Panera Bread Q3 Earnings Call Transcript

123jump.com Staff
22 Nov, 2010
New York City

The retail bakery-cafes operator total quarterly revenue grew 11% to $371.99 million. Net income in the quarter rose 21% to $23 million, helped mainly by higher revenues and improved profit margins. Earnings per diluted share increased to 75 cents from 61 cents per diluted share last year.

Panera Bread Company ((PNRA))
Q3 2010 Earnings Call Transcript
October 27, 2010 8:30 p.m. ET

Executives

Michele Harrison – Vice President, Investor Relations
William W. Moreton – President and Chief Executive Officer
Jeffrey W. Kip – Senior Vice President and Chief Financial Officer

Analysts

David Tarantino – Robert W. Baird & Co.
John Glass – Morgan Stanley
Sharon Zackfia – William Blair & Company
Jeffrey Bernstein – Barclays Capital
Matthew DiFrisco – Oppenheimer & Co.
Stephen Anderson – Miller Tabak
Jason West – Deutsche Bank
Mitchell Speiser – Buckingham Research
Steven West – Stifel Nicolaus
Robert Derrington – Morgan Keegan & Company
Bryan Elliott – Raymond James
Joseph Buckley – Bank of America/Merrill Lynch
Jake Bartlett – Susquehanna International Group

Presentation

Operator

Good day, everyone and welcome to the Panera Bread Company 2010 Third Quarter Earnings Call. Today''s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Michele Harrison. Please go ahead.

Michele Harrison

Thank you very much. Good morning to everyone and welcome to Panera Bread''s third quarter earnings call. I''m Michele Harrison, Panera''s Vice President of Investor Relations and Corporate Development. Here with me this morning are Bill Moreton, our CEO and President and Jeff Kip, our Senior Vice President and Chief Financial Officer.

Before we start, let me call off on a few regulatory matters. I''d like to note that during our opening remarks and in responses to your questions, certain items may be discussed which are not based on historical facts. Any such item including targeted 2010 and 2011 results or conditions and details regarding 2010 and 2011 performance should be considered forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995. All such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially.

With that, I''d like to turn it over to Bill who will lead us in the call.

William W. Moreton

Good morning. Yesterday afternoon, we released earnings for the third quarter of 2010. We''re pleased to deliver another strong quarter with earnings of $0.75 per diluted share for an increase of 23% versus the prior year.

Our strong results this quarter are the by product of our core initiatives and investments we''ve made over the past 12 to 18 months. By continuing to invest in our concept and the quality of our customer''s experience, we''ve been able to drive real sustainable points of competitive differentiation which in turn drives bakery-cafe profit growth.

In the third quarter, system wide one-year comp store sales growth was 6.9% and two-year comp store sales growth was 9.6%, which we believe is at the very highest end of our industry and which has accelerated to 11.9% on a two-year basis through the first 27 days of October.

Through our operating and category management disciplines, we''ve been able to achieve operating leverage and we delivered 23% EPS growth in the quarter and revenue growth of 11% even while making significant investments in our loyalty program rollout and other initiatives that will pay dividends in 2011 and beyond.

We have also been able to deploy our capital both to drive operating growth to a high ROI new bakery-cafe development as well as through an opportunistic high return acquisition and a disciplined share buyback program, all of which will result in continuing earnings accretion going forward.

This year, our company opened new bakery-cafe performance has continued it''s strength through the last three years with year-to-date average weekly sales of $40,950 versus $37,068 in 2009. Our system wide new bakery-cafe AWS is the highest it has been in our history as of the end of the third quarter.

Further, we just completed an acquisition of 37 franchise operated bakery-cafes on the first day of the fourth quarter. The market we acquired was the New Jersey market, which not only has a trailing 12-month average weekly sales volume of $50,211, which is among the highest in our system, but it also has significant development opportunities remaining. The acquisition is within our traditional multiple range of five to six times EBITDA excluding royalties and will be $0.06 to $0.08 per share accretive in 2011.

Lastly, we bought back additional $79 million in shares since the end of the second quarter at an average price of $78.51. Our cumulative share repurchases this year will add approximately $0.10 per share to 2010 EPS and approximately $0.25 to 2011 EPS.

I''d now like to turn the call over to Jeff to review the third quarter results in more detail. Jeff?

Jeffrey W. Kip

Thanks, Bill. Let''s run through our third quarter financial results starting with revenues. Our strong revenue growth has been driven by our strong comps and the outstanding performance of our new bakery-cafes. Again our system wide comps were up 6.9% in the quarter, 9.6% on a two-year basis with company-owned comps up 5.5%, 8.7% on a two-year basis and franchise comps up 7.9%, 10.3% on the two-year basis.

The 5.5% company-owned comp breaks down into the following components. Transaction growth in the third quarter was positive 0.2%, average check growth was 5.3%.

Our third quarter average check breaks down into the following components: Price of approximately 2.0% and growth from mix of approximately 3.3% driven approximately two-thirds by strength in our summer salads, frozen drinks and our meal upgrade program and approximately a third by our catering business.

The other core driver of our revenue growth has been openings of bakery-cafes at frankly our highest volumes in our history. In the third quarter, we opened 22 new bakery-cafes, 10 of these were company-owned stores and 12 were franchise operated. As of the end of the third quarter, year-to-date average weekly sales for the company-owned new units opened in 2010 was 40,950 versus 37,068 for the prior year and year-to-date average weekly sales for franchise operated new units opened in 2010 was $37,719 versus $35,680 for the prior year. We couldn''t be happier with the performance we''ve seen here, our hats are off to our real estate team.

Let me now talk about profit growth starting with our bakery-cafe margin performance. We grew net bakery-cafe sales 10% and bakery-cafe profit margin dollars 13% in the quarter, which gave us bakery-cafe margin expansion of 40 basis points. We were able to improve our margin even while investing approximately $2.5 million or 80 basis points of expense, in -- our loyalty program which reached approximately 75% of our company-owned bakery-cafes in the quarter as we planned.

