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Article by DailyStocks_admin    (07-28-08 08:04 AM)

Filed with the SEC from July 16 to July 23:

Panera Bread (PNRA)
Shamrock Activist Value Fund believes the company has "governance deficiencies." Shamrock suggested that the bakery-cafe chain adopt a majority-voting standard for electing directors, replace its staggered board system with annual election of all directors, and convert outstanding shares of multiple-vote Class B common shares into Class A, so that all common shares have the same voting rights. Shamrock said it has had and will have discussions with the company's senior managers and directors on ways to enhance stockholder value. Shamrock owns 1,349,372 shares (4.67% of the total outstanding).

BUSINESS OVERVIEW

General
Panera Bread Company and its subsidiaries may be referred to as the “Company,” “Panera Bread” or in the first person notation of “we,” “us,” and “our” in the following discussion. Further, we use the term “Panera” to refer specifically to our 1,167 system-wide Panera Bread ® and Saint Louis Bread Co. ® bakery-cafes, and the term “Paradise” to refer specifically to the 63 system-wide Paradise Bakery & Café ® bakery-cafes.
As of December 25, 2007, Panera operated, directly and through franchise agreements with 39 franchisee groups, 1,167 bakery-cafes (501 Company-owned and 666 franchise-operated bakery-cafes). During fiscal year 2007, Panera opened 148 bakery-cafes system-wide (79 Company-owned and 69 franchise-operated bakery-cafes), acquired 36 bakery-cafes from its franchisees, closed eight bakery-cafes system-wide (four Company-owned and four franchise-operated bakery-cafes), and sold one Company-owned bakery-cafe to a franchisee. Panera bakery-cafes are principally located in suburban, strip mall, and regional mall locations and currently operate in 38 states. With its identity rooted in handcrafted, fresh-baked, artisan bread, Panera is committed to providing great tasting, quality food that people can trust. Highlighted by antibiotic free chicken, whole grain bread, select organic and all-natural ingredients and a menu free of man-made trans fat, Panera’s bakery-cafe selection provides flavorful, wholesome offerings. Panera’s menu includes a wide variety of year-round favorites, complemented by new items introduced seasonally with the goal of creating new standards in everyday food choices. In neighborhoods across the country, guests enjoy Panera’s warm and welcoming environment featuring comfortable gathering areas, relaxing decor, and free internet access provided through a managed WiFi network. At the close of each day, Panera bakery-cafes donate bread and baked goods to community organizations in need.
On February 1, 2007, we purchased 51 percent of the outstanding capital stock of Paradise, which at that time operated 22 company-owned bakery-cafes and one commissary and 22 franchise-operated bakery-cafes and one commissary. We have the right to purchase the remaining 49 percent of the outstanding capital stock of Paradise after January 1, 2009 at a contractually determined value. Also, if we have not exercised our right to purchase the remaining 49 percent of the outstanding capital stock of Paradise, the remaining Paradise owners have the right to purchase our 51 percent ownership interest in Paradise after June 30, 2009 at a contractually determined value. Paradise owns and franchises bakery-cafes which feature freshly baked products, such as cookies, muffins and croissants, along with gourmet and specialty coffees, as well as sandwiches, soups, salads, beverages and other items. As of December 25, 2007, Paradise operated, directly and through franchise agreements with 10 franchisee groups, 63 bakery-cafes (31 company-owned and 32 franchise-operated bakery-cafes). Paradise bakery-cafes are principally located in regional malls and life style centers, free standing street locations, downtown business districts, and office buildings, and currently operate in 10 states that are principally in different markets than Panera bakery-cafes. Paradise has been expanding the number of bakery-cafes on a limited basis and opened 21 new bakery-cafes system-wide (10 company-owned and 11 franchise-operated bakery-cafes) and closed one company-owned and one franchise-operated bakery-cafe since the February 1, 2007 acquisition. Additionally, Paradise opened one additional franchise-operated commissary in fiscal year 2007.

We operate as three business segments: the Company bakery-cafe operations segment, the franchise operations segment, and the fresh dough operations segment. See Note 19 of our consolidated financial statements for segment information. As of December 25, 2007, our Company bakery-cafe operations segment consisted of 532 Company-owned bakery-cafes, all located in the United States. As of December 25, 2007, our fresh dough operations segment, which supplies fresh dough items daily to most Company-owned and franchise-operated bakery-cafes, consisted of 23 fresh dough facilities (20 Company-owned and three franchise-operated). Our revenues were $1,066.7 million for the fiscal year ended December 25, 2007, consisting of $894.9 million of bakery-cafe sales, $67.2 million of franchise royalties and fees, and $104.6 million of fresh dough sales to franchisees. Franchise-operated bakery-cafe sales were $1,376.4 million for the fiscal year ended December 25, 2007.

Concept and Strategy
Panera’s restaurant concept focuses on the “Specialty Bread/Bakery-Cafe” category. Panera’s artisan breads, which are breads made with all natural ingredients, a craftsman’s attention to quality and detail, and overall award-winning bakery expertise, are at the heart of the menu. The concept is designed to deliver against consumer desire for a more responsive and special dining experience than that offered by traditional fast food restaurants. Panera’s goal is to maintain recognition of Panera as a leading brand. Panera’s menu, prototype, operating systems, design, and real estate strategy allow us to compete successfully in several segments of the restaurant business: breakfast, lunch, PM “chill out,” dinner, or the evening daypart, and take home bread, through both on-premise sales and Via Panera ® catering.
The distinctive nature of Panera’s menu offerings (centered around fresh artisan bread products), the quality of Panera’s bakery-cafe operations, Panera’s signature bakery-cafe design, and the bakery-cafe locations are integral to Panera’s success. We believe Panera’s concept has significant growth potential, which Panera hopes to realize through a combination of Company and franchisee efforts. Franchising is a key component of Panera’s success. Utilization of franchising has enabled Panera to grow more rapidly because of the added resources and capabilities franchisees provide to implement the concepts and strategy developed by Panera Bread. As of December 25, 2007, there were 666 Panera franchised bakery-cafes operating and signed commitments to open an additional 293 Panera franchised bakery-cafes.
Panera believes providing bakery-cafe operators the opportunity to participate in the success of the bakery-cafe enables Panera to attract and retain experienced and highly motivated personnel, referred to as associates, which results in a better customer experience. As a result, Panera’s compensation, subject to annual minimums, provides some general managers and multi-unit managers compensation based upon a percentage of the cash flows of the bakery-cafe they operate and participation in a multi-year bonus structure also based on bakery-cafe cash flow. This compensation structure is referred to as the Joint Venture Program.
Paradise’s concept focuses on broad and diverse products and services that appeal to retail consumers who visit shopping malls, downtown and village office and shopping districts, and other areas where Paradise bakery-cafes are located. Paradise believes its competitive advantages are the high quality of its freshly prepared food products and the exceptional service provided by its associates.
Menu
The menu is designed to provide Panera’s target customers with products that build on the strength of Panera’s bakery expertise. The key menu groups are fresh baked goods, including a variety of freshly baked bagels, breads, muffins, scones, rolls, and sweet goods, made-to-order sandwiches on freshly baked breads, hearty, unique soups, salads, and custom roasted coffees and cafe beverages such as hot or cold espresso and cappuccino drinks. Panera’s concept emphasizes the sophisticated specialty and artisan breads that support each daypart and Panera’s take-home bread and Via Panera ® businesses. In January 2008, our Crispani ® hand-crafted pizza product line is being removed from the Panera system, with the exception of some bakery-cafes, as Panera does not presently believe that Crispani ® will be profit-neutral in 2008.
Panera regularly reviews and revises its menu offerings to satisfy changing customer preferences. Product development focuses on providing food and beverages that customers crave and trust. New menu items are developed in test kitchens and then introduced in a limited number of the bakery-cafes to determine customer response and verify that preparation and operating procedures maintain product consistency and high quality standards. If successful, they are then rolled out system-wide. New product rollouts are integrated into periodic or seasonal menu rotations, which Panera refers to as “Celebrations.” Examples of products introduced by Panera in 2007 include the Grilled Salmon Salad, Strawberry Poppy Seed Salad, Orchard Harvest Salad, Chicken Tomesto Sandwich, Chicken Pomodoro Panini, Chipotle Chicken Sandwich, Creamy Tomato Soup, Southwest Roasted Corn Soup, New England Clam Chowder Soup, Strawberry Fruit Smoothie, Pumpkin Spice Latte, Panettone Bread, New All Natural Muffins (Blueberry, Cranberry, Carrot Walnut, Reduced Fat Blueberry), Pecan Braid, Strawberry Citrus Pastry, Chocolate Crumb Pastry, Caramel Apple Pastry, and the Turkey Sausage Soufflé.
Marketing
Panera believes it competes on the basis of providing an entire experience rather than through price only. Pricing is structured so customers perceive good value with high quality food at reasonable prices to encourage frequent visits. Panera performs extensive market research, including utilizing focus groups, to determine customer food and drink preferences and price points. Panera attempts to increase its per location sales through menu development, product merchandising, and promotions at everyday prices and by sponsorship of local community charitable events.

Panera franchise-operated bakery-cafes contribute 0.7 percent of their sales to a national advertising fund and 0.4 percent of their sales as a marketing administration fee, and are required to spend 2.0 percent of their sales in their respective local markets on advertising. Panera contributes similar amounts from Company-owned bakery-cafes towards the national advertising fund and marketing administration. Panera can increase national advertising fund contributions from current levels up to a total of 2.6 percent of sales. The national advertising fund and marketing administration contributions received from Panera franchise-operated bakery-cafes are consolidated in our financial statements with amounts contributed by Panera. Liabilities for unexpended funds are included in accrued expenses in our Consolidated Balance Sheets. Panera’s contributions to the national advertising fund and marketing administration, as well as Panera’s own media costs, are recorded as part of other operating expenses in the Consolidated Statements of Operations. Panera may utilize external media when deemed appropriate and cost effective in specific markets.
Panera has established and may in the future establish local and/or regional advertising associations covering specific geographic regions for the purpose of promoting and advertising the bakery-cafes located in that geographic market. If Panera establishes an advertising association in a specific market, the franchise group in that market must participate in the association including making contributions in accordance with the advertising association bylaws. Contributions to the advertising association are credited towards required local advertising spending.
Site Selection and Bakery-Cafe Environment
Panera’s bakery-cafe concept relies on a substantial volume of repeat business. In evaluating a potential location, Panera studies the surrounding trade area, demographic information within that area, and information on competitors. Based on this analysis, including utilization of predictive modeling using proprietary software, Panera determines projected sales and return on investment. The Panera concept has proven successful in a number of different types of locations, such as in-line or end-cap locations in strip or power centers, regional malls, and free-standing.
Panera designs each bakery-cafe to provide a distinctive environment, in many cases using fixtures and materials complementary to the neighborhood location of the bakery-cafe to engage customers. Many locations incorporate the warmth of a fireplace and cozy seating areas and groupings which facilitate utilization as a gathering spot. The design visually reinforces the distinctive difference between Panera’s bakery-cafes and other bakery-cafes. Many of Panera’s bakery-cafes also feature outdoor cafe seating and free Internet access through a managed WiFi network. The average construction, equipment, furniture and fixtures, and signage cost for the 79 Panera Company-owned bakery-cafes opened in 2007 was approximately $1.0 million per bakery-cafe.
The average Panera Company-owned bakery-cafe size is approximately 4,600 square feet. Panera leases all of its bakery-cafe locations and fresh dough facilities. Lease terms for Panera’s bakery-cafes and fresh dough facilities are generally ten years with renewal options at most locations, and generally require Panera to pay a proportionate share of real estate taxes, insurance, common area, and other operating costs. Many bakery-cafe leases provide for contingent rental (i.e. percentage rent) payments based on sales in excess of specified amounts. Certain of Panera’s lease agreements provide for scheduled rent increases during the lease terms or for rental payments commencing at a date other than the date of initial occupancy. See Note 2 to the accompanying consolidated financial statements for further information on Panera’s accounting for leases.
Sites for Paradise’s bakery-cafes include regional malls, free standing street locations, downtown business districts, and office buildings. Paradise operates bakery-cafes ranging in size from 800 to 5,600 square feet. The nature of the Paradise bakery-cafes invites shoppers, passers-by and those who live or work in the vicinity to visit for a meal or snack or to arrange a meeting at the bakery-cafe. The Paradise menu is designed for appeal at all hours of the day. The estimated initial investment to commence operation of a Paradise bakery-cafe ranges from $0.5 million to $0.9 million for an 800 square foot bakery-cafe and ranges from $0.9 million to $1.4 million for a 4,500 square foot bakery-cafe.

