UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 1, 2007

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from       to       .

Commission file number: 0-25123

P.F. Chang’s China Bistro, Inc.

Delaware (State or other jurisdiction of incorporation or organization)		86-0815086 (I.R.S. Employer Identification No.)
7676 East Pinnacle Peak Road Scottsdale, Arizona (Address of principal executive offices)		85255 (Zip Code)

Registrant’s telephone number, including area code:
(480) 888-3000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 1, 2007, there were 25,805,649 outstanding shares of the registrant’s Common Stock.

 

 

TABLE OF CONTENTS

Item						Page
PART I FINANCIAL INFORMATION
1.				Unaudited Consolidated Financial Statements			2
				Consolidated Balance Sheets as of July 1, 2007 and December 31, 2006			2
				Consolidated Statements of Income for the Three and Six Months Ended July 1, 2007 and July 2, 2006			3
				Consolidated Statements of Cash Flows for the Six Months Ended July 1, 2007 and July 2, 2006			4
				Notes to Unaudited Consolidated Financial Statements			5
2.				Management’s Discussion and Analysis of Financial Condition and Results of Operations			9
3.				Quantitative and Qualitative Disclosures About Market Risk			22
4.				Controls and Procedures			22
PART II OTHER INFORMATION
1.				Legal Proceedings			23
1A.				Risk Factors			23
2.				Unregistered Sales of Equity Securities and Use of Proceeds			23
3.				Defaults Upon Senior Securities			23
4.				Submission of Matters to a Vote of Security Holders			24
5.				Other Information			24
6.				Exhibits			24
				Signatures			25
				Index to Exhibits			26

PART I
FINANCIAL INFORMATION

Item 1.		Unaudited Consolidated Financial Statements

P.F. CHANG’S CHINA BISTRO, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

		July 1,				December 31,
		2007				2006
		(Unaudited)				(Note 1)
ASSETS
Current assets:
Cash and cash equivalents		$	9,469			$	31,589
Inventories			4,349				4,232
Prepaids and other current assets			24,373				28,995
Total current assets			38,191				64,816
Property and equipment, net			467,324				421,770
Deferred income tax assets			1,749				—
Goodwill			6,819				6,819
Intangible assets, net			20,939				12,644
Other assets			9,440				7,996
Total assets		$	544,462			$	514,045
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	11,902			$	15,255
Construction payable			14,526				9,075
Accrued expenses			58,302				55,848
Unearned revenue			13,254				18,226
Current portion of long-term debt, including $3,289 and $3,542 due to related parties at July 1, 2007 and December 31, 2006, respectively			6,415				5,487
Total current liabilities			104,399				103,891
Long-term debt, including $3,015 and $588 due to related parties at July 1, 2007 and December 31, 2006 respectively			14,779				13,723
Lease obligation			79,316				71,682
Other liabilities			1,326				1,909
Minority interests			20,334				33,315
Commitments and contingencies (Note 9)			—				—
Common stockholders’ equity:
Common stock, $0.001 par value, 40,000,000 shares authorized: 25,805,649 shares and 25,373,019 shares issued and outstanding at July 1, 2007 and December 31, 2006, respectively			27				27
Additional paid-in capital			189,142				174,101
Treasury stock, at cost, 1,397,261 shares outstanding at July 1, 2007 and December 31, 2006, respectively			(46,373	)			(46,373	)
Retained earnings			181,512				161,770
Total common stockholders’ equity			324,308				289,525
Total liabilities and common stockholders’ equity		$	544,462			$	514,045

See accompanying notes to unaudited consolidated financial statements.

P.F. CHANG’S CHINA BISTRO, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

		Three Months Ended								Six Months Ended
		July 1,				July 2,				July 1,				July 2,
		2007				2006				2007				2006
		(In thousands, except per share amounts)
Revenues		$	267,409			$	225,981			$	531,815			$	454,594
Costs and expenses:
Cost of sales			73,011				61,285				145,926				124,725
Labor			90,665				75,380				179,899				152,317
Operating			42,436				36,210				83,630				71,051
Occupancy			15,615				12,725				30,523				25,218
General and administrative			15,806				14,037				32,528				27,289
Depreciation and amortization			13,606				10,565				26,285				20,920
Preopening expense			3,296				2,817				5,836				4,511
Partner investment expense			(468	)			925				(1,869	)			1,125
Total costs and expenses			253,967				213,944				502,758				427,156
Income from operations			13,442				12,037				29,057				27,438
Interest and other income, net			179				568				522				1,060
Income before minority interest and provision for income taxes			13,621				12,605				29,579				28,498
Minority interest			(1,121	)			(2,033	)			(2,768	)			(4,055	)
Income before provision for income taxes			12,500				10,572				26,811				24,443
Provision for income taxes			(3,223	)			(2,483	)			(7,069	)			(6,541	)
Net income		$	9,277			$	8,089			$	19,742			$	17,902
Net income per share:
Basic		$	0.36			$	0.30			$	0.77			$	0.68
Diluted		$	0.36			$	0.30			$	0.76			$	0.66
Weighted average shares used in computation:
Basic			25,708				26,546				25,598				26,516
Diluted			26,129				27,258				26,088				27,249

See accompanying notes to unaudited consolidated financial statements.

