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California Pizza Kitchen Inc. (NASDAQ:CPKI)

Q3 2007 Earnings Call

November 8, 2007 5:00 pm ET

Executives

Rick Rosenfield - Co-Chairman, Co-President and Co-CEO

Larry Flax - Co-Chairman, Co-President and Co-CEO

Sue Collyns - SVP of Finance and CFO

Analysts

Jeff Farmer

Destin Tompkins

Mike Smith

David Tarantino

Nicole Miller

Steve Anderson

Larry Miller

Mark Lee

Operator

Good evening. My name is [CK], and I will be your conference operator today. At this time, I would like to welcome everyone to the California Pizza Kitchen Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Rosenfield, you may begin your conference.

Rick Rosenfield

Thank you, operator. Good afternoon, everyone. Thanks for joining us on our third quarter conference call. My name is Rick Rosenfield, Co-CEO of California Pizza Kitchen. With me on the phone today is Sue Collyns, our Chief Financial Officer.

Before we begin, I need to remind everyone that part of our discussion this afternoon will include forward-looking statements. They are not guarantees of future performance, and therefore undue reliance should not be placed upon them. We refer all of you to our filings with the Securities and Exchange Commission for a more detailed discussion of the risks that may have a direct bearing on our operating results, performance, and financial condition.

With that out of the way, I want to mention that my Co-CEO, Larry Flax, is on the line. For him, it's Friday morning at 7 AM. And he has the good fortune to be in Seoul, South Korea, participating in the grand opening of our first location in South Korea. Simultaneously, we're also opening our six restaurants in the Philippines.

Good morning, Larry.

Larry Flax

(inaudible). They tell me it's good morning in Korean. It's 7 o'clock in the morning here.

Rick Rosenfield

Good morning

Larry Flax

Good morning, everybody.

Rick Rosenfield

Well, yesterday I am informed that in a news conference the CEO of our South Korean franchisee announced their intent to build 30 CPKs in South Korea in the next five years.

Larry Flax

Yeah. I guess they are very excited over to hear about California Pizza Kitchen.

Rick Rosenfield

That's great. These openings fortify our growing presence in the Pacific Rim, which now comprises 18 restaurants in seven Asian countries and represent yet more opportunity for us to expand our high-margin franchise royalty stream.

Moving to the short-term, I'd like to now discuss highlights for the third quarter of 2007. As we mentioned on our last call in early August, the quarter began with a disappointing start in July. However, as the quarter finished, we regained momentum against the backdrop of continued challenges throughout the industry. And as I'll discuss with you in a moment, we were able to achieve what we believe were pretty impressive results.

For the quarter ended September 30th, we grew revenue 13.5% driven in part by a 3.5% increase in comparable sales versus previous expectations of 2% to 3%. These results came on top of a 5.6% increase [technical difficulty] and equates to a total two-year stacked percentage increase of 9.1%, and a three-year stacked percentage increase of 16.2%.

In addition, this marks 17 consecutive quarters of strong comparable sales since Larry and I returned as Co-CEOs. While this quarter saw minus 3 negative guest counts, it should be understood that over the last three years we've been able to raise pricing by approximately 11% while increasing traffic by more than 5%. We were also able to maintain a positive mix, so in the present economic environment we believe we've delivered.

Now I know there's been a lot of recent discussion as to how certain parts of the country have faired with respect to comps, particularly in California where the press seems quite focused on the weakness in the housing market. I can tell you that for us in California in Q3 we had positive comps that were just shy of 2%. And I think it's important that you understand that in context.

Despite the current relative softness, California remains by far our strongest market and its quiet robust and lucrative for us. Our financial performance in California remains outstanding, and indeed, average weekly sales in California, during Q3, was $75,050, 13.50% above the remainder of our full service portfolio.

Importantly, that weekly sales average was also the highest-ever for our California stores. So, bear in mind, that we, internally, never let the desire for strong comps drive our real estate or financial strategy. We've been intentionally cannibalizing ourselves in California since 1986 when we opened our second restaurant 1.5 mile from our original Beverly Hills restaurant.

And we've continually in-filled, particularly in Southern California, our strongest market, because, quite frankly, our returns justify it. And we think we still have plenty more opportunities for growth in this, our home region. And while our strategy can cause modest traffic losses in individual stores, overall traffic sales and profitability in the market increases. This strategy also increases and leverages our brand awareness.

I'd like to add that we have a number of restaurants in California averaging near at or exceeding $1,000 per square foot in sales. At our price point, this is such a strange capacity that it adds to the difficulty in driving comps. So, all in all, what I'm saying to you is that while, of course, we'd rather not see sectors of our great state experiencing pressure, we're quite satisfied with our business here and the opportunity it continues to provide us.

We're also confident that our overall real estate strategy and brand positioning, generally targeting higher income demographics and providing a quality experience at a relatively low price point, relative to our peers, provides insulation for us in tougher times.

Now specific to the overall company financial results in the third quarter, I am proud to announce that we reached a 20% operating margin, which we always target as the gold standard of performance. This is a credit mostly to our operations taskforce which proved the depth in better managing food preparation, storage and waste, and enabling us to leverage our cost of sales even as many raw commodity costs were still higher year-over-year.

