UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File Number: 0-25123

 

 

 

 

P.F. Chang’s China Bistro, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(480) 888-3000

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 report(s), 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No þ

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

 

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

 

The aggregate market value of the registrant’s common stock held by non-affiliates as of the last day of the registrant’s second fiscal quarter ended, June 28, 2009, was $374,486,928.

 

On February 12, 2010 there were outstanding 22,933,862 shares of the registrant’s Common Stock.

 

DOCUMENTS INCORPORATED BY REFERENCE
(to the extent indicated herein)

 

Specified portions of the registrant’s Proxy Statement with respect to the Annual Meeting of Stockholders to be held April 22, 2010 are incorporated by reference into Part III of this Report.

 

 

TABLE OF CONTENTS

 

 

 

General

 

P.F. Chang’s China Bistro, Inc. (“P.F. Chang’s” or the “Company”) was incorporated in January 1996 as a Delaware corporation. We conducted our initial public offering in December 1998. We incorporated our subsidiary, Pei Wei Asian Diner, Inc., in December 1999 as a Delaware corporation. We report our financial and descriptive information according to two reportable operating segments: P.F. Chang’s China Bistro (“Bistro”) and Pei Wei Asian Diner (“Pei Wei”) (see Notes to Consolidated Financial Statements — Note 19 — Segment Reporting).

 

As of January 3, 2010, we owned and operated 197 full service Bistro restaurants that feature a blend of high quality, Chinese-inspired cuisine and attentive service, in a high-energy contemporary bistro setting. Our restaurants offer intensely flavored, highly memorable culinary creations, prepared from fresh ingredients, including premium herbs and spices imported directly from China. The menu features traditional Chinese offerings and innovative dishes that illustrate the emerging influence of Southeast Asia on modern Chinese cuisine. Our menu is complemented by a full service bar offering an extensive selection of wines, specialty drinks, Asian beers, sake, cappuccino and espresso. We offer superior customer service in a high energy atmosphere and a decor that includes wood and slate floors, life-size replicas of the terra cotta Xi’an warriors and narrative murals depicting scenes of life in ancient China. Additionally, there are two Bistro locations located in Hawaii and two Bistro locations located in international markets that are operated by business partners under licensing agreements.

 

As of January 3, 2010, we also owned and operated 166 quick casual Pei Wei restaurants that serve freshly prepared, wok-seared, contemporary pan-Asian cuisine in a relaxed, warm environment with friendly attentive counter service and take-out flexibility. Pei Wei offers the same spirit of hospitality and commitment to providing fresh, high quality Asian food at a great value that has made our Bistro restaurants successful. Pei Wei opened its first unit in the Phoenix, Arizona metro-area in July 2000.

 

Concept and Strategy

 

Our objectives are to develop and operate a nationwide system of Asian-inspired restaurants that offer guests a sophisticated dining experience, create a loyal customer base that generates a high level of repeat business and provide superior returns to our investors. To achieve our objectives, we strive to offer high quality Asian cuisine in a memorable atmosphere while delivering superior customer service and an excellent dining value. Key to our strategy and success at the restaurant level is a philosophy that allows regional managers, general managers and executive chefs to participate in the profitability of the restaurants for which they have responsibility. We have established Bistro and Pei Wei restaurants in a wide variety of markets across the United States.

 

Menu

 

Bistro

 

The menu for our Bistro restaurants offers a harmony of taste, texture, color and aroma by balancing the Chinese principles of fan and t’sai, which mean “balance” and “moderation”. Fan foods include rice, noodles, grains and dumplings, while t’sai foods include vegetables, meat, poultry and seafood. To further encourage the Chinese principles of fan and t’sai, our menu is served family-style, the traditional Chinese way of dining. Our chefs are trained to produce distinctive Chinese cuisine using traditional recipes from the major culinary regions of China updated with a contemporary twist. The intense heat of Mandarin-style wok cooking sears in the clarity and distinct flavor of fresh ingredients. Slow-roasted Northern-style BBQ spare ribs are prepared in vertical ovens, while handmade shrimp, pork and vegetable dumplings, as well as flavorful fish and vegetables, are prepared in custom-made steamer cabinets. The menu is highlighted by dishes such as Chang’s Spicy Chicken, Mongolian Beef, Dumplings, Chang’s Chicken Lettuce Wraps, Oolong Marinated Sea Bass and Dan Dan Noodles. We also offer an array of vegetarian dishes and are able to modify dishes to accommodate our customers with special dietary needs, including a gluten free menu. No MSG is added to any ingredients at our restaurants.

As a result of our extensive research and development efforts, we periodically change our menu. For example, during 2009 the Bistro introduced Chang’s for Two, a prix-fixe menu offering a four-course meal for two people for $39.95. The menu includes two soups, one starter, two entrees and two mini desserts, all of which can be chosen from an extensive selection of signature dishes and guest favorites. Chang’s for Two allows our customers to enjoy a premium dining experience that offers both enticing culinary cuisine and great value.

 

Additionally, in early 2010, the Bistro added a new daily Happy Hour from 3-6 PM at participating locations that includes appetizers and drink specials priced from $3.00 — $6.00. The Happy Hour menu includes all starters on the Bistro menu as well as a variety of beer, wine, sake and signature cocktails. Our Happy Hour rewards guests by providing appealing, affordable cuisine and drinks at a great value on a daily basis.

 

Entrées at the Bistro range in price from $4.95 — $22.95, and our starters range in price from $3.00 — $13.00. The average check per guest, including alcoholic beverages, is approximately $20.00 to $21.00. Sales of alcoholic beverages, featuring an extensive selection of wine, Asian beer, sake and signature cocktails, have constituted approximately 14% to 15% of total revenues for each of the past three years. Take-away sales comprise approximately 11% of Bistro’s total revenues. Lunch and dinner contribute approximately 32% and 68% of revenues, respectively.

 

Pei Wei

 

The menu at Pei Wei also offers a variety of intensely flavored culinary creations; however, this menu is more concise than that of the Bistro and includes not only Chinese cuisine but other Asian fare as well. As with the Bistro, Pei Wei has a high energy exhibition kitchen featuring made-to-order items using traditional Mandarin-style wok cooking. Along with our handmade dim sum, our guests can order traditional favorites such as Chicken Lettuce Wraps and Mandarin Kung Pao Chicken, while sampling a variety of Asian dishes such as Vietnamese Chicken Salad Rolls, Pad Thai and Spicy Korean Beef.

 

Entrées at Pei Wei range in price from $6.50 to $9.00, with starters ranging from $1.95 to $6.95. The average check per guest at Pei Wei, including beer and wine sales, is approximately $9.00 to $10.00. Sales of alcoholic beverages, featuring limited selection of beer and wine, have constituted approximately 1% to 2% of total revenues for each of the past three years. Take-away sales comprise approximately 39% of Pei Wei’s total revenues. Lunch and dinner contribute approximately 43% and 57% of revenues, respectively.

 

Operations

 

Bistro

 

The Bistro strives to create a sophisticated dining experience through the careful selection, training and supervision of personnel. The staff of a typical Bistro restaurant consists of an Operating Partner, three or four managers, a Culinary Partner, one or two sous chefs and approximately 125 hourly employees, many of whom work part-time. The Operating Partner of each restaurant is responsible for the day-to-day operations of that restaurant, including the hiring, training and development of personnel, as well as operating results. The Culinary Partner is responsible for product quality, purchasing, food costs and kitchen labor costs. We require our Operating Partners and Culinary Partners to have significant experience in the full service restaurant industry.

 

The Bistro has a comprehensive eight-week management development program. This program consists of four weeks of culinary training, including both culinary job functions and culinary management, with the remaining four weeks focused on service strategies, guest relations and administration. All salaried hospitality and culinary management personnel are required to successfully complete all sections of the program. Upon the completion of each four-week section, each trainee must successfully complete a comprehensive certification.

 

The Operating Partners are responsible for selecting hourly employees for their restaurants and are responsible for administering hourly staff training programs that are developed by the training and culinary departments. The hourly employee development program lasts between one and two weeks and focuses on both technical and cultural knowledge.

Additionally, during fiscal 2009, the Bistro implemented a new online ordering system to help facilitate take-away ordering. The Bistro also added online reservation capabilities to its website during 2009.

 

Pei Wei

 

A typical staff at Pei Wei consists of a general manager, a kitchen manager, one or two managers, and approximately 35 hourly employees. Our general managers are responsible for the day-to-day operations of the restaurant, including the hiring, training and development of personnel, as well as operating results. The kitchen manager collaborates with the general manager on product quality, purchasing, food cost and kitchen labor costs.

