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Texas Roadhouse, Inc. (NASDAQ:TXRH)

F2Q08 Earnings Call

July 28, 2008 5:00 pm ET

Executives

Scott M. Colosi - Chief Financial Officer

G. J. Hart - President, Chief Executive Officer, Director

Analysts

Larry Miller - RBC Capital Markets

Greg Ruedy - Stephens Inc.

David E. Tarantino - Robert W. Baird & Co.

Destin Tompkins - Morgan Keegan

Jeff Omohundro - Wachovia Securities

John Glass - Morgan Stanley

Steven B. Rees - JPMorgan

Paul Westra - Cowen & Co.

Keith Siegner - Credit Suisse

Barry Stouffer - BB&T Capital Markets

Jason West - Deutsche Bank

Bryan Elliott - Raymond James & Associates

Conrad Lyon - Global Hunter Securities

Matt DiFrisco - Oppenheimer

Operator

Welcome to the Texas Roadhouse Incorporated second quarter 2008 earnings conference call. (Operator Instructions) Now at this time it’s my pleasure to turn the conference over to Scott Colosi, Chief Financial Officer of Texas Roadhouse. Please go ahead, sir.

Scott M. Colosi

Thanks, Dwayne and good evening, everybody and thanks for being on the call with subscriber this evening. By now, everyone should have access to our earnings announcement released this afternoon for the second quarter ended June 24, 2008. It may also be found on our website at texasroadhouse.com under the investor section.

Before we begin our formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed upon them.

We refer all of you to our recent filings with the SEC for a more detailed discussion of the risks that could impact the future operating results and financial condition of Texas Roadhouse.

On the call with me today is G.J. Hart, our CEO. G.J. is going to provide some general comments on the business and then I’ll walk you through the financials, and then we’ll open it up for questions. G.J.

G. J. Hart

Thank you, Scott and good evening, everyone. In Q2, we had what I would call another respectable quarter as we were still able to generate positive earnings per share growth versus the second quarter of 2007. In general, it’s a challenging environment and we suspect it will continue to be that way for at least the next few quarters. As such, we are focused on doing what we believe are the right things for the long-term success of the business and for the long-term benefit of our shareholders. But before I get into the discussion of strategy, I want to touch on a couple of the results from the quarter.

For the quarter, diluted earnings per share increased 14% from the prior year to $0.14 per share. The $0.14 was a little better than our original plan due to better-than-anticipated restaurant margins driven by the benefit we realized from floating a portion of our beef purchases. While this has been an advantage, we did elect to lock in the portion we had been floating for the remainder of the year because of the volatility in the beef markets, so we are now 100% locked in our proteins for the balance of 2008.

Partially offsetting the slightly better-than-anticipated margins is continued softer sales. In the second quarter, comparable restaurant sales decreased 0.3% -- a little better than our first quarter trend but still negative. For the quarter, our average check increased slightly be 0.4% while traffic was down 0.7%. On the check side of things, we did take some pricing with our menu in May of about 1.2%, and rather than taking it on a handful of items, it was much more across the board.

In addition to pricing, we added a couple of more value-oriented items to the menu. Our baby blossom, which is a smaller version of our popular cactus blossom appetizer, has been doing very well. It is much more conducive for sharing with two or three people and at $2.50 less is a great value. We also added a third slab of rib entrée that includes two sides for under $10. We now have 19 entrees excluding burgers and sandwiches priced under $10.

We also added a couple of combo items with our pulled pork -- a pulled pork and chicken combo and a pulled pork and rib combo. These give us a couple of combos on the lower end in the $11 to $13 range. While it is early, these new menu items have been well-received by our guests and we believe they really help us communicate our value position.

As far as pricing for the rest of the year is concerned, right now we have about 2.5% pricing on our menu. We do continue to see negative mix shift of 1% to 1.5%, mainly entrée driven at this point, as we can see guests trading down to lower priced items. On top of this, the success of our value-oriented entrée items is having about 0.7% negative impact on check, so overall we are getting about half-a-point in check right now.

On the margin side of things, I mentioned restaurant margins were better than we had anticipated. However, they were still down 70 basis points versus last year, primarily resulting from continued wage rate pressures and higher utility costs. For the remainder of the year, they remain somewhat of a wild card, especially utilities.

We are still encouraging our operators to invest in their business as opposed to cutting costs for the sake of better margins in the short-term. Given our partnership structure, our operators are in this for the long haul.

On the development side, we opened 10 new company restaurants during the quarter, which brings our year-to-date openings to 16. We remain on track to open approximately 30 for the year. In addition, we acquired three restaurants from franchisees at the beginning of the second quarter and we announced subsequent to the quarter end, we acquired eight restaurants from a franchise group in Tennessee for just over $9 million.

Now, let me touch briefly on our plans for the remainder of 2008. Given the continued uncertain consumer and inflationary environments, we are leaving our diluted earnings per share growth goal for the year unchanged at 5% to 15%. I can tell you as we sit here in late July, we think we will be more in the middle of that range but we will continue to see how the year plays out.

Before talking more about our future plans, let me turn the call over to Scott to review the financials and a discussion of some of the assumptions incorporated into our 2008 guidance. Scott.