This investment was spread across food, labor and other operating costs. Our sales really experienced only modest lift from the program given that our testing has shown that it takes about 30 to 60 days for the lift from royalty to really start taking hold in the market.

This investment in the additional three quarters of $1 million of rollout expense will expense in the fourth quarter will be fully paid back by the lift we receive from the program over the next two quarters. So, excluding our investment in loyalty, we would actually have grown our bakery-cafe profit margin dollars by approximately 20% and our bakery-cafe margin was -- would actually have grow 120 basis points.

Looking at the key components of our bakery-cafe margin, our labor margin overall was 30 basis points unfavorable on labor investment in loyalty rollout. In other operating expense, margin was approximately 50 basis points unfavorable based primarily on the expense from in-store promotion of loyalty and the cost of the actual loyalty cards.

Cost of food and paper was impacted approximately 20 basis points unfavorably by product use for the royalty rollout, but otherwise was 80 basis points favorable overall based on approved purchasing and category management initiatives.

Finally, occupancy was 50 basis points favorable on sales leverage and lower occupancy costs in our newer stores. Thus the favorability and cost of food and paper in occupancy offset the loyalty rollout investment and we still enjoyed a year-over-year pickup in the bakery-cafe margin and growth in overall profit dollars.

Based on our bakery-cafe profit margin growth, our operating margin expanded 20 basis points. Key items to note are first we enjoyed 70 basis points of leverage on our depreciation margin given our strong sales. Secondly, our G&A is up 50 basis points year-over-year based on investments made in marketing, loyalty infrastructure, infrastructure for future growth and higher incentive comp accruals based on the significant amount by which we''re beating our earlier performance targets.

You may recall that the middle of our original target EPS range for full year 2010, which we gave a year ago, was actually $3.10. We expect to see leverage on G&A in the fourth quarter as year-over-year investments slows in the remainder of the year.

Finally, our cost margin on fresh dough and other product cost of sales to our franchisees, as a percent of these sales to franchisees, is up 260 basis points year-over-year driven by our produce distribution program, which is essentially zero profit as we discussed on our last call.

At the bottom line, net income margin in the quarter increased 50 basis points and net income dollars grew 21% year-over-year. With the benefit of the share buyback completed to date, as noted earlier, our EPS grew 23% our ninth quarter out of 10, we will have grown EPS 20% or more.

To cover a few balance sheet items. We ended the third quarter with approximately $232 million in cash as we generated approximately $28 million of cash from operations net of capital expenditures and tax payments and used approximately $79 million to fund the repurchase of 1,007,984 shares during the quarter at an average price of $78.51. 906,983 of these shares were actually repurchased since our last earnings call and in total, we purchased approximately 1.9 million shares this fiscal year for $150 million at an average price of $78.72.

We estimate that the shares repurchased since the second quarter call added an incremental penny in the third quarter and three pennies to fourth quarter EPS. Our year-to-date repurchases have had a cumulative impact of $0.03 on the third quarter, $0.07 per share on the fourth quarter and $0.10 for the full year 2010.

The full year impact of share repurchases completed in 2010, on our 2011 EPS we estimate to be approximately $0.25 per share. Again, we''re very pleased to deliver earnings growth of 23% on 11% revenue growth while investing in our concept, our customer experience and our competitive position.

Let me now turn it over to Bill to offer color on the quarter and discuss our key initiatives going forward.

William W. Moreton

Thanks Jeff. As Jeff told you, we''ve enjoyed consistent success over the last several years. These results have been driven by our continued investment in the quality of our customers experience to drive competitive differentiation and advantage.

We realized that most initiatives that really make a difference to the customer take multiple years to play out. By making the right strategic investments and executing well against our key initiatives, we''ve been able to maintain our success through all types of economic climates including the recession of the last two years during which we have picked up market share.

In the third quarter, many of the investments we''ve made over the last 12 to 18 months continue to pay off and we''re making additional investments now to ensure we continue on our a successful path in 2011 and beyond. As we have talked about in prior earnings calls, we''re focused on increasing our store profit through driving increased transactions and increased gross profit per transaction.

We believe the biggest driver to sustained transaction growth is providing a quality food experience that is worth walking by the competitors to get. On the last earnings call, we discussed our strategy of striving to own certain categories in the consumers’ minds.

As I mentioned last time, owning a category is not meant to be an arrogant statement. But to us means that we''re on the consumer’s shortlist when they''re looking for a high-quality dining experience without having to pay the tax of additional time and a server tip required at a full-service restaurant.

I''d like to comment on some of the categories that we''re striving to own. First, let''s start with salads. We spent a lot of time during the last call talking about our lettuce program that rolled out last summer, which allows us to control the quality of the lettuce from the field all the way until the consumer eats it in our cafes.

One of our key initiatives this year is doing the same thing with our produce program. This program, similar to lettuce, allows us to better control the quality of our produce and allows us to take several days out of the supply chain. So our customers are eating a much higher-quality fresher product.

The new produce program was fully rolled out across the system this summer and has resulted in a better tasting salads and sandwiches for that matter. Our customers have noticed. So far this year, our signature salad category is up approximately 35% over the prior year.

This has driven much of our growth in both the lunch and dinner day parts. In January of next year, we''ll be rolling out our Thai chopped chicken salad, which will add another exciting taste profile to our salad lineup. Based on the testing that we''ve done, we expect the salad to be a big hit.

High-quality soup is a category that many people have identified with Panera for some time. We continue to broaden the breadth of our soup lineup. In the fourth quarter of last year, you saw us introduce our mac and cheese entree. This is a great example of how we take a very familiar product and add our own twist to it that results in a truly differentiated higher quality offering. Mac and cheese has been a very successful product with both adults and children, and has sold well at both the lunch and dinner day part.

In the fourth quarter of this year, you''ll see us introduce a hearty steak chili with a corn bread crumble. This chili marries the highest quality ingredients with our bakery heritage to make for a truly differentiated cravable product.

When we look at our menu, we''re not only looking for cravable new products, but we''re constantly looking at how we can improve our existing offers. Early next year, we will introduce our new and improved chicken noodle soup, which is a better tasting healthier offering. You''ll see us continue to bring new soups to the table for our customers in 2011.