On the bottomline we are on $0.05, including $0.20 in early termination costs for up to four ASAP's. As of today, we have closed one ASAP location in Queens, New York, and have scheduled a second location closing for next month with one further ASAP closure in negotiations.

Part of the 20% write-off also includes an early termination of a fourth lease for an un-built ASAP unit in our pipeline. These actions will put this chapter behind us and will result in $0.02 accretion on a go-forward basis.

So, here is where we stand today on our, company-owned, ASAP units. We have achieved mixed, but, overall, unsatisfactory results. Nevertheless, we have several highly successful and highly profitable units. And as a result of our recent evaluation, we think we understand where they work and where they don't.

Additionally, we will make some changes at the existing restaurants, continue to support them and enhance financial performance without capital expenditures. That said, we intend to keep tweaking and improving the concept and we'll just see how it evolves overtime, because we continue to believe that it has a complementary role in our portfolio.

During the third quarter, we added six full service restaurants Roseville, Minnesota; Tempe, Arizona; Lake Grove, New York; Nashville, Tennessee; Seal Beach, California; and Houston, Texas. It's interesting to note that our opening in Nashville achieved the highest first week opening volume of any restaurant in our history, only to be surpassed by the first week sales at the restaurant we opened this quarter at Partridge Creek Mall in Detroit, Michigan.

During the quarter our domestic franchise partner, HMSHost, opened a CPK/ASAP location in Los Angeles International Airport, that’s our third in at LAX. Additionally, our international franchise partner, Grupo Calpik of Mexico opened a full service restaurant in Mexico City, that’s our first in that country.

We're very encouraged by the ramp-up in expansion of our airport ASAP units by our partner HMSHosts. They currently operate 16 ASAP's and they plan on opening four units next year. Also, the pizza of venues run by our franchise partners at Dodger and Anaheim stadium did very well for us during the regular baseball season, while our agreement with Staples Center in Los Angeles to be very exclusive pizza provider, just kicked off for us in October. So, we're pleased to be adding another sports venue to our franchise business.

Across the entire portfolio of full service restaurants, average weekly sales were up 3%, with our pre-2002 locations, delivering AWS of $75,351, our highest average weekly sales on record. Our “newer class” of restaurants are performing admirably and are generating significant volumes. Results like these are often associated with honeymoon periods and making AWS growth challenging year-over-year. That said, we are very satisfied and proud of all post 2003 classes.

More than 33% of our base now features the upgraded decor prototype, that we started in 2004, with a more featured bar, while 54% of our restaurants having upgraded warmer ambiance format. This contrast was just 23% and 47%, respectively, a year ago.

While we don’t have a specific timeline, we do expect to refresh the balance of our restaurants overtime. Many of these mature units are all ready among the highest volume in the portfolio. And our experience tells us that if we enhance the ambiance, we'll enhance the volumes. We are constantly evaluating these upgrades with ROIs for our shareholder and today it's been a good use of our capital.

Switching gears, our menu development continues to be at the heart of our success. Our June menu rollout included four new items, The Works Pizza, Cajun Pizza, Mediterranean Salad, and Pan Sauteed Salmon, and one new dessert is: White Chocolate Peanut Butter Cheesecake. Normally, we would have awaited our November rollout to introduce new items. We took a more offensive pasture and introduce our Miso Salad and Crab Cakes via table cards in September. These items are achieving excellent sales and customer satisfaction scores and have become a welcome addition to our offerings.

For our November menu, which was introduced yesterday, in addition to the formal rollout of the Miso Salad and Crab Cake appetizer, we also introduce an Italian Basil and Tomato Pizza, Blue Crab Cakes as an on-tray, and a Red Velvet Cake dessert item, all of which can be seen on the homepage of our website, if you want to get hungry and then help us drive comps.

Our customers have come to expect new offerings in CPK throughout the year, and we're pleased to be carrying on that tradition as we solidify our reputation for innovative offering and consistent quality. I am sure that under the present economic conditions, you'd all appreciate the comment on the fourth quarter, where we have about five and half weeks under our belts. So far comps are running in the 2% to 3% range, which includes a loss of 10 partial store days with the tragic California buyers.

So, before I turn the call over to Sue, I would like to make a number of key points.

First: we're aware that some of our peers have recently announced that they are cutting back on development next year. I can assure you we have no intention to follow a suite. Yes, it’s a challenging macro environment, but we continued to build and operate very successfully.

As I mentioned before, we think because of our relatively low price point and the higher income demographic of our customer base, we consistently demonstrate insulation to a softening economy. As I often said before, I think we're resistant, but not immune to the broad economic pressures.

At the same time, our strategy will be guided by our confidence in the long-term. And we're not going to make decisions and to achieving short-term financial targets. Now, we're very proud of our execution in a growing power of our brand. We're pleased with our full service development schedule, which helps us at 17 new restaurants for 2007, that's company-owned. And as we see the development pipeline currently, approximately the same number for 2008.