Scott M. Colosi

Thanks, G.J. During my review of the second quarter, please note that many of the numbers I will mention are listed in a schedule of supplemental financial and operating data that was included in the press release. So starting at the top of our income statement for the second quarter of 2008, as compared to the same period in 2007, total revenue increased 20%, with company-owned restaurant sales increasing 21%. The growth in company-owned restaurant sales was driven by operating week growth as both comparable restaurant sales and average unit volumes were down from the prior year.

As G.J. mentioned earlier, comparable restaurant sales at company-owned restaurants decreased 0.3% versus an increase of 1.9% last year. For the quarter, our average check increased 0.4% while traffic was down 0.7%.

From a restaurant sales perspective, I’ll offer a little more color on average weekly sales. For the quarter, the 164 restaurants in our same-store sales base averaged about $77,600 a week in sales. These restaurant have been open 18 months as of the beginning of the quarter. There were 32 restaurants that are in our average unit volume base but are not in the same store sales base that have been opened six to 18 months as of the beginning of the quarter. These 32 restaurants averaged about $71,200 a week in sales.

Our newest 26 restaurants, which were opened sometime over the last nine months and thus are in neither our same-store nor our average unit volume calculations, averaged about $76,350 a week in sales during the quarter. And while our newer restaurants are averaging a little less than our older ones in terms of volumes, as a group we anticipate the returns will still be well in excess of our cost of capital.

Franchise royalties and fees were $2.5 million, which was $300,000 lower than last year, primarily due to the acquisition of nine franchise restaurants during the third quarter of 2007, and another three at the beginning of the second quarter this year.

In terms of margins, as a percentage of sales restaurant level margins were 79 basis points lower than last year for the second quarter. Thus, for the year as a whole we are down about 89 basis points. Let me touch briefly on the specific lines for the second quarter.

Cost of sales was down 13 basis points. The driver of this was the 25% of our beef volume that we were floating during the quarter. As G.J. mentioned, we did make the decision to go ahead and lock up this portion of our beef needs for the remainder of the year, so we are now locked in all of our proteins for the balance of 2008.

Partially offsetting the benefit from floating a portion of our beef was the fact that our bread mix, shortening, oil-based ingredients and dairy costs remained higher on a year-over-year basis as they were during the first quarter.

Labor costs were up 55 basis points and similar to the first quarter, labor costs were impacted by the deleveraging associated with negative same-store sales growth and pressure from increases in minimum and tipped wages. With another federal minimum wage increase effective last week, we expect to continue to experience wage rate inflationary pressures.

Rent expense was up slightly, about eight basis points from the prior year, due to us having a higher percentage of leased restaurants as approximately 90% of our deals in 2008 are leased.

After being basically flat year-over-year in the first quarter, other restaurant operating expenses were up 30 basis points versus last year. The real driver here was utilities, specifically electricity and natural gas. On top of this, there was some deleveraging associated with negative average unit volumes.

Pre-opening expenses were just over $100,000 more than the prior year, and while we did open four more restaurants during the quarter this year as compared to last year, the timing of pre-opening costs can vary a little depending upon the timing of the openings for the year.

Depreciation and amortization costs were 18 basis points higher than last year, driven primarily by the cost of new restaurants. G&A expenses as a percentage of revenue were quite a bit lower than last year, 69 basis points. The entire amount of the leverage here was due to the fact that our annual managing partner conference was about $1 million less this year than last year. If you’ll recall, we had a late change of venue last year that resulted in higher than normal costs. Excluding this benefit, G&A was basically flat as a percentage of sales with the second quarter last year as negative 1.7% average unit volume growth prevented any leveraging of the core business.

Our effective tax rate for the quarter was an even 35%, which was consistent with the first quarter but lower than last year due to higher tax credits, primarily the FICA tip credit. Part of the reason for this is increased minimum wage in numerous states. For 2008, we continue to estimate our income tax rate will be approximately 35%.

Our weighted average diluted share count was an even $76 million, which was just over 800,000 shares lower than where we were at the end of 2007, due to the repurchasing of 1.6 million shares of common stock through the end of the second quarter at an average price of $9.29.

On the subject of share repurchases, as of the end of our second quarter, we had repurchased about $15 million worth of our common stock, and subsequent to the end of the second quarter, our board of directors increased the authorization for share repurchases from $25 million to $75 million.

One thing I do want to make very clear as it relates to share repurchases and our resulting capital structure is that we have historically had a very conservative balance sheet with a conservative amount of leverage attached to it, and we absolutely plan to maintain this.

With that said, we will continue to be opportunistic as it relates to share repurchases and evaluate the anticipated returns of such, much like we would the development of new restaurants or the acquisition of restaurants from franchisees.

Now on to full year 2008 guidance -- as noted in our release, our 2008 guidance is unchanged at diluted EPS growth of 5% to 15%, which includes the positive impact from the extra week as we will have during the fourth quarter of 2008. And as G.J. mentioned, as we sit here in late July, we would think somewhere more in the middle of the range as more likely than being at the 5% or 15% side of things.

