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California Pizza Kitchen, Inc. (NASDAQ:CPKI)

Q4 2007 Earnings Call

February 14, 2008 4:30 pm ET

Executives

Richard L. Rosenfield – Co-Chairman, Co-President &Co-Chief Executive Officer

Larry S. Flax – Co-Chairman, Co-President & Co-Chief Executive Officer

Susan M. Collyns – Chief Financial Officer & Senior Vice President, Finance

Analysts

Destin M. Tompkins – Morgan Keegan & Co.

Barry Stouffer with BB&T Capital Markets

David E. Tarantino with Robert W. Baird & Co

Howard Penney – Friedman Billings Ramsey Capital Markets

Larry Miller – RBC Capital Markets

Steve Rees – JP Morgan

Bill Kitchel – Millrace Asset Group

Steven Anderson – MKM Partners

Operator

Good afternoon. My name is Tamika and I will be your conference operator today. At this time, I’d like to welcome everyone to the California Pizza Kitchen fourth 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.

Richard L. Rosenfield

Good afternoon everyone. Thanks for joining us on our fourth quarter and year-end 2007 conference call. My name is Rick Rosenfield, Co-CEO of California Pizza Kitchen. We me on the phone today is my Co-CEO, Larry Flax; as well as 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 on them. We refer all of you to our filings with the Securities & Exchange Commission for a more detailed discussion of the risks that may have a direct bearing on our operating results, performance and financial condition.

A number of you advised us that several of our industry peers have earnings calls scheduled for today, so to accommodate you we moved our traditional timing up by a half an hour. We’ve also shortened our scripted remarks to try to allow some flexibility and adequate time for questions.

Now let’s talk about the fourth quarter and more specifically how we view our positioning in the current environment. Needless to say it was a challenging three months for CPK and for the industry as a whole and our 2008 guidance assumes a continuation of current circumstances. To that point, given that we can’t predict the future we’ll remain as always conservative in our outlook.

For the quarter ended December 30th we grew total revenue 11.6% to $162.9 million which included strong performances from our ancillary revenue streams. While our fourth quarter comp results of 1.8% were below our earlier expectations of 2 to 3% I’d like to remind you that these results came on top of a 6.9% increase in the fourth quarter of 2006. Similar to the third quarter we once again experienced negative guest counts but did maintain positive mix in the fourth quarter with the help of some new menu items which I will discuss momentarily. For our November menu in addition to the formal roll-out of the Miso Salad and Crab Cake Appetizer we also introduced an Italian Basil and Tomato Pizza, Blue Crab Cakes as an entrée and a Red Velvet Cake dessert item. All of these additions can be seen on the home page of our website. As we’ve said before menu development is in our DNA and we’re always evaluating our mix taking low-selling items off the menu while adding new ones that we hope will keep us fresh and relevant.

But we know the hot topic on everyone’s mind is really economic conditions in California and given our significant penetration in the state with more than 40% of our comp base here how are dealing with these pressures? Please bear in mind that our results in California and elsewhere for that matter are coming off of very strong sales. In Q4 despite the fact that we came in below our expected comp California restaurants averaged approximately $71,000 in weekly sales 6% above our national average and the EBITDA for California stores was over 300 basis points higher than the non-California stores. In addition, we have several California restaurants that are averaging near or exceeding $1,000 per square foot in sales and our price point of $13.37 which is $2.00 to $4.00 lower than others in casual dining this constrained capacity making it more difficult to drive comps or at the very least incremental traffic.

Still we will be refreshing about six mature restaurants this year to our upgraded warmer ambience format and upgrading another 20 stores with what we refer to as mini freshenings. Our experience so far tells us that if we enhance the ambience we’ll enhance the volume and guest value scores which will protect and drive market share particularly in light of these challenging times. In the fourth quarter we added seven full-service restaurants. They’re in San Bernardino, California; Detroit, Michigan; Stamford, Connecticut; Mesa, Arizona; Leawood, Kansas; Brandon, Florida; and Las Vegas, Nevada. In addition, our international franchise partners each added one full-service restaurant in Makati City in the Philippines and Seoul, South Korea, respectively. The Seoul restaurant is our first in that country. For the full year we opened 17 full-service restaurants, one net ASAP unit while our franchise partners opened five international CPK locations and two ASAP airport locations. This is a total of 25 new CPK restaurants. That’s a company record.