 

Pei Wei uses a comprehensive nine-week management training program, which consists of six weeks of hands-on culinary functions and culinary management, with the remaining three weeks focusing on service strategies specific to dine-in and take-away service, guest and employee relations and administration. Upon completion of training, each new manager must complete a comprehensive culinary and overall operations certification.

 

Each Pei Wei hourly employee undergoes a week-long comprehensive training program that focuses on the culinary knowledge required for his or her specific position. After completion of the program, each employee is required to pass a test specific to their position prior to serving our guests.

 

Additionally, during fiscal 2009 Pei Wei implemented an online ordering system to help facilitate take-away ordering. Digital menu boards were also installed in all locations to facilitate menu changes and product messaging.

 

Global Brand Development

 

International

 

Based on our belief that our brands would work well in the international market, we are selectively pursuing international expansion of our Bistro restaurants. During the second quarter of fiscal 2009, we signed two development and licensing agreements with partners who will develop and operate Bistro restaurants in international markets. The first two restaurants under these development and licensing agreements opened in Mexico City and Kuwait City during the fourth quarter of fiscal 2009. A third development and licensing agreement was also signed during February 2010. We continue to engage in discussions with additional potential partners regarding expansion of the Bistro into various international markets. We expect these relationships to take the form of license agreements under which we would receive an initial territory fee, store opening fees and ongoing royalty revenues based on a percentage of international restaurant sales.

 

Retail

 

In August 2009, we entered into an exclusive licensing agreement with Unilever to develop and launch a new premium line of frozen Asian-style entrées in the U.S., under the P.F. Chang’s brand. The new products are expected to be available in retail outlets during the first half of fiscal 2010. We will receive ongoing royalty revenues based on a percentage of product sales. These percentages will escalate over the first three years of the agreement.

 

Marketing

 

We focus our business strategy on providing high quality, Asian cuisine prepared by an attentive staff in a distinctive environment at a great value. By focusing on the food, service and ambiance of the restaurant, we strive to create an environment that fosters repeat patronage and encourages word-of-mouth recommendations. We believe that word-of-mouth advertising is a key component in driving guests’ initial trial and subsequent visits, and that creating a great experience for guests will always be the ultimate marketing vehicle.

 

To attract and retain new customers, we have historically utilized a mix of marketing strategies including paid advertising, public relations and local community involvement. While we had used limited radio, print and outdoor advertising in the past, over the past few years we began making more significant investments in these marketing channels in key markets. At the same time, we added online, direct mail, social media, and customer relationship initiatives to the media mix to both drive new customer trials and foster better ongoing communication with our guests. We expect to continue these efforts in fiscal 2010.

Management Information Systems

 

We utilize an integrated information system to manage the flow of information within each restaurant and between the restaurants and the corporate office. This system includes a point-of-sale local area network that helps facilitate the operations of the restaurant by recording sales transactions and printing orders in the appropriate locations within the restaurant. Additionally, the point-of-sale system is utilized to authorize, batch and transmit credit card transactions, to record employee time clock information, to schedule labor and to produce a variety of management reports. Select information that is captured from this system is transmitted to the corporate office on a daily basis, enabling senior management to continually monitor operating results. We believe that our current point-of-sale system will be an adequate platform to support our continued expansion for the foreseeable future.

 

Supply Chain Management

 

Our supply chain management function provides our restaurants with high quality ingredients at competitive prices from reliable sources. Consistent menu specifications, as well as purchasing and receiving guidelines, ensure freshness and quality. Because we utilize only fresh ingredients in all of our menu offerings, inventory is maintained at a modest level. We negotiate short-term and long-term contracts depending on demand for the commodities used in the preparation of our products. These contracts generally average from two to twelve months in duration, though they can be longer at times for certain commodities. With the exception of a portion of our commodities, like produce, we utilize Distribution Market Advantage, a cooperative of multiple food distributors located throughout the United States, as the primary distributor of product to all of our restaurants. We have a non-exclusive contract with Distribution Market Advantage on terms and conditions that we believe are consistent with those made available to similarly situated restaurant companies. Our produce is distributed by a network of local specialty distributors who service our restaurants in adherence to our quality and safety standards. Our most important items are contracted annually to stabilize prices and ensure availability.

 

We believe that competitively priced alternative distribution sources are available should they become necessary. Asian-specific ingredients, primarily spices and sauces, are usually sourced directly from Hong Kong, China, Taiwan and Thailand. We have developed an extensive network of suppliers in order to maintain an adequate supply of items that conform to our brand and product specifications.

 

Competition

 

The restaurant business is intensely competitive with respect to food quality, price-value relationships, ambiance, service and location, and many existing restaurants compete with us at each of our locations. Key competitive factors in the industry include the quality and value of the food, quality of service, price, dining experience, restaurant location and the ambiance of the facilities. For the Bistro, our primary competitors include mid-priced, full service casual dining restaurants. For Pei Wei, our main competitors are other value-priced, quick service concepts as well as locally owned and operated Asian restaurants.

 

There are a number of well-established competitors with substantially greater financial, marketing, personnel and other resources than ours. In addition, many of our competitors are well established in the markets where our operations are, or in which they may be, located. While we believe that our restaurants are distinctive in design and operating concept, other companies may develop restaurants that operate with similar concepts. Additionally, the rising popularity of Asian food may result in increased competition from non-Asian restaurants as well as other food outlets, such as supermarkets, as they increase their number of Asian-inspired menu offerings.

 

Employees

 

At January 3, 2010, we employed approximately 26,000 persons, approximately 300 of whom were home office and field personnel, approximately 1,700 of whom were unit management personnel and the remainder of whom were hourly restaurant personnel. Our employees are not covered by a collective bargaining agreement. We consider our employee relations to be good.

Unit Economics

 

We believe that unit economics are critical to the long-term success of any restaurant concept. Accordingly, we focus on unit-level returns over time as a key measurement of our success or failure. For analysis purposes, we group our restaurants by the year in which they opened. We then compare each “class” to its peers over time as well as to the performance of the entire system. These unit economics are available on our website: www.pfcb.com.

 

Access to Information

 

Our Internet address is www.pfcb.com. We make available at this address, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports, and beneficial ownership reports filed by our directors and officers pursuant to Section 16 of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC.

 

 

The failure of our existing or new restaurants to achieve expected results could have a negative impact on our revenues and financial results, including potential impairment of the long-lived assets of our restaurants, and could negatively impact our stock price.

 

We operated 197 full service Bistro restaurants and 166 quick casual Pei Wei restaurants as of January 3, 2010, 15 of which opened within the last twelve months. The results achieved by these restaurants may not be indicative of longer term performance or the potential market acceptance of restaurants in other locations. There can be no assurance that any new restaurant that we open will have similar operating results to those of prior restaurants. Our new restaurants commonly take several months to reach planned operating levels due to inefficiencies typically associated with new restaurants, including the training of new personnel, lack of market awareness, inability to hire sufficient staff and other factors. The failure of our existing or new restaurants to perform as expected could have a significant negative impact.

 

We are subject to a number of significant risks that might cause our actual results to vary materially from our historical results or future projections including:

 

 

 

 

 

 

Additionally, we have historically 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. Our experience 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 may continue to have, a meaningful impact on preopening expenses as well as labor and operating costs. Due to the foregoing factors, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for a full fiscal year and these fluctuations may cause our operating results to be below expectations of public market analysts and investors, adversely impacting our stock price.

 

Changes in general economic and political conditions could affect consumer spending and may harm our revenues, operating results or liquidity.

 

General weak economic conditions may continue throughout fiscal 2010. As a result, our customers may continue to remain apprehensive about the economy and maintain or further reduce their already lowered level of discretionary spending. This could impact the frequency with which our customers choose to dine out or the amount they spend on meals while dining out, thereby decreasing our revenues and potentially negatively affecting our operating results. Additionally, we believe there is a risk that if the current negative economic conditions persist for a long period of time or become more pervasive, consumers might make long-lasting changes to their discretionary spending behavior, including dining out less frequently on a more permanent basis.

 

Changes in government legislation may increase our labor costs and have a material adverse effect on our business and financial results.