Bear in mind, we consistently said that we approach our development from an opportunistic perspective. And we'll build as many high quality sites as are available to us in the given year, but won't sacrifice our intensive screening process to meet a preordained goal.

Second: our domestic and international franchise is gaining real momentum. And, in speaking with our partners, we know they are rather happy with what we're doing to cultivate our brand both on a national and global level. In fact, the common theme across all of our existing and potential franchisee relationships is the excitement for CPK as a premium brand. One, it has proven itself in a variety of markets and geographies.

For next year, in addition to the four domestic ASAP airports units to be developed by HMSHost, we anticipate a minimum of six units to be opened internationally by our exciting franchise partners, with additional restaurants in Mexico, Japan and Korea.

We've also recently entered into a Letter of Intent with a potential franchise partner for our first restaurant in Dubai. So on the franchising front, we've certainly gained a lot of traction this year, and we're well positioned for a prolonged ramp-up of this high margin revenue stream.

And finally, and quite importantly, our relationship with Kraft continues to exhibit double-digit growth. While it's difficult to measure the obvious benefit to our brand awareness from the exposure in all 50 states and over 17,000 locations, along with the approximately $7 million marketing budget Kraft will spend this year, we know the impact is material. Moreover, the high margin profit contribution has become a significant and valuable part of our business, and we expect future growth to be meaningful.

We look forward to the additional growth of this business with the introduction of new pizza products early next year and a rollout of non-pizza products in the frozen category later next year. We also continued to explore a variety of options to increase placement of our products in the grocery isle.

And with that, I'll pass it over to Sue.

Sue Collyns

Thank you and good afternoon everyone. Total revenue for the third quarter increased 13.5% to $162 million. This consisted of restaurant sales growing at 13.3% to $159.7 million, royalties from Kraft increasing approximately 13.3% to $1.3 million and franchise revenue from both domestic and international growing approximately 44.5% to $1.1 million.

Our third quarter comp sales increased 3.5%, which did include 4.7% of price, 1.5% of negative comp and 0.3% of positive mix. We estimate that we had 15 restaurant closure dates, due to one store remodeled in Newport Beach, California, which was least required and that cost us around 10 basis points for the quarter.

The monthly comps broke out as follows. July comps at 2.9%, which was on top of 5.6% of same period last year, August was 4.7% which compared to 5.8% last year, and September comps rose by 3% compared to 5.4% last year. And this, in particular the Newport Beach location remodel that I just spoke about costs us around 30 basis points during the final month of September.

Full service CPK restaurants delivered a weekly sales average of $68,972, which was 3% higher than a year ago period. All of our classes experienced positive weekly sales average growth with the exception of the class of 2006, which is still coming off honeymoon periods and ended the quarter at approximately $62,700 per week.

And this follows a typical pattern that our history shows, and these classes are certainly build overtime nicely. The class of 2006 incidentally did deliver an EBITDA in the 17% range this quarter, which we thought was very respectable considering that 9 of the 16 restaurants were opened in the last quarter of 2006.

Importantly, the class of 2007 are also posting impressive sales, and they are topping almost $69,000 per week in the third quarter, and gaining even greater momentum so far this fourth quarter.

ASAP results, as Rick mentioned, were disappointing, although we have taken the final set of charges during the third quarter and are moving ahead. Specifically, we incurred an $8.5 million charge which equated to $0.20 EPS that did relate to four ASAP sites which Rick discussed. And by improving our ASAP portfolio now, we do look for around $0.02 accretion on a go-forward basis.

Moving on to the P&L, food, beverage and paper supplies for the quarter were 24.4% of sales, which was 40 basis points better than last year. We did experience pressure across a number of commodities, not the least of which was dairy, which we did anticipate, and that was up an incremental $562,000 in the third quarter. But I'm happy to say through several best practice taskforce initiatives which we got on straightaway, we were able to improve our year-on-year results.

Specifically, our project prices were also favorable which helped us, but most of the credit has to go to operations, their focus on inventory management, things like reducing spoilage and waste, and simply enforcing operational best practices across the group managed to get us to the 24.4% number that we're very happy with.

Our diversified menu and low contracts for the year has made our cost of goods line item a source of relative strength for us in favorable environment. Right now, however, we're working very high to maintain our best practice taskforce initiatives in the fourth quarter to effect these increases in protein and dairy costs, and I am optimistic that we'll have a flat cost of goods in the fourth quarter compared to Q4 of 2006.

Labor expense, direct operating and occupancy costs were flat for third quarter compared to the prior year, and that resulted in GAAP store level margins of 20%, a number that we consider the gold standard of operational excellence.

G&A expense improved 60 basis points to 7.3% of total revenue, and this includes 6.5% of what we call core G&A and 80 basis points of stock-option expense. Depreciation costs were 5.8% of sales and that was 60 basis points higher than last year's third quarter. And our pre-opening costs totaled $2.4 million in the third quarter compared to $1.1 million last year. And that was in line with six full service restaurants that we opened in the third quarter, as well as approximately $518,000 in phantom restaurant rent.

