting the first level of surprise and delight in, as we move next towards kind of more soft rewards or more special or really communicating to the customer, what we think having 8.3 million people’s actual purchasing behavior provides us great capability and it comes down to our ability to tie that with customer research and tie it to analytics. And I would tell you we have very strong capabilities in-house on both.

So loyalty much as we do with media, it is a multi-year process for us that we think will really land us in a great place of understanding our customer more deeply than most anyone else in our industry. We think that provides us great advantage.

Michael Kelter – Goldman Sachs

Thank you.

Operator

We’ll go next to Jeffrey Bernstein with Barclays Capital.

Jeff Bernstein – Barclays Capital

Great. Thank you very much. Just a, I guess, two-part question related to the comp driver. One I know last quarter you talked about the stronger macro headwinds perhaps having a negative impact on your consumer. Just wondering whether you review more higher level what you think that those pressures have perhaps eased over the past quarter or was it more you think changes that you implemented to counter those headwinds that led to the upside to the comp in sales of this quarter and into October and then separately on loyalty plays a part in that and I know you mentioned that last quarter even you talked about some changes and enhancements to tweak as you learn and test and relearn and whatnot. I am just wondering, if you can give a little bit more color on the enhancements that changes perhaps you made the loyalty program to increase the frequency and I guess reduce the cost side of things. Thanks.

Jeffrey Kip

David, it’s Jeff – excuse me – Jeff, it’s Jeff. Listen, we haven’t necessarily changed our view really of the economy. I think we were really pleasantly surprised by our quarter. But if you look at our monthly breakdown it was really a big lift in September when actually more broadly industry indicators have the whole sector of, which you are probably better to explain than I am. So we didn’t necessarily do anything to counter our strategy or our tactics in the four walls. We just saw a great consumer response. In September, we’ve seen in carryover through October although at a lesser level but we still look guardedly at the overall economy, and we didn’t really dwell on it looking at next year’s comp’s. But we do have great media investment going in next year but we are very respectful of where the consumer is right now. So if you have a great explanation on the restaurant sector surge in September, we would love to hear it, too.

William Moreton

Let me add to, I absolutely agree with Jeff. I mean we are very respectable of the economy and the difficulty that there is and that’s what we tried to talk about the last quarter. And as just that our fundamental view on the economy hasn’t changed. I think it will likely be the very similar next time at this year as it is today. The truth is that over a multi-period now over a decade plus our consumers we’ve proven fairly resilient in both boom times and more difficult economic times and we continue to be very respectful of that, though we understand the issues that are in the economy. So we try to bring all that together as we talk to you guys and be as transparent as possible with our guidance and our thoughts.

So that’s kind of on the micro side. On the loyalty side, what I would tell you the primary enhancements that we are putting in this year and going into next are around we’ve looked a lot at the rewards we are offering by frequency band and what really moves customers. And so what we’ve been able to do is we’ve adjusted a little bit rewards for certain frequency bands. So that in our mind, we are matching them appropriately. We might have been kind of rewarding a little bit to frequency some of the customer bands and when I say customer bands, what I mean by that is the frequency with which they visit the bakery-cafes. So we are trying to match those rewards to what really drives behavior

So that has resulted in somewhat less in terms of the rewards we are giving away, and then the second thing I would tell you that we are getting better at and I expect we will get quite a lot better at it next year is really matching the relevancy of the rewards to the customer. We’ve done some experimenting to try to move a customer to different dayparts and that works in part but it’s really kind of customer dependent and that’s the power of this is a certain customers use Panera in certain ways and what we are finding is it’s best to reward them with things that are relevant to them in the way in which they move Panera. So we will use our rewards to try to move people a little too different dayparts are different sections of the menu in the daypart that they come visit us but we are really getting much better at that relevancy piece for each of our customers.

Jeff Bernstein – Barclays Capital

Thank you.

Operator

We will go next to Chris O’Cull with SunTrust Bank.

Christopher O’Cull – SunTrust Bank

Thanks. Good morning.

William Moreton

Good morning.