The high-quality smoothie and frozen drink category is another one where we feel we''re one of the first options in our customer''s minds. Smoothies and frozen drinks have lifted both our lunch and chill business.

We saw units up approximately 27% over last year in Q3 led by the frozen strawberry lemonade. We''ll be adding additional smoothies flavors next year and believe we can continue to drive growth in this profitable segment.

Hot sandwiches is another category representing great potential for us. For Panera, sandwiches -- hot sandwiches come in two forms. The first thing, our hot breakfast sandwiches. This year we''ve continued to broaden our successful breakfast sandwich lineup by adding bagels as a carrier for our sandwiches.

Our breakfast sandwich category is up 26% year-to-date and has been the primary driver of our breakfast growth. We''re adding a french toast sausage breakfast sandwich in the fourth quarter of this year that adds a sweet taste profile to our current lineup.

The second type of hot sandwich at Panera is our panini sandwiches, which we serve at lunch and dinner. One of the investments that we''ve made this year is to work with the manufacturer on a proprietary basis to develop the next generation panini grill exclusively for Panera. This grill results in more even heating and will allow us to make our panini sandwiches to order. The grills are being rolled into our cafes throughout the third and fourth quarters.

Our new improved panini''s will be the focus of our second quarter celebration in 2011. We believe the combination of our high-quality fresh ingredients, made to order sandwiches cooked on a new grill provide a truly better hot breakfast sandwich and panini, which we expect will result in significantly greater next -- growth next year in these categories.

Also, as a part of the second quarter celebration next year, we will be introducing steak as a new protein for Panera. We have developed a breakfast sandwich, panini and salad that feature a very high-quality steak product. We''re very excited to make steak a part of our menu and expect this will significantly help with our lunch and dinner day parts in 2011 and beyond.

The next arrow in our quiver for building sustained transaction growth is through marketing. Our initiatives in marketing break into two pieces, the first being to drive quality awareness through our media advertising, the second being to deepen our relationship with our customers primarily through the royalty of our My Panera loyalty program.

In terms of media, we''ve been testing and learning over the last four years. In the Panera way, we continued to iterate and learn and have been cautiously increasing our investment over that time period.

I''d like to make of couple points to you about our media program so far, about our learnings. First, we''re continuing to test and learn what the most effective mix of radio, TV and outdoor advertising is for us in each market. That process will continue throughout 2011.

Second, over the course of this year, we believe that our advertising expenses have more than paid for themselves. As Jeff mentioned earlier, we''re expecting incremental lift in our sales in the fourth quarter partially based on media spending.

We should also note that we''re starting from a fairly low level of advertising expense. For the full year, we expect to spend approximately 1.1% of total system wide revenues on media advertising.

Based on the information we''ve seen, we believe that many restaurant companies spend between 3% and 5% of total revenue in media advertising. Therefore we believe we have room to cautiously increase our spending over the next few years while making sure that this spending continues to yield a positive return.

Additionally, I want to mention that we''re making progress on our media messaging. We''re working to find the best way to truly capture Panera''s soul. The authenticity of our brand, which we feel will strongly resonate with our customers and their values.

Next, I''d like to talk with you a little bit about the My Panera loyalty program. As I''ve said previously, the goal of this program is to deepen our relationships with our customers resulting in greater frequency of visits. As of today, loyalty has been rolled out to nearly 100% of our company-owed markets and approximately 940 bakery-cafes system wide.

We expect it to be fully rolled out by the end of this year. As we''ve discussed, it is a reward based surprise and delight program under which the customer doesn''t know what he or she is getting next.

We''re really excited about the impact we''ve seen so far. Not just the positive impact on our comp store sales, but also on our relationships with our best customers who''ve really enjoyed the program. At it''s core, our loyalty program drives more frequency in our best customers.

We are targeting about a point and a half of sales lift in the fourth quarter from this program and believe it will grow from there and contribute more in 2011 as the program reaches steady state. Operation is another key place that we can build relationships and frequency.

We believe that relationships between our associates and our customers can be a real point of differentiation. As we''ve discussed in the past, based on this philosophy, we took a contrarian approach to operations during the recession, maintaining labor, giving full raises and investing in our people while staying focused on delivering for the guest.

The result was higher engagement score with our associates and lower turnover for our team members. GM turnover is now below 10% and reflects in our improved speed and accuracy metrics and record customer satisfaction scores.

As part of our operational investment, we also continued to work on elevating our service system and reducing customer hassle. We''ve discussed this work in the past as our ease of use initiative. It includes efforts such as improving to go experience, expanding our table service test and expanding and refining our drive-through locations.

I would now like to take a couple minutes to update you on our key initiatives to continue to drive gross profit per transaction. We''ve mentioned a number of times the catering success we''ve had in 2010. Sales are up 23% year-to-date. We believe that catering has a potential to be a major platform going forward given our brand, our national footprint and our food capabilities.

We believe that catering can add half a point to comp store sales for the foreseeable future. Over the past few years, we''ve been steadily investing in our catering staff, systems and processes which have driven our success over the last 18 months.

In 2011, you will see us roll out our online catering program across the system in the first quarter. We''re also testing a number of initiatives around our production system, packaging and menu in order to provide the same quality Panera experience to our catering and to go customers as we provide to our eat in customers.

Finally, our category management initiatives continue to progress well. As an update, our meal upgrade program and just as a reminder that''s the program that provides a customer the chance to get a baked good for $0.99 if they buy an entree and a drink, this program continues to be very successful. Approximately 13% of all transactions from 11 a.m. on are getting a meal upgrade. This added approximately 60 basis points to our gross profit growth per transactions in the third quarter.

To sum up, we believe that the investments that we''re making to continually improve the quality of our customers experience, have driven and will continue to drive, real sustainable points of differentiation and competitive advantage. We believe these points of differentiation will allow us to achieve our long-term EPS growth target of 15% to 20% that we outlined for you in the last call.

I''d now like to turn it over to Jeff who will take you through our fourth quarter and full year 2010 targets and our initial target for 2011. Jeff?