Our net interest expense was $42,000 and that compared to interest income of $154,000 last year, as we took out some debt against our line of credit this quarter, and ended our debt balance of $17 million.

Our income tax expense totaled $700,000 in the quarter and it represented an effective tax rate of around 32.2%, compared to 33% last year, and the rates being driven by the lowest earnings before tax number.

We executed $16.8 million buyback authorization during the quarter at an average price of $19.13, which concluded our previous authorization of $30 million. And as you may recall, we also announced a new $50 million buyback authorization on our August 9 conference call.

Taken together this resulted in GAAP diluted earnings per share of $0.05 versus $0.23 in the same period of 2006, or around $0.25 EPS on a pro forma basis, excluding the termination charges we incurred that related to ASAP.

Additionally, our diluted share count was reduced to 29.2 million shares in the third quarter of 2007 from 29.5 million shares in the third quarter of last year. And that decline was a direct result of the share repurchase.

With regard to our balance sheet, we ended the third quarter with $10.6 million of cash and $17 million of debt. And as previously stated, we do have a $75 million line of credit with attractive rates and that's reduced only by our debt and our $6.1 million of Letters of Credit.

Finally, in terms of CapEx: CapEx in the third quarter was approximately $25 million and that included about $20 million for new restaurants with a remainder related to maintenance in our existing location. That brings us to $57 million in CapEx for the first nine months of the year and we do expect to spend approximately $30 million in the fourth quarter for eight stores in progress at various levels for the full year number of $85 million in 2007.

Now, I would like to discuss guidance for the fourth quarter as well as 2008. Because of the uncertain environment, we do believe it's prudent to maintain the previously announced comps of 2% to 3% for the fourth quarter and this includes 4.7% of price and it is on top of the 6.9% comp comparison from last year.

We will be opening up seven full service restaurants this quarter, of which three have already opened, and in terms of international franchise stores, we have two planed for the fourth quarter, as Rick discussed, for the full year total of five locations. We did say six on the last call, you might recall, but a new store in Mexico did get push to the first quarter of 2008. In addition, HMSHost driven up one airport location in the third quarter at LAX terminal 8, for total of two this year.

So to recap, in the beginning of the year in terms of international and franchise locations, we said four franchise locations, three would be international and one will be domestic. But the final number now will be seven, that's five international and two domestic. That's on top of 17 full-service stores this year and the net one ASAP for total of 25 new units in 2007, which for us is a record.

In terms of EPS, we estimate our fourth quarter will be between $0.22 and $0.23 and, again, that's in line with the 2% to 3% comp rate. And moving on to 2008, we're also maintaining comps between 2% to 3%, which given the current environment seems to be the prudent range and consistent with our Q4 expectations.

We intend to open 17 full service restaurants, one LA Food Show and our international franchise partners have committed to opening up a minimum of six full services and HMSHost intends to open four airport locations. In addition, we believe new product introductions across will secure a minimum 25% increase in our royalty stream from them. So that's a total of 28 stores in 2008, which compares to 25 stores in 2007.

So, [precious] of note for us include commodities, which we forecast will cost us approximately $3 million in price increases over 2007, minimum wage increases in 26 days, which we estimate will cost us $1.8 million, remodel, which will cost us approximately $1.2 million in loss EBITDA and approximately 33-week, and finally, an accelerated depreciation on those remodels, which we anticipate will cost us approximately $670,000.

That all totals approximately $0.15 in extra costs over 2007 run rate. So, in total, 2% to 3% in costs, 28 new units and layering in the effects of the aforementioned commodity wage and remodel decision leads us to expect approximately $0.85 to $0.92  EPS in 2008.

And with that, I'd like to turn the call back to Rick for closing comments.

Rick Rosenfield

Thanks, Sue. As I think we have expressed throughout this call, we feel good about our business today. We're optimistic as we look forward to 2008.

Before we end our formal remarks, I want to highlight some key marketing and technology based initiatives in play right now. With regard to marketing, you might recall that we spend less than 1% of our revenues, and Kraft itself outspends us by two times as they are obligated to spend 5% of revenue towards marketing our brand. This year that will total approximately $7 million.

In addition to Kraft's spend we have launched direct mailer campaigns to promote our new menu. These mailers will be sent to over 4 million guests through traditional newspaper inserts as well as electronically through our email database. These additional and expensive steps are expected to provide increased awareness as we finish out the year.

In addition our gift card program is already in full swing, and year-to-date sales are tracking up 20% over the prior year. Then in September we launched a relationship with Blackhawk, which places our gift cards in retailers and that's primarily supermarkets. We expect it will rollout to approximately 11,000 locations by the end of the year. So all in all, we expect to have a banner year in our gift card sales.

We also developed a rewards program in conjunction with American Express, with a special limited time bonus program between November 15th and December 31st. For every $100 in gift cards purchased, we are offering a $320 gift card to the purchaser, which should facilitate new traffic and also act as a reward to our most loyal guest at the same time.

In terms of technology initiatives, which will be initiated in the first half of '08, we're currently testing a new wireless curb site cash sharing technology designed to speed up or takeout business, and also implementing a centralized takeout call center. These initiatives should make for a greater customer experience.