I do want to mention that our forecast includes the following three assumptions; first, we’ll open approximately 30 company restaurants; second, we’ll generate comparable restaurant sales growth of negative 1% to flat for the full year; and third, based on reducing our same-store sales expectations and higher utility costs, we’re now anticipating our restaurant margins will be down 80 to 120 basis points for the year.

Now I’d like to turn the call back over to G.J.

G. J. Hart

As I said last quarter, it continues to be a tough environment for restaurant operators, driven by both consumer and inflationary pressures. However, we remain committed to doing what’s right for the long-term success of our business and believe this has paid and will continue paying dividends.

So from an operational perspective, we are maintaining the course and looking at this difficult time as an absolute opportunity to further distance ourselves from our competition, as they may begin to cut food quality and service in the name of efficiencies.

We strongly believe that this will result in increased market share, as common sense tells us that when guests have a bad food or service experience in this environment, there’s very little chance that they will be making a return visit.

Operations aside, I can tell you that we continue to focus on our capital allocation strategy. While we definitely believe we have a lot of runway in front of us in terms of development, we are also cognizant in how challenging the sales and cost environment is, and the resulting impact on the returns, especially given the inflation and construction costs over the last several years. We strive to create shareholder value by generating returns on invested capital in excess of our cost of capital, not by growing for just growth’s sake.

As we look at our capital allocation, we see it as a balance of three things -- one, the development of new restaurants; two, the acquisition of franchise restaurants; and three, share repurchases.

Fortunately, being free cash flow positive affords us tremendous flexibility with regard to the timing of each, so as we look at things, we do plan to create value by adding new restaurants, given the fact that we have a store model that can create returns in excess of the cost of our capital. The real challenge is determining at what rate that will be, especially here in the near term.

In addition, we will continue to supplement company-owned restaurant growth by opportunistically evaluating franchise acquisitions, and as Scott mentioned, our board did recently increase our share repurchase authorization, so you can assume we will continue to opportunistically evaluate the repurchase of our stock.

While our capital allocation strategy will likely be a combination of new restaurant development, acquisition of franchise restaurants and share repurchases, we are proud of our historically conservative balance sheet and intend to maintain it as we definitely understand that leverage cuts both ways.

Switching gears a bit, let me remind you that our business continues to really be all about our team members and their commitment to executing our mission of legendary food and legendary service. We are not asking or encouraging our operators to cut back one bit, as we believe tough times represent an opportunity for us to out-execute much of the competition and take more than our share of the market.

Before opening the call up for questions, I want to once again take the time to thank all the Texas Roadhouse team members for their continuing support, effort, and commitment to offering legendary food and legendary service to each and every guest that walk through our doors, and I want to say a special word of welcome to the managers and team members of the restaurants in Tennessee we recently acquired. With this most recent acquisition, we are gaining much more than eight restaurants; we are also inheriting an experienced set of operators who are focused on executing our mission. We look forward to many great years ahead with you.

And with that, that covers our prepared remarks so Operator, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Larry Miller with RBC Capital Markets.

Larry Miller - RBC Capital Markets

Nice job in a really tough environment. I think you’ve got a lot to be proud of there. Can I ask a couple of questions and then I’ll hop off the line? On the beef contract, what was the rate that you guys ended up locking in on and what can we expect for 2008? And as you sit here today and you are thinking about what beef might be for 2009, is there going to be an opportunity first of all in the contract to -- I’ve been hearing a lot of folks aren’t offering contracts. And as you think about maybe your non-beef exposure for next year, what -- is there any areas of opportunity there that you might be able to kind of offset any kind of inflation that you might see in 2009? Thanks.

G. J. Hart

Firstly, our beef, our 25% that we locked in recently, I will tell you is a little bit more than what that portion of the floating beef in the first half but less than our contract price that we had on the balance of it, somewhere in between and that’s about as far as we want to go with that.

And in terms of 2009, on all proteins, we are in the midst of discussions that we’ll be having over the next several weeks with our vendor partners and we’ll have a much better sense of where we are going into 2009. I think it’s fair to say that it’s uncertain right now for our vendor partners as well as us. I don’t know that anyone’s told us at this point they are not offering contracts and we’ve had a few discussions already. So I think it’s uncertain and really there’s not a lot more I can add until I have these meetings.

Larry Miller - RBC Capital Markets

Okay, thanks. If I might ask just two more quick ones; Scott, can you talk about the return on capital on those three groups of stores? What is the return on capital, the comp base? What’s the return on capital of that non-comp base, and then the stores that were less than nine months?

And then historically you’ve told us a little bit about monthly comparisons that you have. What does Q3 of last year look like on a monthly basis? Thanks very much.

Scott M. Colosi

Larry, on the comp, are you talking this year or last year on --

Larry Miller - RBC Capital Markets

Last year. You said you were down 3% at the start of the quarter. What does the comparison look like at this time last year? I just couldn’t remember.

Scott M. Colosi

Last year in April, we were up 3.7; in May, up about 0.8; in June, up about 1.2.

Larry Miller - RBC Capital Markets

I was thinking Q3, thanks.

Scott M. Colosi

Q3? I’m sorry.

Larry Miller - RBC Capital Markets

Yeah, of last year.

Scott M. Colosi

Q3 last year, 2.6 in July; 3.3 in August; and 1.5 in September.

Larry Miller - RBC Capital Markets

Okay, thanks.