Christopher O’Cull – SunTrust Bank

Bill, were franchisee comps driven primarily by the check growth during the quarter and if so, why do you think you are seeing different traffic performance between the company cafes and the franchisees?

William Moreton

Yeah, I’ll start and then let Jeff – Jeff I don’t have in my mind the breakdowns specifically. The one thing I would give you his frame of reference for company versus franchise comps. We think it’s really important to look at the two years, Chris because that kind of takes out the timing of when some things were rolled out in different sections. In the company and the franchise and on a two-year basis I think you see those numbers a lot closer. Jeff if I get this wrong but I think the company has about 11.5 and the franchisees are about 11 in the two-year basis.

So although it looks like a little wider gap right at this moment over a two-year time period we are really fairly close and I would tell you throughout our history we’ve been fairly close and I would describe that more than anything else as timing of certain of the initiatives rolled out. I mean typically we rollout initiatives first, test them on our nickel and then the franchisees followed fairly closely thereafter. And again we are very lucky our franchisees follow very much our lead and the quality of operations and the franchised cafe is identical to a company cafe which is part of our power but so that’s a little broader framework Jeff I don’t know if you have any specific color on the components in this quarter.

Jeffrey Kip

The only thing I would say is they tend to end up with a little less price than we do a significant portion of them go with our price increase but not all do. So I think you understand there was a little bit of variance there as well. But...

Christopher O’Cull – SunTrust Bank

Okay.

William Moreton

Thanks, Chris.

Operator

We will go next to Brian Bittner with Oppenheimer.

Brian Bittner – Oppenheimer

Good morning, great quarter. I apologize if I missed this, but can you talk a little bit more about the investments that are accelerating in the fourth quarter what is the primary driver there?

Jeffrey Kip

Listen, I think this is kind of normal stuff. We are spending 1 to $2 million and what you’re really talking about his research, a couple of consulting studies looking at market potential development may be things like that and other G&A. It’s not something material but it’s just something normal and natural you do as you look out over the course of the rest of the year and think about setting yourself up to execute in the next year.

Operator

We will go next to Jason West with Deutsche Bank.

Jason West – Deutsche Bank

Yeah, thanks. I was wondering if you guys could talk a little bit about the new store development kind of how the outlook for the next year or two in terms of geographies and the types of markets you are going into compares to the historical growth path of the company thinking more urban stores other geographies where you see the most opportunity, things like that?

William Moreton

Yeah, sure, Jason. I’ll start and Jeff can add. In terms of geographies I think it’s very much the same geographies. What we believe we have the opportunity to do is penetrate quite a bit more deeply into the markets that we are in already. So it very much we have again it’s a multiyear strategy as we believe there is quite a long way to penetrate more deeply into the markets that we already exist as I mentioned earlier we are starting to see more and more high-quality real estate sites become available and we are able to jump on those as we have them. That said, within the existing markets like Boston, Chicago, Washington, DC, we are doing a little bit of edge urban, if you will. And what that is to me is we still have all the same traffic drivers that we have in the typical suburban location retail mix office residential, but we are a little bit more close to the urban setting. But we are not in a place where we are looking at a five day a week store, on the corner of Main and Main in Downtown Manhattan or something like that.

So I would tell you same geographies, same basic traffic drivers, but we are doing a little bit edge urban. The one other place I would mention to you is we view Canada as a big potential growth market for us as we look out over the next several years. We have the three bakery cafes there today. We have a number of them that are in the pipeline and we have brought our biggest franchisee to come into the Toronto market with us and co-develop. So we think that Canada provides us a fair bit of opportunity as we look forward here into the next couple of years.

Jason West – Deutsche Bank

Thanks.

Operator

We will take our next question from Nicole Miller with Piper Jaffray.

Nicole Miller – Piper Jaffray

Good morning. Without completely playing your hand the momentum you have, how do you plan to capitalize that in the holiday period for catering specifically?

William Moreton

I would tell you, Nicole, again our catering is by and large based on the strength of the products that we have, our national footprint and so what I would tell you as we get more and more refined with our regional catering sales manager and our sales forces and our database, I think that we are better able to target kind of customers.