P.F. CHANG’S CHINA BISTRO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

		Six Months Ended
		July 1,				July 2,
		2007				2006
		(In thousands)
Operating Activities:
Net income		$	19,742			$	17,902
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			26,285				20,920
Equity based compensation			4,797				4,751
Deferred income taxes			(811	)			(4,219	)
Partner investment expense			(1,869	)			1,125
Partner bonus expense, imputed			669				959
Tax benefit from disqualifying stock option dispositions credited to equity			(4,136	)			(1,365	)
Minority interest			2,768				4,055
Other			(25	)			—
Changes in operating assets and liabilities:
Inventories			(117	)			(158	)
Prepaids and other current assets			7,064				3,082
Other assets			(1,774	)			(326	)
Accounts payable			(3,353	)			(4,086	)
Accrued expenses			2,454				5,334
Lease obligation			7,711				3,224
Unearned revenue			(4,972	)			(4,597	)
Other liabilities			57				—
Net cash provided by operating activities			54,490				46,601
Investing Activities:
Capital expenditures			(64,371	)			(41,782	)
Purchase of minority interests			(9,461	)			(1,214	)
Capitalized interest			(751	)			(421	)
Purchase of short-term investments			—				(12,835	)
Sale of short-term investments			—				10,655
Net cash used in investing activities			(74,583	)			(45,597	)
Financing Activities:
Repayments of long-term debt			(14,293	)			(4,409	)
Proceeds from stock options exercised and employee stock purchases			6,108				2,859
Borrowings on credit facility			6,000				—
Distributions to minority partners			(4,128	)			(5,069	)
Tax benefit from disqualifying stock option dispositions credited to equity			4,136				1,365
Proceeds from minority partners’ contributions			227				430
Payments of capital lease obligation			(77	)			(71	)
Purchase of subsidiary common stock			—				(7,345	)
Net cash used in financing activities			(2,027	)			(12,240	)
Net decrease in cash and cash equivalents			(22,120	)			(11,236	)
Cash and cash equivalents at the beginning of the period			31,589				31,948
Cash and cash equivalents at the end of the period		$	9,469			$	20,712
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest		$	982			$	661
Cash paid for income taxes, net of refunds			1,400				7,085
Supplemental Disclosure of Non-Cash Items:
Purchase of minority interests through issuance of long-term-debt and conversion to members’ capital		$	10,276			$	(333	)
Change in construction payable			5,451				3,100

See accompanying notes to unaudited consolidated financial statements.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Business and Basis of Presentation

As of July 1, 2007, P.F. Chang’s China Bistro, Inc. (the “Company”) owned and operated 157 full service restaurants throughout the United States under the name of “P.F. Chang’s China Bistro.” The Company also owned and operated 126 quick casual restaurants under the name of “Pei Wei Asian Diner” and one full service restaurant under the name “Taneko Japanese Tavern.”

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended July 1, 2007 are not necessarily indicative of the results that may be expected for the year ending December 30, 2007.

The consolidated balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Share-Based Compensation

The Company grants stock options for a fixed number of shares to certain employees and directors with an exercise price equal to or greater than the fair value of the shares at the date of grant. The Company also grants restricted stock with a fair value determined based on the Company’s closing stock price on the date of grant. On January 2, 2006, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 123 (revised 2004) (SFAS 123R), Share-Based Payment, and SEC Staff Accounting Bulletin No. 107 (SAB 107), Share-Based Payment, requiring the measurement and recognition of all share-based compensation under the fair value method. The Company implemented SFAS 123R using the modified prospective transition method, which does not result in the restatement of previously issued financial statements.

The fair value for options granted during the three and six months ended July 1, 2007 and July 2, 2006 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:

		Three Months Ended								Six Months Ended
		July 1, 2007				July 2, 2006				July 1, 2007				July 2, 2006
Weighted average risk-free interest rate			4.6	%			4.9	%			4.6	%			4.9	%
Expected life of options (years)			5.0				6.1				4.6				6.1
Expected stock volatility			35.0	%			35.0	%			35.0	%			35.0	%
Expected dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

The estimated fair value of share-based compensation plans and other options is amortized to expense over the vesting period. See Note 6 to the consolidated financial statements for further discussion of the Company’s share-based employee compensation.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assets and liabilities. The standard expands required disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS 157 on its consolidated financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize the impact of a tax position in the Company’s financial statements if that position is more likely than not to be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of FIN 48 did not have a material impact on the Company’s consolidated financial statements. See Note 7 to the consolidated financial statements for further discussion of the Company’s adoption of FIN 48.

In May 2007, the FASB issued FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB Interpretation No. 48 (“the FSP”). The FSP provides guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Under the FSP, a tax position could be effectively settled on completion of examination by a taxing authority if the entity does not intend to appeal or litigate the result and it is remote that the taxing authority would examine or re-examine the tax position. Application of the FSP shall be upon the initial adoption date of FIN 48. The FSP did not have a material impact on the Company’s consolidated financial statements.

In March 2006, the FASB Emerging Issues Task Force issued Issue 06-3 (“EITF 06-3”), How Sales Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement. A tentative consensus was reached that a company should disclose its accounting policy (i.e., gross or net presentation) regarding presentation of taxes within the scope of EITF 06-3. If taxes are significant and reported on a gross basis, a company should disclose the amount of such taxes for each period for which an income statement is presented. The guidance is effective for periods beginning after December 15, 2006. The Company presents sales tax on a net basis in its consolidated financial statements.