Scott M. Colosi

With regard to the returns, I’m not going to get too specific on the returns. I’ll tell you that certainly the returns are much higher on the older stores as they’ve got a little bit higher sales and certainly they’ve got much, much lower investment costs, so certainly today our return equation is much tougher to get to that mid-teens to high-teens IRR levels that we are looking at, whereas historically let’s say on an EBITDAR return basis, which is typically what we report when we go to our conferences, EBITDAR as a percent of the total investment, including capitalizing leases and including pre-opening and so forth, we historically were opening up in the mid to higher 20s and now we are talking in the low 20s to 20% range is kind of where we are currently. And needless to say, we are certainly concerned as we look in the future with continued inflation in both construction costs and operating costs.

Larry Miller - RBC Capital Markets

But you guys will continue to open stores as long as they are above that 15% to 18% range and right now you are in the low 20s, right?

Scott M. Colosi

As long as we feel confident that we can attain those types of mid-teens IRRs, mid- to high-teens, mid-teens kind of if we are owning property, higher teens if we are a little more highly leased, yeah, we’ll continue to develop restaurants.

Larry Miller - RBC Capital Markets

Okay. Thank you very much.

Operator

Our next question comes from Greg Ruedy with Stephens Inc.

Greg Ruedy - Stephens Inc.

Good afternoon. I’m wondering what sort of contingencies you might have in place should other key retailers rationalize their store base, and have you felt anything to date?

G. J. Hart

You mean in terms of other restaurant companies closing their doors?

Greg Ruedy - Stephens Inc.

Or just retail across the board, yes.

G. J. Hart

I think it’s fair to say, and we’re starting to see some closures. I can tell you that any of the major casual dining chains, we’ve seen anything significant. Certainly they’ve slowed down their growth and you guys track that better than we do. But in terms of contingencies, I think we look at it as an opportunity from a real estate perspective and we continue to evaluate those opportunities as they come before us.

Scott M. Colosi

Certainly we’ve got to be paying attention, i.e. if we are going into what would be a new development, we’ve definitely got to be paying attention and make sure that whoever the anchors are going to be, that we are confident that they are in fact going to develop those locations and we are not going to be just there by ourselves.

Greg Ruedy - Stephens Inc.

Okay. When you -- going back to your capital allocation strategy, the three prongs that you mentioned and growth for growth’s sake, if we’re looking out to next year, can you disclose how many leases you have under contract and how should we maybe compare it to this year’s in absolute terms?

Scott M. Colosi

Yeah, we’re not going to get into development for 2009 and we’ll get a lot more specific at our next conference call at the end of October. But suffice it to say, whatever development we do have in 2009, a very high percentage of those locations are going to leased locations that I can tell you -- I know that for sure.

Greg Ruedy - Stephens Inc.

Okay, the eight franchisees you acquired recently, it looks like their AUVs is about $0.5 million below the system average. What kind of opportunity do you have to push them towards that average, or are they almost mature units and they are pretty much locked in where they are at?

Scott M. Colosi

We never think a unit is mature and therefore we can’t grow sales in a unit, but the mix of stores, some are very old, meaning they are 10 years old in our system. Some are just a few years old, so it’s really across the board. We believe they are very high quality operators and they’ve had great leadership throughout their history, so I think we are very bullish on that they can continue to grow as the rest of our system grows.

Greg Ruedy - Stephens Inc.

Great. Appreciate it. I’ll pass it along.

Operator

Our next question is from David Tarantino with Robert W. Baird.

David E. Tarantino - Robert W. Baird & Co.

Good afternoon and congratulations on good results in a tough environment. Scott, just a clarification question on the quarter to date comp number that you gave for Q3. Could you disaggregate that between check and traffic? And also, would there be an impact from the timing of July 4th this year in that number?

Scott M. Colosi

I can’t give you Q3 off the top of my head of what guest and traffic was. I have to look that up -- for last year, I’d have to look that up. For July, our check was barely positive, so traffic was about down 3. Yes, we believe Fourth of July was pretty impactful, probably about a point, meaning that Fourth of July was on Friday this year versus on Wednesday last year, so certainly that hurt us a bit for the month.

David E. Tarantino - Robert W. Baird & Co.

So just to clarify, the traffic in the third quarter would be down about 2% excluding that shift, is that the way to read it?

Scott M. Colosi

I’d rather say it another way -- you know, July may have impacted us by a point. It’s really a ballpark guesstimate for it. I’ll just tell you the actual number is we’re down three for the month.

David E. Tarantino - Robert W. Baird & Co.

Okay, thanks. And a question, G.J., on overall pricing philosophy; given the response you’ve seen since the increase that you had in May, what’s the appetite for increasing prices as you look out into potential inflation issues in 2009?

G. J. Hart

Well, first in terms of the price increase we took with, and in addition to value -- products that we put on the menu, I think it’s really too early to tell the real effect of what’s happened. I mean, clearly we knew by putting items on below $10 and with the baby blossom that they would have an effect, and as I mentioned in the script, that was the case.

Now, in terms of going forward, we are going to be testing some additional pricing as we go through the balance of this year, in anticipation of what we may or may not have to do going forward.