In 2008 we’re going to build 12 to 13 full service CPK restaurants which while down from our original expectation is the result of our prudence in the current environment. Incidentally this past Monday we opened three new full-service restaurants in what we refer to as Super Monday. These restaurants are located in Boca Raton, Florida; Philadelphia, Pennsylvania; and Seattle, Washington. With regard to our ancillary revenues our royalty stream via domestic and international franchising has also shifted into high gear and we view our ability to pull these levers as an important component of our business model going forward as it provides a unique stream of pre-tax income which is certainly helpful in the current environment.

HMS Host plans to build four new airport locations in 2008 as they ramp up their development. On the international front I’m pleased that it also been area where we have experienced significant growth recently which should continue in 2008 and beyond. Specifically, our Mexico franchisee which opened their first location last August and a second already this year will add one additional location this year while our South Korean franchisee will be opening their second and third locations coming off their first restaurant which opened in November. Our Japanese franchisee will also be adding to their CPK presence with a third location.

Finally we have also signed a letter of intent for our first restaurant in Dubai, United Arab Emirates for a total of six international franchise restaurants this year. We’re also continuing to leverage our brand through Kraft which is currently in frozen pizzas. The Kraft business has increased at a compound annual growth rate of around 58% over the last three years more than doubling from the 1.42 million in 04 to 4.7 million in 27 as a royalty. In 2008 we are also anticipating growth in excess of 20%. Our CPK brand in Kraft line has about a 4.5% national market share and generated $145 million in retail sales last year. In addition, Kraft’s required to spend 5% of net revenues advertising our brand. In 2007 that amounted to approximately $6.5 million in marketing for CPK more than twice what we spend on ourselves. In addition, distribution through 17,000 locations at all 50 states and the District of Columbia is also a major plus for brand equity and that’s only going to get better in our view.

As we told you recently Kraft in collaboration with us is about to launch a new pizza product and I’m happy to be able to first discuss it with you now. It’s a microwaveable pizza in a single-serve format called California Pizza Kitchen for One. It will allow consumers to enjoy the flavor combinations and quality of California Pizza Kitchen at their home or office in less than four minutes. We’re really proud of this product and quite excited to be entering into the single-serve segment which is a $1 billion market. Anecdotally one of the fun ads that Kraft has created and is soon to launch for us with this product is that “the single scene has dramatically improved”. In addition to introducing this single-serve product in April we are also continuing to explore opportunities to work with Kraft on other aspects of our product for portfolio. These opportunities are not built into our forecast at this stage. Additionally, we anticipate that Kraft advertising for CPK brand and products will start utilizing national print and we expect over time move-in to national TV, a big plus for us. Between our franchising and Kraft relationships you can see that the 2007 royalty stream totaled $8.6 million and that represented approximately 25% of our pro forma income in 2007.

Moving back to the present I’d like to make some comments that I’m sure you’re all interested in on what we’re seeing the first quarter so far. I have to tell you it’s been a bit frustrating that I don’t think we have a clear picture of where we are on a steady-state basis. It started with the non-lapping New Year’s, then we had non-lapping Martin Luther King weekend and the whole picture has been clouded by some extraordinarily bad weather not only in the Eastern half of the country but throughout the West. Moreover much of this bad weather has occurred on the weekends when it matters most to us in the restaurant business. That said, we are currently still slightly positive, however five of the last 10 weeks had negative comps. While we cannot control the macro environment one of the benefits of scaling back development is our ability to focus on all facets of execution including personnel development and margin improvements. As part of that we’re making sure that we continue to provide all our guests with an amazing CPK experience every time they dine with us.

Before I turn the call over to Sue I do want to make a comment on our recent accelerated stock repurchase announcement. This is an important step for our company returning capital to shareholders and immediately we expect our actions to be accretive by $0.02. As stewards of our capital structure we felt it was important to be active in our own stock particularly at such attractive levels and to do what we can to enhance value for our investors in that regard.

With that I’ll pass it over to Sue.