2. Net Income Per Share

Net income per share is computed in accordance with SFAS 128, Earnings per Share. Basic net income per share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed based on the weighted average number of shares of common stock and potentially dilutive securities, which includes options outstanding under the Company’s stock option plans. For the three months ended July 1, 2007 and July 2, 2006, 1.6 million and 1.7 million, respectively, of the Company’s shares were excluded from the calculation due to their anti-dilutive effect. For the six months ended July 1, 2007 and July 2, 2006, 1.5 million and 1.2 million, respectively, of the Company’s shares were excluded from the calculation due to their anti-dilutive effect.

3. Intangible Assets

Intangible assets consist of the following (in thousands):

		July 1,				December 31,
		2007				2006
Intangible assets, gross		$	23,433			$	14,343
Accumulated amortization			(2,494	)			(1,699	)
Intangible assets, net		$	20,939			$	12,644

Intangible assets as of July 1, 2007 include additional intangible assets recognized upon the Company’s buyout of minority partner interests when the Company’s purchase price exceeded the imputed fair value at the time of the original investment.

4. Accrued Expenses

Accrued expenses consist of the following (in thousands):

		July 1,				December 31,
		2007				2006
Accrued payroll		$	17,094			$	18,099
Sales and use tax payable			6,084				6,531
Property tax payable			3,751				3,159
Accrued insurance			15,230				13,701
Accrued rent			3,439				3,708
Other accrued expenses			12,704				10,650
Total accrued expenses		$	58,302			$	55,848

5. Credit Facility

On August 4, 2006, the Company entered into a credit agreement with a commercial lending institution which allows for borrowings of up to $50.0 million at an interest rate of 50 basis points over the applicable London Interbank Offered Rate (“LIBOR”). The revolving credit facility expires on August 4, 2011 and contains certain restrictions and conditions which require the Company to maintain a maximum adjusted leverage ratio of 2.25:1 and a minimum fixed-charge coverage ratio of 1.25:1. The Company was in compliance with these restrictions and conditions as of July 1, 2007. As of July 1, 2007, the Company had borrowings outstanding under the credit facility totaling $10.0 million with an average interest rate of 6.0% as well as $9.7 million committed for the issuance of a letter of credit, which is required by insurance companies for the Company’s workers’ compensation and general liability insurance programs. Available borrowings under the line of credit were $30.3 million as of July 1, 2007.

6. Share-Based Compensation

Share-based compensation expense includes compensation expense, recognized over the applicable vesting periods, for new share-based awards and for share-based awards granted prior to, but not yet vested as of, the Company’s adoption of SFAS No. 123 (Revised 2004), “Share-Based Payment” on January 2, 2006. At July 1, 2007, non-vested share-based compensation, net of estimated forfeitures, totaled $18.0 million for stock options and $2.0 million for restricted stock. This expense will be recognized over the remaining weighted average vesting period which is approximately 2.4 years for stock options and 2.1 years for restricted stock.

Reported share-based compensation is classified as follows (in thousands):

		Three Months				Three Months				Six Months				Six Months
		Ended				Ended				Ended				Ended
		July 1, 2007				July 2, 2006				July 1, 2007				July 2, 2006
Labor		$	201			$	372			$	409			$	716
General and administrative			2,279				2,189				4,388				4,035
Total share-based compensation			2,480				2,561				4,797				4,751
Less: tax benefit			(682	)			(711	)			(1,319	)			(1,318	)
Total share-based compensation, net of tax		$	1,798			$	1,850			$	3,478			$	3,433

7. Income Taxes

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation, the Company recognized no material adjustment to the liability for unrecognized income tax benefits that existed as of December 31, 2006. At the date of adoption, the Company had $2.1 million of unrecognized tax benefits, all of which would impact the Company’s effective tax rate if recognized. As of July 1, 2007, the Company had $1.6 million of unrecognized tax benefits.

It is the Company’s policy to recognize interest and penalties related to uncertain tax positions in income tax expense. As of both the date of adoption and July 1, 2007, the Company had accrued $0.2 million of interest and $0.1 million of penalties related to uncertain tax positions.

8. Segment Reporting

The Company operates exclusively in the food service industry and has determined that its reportable segments are those that are based on the Company’s methods of internal reporting and management structure. The Company’s reportable segments are Bistro and Pei Wei. During fiscal 2006, the Company opened Taneko Japanese Tavern, a new full service restaurant located in Scottsdale, Arizona, which is reported within Shared Services and Other. There were no material amounts of revenues or transfers among reportable segments.

The table below presents information about reportable segments (in thousands):

						Shared Services
		Total				and Other				Bistro				Pei Wei
For the Three Months Ended July 1, 2007:
Revenues		$	267,409			$	586			$	208,174			$	58,649
Income (loss) before provision for income taxes			12,500				(7,581	)			20,044				37
Capital expenditures			35,686				92				25,180				10,414
Depreciation and amortization			13,606				388				10,054				3,164
For the Three Months Ended July 2, 2006:
Revenues		$	225,981			$	—			$	183,705			$	42,276
Income (loss) before provision for income taxes			10,572				(6,095	)			17,124				(457	)
Capital expenditures			24,380				961				15,429				7,990
Depreciation and amortization			10,565				281				8,220				2,064
For the Six Months Ended July 1, 2007:
Revenues		$	531,815			$	1,308			$	415,202			$	115,305
Income (loss) before provision for income taxes			26,811				(15,537	)			42,056				292
Capital expenditures			64,371				135				45,476				18,760
Depreciation and amortization			26,285				761				19,537				5,987
For the Six Months Ended July 2, 2006:
Revenues		$	454,594			$	—			$	370,629			$	83,965
Income (loss) before provision for income taxes			24,443				(11,747	)			35,431				759
Capital expenditures			41,782				1,338				27,210				13,234
Depreciation and amortization			20,920				561				16,316				4,043
As of July 1, 2007:
Total assets		$	544,462			$	33,175			$	408,538			$	102,749
Goodwill			6,819				—				6,566				253
As of December 31, 2006:
Total assets		$	514,045			$	29,755			$	395,263			$	89,027
Goodwill			6,819				—				6,566				253