David E. Tarantino - Robert W. Baird & Co.

Okay. Thank you.

Operator

Our next question is from Destin Tompkins with Morgan Keegan.

Destin Tompkins - Morgan Keegan

Thanks. I wanted to follow-up on the commodities question; looking at 2009, obviously there’s a lot of fear about what could happen to the protein prices especially. If in fact we did see a 10% to 15% increase in those protein costs, can you give us what your thought process might be in terms of menu pricing?

G. J. Hart

Well, I think it’s way too early to be talking about 10% to 15%. I think I’ve said this before -- costs may go up but that doesn’t mean you are going to get it on the demand side, and given the macro environment I would suggest to you that we’ve seen, and particularly at retail, that there’s been a real trade-off from these high-priced middle cut meats. So I think it’s way too early to suspect that at this point. And in fact, if you see most recently, you see some of the things like ground chuck and some of the end cuts going up faster than you do the middle cut. So I would tell you that I wouldn’t be that pessimistic at this point.

And in terms of what that pricing might look like, I would suspect with continued wage inflation and with that kind of inflation on food, you’d be looking at needing somewhere between 3% and 5% pricing to stay even.

Destin Tompkins - Morgan Keegan

Okay, thanks, that’s helpful, G.J. Additionally, as you look at your guidance for the rest of this year, I think just doing some quick math, it looks like you need to average around negative 1% comp or so to get to the low-end of your guidance. Is there anything you guys have planned from a promotional standpoint or a menu standpoint that might give you a little bit more confidence that you could see an acceleration, or is it the easier comparisons that you see out there that maybe give you more confidence?

G. J. Hart

Well, I would tell you that from promotions, as you know we don’t bury promotions very often. We are going into our Great Steak promotion and then beyond that, we are already planning for our gift card promotions into the fall and into Christmas. We continue to intensify our local store marketing efforts. We continue to increase the number of training conferences that we do for our local store marketers, and beyond that, we’re really not doing anything significantly different. We hope that we will continue to execute and that’s why you hear us talk about continuing to focus on those fundamentals and that we believe we’ll continue to steal share by executing with as many items that we have under $10 and really where we are positioned and we believe even stronger than ever before compared to our competitors, we believe we are well-positioned to go through the balance of this year.

Destin Tompkins - Morgan Keegan

Okay, so you really haven’t changed your thought process in terms of whether it’s advertising or couponing or some sort of other promotional activity at this point?

G. J. Hart

No, sir.

Destin Tompkins - Morgan Keegan

Okay, great. Thank you.

Operator

We’ll next go to Jeff Omohundro with Wachovia.

Jeff Omohundro - Wachovia Securities

Thanks. Just two questions; first, I wonder if you could give us an update on the seating capacity expansion test, how that’s tracking and perhaps an update on the investment costs behind that?

Scott M. Colosi

We’ve had four of these locations where we’ve added seats to them and they’ve been opened for a while now, and they continue to do very, very well -- strong sales results and in very high return on invested capital in those locations, four locations. So we’ve got a number that are in the process of either being constructed or permitted out or recently just got done literally within the last couple of weeks. So really by the end of this year, probably early next year, we’re going to have a really good view of how this thing is shaking out on a larger scale, because we’ll have a dozen restaurants kind of up and going with these extra seats.

The cost, looks like it’s going to be between $125,000 and about $150,000.

Jeff Omohundro - Wachovia Securities

Okay. And you mentioned the labor pressures that I think we’re all aware of. I wonder if you could also, however, address some of the initiatives that the company is pursuing to help reduce turnover and to help mitigate some of the cost pressures. Thanks.

G. J. Hart

In terms of turnover, we are better year over year on turnover at the moment, and we think part of that really centers around the selection process in the first place, and then also making sure that our managing partner in each and every restaurant validate that new hire. And we’ve been on that bandwagon for quite a while now and we are starting to see some benefits from that and right now, we’re running around I think 10% or 12% better on an hourly turnover basis than we were a year ago.

In addition to that, we are making sure that from a training perspective that we’ve got training coordinators in every one of our restaurants and making sure that the new folks coming into our system really understand what the expectations are. I think we are doing a better job at that. Ultimately that’s driving the improvement in our turnover as well.

Jeff Omohundro - Wachovia Securities

Thanks.

Operator

Our next question is from John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thank you. Just following up first on the expanded seating capacity, what percentage of the store base do you think could effectively be expanded? And is that going to be part of your -- a material part of your ’09 capital plan, or capital allocation?

Scott M. Colosi

You know, that’s really hard to say at this point what percentage of the system. One would hope it would be a relatively significant portion of it but certainly we’ll know much more about that once we get into the year next year. That said, I don’t think it’s going to be a very material part of our capital plan for 2009.

John Glass - Morgan Stanley

Okay, and then on the cost of goods, you’ve seen a benefit year-to-date, although that benefit seems to have diminished a little bit this quarter versus the first quarter, so thinking about how you put a new beef contract into place now, what happens in the back half of the year I guess to the basket of commodities?