Franchise Operations
Panera began a broad-based franchising program in 1996. Panera continues to extend its franchise relationships beyond its current franchisees and annually files a Franchise Disclosure Document to facilitate sales of additional franchise and area development agreements, which we refer to as ADAs. The Panera franchise agreement typically requires the payment of a franchise fee of $35,000 per bakery-cafe (generally broken down into $5,000 at the signing of the ADA and $30,000 at or before the bakery-cafe opens) and continuing royalties of 4 to 5 percent of sales from each bakery-cafe. Panera franchise-operated bakery-cafes follow the same standards for in-store operating standards, product quality, menu, site selection, and bakery-cafe construction as do Panera Company-owned bakery-cafes. The franchisees are required to purchase all of their dough products from sources approved by Panera. Panera’s fresh dough facility system supplies fresh dough products to substantially all Panera franchise-operated bakery-cafes. Panera does not finance franchisee construction or ADA payments. In addition, Panera does not hold an equity interest in any of the Panera franchise-operated bakery-cafes.
We have entered into franchise ADAs with 39 Panera franchisee groups, or area developers, as of December 25, 2007. Also, as of December 25, 2007, there were 666 Panera franchise-operated bakery-cafes open and commitments to open 293 additional Panera franchise-operated bakery-cafes. Panera expects these bakery-cafes to open according to the timetables established in the various ADAs with franchisee groups, with the majority opening in the next four to five years. Panera expects its area developers to open approximately 55 new Panera franchise-operated bakery-cafes in 2008. The ADAs require an area developer to develop a specified number of bakery-cafes on or before specific dates. If a franchisee fails to develop bakery-cafes on schedule, Panera has the right to terminate the ADA and develop Company-owned locations or develop locations through new area developers in that market. Panera may exercise one or more alternative remedies to address defaults by area developers, including not only development defaults, but also defaults in complying with Panera’s operating and brand standards and other covenants under the ADAs and franchise agreements. At the present time, Panera does not have any international franchise development agreements.
Paradise, in addition to owning and operating various bakery-cafes, franchises bakery-cafes to operate under its trade name, Paradise Bakery & Café ® . A franchise includes, but is not necessarily limited to, territory rights, trade secrets, a business plan, a system guide and a license to use specified trade names and trademarks and distribute products. Paradise requires an initial franchise fee of up to $60,000 for single bakery-cafe franchises. Paradise offers to certain qualified operators the opportunity to enter into an ADA, which permits a purchaser, upon payment of an area development fee, to obtain the rights to open future bakery-cafes in predetermined areas. Under an ADA, a purchaser generally pays an area development fee of $10,000 to $15,000 for each bakery-cafe to be opened under the ADA and an initial franchise fee of up to $40,000 for each bakery-cafe developed under the ADA. Paradise has entered into franchise agreements with 10 franchisee groups, or area developers, as of December 25, 2007. Also, as of December 25, 2007, there were 32 Paradise franchise-operated bakery-cafes open and commitments to open 10 additional Paradise franchise-operated bakery-cafes. Paradise expects its franchisees to open approximately 5 new Paradise franchise-operated bakery-cafes in 2008.
Bakery-Cafe Supply Chain
Panera bakery-cafes use fresh dough for their artisan and sourdough breads and bagels. Fresh dough is supplied daily to both Panera Company-owned and franchise-operated bakery-cafes by Panera fresh dough facilities, which together are referred to as Panera’s bakery-cafe supply chain. As of December 25, 2007, there were 20 Panera fresh dough facilities, 19 of which were Company-owned and one of which was franchise-operated.
Panera believes its fresh dough facility system provides a competitive advantage. The fresh dough facilities ensure consistent quality and supply of fresh dough products to both Panera Company-owned and franchise-operated bakery-cafes. Panera focuses its growth in areas that allow it to continue to gain efficiencies through leveraging the fixed cost of the fresh dough facility structure. Panera will also selectively enter new markets which requires the construction of additional fresh dough facilities when sufficient numbers of bakery-cafes are opened that permit efficient distribution of the fresh dough. The fresh dough distribution system delivers product daily to bakery-cafes. Distribution is accomplished through a leased fleet of temperature controlled trucks operated by Panera associates. At December 25, 2007, Panera leased 169 trucks. The optimal distribution range is approximately 300 miles; however, when necessary, the distribution ranges may be up to 500 miles. An average distribution route delivers dough to seven bakery-cafes. Panera believes there are numerous suppliers of its needed product ingredients and Panera could obtain ingredients from an alternative supplier if necessary.
Panera has contracted externally for the supply of the remaining baked goods in the bakery-cafes, referred to as sweet goods. Sweet goods products are completed at each bakery-cafe by professionally trained bakers. Completion includes finishing with fresh toppings and other ingredients and baking to established artisan standards.

Panera uses independent distributors to distribute sweet goods products, tuna and other materials to bakery-cafes. With the exception of fresh dough products and the majority of Panera’s cream cheese supplied by the fresh dough facilities, virtually all other food products and supplies for Panera retail operations, including paper goods, coffee, and smallwares, are contracted for by Panera and delivered by vendors to an independent distributor for delivery to the Panera bakery-cafes.
Panera franchise-operated bakery-cafes operate under individual contracts with one of Panera’s distributors. As of December 25, 2007, there were three primary distributors serving the Panera system.
Management Information Systems
Each Panera Company-owned bakery-cafe has computerized point-of-sale registers which collect transaction data used to generate pertinent information, including, among other things, product mix and average check. All product prices are programmed into the point-of-sale register from Panera’s headquarters office. Panera allows franchisees, that elect to do so, access to certain of its proprietary bakery-cafe systems and systems support. Franchisees set their own menu prices.
Panera uses in-store enterprise application tools to assist in labor scheduling and food cost management, to provide corporate and retail operations management quick access to retail data, to allow on-line ordering with distributors, and to reduce managers’ administrative time. The system supplies sales, bank deposit, and variance data to Panera’s accounting department on a daily basis. Panera uses this retail data to generate daily and weekly consolidated reports regarding sales and other key metrics, as well as detailed profit and loss statements for each Panera Company-owned bakery-cafe. Additionally, Panera monitors the average check, customer count, product mix, and other sales trends. Panera also uses this retail data in its “exception-based reporting” tools to safeguard its cash, protect its assets, and train its associates. The Panera fresh dough facilities have computerized systems which accept electronic orders from the bakery-cafes and deliver the ordered product back to the bakery-cafes. Panera also uses an eLearning system and Learning Tools website to provide on-line training for Panera’s retail associates and on-line baking instructions for its bakers.
Most bakery-cafes also provide customers free Internet access provided through a managed WiFi network. As a result, we host one of the largest free public WiFi networks in the country.
Competition
We compete with numerous sources in our trade areas. Our Panera and Paradise bakery-cafes compete with specialty food, casual dining and quick service cafes, bakeries, and restaurant retailers, including national, regional and locally-owned cafes, bakeries, and restaurants. Our bakery-cafes compete based on customers’ needs for breakfast, lunch, PM “chill-out,” dinner, and take home bread. The competitive factors include location, environment, customer service, price and product quality. We compete for leased space in desirable locations. Some of our competitors may have capital resources greater than ours. For further information on competition, see “Item 1A. Risk Factors” in this Form 10-K.
Employees
As of December 25, 2007, Panera had approximately 7,800 full-time associates (defined as associates who average 25 hours or more per week), of whom approximately 500 were employed in general or administrative functions, principally at or from Panera’s support centers or executive offices; approximately 1,000 were employed in Panera’s fresh dough facility operations; and approximately 6,300 were employed in Panera’s bakery-cafe operations as bakers, managers, and associates. Panera also had approximately 14,000 part-time hourly associates at Panera bakery-cafes at December 25, 2007. Panera does not have any collective bargaining agreements with its associates and considers its employee relations to be good. Panera places a priority on staffing its bakery-cafes, fresh dough facilities, and support center operations with skilled associates and invests in training programs to ensure the quality of its operations.
As of December 25, 2007, Paradise had approximately 350 full-time associates, of whom approximately 40 were employed in general or administrative functions; approximately 10 were employed in Paradise’s commissary operations; and approximately 300 were employed in Paradise’s bakery-cafe operations as bakers, managers, and associates. Paradise also had approximately 1,250 part-time hourly associates at Paradise bakery-cafes at December 25, 2007. Paradise does not have any collective bargaining agreements with its associates and considers its employee relations to be good. Paradise places a priority on staffing its bakery-cafes, fresh dough facility, and support operations with skilled associates and invests in training programs to ensure the quality of its operations.

CEO BACKGROUND

Ronald M. Shaich. Mr. Shaich is a co-founder of our company and has served as a director since 1981. Mr. Shaich has also served as Chairman of the Board since May 1999 and as our Chief Executive Officer since May 1997. Mr. Shaich previously served as Co-Chairman of the Board from January 1988 to May 1999 and as Co-Chief Executive Officer from January 1988 to May 1994. Mr. Shaich serves as a director of the non-profit Lown Cardiovascular Research Foundation and as a trustee of the non-profit Rashi School.

Fred K. Foulkes, Ph.D. Dr. Foulkes has served as a director since June 2003. Dr. Foulkes has been a Professor of Organizational Behavior and the director of the Human Resources Policy Institute at Boston University School of Management since 1981 and has taught courses in human resource management and strategic management at Boston University since 1980. From 1968 to 1980, Dr. Foulkes was a member of the Harvard Business School faculty. Dr. Foulkes serves on the Board of Directors and is Chair of the Compensation Committee of Bright Horizons Family Solutions, a provider of employer-sponsored child care, early education and work/life consulting services.