Susan M. Collyns

Good afternoon everyone. Total revenue for the fourth quarter increased 11.6% to $162.9 million. This consisted of restaurant sales growing at 11.3% to $160.2 million, royalties from Kraft increasing approximately 32.3% to $1.7 million and franchise revenue from both domestic and international growing approximately 41% to $1 million. Our fourth quarter comp sales increased 1.8% which included 5.2% of price, 3.6% of negative guest count and 0.2% of positive mix. As we stated in our January 15th sales release the monthly comps broke down as follows. October was 2.8% which was on top of 6.7% the previous year, November comps at 1.7% which compared to 6.6% last year and December comps rose by 0.7% compared to 7.4% last year. Company-wide full-service CPK restaurants delivered a weekly sales average of $56,438 which was just under 1% higher than a year ago. Food, beverage and paper supplies for the quarter were 25% which was 20 basis points worse than last year. Darien Seafood really drove this increase which we did anticipate and we discussed in the last call as cheese costs started to rise and I think they ended out the quarter at $1.99 per pound.

Labor expense was up 10 basis points which we were very happy with considering the sales we leveraged while direct operating and occupancy costs were up 60 basis points to 21% of sales compared to the prior year largely due to higher repairs and maintenance, credit card charges and increasing rent, expansion rent charges, taken together this resulted in restaurant operating margins of 17.7%. G&A expense improved 20 basis points to 7.1% of total revenue and this includes 6.5% of what we call core G&A and 60 basis of stock option expense. Depreciation costs were 6.2% of sales and they were 70 basis points higher than last year’s fourth quarter and that was in line with new stores being depreciated. Our pre-opening costs totaled $2.6 million compared to $4.4 million last year which includes seven full-service restaurants that we opened in the fourth quarter as well as approximately $506,000 in expansion rent charges.

Our net interest expense was $209,000 and that compared to interest income of $52,000 last year and we carried a $21 million debt balance. Our income tax expense totaled $1.6 million in the quarter and it represented an effective tax rate of around 25% compared to 24.1% last year due to continuing benefits from tax credits. All of this resulted in fourth quarter EPS of $0.17 which was right in between $0.16 and $0.18 we guided to on January 15th. This compares to $0.13 in the same period of 2006. Diluted share count ended up being 28.6 million and that was down from 29.5 million shares on a year ago basis. We didn’t repurchase any of our own shares during the fourth quarter under our $50 million buyback authorization but as you probably remember we did announce an accelerated share repurchase totaling $43.6 million with Bank of America on February the 1st.

Moving onto our balance sheet we ended the fourth quarter with $10.8 million of cash and $21 million of debt and as our recent press release indicated we do have a new $100 million line of credit that’s reduced only by this debt as well as letters of credit and the recently announced $43.6 million accelerated share repurchase. Capital expenditure in the fourth quarter totaled $27.2 million and that included about $20 million for new restaurants with the remainder related to maintenance in our existing locations. For the full year we ended up spending $84.3 million which was in line with our previous guidance of around $85 million.

Moving onto guidance for 2008 we now estimate $0.56 to $0.62 EPS which hasn’t changed from our January 15 estimate except that we did increase the range by $0.02 for the anticipated accretion that relates to the accelerated share repurchase as well as our calc, our share calcs that is, reducing to approximately 26 million shares on an annual basis. Interest expense in line with this ASR has also changed and that has increased to $3 million for the full year.

To touch on the full year highlights we do expect comps between -1 to 0% for the full year of 2008, 12 to 13 new California Pizza Kitchen full-service stores, one LA Food Show restaurant, six international restaurants, four airport openings with HMS Host. Of course as previously mentioned 2008 will be the fourth straight of rising commodity cost as well as the second year of significant minimum wage increases and we’ve baked that into margins. Finally we estimated that our tax rate will be approximately 32%. In terms of capital expenditure, as Rick mentioned, we plan on completing six remodels in 2008 and approximately 20 freshenings or mini remodels that were budgeted at around $10 to $12 million so total cap ex for 2008 including these remodels, capitalized maintenance as well as new stores is estimated around $62 million before tenant improvement allowance which we estimate at approximately $4 million.

Finally before turning the call over to Rick, I’d like to comment on the first quarter of 2008. Based on the comp twisting right now we are estimating relatively flat comps which would result in $0.04 to $0.06 EPS. This range includes five new full-service stores openings, two international openings, interest expense of roughly $500,000 as well as a diluted share cap that will reduce from the fourth quarter of last year to the first quarter of this year of 27 million shares outstanding and that of course is related to the accelerated share repurchase and the buyback.