 

A substantial number of our restaurant personnel are hourly workers whose wage rates are affected by increases in the federal or state minimum wage or changes to tip credits. Tip credits are the amounts an employer is permitted to assume an employee receives in tips when the employer calculates the employee’s hourly wage for minimum wage compliance purposes. FICA tip credits resulting from tip credit reporting are also a significant factor when calculating the Company’s effective tax rate. Mandated increases in minimum wage levels and changes to the tip credit have recently been and continue to be proposed and implemented at both federal and state government levels. Additionally, as minimum wage rates increase, we may need to increase not only the wages of our minimum wage employees but also the wages paid to employees at wage rates that are above minimum wage. Future legislation that increases minimum wage rates or changes allowable tip credits may increase our labor costs or effective tax rate and have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Additionally, potential changes in labor legislation, including all or parts of the Employee Free Choice Act (“EFCA”), could result in portions of our workforce being subjected to greater organized labor influence. The EFCA, also referred to as the “card check” bill, could impact the nature of labor relations in the United States, specifically, how union elections and contract negotiations are conducted. The EFCA aims to make it easier for unions to form, and employers of unionized employees may face mandatory, binding arbitration of labor scheduling, costs and standards, which could increase the costs of doing business. Although we do not currently have any union employees, EFCA or similar labor legislation could have an adverse effect on our business and

financial results by imposing requirements that could potentially increase costs, reduce flexibility and impact our ability to service our guests.

 

We are dependent on sales concentrated in certain geographic areas as well as sales generated by corporate spending.

 

Our financial performance is highly dependent on restaurants located in California, Arizona, Nevada and Florida which comprise one-third of our total store population. Additionally, restaurants located in Texas comprise almost 20 percent of our total store population. In recent years, certain of these states have been more negatively impacted by the housing downturn, unemployment and the overall economic crisis than other geographic areas. As a result, we have seen a more substantial decline in guest traffic at some of our restaurants in these locations, which has adversely affected the operations of the company as a whole. If we are unable to improve operating performance in these geographic areas, our financial results will continue to be adversely affected.

 

Our business is also influenced by the level of corporate travel and entertainment spending by businesses as a significant portion of our sales is generated by guests conducting business at our restaurants. During fiscal 2009, there was a considerable reduction in business travel and corporate spending in general, which negatively impacted our revenues. Such reduced spending could continue to have a significant negative impact on our financial results until such time as corporate spending increases.

 

Intense competition in the restaurant industry could prevent us from increasing or sustaining our revenues and profitability.

 

The restaurant industry is intensely competitive with respect to food quality, price-value relationships, ambiance, service and location, and many restaurants compete with us at each of our locations. Our competitors at the Bistro concept include mid-price, full service, casual dining restaurants. For Pei Wei, our main competitors are other value-priced, quick-service concepts as well as locally owned and operated Asian restaurants. There are a number of well-established competitors with substantially greater financial, marketing, personnel and other resources than ours, and many of our competitors are well established in the markets where we have restaurants, or in which we intend to locate restaurants. Additionally, other companies may develop restaurants that operate with similar concepts and the rising popularity of Asian food may result in increased competition from non-Asian restaurants as well as other food outlets.

 

Any inability to successfully compete with the other restaurants in our markets may prevent us from increasing or sustaining our revenues and profitability and could have a material adverse effect on our business, financial condition, results of operations or cash flows. We may also need to modify or refine elements of our restaurant system to evolve our concepts in order to compete with popular new restaurant formats or concepts that develop from time to time. We cannot ensure that we will be successful in implementing these modifications or that these modifications will not reduce our profitability.

 

Global Brand Development initiatives could negatively impact our brand.

 

Our business expansion into international markets and retail product licensing could create new risks to our brand and reputation. We believe that we have selected high-caliber International operating partners with significant experience in restaurant operations; however, there is risk that our brand could be harmed if customers have negative experiences at International Bistro locations due to issues with food quality or operational execution. Our new line of premium frozen Asian-style entrées is expected to be available in retail outlets during fiscal 2010. We believe that this new retail product offering is a growth opportunity that allows our brand to reach more customers more often. Though we believe our guests will view it as a different experience from dining in our restaurants, there is a risk that guests may be inclined to visit our restaurants less frequently due to the availability of similar products in retail outlets or they may develop a lower opinion of our brand due to issues with food quality or overall product expectations. If customers have negative perceptions or experiences at International restaurants or with retail products, our brand value could suffer which could have an adverse effect on our business.

Damage to our brands or reputation could negatively impact our business.

 

Our success depends substantially on the value of our brands and our reputation for offering a high quality, memorable experience to our guests. Our brands have been highly rated in annual consumer studies such as Restaurants & Institutions’ annual Choice in Chains survey in which P.F. Chang’s won honors in the casual dining and Asian categories as well as across numerous demographic groups during fiscal 2009. We believe that we must protect and grow the value of our brands to continue to be successful in the future. Any incident that erodes consumer trust in or affinity for our brands could significantly reduce their value. If consumers perceive or experience a reduction in food quality, service, ambiance or in any way believes we failed to deliver a consistently positive experience, our brand value could suffer which could have an adverse effect on our business.

 

Additionally, multi-unit food service businesses such as ours can be materially and adversely affected by widespread negative publicity of any type, particularly regarding food quality, illness or public health issues (such as epidemics or the prospect of a pandemic), safety, injury or other health concerns. We have taken steps to mitigate each of these risks. To minimize the risk of food-borne illness, we have implemented a HACCP system for managing food safety and quality. Nevertheless, these risks cannot be completely eliminated and any outbreak of illness attributed to our restaurants or within the food service industry in general could cause a decline in our sales and have a material adverse effect on our results of operations.

 

Litigation could have a material adverse effect on our business.

 

We are, from time to time, the subject of complaints or litigation from guests alleging food borne illnesses, injuries or other food quality, health or operational concerns. We may be adversely affected by publicity resulting from such allegations, regardless of whether such allegations are valid or whether we are ultimately determined to be liable. We are also subject to complaints or allegations from former or prospective employees from time to time as well as vendors, landlords, and other third-parties. A lawsuit or claim could result in an adverse decision against us that could have a material adverse effect on our business. Additionally, the costs and expense of defending ourselves against lawsuits or claims, regardless of merit, could have an adverse impact on our profitability and could cause variability in our results compared to expectations.

 

We are subject to state “dram shop” laws and regulations, which generally provide that a person injured by an intoxicated person may seek to recover damages from an establishment that wrongfully served alcoholic beverages to such person. While we carry liquor liability coverage as part of our existing comprehensive general liability insurance, we may still be subject to a judgment in excess of our insurance coverage and we may not be able to obtain or continue to maintain such insurance coverage at reasonable costs, or at all.

 

Adverse public or medical opinions about the health effects of consuming our products or new information or attitudes regarding diet and health could result in changes in regulations and consumer eating habits that could adversely affect our business.

 

Multi-unit restaurant operators and foodservice operations have received more scrutiny from regulators and health organizations in recent years relating to the health effects of consuming certain products. Regulations and consumer eating habits may change as a result of new information or attitudes regarding diet and health. Although our menu provides a range of healthy options, an unfavorable report on our menu ingredients, the size of our portions or the consumption of our menu items could influence the demand for our offerings. These changes may include regulations that impact the ingredients and nutritional content of our menu items. For example, a number of states, counties and cities are enacting menu labeling laws requiring multi-unit restaurant operators to make certain nutritional information available to guests or restrict the sales of certain types of ingredients in restaurants. The success of our restaurant operations is dependent, in part, upon our ability to effectively respond to changes in consumer health and disclosure regulations and to adapt our menu offerings to trends in eating habits. If consumer health regulations or consumer eating habits change significantly, we may be required to modify or delete certain menu items. We may experience higher costs associated with the implementation and oversight of such changes. To the extent we are unable to respond with appropriate changes to our menu offerings, it could materially affect customer demand and have an adverse impact on our business.

Our failure to comply with governmental regulations could harm our business and our reputation.

 

We are subject to regulation by federal agencies and to licensing and regulation by state and local health, sanitation, building, zoning, safety, fire and other departments relating to the development and operation of restaurants. These regulations include matters relating to:

 

 

Our facilities are licensed and subject to regulation under state and local fire, health and safety codes. The development and construction of additional restaurants will be subject to compliance with applicable zoning, land use and environmental regulations. We may not be able to obtain necessary licenses or other approvals on a cost-effective and timely basis in order to construct and develop restaurants in the future.

 

Various federal and state labor laws govern our operations and our relationship with our employees, including minimum wage, overtime, working conditions, fringe benefit and citizenship requirements. In particular, we are subject to the regulations of the Bureau of Citizenship and Immigration Services, or BCIS. The United States Congress has recently been considering changes to Federal immigration laws and various states, some of which where we have significant operations, are also in the process of considering or have already adopted new immigration laws. Some of these new laws may adversely affect our operations by increasing our obligations for compliance and oversight. Although we require all workers to provide us with the government-specified documentation evidencing their employment eligibility, some of our employees may, without our knowledge, be unauthorized workers. Unauthorized workers are subject to seizure and deportation and may subject us to fines, penalties or loss of our business license in certain jurisdictions. Any material disruption of our business, as a result of seizure of our workers, changes in immigration law, or significantly increased labor costs at our facilities in the future, could have a material adverse effect on our business, financial condition and operating results.