Domenic Colasacco. Mr. Colasacco has served as a director since March 2000 and as Lead Independent Director since January 2008. Mr. Colasacco has been President and Chief Executive Officer of Boston Trust & Investment Management, a banking and trust company providing fiduciary and investment management services, since 1992. Mr. Colasacco joined Boston Trust in 1974 after beginning his career in the research division of Merrill Lynch & Co. in New York City.

W. Austin Ligon. Mr. Ligon has served as a director since January 2008. Mr. Ligon is a co-founder of CarMax, Inc., a national retailer of used cars, and served as CarMax’s President from 1995 until June 2006 and its Chief Executive Officer from October 2002 to June 2006. Prior to CarMax, Mr. Ligon held a number of senior planning positions at Circuit City from 1991 to 1995, including Senior Vice President of Corporate Planning and Senior Vice President-Automotive. Mr. Ligon is a member of the advisory board of the Center for Talented Youth, Johns Hopkins University, the Yale School of Management and the University of Virginia, Board of Visitors.

Larry J. Franklin. Mr. Franklin has served as a director since June 2001. Mr. Franklin has been the President and Chief Executive Officer of Franklin Sports, Inc., a branded sporting goods manufacturer and marketer, since 1986. Mr. Franklin joined Franklin Sports, Inc. in 1970 and served as its Executive Vice President from 1981 to 1986. Mr. Franklin currently serves on the Board of Directors of Bradford Soap International, Inc., a private manufacturer of private label soaps.

Charles J. Chapman, III. Mr. Chapman has served as a director since January 2008. Mr. Chapman has been the Chief Operating Officer of American Dairy Queen Corporation, a leading franchisor of quick service restaurants and wholly-owned subsidiary of Berkshire-Hathaway, since October 2005. From January 2001 to October 2005, Mr. Chapman held a number of senior positions at American Dairy Queen. Prior to joining American Dairy Queen, Mr. Chapman served as Chief Operating Officer of Bruegger’s Bagels, Inc. and President and co-owner of a Bruegger’s franchise, Beantown Bagels, and held marketing and operations positions with Darden Restaurants. Mr. Chapman began his career as a consultant at Bain & Company.

George E. Kane. Mr. Kane has served as our Director Emeritus since May 2004. Mr. Kane served as a director from November 1988 to May 2004. Mr. Kane was also one of our directors from December 1981 to December 1985 and a Director Emeritus from December 1985 to November 1988. Mr. Kane retired in 1970 as President of Garden City Trust Company (now University Trust Company) and served as an Honorary Director of University Trust Company from December 1985 to January 2000.


MANAGEMENT DISCUSSION FROM LATEST 10K

General
In fiscal year 2007, we earned $1.79 per diluted share with the following performance on key metrics: system-wide comparable bakery-cafe sales growth of 1.6 percent (1.9 percent for Company-owned bakery-cafes and 1.5 percent for franchise-operated bakery-cafes); system-wide average weekly sales declined 1.2 percent to $38,668 ($37,548 for Company-owned bakery-cafes and $39,433 for franchise-operated bakery-cafes); and 169 new bakery-cafes opened system-wide, including 89 Company-owned bakery-cafes and 80 franchise-operated bakery-cafes. Additionally, 36 bakery-cafes were acquired by the Company from franchisees, one bakery-cafe was sold by the Company to a franchisee, and 10 bakery-cafes were closed system-wide, including five Company-owned bakery-cafes and five franchise-operated bakery-cafes. Further, on February 1, 2007, we purchased 51 percent of the outstanding stock of Paradise Bakery & Café, Inc., referred to as Paradise, then owner and operator of 22 bakery-cafes and one commissary and franchisor of 22 bakery-cafes and one commissary. The fiscal 2007 results of $1.79 per diluted share also included charges totaling $0.03 per diluted share, which is comprised of a write-down of our investment in the Columbia Strategic Cash Portfolio of $0.02 per diluted share and a charge of $0.01 per diluted share related to the discontinuation of our Crispani ® product line. See “Reconciliation of Non-GAAP Measurements to GAAP Results” later in this section in this Form 10-K.

In fiscal year 2006, we earned $1.84 per diluted share with the following system-wide performance on key metrics: comparable bakery-cafe sales growth of 4.1 percent (3.9 percent for Company-owned bakery-cafes and 4.1 percent for franchise-operated bakery-cafes); system-wide average weekly sales of $39,150 ($37,833 for Company-owned bakery-cafes and $39,894 for franchise-operated bakery-cafes); and 155 new bakery-cafes opened system-wide, including 70 Company-owned bakery-cafes and 85 franchise-operated bakery-cafes. The fiscal 2006 results of $1.84 per diluted share also included a charge of $0.03 per diluted share related to the acquisition of Paradise. See “Reconciliation of Non-GAAP Measurements to GAAP Results” later in this section in this Form 10-K.
In fiscal year 2005, we earned $1.65 per diluted share with the following system-wide performance on key metrics: comparable bakery-cafe sales growth of 7.8% (comparable bakery-cafe sales growth of 7.4% for Company-owned bakery-cafes and 8.0% for franchise-operated bakery-cafes), system-wide average weekly sales of $38,318 ($37,348 for Company-owned bakery-cafes and $38,777 for franchise-operated bakery-cafes), and 139 new bakery-cafes opened system-wide, including 66 Company-owned bakery-cafes and 73 franchise-operated bakery-cafes. The fiscal 2005 results of $1.65 per diluted share do not include stock-based compensation expense of $0.13 per diluted share because SFAS No. 123R, Accounting for Stock-based Compensation, did not require the expensing of stock options in fiscal 2005. See “Reconciliation of Non-GAAP Measurements to GAAP Results” later in this section in this Form 10-K.
We include in this report information on Company, franchisee and/or system-wide comparable bakery-cafe sales percentages. Franchise-operated and system-wide comparable bakery-cafe sales percentages are non-GAAP measures, which should not be considered in isolation or as a substitute for other measures of performance prepared in accordance with Generally Accepted Accounting Principles, or GAAP, and may not be comparable to system-wide comparable bakery-cafe sales as defined or used by other companies. We do not record franchise-operated bakery-cafe sales as revenues. However, royalty revenues are calculated based on a percentage of franchise-operated bakery-cafe sales, as reported by franchisees. We use franchise-operated and system-wide sales information internally in connection with store development decisions, planning, and budgeting analyses. We believe franchise-operated and system-wide sales information is useful in assessing consumer acceptance of our brand, facilitates an understanding of financial performance and the overall direction and trends of sales and operating income, helps us appreciate the effectiveness of our advertising and marketing initiatives to which our franchisees contribute based on a percentage of their sales, and provides information that is relevant for comparison within the industry.
Our revenues are derived from Company-owned bakery-cafe sales, fresh dough sales to franchisees, and franchise royalties and fees. Fresh dough sales to franchisees are primarily the sales of dough products and sales of tuna and cream cheese to certain of our franchisees. Franchise royalties and fees include royalty income and franchise fees. The cost of food and paper products, labor, occupancy, and other operating expenses relate primarily to Company-owned bakery-cafe sales. The cost of fresh dough sales relates primarily to the sale of fresh dough products and tuna and cream cheese to franchisees. General and administrative, depreciation and amortization, and pre-opening expenses relate to all areas of revenue generation.
In fiscal 2006, we adopted a new quarterly fiscal calendar whereby each of our quarters include 13 weeks (4 week, 5 week, and 4 week period progressions in each quarter), rather than our prior quarterly fiscal calendar which had 16 weeks in the first quarter and 12 weeks in the second, third, and fourth quarters (4 week period progressions in each quarter).
In fiscal year 2005, we changed our fiscal week to end on Tuesday rather than Saturday, with our fiscal year ending on the last Tuesday in December. This change allowed us to better serve customers by shifting the weekly closing activities to a less busy day of the week. As a result, our 2005 fiscal year ended on December 27, 2005 instead of December 31, 2005 and, therefore, consisted of fifty-two and a half weeks rather than the fifty-three week year that would have resulted without the calendar change. These additional three days in fiscal year 2005 did not have a material impact on our financial statements. As a result of this calendar change, the next fifty-three week fiscal year will occur in fiscal year 2008.

Company-owned comparable bakery-cafe sales percentages are based on sales from bakery-cafes that have been in operation and Company-owned for at least 18 months. Franchise-operated comparable bakery-cafe sales percentages are based on sales from franchised bakery-cafes, as reported by franchisees, that have been in operation and franchise-operated for at least 18 months. Both Company-owned and franchise-operated comparable bakery-cafe sales exclude closed locations. System-wide comparable bakery-cafe sales percentages are based on sales at both Company-owned and franchise-operated bakery-cafes.
Reconciliation of Non-GAAP Measurements to GAAP Results
We include in this report information on Company, franchisee and/or system-wide comparable bakery-cafe sales percentages. Franchise-operated and system-wide comparable bakery-cafe sales percentages are non-GAAP measures, which should not be considered in isolation or as a substitute for other measures of performance prepared in accordance with GAAP and may not be comparable to system-wide comparable bakery-cafe sales as defined or used by other companies. We do not record franchise-operated bakery-cafe sales as revenues. However, royalty revenues are calculated based on a percentage of franchise-operated bakery-cafe sales, as reported by franchisees. We use franchise-operated and system-wide sales information internally in connection with bakery-cafe development decisions, planning, and budgeting analyses. We believe franchise-operated and system-wide sales information is useful in assessing consumer acceptance of our brand, facilitates an understanding of financial performance and the overall direction and trends of sales and operating income, helps us appreciate the effectiveness of our advertising and marketing initiatives to which our franchisees contribute based on a percentage of their sales, and provides information that is relevant for comparison within the industry.
In addition to the results provided in accordance with GAAP throughout this report, we have also provided certain non-GAAP measurements to exclude the impact of certain one-time charges on the fiscal 2007 and 2006 results and to conform 2005 results to the 2006 and 2007 presentation related to our stock-based compensation expense. The fiscal 2007 one-time charges totaled $0.03 per diluted share, which included a write-down of our investment in the Columbia Strategic Cash Portfolio of $0.02 per diluted share and a charge of $0.01 per diluted share related to the discontinuation of our Crispani ® product line. The fiscal 2006 results include a one-time charge of $0.03 per diluted share related to the Paradise acquisition. Effective December 28, 2005, the beginning of our first quarter of 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Accounting for Stock-based Compensation , which required all stock-based compensation, including grants of employee stock options to be recognized in the Consolidated Statements of Operations based on their fair values. We adopted this accounting treatment using the modified prospective transition method, as permitted under SFAS No. 123R; therefore, results for prior periods have not been restated. Prior to the adoption of SFAS No. 123R, we accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , and related interpretations. Accordingly, stock-based compensation was included as pro forma disclosure in the financial statement footnotes.
We are providing the table below because management believes it provides useful information to investors regarding our results of operations by providing current and prior reported amounts on a comparable basis. The non-GAAP net income and diluted earnings per share amounts of $58.5 million and $1.82, respectively, for the fiscal year ended December 25, 2007; $59.9 million and $1.87, respectively, for the fiscal year ended December 26, 2006; and $48.1 million and $1.52, respectively, for the fiscal year ended December 27, 2005 are considered “non-GAAP financial measures” under applicable SEC rules because they are adjusted to exclude certain one-time charges in fiscal 2007 and 2006 and to include stock-based compensation expense in fiscal 2005, which are not included in the directly comparable measures calculated in accordance with GAAP. These non-GAAP financial measures are not a substitute for the reported GAAP measures. The adjustments for these one-time charges and adjustment for stock-based compensation expense had the following effect on reported amounts (in thousands, except earnings per share):

Results of Operations
Fiscal Year 2007 Compared to Fiscal Year 2006
Revenues
Total revenues for the fiscal year ended December 25, 2007 increased 28.7 percent to $1,066.7 million compared to $829.0 million for the fiscal year ended December 26, 2006. The growth in total revenue for the fiscal year ended December 25, 2007 compared to the prior year is primarily due to the opening of 169 new bakery-cafes system-wide in 2007, the acquisition of 44 system-wide bakery-cafes on February 1, 2007 as a result of the purchase of 51 percent of the outstanding stock of Paradise, and the increase in system-wide comparable bakery-cafe sales for the fiscal year ended December 25, 2007 of 1.6 percent.