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

Richard L. Rosenfield

These are certainly difficult times but we feel that CPK is a great and emerging global brand capable of growth in the US as well as extensions domestically and internationally. We’re quite satisfied with our overall real estate strategy and market position targeting higher income demographics and providing a quality experience at a relatively low price point. But in the current environment we’re not in reactive mode, rather we’re working hard to improve performance throughout the P&L with a strong focus on capital allocation. Historically that had been through new store openings. However in the current environment we feel very good about our decision to return capital to shareholders via the accelerated stock repurchase program. Additionally in terms of maximizing EPS we have formed an energy task force to look for ways to better manage usage and cut costs operationally.

Larry and our Ops team are very serious about managing our costs of goods sold and labor as we did in Q4. In addition to other initiatives we started in 2007 we have reshaped our management bonus plan to drive results around increased sales and profitability or flow through as we call it internally. Finally by Q2 we will be rolling out wireless curbside, online ordering and we have a series of additional technology related initiatives that should reduce the administrative burden on our managers. Although shorter term in nature these are initiatives that will affect the longer term which as always is our main concern.

I think that you can see that our focus is on continual improvement, prudent allocation of capital and enhancing EPS growth despite macro factors. And with that I’d like to open the line for questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first call comes from the line of Destin Tompkins of Morgan Keegan.

Destin M. Tompkins – Morgan Keegan & Co.

I wanted to ask on commodities question there. Can you kind of just give us what your expectations are for cheese and wheat? Those are clearly the hot topics right now. What your assumptions are for cheese prices through the year and Q1 specifically and then I think you’ve maybe locked in your dough needs and how wheat affects you guys.

Susan M. Collyns

In terms of dairy we’ve locked in around a quarter of the year right now and the full year estimates that we’re kind of blending it out at around $1.80 a pound. That’s what’s built into our budget and I think the full year cost of goods number that we’re estimating is around 25%. So that’s obviously up from this year’s 24.7% by around 30 basis points. In terms of wheat that’s obviously an area of significant concern for us. The drought, the reduced acreage, the increase in demand from Europe are obviously pushing prices higher together with farmers moving their crops from wheat to ethanol. So our wheat prices have gone up for dough, so has pasta and we’ve only locked in our pizza dough for six months and I think we’ve seen around a 12% increase there. So that’s obviously a challenging area but pasta has been locked in for the full year.

Destin M. Tompkins – Morgan Keegan & Co.

But when you blend all that in you feel like cost of sales will be in that 25% range?

Susan M. Collyns

That’s right.

Destin M. Tompkins – Morgan Keegan & Co.

And then on the share repurchases, I’m not sure if I caught all of it. Did you say you expect the share count to be around 27 million by the end of Q1?

Susan M. Collyns

That’s right. At an average of 26 million shares for the full year and that’s just assuming and taking into account the reduced share count from this first $43.6 million share repurchase. It does not assume any other repurchases occur throughout the year at this point.

Destin M. Tompkins – Morgan Keegan & Co.

And have you completed that share repurchase?

Susan M. Collyns

No. The ASR straddles around a two and a half to five month period and part of it is factored into the Q1 number. We obviously don’t get all the benefit from whatever shares get retired because as you probably know it gets prorated in depending upon when it’s purchased.

Destin M. Tompkins – Morgan Keegan & Co.

And then one more quickly, to get to your earnings guidance, there’s obviously significant margin degradation on the operating margin line and if you’re talking about 25% cost of sales, where is that you’re seeing the most pressure that’s driving those operating margins down?

Susan M. Collyns

It’s largely on the labor line, driven by some minimum wage increases but also, Destin, the seven new stores that we had opened in the fourth quarter of 2007 together with the five new stores that will open in this quarter.

Operator

Your next question comes from the line of Barry Stouffer with BB&T Capital Markets.

Barry Stouffer with BB&T Capital Markets

What’s the average check increase or price increase factored into your full year comp guidance?

Susan M. Collyns

Right now we have a 4% pricing assumption in our comp guidance.

Barry Stouffer with BB&T Capital Markets

And could you review the first quarter openings? That went by a little fast for me to get.

Richard L. Rosenfield

Well we’ve already opened one in California, one in Boca Raton, one in Philadelphia and one in Seattle. And we have one more opening on Monday in Atlanta in this quarter.

Barry Stouffer with BB&T Capital Markets

And would you care to share a pre-opening expense estimate for the first quarter?

Susan M. Collyns

Sure, it’ll be around $1.8 to $2 million.

Operator

Your next question comes from the line of David E. Tarantino with Robert W. Baird & Co.