Jeffrey W. Kip

Thanks, Bill. So as Bill mentioned I will take you through the targets for the fourth quarter, full year 2010 and then full year 2011 and then we''ll move on to Q&A. So starting with the fourth quarter of 2010, we are raising our fourth quarter target for earnings per diluted share by $0.04 based on both the impact of the incremental share buybacks since our last earnings call, which was approximately $0.03 and improved outlook on operating margins which adds the additional penny.

Our new fourth quarter EPS target is thus $1.15 to $1.17, which would be 21% to 23% growth over the prior year. Our fourth quarter target does not assume any incremental share repurchases subsequent to today''s call and we continue to suggest that analyst not build the impact of incremental subsequent buyback into their estimates given the variable nature of our buyback program.

We''ve obviously had quarters where we''ve bought a significant number of shares and we have also had quarters where we''ve bought none since we put the program into place. We are assuming in our EPS number 30.1 million fully diluted shares for our fourth quarter EPS. We expect only minimal accretion in the fourth quarter from our purchase of the New Jersey market given deal integration and other transition costs.

Our target range for fourth quarter comps remains at 4% to 6%, implying a range for two-year comps of 11.3% and 13.3% in acceleration of approximately 300 basis points from our two-year comp trend to date at the midpoint of the range. This acceleration is driven by, first approximately 150 basis points of additional lift we expect from the rollout of our new loyalty program. And two, sequentially 150 basis points of lift from sequentially increased media spend versus the prior year in the fourth quarter against the third quarter.

By component, the 4% to 6% comp target breaks down to transaction growth of 1% to 3% and check growth of about 3%. Check growth consists of average year-over-year price increase in the quarter of about 2% and favorable mix impact on check of 1%, which is really primarily driven by catering in the fourth quarter.

As noted, our company-owned comp for the first 27 days of October was 4.4%, 11.2% on a two-year basis, again an acceleration from the third quarter two year number. Given that approximately 60% of our company-owned loyalty rollout was done in September and October, we expected the lease lift from the program in October and expected to build in November and December.

Because we''ve seen that the program meets 30 to 60 days to start to show lift and get the steady state in our test markets. Our media is also a little lighter in October relative to the rest of the quarter.

Finally we''ve raised our fourth quarter target for operating margin improvement by 25 basis points up to a range of 25 to 75 basis points. For our incremental loyalty rollout cost, we''ve actually run our core operating metrics more efficiently as the year has gone on giving us a modestly improved margin outlook for the fourth quarter.

Let''s now wrap up our fiscal 2010 discussion with a summary of the revised full year targets. We''re raising our 2010 full year EPS target range from $3.50 to $3.52 up to a range of $3.57 to $3.59. This increase is based largely on the impact from our share repurchases executed in the third quarter.

Our revised 2010 EPS target implies a year-over-year EPS growth rate of 28% to 29%, and again includes no impact from any incremental share purchases subsequent to today. Our comp and margin targets for the year remain unchanged. Our full year comp target remains at 7% to 8% with an implied two-year comp target of 9.4% -- at 10.4%.

By component, our full year comp target breaks down into a transaction growth 1.5% to 2% and check growth of about 5.5% to 6%. We''re continuing to target full year operating margin improvement of 100 to 150 basis points.

Finally, in terms of new units for 2010, we now believe new unit development will be at the lower end of our original range of 80 to 90 new bakery-cafes. And we expect new unit AWS for the year to be at or above the high end of our original $36,000 to $38,000 a week target range.

I''d now like to discuss our initial targets for fiscal year 2011. We''re establishing our initial 2011 EPS target range at $4.30 to $4.35 implying year-over-year EPS growth of 20% to 22%. We''re assuming 30.4 million fully diluted shares for fiscal year 2011.

We assume the total impact on 2011s EPS number from share repurchase completed in fiscal year 2010 to be approximately $0.25. The full year 2010 impact is going to end up being approximately $0.10.

We also expect accretion from the New Jersey acquisition of $0.06 to $0.08 in 2011. Again the fiscal 2011 EPS target range does not include any incremental share repurchase subsequent to today.

If you remove share buyback impact and the accretion expected from the New Jersey acquisition from both fiscal year 2011 and fiscal year 2010 in order to an get apples-to-apples operating EPS comparison, the implied operating earnings growth is 14% to 16%, which is a number we feel confident we can deliver based on our 2011 target operating metrics, which I''ll walk through now.

Starting with comp growth, in 2011, we''re targeting comp growth of 4% to 6% built primarily on transaction growth of 2% to 4% driven by operational execution, lift from our loyalty program and the increased media spending Bill discussed. Our target check growth for fiscal 2011 is approximately 2% consisting of approximately 1.5% from price and approximately 0.5% from catering.

We are not building any retail check mix impact into our comp target. We currently expect operating margin to be flat to modestly up in 2011 as we continue to invest in media, infrastructure and operations. We expect only modest leverage out of our fresh dough facilities and our G&A as well as strategically invest to provide for future growth.

We don''t expect leverage to the cost of goods line, the way we have seen recently as we would expect food cost inflation of 1% to 1.5%, slightly higher than we expected on the last call. But the impact of that increase is included in our EPS guidance.

We expect wheat cost for 2011 to be roughly flat versus 2010 as we currently have nearly 75% of our wheat locked in for 2011 modestly below the 2010 and we''ll buy out the rest of the year modestly above the prices we had in 2010.

Our new unit development target for 2011 is going to accelerate to 95 to 105 new bakery-cafes. Our AWS range for the new units will be the same as it has been for 2010 at $36,000 to $38,000 a week, a level of sales that delivers us our 15% target for fully loaded free cash ROI.

Finally, in terms of uses of cash beyond building as many more high ROI Paneras as we can, we''ll continue to opportunistically look for acquisitions especially our own brand either franchisees or similar soup salad sandwich businesses with strategic fit, such as Paradise. And as we''ve demonstrated this year, we will also continue to return capital opportunistically to our shareholders when we have the chance to buy our stock at levels which provide an appropriate return.