At the same time we kind of have a national effort rolling out to look at more national accounts and then the biggest single piece I would tell you as we look into the fourth quarter and the holidays is really the ability around the use of digital marketing and our ability to try to raise awareness that way.

So you will see us really emphasize catering in the fourth quarter and beyond in terms of kind of some of our digital media strategies. So we just continue to be excited about the sales infrastructure we built, the tools they’ve got, online catering which is just still not in all our cafes but in most all of them now and as people become more aware through our messaging and the MyPanera Program where we can talk about catering more, we think that we will continue to get a bigger and bigger share of that overall catering market out there. So we feel very good about that coming into both the holidays and into next year.

Operator

We’ll go next to Sharon Zackfia with William Blair.

Sharon Zackfia – William Blair

Hi. Good morning. I apologize if I missed this, but could you talk about the cadence of your expected food cost inflation over 2012?

Jeffrey Kip

We didn’t. We just gave you the full year number,

William Moreton

Which was 4%.

Jeffrey Kip

Roughly 4%.

Sharon Zackfia – William Blair

Could you talk about the catering?

Jeffrey Kip

We are not going to quarter rising it right now. We’ll go through that as the year goes on.

Sharon Zackfia – William Blair

Okay. And maybe can I ask a second question since...

Jeffrey Kip

Sure.

Sharon Zackfia – William Blair

In terms of the price benefit that you have next year, is that more weighted to the first half of the year and the second-half.

Jeffrey Kip

It’s heaviest in the first quarter. If you think about it we are 3.5 now and so we’re going to average three next year. So it will be highest in the first quarter and lowest in the fourth quarter.

William Moreton

And again it’s important Sharon. I just like to restate something that we said in past calls though, but our whole philosophy around pricing is to try to look at the all-in inflation in our total P&L, so include labor, occupancy all the rest and try to match our price increase to that, which we think that we are able to do this year and next as well and we are very careful in looking at competitive prices and understanding how our customers are viewing it and our scores continue to be exceptionally high on price value and we continue to recognize that the value our customer sees and feels is a lot more than just the price of the product, it’s the quality environment, the people and all the rest. So right now, I think that we’re in a nice place on that equation of price value but we will continue to try to price in line with inflation so that we don’t feel squeezed in the margin and have to try to deteriorate the customer experience in another piece. That’s our goal is not to do that.

Operator

And we’ll go next to Phillip Juhan with BMO Capital Markets.

Phillip Juhan – BMO Capital Markets

Yeah. Thanks, guys. Hi, Bill, you talked about North American development a bit but can you give us a sense as you start to think about perhaps expanding outside of North America, which markets you are thinking about and perhaps the potential timing of expansion outside of North America. Thank you.

William Moreton

Yeah. What I tell you Philip is we are doing some exploration outside of North America but at this point really we believe that there is a great deal of growth of left in U.S. and Canada as I just mentioned before. So it isn’t something that we are going to undertake in the very short-term. I think one of the things that we recognize and looking at other people in our industry an awful lot of people haven’t succeeded when they’ve gone internationally and beyond even those that have it’s a very long-term effort to do that.

There is a fair bit of investment upfront and you reap the rewards quite, if you year is out. So as we look at potential international investment we think about that as something that might affect us and down the road. But we are not committed to it and we are currently in the evaluation stages. So it would be premature to say market specific because we are evaluating a couple markets but at this point really we honestly believe in the near-term and medium-term our best growth is available to us in the U.S. and Canada, and there is plenty of that. Thank you.

Operator

Our next question comes from Mitch Speiser with Buckingham Research.

Mitchell Speiser – Buckingham Research

Great. Thanks very much. Can you give us an update on the drive-through opportunity in particular how many stores you have now and the ROI trends, if there has been cannibalization in test and what percent of stores you think will be opened in 2012. We drive those and maybe also just what can be converted from the existing store base and I guess just to put it all in general, if you can maybe prioritize the importance of the drive-through opportunity. Thank you.