Finally, we'll be throwing out a web-based ordering system, which not only will make ordering easier and more efficient, but have the added benefit of exposing our customers to our website. As you can see, we're certainly not resting on our laurels. We have a number of new and exciting marketing and technology initiatives, and we're committed to making CPK experience the best it can be.

And with that said, we'll open it up to questions, operator.

Question-and-Answer Session

Operator

(Operator Instructions).

Your first question comes from the line of Jeff Farmer.

Jeff Farmer

Your $0.85 to $0.92 '08 guidance plus pretty meaningful EBIT margin compression, can you just give us a little bit more color on what you're expecting at the restaurant level, maybe G&A, D&A, especially considering that you're getting probably $0.02 benefit from the ASAP closures?

Sue Collyns

Sure. It really relates to the commodity cost that we anticipate, Jeff, the $3 million I mentioned. We got specific pressure like most of our peers have, obviously in dairy, paper, beverages, chicken and groceries. I think they are the top five. And then in addition to that, you've also got the 26 states implementing minimum wage increases and that's anticipated to cost as approximately $1.8 million.

Those two line items that end up -- I mean the cost of goods increases, that's about 20 basis points right there. And the minimum wage, I think, labor in general would have been flat at about 36.7% where we think we'll come in on this year without those minimum wage pressure.

Jeff Farmer

Okay. And then in terms of your pricing assumptions in 2008, what's going on there?

Sue Collyns

We've generally got approximately 4%.

Jeff Farmer

Okay. And then, final question: just sequentially your G&A fell versus the 2Q. Is that just a function of lower bonus accruals or is something else going on there?

Sue Collyns

Well, in terms of a percent it obviously fell. The absolute number, I think, was 10.5, excluding the FAS 123R compared to 10.7 in Q2 of last year. There were just some timing difference, then consulting fees, those sorts of things, as well as managers in training. A lot of them had gone through that sequence in the second quarter, which is why that number was disproportionately high, and then we got a bit of a pickup in Q3.

Jeff Farmer

Okay. Thank you.

Operator

Your next question comes from the line of Destin Tompkins.

Destin Tompkins

Thank you. I just had some questions on the CapEx outlook for 2008. Do you have an idea of how many remodels you'll do to layer on to the 17 new full service restaurants you're going to open?

Sue Collyns

Yeah. I think we had around six remodels budgeted next year, some of them are least required but most of them are just strategic from our perspective. And the totaled CapEx number in that for the remodel is I think at $10 million or $12 million number right now. Total CapEx the next year right now is looking at around $66 million and that’s before tentative improvement allowance, which I believe is approximately $6 million.

Destin Tompkins

Okay. And on the timing of that development, should we model it similar to the way it occurred in 2007?

Rick Rosenfield

I think in...

Sue Collyns

They're backend loaded actually, I think we're losing around 33 store weeks from those remodeled that most of them are occurring in the backend of the year, primarily Q4, we're obviously trying to take advantage of the summer pop and not have our restaurants down during the key time for us.

Rick Rosenfield

Now, that in general we try, if we have our brothers we try to do them, right after Labor Day.

Destin Tompkins

All right. And then the LA Food Show, is that in early part of 2008 or--?

Sue Collyns

That’s per comp.

Destin Tompkins

Okay. And then could you just update, I know you went through the share repurchase activity, but I may have missed it, on the new authorization have you used any of the new authorization at this point?

Sue Collyns

We've not used any of the new authorization at this point.

Destin Tompkins

Okay. Great. Thank you.

Operator

Your next question comes from the line of Mike Smith.

Mike Smith

Good afternoon.

Rick Rosenfield

Hi Mike.

Mike Smith

I am a little bit confused about the ASAP charge, not that they have a problem with it, but how many ASAPs do you have once you close -- once you're going to close?

Sue Collyns

We've 10 right now and we've three remaining, we had four originally…

Rick Rosenfield

And I think of the fiscal facilities, we will close -- well, we've closed, we have arranged to close one more and we are negotiating to close the second. That's in the actual opened restaurants.

Sue Collyns

And there was one and there was another store that was not built but we are negotiating out of that particular leasing.

Mike Smith

Okay. So you have 10 actual stores that open up every morning?

Rick Rosenfield

Yes.

Sue Collyns

Right.

Mike Smith

And you've got rid of one or it's [signed sealed] delivered?

Rick Rosenfield

One has closed. Okay, starting with 11, one is closed.

Mike Smith

Okay.

Rick Rosenfield

One will close by the end of the year. That will make it nine. And then, we are negotiating and don't know when the one remaining one will close, sometime next year if we are able to negotiate it out.

Mike Smith

And so you've already taken some charges for closing the ASAP, what were the prior charges? My memory is failing me.

Sue Collyns

Well, it was 8.5 this quarter and it was approximately $770,000 last quarter in Q2.

Mike Smith

Okay. So let me see if I get this right. So you've written down $9.2 million for total of two?

Sue Collyns

No. We've written down $9.2 million for total of five.