Average weekly sales is calculated by dividing total net sales by operating weeks. Accordingly, year-over-year results reflect sales for all locations, whereas comparable store sales exclude closed locations and are based on sales for bakery-cafes that have been in operation and owned for at least 18 months. New stores typically experience an opening “honeymoon” period whereby they generate higher average weekly sales during the first 12 to 16 weeks they are open as customers “settle-in” to normal usage patterns from initial trial of the location. On average, the “settle-in” experienced is 5 percent to 10 percent from the average weekly sales during the “honeymoon” period. As a result, year-over-year results of average weekly sales is generally lower than the results in comparable bakery-cafe sales. This results from the relationship of the number of bakery-cafes in the “honeymoon” phase, the number of bakery-cafes in the “settle-in” phase, and the number of stores in the comparable store base.
Bakery-cafe sales for the fiscal year ended December 25, 2007 increased 34.3 percent to $894.9 million compared to $666.1 million for the fiscal year ended December 26, 2006. The increase in bakery-cafe sales for the fiscal year ended December 25, 2007 compared to the prior fiscal year is primarily due to the impact of a full year’s operations of the 70 Company-owned bakery-cafes opened in 2006, the opening of 89 new Company-owned bakery-cafes, the acquisition of 36 bakery-cafes from franchisees in 2007, and to a lesser extent the 1.9 percent increase in comparable Company-owned bakery-cafe sales for the fiscal year ended December 25, 2007. Bakery-cafe sales were also positively impacted by revenues from the 22 Paradise company-owned bakery-cafes acquired on February 1, 2007 and consolidated into our results prospectively from the acquisition date. In total, Company-owned bakery-cafe sales as a percentage of total revenue increased by 3.5 percentage points to 83.9 percent for the fiscal year ended December 25, 2007 as compared to 80.4 percent in the prior fiscal year. Bakery-cafes included in comparable sales increases and not included in comparable sales increases consisted of 4.8 percent and 95.2 percent, respectively, of the $228.8 million increase in sales from the prior fiscal year. In addition, average weekly sales for Company-owned bakery-cafes for the fiscal year ended December 25, 2007 decreased as compared to the prior year primarily due to the growth of bakery-cafes opened three years or fewer as a percentage of total bakery-cafes opened, which experience a slower initial ramp-up of average weekly sales; due to lower average weekly sales for bakery-cafes opened in 2007, which averaged $33,835 for fiscal year 2007 driven by the greater concentration of Company-owned bakery-cafe openings in immature markets; and due to lower year-over-year sales price increases in our Company-owned bakery-cafes in 2007 as compared to 2006. The average weekly sales per Company-owned bakery-cafe and the related number of operating weeks for the periods indicated are as follows:

The increase in royalty revenue for the fiscal year ended December 25, 2007 compared to the prior fiscal year can be attributed to the impact of a full year’s operations of the 85 franchise-operated bakery-cafes opened in 2006, the opening of 80 franchise-operated bakery-cafes and to a lesser extent the purchase of one bakery-cafe from the Company in 2007 and the 1.5 percent increase in comparable franchise-operated bakery-cafe sales for the fiscal year ended December 25, 2007. Franchise royalties and fees were also positively impacted by the consolidation of royalties and fees from the 22 Paradise franchise-operated bakery-cafes acquired on February 1, 2007 and included in our results prospectively from the acquisition date and partially offset by the sale of 36 bakery-cafes by franchisees to the Company in fiscal year 2007. Franchise-operated bakery-cafes included in comparable sales increases and not included in comparable sales increases contributed 12.3 percent and 87.7 percent, respectively, of the $131.0 million increase in sales from the prior fiscal year. Further, our franchise royalties have been negatively impacted by this trend of decreasing average weekly sales experienced in fiscal 2007.

As of December 25, 2007, there were 698 franchise-operated bakery-cafes open and commitments to open 303 additional franchise-operated bakery-cafes. We expect these bakery-cafes to open according to the timetables established in the various Area Development Agreements, referred to as ADAs, with franchisees, with the majority opening in the next four to five years. In 2008, we expect our area developers to open approximately 60 new franchise-operated bakery-cafes. The ADA requires a franchisee to develop a specified number of bakery-cafes on or before specific dates. If a franchisee fails to develop bakery-cafes on schedule, we have the right to terminate the ADA and develop Company-owned locations or develop locations through new area developers in that market. We may exercise one or more alternative remedies to address defaults by area developers, including not only development defaults, but also defaults in complying with our operating and brand standards and other covenants under the ADAs and franchise agreements.
Fresh dough sales to franchisees for the fiscal year ended December 25, 2007 increased 3.3 percent to $104.6 million compared to $101.3 million for the fiscal year ended December 26, 2006. The increase in fresh dough sales to franchisees was primarily driven by the previously described increased number of franchise-operated bakery-cafes opened and the purchase of one bakery-cafe from the Company since the prior fiscal year, partially offset by lower overall dough sales resulting from a shift in bakery-cafe menu mix away from the bread and bagels we self-manufacture in our fresh dough facilities.

Costs and Expenses
The cost of food and paper products includes the costs associated with the fresh dough operations that sell fresh dough products to Company-owned bakery-cafes, as well as the cost of food and paper products supplied by third party vendors and distributors. The costs associated with the fresh dough operations that sell fresh dough products to the franchise-operated bakery-cafes are excluded and are shown separately as fresh dough cost of sales to franchisees in the accompanying Consolidated Statements of Operations. The cost of food and paper products was $277.7 million, or 31.0 percent of bakery-cafe sales, for the fiscal year ended December 25, 2007, compared to $197.2 million or 29.6 percent of bakery-cafe sales, for the fiscal year ended December 26, 2006. This increase in the cost of food and paper products as a percentage of bakery-cafe sales between the 2007 and 2006 fiscal years was primarily due to commodity pressures from items such as wheat, dairy, gasoline and proteins, coupled with general inflationary cost pressures, which outpaced the increase in sales prices over the same fiscal years; a shift in consumer demand to products involving higher ingredient costs; and a modest shift in mix away from bakery-cafe related products such as breads and bagels, which we self-manufacture in our fresh dough facilities, towards baked and sweet goods such as soufflés, scones and muffins, which are produced through a contract manufacturer. Partially offsetting these cost pressures was improved leverage of our fresh dough manufacturing costs due to additional bakery-cafes opening. For the fiscal year ended December 25, 2007, there was an average of 55.8 bakery-cafes per fresh dough facility compared to an average of 50.7 for the prior fiscal year.
Labor expense was $286.2 million, or 32.0 percent of bakery-cafe sales, for the fiscal year ended December 25, 2007 compared to $205.0 million, or 30.8 percent of bakery-cafe sales, for the fiscal year ended December 26, 2006. The labor expense as a percentage of bakery-cafe sales increased between the 2007 and 2006 fiscal years primarily as a result of the additional labor required in our bakery-cafes in support of our evening daypart initiative launched in the third quarter of fiscal year 2006, higher bakery-cafe labor in conjunction with the roll-out of certain operational improvement initiatives focusing on our lunch daypart, and general inflationary cost pressures, which outpaced the increase in sales prices over the same fiscal years.
Occupancy cost was $70.4 million, or 7.9 percent of bakery-cafe sales, for the fiscal year ended December 25, 2007 compared to $48.6 million, or 7.3 percent of bakery-cafe sales, for the fiscal year ended December 26, 2006. The increase in occupancy cost as a percentage of bakery-cafe sales between the 2007 and 2006 fiscal years was primarily due to higher average per square foot costs in newer markets outpacing the growth in sales in 2007.
Other operating expenses of $121.3 million, or 13.6 percent of bakery-cafe sales, for the fiscal year ended December 25, 2007 remained consistent with the fiscal year ended December 26, 2006 of $92.2 million, or 13.8 percent of bakery-cafe sales.
Fresh dough facility cost of sales to franchisees was $86.6 million, or 82.8 percent of fresh dough facility sales to franchisees, for the fiscal year ended December 25, 2007, compared to $85.6 million, or 84.5 percent of fresh dough facility sales to franchisees, for the fiscal year ended December 26, 2006. The decrease in the fresh dough facility cost of sales rate for fiscal year 2007 compared to fiscal year 2006 was primarily due to improved operating efficiencies in the fresh dough facilities as average bakery-cafes served per fresh dough facility has continued to increase in 2007 as compared to 2006, partially offset by modestly unfavorable input costs.
General and administrative expenses was $69.0 million, or 6.5 percent of total revenue, for the fiscal year ended December 25, 2007 and $59.3 million, or 7.2 percent of total revenue, for the fiscal year ended December 26, 2006. The decrease in the general and administrative expenses rate between the 2007 and 2006 fiscal years were primarily due to disciplined expense management, leverage from sales growth, and lower incentive bonus expense as a result of weaker corporate performance. Partially offsetting the decrease in the general and administrative expenses rate between the 2007 and 2006 fiscal years were a $0.8 million charge incurred in the fourth quarter of 2007 for purchase commitments and equipment related to our Crispani ® hand-crafted pizza product that Panera will no longer utilize as a result of the decision to discontinue this product in the majority of our markets beginning in early 2008.
Other Income and Expense
Other income and expense for the fiscal year ended December 25, 2007 decreased to $0.3 million of expense, or less than 0.1 percent of total revenue, from $2.0 million of income, or 0.2 percent of total revenue, for the fiscal year ended December 26, 2006. The decrease in other income and expense for fiscal year 2007 compared to fiscal year 2006 was primarily from lower interest income in 2007 resulting from lower cash and investments on-hand in 2007; a charge of approximately $0.2 million in the first quarter of 2007 stemming from the Paradise acquisition; a charge of approximately $1.1 million in the second quarter of 2007 relating to the termination of franchise agreements for certain acquired franchise-operated bakery-cafes that operated at a royalty rate lower that the current market royalty rates; and a charge of approximately $1.0 million in the fourth quarter of 2007 relating to an unrealized loss on our investment in the Columbia Strategic Cash Portfolio, or the Columbia Portfolio, as a result of adverse market conditions that unfavorably affected the fair value and liquidity of collateral underlying the Columbia Portfolio. Partially offsetting these items was a $0.5 million gain from the sale of a bakery-cafe to a franchisee in the second quarter of 2007. See Note 3 to the accompanying consolidated financial statements for further information with respect to the acquisition charges and gain on sale of the bakery-cafe and Note 4 for further discussion regarding the Columbia Portfolio. Other income and expense in fiscal year 2006 primarily included interest income and $1.5 million of charges associated with the Paradise acquisition.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations
The following table sets forth the percentage relationship to total revenues, except where otherwise indicated, of certain items included in the accompanying Consolidated Statements of Operations for the periods indicated.