9. Commitments and Contingencies

The Company is engaged in various legal actions, which arise in the ordinary course of its business. The Company is also currently under examination by various taxing authorities for calendar years 2003 through 2005. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations, liquidity or financial condition of the Company.

10. Subsequent Event

In July 2007, the Company’s Board of Directors authorized a program to repurchase up to $50.0 million of the Company’s outstanding shares of common stock from time to time in the open market or in private at prevailing market prices over the next two years. The Company intends to use cash on hand and available credit lines to repurchase shares.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

This information should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2006 contained in our 2006 Annual Report on Form 10-K.

Some of the statements in this section contain forward—looking statements, which involve risks and uncertainties. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-looking statements contained in this section involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed under “Risk Factors” in Item 1A (a detailed description of which can be found under the caption “Risk Factors” in our most recently filed form 10-K) and elsewhere in this Form 10-Q, including, but not limited to, failure of our existing or new restaurants to achieve predicted results, the inability to develop and construct our restaurants within projected budgets and time periods and our ability to successfully expand our operations. Because we cannot guarantee future results, levels of activity, performance or achievements, you should not place undue reliance on these forward-looking statements.

Overview

We own and operate three restaurant concepts in the Asian niche: P.F. Chang’s China Bistro (“Bistro”), Pei Wei Asian Diner (“Pei Wei”) and Taneko Japanese Tavern (“Taneko”).

Bistro

As of July 1, 2007, we owned and operated 157 full service Bistro restaurants that feature a blend of high quality, traditional Chinese cuisine with attentive service and American hospitality in a sophisticated, contemporary bistro setting. P.F. Chang’s was formed in early 1996 with the acquisition of the four original Bistro restaurants and the hiring of an experienced management team. Utilizing a partnership management philosophy, we embarked on a strategic expansion of the concept targeted at major metropolitan areas throughout the United States. We own and operate all of our restaurants with the exception of a Bistro restaurant located in Honolulu, Hawaii which opened in September 2006 under a joint venture arrangement in which we own a minority interest.

We intend to open 19 new Bistros during fiscal 2007, five of which were open by the end of the second quarter of 2007. We will continue our development in existing markets and plan to enter eight new markets in 2007. We have signed lease agreements for all of our development planned for fiscal 2007. We intend to continue to develop Bistro restaurants that typically range in size from 6,000 to 7,500 square feet, and that require, on average, a total cash investment of approximately $2.8 million to $3.0 million and total invested capital of approximately $4.0 million per restaurant (net of estimated landlord reimbursements). This total capitalized investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. Preopening expenses are expected to average approximately $415,000 per restaurant during 2007, which includes approximately $50,000 per restaurant in preopening rent.

Pei Wei

As of July 1, 2007, we owned and operated 126 quick casual Pei Wei restaurants that offer a modest menu of freshly prepared, high quality Asian cuisine served in a relaxed, warm environment offering attentive counter service and take-out flexibility. Pei Wei opened its first unit in July 2000 in the Phoenix, Arizona area and has expanded significantly since then.

We intend to open 37 Pei Wei restaurants in 2007, 19 of which were open by the end of the second quarter of 2007. We will continue our development in existing markets and plan to enter nine new markets in 2007. We have signed lease agreements for all of our development planned for fiscal 2007. Our Pei Wei restaurants are generally 2,800 to 3,400 square feet in size and require an average total cash investment of approximately $750,000 to $850,000 and total invested capital of approximately $1.4 million per restaurant (net of estimated landlord reimbursements). Preopening expenses are expected to average approximately $140,000 per restaurant during 2007, which includes approximately $27,000 per restaurant in preopening rent.

Taneko

On October 2, 2006, we opened our first Taneko restaurant in Scottsdale, Arizona, featuring natural, organic and seasonal ingredients highlighting the diverse cooking styles of Japan. Inspired by izakayas, or local taverns, Taneko offers an extensive variety of food and beverages in a comfortable atmosphere.

Change in Partnership Structure

We utilize a partnership philosophy to facilitate the development, leadership and operation of our restaurants. Historically, this philosophy was embodied in a traditional legal partnership structure, which included capital contributions from our partners in exchange for an ownership stake in the profits and losses of our restaurants. Effective January 2007 for new store openings, the Bistro began employing a different structure to achieve the same goal. At the restaurant level, our Operating and Culinary Partners (still “partners” in the philosophical, but not legal sense) no longer have a direct ownership stake in the profits and losses of a restaurant, but are instead eligible to receive monthly incentive payments based upon the profitability of the restaurant, as well as participate in an incentive program that rewards long-term improvements in the operating performance of the restaurant. As a result of these changes, awards made to the individuals participating in the new plan are classified as compensation rather than as minority interest expense. Accordingly, compensation expense for our Operating and Culinary Partners is reflected in the consolidated income statement as Labor Expense. Additionally, a similar structure exists for our Market Partners and Regional Vice Presidents, with related compensation reflected as General and Administrative Expense in the consolidated income statement. Partner investment expense is no longer recognized for new Bistro restaurant openings beginning in 2007 as a result of this change. Additionally, many existing legal partners have requested an early buyout of their partnership interest as a result of their desire to participate in the new plan, the financial impact of which is discussed under “Partner Investment Expense” in Results of Operations.