William Moreton

So just globally the way we look at drive through is it’s a nice ROI answer. We think that our retrofits which were more expensive than putting a drive through on a new build, still return nicely and give us a nice lift. . There is not a massive opportunity. We think this is something that will be a nice positive for us over a few more years particularly in the franchise community where we haven’t really gotten the drive-through retrofit program off the ground but you’re not talking about something that’s a 100 basis point of comp enhancement over a multiyear period or something like that so I don’t think that’s the right way to think about it.

And you know, we’ll still do, I don’t know what the number is , 1, 2 dozen of these things a year for a few years depending on how rapidly our franchisees move on it. And then in terms of new stores I think we think we don’t have a quota or a target. The way we think about it is, we want to find retro areas and great locations within the trade area and a drive-through that will work well from a traffic perspective obviously helps the quality of the site within the trade area so we don’t have a mandate to go get drive-through is as we have a mandate to get great sites.

And we generally think maybe we’ll do 15 or 20% of our new unit has drive-through is but it’s not the head of development doesn’t have that in his bonus program, right. It’s something that we found to be a great overall enhancer. I think that on the margin there has been sites we might not otherwise have done because we didn’t feel like the retail characteristics were as strong but with the drive-through and the traffic characteristics of the roads around we found that stores would actually work done as a drive-through so it’s probably added a few stores to our total opportunity. But again you’re not talking about a game changer for us one way or the other you are talking about a nice enhancer.

Operator

Our next question comes from Nick Setyan with Wedbush Securities.

Nick Setyan – Wedbush Securities

Good morning, thanks. Catering growth continues at a very nice pace. Would you please give us a little bit of color on how much catering growth contributes through growth in mix versus say fine-tuning loyalty? Thanks.

William Moreton

Yeah, I mean, Jeff, can give you kind of some broad brush numbers, but again, catering we really do consider that, Nick, one of our big multiyear initiatives. It has continued to drive up, drive growth which really drives our average check, right. There aren’t all that many transactions but obviously the average check is over $100 per transaction so you really see that as Jeff mentioned in our average check growth and Jeff has contributed...

Jeffrey Kip

A point or so, about.

William Moreton

About a point this quarter and going forward you would expect something in the same kind of...

Jeffrey Kip

We’re going in mid-20s you’re talking in that general range that’s where we’ve been for the last year or so that we’ve been delivering 20% plus catering growth.

William Moreton

All right. And I’m just trying to get for one minute the last question in this it’s interesting as you think about both catering and drive-through they are both about something of the same thing recognizing a consumer need and how we try to meet that need. So as Jeff said drive-through really given that we have 1,500 units today and will have a little over 100 drive-throughs by the end of the year it really is opportunistic and it isn’t going to be a big percentage of the system.

But on the margin as we grow it’s a way to meet another consumer need that’s time pressured but yeah once the quality of the Panera experience. And catering in all-purpose in general we view is there is a great market out there that’s looking for the quality of the Panera food. We think it travels very well and it really is as much as anything is getting people getting in their short list of who caterers and really trying to take that part and with our national footprint and the quality of the Panera brand we think we will continue to penetrate if you will the consumer psyche that’s looking for that catering need and that’s why we think it’s a big multiyear platform. Thank you, Nick.

Operator

We will go next to Stephen Anderson with Miller Tabak.

Stephen Anderson – Miller Tabak

Yes, good morning. Taking a look at your labor cost line obviously a lot is going has to do with the rising same restaurant sales if I recall there is a something about labor about the health insurance about any kind of benefit can that be quantified and if you will see that going forward?

Jeffrey Kip

We are not – so what we’ve said is the pickups we’ve seen have been driven by labor discipline around our new higher wage rate and are off cycle raises. And what we did this year with medical about a year ago is we made the decision to go to two networks and we set up some incentives in our program to drive higher network utilization so we’ve seen a pick-up there. We are not specifically quantifying the basis point of those programs. And then we are annualizing in them Q4. So we’re expecting the labor margin to flat now year-over-year in Q4 is what we’ve said.