Company-owned comparable bakery-cafe sales percentages are based on sales from bakery-cafes that have been in operation and Company-owned for at least 18 months. Franchise-operated comparable bakery-cafe sales percentages are based on sales from franchised bakery-cafes that have been in operation and franchise-operated for at least 18 months. Both Company-owned and franchise-operated comparable bakery-cafe sales exclude closed locations.
Revenues
Total revenues for the thirteen weeks ended September 25, 2007 increased 33.3 percent to $273.2 million compared to $205.0 million for the thirteen weeks ended September 26, 2006. The growth in total revenue for the thirteen weeks ended September 25, 2007 compared to the same period in 2006 is primarily due to the opening of 157 new bakery-cafes system-wide since September 26, 2006, the acquisition of 44 system-wide bakery-cafes on February 1, 2007 as a result of the purchase of 51 percent of the outstanding stock of Paradise, and the increase in system-wide comparable bakery-cafe sales for the thirteen weeks ended September 25, 2007 of 2.6 percent.

Total revenues for the thirty-nine weeks ended September 25, 2007 increased 28.5 percent to $765.8 million compared to $596.1 million for the thirty-nine weeks ended September 26, 2006. The growth in total revenue for the thirty-nine weeks ended September 25, 2007 compared to the same period in 2006 is primarily due to the opening of 157 new bakery-cafes system-wide since September 26, 2006, the acquisition of 44 system-wide bakery-cafes on February 1, 2007 as a result of the purchase of 51 percent of the outstanding stock of Paradise, and the increase in system-wide comparable bakery-cafe sales for the thirty-nine weeks ended September 25, 2007 of 1.6 percent.

Average weekly sales is calculated by dividing total net sales by operating weeks. Accordingly, year-over-year results reflect sales for all locations, whereas comparable store sales exclude closed locations and are based on sales for bakery-cafes that have been in operation and owned for at least 18 months. New stores typically experience an opening “honey-moon” period whereby they generate higher average weekly sales during the first 12 to 16 weeks they are open as customers “settle-in” to normal usage patterns from initial trial of the location. On average, the “settle-in” experienced is 5 percent to 10 percent from the average weekly sales during the “honey-moon” period. As a result, year-over-year results of average weekly sales is generally lower than the results in comparable bakery-cafe sales. This results from the relationship of the number of bakery-cafes in the “honey-moon” phase, the number of bakery-cafes in the “settle-in” phase, and the number of stores in the comparable store base.
Bakery-cafe sales for the thirteen weeks ended September 25, 2007 increased 40.6 percent to $232.2 million compared to $165.1 million for the thirteen weeks ended September 26, 2006. The increase in bakery-cafe sales for the thirteen weeks ended September 25, 2007 compared to the same period in 2006 is primarily due to the opening of 76 new Company-owned bakery-cafes and the acquisition of 49 bakery-cafes from franchisees since September 26, 2006. Bakery-cafe sales were also positively impacted by revenues from the 22 Paradise company-owned bakery-cafes acquired on February 1, 2007 and consolidated into our results prospectively from the acquisition date. In total, Company-owned bakery-cafe sales as a percentage of total revenue increased by 4.5 percentage points to 85.0 percent for the thirteen weeks ended September 25, 2007 as compared to 80.5 percent for the same period in 2006. Bakery-cafes included in comparable sales increases and not included in comparable sales increases consisted of 7.5 percent and 92.5 percent, respectively, of the $67.1 million increase in sales from the comparable period in 2006. In addition, average weekly sales for Company-owned bakery-cafes for the thirteen weeks ended September 25, 2007 increased modestly as compared to the same period in 2006 but lagged the increase in comparable bakery-cafe sales for the same comparative periods primarily due to the greater concentration of Company-owned bakery-cafe openings in immature markets, which experience a slower initial ramp-up of average weekly sales.

Bakery-cafe sales for the thirty-nine weeks ended September 25, 2007 increased 33.9 percent to $639.0 million compared to $477.3 million for the thirty-nine weeks ended September 26, 2006. The increase in bakery-cafe sales for the thirty-nine weeks ended September 25, 2007 compared to the same period in 2006 is primarily due to the opening of 76 new Company-owned bakery-cafes and the acquisition of 49 bakery-cafes from franchisees since September 26, 2006. Bakery-cafe sales were also positively impacted by revenues from the 22 Paradise company-owned bakery-cafes acquired on February 1, 2007 and consolidated into our results prospectively from the acquisition date. In total, Company-owned bakery-cafe sales as a percentage of total revenue increased by 3.3 percentage points to 83.4 percent for the thirty-nine weeks ended September 25, 2007 as compared to 80.1 percent for the same period in 2006. Bakery-cafes included in comparable sales increases and not included in comparable sales increases consisted of 4.1 percent and 95.9 percent, respectively, of the $161.7 million increase in sales from the comparable period in 2006. In addition, average weekly sales for Company-owned bakery-cafes for the thirty-nine weeks ended September 25, 2007 decreased as compared to the same period in 2006 primarily due to the greater concentration of Company-owned bakery-cafe openings in immature markets, which experience a slower initial ramp-up of average weekly sales, coupled with lower year-over-year sales price increases in our Company-owned bakery-cafes in 2007 as compared to 2006.

The increase in royalty revenue for the thirteen weeks ended September 25, 2007 compared to the same period in 2006 can be attributed to the opening of 81 franchise-operated bakery-cafes and the purchase of one bakery-cafe from the Company since September 26, 2006 and to a lesser extent the 2.1 percent increase in comparable franchise-operated bakery-cafe sales for the thirteen weeks ended September 25, 2007. Franchise royalties and fees were also positively impacted by the consolidation of royalties and fees from the 22 Paradise franchise-operated bakery-cafes acquired on February 1, 2007 and included in our results prospectively from the acquisition date and partially tempered by the sale of 49 bakery-cafes by franchisees to the Company since September 26, 2006. Franchise-operated bakery-cafes included in comparable sales increases and not included in comparable sales increases contributed 21.1 percent and 78.9 percent, respectively, of the $27.2 million increase in sales from the comparable period in 2006.

The increase in royalty revenue for the thirty-nine weeks ended September 25, 2007 compared to the same period in 2006 can be attributed to the opening of 81 franchise-operated bakery-cafes and the purchase of one bakery-cafe from the Company since September 26, 2006 and to a lesser extent the 1.6 percent increase in comparable franchise-operated bakery-cafe sales for the thirty-nine weeks ended September 25, 2007. Franchise royalties and fees were also positively impacted by the consolidation of royalties and fees from the 22 Paradise franchise-operated bakery-cafes acquired on February 1, 2007 and included in our results prospectively from the acquisition date and partially tempered by the sale of 49 bakery-cafes by franchisees to the Company since September 26, 2006. Franchise-operated bakery-cafes included in comparable sales increases and not included in comparable sales increases contributed 12.1 percent and 87.9 percent, respectively, of the $104.8 million increase in sales from the comparable period in 2006.