The Pei Wei partnership structure is not affected by the changes at the Bistro and the traditional partnership structure remains in effect for new Pei Wei restaurant openings during 2007.

Critical Accounting Policies

Our critical accounting policies are those that require significant judgment. There have been no material changes to the critical accounting policies previously reported in our 2006 Annual Report on Form 10-K.

Results of Operations

The following tables set forth certain unaudited quarterly information for the three and six month periods ended July 1, 2007 and July 2, 2006, respectively. This quarterly information has been prepared on a basis consistent with the audited financial statements and, in the opinion of management, includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. P.F. Chang’s quarterly operating results may fluctuate significantly as a result of a variety of factors, and operating results for any quarter are not necessarily indicative of results for a full fiscal year.

One of the factors that has in the past caused fluctuations in our operating results is preopening expenses. Historically, we have experienced variability in the amount and percentage of revenues attributable to preopening expenses. We typically incur the most significant portion of preopening expenses associated with a given restaurant within the two months immediately preceding, and the month of, the opening of the restaurant. Additionally, there may be variability in the amount and percentage of revenues attributable to partner investment expense as a result of the timing of opening new Pei Wei restaurants and the timing of purchasing partner interests. Partner investment expense generally represents the difference between the imputed fair value of our partners’ ownership interests and our partners’ cash capital contribution for these interests.

In addition, our experience to date has been that labor and operating costs associated with a newly opened restaurant for the first several months of operation are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Accordingly, the volume and timing of new restaurant openings has had and is expected to continue to have, a meaningful impact on preopening expenses, labor, operating and partner investment costs until such time as a larger base of restaurants in operation mitigates such impact.

Results for the three months ended July 1, 2007 and July 2, 2006

Our consolidated operating results for the three months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Three months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	267,409				100.0	%		$	225,981				100.0	%		$	41,428				18.3	%
Costs and expenses:
Cost of sales			73,011				27.3	%			61,285				27.1	%			11,726				19.1	%
Labor			90,665				33.9	%			75,380				33.4	%			15,285				20.3	%
Operating			42,436				15.9	%			36,210				16.0	%			6,226				17.2	%
Occupancy			15,615				5.8	%			12,725				5.6	%			2,890				22.7	%
General and administrative			15,806				5.9	%			14,037				6.2	%			1,769				12.6	%
Depreciation and amortization			13,606				5.1	%			10,565				4.7	%			3,041				28.8	%
Preopening expense			3,296				1.2	%			2,817				1.2	%			479				17.0	%
Partner investment expense			(468	)			(0.2	%)			925				0.4	%			(1,393	)			—
Total costs and expenses			253,967				95.0	%			213,944				94.7	%			40,023				18.7	%
Income from operations			13,442				5.0	%			12,037				5.3	%			1,405				11.7	%
Interest and other income, net			179				0.1	%			568				0.3	%			(389	)			(68.5	%)
Minority interest			(1,121	)			(0.4	%)			(2,033	)			(0.9	%)			912				(44.9	%)
Income before provision for income taxes			12,500				4.7	%			10,572				4.7	%			1,928				18.2	%
Provision for income taxes			(3,223	)			(1.2	%)			(2,483	)			(1.1	%)			(740	)			29.8	%
Net income		$	9,277				3.5	%		$	8,089				3.6	%		$	1,188				14.7	%

Certain percentage amounts do not sum to total due to rounding. Percentages over 100% not displayed.

Operating results for the Bistro for the three months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Three months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	208,174				100.0	%		$	183,705				100.0	%		$	24,469				13.3	%
Costs and expenses:
Cost of sales			56,696				27.2	%			49,810				27.1	%			6,886				13.8	%
Labor			69,827				33.5	%			60,753				33.1	%			9,074				14.9	%
Operating			32,194				15.5	%			28,653				15.6	%			3,541				12.4	%
Occupancy			11,598				5.6	%			9,928				5.4	%			1,670				16.8	%
General and administrative			5,907				2.8	%			5,319				2.9	%			588				11.1	%
Depreciation and amortization			10,054				4.8	%			8,220				4.5	%			1,834				22.3	%
Preopening expense			1,790				0.9	%			1,575				0.9	%			215				13.7	%
Partner investment expense			(753	)			(0.4	%)			570				0.3	%			(1,323	)			—
Total costs and expenses			187,313				90.0	%			164,828				89.7	%			22,485				13.6	%
Income from operations			20,861				10.0	%			18,877				10.3	%			1,984				10.5	%
Interest and other income, net			20				0.0	%			—				0.0	%			20				—
Minority interest			(837	)			(0.4	%)			(1,753	)			(1.0	%)			916				(52.3	%)
Income before provision for income taxes		$	20,044				9.6	%		$	17,124				9.3	%		$	2,920				17.1	%

Certain percentage amounts do not sum to total due to rounding. Percentages over 100% not displayed.