 

In fiscal 2009, approximately 14 percent of our revenues at the Bistro and 1 percent of revenues at Pei Wei were attributable to the sale of alcoholic beverages. We are required to comply with the alcohol licensing requirements of the federal government, states and municipalities where our restaurants are located. Alcoholic beverage control regulations require applications to state authorities and, in certain locations, county and municipal authorities for a license and permit to sell alcoholic beverages. Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of the restaurants, including minimum age of guests and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, storage and dispensing of alcoholic beverages. If we fail to comply with federal, state or local regulations, our licenses may be revoked and we may be forced to terminate the sale of alcoholic beverages at one or more of our restaurants.

 

We receive and maintain certain personal information about our guests and employees. The use of this information by us is regulated at the federal and state levels. If our security and information systems are compromised or our business associates fail to comply with these laws and regulations and this information is obtained by unauthorized persons or used inappropriately, it could adversely affect our reputation, as well as results of operations, and could result in litigation against us or the imposition of penalties. As privacy and information security laws and regulations change, we may incur additional costs to ensure we remain in compliance.

 

The federal Americans with Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. We are required to comply with the Americans with Disabilities Act and regulations relating to accommodating the needs of the disabled in connection with the construction of new facilities and with significant renovations of existing facilities.

Failure to comply with these and other regulations could negatively impact our business and our reputation.

 

Changes in food costs could negatively impact our revenues and results of operations.

 

Our profitability is dependent in part on our ability to anticipate and react to changes in food costs. Other than for a portion of our commodities, such as produce, which are purchased locally by each restaurant, we rely on Distribution Market Advantage, a cooperative of multiple food distributors located throughout the nation, as the primary distributor of our ingredients. We have a non-exclusive contract with Distribution Market Advantage on terms and conditions that we believe are consistent with those made available to similarly situated restaurant companies. Although we believe that alternative distribution sources are available, any increase in distribution prices or failure to perform by the Distribution Market Advantage could cause our food costs to fluctuate. Any disruption in the supply of specialty items from China due to quality or availability issues could also cause our food costs to fluctuate. Additional factors beyond our control, including adverse weather conditions and governmental regulation, may affect our food costs. We may not be able to anticipate and react to changing food costs through our purchasing practices and menu price adjustments in the future, and failure to do so could negatively impact our revenues and results of operations.

 

Our inability to retain key personnel could negatively impact our business.

 

Our success will continue to be highly dependent on our key operating officers and employees. We must continue to attract, retain and motivate a sufficient number of qualified management and operating personnel, including regional managers, general managers and executive chefs, to maintain consistency in the quality and atmosphere of our restaurants. Additionally, the ability of these key personnel to maintain consistency in the quality of our product offerings and service and atmosphere of our restaurants is a critical factor in our success. Any failure to attract, retain and motivate key personnel may harm our reputation and result in a loss of business.

 

Development is critical to our long-term success.

 

Critical to our long-term future success is our ability to successfully expand our operations. We have expanded from seven restaurants at the end of 1996 to 363 restaurants as of January 3, 2010. We expect to open three to five new Bistro restaurants and three to five new Pei Wei restaurants during fiscal 2010. Our ability to expand successfully will depend on a number of factors, including:

 

 

The opening of additional restaurants in the future will depend in part upon our ability to generate sufficient funds from operations or to obtain sufficient equity or debt financing on favorable terms to support our expansion as well as the availability of high-quality commercial real estate projects of the type we typically target for new locations. We may not be able to open our planned new restaurants on a timely basis, if at all, and, if opened, these restaurants may not be operated profitably. We have experienced, and expect to continue to experience, delays in restaurant openings from time to time. Delays or failures in opening planned new restaurants could have an adverse effect on our business, financial condition, results of operations or cash flows.

Federal, state and local tax rules can adversely impact our results of operations and financial position.

 

We are subject to federal, state and local taxes in the U.S. Significant judgment is required in determining the provision for income taxes. Although we believe our tax estimates are reasonable, if the IRS or other taxing authority disagrees with the positions we have taken on our tax returns, we could have additional tax liability, including interest and penalties. If material, payment of such additional amounts upon final adjudication of any disputes could have a material impact on our results of operations and financial position.

 

Complying with new tax rules, laws or regulations could impact our financial condition and increases to federal or state statutory tax rates and other changes in tax laws, rules or regulations may increase our effective tax rate. Any increase in our effective tax rate could have a material impact on our financial results.

 

 

Fluctuating insurance requirements and costs could negatively impact our profitability and projections.

 

The cost of workers’ compensation insurance, general liability insurance and directors and officers’ liability insurance fluctuates based on market conditions and availability as well as our historical trends. We self-insure a substantial portion of our workers’ compensation and general liability costs and unfavorable changes in trends could have a negative impact on our profitability.

 

Additionally, health insurance costs in general have risen significantly over the past few years and are expected to continue to increase in 2010. These increases, as well as potential legislation requirements for employers to provide specified levels of health insurance to all employees, could have a negative impact on our profitability if we are not able to offset the effect of such increases with plan modifications and cost control measures, or by continuing to improve our operating efficiencies.

 

Our marketing programs may not be successful.

 

We have significantly increased in our marketing expenditures over the past few years and expect to continue investing in campaigns and initiatives designed to attract and retain guests. These efforts may not be successful, resulting in expenses incurred without the benefit of higher revenues.

 

Potential labor shortages may delay planned openings or damage customer relations.

 

Our success will continue to depend on our ability to attract and retain a sufficient number of qualified employees, including kitchen staff and wait staff, to work our restaurants. Our inability to recruit and retain qualified individuals may delay the planned openings of new restaurants while high employee turnover in existing restaurants may negatively impact customer service and customer relations, resulting in an adverse effect on our revenues or results of operations.

 

The inability to develop and construct our restaurants within projected budgets and time periods could adversely affect our business and financial condition.

 

Each of our restaurants is distinctively designed to accommodate particular characteristics of each location and to blend local or regional design themes with our principal trade dress and other common design elements. This presents each location with its own development and construction risks. Many factors may affect the costs and timeframes associated with the development and construction of our restaurants, including:

 

 

 

If we are not able to develop additional restaurants within anticipated budgets or time periods, our business, financial condition, results of operations and cash flows may be adversely affected.

 

The seasonality of our business could result in fluctuations in our financial performance

 

Our business is subject to seasonal fluctuations. Our sales volumes are generally higher in the winter months and lower in the summer months, which can cause fluctuations in our operating results from quarter-to-quarter within a fiscal year. As a result, results of operations for any single quarter are not indicative of results that may be achieved for a full fiscal year. Additionally, quarterly fluctuations in our results can impact the amount of quarterly cash dividend payments, which are based on a fixed percentage of net income.

 

Special Note Regarding Forward-Looking Statements

 

Some of the statements in this Form 10-K and the documents we incorporate by reference constitute forward-looking statements. In some cases, forward-looking statements can be identified 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 document 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 and elsewhere in this Form 10-K, including, but not limited to, failure of our existing or new restaurants to achieve predicted results, changes in general economic and political conditions and changes in government legislation may increase our labor costs. Because we cannot guarantee future results, levels of activity, performance or achievements, undue reliance should not be placed on these forward-looking statements.

 

 

None.

 

Our Bistro restaurants average 6,900 square feet and our Pei Wei restaurants average 3,100 square feet. The following table lists the number of existing Bistro and Pei Wei locations by state as of January 3, 2010:

 

Additionally, two international Bistro restaurants were opened in Mexico City and Kuwait City during the fourth quarter of fiscal 2009 under international development and licensing agreements. Two Bistro restaurants are also operated in Hawaii under a joint venture arrangement in which we own a noncontrolling interest.

 

Our home office is located in a 50,000 square foot office building in Scottsdale, Arizona. We purchased the land and building during 2004.

 

Expansion Strategy and Site Selection

 

We have historically developed Bistro and Pei Wei restaurants in both new and existing markets utilizing an expansion strategy targeted at metropolitan areas throughout the United States. Within each targeted metropolitan area, we identify specific areas with high traffic patterns and suitable demographic characteristics, including population density, consumer attitudes and household income. Within an appropriate area, we evaluate specific sites that provide visibility, accessibility and exposure to traffic volume. Our site criteria are flexible, as is evidenced by the variety of environments and facilities in which we currently operate. These facilities include freestanding buildings, regional malls, urban properties and entertainment and strip centers.