Mike Smith

For five units?

Sue Collyns

Right.

Mike Smith

But they are not all closing?

Sue Collyns

Well, we anticipate that they will close or we'll negotiate out of them.

Mike Smith

But that's of the $9.2 million is four what you think you have today.

Sue Collyns

Right. We have fully reserved for what we anticipate to be total exposure.

Mike Smith

With those nine, are they all profitable?

Sue Collyns

There are five that are actually very profitable and those have an EBITDA over the 18% mark. So they are doing very nicely. The remainder are kind of average, but none of them are bleeding like this other one that we have targeted to close. I mean, basically, Mike, ASAP doesn't really help us a lot, but it also doesn't hurt us right now, stripping out the one big store that we did close in the month of August. For the Q3, ASAP actually drew off $300,000 in EBITDA, so to the remaining 10 that were left and their average WSA for the remaining 10 was $31,000 a week.

So you've got five of that group that actually do more than $35,000 a week and EBITDA of over 18% so the remainder, as I said don't really helped us a lot, but also doesn't really hurt us.

Mike Smith

Are the trends there that they will help you or they, or you're just not closing them because you don't want to take the hits?

Rick Rosenfield

No. it's not about not taking the hits. It's not economic for us to close them. And you know, we expected making -- we are tweaking, we are continue to make improvements with them. And I would expect, we'll improve the economic over time for the remaining units.

Mike Smith

Thank you.

Rick Rosenfield

Without expanding, as we say a lot of capital for us. We have a team on it and we are managing them and going onward.

Mike Smith

Thank you.

Operator

Your next question comes from the line of David Tarantino.

David Tarantino

Hi. Good afternoon.

Rick Rosenfield

Hi, David.

David Tarantino

Just a question on the comps guidance for 2008, I understand the intend to be conservative there, but just wondering: why you wouldn't expect any pick up as you start to cycle some easier comparisons?

Sue Collyns

To be honest, David, it is just too early to call right now. You know what we're seeing in Q4 is in 2% to 3% range. And we at this point in time, we don't have any better numbers other than you numerically knowing that you're going to comp again, we're going to comp again slightly softer comps. But there are also lot about the economic conditions and discussions whether just by rate mortgages or a high gas prices in general oil is just unknown at this point. I think nothing would make us happy if we're able to get on the Q4 or Q1 call of next year and increase that.

Rick Rosenfield

I guess in a nutshell: we don't have any special knowledge.

Sue Collyns

Right.

Rick Rosenfield

We'll try to be conservative and make our best call, but I think all of us would say: there're questions on the horizon.

Sue Collyns

We are optimistic, and that was part of the point of Rick's last commentary in terms of the prepared remark, talking about a number of the marketing initiatives we have in Q4 on top of the technology initiative that we are very hopeful will continue to drive sales and separate us from the rest of the casual dining sector.

Rick Rosenfield

I think Sue makes the point that, at the end of the day, we feel quite good about our business. And yeah, we rather wouldn't be a softened economy right now, but our core business is great and we're firing on all fronts.

David Tarantino

Okay. I guess a follow-up to that. Have you assumed any benefits from those initiatives that you just mentioned in the comps or not?

Sue Collyns

Well, I think its relative in a sense. I think 2% to 3% comp in this marketplace seems to be quite aspirational from a peer group perspective, even though it's obviously significantly below what we've seen more ourselves. So I think, right now, we're pretty happy to maintain within that range. We've still got a relationship with Blackhawk, and they are actually a group that provides one-stop gift card to retailers, to the prepaid gift cards. That’s a new relationship for us and we only just signed that in the third quarter.

So there is an opportunity there for sales to be driven higher. But again, because we haven't seen it right now and it’s difficult to quantify, we haven't really built it into our numbers. But between franchise opportunities domestically, our relationship with Host 17 stores at full service that we'll be doing, we're doing 28 stores next year on top of great technology and other marketing initiatives. And as Rick said, we've really never felt better about the business, despite the economic and cost pressures that are out there. But they're going to pass.

David Tarantino

Okay. And then a question on buybacks: have you assumed any accretion from buybacks that might occur in the next few quarters?

Sue Collyns

Yeah, in terms of the count obviously, but 2008, we'll see the benefit in that diluted share numbers. So I think right now in Q3, we're tracking 29.2 million roughly in shares outstanding and expecting that not to really increase too much for next year. I think it might have a number of $29.3 million to $29.4 million in it.

David Tarantino

But to be clear, Sue, does that include any buybacks that you might do going forward or is that just to include what you've already done?

Sue Collyns

Well, the biggest driver of diluted shares outstanding is actually your stock price. I mean obviously the buyback number does influence as well, so the key is really: what stock price assumption do we have in there? And we don't really comment on that.

David Tarantino

Okay, great. Thank you.

Operator

Your next question comes from the line of Destin Tompkins.

Destin Tompkins

I just had a couple of quick follow-ups. One, can you share with us maybe: just what would you assume in 2008 for an increase in the Kraft's business?

