Summary of P F CHANGS CHINA BISTRO INC

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This information should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 30, 2007 contained in our 2007 Annual Report on Form 10-K.
Some of the statements in this section contain forward-looking statements, which involve risks and uncertainties. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-lookingstatements contained in this section involve known and unknown risks, uncertainties and situations that may cause our or our industry's actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed under "Risk Factors" in Item 1A (a detailed description of which can be found under the caption "Risk Factors" in our most recently filed form 10-K) and elsewhere in this Form 10-Q, including, but not limited to, failure of our existing or new restaurants to achieve predicted results, the adequacy of anticipated sources of cash to fund our capital requirements and development of new restaurants, our ability to successfully expand our operations by developing and constructing our restaurants within projected budgets and time periods and changes in general economic and political conditions that affect consumer spending. Because we cannot guarantee future results, levels of activity, performance or achievements, you should not place undue reliance on these forward-looking statements. Overview
We own and operate 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, which had been classified as a discontinued operation in the Company's unaudited consolidated financial statements at the end of fiscal 2007. Bistro
As of September 28, 2008, we owned and operated 182 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 with the exception of two Bistro restaurants located in Hawaii which are operated under a joint venture arrangement in which we own a minority interest.
We intend to open 17 new Bistros during fiscal 2008, 10 of which were open by the end of the third quarter of 2008. We have continued our development in existing markets and by the end of 2008, will have entered five new markets. We have signed lease agreements for all of our new Bistro restaurants planned for fiscal 2008. We intend to continue to develop Bistro restaurants that typically range in size from 6,000 to 7,500 square feet, and that require, on average, a total cash investment of approximately $2.8 million to $3.0 million and total invested capital of approximately $4.0 million per restaurant, both of which are net of estimated landlord reimbursements. This total capitalized investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. Preopening expenses are expected to average approximately $400,000 per restaurant during 2008. Pei Wei
As of September 28, 2008, we owned and operated 165 quick casual Pei Wei restaurants that offer a modest menu of freshly prepared, high quality Asian cuisine served 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.
In fiscal 2008, we have slowed our growth substantially and limited the number of openings in new markets through the planned development of 25 new restaurants, primarily located in mature or under-penetrated markets. As of the end of the third quarter of 2008, 21 of these new restaurants were open. Our Pei Wei restaurants are generally 2,800 to 3,400 square feet in size and require an average total cash investment of approximately $800,000 to $900,000 and total invested capital of approximately $1.5 million per restaurant, both of which are net of estimated landlord reimbursements. Preopening expenses are expected to average approximately $150,000 per restaurant during 2008. We have signed lease agreements for all of our new Pei Wei restaurants planned for fiscal 2008.

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Restaurant Closings and Asset Impairment Charges As part of ongoing profitability initiatives, we will be closing 10 underperforming Pei Wei restaurants during the fourth quarter of 2008. This decision was a result of a rigorous evaluation of our entire store portfolio. We reviewed each location's past and present operating performance combined with projected future results. The locations selected for closure represent restaurants with lower profitability that are not projected to provide acceptable returns in the foreseeable future.
During the third quarter of 2008, we recognized non-cash asset impairment charges of $7.5 million ($4.7 million net of tax) related to the planned closure of 10 underperforming Pei Wei stores. These asset impairment charges reduced current quarter diluted earnings per share by $0.19. We also anticipate that additional charges related to these store closures will be recognized during the fourth quarter of 2008 for lease termination costs and severance payments. We anticipate reflecting these charges as well as all historical operations related to the closed stores within discontinued operations in the consolidated financial statements during the fourth quarter of 2008. We expect Pei Wei restaurant operating income margins to improve by approximately 70-80 basis points in fiscal 2009 as a result of these store closures.
Critical Accounting Policies
Our critical accounting policies are those that require significant judgment. There have been no material changes to the critical accounting policies previously reported in our 2007 Annual Report on Form 10-K. Results of Operations
The following tables set forth certain unaudited quarterly information for the three and nine month periods ended September 28, 2008 and September 30, 2007, respectively. This quarterly information has been prepared on a basis consistent with the audited financial statements and, in the opinion of management, includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. Our quarterly operating results may fluctuate significantly as a result of a variety of factors, and operating results for any quarter are not necessarily indicative of results for a full fiscal year.
One of the factors that has in the past caused fluctuations in our operating results is preopening expenses. Historically, we have experienced variability in the amount and percentage of revenues attributable to preopening expenses. We typically incur the most significant portion of preopening expenses associated with a given restaurant within the two months immediately preceding, and the month of, the opening of the restaurant. Additionally, there may be variability in the amount and percentage of revenues attributable to partner investment expense as a result of the timing of opening new Pei Wei restaurants and the timing of purchasing partner interests. Partner investment expense generally represents the difference between the imputed fair value of our partners' ownership interests and our partners' cash capital contribution for these interests.
In addition, our experience to date has been that labor and operating costs associated with a newly opened restaurant for the first several months of operation are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Accordingly, the volume and timing of new restaurant openings has had and is expected to continue to have, a meaningful impact on preopening expenses, labor, operating and partner investment costs.