 

We plan to open three to five new Bistro restaurants during fiscal 2010 primarily located in existing markets. Additionally, we plan to open three to five new Pei Wei restaurants during fiscal 2010 in new and existing markets. As of the date of this Form 10-K, we had opened one of the new Pei Wei restaurants and none of the new Bistro restaurants planned for fiscal 2010.

 

Bistros typically range in size from 6,000 to 7,500 square feet, and require an average total capitalized investment of approximately $3.5 million to $4.0 million per restaurant (net of estimated tenant incentives). This total investment includes the capitalized lease value of the property, which can vary greatly depending on the specific location. We expect that our planned future restaurants will require, on average, a total cash investment per restaurant of approximately $2.5 million to $3.0 million (net of estimated tenant incentives). Preopening expenses are expected to average approximately $350,000 to $400,000 per Bistro restaurant during fiscal 2010.

 

Pei Wei restaurants typically range in size from 2,800 to 3,400 square feet and require an average total capitalized investment of approximately $1.5 million per restaurant (net of estimated tenant incentives). This total investment cost includes the capitalized lease value of the property, which can vary greatly depending on the specific location. We expect that our planned future restaurants will require, on average, a total cash investment per restaurant of approximately $750,000 to $850,000 (net of estimated tenant incentives). Preopening expenses are expected to average approximately $140,000 to $160,000 per Pei Wei restaurant during fiscal 2010.

 

We currently lease the sites for all of our Bistro and Pei Wei restaurants and do not intend to purchase real estate for our sites in the future. Current restaurant leases have expiration dates ranging from 2010 to 2025, with the majority of the leases providing for at least one five-year renewal option. We are currently negotiating with the landlords on lease renewal options for three restaurant leases that are scheduled to expire in 2010. Generally, our leases provide for minimum annual rent, and most leases require additional rent based on a percentage of sales volume in excess of minimum contractual levels at the particular location. Most of our leases require us to pay the costs of insurance, property taxes, and a portion of the lessor’s operating costs. We do not anticipate any difficulties renewing existing leases as they expire.

 

We are engaged in legal actions arising in the ordinary course of our business and believe that the ultimate outcome of these actions will not have a material adverse effect on our results of operations, liquidity or financial position.

 

 

None.

 

 

Our common stock is traded on the NASDAQ Global Select Market under the symbol PFCB.

 

The following table sets forth the high and low price per share of our common stock for each quarterly period for our two most recent fiscal years:

 

 

We have not historically paid any cash dividends. During February 2010, the Board of Directors approved the initiation of a quarterly variable cash dividend based on our desire to consistently return excess cash flow to its shareholders. The amount of the cash dividend will be computed based on 45% of quarterly net income and is expected to total approximately $0.90 per share during fiscal 2010. Based on seasonal fluctuations in quarterly net income, the amount of cash dividend payments, which are based on a fixed percentage of net income, may fluctuate between quarters.

 

On February 12, 2010, there were 112 holders of record of P.F. Chang’s common stock.

 

Issuer Purchases of Equity Securities

 

Our Board of Directors has authorized programs to repurchase our outstanding shares of common stock from time to time in the open market, pursuant to Rule 10b5-1 trading plans or in private transactions at prevailing market prices. Under previous share repurchase programs authorized by our Board of Directors, we have repurchased a total of 5.1 million shares of our common stock for $146.0 million at an average price of $28.83 since July 2006. Included in this total are 1.4 million shares of our common stock repurchased during 2009 for $39.7 million at an average price of $27.73.

 

In December 2009, our Board of Directors authorized a new share repurchase program to repurchase up to $100.0 million of our outstanding shares of common stock from time to time in the open market or in private transactions at prevailing market prices over the next two years. We intend to use cash on hand to repurchase shares. We did not repurchase any shares under this authorization during fiscal 2009.

 

The following table sets forth our share repurchases of common stock during each period in the fourth quarter of fiscal 2009:

 

 

 

Performance Graph

 

The following graph compares the cumulative five-year total return on the Company’s common stock with the cumulative total returns of the Nasdaq Composite Index and the Russell 2000 Index, in each case assuming an initial investment of $100 on January 2, 2005 and no dividend payments. Historical performance should not be considered indicative of future stockholder returns.

 

Comparison of Cumulative Total Return from January 2, 2005 through January 3, 2010

 

 

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

 

 

 

No cash dividends were paid during any of the five previous years.

 

 

Overview

 

The following section presents an overview of our restaurant concepts, other business lines, our growth strategy and challenges we face. A summary of our 2009 financial results and our 2010 outlook are also presented.

 

Restaurants

 

We own and operate two restaurant concepts in the Asian niche: P.F. Chang’s China Bistro (“Bistro”) and Pei Wei Asian Diner (“Pei Wei”). On August 1, 2008, we sold the long-lived assets of Taneko Japanese Tavern (“Taneko”), a third restaurant concept developed in 2006, which has been classified as a discontinued operation in the Company’s consolidated financial statements since the end of fiscal 2007.

 

Bistro

 

As of January 3, 2010, we owned and operated 197 full service Bistro restaurants that feature a blend of high quality, traditional Chinese cuisine and attentive service in a high energy 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 in the U.S. with the exception of two Bistro restaurants located in Hawaii which are operated under a joint venture arrangement in which we own a noncontrolling interest. Additionally, two international Bistro restaurants were opened in Mexico City and Kuwait City during the fourth quarter of fiscal 2009 under international development and licensing agreements.

 

Pei Wei

 

As of January 3, 2010, we also owned and operated 166 quick casual Pei Wei restaurants that serve freshly prepared, wok-seared, contemporary pan-Asian cuisine in a relaxed, warm environment with friendly attentive

counter service and take-out flexibility. We opened our first Pei Wei restaurant in July 2000 in the Phoenix, Arizona area and have expanded the concept significantly since that time. We closed 10 Pei Wei restaurants during the fourth quarter of 2008 and the results of these restaurants are reported within discontinued operations in our consolidated income statements for all periods presented. See Note 2 to our consolidated financial statements for further discussion.

 

Global Brand Development

 

International

 

We are selectively pursuing international expansion of our Bistro restaurants. During the second quarter of fiscal 2009, we signed two development and licensing agreements with partners who will develop and operate Bistro restaurants in international markets. We expect these relationships to take the form of license agreements under which we would receive an initial territory fee, store opening fees and ongoing royalty revenues based on a percentage of international restaurant sales.

 

The first development and licensing agreement was signed with M.H. Alshaya, the Middle East’s leading retailer, to develop 34 Bistro restaurants throughout the Middle East over the next 10 years. The first restaurant opened in Kuwait City during the fourth quarter of fiscal 2009.

 

The second development and licensing agreement was signed with Alsea S.A.B. de C.V., the leading quick service restaurant operator in Mexico, to develop 30 Bistro restaurants in Mexico over the next 10 years. The first restaurant opened in Mexico City during the fourth quarter of fiscal 2009. Additionally, during February 2010, we signed a development and licensing agreement with Global Restaurant Concepts, Inc., a leading casual dining operator in the Philippines, to develop eight restaurants over the next five years. The first restaurant is scheduled to open in Manila during the first quarter of fiscal 2011.

 

We continue to engage in discussions with additional potential partners regarding expansion of the Bistro into various international markets.

 

Retail

 

In August 2009, we entered into an exclusive licensing agreement with Unilever to develop and launch a new premium line of frozen Asian-style entrées in the U.S., under the P.F. Chang’s brand. The new products are expected to be available in retail outlets during the first half of fiscal 2010. We will receive ongoing royalty revenues based on a percentage of product sales.

 

Other Ventures

 

In August 2009, we announced an agreement with FRC Balance LLC, d/b/a True Food Kitchen, to provide debt capital for the early-stage development of True Food Kitchen restaurants. The agreement provides for up to a $10.0 million loan facility to develop True Food Kitchen restaurants and can, under certain conditions, be converted by us into a majority equity position in True Food Kitchen. As of January 3, 2010, no borrowings were outstanding under the loan facility.

 

Our strategy

 

Our objective is to be the best operator of Asian restaurants as viewed by our guests and our employees. We aim to develop and operate a nationwide system of Asian-inspired restaurants that offer guests a sophisticated dining experience, create a loyal customer base that generates a high level of repeat business and provide superior returns to our investors. To achieve our objectives, we strive to offer high quality Asian cuisine in a memorable atmosphere while delivering exceptional customer service and an excellent dining value.