Scott M. Colosi

Well, the beef, the new beef contract is going to in effect raise our food costs a little bit, a slight amount, for the remainder of the year and that really comes down to sort of what happens with some of the floating stuff, such as dairy, potatoes, some of the other produce items were primarily the things that are going to move our food costs around a little bit and also just kind of what happens to some of the new items we’ve put on the menu that G.J. talked about earlier -- the third slab of ribs, the pulled pork combos, those are lower food cost items, the pulled pork items especially, as a percent of sales so we’ll have to see how that all pans out.

John Glass - Morgan Stanley

Are you thinking now though that food costs switches from being favorable to unfavorable, to second half versus first half?

Scott M. Colosi

I would say food cost could still be a little bit favorable year-over-year second half of the year.

John Glass - Morgan Stanley

Just what happened in July in your view? A number of restaurants have seen this down-tick and in your opinion, is it a regional issue, is it a day-part issue, or is it just simply the consumer and gas prices and all the stuff we’ve all talked about ad nauseam?

Scott M. Colosi

Certainly you can speculate on all those fronts. We really haven’t seen any material change regionally from one month to the next. I would suspect certainly with gas moving well over $4 a gallon, at least for most of the month and part of June, certainly I’m sure that’s had an impact.

John Glass - Morgan Stanley

Thank you.

Operator

Our next question is from Steven Rees, JPMorgan.

Steven B. Rees - JPMorgan

Thank you. Just on the Tennessee franchise acquisition, the eight units, you said it wasn’t expected to be accretive this year but yet see overall unit volumes look to be pretty healthy at $3.5 million. Is there something with the margin performance of those units or the investment in G&A you have to make that’s leading to this not being accretive this year?

Scott M. Colosi

There’s two things there with that acquisition; one is we’re leasing all the real estate assets, so we’ve got a lot of rent, which is one reason why the purchase price is just over $1 million a restaurant in that deal. So of course, for the accounting rules, you’ve got the full rent impact plus you’ve got a lot of straight line rent that you’ve got to book. On top of that, we’ve got amortization of an intangible asset. We’ve got the expensing for stock grants for the operators in the program, and of course you’ve got book depreciation, so there’s a lot of non-cash expenses that weigh down the earnings impact where from a cash flow perspective, it’s actually accretive from a cash flow per share perspective.

Steven B. Rees - JPMorgan

Okay, but the actual restaurant level margins were -- but they are pretty healthy?

Scott M. Colosi

They are in line with where they should be given the volumes of the restaurants.

Steven B. Rees - JPMorgan

Okay. Thank you. And then just G.J., on the -- you know, you were pretty successful in the value promotions in the second quarter, stabilizing traffic, some of the smaller portions and now with traffic getting a little bit worse, do you think you have to be more aggressive communicating this value and do you plan on coming up with even more lower priced options?

G. J. Hart

Well, we’re always looking to do more R&D work to see what we can do on the value side, so yes, that is continuing. I will tell you that we do need to be more conscious about having the communication strategy around these new items, and in addition there are -- you know, we’ve always had a two-for program for the folks that are coming in on the early day part and we continue to believe that we can push that area as well to screen value.

But absolutely value is where it’s at and we will continue to communicate it through our local store marketing efforts.

Steven B. Rees - JPMorgan

Okay, and then finally on the mix, it doesn’t sound like it got significantly worse; it’s down 1 to 1.5, and you said it was mostly entrée driven, but are you seeing any weakness in beverage sales?

G. J. Hart

Alcohol sales have pretty much been consistent but they are down -- sorry, I take that back. I think they are down about three-tenths of that during the period. I think we are continuing to see premium alcohol sales go up and what’s that really telling us, I think people are, if they are going to have a drink, they are going to get the best, so we are seeing that.

Steven B. Rees - JPMorgan

Okay, great. Thank you very much.

Operator

Our next question then is from Paul Westra with Cowen & Company.

Paul Westra - Cowen & Co.

Great, thanks. Good afternoon. Most of my questions were asked but just one modeling question, Scott, this extra week in the fourth quarter, can you expect some extra leverage from that flowing to the P&L? And if so, is that in your margin guidance?

Scott M. Colosi

Yes, that’s all in there, from the extra week.

Paul Westra - Cowen & Co.

And do you expect -- I guess dollar profits will be slightly more impactful than the sale --

Scott M. Colosi

I think that the impact on margins is negligible from the extra week, when we’re giving you full-year guidance of margins being down 80 to 100 basis points, 80 to 120. The impact of the extra week is negligible on that.

Paul Westra - Cowen & Co.

Okay, and then a second question on pricing -- I know you are running 2.5 now; G.J., you mentioned you are doing some testing. When is the next window that which you would take price? I think 1.25 I guess is falling off later in the year.

G. J. Hart

Well, I said we are going to be testing. We aren’t testing anything yet. My sense of it at the earliest would be later, at the very end of this year or the beginning part of next year.

Paul Westra - Cowen & Co.

And will you make that decision I guess post what you will likely lock in in ’09?

G. J. Hart

Absolutely. We need to really understand where we are headed from a cost perspective and we think we’ll have a pretty good feel of that over the next month or so.

Paul Westra - Cowen & Co.

And I guess lastly, I’ll just ask the question maybe one more time; obviously July has stepped down here a little bit. It was impacted by the July 4th shift. Obviously your forward comp guidance looks to be about what you’ve been year-to-date. Why the confidence that comps improve going forward versus July’s step down?