David E. Tarantino with Robert W. Baird & Co

Could you talk a little bit more about some of the opportunity for cost savings on the labor line? I think you mentioned that as a positive in Q4. What kind of upside is there this year and how much of that have you assumed in guidance?

Susan M. Collyns

Well, I think it just gets to the ongoing operational improvements that Larry works with the regional vice presidents and the RDs. We talk about labor on a weekly basis. We’ve actually just rolled out some new technology to all the stores in terms of helping them forecast labor a bit better. So that is an important sensitivity. The other driver that’ll help us this year on an annual basis as opposed to Q1 and Q2 where we have most of our new store openings as well as the 2007 stores becoming more efficient and being a drag on the first half of the year results but obviously less of a drag in the back half of the year results as WSA increases and those new stores become efficient is the manager population. You know we’ve had a lot of growth in terms of new managers joining the company and being promoted and as those managers become more experienced and hone their skills together with some of these technology improvements that Rick mentioned and taking them out of the administrative side of the business into the floor working with guests and trying to amaze them every time –

Richard L. Rosenfield

As we cut back a little in development we do gap efficiencies because we have less managers in training and then less training management.

Susan M. Collyns

Right. One of the other big initiatives is to the extent that we believe very seriously that bonuses motivate behavior. We have restructured the bonus program and now there are two key drivers, its sales and its profits. We’ve been very clear about that directive and creating an incentive structure to really reward the superstars and reward far less people who don’t contribute in the way that we’re looking for them to.

Richard L. Rosenfield

I’ll also add though while we’re focused on sales etcetera and profit, this assumes that they have to hit their quality assurance and customer satisfaction scores.

Susan M. Collyns

The other two drivers for us have been our medical insurance and our workers’ compensation rates. California Pizza Kitchen has one of the best safety and workers’ compensation set of practices in the industry and our rates have really improved in recent years together with our medical costs so where that may have been a pressure point in previous years we’re not expecting I to be that much of a pressure point so we’re getting helped out there a bit.

David E. Tarantino with Robert W. Baird & Co

Can you talk some about what kind of sales driving initiatives you might have for the balance of the year?

Susan M. Collyns

We do have an incentive program, a marketing consumer driven incentive program in the second quarter that we’re reluctant to announce exactly what that is at this point for competitive reasons. It’s a program we did do back in the late 90s, it was very successful and we will certainly be able to talk about it in the next earnings call because it will roll out towards the back end of April and the month of May.

David E. Tarantino with Robert W. Baird & Co

Just a follow up for that, is that something you’re planning only for Q2 or would that be something you would consider doing in the second half also?

Susan M. Collyns

No. It really is an initiative that is centered on the second quarter of the year.

David E. Tarantino with Robert W. Baird & Co

Have you assumed benefits from that initiative in your guidance?

Susan M. Collyns

Yes, we have.

Operator

Your next question comes from the line of Howard Penney with FBR Capital Markets.

Howard Penney – Friedman Billings Ramsey Capital Markets

It looks like from the numbers you gave you have $46 million in new store cap ex for next year and 12 stores, it looks like it’s about $3.8 million per store. Is that right?

Susan M. Collyns

No, that’s a bit on the heavy side. I think new stores will close at just sort of $35 million.

Howard Penney – Friedman Billings Ramsey Capital Markets

Would you expect a better than 66.5 in average weekly sales for those new stores given the new concentration of the site selection strategy?

Susan M. Collyns

Well, it’s not really a new concentration it’s about the additional filter that was put on this year’s store openings. We do have around 25% of our stores this year that are still going to be opened up in California which is obviously a challenging market right now together with Florida and some other markets that are challenged.

Howard Penney – Friedman Billings Ramsey Capital Markets

So what would you look at for what you think the new stores can do in average weekly sales?

Susan M. Collyns

The blended average that we’re using internally is $65,000. We’ve comfortably met that for the last couple of years and feel that’s a good place to start.

Howard Penney – Friedman Billings Ramsey Capital Markets

And they would mature at something much higher than that?

Susan M. Collyns

Right.

Operator

Your next question is from Larry Miller with RBC Capital Markets.

Larry Miller – RBC Capital Markets

I did also have a question, maybe I’ll help Nicole out there on the single-serve pizza, what is the price point on that? And, can you kind of dimensionalize what the share of the frozen pizza case is in terms of single-serve and what’s the history between cannibalization between the larger pizzas and the single-serve pizzas? And I had a quick follow up question on something else.