Stephen Anderson – Miller Tabak

Okay. Thank you.

Operator

We’ll go next to Robert Derrington with Morgan Keegan.

Robert Derrington – Morgan Keegan

Thank you. You know Bill, could you give us a little bit of color. Have you figured out how to kind of dovetailed in the loyalty program with your catering to try and possibly incentivize some of the folks who place the key orders for so many of these accounts? And second part of that question, the retail sales particularly the new pumpkin cookie sound as though they’ve been terrific. Has that given you new ideas in how to try and move that piece of the business, which could be used for both obviously in-store as well as catering?

William Moreton

Yeah. I would say this Bob. Right now in terms of there isn’t a specific catering loyalty program. That is something that we think about. One of the things that we are trying to do and we’ve talked a little but about is really find how to make it as easy as we can for a customer to stay connected to Panera and meet all their different needs.

So I would tell you one of the ways that we’re going to do that going forward is through our MyPanera loyalty program and so that’s a specific identifier for you whether you are a catering customer, and in café to go customer however you use Panera. So I think we have opportunities to cross pollinate there. So we’ll see how loyalty plays in as we go more broadly. What our sales tools Bob and some of the disciplines we brought in our customer hub database, it allows us to understand a lot better who orders from us, how often they are frequency and allows us to really talk to them and try to ensure that we are meeting their needs going forward.

To your point on the bakery, it’s interesting in the pumpkin cookie. Absolutely that’s something that can help be played up to really digital media we think is the best way search engine marketing and kind of some of our digital media initiatives to try to really reach out and again increasing the consumer psyche, Panera is a catering solution. You know we’ve tagged that the certain of our radio advertising and things. We think that that’s, there is kind of a grass-roots momentum to this that’s really starting to build on catering.

With the pumpkin cookies I think demonstrating our bakery expertise is a good thing both inside the four walls and with catering. If you really think of one of our greatest points of differentiation is compared to everyone else out there we have more than 2,000 trained bankers in our system and their ability to bring true bakery talent on the fresh dough that we bring into the cafes every day really makes a better quality product and we are trying to message that as part of our make today better. You will see us hit that in our catering kind of digital messaging and then inside the four walls.

So you are quite right there is a connection to catering but I think really playing up that point of difference houseboats of the four walls and catering. So long story short Bob we are in the beginning stages of how we think of catering as just another solution customer solution and how we tie it into everything that we are doing in Panera. So we are excited to look forward and think of that going forward. Thank you.

Operator

I’ll go next to Bart Glenn with DA Davidson.

Bart Glenn – DA Davidson

Thank you. I was just curious, if you had a perspective on what the bigger transaction opportunity is over time whether that might be which of the dayparts. Thank you.

William Moreton

Yeah. I’ll just give you just a quick thing, Bart. Something I didn’t mention that I often do during the prepared remarks is every single day part of ours continues to grow profitably, and that’s been the case now going back many quarters in a row. So unlike different concepts where sometimes they push breakfast and that’s what’s driving the company. We have had profitable growth in every single day part now for many quarters in a row going back more than a couple years. So we are very pleased with that.

As we look at opportunities candidly we think they exist in every day part, which is what we feel very good about. So it isn’t – I don’t think we will be driven more by one day part than another. I would tell you that we’ve been able to with our breakfast sandwich program really provide a different meet a different consumer need to a more substantial kind of more center of the plate kind of breakfast, so you will see us continue to expand out our breakfast lineup and we are concentrating on products now that work both at the lunch day part and the dinner day part through kind of our hot sandwich platform and our soup platform. So we think there is opportunity in every single day part and we’ve demonstrated that over multiple quarters and expect to going forward. So thank you, Bart.

Jeffrey Kip

And operator I think we’ll take one more question and then wrap up the call.

Operator

We have no further questions at this time.

William Moreton

Outstanding. We won’t take one more question.

Have a nice day everybody.

Jeffrey Kip

Thank you everybody. Take care.

Operator

And that conclude today’s conference. We thank you for your participation.

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