 

We are currently operating restaurants exclusively in the Asian niche due in part to the continued popularity of Asian cuisine, combined with a relatively lower level of organized competition in this segment compared to other popular cuisines segments such as Mexican and Italian. We believe this creates a significant long-term opportunity for us to both grow our existing restaurant sales and open new locations in new and existing markets. We are selective when choosing our new restaurant locations and assess anticipated returns on invested capital at both an

individual restaurant and market level when determining future development plans. We seek an average unit-level return on invested capital of 30 percent for both of our concepts and plan to continue opening new restaurants to the extent that we continue to achieve our target rate of return.

 

Our challenges

 

Our business is highly sensitive to changes in guest traffic. Increases in guest traffic drive higher sales, which improve the leverage of our fixed operating costs and thus enable us to achieve higher operating margins. As guest traffic decreases, as it has during the past few years, lower sales result in decreased leverage that can lead to deteriorations in our operating margins. To help offset the negative impacts of decreased leverage in a declining sales environment, our Bistro and Pei Wei operators have undertaken a series of initiatives designed to gain efficiencies at the restaurant level, with a focus on labor and cost of sales improvement opportunities, while taking special care to ensure that these initiatives do not negatively impact our guests’ dining experience. These initiatives included a focus on improved cross-training, food preparation and scheduling, which created significant improvement in back of the house labor efficiencies.

 

The restaurant industry can be significantly affected by changes in discretionary spending patterns, economic conditions, consumer tastes, lifestyle trends and cost fluctuations. In recent years, consumers have been under increased economic pressures and as a result, many have changed their discretionary spending patterns. Many consumers dine out less frequently than in the past or have reduced the amount they spend on meals while dining out. Accordingly, we strive to continuously evolve and refine the critical elements of our restaurant concepts to help maintain and enhance the strength of our brands and remain fresh and relevant to our guests while maintaining a high value-to-price perception. We continuously update our menu offerings and have injected our restaurants with an updated contemporary look and feel. We also continue to implement a number of new marketing initiatives designed to increase brand awareness and help drive guest traffic.

 

The restaurant business is intensely competitive with respect to food quality, price-value relationships, ambiance, service and location, and many existing restaurants compete with us at each of our locations. Additionally, the continued popularity of Asian cuisine may result in increased competition from new Asian-branded concepts as well as non-Asian restaurants and other food outlets, such as supermarkets, that may increase their Asian-inspired menu offerings.

 

Our business is also influenced by the level of corporate travel and entertainment spending by businesses as a significant portion of our sales is generated by guests conducting business at our restaurants. During fiscal 2009, there was a considerable reduction in business travel and corporate spending in general, which negatively impacted our fiscal 2009 revenues and is expected to continue to have a significant effect on our results until such time as corporate spending increases.

 

Our 2009 Financial Results

 

During 2009, we experienced continued deterioration in guest traffic at our Bistro restaurants, while we saw improvement in guest traffic at our Pei Wei restaurants. We achieved higher operating margins at both concepts due to labor and operational efficiencies, which contributed to higher income in fiscal 2009.

 

Our 2009 financial results include:

 

 

2010 Outlook

 

We anticipate fiscal 2010 consolidated revenues will be flat compared to fiscal 2009. This is based on our expectation of slightly lower average weekly sales at both concepts during fiscal 2010 and the impact of a 52-week fiscal year in fiscal 2010 (versus 53 weeks in fiscal 2009), offset by the benefit of a full year of revenues for restaurants that opened during fiscal 2009 combined with revenues from six to ten anticipated new restaurant openings during fiscal 2010.

 

Despite the impact of slightly lower anticipated average weekly sales, we expect restaurant operating margins for fiscal 2010 to be consistent with fiscal 2009, primarily due to our expectation of favorable cost of sales offsetting the anticipated impact of deleverage of certain fixed operating costs and higher planned marketing spend.

 

We expect to open three to five new Bistro restaurants and three to five new Pei Wei restaurants during fiscal 2010. As a result, we anticipate slightly lower preopening expenses for fiscal 2010. Additionally, we expect to decrease interest expense and reduce diluted shares outstanding as a result of our planned paydown of outstanding credit line borrowings and additional repurchases of our common shares during fiscal 2010.

 

We also plan to fully repay our outstanding credit line borrowings of $40.0 million and repurchase approximately $40.0 million in common shares under our current $100.0 million share repurchase authorization during fiscal 2010.

 

Overall, we expect consolidated diluted earnings per share from continuing operations to approximate $2.00 for fiscal 2010.

 

2010 Development

 

Bistro

 

We intend to open three to five new Bistro restaurants in 2010, primarily located in existing markets. Our Bistro restaurants typically range in size from 6,000 to 7,500 square feet, and require an average total cash investment of approximately $2.5 million to $3.0 million (net of estimated tenant incentives) and total invested capital of approximately $3.5 million to $4.0 million per restaurant (net of estimated tenant incentives). This total capitalized investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. See “Risk Factors — Development and Construction Risks.” Preopening expenses are expected to average approximately $350,000 to $400,000 per restaurant during fiscal 2010.

 

Pei Wei

 

We intend to open three to five new Pei Wei restaurants in new and existing markets. Our Pei Wei restaurants typically range in size from 2,800 to 3,400 square feet and require an average total cash investment of approximately $750,000 to $850,000 (net of estimated tenant incentives) and total invested capital of approximately $1.5 million per restaurant (net of estimated tenant incentives). Preopening expenses are expected to average approximately $140,000 to $160,000 per restaurant during fiscal 2010.

 

Operating Statistics

 

There are several key financial metrics that can be useful in evaluating and understanding our business. These metrics, which are widely used throughout the restaurant industry, include short-term revenue measures such as average weekly sales and total revenues and long-term profitability measures such as return on invested capital, each of which are described in further detail below. We believe it is helpful to review these measures both in total and by class year (i.e., year of restaurant opening).

 

 

 

The following table shows total revenues and average weekly sales for our company-owned Bistro and Pei Wei restaurants based on the year of opening (revenues in thousands):

 

 

 

 

Return on invested capital metrics are available on our website at www.pfcb.com.

 

Critical Accounting Policies

 

Our significant accounting policies are disclosed in Note 1 to our consolidated financial statements. The following discussion addresses our most critical accounting policies, which are those that require significant judgment.

 

Share-Based Compensation

 

We account for share-based compensation based on fair value measurement guidance. We use the Black-Scholes option pricing model, which requires the input of subjective assumptions, for our options and cash-settled liability awards, with the exception of performance units. These assumptions include estimating 1) expected term, 2) common stock price volatility over the expected term and 3) the number of awards that will ultimately not vest (“forfeitures”). For performance units, a Monte Carlo simulation model is used to calculate fair value. The Monte Carlo simulation model incorporates the historical performance, volatility and correlation of our stock price and the Russell 2000 Index. Additionally, we use assumptions to estimate the expected forfeiture rate related to restricted stock in determining the share-based compensation for these awards. Changes in these assumptions can materially affect fair value and our estimates of share-based compensation and consequently, the related amount recognized in the consolidated statements of income.

Impairment of Long-Lived Assets

 

We review property and equipment and intangible assets with finite lives (those assets resulting from the acquisition of noncontrolling interests in the operating rights of certain of our restaurants) for impairment when events or circumstances indicate these assets might be impaired, but at least quarterly. An analysis is performed at the individual restaurant level and primarily includes an assessment of historical cash flows and other relevant facts and circumstances. For restaurants open greater than two years, negative restaurant-level cash flows over the previous twelve-month period is considered a potential impairment indicator. In these situations, we evaluate future restaurant cash flow projections in conjunction with qualitative factors and future operating plans. Based on this assessment, we either (a) continue to monitor these restaurants over the near-term for evidence of improved performance or (b) immediately recognize an impairment charge based on the amount by which the asset carrying value exceeds fair value, which is based on undiscounted future cash flows.

 

In the past, restaurants under monitoring have typically achieved cash flow improvements in a timely fashion such that no impairment charge was deemed necessary and the restaurant was removed from active monitoring. However, an impairment charge was recognized during fiscal 2008 based on our decision to close ten underperforming Pei Wei restaurants, including several locations that were previously being monitored for impairment. We did not recognize any impairment charges during fiscal 2009.

 

Our impairment assessment process requires the use of estimates and assumptions regarding future cash flows and operating outcomes, which are subject to a significant degree of judgment based on our experience and knowledge. These estimates can be significantly impacted by changes in the economic environment, real estate market conditions and overall operating performance. At any given time, we are actively monitoring a small number of restaurants and impairment charges could be triggered in the future if individual restaurant performance does not improve or if management decides to close that location. Also, if current economic conditions worsen, additional restaurants could be placed on active monitoring and potentially trigger impairment charges in future periods.