Operating results for Pei Wei for the three months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Three months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	58,649				100.0	%		$	42,276				100.0	%		$	16,373				38.7	%
Costs and expenses:
Cost of sales			16,070				27.4	%			11,475				27.1	%			4,595				40.0	%
Labor			20,480				34.9	%			14,627				34.6	%			5,853				40.0	%
Operating			10,004				17.1	%			7,557				17.9	%			2,447				32.4	%
Occupancy			3,963				6.8	%			2,797				6.6	%			1,166				41.7	%
General and administrative			2,878				4.9	%			2,485				5.9	%			393				15.8	%
Depreciation and amortization			3,164				5.4	%			2,064				4.9	%			1,100				53.3	%
Preopening expense			1,506				2.6	%			1,126				2.7	%			380				33.7	%
Partner investment expense			285				0.5	%			355				0.8	%			(70	)			(19.7	%)
Total costs and expenses			58,350				99.5	%			42,486				100.5	%			15,864				37.3	%
Income from operations			299				0.5	%			(210	)			(0.5	%)			509				—
Interest and other income, net			22				0.0	%			33				0.1	%			(11	)			(33.3	%)
Minority interest			(284	)			(0.5	%)			(280	)			(0.7	%)			(4	)			1.4	%
Income before provision for income taxes		$	37				0.1	%		$	(457	)			(1.1	%)		$	494				—

Certain percentage amounts do not sum to total due to rounding. Percentages over 100% not displayed.

Revenues

Our revenues are derived primarily from food and beverage sales. Each segment contributed to current year revenue growth as follows:

Bistro: The increase in revenues was attributable to revenues of $24.4 million generated by the 20 new Bistro restaurants that opened during the first half of 2007 and the second half of 2006, partially offset by a slight net decrease in revenues for restaurants that opened prior to the second quarter of 2006. An effective price increase of approximately 2-3% impacted all restaurants and also contributed to the increase in revenues. Such increases were partially offset by a decline in overall guest traffic during the second quarter of fiscal 2007.

Pei Wei: The increase in revenues was attributable to revenues of $14.3 million generated by the 38 new Pei Wei restaurants that opened during the first half of 2007 and the second half of 2006 and a $2.0 million increase in revenues for restaurants that opened prior to the second quarter of 2006. An effective price increase of approximately 1-2% impacting all restaurants and a slight increase in overall guest traffic also contributed to the increase in revenues.

In addition to the revenues earned by Bistro and Pei Wei, consolidated revenues include $0.6 million of revenues generated by our Taneko concept.

Costs and Expenses

Cost of Sales

Cost of sales is comprised of the cost of food and beverages. Each segment contributed as follows:

Bistro: Cost of sales as a percentage of revenues at the Bistro increased slightly due to an adjustment resulting from a modification of our accounting policy related to rebate accruals during the second quarter of 2006. Excluding this adjustment, cost of sales as a percentage of revenues decreased slightly primarily due to lower pork and seafood expense resulting from favorable pricing, improved yields and increased purchasing through national distribution contracts, partially offset by slightly higher poultry prices and increased produce expense.

Pei Wei: Cost of sales as a percentage of revenues at Pei Wei increased due to an adjustment resulting from a modification of our accounting policy related to rebate accruals during the second quarter of 2006. Excluding this adjustment, cost of sales as a percentage of revenues decreased slightly primarily due to lower pork expense resulting from favorable pricing and yields partially offset by higher poultry costs.

Labor

Labor expenses consist of restaurant management salaries, hourly staff payroll costs, other payroll-related items and imputed partner bonus expense. Imputed partner bonus expense represents the portion of restaurant level operating results that are allocable to minority partners, but are presented as bonus expense for accounting purposes. Each segment contributed as follows:

Bistro: Labor expenses as a percentage of revenues at the Bistro increased primarily due to higher management incentive costs principally resulting from the 2007 change in the Bistro partnership structure as well as wage rate pressure across all labor categories. The impact of these factors was partially offset by the benefit of reduced workers’ compensation insurance liabilities resulting from lower than anticipated claims development.

Pei Wei: Labor expenses as a percentage of revenues at Pei Wei increased primarily due to decreased leverage resulting from lower average weekly sales, increased management incentive costs and continued wage rate pressure in culinary positions.

Operating

Operating expenses consist primarily of various restaurant-level costs such as repairs and maintenance, utilities and marketing, which are generally variable and fluctuate with revenues. Our experience to date has been that operating costs during the first four to nine months of a newly opened restaurant are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Each segment contributed as follows:

Bistro: Operating expenses as a percentage of revenues at our Bistro restaurants decreased due to an adjustment resulting from a modification of our accounting policy related to utility accruals during the second quarter of 2006. Excluding this adjustment, operating expenses as a percentage of revenues increased primarily due to higher disposable supplies expenses, increased marketing spending and higher maintenance contract costs.

Pei Wei: Operating expenses as a percentage of revenues at our Pei Wei restaurants decreased due to an adjustment resulting from a modification of our accounting policy related to utility accruals during the second quarter of 2006. Excluding this adjustment, operating expenses as a percentage of revenues were consistent with prior year. This was primarily due to reduced take-out supplies, disposable supplies and menu printing costs partially offset by higher utilities and maintenance expenses and increased marketing spending as well as the impact of decreased leverage resulting from lower average weekly sales.