As of September 25, 2007, there were 675 franchise-operated bakery-cafes open and commitments to open 323 additional franchise-operated bakery-cafes. We expect these bakery-cafes to open according to the timetables established in the various Area Development Agreements, referred to as ADAs, with franchisees, with the majority opening in the next four to five years. In 2007, we expect our area developers to open 76 to 79 new franchise-operated bakery-cafes. The ADA requires a franchisee to develop a specified number of bakery-cafes on or before specific dates. If a franchisee fails to develop bakery-cafes on schedule, we have the right to terminate the ADA and develop Company-owned locations or develop locations through new area developers in that market. We may exercise one or more alternative remedies to address defaults by area developers, including not only development defaults, but also defaults in complying with our operating and brand standards and other covenants under the ADAs and franchise agreements.
Fresh dough sales to franchisees for the thirteen weeks ended September 25, 2007 remained consistent at $24.7 million as compared to the thirteen weeks ended September 26, 2006. Fresh dough sales to franchisees for the thirty-nine weeks ended September 25, 2007 increased 4.7 percent to $77.3 million compared to $73.8 million for the thirty-nine weeks ended September 26, 2006. The increase in fresh dough sales to franchisees was primarily driven by the previously described increased number of franchise-operated bakery-cafes opened and the purchase of one bakery-cafe from the Company since September 26, 2006, partially tempered by the sale of 49 bakery-cafes by franchisees to the Company since September 26, 2006 and lower overall dough sales resulting from a shift in bakery-cafe menu mix away from the bread and bagels we self-manufacture in our fresh dough facilities.
Costs and Expenses
The cost of food and paper products includes the costs associated with the fresh dough operations that sell fresh dough products to Company-owned bakery-cafes, as well as the cost of food and paper products supplied by third-party vendors and distributors. The costs associated with the fresh dough operations that sell fresh dough products to the franchise-operated bakery-cafes are excluded and are shown separately as fresh dough cost of sales to franchisees in the accompanying Consolidated Statements of Operations. The cost of food and paper products was $75.0 million, or 32.3 percent of bakery-cafe sales, for the thirteen weeks ended September 25, 2007 compared to $50.0 million, or 30.3 percent of bakery-cafe sales, for the thirteen weeks ended September 26, 2006. The cost of food and paper products was $200.2 million, or 31.3 percent of bakery-cafe sales, for the thirty-nine weeks ended September 25, 2007 compared to $141.9 million, or 29.7 percent of bakery-cafe sales, for the thirty-nine weeks ended September 26, 2006. This increase in the cost of food and paper products as a percentage of bakery-cafe sales between the thirteen and thirty-nine weeks ended September 25, 2007 as compared to the same periods in 2006 was primarily due to commodity pressures from items such as dairy, gasoline, wheat and proteins, coupled with general inflationary cost pressures, which outpaced the increase in sales prices over the same periods; a shift in consumer demand to products involving higher ingredient costs; and a modest shift in mix away from bakery-cafe related products such as breads and bagels, which we self-manufacture in our fresh dough facilities, towards baked and sweet goods such as soufflés, scones and muffins, which are produced through a contract manufacturer. Partially offsetting these cost pressures was improved leverage of our fresh dough manufacturing costs due to additional bakery-cafes opening. For the thirteen weeks ended September 25, 2007, there was an average of 56.6 bakery-cafes per fresh dough facility compared to an average of 54.8 for the same period in 2006. For the thirty-nine weeks ended September 25, 2007, there was an average of 55.0 bakery-cafes per fresh dough facility compared to an average of 52.6 for the same period in 2006.
Labor expense was $75.5 million, or 32.5 percent of bakery-cafe sales, for the thirteen weeks ended September 25, 2007 compared to $52.1 million, or 31.6 percent of bakery-cafe sales, for the thirteen weeks ended September 26, 2006. Labor expense was $205.4 million, or 32.1 percent of bakery-cafe sales, for the thirty-nine weeks ended September 25, 2007 compared to $147.6 million, or 30.9 percent of bakery-cafe sales, for the thirty-nine weeks ended September 26, 2006. The labor expense as a percentage of bakery-cafe sales increased between the thirteen and thirty-nine weeks ended September 25, 2007 as compared to the same periods in 2006 primarily as a result of higher bakery-cafe labor costs incurred in conjunction with the roll-out of certain operational improvement initiatives focusing on our lunch daypart coupled with general inflationary cost pressures, which outpaced the increase in sales prices over the same periods. In addition, labor expense as a percentage of bakery-cafe sales increased between the thirty-nine weeks ended September 25, 2007 as compared to the same period in 2006 as a result of higher bakery-cafe labor costs incurred in support of our evening daypart initiative launched in the third quarter of 2006.
Occupancy cost was $18.6 million, or 8.0 percent of bakery-cafe sales, for the thirteen weeks ended September 25, 2007 compared to $12.3 million, or 7.4 percent of bakery-cafe sales, for the thirteen weeks ended September 26, 2006. Occupancy cost was $50.5 million, or 7.9 percent of bakery-cafe sales, for the thirty-nine weeks ended September 25, 2007 compared to $34.8 million, or 7.3 percent of bakery-cafe sales, for the thirty-nine weeks ended September 26, 2006. The increase in occupancy cost as a percentage of bakery-cafe sales between the thirteen and thirty-nine weeks ended September 25, 2007 compared to the same periods in 2006 was primarily due to rising average per square foot costs in newer markets outpacing the growth in sales in 2007.
Other operating expenses were $32.5 million, or 14.0 percent of bakery-cafe sales, for the thirteen weeks ended September 25, 2007 compared to $24.6 million, or 14.9 percent of bakery-cafe sales, for the thirteen weeks ended September 26, 2006. Other operating expenses were $87.8 million, or 13.7 percent of bakery-cafe sales, for the thirty-nine weeks ended September 25, 2007 compared to $67.1 million, or 14.1 percent of bakery-cafe sales, for the thirty-nine weeks ended September 26, 2006. The decrease in other operating expenses rate for the thirteen and thirty-nine weeks ended September 25, 2007 compared to the same periods in 2006 is primarily due to lower local marketing expenses incurred in support of our evening daypart initiative in 2007 as compared to 2006.
Fresh dough facility cost of sales to franchisees was $20.1 million, or 81.6 percent of fresh dough facility sales to franchisees, for the thirteen weeks ended September 25, 2007, compared to $20.3 million, or 82.2 percent of fresh dough facility sales to franchisees, for the thirteen weeks ended September 26, 2006. Fresh dough facility cost of sales to franchisees was $63.6 million, or 82.2 percent of fresh dough facility sales to franchisees, for the thirty-nine weeks ended September 25, 2007, compared to $62.8 million, or 85.2 percent of fresh dough facility sales to franchisees, for the thirty-nine weeks ended September 26, 2006. The decrease in the fresh dough facility cost of sales rate for the thirteen and thirty-nine weeks ended September 25, 2007 compared to the same periods in 2006 is primarily due to improved operating efficiencies in the fresh dough facilities as average bakery-cafes served per fresh dough facility has continued to increase in 2007 as compared to the same periods in 2006, partially offset by modestly unfavorable input costs.
General and administrative expenses were $18.4 million, or 6.7 percent of total revenue, for the thirteen weeks ended September 25, 2007 compared to $16.6 million, or 8.1 percent of total revenue, for the thirteen weeks ended September 26, 2006. General and administrative expenses were $52.9 million, or 6.9 percent of total revenue, for the thirty-nine weeks ended September 25, 2007 compared to $45.4 million, or 7.6 percent of total revenue, for the thirty-nine weeks ended September 26, 2006. The decrease in the general and administrative expenses rate for the thirteen and thirty-nine weeks ended September 25, 2007 compared to the same periods in 2006 was primarily due to lower local marketing expenses incurred in support of our evening daypart initiative in 2007 as compared to 2006, lower legal costs in 2007 as significant legal costs were incurred in 2006 related to litigation that was favorably resolved in the third quarter of 2006, and disciplined expense management.

CONF CALL

Jeffrey Kip

Welcome to Panera Bread’s second quarter earnings call. With me this morning is Ron Shaich, our Chairman and Chief Executive Officer. I’d also like to introduce everyone to Michelle Harrison who is our new Vice President of Investor Relations. We are very excited to have her on board, and she is looking forward to hearing from all of you.

Let me cover a few regulatory matters first. I’d like to note that during our opening remarks and then our responses to your questions, certain items may be discussed which are not based on historical fact. Any such items including targeted 2008 results or conditions and details relating to 2009 performance should be considered forward-looking statements within the meaning of the Private Securities and Litigation Reform Act of 1995. All such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Ron will begin our call with a few introductory remarks.

Ronald Shaich

Welcome to our Q2 earning conference call. Frankly, I’ve been looking forward to this call for some time. Simply put, we had a great Q2. EPS was up 33%, and the future again looks bright. This is particularly so when one considers the hyperinflation in wheat we are presently absorbing and the extraordinary weakness in our economy that we in this industry confront. So rarely have I felt so good about a quarter. The hardest thing about being a CEO is when you don’t deliver for the people who believe in you, and that is how we felt late last year. What makes this quarter so gratifying is that it’s a small way a repaying those of you who believed in us and our company when it didn’t seem so clear that one should do so last year. I particularly want to thank those investors who stuck with us when our results were weaker last fall. Frankly, Q2 is for you. Okay, let’s get right to it.

Our plan to improve margins while holding or growing transactions and improving return on invested capital is working, and it’s working well, and we are pleased to be able to share that success with you today. I’d now like to ask Jeff to review Q2 with you. I’ll then provide some color commentary on our plan to move the business forward. Jeff will then provide you our targets for Q3 and Q4 2008 as well as assumptions that underlie them. I will then conclude.

Jeffrey Kip

Thanks Ron. Let's get right into the second quarter results. Last night, we issued our second quarter earnings release for the thirteen weeks ending June 24, 2008. Let’s first review the metrics. Our comparable bakery cafe sales increased 6.5% in company-owned locations during the second quarter. We estimate that this number benefited approximately 30 to 40 basis points from the shift of Easter from the second quarter last year to the first quarter year. Retail price was approximately 5.5% year over year. Net of the Easter shift, transaction and mix growth amounted to approximately +0.6 to +0.7% year over year, with mix impact modest. Comps increase 4.8% at franchise operated locations.

Average weekly sales for company-owned units opened in fiscal 2008 were $35,776 in the second quarter. Year to date, that number is $36,640, in line with our full year target of $36,000 to $38,000. We opened 19 bakery cafes in the second quarter, 6 of which were company owned and 13 of which were franchise operated.

Our net income for the second quarter was $15.7 million after charges of $0.02 per diluted share, resulting from unfavorable tax adjustment, and $0.01 per diluted share from the further writedown of the company’s investment in the Columbia’s Strategic Cash Portfolio. Including the impact of these charges, earnings per share were $0.52 per diluted share. This compares the net income of $12.6 million and EPS of $0.39 per diluted share in the second quarter of the prior year.

Let’s get into a little more detail on the P&L and our margins for the second quarter versus the comparable period a year ago. Starting with total revenue, second quarter revenues increased 27% to $320.9 million in 2008 versus $253 million in the comparable period of 2007. The breakdown is as follows: Net bakery cafe sales increased 31% to $274.4 million in 2008 from $209.6 million in 2007, driven primarily by sales from units opened in the last four quarters, by acquisitions over the same period, and increases in comparable bakery cafe sales.

Franchise royalties and fees increased 6% to $18.1 million in the second quarter of 2008, from $17 million in the same quarter in the prior year, driven by new franchise-operated bakery cafes opened in the trailing four quarters, partially tempered by the impact of the acquisition of franchise-operated bakery cafes by the company. Fresh dough sales to franchisees grew 8% to $28.4 million in 2008 from $26.3 million in 2007. As a result of these differential growth rates, we continue to experience a ship in total revenue mix as bakery cafe sales as a percent of total revenues increased to 85.5% in the second quarter of 2008, compared to 82.9% in 2007, while over the same period, franchise royalties and fees declined to 5.6% from 6.7%. The net impact of the shift on operating margin is approximately 110 basis points of optical unfavorability on margin year over year. Fresh dough sales to franchisees declined as a percent of total sales to 8.8% from 10.4%. We will return to this a little later when we discuss operating margins.

Now, let’s move on to P&L margin analysis. Restaurant margins overall were higher by about 170 basis points in the second quarter of 2008 versus the same quarter of 2007. Let’s go through the bakery cafe margin by component now. First, cost of food and paper products improved by 30 basis points year over year to 30.3% of restaurant sales. Together, our category management initiatives and operational focus drove 190 basis points of favorability year over year, while the impact of wheat and other cost inflation drove an offsetting 160 basis points of unfavorability, netting to our 30 basis points of pick-up year over year.

Going forward, we don’t expect to retain all of that 190 basis point of favorability each quarter as September marks the anniversary of our kickoff of category management and the fourth quarter anniversaries our menu reorganization and November 2007 price increase.

Labor as a percentage of restaurant sales improved 100 basis points year over year to 31.1% of restaurant sales. Higher than anticipated sales and sound execution versus some inefficiency in Q2 2007 added to the 100 basis points margin benefit we got by removing Crispani in the beginning of this year. That benefit, you will recall, was partially offset by the addition of the expedited position which added an additional 50 basis points of labor. In the third and fourth quarters, we continue to target 100 basis points of labor margin improvement from Crispani removal without the offset from the expeditor as we anniversary the edition of that position in July.

Occupancy costs in the second quarter increased 30 basis points versus the prior year to 8.1% of restaurant sales, based upon somewhat higher average per square foot costs in immature stores outpacing the growth in sales during the second quarter of 2008 as compared to 2007. Other operating expenses as a percent of restaurant sales in the second quarter of the year improved 70 basis points to 13.4% from 14.1% in the prior year, as we benefited from higher than expected sales and continue to make progress in our cost control efforts in this area. In the back half of 2008, we don’t expect the same level of favorable gains and other operating expenses given the timing of certain field marketing expenses.