Sue Collyns

Yeah, I mean we are looking really for over 20% growth year-on-year. I mean the CAGR for Kraft has been over 60%. We're obviously not anticipating that that would continue. But this year we anticipate they'll do over $140 million on the retail side and looking for that to grow a minimum of 20% next year.

Destin Tompkins

And does that assume much benefit from the potential new product that you're looking into?

Sue Collyns

Well, again, it's sort of hard to estimate that, so 20% lift candidly is what we think is a realistic number right now.

Destin Tompkins

Great. That's helpful. And then, on the tax rate can you give us an idea what we should expect for Q4 in 2008 tax rate?

Sue Collyns

Okay. Q4, I am looking at around 32 to same amount for this year. For the full year rate, I think we're looking at around 33.6 for 2007, and for 2008 looking closer to the 34%.

Destin Tompkins

Thank you.

Operator

Your next question comes from the line of Jeff Farmer.

Jeff Farmer

Hi, guys. I just wanted to come back as very quick on the '08 EPS guidance? So you touched on this little bit, but again, sort of, putting in the numbers real time it's looks like, in addition, to the restaurant level margin pressure, are you expecting sort of G&A pressure, as well as G&A pressures as a percent of revenue in '08?

Sue Collyns

We're anticipating, seeing some leverage in the G&A line next year.

Jeff Farmer

Okay. I'll sort of come back [after the call]. Thank you.

Sue Collyns

Okay.

Operator

Your next question comes from the line Nicole Miller.

Nicole Miller

Good afternoon.

Rick Rosenfield

Hi. Nicole.

Nicole Miller

Hi. I am sorry there is a lot going on tonight, so if I ask something that's been asked you can just tell me to read it in the transcript. It looks like you are lapping 1.5% of price in November. What was -- can you talk about what was added and what you are rolling on in the fourth quarter?

Sue Collyns

Yeah. You're exactly right. And we added 1.5%, again, so that's why the pricing between Q3 and Q4 has remained consistent. We're at 4.7%.

Nicole Miller

Okay. And looking into next year: what are your pricing projections?

Sue Collyns

We said it's 4%.

Nicole Miller

For the year or just it will be higher in the front half than lower in the back half?

Sue Collyns

Yeah. The average for the year is 4%.

Nicole Miller

Average. Okay. And could you give us an update on October, November or quarter-to-date fourth quarter same-store sales?

Sue Collyns

I need to say, that they are tracking within that 2% to 3% range on any given day.

Nicole Miller

Is it fair to, I mean, we had a big retail comp day and I think, what we can, what we walked away with was October was not good, November is much better, is it fair to say, your business is, did you see anything that correlates to that?

Sue Collyns

No. October for us only finished on Sunday, this is our first, what, three days now that we've had visibility into November. So for us, it's actually a little bit tough to answer that, three days is not really a trend. I think for us the biggest thing in the sense is California held up, as Rick said at about 1.9% in Q3. So we've got, you know, then California is 20 -- 42% of our base.

But we've got five other states, that represents the next 25% of our sales being Illinois, Florida, Texas, Virginia and Arizona and they all did very well in Q3. They were 5.5% at Illinois, Florida did 4.3, Texas did 8.3, Virginia was 3.9% and Arizona was 5.2%. So we've still got a lot of strength in other parts of the country. In addition to, as Rick mentioned, which you may not have heard but California WSA reaching the highest levels that it ever did in Q3.

Nicole Miller

Okay. And then, just to look at, I guess, what could benefit mix shift where new products, I think you had been proactive in rolling out of couple of things that headed in November, when you changed what was added?

Rick Rosenfield

Yeah. We rolled out ahead. You know the Miso Crab Salad, which is really doing great and then the Crab Cakes on appetizer. And now, we've added November Crab Cake on tray and the new Tomato/Basil Pizza and made the others permanent as well.

Nicole Miller

What is the biggest driver right now by category, in terms of, mix shift? I mean are salads still popular or on tray is really driving it?

Rick Rosenfield

Well, I would really say Pizza is our middle name, but pizzas are third of our sales, but salads have grown to 23% of our sales. So introducing new salads, as always, is the great things for us. It's a big deal as you know.

Sue Collyns

And guests do love the appetizers. You know the last week appetizer pop was really the lettuce wraps as well as the avocado club rolls and the now the Crab Cakes are also gaining great traction. People love them. So that's worked out well for us.

Rick Rosenfield

Again, and then, we have had them in the appetizer and now we are putting them in the on tray the Crab Cake. So we're pretty enthusiastic about what we think that will drive.

Nicole Miller

Great. And one last question, I was just looking through here through my notes. If I understand a craft relationship correctly, they have to spend a certain percentage of growth sales on advertising and as, you know, you suggested, if that business even continues to grow only at 20%, it's going to start to be a very meaningful number that doesn’t need to allocate to marketing.

So what kind of insight can you give us into their thought process? And I guess, the real question here is what is the potential to see traditional mass marketing come out of that craft relationship and benefit with CPK brand?