Occupancy

Occupancy costs include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes. Each segment contributed as follows:

Bistro: Occupancy costs as a percentage of revenues at the Bistro increased primarily due to higher general liability insurance costs for 2007 and a slight increase in property tax expense due to new stores opening in geographic areas with higher property tax rates.

Pei Wei: Occupancy costs as a percentage of revenues at Pei Wei increased primarily due decreased leverage resulting from lower average weekly sales and higher general liability insurance costs for 2007.

General and Administrative

General and administrative expenses are comprised of expenses associated with corporate and administrative functions that support restaurant development and operations and provide infrastructure to support future growth, including management and staff salaries, employee benefits, travel, legal and professional fees, technology and market research. Each segment contributed as follows:

Bistro: General and administrative costs at the Bistro increased primarily due to higher management incentive accruals due to the impact of the 2007 change in the Bistro partnership structure.

Pei Wei: General and administrative costs at Pei Wei increased primarily due to an increase in compensation and benefits expense related to the addition of development and operating partners, higher management incentive accruals and, to a lesser extent, increased health insurance costs and higher share-based compensation expense. As a percentage of revenues, Pei Wei’s general and administrative costs decreased compared to the prior year due to improved leveraging of general and administrative costs resulting from additional store openings.

Shared Services and Other: General and administrative costs for Shared Services and Other increased $0.9 million principally due to higher compensation and benefits expense primarily related to the addition of corporate management personnel, and, to a lesser extent, increased share-based compensation expense.

Depreciation and Amortization

Depreciation and amortization expenses include the depreciation and amortization of fixed assets and the amortization of intangible assets and non-transferable liquor license fees. Each segment contributed as follows:

Bistro: Depreciation and amortization increased primarily due to additional depreciation and amortization on restaurants opened during the last half of fiscal 2006 and during the first half of fiscal 2007 and, to a lesser extent, an increase in amortization of intangible and other assets. As a percentage of revenues, depreciation and amortization increased due to higher average capital expenditures for new restaurants and increased remodeling costs at existing restaurants.

Pei Wei: Depreciation and amortization increased primarily due to additional depreciation and amortization on restaurants opened during the last half of fiscal 2006 and during the first half of fiscal 2007. As a percentage of revenues, depreciation and amortization increased due to decreased leverage resulting from lower average weekly sales and higher average capital expenditures for new restaurants.

Preopening Expense

Preopening expenses, which are expensed as incurred, consist of expenses incurred prior to opening a new restaurant and are comprised principally of manager salaries and relocation costs, employee payroll and related training costs. Preopening expenses also include straight-line rent for the period between the possession date of leased premises and the restaurant opening date. Each segment contributed as follows:

Bistro: Preopening expense increased primarily due to the timing of costs related to upcoming third and fourth quarter new restaurant openings compared to the prior year.

Pei Wei: Preopening expense increased primarily due to the impact of opening ten new Pei Wei restaurants during the second quarter of 2007 compared to seven new Pei Wei restaurants during the second quarter of 2006, partially offset by a slight decrease in average per location preopening costs incurred during the current year principally due to opening additional new stores in mature markets which typically results in lower preopening costs due to operational efficiencies.

Partner Investment Expense

Partner investment expense represents the difference between the imputed fair value of our legal partners’ ownership interests at the time the partners invest in their restaurants and our partners’ cash contributions for those ownership interests. Additionally, for those partners who are bought out prior to the restaurant reaching maturity (typically after five years of operation), partner investment expense includes a reversal of previously recognized expense for the difference between the fair value of the partner’s interest at inception date and the fair value at the date of repurchase, to the extent that the former is greater.

Each segment contributed as follows:

Bistro: Partner investment expense at the Bistro decreased due to the change in partnership structure discussed above, which led to a significant increase in early buyouts of minority partner interests during the first half of fiscal 2007. These early buyouts resulted in a $0.8 million reversal during the second quarter of previously recognized partner investment expense due to the fair value of the partner’s interest at inception date exceeding the fair value of the partner’s interest at repurchase date. Additionally, as a result of the change in partnership structure, partner investment expense is no longer recognized at the time a new restaurant opens.

Pei Wei: Partner investment expense at Pei Wei decreased primarily due to expense reductions related to minority partner buyouts and, to a lesser extent, the impact of a lower imputed fair value of partnership interests in new Pei Wei restaurants in 2007. These items were partially offset by the impact of opening ten new restaurants during the second quarter of fiscal 2007 compared to opening seven new restaurants during the second quarter of fiscal 2006.

Interest and Other Income (Expense), Net

Consolidated interest and other income (expense), net decreased primarily due to lower interest income resulting from the sale of interest-bearing securities to finance our share repurchase program, which commenced during the third quarter of fiscal 2006 (see “Share Repurchase Program” in the Liquidity and Capital Resources section for further detail). Interest income earned during 2007 primarily relates to interest-bearing overnight deposits.

Minority Interest

Minority interest represents the portion of our net earnings which is attributable to the collective ownership interests of our minority investors. As previously discussed, in many of our restaurants we employ a partnership management structure whereby we have entered into a series of partnership agreements with our regional managers, certain of our general managers, and certain of our executive chefs. Each segment contributed as follows:

Bistro: Minority interest as a percentage of revenues at the Bistro decreased due to the impact of partner buyouts occurring during the first half of fiscal 2007, which resulted in a reduction in the number of minority interests from 357 as of July 2, 2006 to 182 minority interests as of July 1, 2007.