In total, bakery cafe margins are again up 170 basis points year over year, primarily as the result of our ability to take price to offset inflation, category management initiatives driving a more profitable mix of business, and favorable labor costs given the removal Crispani which have more than offset the rise of wheat and fuel costs.

Moving on from restaurant margins, fresh dough cost of sales to franchisees as a percent of fresh dough sales to franchisees left 720 basis points over the year unfavorable. Approximately 780 basis points of this unfavorability was driven by the $2.2 million impact of wheat cost increases, net of our price increases, with the all-in cost of the wheat at its high point in the second quarter for the whole year at $17.25 a bushel versus $5.80 per bushel last year. Again, the number we quote is wheat futures plus cost of basis per bushel.

Increases in diesel costs per gallon year over year drove another additional 40 basis points of unfavorability in this margin line. Our revised guidance for the remainder of the year assumes a diesel cost per gallon of approximately $5 for the each of the third and fourth quarters versus approximately $3 and $3.30 respectively in the prior year. In the second quarter, diesel was around $4.50 per gallon versus approximately $3 in the same period of the prior year.

Operating leverage in our manufacturing facilities yielded 100 basis points offsetting favorability, netting us to the total 720 basis points of unfavorability. Depreciation costs in the second quarter improved 50 basis points to 5.1% of total revenues versus the prior year at 5.6%. The positive leverage on this line is driven by sales leverage and our investments.

General and administrative expense in the second quarter improved 20 basis points year over year to 6.7% from 6.9% in the prior year. This improvement, driven by strong G&A disciple, came even though we accrued 80 basis points more of incentive compensation program expense versus the prior year. This significant increase was driven by the fact that these programs were substantially under water last year, and we are accruing higher than our target year to date given our exceptionally strong performance. We expect an additional 40 basis points per quarter of bonus accrual in each of the quarters in the second half of the year given our expected performance driving an unfavorable G&A margin versus the prior year.

Pre-opening expenses in the quarter improved 30 basis points to 0.3% of total revenues versus 0.6% in the second quarter of 2007 as we opened 11 fewer company-owned units in the second quarter than we did in the same period last year. The slowdown in new openings reflects the more rigorous investment criteria we discussed on our first quarter earning call. We’d expect this year-over-year comparison to continue to be positive in the second half of 2008. We feel very good about our overall improvement in operating margin. A hundred basis point year-over-year increase is a very strong marker towards our internal goal of 150 to 200 basis points’ improvement in the 2009 operating margin versus our 2007 margin. Overall, we actually generated more than 400 basis points of favorability through margin improvement initiatives and strong execution to offset more than 300 basis points of margin headwind in the quarter. This headwind I refer to is created by a full 190 basis points of unfavorability, net of price increases based on the cost increase per bushel in wheat and an another additional 110 basis points margin headwind created by the optical margin shift driven by the acquisition of our franchise bakery cafes.

As you know, we believe it when we buy a franchise bakery cafe at 5 to 5-1/2 times differential cash flow, and that’s EBITDA net of royalties, we earn an outstanding return on capital, but it drives an unfavorability in our operating margin simply because franchise revenues are 100% income and acquired stores have a high teens margin. Thus, we call this shift optical rather than economic. Based on our ability to drive favorability over and above the challenges we face, we now anticipate finishing the year with favorable year-over-year operating and bakery cafe margins versus 2007.

Moving on to taxes. The effective tax rate for the quarter was 39.6% compared to 32.5% in the comparable period of 2007. Prior year was lower than average driven by favorable unwinding of a FIN 48 tax exposure reserve, whereas in the second quarter of 2008, we experienced the unfavorability of the previously mentioned $0.02 FIN 48 reserve expense. Currently, we are projecting the possibility of an additional up to $0.02 of incremental discreet tax in the third quarter of 2008. The tax rate would be approximately 40% in the third quarter and 30% fourth quarter under that scenario. Going forward, we expect our tax rate to move in the range between 38% and 40%.

Moving on to cash flow for the quarter. The company generated $62.7 million of cash from operations and employee stock option exercises and had capital expenditures of $15.9 million. In addition, we repaid $42 million of our credit facility in the second quarter of 2008. At the end of the second quarter, the balance on our credit facility was $18 million. Continued strong cash flow has allowed us to further reduce the credit facility to its current level of $10 million, meaning that our performance this year has allowed us to pay down $65 million of the $75 million we borrowed to fund our $75 million share purchase completed in the first quarter of this year. As a side note on that transaction, given the way our business has performed year to date, we continue to be extremely pleased with the level, an average share price of $34.62, at which we repurchased the $2.1 million shares in the fourth quarter of 2007 and the first quarter of 2008.

Now, let me give you an update on our position in the Bank of America’s Columbia Strategic Cash Portfolio. During the second quarter, we adjusted our net asset value from $0.93 on the dollar to $0.89 on the dollar which resulted in approximately $0.01 hit per diluted share to earnings. The current credit environment and the deterioration of many asset classes beyond just mortgage-backed securities have led us to believe that a net asset value of $0.89 on the dollar more accurately reflects the risk in the remaining investment portfolio. Including the adjustment and a 3% cash redemption we received in the quarter, we ended the second quarter with $13.5 million of investments in Columbia Strategic Cash Portfolio which compares to the year-end balance of $23.2 million. To date, we have received redemption of more than 43% of the funds we had in the Bank of America fund at nearly 98.5 cents on the dollar. Our current expectation based on what Bank of America has told us is that the fund will continue to liquidate into 2009.

We ended the second quarter with $22.1 million in cash, excluding the $13.5 million of NAV in the Columbia Fund, and $18 million of debt. This compares to year end when prior to completion of our share repurchase program, we had about $68 million in cash and $75 million of debt. On average for the quarter, there were approximately 30.3 million fully diluted shares outstanding including the impact of 1.7 million stock options outstanding with an average exercise price of $39.56 per share. Now, I’d like to hand it back to Ron to review our strategic initiatives.

Ronald Shaich

As you all know, we’ve been deeply focused on our plan to move the business forward. We bet on a plan of action to improve margins while maintaining or growing transactions and strengthening return on invested capital, all the while driving long-term concept differentiation. Along the way, we learned a great deal. First, we learned that the inflationary cost pressures of 2008 would be far worse than we ever could have expected. Second, we learned that the economy would be far weaker than we could have imagined, and third, we’ve learned that our plan is working better than we ever would have hoped for. With that in mind, let’s walk through the three prongs of our plan.

Let’s begin with margins. As Jeff indicated, we saw significant traction on our margin initiatives in Q2. Simply put, we are exceeding our goals from margin improvement. How? Most importantly, we’ve been using our category management function to drive improved gross profit per transaction. Indeed, our category management team has been very effective in helping us to effect disciplined price adjustments. To that end, we've been intensively focused on executing the pricing philosophy we laid out for you several quarters ago. Our objective in that philosophy has been to drive gross profit per transaction by changing consumer behavior and by effectively executing a high/low pricing strategy. As you know, the manifestation of this work has been several carefully tested price and menu adjustments in the past 9 months.

Let’s now discuss these pricing initiatives individually. In November 2007, we took an approximately 2.5% increase and reorganized the products on our menu panels. The focus of this increase was a higher priced specialty products. The focus of our re-menuing was on bringing greater prominence to our higher gross profit items. This initiative was rigorously tested, and the testing demonstrated that we would be able to effect the changes with no noticeable degradation in transaction growth. As you know, this is exactly what happened.

In late March 2008, we implemented another retail price adjustment of approximately 2.7% in company stores. This adjustment focused on raising prices at a number of entry level items. This price increase was also rigorously tested, and again the test and actual results proved there was limited, if any, negative transaction impact. In addition, many of our franchisees followed our lead and implemented a menu structure similar to ours in early April. On June 18, 2008, we implemented a price increase on many of our bagels at our company-owned bakery cafes. To do so, we executed our high/low strategy, pricing signature bagels at $1.25 and our non-signature bagels at $0.99. This represents an additional lift of approximately 1% of total sales. It also allowed us to raise our go-transfer prices to franchisees to cover more of the hit from wheat. We’re pleased to report that actual results performed consistently with our testing. More importantly, we continue to see little or no negative consumer blow-back from this adjustment.

In addition, we just completed our testing of an additional 1% across-the-menu increase. Based on those successful tests, I’m pleased to be able to report to you today we plan to roll out an additional 1% increase in September. In sum, the net result of these price adjustments is a year-over-year price increase of 5.5% for Q2, a projected year-over-year price increase of approximately 6.5% for Q3, and a projected year-over-year price increase of approximately 6% in Q4, and most importantly, research that we recently conducted shows that Panera’s value score remains as strong as strong as ever despite the pricing adjustments we executed at the end of 2007 and in 2008.

In addition, our category management team has been successful in effectively pricing new products, such as our new grilled breakfast sandwiches and the reintroduction of our strawberry poppy seed salad such that each of these products drives up gross profit per transaction.

Before I conclude my comments on category management, let me note that we are hard at work on the other category management initiatives for 2009. One such test is a combo program for our breakfast products. We’re also testing a menu restructuring to offer more size and more price alternatives on our soup. In addition, we will also begin testing a new pricing initiative in the fourth quarter with hopes of implementing those adjustments at the beginning of Q2 2009. Expect to get updated on these initiatives as we go forward. Let me also note that we made real progress on other cost initiatives, particularly controllables. As I’ve shared with you before, our goal is to have those costs below the gross profit line grow at a rate significantly less than the growth of our gross profit, and our team has done a great job of doing just that.

Let’s now turn our attention to transactions, the second prong in our plan. The truth is we’ve been very surprised to see transaction strength. In fact, transactions were up half a point in Q2. So, here’s the question. Does this mean that Panera is recession resistant? No. What it means is that we’ve been able to take control of our destiny. We’ve been able to build transactions to offset recessionary pressures. Is it possible that we may be less affected by recession than other brands? The answer is yes, given the higher average income of our customers and the fact that we’re a breakfast and lunch spot for working people rather than a casual dining establishment for dinner. But despite all that, the economic doldrums are certain to hit Panera customers as well. So what’s going on, and how then were we able to grow transactions despite our price increases and our category management initiatives in Q2? Think of it like a cup. Transaction loss is metaphorically like holes in the bottom of that cup. Think of those holes as small leaks if you wish. We have been able to offset the leakage in our metaphorical cup by pouring into the top of that cup, increase transactions from our new breakfast sandwiches and from the strength of our media as well as our continued operational focus, and we estimate that taken together, these positive transaction builders offset the transaction losses we would experience coming about as a result of the uncertain economic environment and its effect on certain of our customers.