Scott M. Colosi

You know, we’re not forecasting or modeling a significant change from where we were the first half of the year, and I think in the first half of the year, our comps were down 0.7. We’re going to have a little bit more pricing second half of the year than we had the first half of the year. We’ve got a few months later in the year where we do have relatively easier comparisons. That’s kind of what’s driving our range on the negative 1 to zero. We’re not putting a lot of weight to July at this point. You know, oil has come back a little bit, gas prices have come back a little bit. We don’t know if it’s going to last or not; it could get worse, could get better. Obviously we don’t know. So that’s kind of sort of what went into our thinking.

Paul Westra - Cowen & Co.

So conversely July, what you saw didn’t really shake your confidence that the world has changed dramatically from --

Scott M. Colosi

Yeah, we don’t get shaken from a few weeks of down sales too easily. But again, we’re feeling like we can achieve what we did in the first half of the year when we had less pricing in the numbers. We think we can at least duplicate that in the second half of the year.

Paul Westra - Cowen & Co.

Great, thanks, and congrats on the solid quarter.

Operator

(Operator Instructions) We’ll next go to Keith Siegner with Credit Suisse.

Keith Siegner - Credit Suisse

Thanks. Just two really quick questions; the value has always had kind of a really broad demographic appeal and you’ve talked about the 25% of your customers that kind of come up from family dining and the 25% that come down. I mean, just for us who are trying to gain a little bit of insight into the bigger picture, have you seen any different trends maybe in the traffic across those different demographics that make up your customer base?

G. J. Hart

You know, that’s a very hard question to answer. I always like to say that these days in our restaurants, you’ll see more BMWs in the parking lot than ever before but we don’t have hard facts or data to tell you exactly that.

With 300-plus restaurants, it’s hard to know that but we believe that we are getting some higher income folks into our buildings just by walking through them. But to give you date, there really isn’t any.

Keith Siegner - Credit Suisse

No, that’s okay, I mean, just any kind of insight was definitely helpful. And then just one last quick question; the Tennessee franchises, I’m pretty sure it’s my understanding that those have the Friday lunch. Is that the case? And if they are ones with Friday lunch, now that they are company-owned, do you think about that any differently or --

G. J. Hart

Well actually, Keith, to be fair, those Tennessee, the older stores in Tennessee, actually almost all of them are open for lunch seven days a week and that’s the one market that’s been that way for as long as they’ve been open. It is yet undetermined whether or not we will eliminate lunch or not. It’s fair to say that we probably will test that at some point.

Keith Siegner - Credit Suisse

Okay. Thank you.

Operator

Our next question is from Barry Stouffer with BB&T Capital Markets.

Barry Stouffer - BB&T Capital Markets

Good afternoon, gentlemen. I just have one quick question; just curious if you could comment at all about food cost in the third quarter relative to the second quarter.

G. J. Hart

Barry, we can’t hear you at all.

Barry Stouffer - BB&T Capital Markets

Is this better? Sorry, my headset sometimes doesn’t work too good. My question was just if you could comment on food costs in the third quarter relative to the second quarter. It sounds like you are expecting some increase because of the change in the beef contract.

G. J. Hart

Well, you’d have a little bit of increase because of the beef contract. You’d have a little bit of a decrease because of the pricing that we took, and then it’s going to come down to really menu mix and what kind of shifts we see or don’t see, and some of the floating stuff with regard to produce and dairy specifically, so it could be -- so all that means in total, you could have something from flat to up slightly from the quarter.

Barry Stouffer - BB&T Capital Markets

Versus second quarter?

G. J. Hart

Yes.

Barry Stouffer - BB&T Capital Markets

Okay. Thank you.

Operator

Our next question then is from Jason West with Deutsche Bank.

Jason West - Deutsche Bank

I was wondering if you could talk a bit about the outlook for free cash flow for ’08, and a follow-up question on that; for each restaurant that you guys open, what is the average CapEx now running at?

Scott M. Colosi

Jason, this is Scott. The average CapEx now is probably about close to $3 million, is probably about the average. And so that assumes we’re leasing about 80% of the land, so if we don’t -- you know, if we open one less store, we probably save $3 million on average in capital spending; if we open one more store, we’re spending $3 million more.

From a free cash flow perspective, we’re expecting to be $10 million-ish of free cash flow. That’s after our capital spending on new restaurants but prior to any acquisitions and prior to any share repurchases. So we’ve made two acquisitions this year. They total about $17 million, $18 million right now in total and then it comes down to the share repurchase and how much we spend on share repurchases will dictate how much money we have to borrow on our credit facility to fund everything.

Jason West - Deutsche Bank

Okay, and just follow-up on pricing; you guys said you were running about 2.5% right now. What falls off as we move through the back half of the year?

Scott M. Colosi

Nothing falls off in the back half of the year. We’re going t have the approximate 2.5 all the way through the beginning of next year.

Jason West - Deutsche Bank

Okay, and then just a last one on the guidance; it looks like the food costs got pretty good visibility; you’re not expecting a big jump, it doesn’t sound like, barring some of those unhedged items. You do have a pretty -- a lot easier compare on the labor line in the back half of the year. It just seems like the guidance would be pointing towards the higher end based on some of those big items. I don’t know if there was anything in G&A or other operating that’s going to be a big delever in the back half, or something I’m missing there.