Pei Wei: Minority interest as a percentage of revenues at Pei Wei decreased slightly due to the impact of lower restaurant net income and partner buyouts occurring during the first half of fiscal 2007 compared to the prior year.

Provision for Income Taxes

Our effective tax rate was 25.8% for the second quarter of fiscal 2007 compared to 23.5% for the second quarter of fiscal 2006. The income tax rates for the second quarter of fiscal 2007 and fiscal 2006 differed from the expected provision for income taxes, which is derived by applying the statutory income tax rate, primarily as a result of FICA tip credits.

See Note 7 to the consolidated financial statements for a discussion of our adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.

Results for the six months ended July 1, 2007 and July 2, 2006

Our consolidated operating results for the six months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Six months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	531,815				100.0	%		$	454,594				100.0	%		$	77,221				17.0	%
Costs and expenses:
Cost of sales			145,926				27.4	%			124,725				27.4	%			21,201				17.0	%
Labor			179,899				33.8	%			152,317				33.5	%			27,582				18.1	%
Operating			83,630				15.7	%			71,051				15.6	%			12,579				17.7	%
Occupancy			30,523				5.7	%			25,218				5.5	%			5,305				21.0	%
General and administrative			32,528				6.1	%			27,289				6.0	%			5,239				19.2	%
Depreciation and amortization			26,285				4.9	%			20,920				4.6	%			5,365				25.6	%
Preopening expense			5,836				1.1	%			4,511				1.0	%			1,325				29.4	%
Partner investment expense			(1,869	)			(0.4	%)			1,125				0.2	%			(2,994	)			—
Total costs and expenses			502,758				94.5	%			427,156				94.0	%			75,602				17.7	%
Income from operations			29,057				5.5	%			27,438				6.0	%			1,619				5.9	%
Interest and other income, net			522				0.1	%			1,060				0.2	%			(538	)			(50.8	%)
Minority interest			(2,768	)			(0.5	%)			(4,055	)			(0.9	%)			1,287				(31.7	%)
Income before provision for income taxes			26,811				5.0	%			24,443				5.4	%			2,368				9.7	%
Provision for income taxes			(7,069	)			(1.3	%)			(6,541	)			(1.4	%)			(528	)			8.1	%
Net income		$	19,742				3.7	%		$	17,902				3.9	%		$	1,840				10.3	%

Certain percentage amounts do not sum to total due to rounding. Percentages over 100% not displayed.

Operating results for the Bistro for the six months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Six months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	415,202				100.0	%		$	370,629				100.0	%		$	44,573				12.0	%
Costs and expenses:
Cost of sales			113,477				27.3	%			101,581				27.4	%			11,896				11.7	%
Labor			139,139				33.5	%			123,405				33.3	%			15,734				12.7	%
Operating			63,878				15.4	%			56,550				15.3	%			7,328				13.0	%
Occupancy			22,815				5.5	%			19,787				5.3	%			3,028				15.3	%
General and administrative			11,834				2.9	%			10,436				2.8	%			1,398				13.4	%
Depreciation and amortization			19,537				4.7	%			16,316				4.4	%			3,221				19.7	%
Preopening expense			3,046				0.7	%			2,641				0.7	%			405				15.3	%
Partner investment expense			(2,679	)			(0.6	%)			996				0.3	%			(3,675	)			—
Total costs and expenses			371,047				89.4	%			331,712				89.5	%			39,335				11.9	%
Income from operations			44,155				10.6	%			38,917				10.5	%			5,238				13.5	%
Interest and other income, net			71				0.0	%			—				0.0	%			71				—
Minority interest			(2,170	)			(0.5	%)			(3,486	)			(0.9	%)			1,316				(37.8	%)
Income before provision for income taxes		$	42,056				10.1	%		$	35,431				9.6	%		$	6,625				18.7	%

Certain percentage amounts do not sum to total due to rounding. Percentages over 100% not displayed.

Operating results for Pei Wei for the six months ended July 1, 2007 and July 2, 2006 were as follows (dollars in thousands):

		Six months ended
		July 1,				% of				July 2,				% of
		2007				Revenues				2006				Revenues				Change				% Change
Revenues		$	115,305				100.0	%		$	83,965				100.0	%		$	31,340				37.3	%
Costs and expenses:
Cost of sales			31,921				27.7	%			23,144				27.6	%			8,777				37.9	%
Labor			40,031				34.7	%			28,912				34.4	%			11,119				38.5	%
Operating			19,386				16.8	%			14,501				17.3	%			4,885				33.7	%
Occupancy			7,599				6.6	%			5,431				6.5	%			2,168				39.9	%
General and administrative			5,908				5.1	%			4,784				5.7	%			1,124				23.5	%
Depreciation and amortization			5,987				5.2	%			4,043				4.8	%			1,944				48.1	%
Preopening expense			2,789				2.4	%			1,729				2.1	%			1,060				61.3	%
Partner investment expense			810				0.7	%			129				0.2	%			681				—
Total costs and expenses			114,431				99.2	%			82,673				98.5	%			31,758				38.4	%
Income from operations			874				0.8	%			1,292				1.5	%			(418	)			(32.4	%)
Interest and other income, net			16				0.0	%			36				0.0	%			(20	)			(55.6	%)
Minority interest			(598	)			(0.5	%)			(569	)			(0.7	%)			(29	)			5.1	%
Income before provision for income taxes		$	292				0.3	%		$	759				0.9	%		$	(467	)			(61.5	%)