Rick Rosenfield

I think as I mentioned a little earlier in the call, their spend this year will be $7 million on advertising, which is more than twice what we spend and, obviously, as that business ramps up, they are going to be creative in this spend. We expect national print next year. I would expect it to revolve into the national TV and particularly in conjunction with us as we grow. And so those are things we are evaluating and I think we can anticipate. And of course, we co-brand with them in the advertising at the Dodger stadium and Angels in Anaheim. And it's great to have them as a partner, and with the required spend though less.

Nicole Miller

That's all I had. Thanks so much.

Sue Collyns

Just to clarify that in the call, it will be national print for the first time in 2008 compared to any regional print historically.

Operator

(Operator Instructions).

Our next question comes from the line of Steve Anderson.

Steve Anderson

Good evening. Just want to go through with you on the guidance for the food commodities. Is the $3 million number based on the commodities that you've already contracted for in '08 or is it just your projection?

Sue Collyns

Some of them are contracted, but not all of them. For example, the $1 million increase in diary, a large part of that is obviously not contracted yet. And we're basically locking up most of those 2008 items right now. So if they're not in progress, we hope to have them concluded in the next six weeks.

Steve Anderson

As for example, for the chicken or some of the other contracts, so what's the percentage price increase you're taking?

Sue Collyns

I don't have it here by percent really, but meat as a category represents around 15% of total cost of goods.

Steve Anderson

Okay.

Operator

Our next question comes from the line of Larry Miller.

Larry Miller

Hey, guys. Maybe I could just finish that out. Did you lock on dairy yet, Sue? What are you assuming in terms of dairy cost for next year on cheese?

Sue Collyns

Right now, I mean I might stop that by sort of referencing Q3 and Q4. We had hoped that Q3 -- we had budgeted Q3 at around $2, and we ended up coming in $1.95. And next year, we do have some future contracts out there that we are trying to chase right now. I not sure we are going to get the price we want though. So nothing is actually locked in -- that's 100% quite yet

Larry Miller

So I guess --

Sue Collyns

So right now, it is all floating.

Larry Miller

Well, I guess if you had a lot today, what would it be and what is it that you are chasing?

Sue Collyns

Well, we're trying to chase close to $1.70 number right now I think we would be pretty happy with.

Larry Miller

Okay, very good. And then, Rick, you mentioned; cannibalization, particularly in Southern California and the cannibalization. Can you give an estimate there for what that might have cost you on comp line or generally for comps?

Sue Collyns

Yeah, I think cannibalization, in general, is approximately 20 basis points

Rick Rosenfield

Right, but that's using current, what I would call, current cannibalization, right? We can't really measure what's been our strategic plan of 20 years as we opened stores in proximate neighborhoods, and that's not in that number. So overall, it puts pressure on comps while we open great stores.

Larry Miller

Okay. And is it fair to say that those 10 days that you lost on fires, about 10 days, is this point based on what the remodel was?

Sue Collyns

No. I think, to me, the California fires are two dimensional. One is the absolute store closure days, and we had 10 partial days of that. But then, you've also got the effect on consumer confident and traffic patterns in general. And that's too early to call what that will be for the quarter other than, as I said, right now, we are still seeing 2% to 3% comp for any given day. So we'll see how things go.

Larry Miller

Okay. Thanks, guys.

Rick Rosenfield

Sure.

Operator

Our next question comes for line of David Tarantino.

David Tarantino

Hi. Just a follow-up question on the buyback. Is there any reason why you wouldn't be more aggressive in the short term, especially given where the stock is today?

Rick Rosenfield

Well, I think what we have said and we continue to say is, we evaluate it constantly, and we don't flag to the market what we're going to do, and we go into the market from time to time.

David Tarantino

Okay. Thank you.

Operator

(Operator Instructions)

Rick Rosenfield

It sounds like -- let's take a moment if anybody does want to ask.

Operator

Our next question comes from the line of [Mark Lee].

Mark Lee

Good afternoon.

Rick Rosenfield

Hello, Mark.

Mark Lee

Yeah, I know you mentioned cost pressures from dairy and of chicken. Can you comment a little bit on wheat cost pressures?

Sue Collyns

Yeah, I mean in terms of our pizza dough, that contract for us actually is coming up in December, and we're in the middle of negotiating that as well. I think for us, the dough lines increased around 3.5% over the last three years. And our current vendor is looking to increase it in 2008 again. And we'll see where we settle. But I'm guessing it's probably somewhere between that 3.5% to 5% mark, and that's we built into our budget for next year.

Mark Lee

And can I also ask you on, maybe you can give me a ballpark number on how many pounds of dollar you guys use per year for store?

Sue Collyns

You know, I wouldn't know that number off the top of my head. I think if I did, I'd be called head of procurement. So I'll have to get back to you.

Mark Lee

Okay, well, great. I appreciate your help. Thank you.

Rick Rosenfield

Thanks.

Operator

There are no further questions at this time. Do you have any closing remarks, Mr. Rosenfield?

Rick Rosenfield

Thank all of you for your attendance, and we look forward to talking to you on our next call.

Operator

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

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Source: California Pizza Kitchen Q3 2007 Earnings Call Transcript
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