 

Income Taxes

 

We provide for income taxes based on our estimate of federal and state income tax liabilities. These estimates include, among other items, effective rates for state and local income taxes, allowable tax credits for items such as taxes paid on reported tip income, estimates related to depreciation and amortization expense allowable for tax purposes, and the tax deductibility of certain other items.

 

Our estimates are based on the information available to us at the time that we prepare the income tax provision. We generally file our annual income tax returns several months after our fiscal year-end. Income tax returns are subject to audit by federal, state, and local governments, generally years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.

 

On a quarterly basis, we review and update our inventory of tax positions as necessary to add any new uncertain positions taken, or to remove previously identified uncertain positions that have been adequately resolved. Additionally, uncertain positions may be re-measured as warranted by changes in facts or law. Accounting for uncertain tax positions requires significant judgments, including estimating the amount, timing and likelihood of ultimate settlement. Although we believe that these estimates are reasonable, actual results could differ from these estimates.

 

Lease Obligations

 

We lease all of our restaurant properties. At the inception of the lease, each property is evaluated to determine whether the lease will be accounted for as an operating or capital lease. The term of the lease used for this evaluation includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured and failure to exercise such option would result in an economic penalty.

 

There is potential for variability in the rent holiday period, which begins on the possession date and ends on the store open date, during which no cash rent payments are typically due under the terms of the lease. Factors that may affect the length of the rent holiday period generally relate to construction related delays. Extension of the rent holiday period due to delays in store opening will result in greater preopening rent expense recognized during the rent holiday period and lower occupancy expense during the rest of the lease term (post-opening).

For leases that contain rent escalations, we record the total rent payable during the lease term, as determined above, on a straight-line basis over the term of the lease (including the rent holiday period beginning upon our possession of the premises), and record the difference between the minimum rent paid and the straight-line rent as a lease obligation. Many of our leases contain provisions that require additional rental payments based upon restaurant sales volume (“contingent rent”). Contingent rent is accrued each period as the liability is incurred, in addition to the straight-line rent expense noted above. This results in variability in occupancy expense as a percentage of revenues over the term of the lease in restaurants where we pay contingent rent.

 

Management makes judgments regarding the probable term for each restaurant property lease, which can impact the classification and accounting for a lease as capital or operating, the rent holiday and/or escalations in payments that are taken into consideration when calculating straight-line rent and the term over which tenant incentives received from landlords in connection with certain operating leases for each restaurant are amortized. These judgments may produce materially different amounts of depreciation, amortization and rent expense than would be reported if different assumed lease terms were used.

 

Self Insurance

 

We are self-insured for a significant portion of our current and prior years’ exposures related to our workers’ compensation, general liability, medical and dental programs. We have paid to our insurance carrier amounts that approximate the cost of claims known to date and we have accrued additional liabilities for our estimate of ultimate costs related to those claims. We develop these estimates using historical experience factors to estimate the ultimate claim exposure. Our self-insurance liabilities are actuarially determined and consider estimates of expected losses, based on statistical analyses of our actual historical trends as well as historical industry data. If actual claims experience differs from our assumptions and estimates, changes in our insurance reserves would impact the expense recorded in our consolidated income statements.

 

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. Under this legal partnership program, each partner who wished to participate in our legal partnership structure, to the extent applicable, was required to make a cash capital contribution in exchange for a specified interest in the partnership. The ownership interest purchased by each partner generally ranged between two and ten percent of the restaurant or region the partner oversees. Generally, no more than ten percent of an individual restaurant was owned in total by noncontrolling partners. We performed an assessment of what the imputed fair value of these interests might be for a passive equity investor (i.e. not someone actually working in the restaurant), utilizing a discounted cash flow model and updated assumptions based on the results of an annual valuation analysis. This methodology involved the use of various estimates relating to future cash flow projections and discount rates for which significant judgments were required. We recognized any excess of the imputed fair value of these interests, determined by using the discounted cash flow model, over the cash contribution paid by our partners as partner investment expense upon purchase by the partner of the respective interest.

 

At the end of a specific term (generally five years), we have the right, but not the obligation, to purchase the noncontrolling interest in the partner’s respective restaurant or region at fair value. The estimated fair value of the noncontrolling interest is determined by reference to current industry purchase metrics as well as the historical cash flows or net income of the subject restaurant or region. We have the option to pay the agreed upon purchase price in cash over a period of time not to exceed five years. Given that there is no public market for these interests, the fair value determinations are subjective and require the use of various estimates for which significant judgments are required. Prior to fiscal year 2009, any excess of the purchase price over the imputed fair value was recorded as an intangible asset and amortized over approximately 15 years for our Bistro restaurants and approximately 10 years for our Pei Wei restaurants. Beginning in fiscal year 2009 upon the adoption of new accounting guidance, an intangible asset is no longer recognized upon buyout of noncontrolling interests. Instead, any excess of the purchase price over the imputed fair value is recognized as a reduction to additional-paid-in-capital in equity. See Note 1 to our consolidated financial statements for further discussion.

Effective January 2007 for new store openings, the Bistro began employing a different partnership structure to achieve the same goal. At the restaurant level, our Operating and Culinary Partners at stores opened on or after January 1, 2007 (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 to participate in an incentive program that rewards improvements in the operating performance of the restaurant. As a result of these changes, incentive payments made to the individuals participating in the new plan are classified as compensation expense rather than as net income attributable to noncontrolling interests. Accordingly, compensation expense for these Operating and Culinary Partners is reflected in the consolidated income statement as labor expense. Additionally, a similar structure exists for our Market Partners, Market Chefs and Regional Vice Presidents, with related compensation expense reflected as general and administrative expense in the consolidated income statement. As a result of this change, since the beginning of 2007, we have no longer recognized partner investment expense for new Bistro restaurant openings. Additionally, many existing legal partners requested an early buyout of their partnership interests during 2007 and 2008 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 was not affected by the changes at the Bistro and the traditional partnership structure remains in effect for new Pei Wei restaurant openings.

 

Results of Operations

 

We operate on a 52/53-week year, with the fiscal year ending on the Sunday closest to December 31. Fiscal year 2009 was comprised of 53 weeks and fiscal years 2008 and 2007 were each comprised of 52 weeks.

 

Fiscal 2009 compared to Fiscal 2008

 

Our consolidated operating results for the fiscal years ended January 3, 2010 (fiscal 2009) and December 28, 2008 (fiscal 2008) were as follows (dollars in thousands):

 

Certain percentage amounts may not sum due to rounding.

 

Selected operating statistics for the Bistro were as follows (dollars in thousands):

 

 

Selected operating statistics for Pei Wei were as follows (dollars in thousands):

 

 

Percentages over 100% are not displayed.

 

Revenues

 

Our revenues are derived primarily from food and beverage sales. Each segment contributed as follows:

 

Bistro:  The increase in revenues was attributable to incremental new store revenues of $44.7 million, comprised of a full year of revenues from the 17 new stores that opened during 2008 and revenues generated by the eight new Bistro restaurants that opened during 2009. The increase was partially offset by a $39.1 million decline in revenues for stores that opened prior to 2008, due to a significant reduction in overall guest traffic combined with a slight decline in the average check. Fiscal year 2009 also includes the benefit from one extra week of revenues compared to fiscal year 2008.

 

Pei Wei:  The increase in revenues was attributable to incremental new store revenues of $19.1 million, comprised of a full year of revenues from the 25 new stores that opened during 2008 and revenues generated by the seven new Pei Wei restaurants that opened during 2009. The remainder of the increase was due to a $5.4 million increase in revenues for stores that opened prior to 2008, as well as a slight increase in overall guest traffic partially offset by a slight decline in the average check. Fiscal year 2009 also includes the benefit from one extra week of revenues compared to fiscal year 2008.

Costs and Expenses

 

Cost of Sales

 

Cost of sales is comprised of the cost of food and beverages. Cost of sales as a percentage of revenues decreased at both Bistro and Pei Wei due to the net impact of favorable product mix shifts, operational efficiencies, and favorable produce pricing. These declines were partially offset by higher wok oil costs. We negotiate annual pricing agreements for many of our key commodities and such contracts provided for favorable produce costs, consistent beef and seafood costs, and unfavorable poultry costs for fiscal 2009 as compared to fiscal 2008.