Approximately $448 million is available under our repurchase authorization. Again, we advise against building buyback assumptions into estimates given the variable nature of our buyback activity.

With that operator, we''d now like to turn it over to you for questions. Thanks very much.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, if you would like to ask a question, press star one on your telephone keypad. In the interest of time, please ask just one question. After your question has been answered, if you have an additional question, you may again press star one to re-enter the queue. If you were using a speaker phone, please make sure that your mute function is disengaged to allow your signal to reach our equipment. Again, star one for question and our first question will come from David Tarantino with Robert W. Baird.

David Tarantino – Robert W. Baird & Co.

Hi, good morning. Just a question, Jeff on your 2011 outlook. I''m trying to reconcile your outlook for core operating income growth relative to your long-term targets. It looks like you''re assuming operating income growth near the middle of your long-term target, but also assuming comps maybe slightly above that long-term goal. So just wondering, what is it about 2011 that is hitting the margin line and may be preventing you from getting margin expansion on a mid single-digit type comp number?

Jeffrey W. Kip

I think it, David, it''s a good question first of all, thanks. And then I think essentially what you''re seeing is we are in a pattern of continually making tactical and strategic investments to maintain that long-term earnings growth model. And at times, we may deliver a little more comp than roughly 3% to 4% we said would tie over time and at times, we may deliver a little less and get more margin expansion when we deliver less and less margin expansion when we deliver more.

I think next year we''re a little more loaded with increasing spend. For the full year loyalty program, we''re obviously, as Bill mentioned, raising our media spending and we''ll continue to tactically put money into some infrastructure. And I think it''s a year again where we''ll be a little higher than our standard range on comps and maybe a little lower on the op margin, we''ll get to the same place as we''ve done in many other years in many different ways.

David Tarantino – Robert W. Baird & Co.

Very helpful. Thank you.

Operator

We''ll move on to John Glass with Morgan Stanley.

John Glass – Morgan Stanley

Thanks. I wanted to ask about traffic and loyalty. In the light of flat traffic this quarter where some peers at least had seen some acceleration, clearly consumers better today than they were a year ago. Why do you think absent the increase in loyalty, why you''re only experiencing flat traffic, is there a value question or sort of what your perspective on that is? And then you add loyalty, what is steady straight improvement in traffic? I know you talked about the fourth quarter, but how much better do you think based on early observations do you think you can get as it gets fully rolled out?

William W. Moreton

Hi, John this is Bill. A couple perspectives I think on traffic. First of all, I think that much like comp store sales, you have to look at traffic over a multiple year basis. And if you look at two-year traffic in the third quarter we are at about 1.8% and that very much is in line with our long-term goal of looking to try to do 1% transactions, traffic transaction growth in the long term which we''ve seen very few if anybody do on a sustained basis.

So we actually felt on a two-year basis, we''re right in a good place. As Jeff mentioned, we expect traffic to accelerate in the fourth quarter and go to about 1% to 3% in that quarter, which on a two-year basis would put an implied traffic increase of 4% to 6%. So we actually are feeling very good about where we''re at, it''s in line with our long-term goals and on a two-year basis makes sense.

In terms of loyalty, John, what we''ve seen is, again it''s early in the process, but we think it''s a 2% plus kind of traffic generator. And so we''ll see as it continues to mature and we''re very excited about the program today.

John Glass – Morgan Stanley

Thanks.

William W. Moreton

Sure.

Operator

We move to Sharon Zackfia with William Blair.

Sharon Zackfia – William Blair & Company

Hi, good morning. On the loyalty program, maybe a follow up. I appreciate that you say it takes about 30 to 60 days to kind of get it into full swing. But after that 30 to 60 days, how do you see it ramp? I mean does it get to a level and kind of just stay there in terms of the incremental traffic build? And then the media that you''re doing in the fourth quarter incrementally, is that targeted around the loyalty or is that just increased brand building expenses?

William W. Moreton

Sharon, first in terms -- what you have to realize with the royalty program, it''s very new and it''s just rolling out and so we really don''t have a great deal of history on it. But what some of the indications have seen is that it does -- it ramps up over the first 30 to 60 days and then it''s fairly stable from there and maybe increases a little bit as time goes on.

In terms of the media part of it, certainly will be on the loyalty program, but other pieces of it''ll be promoting the brand in general. As I mentioned, I think that we''re getting a lot closer in our media messaging to not only having calls for action around specific products but we''re starting to put in place some of the key core attributes of Panera around authenticity, fresh dough, made with real bakers and we''re trying to get some of that across as well and you''ll see that in our messaging in media as we go forward through the fourth quarter and the beginning of next year.

Sharon Zackfia – William Blair & Company

Okay. Thank you.

Operator

We go now to Jeffrey Bernstein with Barclays Capital.

Jeffrey Bernstein – Barclays Capital

Great. Thank you very much. Just a question on the unit growth looking at 2011 versus 2010, it seems like it''s an acceleration from the 80 units in 2010. Just wondering whether you can give some color on a couple things. One, the breakdown of the company versus franchise as we look to 2011 and perhaps more broadly on franchise sentiment looking to 2011, it would seem based on the very strong results you''re reporting that the franchisees would be pretty happy with their results and we would expect to see an acceleration in the franchise''s unit growth.

I''m just wondering whether you''re seeing the same thing, if you can kind of gauge franchisees sentiments? I know you made an acquisition of some franchisees and you''re talking about this year being at the low end of the range. So just trying to gauge the appetite for unit growth going into 2011 from a franchisees and their overall health. Thank you.

William W. Moreton

Sure, Jeff I''d make a few comments. First we are seeing-- we''ll see-- we believe we''ll see acceleration both in company and franchise units in 2011. The split is roughly 50/50, maybe slightly more company than franchise but that both of us will accelerate our growth in 2011.

I think that as we''ve said before with the cost environment on both the construction costs and the lease -- and the rental cost continuing to be down from historic norms, 2010 given our new unit average weekly sales and those costs being in line and slightly down from historic norms. We''re going to see some of the highest returning ROI class of new bakery-cafes in our history again in 2010 as we did in 2009.