As you read in our release, we are today pre-releasing comparable company-owned bakery cafe sales for the first 27 days of Q3. Company comps in those first 27 days were 3.6% and franchise comps were about 4%. Truth be told, these comps are down sequentially, so what’s going on? As ever, we don’t fully understand the more modest comps of Q3. Simply put, it’s too early to read the results coming in as we march forward with just 3 weeks of results. But here’s what we do know. We know that the way the July Fourth holiday fell this year negatively impacted comps. More importantly, we know that in the first three weeks of Q3 2008, we’ve been running against some of the most powerful comp weeks of 2007. As you may recall, in Q2 2007, company-owned comps were 1.7%. In the first period of Q3 2007, that is to say period 7, the one we’re in right now, comps in 2007 were 4.4%. This was where our very successful summer celebration rooted in our strong summer salads really took off. In the second period of Q3 2007, that is to say period 8, comps were 4.1%, and in the third period of Q3 2007, that is to say period 9, comps were down to only +1.5% as our summer celebration and its success in building the business began to recede.

Think of it this way. In Q2 2008, we ran 2-year company-owned comps of 8.2%. For the first 3 weeks of Q3, company stores ran 2-year comps again of 8.2%. In Q3, with comps targeted at 4% to 5%, we are assuming 2-year comps of 6.9% to 7.9%. In Q4 2008, with comps targeted at 3.5% to 4.5%, we are assuming 2-year comps of 6.1% to 7.1% which we think makes sense for our use in our target given the weakening economic picture. The point is we’re going up against some of the stronger comps from 2007 at the same time that the economy continues to weaken. So in the context of that, discretion is better than valor, and expectations for weaker transaction growth in Q3 and Q4 makes sense.

Now, let me turn our attention to our progress on ROIC. We know that driving our ROIC, that is to say or return on invested capital, from good back to great involves two things. First, it involves our core margins. Second, it involves the average weekly sales of our new cafes. Obviously our core margins have improved significantly. In fact, when we look at our company store business as a standalone business, utilizing the same transfer prices as our franchisees as we frankly do internally, our average bakery cafe, including our new openings year over year have seen profit growth of 16% in Q2. This is the result of our margin improvement efforts and the leveraging of our fixed costs.

In addition, our average weekly sales on new cafes in the class of 2008 continues to be significantly stronger than the prior year. We are currently looking at average weekly sales of $35,776 for new company bakery cafes for Q2. It is true that our Q2 openings were weaker than the extraordinary numbers we produced in Q1. Having said that, year to date, they are up $36,640 which is 15% higher than the new unit AWS at this time last year, but just as we told you in Q1 not to get excited about the numbers, I’d say the same thing about the Q2 numbers. I feel very comfortable in telling you this because we’ve actually had a couple of very strong openings recently. In fact, to my amazement, we just opened a store in North Carolina doing over $80,000 a week. So, here’s the bottomline on average weekly sales. We remain confident that despite the ups and downs, we’ll finish the year with our class of 2008 producing AWS in our target range of $36,000 to $38,000 and well ahead of what the class of 2007 produced last year.

One final note before I turn it back to Jeff for a review of our Q3 and Q4 targets. Sometime last year, I had the opportunity to travel with one of our sell side analysts. I’d like to recall for you his comments. He noted that one of the great risks for companies like Panera, in fact one of the great risks for almost every company in the food service industry was the day and their management teams had never before operated in an inflationary environment. As a result, he lamented, none of the companies had systems or procedures in place, nor management attuned to operating in inflationary times.

I spent a great deal of time last fall thinking about that comment, and I realized how absolutely correct this analyst was. As a result, our senior team spent a fair amount of time last fall reviewing all of our practices and procedures in an effort to prepare the organization to operate in an environment with far greater inflation. That thinking led us to build out the category management function and create a true strategic pricing discipline focused on understanding where customers perceive value. Both of these changes have proven beneficial to our margins in 2008. It also led us to change our thinking and focus far more on gross profit per transaction as opposed to average check or sales per transaction. As we did so, we shifted our key internal metrics to gross profit dollars from comp dollars. In essence, in the past we had been focused on the dollars consumers brought into the cafe, but for the last 9 months and going forward, we have been and will be focused on the dollars consumers leave when they walk out of the cafe.

Finally, this thinking has led us to restructures our purchasing processes such that to the greatest extent possible, we are committed to purchasing six months ahead, at least 6 months ahead, with relatively short purchase commitments. In fact, our general practice today is to purchase 6 months ago for a 6-month contracted period. This enables us to project out our underlying inflation and to make sure we are strategically pricing to cover that inflation. In addition, such a strategy allows us to moderate the impact of cost gyrations. The bottomline? Panera has been rebuilding itself to operate in an inflationary environment, and I believe that those skills along with our plan to improve margins, grow transactions, and improve ROIC while increasing long-term concept differentiation will pay dividends over the next couple of year.

Now, let me turn it back to Jeff who will take you through our target for Q3 and our targets for the second half of the year. I’ll then return for a very brief closing comment.

Jeffrey Kip

I’d like to now lay out for you our financial outlook and targets for the remainder of 2008 and offer a few initial comments on 2009. As part of this earnings release, we have not broken out the third and fourth quarters of 2008 separately in our targets. Our combined EPS target previously was $1.14 to $1.26 per share. We revised our second half target upward for 2008 to $1.24 to $1.30 share, or 33% to 40% growth versus the prior year. This breaks down to $0.42 to $0.44 per share for the third quarter, or 14-19% growth, and $0.82 to $0.86 per share for the fourth quarter, or 46 to 54% growth.

Let’s get into a little more detail by quarter, starting with our third quarter financial targets. As I just noted, the third quarter EPS is now targeted at $0.42 to $0.44 per share. Our guidance on key metrics is as follows. We moved our transaction guidance to a target range of -1.5% to -2.55%, based on our concerns for the economic environment. Consistent with that and the 6.5% pricing in the quarter, Ron discussed, we are targeting 4-5% company-owned comp store sales growth in Q3.

Moving on to third quarter margins, as Ron and I both discussed, we’re pleased with the progress we’ve made on our margin initiatives. We expect continued favorability on our cost to sales line, although perhaps not at the level we saw in Q2 as we started to anniversary couple of management rollout pricing and improved executions in the second half of 2007, and wheat costs continue to present a significant headwind. We now expect wheat costs of $15 per bushel in the third quarter versus $5.80 in the prior year, driving $3 million plus in cost of sales expenses in bakery cafes year over year.

In terms of cost of dough sales to franchises, while we have taken pricing on our dough sales to neutralize the negative dollar impact, margin will continue to be materially unfavorable versus the prior year because expense and sales will increase by the same dollar amounts and fuel cost increases will offset in part the operating leverage in that business. As previously mentioned, we are now expecting gasoline costs of about $5 per gallon for Q3 and Q4. At the very beginning of the year, we had actually anticipated $3.50 per gallon for the year.

In terms of labor margin, as we previously mentioned, we are targeting 100 basis points of improvement n the labor line in both third and fourth quarters from Crispani now. Finally, as also previously discussed, we have possible tax exposures of between zero and $0.02 for the third quarter. The facts don’t yet support a FIN 48 Reserve, but we’re concerned there’s possibility that some expense could hit us. Our best guess as to timing of if the possible exposures actually hit us at all would be tax expense of $0.02 in the third quarter, over and above our average tax rate.

Let’s now discuss our fourth quarter 2008 targets. We’re guiding to an EPS target range of $0.82 to $0.86 per share. The EPS target is built on the following sales metrics. Transaction growth of negative 1.5% to negative 2.5%, a year-over-year price increase of 6%, a comparable store sales growth in a target range of 3.5% to 4.5%. Key metrics for margin are all-in cost of wheat for the fourth quarter at $12 per bushel, versus $5.80 in the prior year, driving $2.5 million of incremental bakery cafe cost of sales of expense. In terms of dough sales to franchisees, we expect dough prices at breakeven to wheat costs. Again in the fourth quarter, we expect continued improvement in our cost of sales from our initiatives, and we expect to continue to enjoy 100 basis points from improvement in the labor line from the removal of the fixed labor associated with Crispani.

Based on all these assumptions, we are now targeting approximately 200 basis points of favorability year over year in both our restaurant and our operating margins in the fourth quarter, despite significant unfavorability driven by both wheat and gasoline inflation. I’d like to conclude by commenting on full-year 2008 guidance and add a couple of points on expectations for 2009. For fiscal 2008, we’re raising our EPS guidance from $2.03 to $2.17 to $2.17 to $2.23, for an overall earnings growth of 21-25% over $1.79 we earned in 2007. To avoid confusion, this target is net of all charges. In other words, all charges that we’ve expensed in the first and second quarter are in that number. Thus, we assume $0.41 and $0.52 for the second quarter, in addition to the $1.24 to $1.30 we are now targeting for the second half of the year. I want to remind you that this full-year growth is still net of approximately $0.34 year-over-year negative impact resulting from the rising cost of wheat net of price increases. So had wheat costs remained the same as last year, a truly phenomenal year we would be having. Now, as I mentioned before, in 2009 we continue to hold 150 to 200 basis points of improvement in the operating margin line over 2007 operating margin as our internal target. We are seeing the progress on our key initiatives and metrics that builds our confidence that we can reach that goal.

In terms of 2009 EPS targets, analysts’ consensus estimates currently have our 2009 EPS at a 17% to 21% growth rate versus our revised 2008 full-year target of $2.17 to $2.23. We believe that these kinds of numbers are at the high end of prudent. The end of the current hyperinflationary environment and broader economic recession do not appear to be near end. We currently believe that core cost of sales inflation in our retail business will run 5-6% for 2009, and while we are committed to take pricing to offset this cost inflation, we are very cognizant of the toll this can take on our transaction counts in a tough economy.

In terms of wheat costs, we have locked in wheat for the first half of 2009 at approximately $10 per bushel, and will walk the second half of the year and the fourth quarter through a disciplined purchasing process. However, there are significant offsets to the benefit that price will yield year over year driven by first fuel inflation and second other commodity cost increases and one of the big ones right now is dairy and broad 4-5% inflation across all the other costs in our fresh dough facilities, without any incremental price in that business expected. With the high likelihood of a lingering recession through 2009 and its potential corollary impact of negative transactions, we feel it would not be wise to estimate 2009 growth any higher than 20%.

With that, I’d like to turn it turn it back to Ron for closing remarks.

Ronald Shaich

Let me conclude as I began. We could not be more pleased with our second quarter results, and we could not be more pleased with our prospects for the future. To deliver 33% EPS growth in the second quarter despite a weak consumer environment and despite the hyper-inflation we are experiencing in wheat and gasoline is quite gratifying. To be able to raise our second half 2008 targets to reflect a 33-40% increase over the prior year is a reflection of the strength of our concept, it’s a reflection of the power of our plan, and it’s a reflection of the confidence we have in our support center team, our operators, and our franchisees. That ends our prepared comments.

At this time, we are open to take your questions. As is our custom, we request that you ask only one question at a time, and you do so in order as it allows us to give as many of you on the call as possible an opportunity to weigh in. If you have additional question, we would request that you return to the queue. We’re happy to stand online until all your questions have been asked or until the market opens at 9:30. We’ll certainly give you 15 minutes, so we’ll stay on the line till 9:35. Operator, we’re ready for that first question.

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