Richard L. Rosenfield

We’re checking, Larry is here too and he and I both have the memory that this is just under $3.00.

Susan M. Collyns

It’s a $2.99 product.

Richard L. Rosenfield

Yeah, I think so. In the history of cannibalization has been pretty interesting meaning amazingly non-cannibalistic in our experience with Kraft so far. When we introduced the Thin N Crispy it grew without seriously cannibalizing the self rising crust which was quite pleasing. I’d say we’re hopeful in the same context – then we commented size of the single-serve market and that’s outside of pizza is a billion dollar market and Kraft looks at it as a rather different market.

Larry Miller – RBC Capital Markets

How long do you think you would keep the pipeline with no growth? I mean, are we looking into 09? What’s your thoughts on what you need to see to resume growth?

Richard L. Rosenfield

I’m not sure if I know what you mean by no growth? On the pipeline, I think our view is we’re playing it as we see conditions on rise. We’re allocating capital in the way that we think is best. In the meantime, our development team understands full well and the message to our developers is, we will do every A location that we’re offered.

Larry Miller – RBC Capital Markets

Okay. That’s helpful. So, we’re not talking zero growth going forward, we’re just being very selective.

Richard L. Rosenfield

Right. Exactly. We’re putting an additional filter on it, we’re eager as I say to sign every A location and we’ll play it by ear with capital allocation as we go forward. Right now we like as well, remember just by scaling back on our company-owned stores we’re ramping up international and HMS house but particularly international and looking at these other alternatives in the supermarket as a way of really providing us great leverage without the bricks and mortars capitals.

Operator

(Operator Instructions) Your next comes from Steve Rees with JP Morgan.

Analyst for Steve Rees – JP Morgan

I just had a quick question on the remodels. Can you just kind of go through the capital cost on each one. I heard there’s a refresher and there’s more of a substantive one for the six of them I believe, can you just go through that?

Susan M. Collyns

Right. We had six fairly substantial remodels, two of those in particular fully blown remodels and the remainder are less substantial. Then, we have a group of mini freshenings and that can be something from as small as painting the store and giving all the table tops new table tops as well as putting new chairs in, to carpet, to pizza tile, so it kind of depends but the blended average throughout the total if you divide the total number of $10 to $12 million by around 26 is around $450,000 a piece. That is kind of a good place to start. The goal here is to protect and defend the market share where we do have strength and to give some extra value to consumers because we know ultimately that will drive the check average up because it has in every other single remodel that we’ve done across the country.

Analyst for Steve Rees – JP Morgan

And the fully blown ones, is there store closure time on those?

Susan M. Collyns

Yeah there is. We have around 23 weeks of store closures baked into those numbers right now as well as an impact on EBITDA that’s already baked in. I think the EBITDA impact is almost $1 million and we’ve baked in some accelerated depreciation, the totals around $300,000 to $400,000.

Operator

Your next question is from Bill Kitchel with Millrace Asset Group.

Bill Kitchel – Millrace Asset Group

A quick question Rich, you were talking about Kraft and in your comments you talked about, I think, 20% sort of growth over 2007 is what you’re looking towards. And yet, you’ve got more SKUs and more distribution spots and you’re also holding at the highest royalty rate, I believe. Or, does that change in 2008 and are you just being conservative on that growth going forward?

Richard L. Rosenfield

I think we’re being conservative on the growth going forward and the royalty rate does not change.

Bill Kitchel – Millrace Asset Group

Could you just kind of walk through the mechanics on the buyback on the balance sheet for Q1 and sort of then go into sort of your philosophy on using capital in that regard because I think it’s great. Sue, I think you alluded to this being the first $50 million or there about tranche and that does not include more repurchases. You ended the year with $10 million in cash, you do generate a lot of cash but, what is your philosophy for the balance sheet as you go through this tough environment? And, how levered will you go during sort of a slower growth period? Just give us some color on that.

Richard L. Rosenfield

I’ll start with the first and then we’ll let Sue address the balance sheet but I’ll try to put some color on the philosophy. Before we start though Bill, we just found out that the price for the single-serve for those that are on, is the recommended price is $3.29 for the single-serve. Going back philosophically, I think our board continuously goes over and engages in these strategies so this $50 million is on top of $50 million in buyback that we had accomplished I think within the last year or so, I think Sue. 2007.