So I tell you the franchise appetite, they feel very good, we''re very blessed. We only have 38 franchisees, different than a lot of concepts and it''s a real advantage for us. They''re all very well capitalized, bigger organizations, some -- many of them with multiple concepts.

And candidly, Panera is the one that''s performing the best for them, so we do see them committing more capital to it and they''re very comfortable, we just came off a franchise roundtable meeting a few weeks ago and I''ll tell you, they''re very enthusiastic. And I expect that you''ll see acceleration on both sides, company and franchise, as good sites are available, while still holding our disciplines. And that''s where we''re seeing these high returns and you''re seeing these high average weekly sales volumes. Thanks, Jeff.

Jeffrey Bernstein – Barclays Capital

Thank you.

Operator

For our next question, we''ll go to Matt DiFrisco with Oppenheimer.

Matthew DiFrisco – Oppenheimer & Co.

Thank you. A little bit of follow up that, that 38 franchise number, can you just update us when you bought the New Jersey franchise did you take out a franchise guy completely or did you just take a couple of stores? And then also when understanding those type of acquisitions, is there a large part of the corporate outside of the store model coming in i.e. regional guys you''re bringing in or are you pretty much just bringing on the stores on to your balance sheet -- on to your income statement?

Jeffrey W. Kip

So, I think the first question you asked, is did we completely buy out a franchisee and the answer is yes. The gentleman and his family who owned that market are now that in the system as formal franchisees any longer. There''s a full market.

And then secondly, I think you were asking whether we brought in their above store infrastructure. And the answer is mostly, not all of the people came, but you need an above store infrastructure to run the stores. And in fact the significant part of that is actually in the other operating piece of our bakery-cafe P&L, some of it''s in the G&A.

But, yes so we did take on that infrastructure and it''s built into the level of EBITDA. We buy out-- we buy-- when we think about buying we take the store level EBITDA, we net out the loyalty and then we net out the overhead that it''s going to require to run the market effectively as a Panera market. And that''s the EBITDA, we buy the market on. Does that answer your questions?

Matthew DiFrisco – Oppenheimer & Co.

Yes, it does. Thank you.

Jeffrey W. Kip

Great.

William W. Moreton

And I''d just like to add one comment to Jeff''s just more broadly. We''re a system of certain maturity now and there are some franchisees that are replacing their life like the gentlemen that sold the New Jersey cafes that they are wanting to do other things in their life outside the restaurant industry or somewhere else and we have many other franchisees that are very interested in acquiring markets and continuing to grow. So on a total basis we feel very good about the health of our franchise system and their appetite for growth. So we''re in a very fortunate place there.

Operator

We''ll move now to Steve Anderson with Miller Tabak.

Stephen Anderson – Miller Tabak

Good morning. I just wanted to get a little more color on the product distribution program you had mentioned in the third quarter. Is this something we can expect in the quarters to come?

Jeffrey W. Kip

Is that produce distribution, Steve?

Stephen Anderson – Miller Tabak

Produce distribution, that fits, okay.

Jeffrey W. Kip

Yes, it -- that''s a ongoing program and we talked about it in the last quarter, it could built over time so it''s got a higher revenue number which comes into the dough and other product cost of sales at 100% expense margin. Yes, that''s something that we’ll continue.

Stephen Anderson – Miller Tabak

Okay. Thank you.

William W. Moreton

And again the core of the product, or program, Steve is what we''re doing is much as we did with lettuce we''re utilizing our fresh dough facility system and the 20 fresh dough facilities across the country as a distribution arm to be able to take product and get it to the cafes much quicker than we could otherwise going through third parties.

So it really is improving the quality and the taste and we think that''s coming through in both the salads and sandwiches and we''ve got many customer comments to that effect, so we feel very good about that.

Stephen Anderson – Miller Tabak

Thank you.

Operator

We''ll go now to Jason West with Deutsche Bank.

Jason West – Deutsche Bank

Yeah. Thanks. Just a question on the mix outlook for next year, mix has been an important driver of the comps this year. I think a chunk of that has been catering just recovering cyclically. But if you could talk about the outlook away from catering next year and why you expect mix to be flat, is it because you''re -- what you''re promoting or just tough compares? If you could talk about that a bit, thanks.

Jeffrey W. Kip

I think what you''ve seen, is we have had great success in effectively getting our customers to trade up to what our higher ticket items rather than same items higher priced. And we''ve been able to do it by investing in the quality of the ingredients and really, to use Bill''s phrase, we''ve provided a product that people are going to walk past the competitors to buy.

We probably aren''t going to strategically attack our product development program in the same way in the next year. We think we''ve had a tremendous amount of success and really gotten a lot out of getting our customers to upgrade. And our view is that that''s not where the action is right now in terms of growing gross profit in the top line.

Our view is that where the action is right now is really driving a foot traffic in the stores and you see that in the media, loyalty, our operational initiatives and it''s what we''ll do with product development. And at this time we see for next year netting versus a really strong year this year in terms of check growth to kind of net flat. If you looked at check growth on a two-year basis I think you''d see that we''d probably still end up with a pretty good two-year number. And that''s I just think globally how we''re looking at it.

William W. Moreton

Yes, absolutely. Just tacking on to what Jeff said. I mean, Jason, 5% to 6% check growth is really just phenomenal performance. And again we think it''s driven by, as Jeff said, we''re really providing product that our customers -- that is really worth more and they''re willing to pay a little bit more. You''ll see us continue to do some of that next year through the rollout of the steak and our focus on our hot panini sandwiches. But as Jeff said, we think the primary driver next year will be more transactional-based through media and royalty -- and loyalty program. Thanks.

Operator

We''ll take our next question from Mitch Speiser with Buckingham Research.

Mitchell Speiser – Buckingham Research

Thanks. You mentioned drive-thru, can you give us a sense of how they drive-thrus are out there? Are these average weekly sales at the drive-thrus better, and where that opportunity could go over time? Thanks.