 

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 is allocable to certain noncontrolling partners, but is presented as bonus expense for accounting purposes. Each segment contributed as follows:

 

Bistro:  Labor expenses as a percentage of revenues decreased primarily due to improved labor efficiencies in culinary and hospitality positions and, to a lesser extent, the benefit of reduced workers’ compensation insurance liabilities resulting from lower than anticipated claim development. These declines were partially offset by the impact of decreased leverage on lower average weekly sales on the portion of labor expenses that is fixed in nature and, to a lesser extent, higher management incentive and health insurance costs.

 

Pei Wei:  Labor expenses as a percentage of revenues decreased primarily due to improved labor efficiencies in culinary and hospitality positions, lower manager salaries resulting from reduced management headcount, and the benefit of reduced workers’ compensation insurance liabilities resulting from lower than anticipated claim development. These declines were partially offset by higher expenses associated with the utilization of additional key hourly employees as well as the impact of decreased leverage on lower average weekly sales on the portion of labor expenses that is fixed in nature and, to a lesser extent, higher management incentive accruals.

 

Operating

 

Operating expenses consist primarily of various restaurant-level costs such as repairs and maintenance, utilities and marketing, certain of which are variable and may 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. Also, expenditures associated with marketing expenses are discretionary in nature and the timing and amount of marketing spend will vary. Each segment contributed as follows:

 

Bistro:  Operating expenses as a percentage of revenues increased primarily due to the impact of decreased leverage on lower average weekly sales on the portion of operating costs that is fixed in nature, higher repairs and maintenance expense and higher menu printing costs. These increases were partially offset by lower utilities costs resulting from favorable rates and lower usage.

 

Pei Wei:  Operating expenses as a percentage of revenues decreased primarily due to lower utilities costs resulting from favorable rates, lower menu printing costs and the impact of increased leverage resulting from an extra week of revenues in fiscal 2009 on the portion of operating costs that is fixed in nature. These decreases were partially offset by higher repairs and maintenance costs and, to a lesser extent, increased marketing spend.

 

Occupancy

 

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

 

Bistro:  Occupancy costs as a percentage of revenues decreased from prior year primarily due to lower contingent rent expense resulting from lower sales, the impact of increased leverage resulting from an extra

week of revenues in fiscal 2009 and, to a lesser extent, decreased general liability insurance. These decreases were partially offset by the impact of decreased leverage on lower average weekly sales.

 

Pei Wei:  Occupancy costs as a percentage of revenues decreased from prior year primarily due to the impact of increased leverage resulting from an extra week of revenues in fiscal 2009 and lower property tax expense partially offset by the impact of decreased leverage on lower average weekly sales.

 

General and Administrative

 

General and administrative expenses are comprised of costs associated with corporate and administrative functions that support restaurant development and operations and provide infrastructure to support future growth including, but not limited to, management and staff compensation, employee benefits, travel, legal and professional fees, technology and market research.

 

Consolidated general and administrative costs increased primarily due to higher management incentive accruals, higher share-based compensation expense, principally resulting from the performance unit award grants issued to our co-CEOs during the first quarter of 2009 and the cash-settled liability awards issued during fiscal 2009, as well as additional compensation expense resulting from unrealized holding gains associated with investments in the 401(k) Restoration Plan. These increases were partially offset by lower management salaries due to decreased headcount and a reduction in other administrative support costs. Fiscal 2008 also includes $2.0 million of cash and non-cash charges related to a separation agreement with the former Pei Wei president which included a severance payment, accelerated vesting of unvested options and the extension of the expiration date of all outstanding stock options.

 

Depreciation and Amortization

 

Depreciation and amortization expenses include the depreciation of fixed assets, gains and losses on disposal of assets and the amortization of intangible assets, software and non-transferable liquor license fees.

 

Depreciation and amortization increased at both Bistro and Pei Wei primarily due to additional depreciation on restaurants that opened during fiscal 2009 and fiscal 2008. As a percentage of revenues, depreciation and amortization increased at both Bistro and Pei Wei primarily due to the impact of decreased leverage resulting from lower average weekly sales, partially offset by the impact of increased leverage resulting from an extra week of revenues in fiscal 2009.

 

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, employee payroll and related training costs. Preopening expenses also include straight-line rent expense for the period between the possession date of leased premises and the restaurant opening date. Each segment contributed as follows:

 

Bistro:  Preopening expense decreased primarily due to the impact of opening eight new restaurants during fiscal 2009 compared to opening 17 new restaurants during fiscal 2008.

 

Pei Wei:  Preopening expense decreased primarily due to the impact of opening seven new restaurants during fiscal 2009 compared to opening 25 new restaurants during fiscal 2008.

 

Partner Investment Expense

 

Partner investment expense represents the difference between the imputed fair value of noncontrolling interests at the time our partners invested in our restaurants and our partners’ cash contributions for those ownership interests. Additionally, for those interests that 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 noncontrolling 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:  All partner investment expense activity for the Bistro is related to early buyouts of noncontrolling interests. The change in partner investment expense resulted from fewer early buyouts of noncontrolling interests during fiscal 2009 compared to fiscal 2008.

 

Pei Wei:  Partner investment expense decreased primarily due to the impact of opening fewer new restaurants during fiscal 2009 compared to fiscal 2008.

 

Interest and Other Income (Expense), Net

 

Interest expense primarily consists of interest costs in excess of amounts capitalized related to our outstanding credit line and other borrowings, as well as accretion expense related to our conditional asset retirement obligations. Interest income earned primarily relates to interest-bearing overnight deposits. Realized and unrealized holding gains (losses) related to investments in the 401(k) Restoration Plan are included within other income (expense), with a corresponding offset in general and administrative expense.

 

The change in consolidated interest and other income (expense), net was primarily due to lower interest expense resulting from the repayment of $40.0 million of our outstanding credit line borrowings in fiscal 2009. Additionally, unrealized holding gains during the current year compared to unrealized holding losses in the prior year associated with investments in the 401(k) Restoration Plan, lower capitalized interest and lower interest income contributed to the change. We expect to continue to recognize net interest expense until such time as we further lower our outstanding debt levels or increase our development.

 

Provision for Income Taxes

 

Our effective tax rate from continuing operations, including discrete items and deduction for noncontrolling interests, was 29.7% for fiscal 2009 compared to 25.8% for fiscal 2008. Prior fiscal year includes the impact of a change in estimate related to amended tax returns. Additionally, fiscal year 2009 state tax expense increased from fiscal year 2008. This is due to an increase in state tax filings, impacts of state tax reform measures and changes in filing methodology as a result of audits. The income tax rate for both fiscal 2009 and fiscal 2008 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. In fiscal year 2009, income from continuing operations increased at a greater rate than FICA tip credits generated as compared to fiscal year 2008. Because there are no tipped employees at Pei Wei, as Pei Wei contributes more net income, and if Bistro’s income from operations grows at a rate greater than revenue growth, the impact of Bistro’s tip credit on the company’s effective tax rate will continue to decrease.

 

Management has evaluated all positive and negative evidence concerning the realizability of deferred tax assets and has determined that, with the exception of a small amount of state net operating losses, we will recognize sufficient future taxable income to realize the benefit of our deferred tax assets.

 

Loss from Discontinued Operations, Net of Tax

 

The results of Taneko and 10 closed Pei Wei restaurants are classified as discontinued operations for all periods presented. During fiscal 2009, we recognized pretax charges of $1.4 million related to estimated and actual lease termination costs. See Fiscal 2008 compared to Fiscal 2007 Loss from Discontinued Operations, Net of Tax section for further discussion.

 

Net Income Attributable to Noncontrolling Interests

 

Net income attributable to noncontrolling interests represents the portion of our net income which is attributable to the collective ownership interests of our noncontrolling partners. In certain 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:  The change in net income attributable to noncontrolling interests was primarily due to the full year impact of noncontrolling interest buyouts that occurred during fiscal 2008 and, to a lesser, extent, the impact of noncontrolling interest buyouts occurring during fiscal 2009. These buyouts reduced the number of noncontrolling interests from 133 at the beginning of fiscal 2008 to 20 as of January 3, 2010.

 

Pei Wei:  Net income attributable to noncontrolling interests as a percentage of revenues increased from the prior year primarily due to the impact of higher restaurant net income and, to a lesser extent, a cumulative adjustment of prior period expense, partially offset by the impact of 132 noncontrolling interest buyouts occurring since the beginning of fiscal 2008.

 

Fiscal 2008 compared to Fiscal 2007

 

Our consolidated operating results for the fiscal years ended December 28, 2008 (fiscal 2008) and December 30, 2007 (fiscal 2007) were as follows (dollars in thousands):

 

 

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

Selected operating statistics for the Bistro were as follows (dollars in thousands):