Scott M. Colosi

Well, one thing in the third quarter is we are lapping our insurance credit. Typically when our actuaries review our -- the reserves that we have set up for insurance claims, typically the last couple of years we’ve gotten some pretty big credits on the current year’s worth of claims. And so we are lapping a pretty big one -- I think it was $600,000 or $700,00 from last year that we’re coming up and lapping this year in the third quarter. We haven’t assumed anything in our forecast for that, there being a benefit or not. So certainly if there is a benefit, that will help us but as always, there’s always the risk of there being an expense that we have to take.

Jason West - Deutsche Bank

Okay, thanks.

Operator

Our next question is from Bryan Elliott with Raymond James.

Bryan Elliott - Raymond James & Associates

Good evening. Just a couple of quick housekeeping things, actually -- what was stock comp expense in the quarter, the non-cash? Do you have that, Scott?

Scott M. Colosi

Let me see if I can quickly dig that up here --

Bryan Elliott - Raymond James & Associates

And while you are doing that, did you take -- you took some price in May. Did you take a little more in June as well? Did we have that wrong?

G. J. Hart

No, we just took it in May.

Scott M. Colosi

Okay, stock comp for the second quarter was $1.9 million, and G.J. answered your question on the price --

G. J. Hart

Yes, we did.

Bryan Elliott - Raymond James & Associates

And do you have a wheat contract that expires shortly in August?

Scott M. Colosi

It’s September and we are working on a new one now, and as you probably are aware, wheat prices have come back quite a bit.

Bryan Elliott - Raymond James & Associates

Is that an annual? Was that put in place this time last year?

Scott M. Colosi

Yes, sir.

Bryan Elliott - Raymond James & Associates

Okay. All right, that’s all I got. Appreciate it. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Conrad Lyon with Global Hunter Securities.

Conrad Lyon - Global Hunter Securities

Good afternoon. Just a quick question, geared more towards the franchisees -- how are the transactions evolving, or the recent ones these days? Is it more you guys going out or are the franchisees coming to you these days? Any major shift there?

G. J. Hart

I don’t think there’s really been any shift at all. They know that we are open to a dialog and most of them have approached us.

Conrad Lyon - Global Hunter Securities

Okay, and Scott, a quick housekeeping question; I’m not sure if you mentioned this -- what was your CapEx for the quarter?

Scott M. Colosi

I can’t tell you for the quarter but I can tell you year-to-date, our development or our CapEx on the ongoing business is $53 million, and then you’ve got the $8 million from the three store acquisition as an addition, so total cash used in investing activities is about $61 million. That’s year-to-date.

Conrad Lyon - Global Hunter Securities

All right. Thank you very much, guys.

Operator

The last question in the queue is Matt DiFrisco with Oppenheimer.

Matt DiFrisco - Oppenheimer

Thank you. Just two question, I won’t hold you up here; first on the pre-opening, I think Scott, you mentioned during your prepared remarks, pre-opening, the timing could vary. Are we expecting then a large portion of these 10 stores to fall into the second half of the year or are we still running around that $400,000 per store rate?

Scott M. Colosi

We’re still running between I would say 400 and 450, depending upon if it’s a leased property and how much the rent is and how much rent we have to expense up front kind of thing, but we’re running pretty consistently around that average.

Matt DiFrisco - Oppenheimer

But should -- I guess having the 10 stores and being in the mid threes there, should we, or low $3 million range, are you inferring then there’s nearly upwards of $1 million that could fall into the third quarter related to these 10 stores?

Scott M. Colosi

I would say that you’ve kind of got a certain amount of run-rate on pre-opening, and that run-rate is going to be influenced on current openings we have now and also on future openings, both in the fourth quarter and the next year, so that’s all going to come into play into what the current run-rate of pre-opening is and kind of how much we’re spending month to month.

So I think so far this year, we’ve had a relatively consistent amount of pre-opening month to month and I would presume that you could extrapolate that forward for the rest of the year.

Matt DiFrisco - Oppenheimer

Okay, and then looking at your average weekly sales, I know there’s been some mention of this in the last couple of calls, and looking at the analysis that we’re able to, given that you give such granularity on your operating weeks and the same-store sales and your volumes, it looks like you’ve narrowed that gap now. Is that right to assume that it looks like the stores outside the comp base are starting to come closer to the trends that you are seeing within your older comp stores, so one could deduct that the volumes are coming closer to par or something that is a little bit better than what we saw of the gap being so wide in the first quarter?

Scott M. Colosi

They were a little bit close in the second quarter but not -- I would not say it’s a material difference. I’d say that the trend has changed.

Matt DiFrisco - Oppenheimer

Okay. Thank you.

Operator

And now at this time, I’d like to turn the call to G.J. Hart for any additional or closing comments.

G. J. Hart

Well, thank you all for joining us tonight. We look forward to seeing you or talking to you in our next call. Good evening.

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Source: Texas Roadhouse F2Q08 (Qtr End 6/24/08) Earnings Call Transcript
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