William W. Moreton

Yes, sure, Mitch. First of all to give you a couple, excuse me, I''m kind of getting over a little cold here. To give you some statistics, by the end of 2010 we expect to have just under 70 drive-thrus in the system. And we expect going forward that that''ll be a component of our new growth, somewhere in the 20% to 30% range of our new bakery-cafes. And 2011 will be a drive-thrus and we''ll do some retrofits as well.

What we found drive-thru to be, it''s one of the ways that we''re trying to make the customer experience easier at Panera and we find that to be a great convenience play. And it actually increases frequency with some customers and it actually attracts some customers that we wouldn''t ordinarily get that are more drive-thru dependant.

So we''ve seen it to be a great return on investment kind of increase in our driver. We''ve seen when we roll them out that in general the average weekly sales are higher. And certainly on the retrofits, we''ve seen the average weekly sales go up to the point where it provides a great return on that incremental investment.

So it''s something that we''re doing again about 70, just under 70 at the end of 2010, so not a huge piece of our total portfolio but something that we see growing. Because we think we found a way to do it consistent with the Panera concept and quality. We do it such that the drive-thru is not evident when you''re sitting in the bakery-cafes and you don''t see people on headsets running around and a lot of noise and things.

So we''ve been able to walk that tight rope to keep the experience inside the four walls of the bakery-cafe and yet provide a more convenient alternative for many of our customers. So you''ll see it be a part of our portfolio going forward. But again, dimensionally it''s-- we''re just under 70 by the end of this year. Thank you.

Operator

We move now to Steve West with Stifel Nicolaus.

Steven West – Stifel Nicolaus

Hey, guys. Real quick, can you talk about the new unit growth guidance for next year? Your picking up the pace a little bit more at least in absolute terms and I guess how do you get confidence around that number, that''ll be the pretty much the biggest number you''ve put up in since 2006 really since before the recession, excluding kind of Paradise? How confident are you in that number to be able to deliver on that?

William W. Moreton

Well, we gave it to you as guidance, so we have a degree of confidence in the number. I guess what I would say, Steve, it''s -- we would be willing to go faster this year. I think that we''re still getting through this dislocation between the landlords, the lenders and certain of the tenants. I mean, obviously, a big tenant like Blockbuster declaring bankruptcy has a big effect on the market and presents a lot of opportunities.

As I mentioned, given the cost of the construction and the rent, this was a great time to develop the best time. And given our capitalization and our franchisees, we''re very anxious to do it. So what I would tell you is, it really is that dislocation with the landlords and everybody that''s made it a little slower than we thought it might be this year.

But based on the first pass approvals, we have a process we go through so that we have a sense of what our first pass approvals are for next year given the length of the development cycle and we feel very good with that guidance. And we think that the real estate disciplines we put in place really since 2011, have really resulted in these higher average weekly sales volumes that you have seen us produce and really giving us the ability to hone in and make improved real estate decisions.

So we feel very good with our capability to do it both financially, operationally and on the development side and we think we''re putting great tools against it. So we feel confident to give you that as our target for next year.

Operator

We''ll take our next question from Robert Derrington with Morgan Keegan.

Robert Derrington – Morgan Keegan & Company

Yeah. Thank you. A question, Bill, if you could help us think through in the second quarter when you introduce steak to the system, it effects a couple of different things. I heard what you said about trying to keep your check average relatively flat for the most part other than the pricing and the catering. But steak, given what we''ve seen with the commodity appears as though it would be higher and so would have some positive affect on your check average. How does that affect both the check average in the second quarter as well as the cost of sales (inaudible)?

William W. Moreton

Well, what I would say, Rob, I''d give you a couple thought on that. First steak is an example of bringing a premium protein into Panera that we feel our customers will respond very well to. So we''re very excited about bringing that protein in. I would tell you that the costs of the product are already built into to all the guidance that we''ve given you for 2011.

In terms of average check, I want to be clear about this, what we''re doing is, when we think of price, we think that we have some room, a little bit of headroom on price and our ability to do it. We look at more value to the consumer and price is only one part of the total value.

The consumer has been willing to, over the last couple of years with us, pay a little bit higher price for products that are worth it. We certainly think that the steak products that we''re going to rollout will fall into that signature category of ours, Rob. So we think that they will be priced higher to make the proper margins for the cost of the product. We think they''re worth it to the consumer and that we''ll see them to continue to -- we''ll see them buy it to a great extent we expect it to be very popular and very successful. And again that''s how we''ve balanced things.

What we haven''t done is taken just a lot of price increases on the low end. We''ve kind of protected the low end and what we''re doing to get the average check up and the mix up has been to provide products that really are worth the money to our consumers and that''s what we''ve seen, really their buying patterns over the last couple of years. And steak would very much fall into that same category we''d say.

Robert Derrington – Morgan Keegan & Company

That''s great color. Thanks.

William W. Moreton

Thank you.

Operator

Ladies and gentlemen, as a reminder, it is star one, if you would like to ask a question. We go now to Bryan Elliott with Raymond James.

Bryan Elliott – Raymond James

Good morning. Thanks. Bill, I''d like a little bit of maybe drill down on the media spending that you''ve been doing, the more traditional, you''ve talked a lot about the loyalty program, but obviously there''s a lot of traditional testing going on and maybe just drill down a bit on findings and what you''re learning there obviously you''re continuing to go forward with it, so you''re seeing results from it. But just a little additional information there would be helpful.

William W. Moreton

Yes, Bryan, I''ll give you a couple perspectives. As you know, we don''t go very deep into that for competitive reasons so, excuse me, I''m not going to give a lot of specifics. But what I would say to you is a couple things. We continue to experiment with different types of media with television, radio and outdoor. And we really are looking at -- we believe that each market probably has an optimum mix of those medias, so we continue to do that.

As we mentioned on the last call, we''re on television in just over 20 markets. I think it''s 27 markets today. And it''s just a piece of the mix. Digital is also a piece of the media mix that we''re playing with in each of the markets. So we''re looking for the most cost effective that provides the best return of that mix by market.

I would tell you more globally, what we tried to give is a little bit of color in terms of our total spend. And really what we think of media is having kind of an S curve, with a slight flattening at the beginning and then a steep upward and then there is a point at which it has diminishing marginal return.