Susan M. Collyns

Right. Since the end of 2005 we actually purchased based 2.6 million shares at an average price of $18.61 so that totaled $48,464,000 and that was concluded in Q3 of 2007. Over and above that we had another $50 million authorization from August of last year and after the sales pre-announcement and we came out of blackout we were in the open market for about a week and we did purchase shares that was basically the difference between the $50 million that we had authorized and the $46.3 and we elected after much discussion to do the ASR.

Richard L. Rosenfield

I’d add philosophically, I’m not sure it will be that helpful but, as I’ve always said, we are not buying back stock to support the stock price. We go into the market to buy back stock because we think it’s a good value for our shareholders and a way of returning capital. I would say is in general we tend to be relatively risk adverse. So, this is obviously the most debt we’ve taken and we’re quite comfortable with it at this level. Whether we would take on more debt might be a reflection on what the stock price and what our feeling is for alternative uses of capital at any given time. But, we feel very good about the strategy and again, we sort of take it up quarter-by-quarter or minute-by-minute with the board as needed and are pretty much ready to respond to circumstances.

Bill Kitchel – Millrace Asset Group

Is there a debt to cap, sort of max range that we might see you graze up against at some point if you felt it was compelling?

Richard L. Rosenfield

I don’t think we’re ready to go there yet, to comment on that.

Susan M. Collyns

I think we can say though that by the end of this year, 2008, we’ll still have roughly $45 million worth of debt that we anticipate on the balance sheet. But, by the end of 2009, assuming moderate comp sales growth together with some new store openings probably at around the same level we had this year, we should turn into a net free cash flow balance that is about breakeven or slightly positive.

Richard L. Rosenfield

Without any additional buybacks.

Susan M. Collyns

Correct. So, that’s assuming no additional buyback and just doing that mathematical calculation by the end of 2009 we won’t have any debt. So, we’ll pay it off pretty quickly.

Bill Kitchel – Millrace Asset Group

Okay. Thank you. Then, just the mechanics, the ASR, did you say that was two and a half to five month process but you are able to recognize the full benefit of it for Q1 so the share count goes down for Q1 even though the process may still be going on?

Susan M. Collyns

Well, we would be able to retire the shares that we have actually bought back as of the end of Q1 on a pro rata basis. But, because this could stretch out from two and a half months to five months at the end point, and as you know we announced this on February the 1st, it could extend well into the back end of Q2 so you’re not going to get the benefit of those shares retiring until that point and even then, you only do it on a pro rata basis. So, if we were running at 27 million share count in Q1, let’s say Q2 might be 26.5 million and then by the end of the year it will straggle down to 26 million. Now, the biggest drive though, as you probably know, with diluted share count is the stock price. So, if macroeconomic conditions change and if the whole industry and our stock price with the rest of the industry increased precipitously to perhaps October, 2007 numbers again, then that’s going to change your diluted share count outstanding and that’s going to move that back up to maybe 26.5 to 27 million. So, it does kind of depend on what happens with the stock price but I have assumed kind of a steady state for this math and really just layering in the buyback at $46.3 million.

Bill Kitchel – Millrace Asset Group

So the accounting treatment is not sort of a $46.5 million entry and a share count based on that volume. It is actually as you would expect based on an amount that’s brought in during the period.

Susan M. Collyns

That’s right, on a pro rata basis. So, you’re talking around 2.8 to maybe 3.2 million shares depending on the prices that is averaged over that period and we just have to wait and see what the prices are over that time frame.

Operator

Your next question comes from Steven Anderson with MKM Partners

Steven Anderson – MKM Partners

[inaudible] the debt question, can you comment at all to the actual structure of the debt you have taken on in terms of how it is indexed against LIBOR or if there’s any fixed rate debt in there? Thanks.

Susan M. Collyns

Sure, you’re talking about the new line of credit with BOA Steven, of $100 million?

Steven Anderson – MKM Partners

Yeah.

Susan M. Collyns

It’s on exactly the same rates as our previous agreement. It’s L+80 and so there are no real changes other than paying the extra rate I think 15 basis points for the unused amount between $75 and $100 million, that’s really the only changes.

Operator

At this time there are no further questions. Mr. Rosenfield please proceed with any closing remarks.

Richard L. Rosenfield

Thank you all. Thank you for joining us. Happy Valentine’s Day and we’ll hear from you on the Q1 call. Thanks.

Operator

This concludes today’s presentation. You may now disconnect.

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