We think we''re somewhere at the bottom of that S curve. And we have our people, our media buyers with very sophisticated modeling and things and they help us think through that. So I would tell you that if we find that we think we have the opportunity for a period of time, there''s quite a long runway here and that we''re just really in the beginnings of the program trying to optimize the different types of mediums through which you can advertise, and again digital will be a piece of that as well.

And then as I mentioned the key thing is what the messaging is and I think that we''re getting closer and closer to capturing kind of the core message and value of Panera that we think will resonate very much with our consumers and continue to drive the results.

Bryan Elliott – Raymond James

How about any research findings or anything as far as sort of awareness levels, things like that that might have surprised you?

William W. Moreton

No, I mean they''re very much in line. Again, we''re not going to give specifics, but the whole idea behind media to us, Bryan is to drive quality awareness. So everything we''re doing in media is to try to drive that message and we''re seeing results much as we would have expected. But I''m afraid we''re not going to give anymore specifics of that at this time.

Bryan Elliott – Raymond James

All right. Understood. Thanks.

William W. Moreton

Thanks, Bryan.

Operator

We go now to Joe Buckley with Banc of America/Merrill Lynch.

Joseph Buckley – Bank of America/Merrill Lynch

Thank you. Quick question on My Panera. I seem to be echoing, I''ll pick up my handset. Sorry about that. You talk about 80 basis points of margin pressure in the quarter, could you talk about the effect on the ongoing gross profit per transaction from My Panera ?

Jeffrey W. Kip

Sure, Joe. It''s not -- the discounts are netted out of the net sales. So, it''s not really going to have an impact. We -- the program moves a lot differently at different stages, but at steady state, we essentially just see higher frequency from our more frequent, most valuable customers actually and not a material impact on overall check or gross profit per transaction.

Obviously, the discounts are netted out and that''s where the cost is, so. But at the stand alone transaction outside of the rewards, is not impacted.

William W. Moreton

And I''d just like to make a comment. The real value, I mean we''ve been very pleased with the incremental sales lift on the beginnings of the roll out of My Panera. But the real value to us, what we were really after with this program is the data that it provides us. It allows us to really track what customers are doing instead of what they''re telling they''re doing. We can really track that on the credit card and the database.

So we can really see that. And it gets us about as close to one, the ability to market one to one as you can get. We can really look at by individual and with the system that is really quite robust. It allows us the ability to really look at people''s buying patterns, see how we have the ability to change them and really market to them in a way that moves them and their behavior in a way that we''d like them to move between day parts and see if that resonates and within product lines.

So that''s the real value for it. So what I would suggest to you is we really believe loyalty, we''re just scratching the surface of what it can do to us. And we believe that''ll actually be multiple years where we''re really getting the biggest value our of loyalty, that is the data and the ability to market as close to one to one as you can get today. Thanks, Joe.

Joseph Buckley – Bank of America/Merrill Lynch

Thank you.

Operator

We go now to Jake Bartlett with Susquehanna.

Jake Bartlett – Susquehanna International Group

Hello, this is the question for Jeff. I know you''ve been price sensitive in terms of share buybacks. And I''m just wondering sort of what the highest price per share you paid in the quarter, whether you bought any in September? Just trying to get an idea on kind of how price sensitive you all are going forward.

Jeffrey W. Kip

I think I already gave you all the share buyback information on the quarter. We obviously don''t give ranges. We disclose the average price and the number of shares. And we obviously think $78 and change is a good price to buy out and we bought a considerable number of shares there. And our Board reviews and sets the price ranges following every quarter and so actually to be totally honest don''t know what our range is going to be next quarter or in the future.

Jake Bartlett – Susquehanna International Group

Okay. But in your 10-Q, will you be disclosing on a monthly basis?

Jeffrey W. Kip

No.

Jake Bartlett – Susquehanna International Group

Okay. Thanks.

Michele Harrison

And Operator, we noted it''s a little bit after 9:30 so if we could just take maybe the last one or two questions and then close it out.

Operator

Thank you, sir. We''ll go again to Matt DiFrisco with Oppenheimer.

Matthew DiFrisco – Oppenheimer & Co.

Hi. Thank you. I appreciate all the detail you guys have given on the call and I won''t hold you up here, I just wanted one quick detail, if you can give us, on the smoothies you referenced and the strong growth rate you''re seeing there. Can you, I guess, quantify either in percent of sales or dollars roughly what you see on a store basis right now off the smoothies? I want to try to get a better understanding of the potential you''d see there growing forward.

William W. Moreton

Yeah. Matt, yes again, we don''t want to give too much specificity. But we would say the low single-digits in terms of smoothies as a percent of total sales. But with that, we think it''s a category candidly that really helps drive our chill business. So it''s very -- although low single-digits in terms of the total day, it''s been very important to our chill business and driving that business and it''s getting people to really come into Panera and thinking of us in a different way than they had for a different kind of occasion.

So again, we talked about the year-over-year growth. We believe that category will continue to fill out, it''s a category that we believe that we can own that high quality smoothie with real natural yoghurt and things, it''s a real profit generator for us. Thanks.

Matthew DiFrisco – Oppenheimer & Co.

Thank you.

William W. Moreton

Last question, Operator, please

Operator

For our final question, we take a follow up from Steve Anderson with Miller Tabak.

Stephen Anderson – Miller Tabak

Hi. Yes, just a follow up on your 2011 growth plans. Of the 95 to 105 that you plan to open, how many of them do you target for international, specifically Canada?

William W. Moreton

Yeah. Again, we don''t really break out by market, Steve. But a couple of them we would say is Canada. Again, Canada is a market that we think provides good intermediate term growth for Panera and we''re proceeding down that line. But thank you very much.

Stephen Anderson – Miller Tabak

Thank you.

William W. Moreton

And with that, Operator, we''d like to close the call today. But as always, Jeff, Michele and I are available for any of your questions afterwards. Thank you all very much.

Operator

Again, ladies and gentlemen, that does concludes today''s conference. We thank you for your participation.