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Results for the three months ended September 28, 2008 and September 30, 2007 Our consolidated operating results for the three months ended September 28, 2008 and September 30, 2007 were as follows (dollars in thousands):

                                                                      Three months ended
                              September 28,          % of           September 30,          % of
                                  2008             Revenues             2007             Revenues         Change        % Change

Revenues                     $       298,359           100.0 %     $       270,282           100.0 %     $ 28,077            10.4 %
Costs and expenses:
Cost of sales                         81,075            27.2 %              73,865            27.3 %        7,210             9.8 %
Labor                                 99,140            33.2 %              91,789            34.0 %        7,351             8.0 %
Operating                             52,767            17.7 %              43,816            16.2 %        8,951            20.4 %
Occupancy                             17,594             5.9 %              15,970             5.9 %        1,624            10.2 %
General and
administrative                        18,152             6.1 %              17,186             6.4 %          966             5.6 %
Depreciation and
amortization                          17,510             5.9 %              14,749             5.5 %        2,761            18.7 %
Preopening expense                     1,519             0.5 %               4,939             1.8 %       (3,420 )         (69.2 %)
Partner investment
expense                                   99             0.0 %                 (71 )          (0.0 %)         170               -
Asset impairment charge                7,510             2.5 %                   -             0.0 %        7,510               -

Total costs and expenses             295,366            99.0 %             262,243            97.0 %       33,123            12.6 %

Income from operations                 2,993             1.0 %               8,039             3.0 %       (5,046 )         (62.8 %)
Interest and other income
(expense), net                          (895 )          (0.3 %)                (10 )          (0.0 %)        (885 )             -
Minority interest                       (367 )          (0.1 %)               (808 )          (0.3 %)         441           (54.6 %)

Income before provision
for income taxes                       1,731             0.6 %               7,221             2.7 %       (5,490 )         (76.0 %)
Provision for income
taxes                                  1,055             0.4 %              (1,618 )          (0.6 %)       2,673               -

Income from continuing
operations                             2,786             0.9 %               5,603             2.1 %       (2,817 )         (50.3 %)
Income (loss) from
discontinued operations,
net of tax                               176             0.1 %                (328 )          (0.1 %)         504               -

Net Income                   $         2,962             1.0 %     $         5,275             2.0 %     $ (2,313 )         (43.8 %)

Certain percentage amounts may not sum to total due to rounding. Percentages over 100% not displayed.
Selected operating statistics for the Bistro for the three months ended September 28, 2008 and September 30, 2007 were as follows (dollars in thousands):

                                                                          Three months ended
                                  September 28,          % of           September 30,          % of
                                      2008             Revenues             2007             Revenues         Change        % Change

Revenues                         $       226,443           100.0 %     $       208,544           100.0 %     $ 17,899             8.6 %
Costs and expenses:
Cost of sales                             61,430            27.1 %              56,943            27.3 %        4,487             7.9 %
Labor                                     74,387            32.9 %              69,946            33.5 %        4,441             6.3 %
Operating                                 38,556            17.0 %              32,981            15.8 %        5,575            16.9 %
Occupancy                                 12,536             5.5 %              11,739             5.6 %          797             6.8 %
Minority interest                            271             0.1 %                 599             0.3 %         (328 )         (54.8 %)
Depreciation and amortization             12,771             5.6 %              10,861             5.2 %        1,910            17.6 %
Preopening expense                           732             0.3 %               2,974             1.4 %       (2,242 )         (75.4 %)
Partner investment expense                  (103 )          (0.0 %)               (433 )          (0.2 %)         330           (76.2 %)

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

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Selected operating statistics for Pei Wei for the three months ended September 28, 2008 and September 30, 2007 were as follows (dollars in thousands):

                                                                         Three months ended
                                  September 28,          % of          September 30,          % of
                                      2008             Revenues            2007             Revenues        Change        % Change

Revenues                         $        71,916           100.0 %    $        61,738           100.0 %    $ 10,178            16.5 %
Costs and expenses:
Cost of sales                             19,645            27.3 %             16,922            27.4 %       2,723            16.1 %
Labor                                     24,753            34.4 %             21,843            35.4 %       2,910            13.3 %
Operating                                 14,211            19.8 %             10,835            17.5 %       3,376            31.2 %
Occupancy                                  5,058             7.0 %              4,231             6.9 %         827            19.5 %
Minority interest                             96             0.1 %                209             0.3 %        (113 )         (54.1 %)
Depreciation and amortization              4,394             6.1 %              3,417             5.5 %         977            28.6 %
Preopening expense                           787             1.1 %              1,965             3.2 %      (1,178 )         (59.9 %)
Partner investment expense                   202             0.3 %                362             0.6 %        (160 )         (44.2 %)

Certain percentage amounts may not sum to total due to rounding. Percentages over 100% not displayed.
Revenues
Our revenues are derived primarily from food and beverage sales. Each segment contributed as follows:
Bistro: The increase in revenues was attributable to revenues of $24.7 million generated by the 20 new Bistro restaurants that opened during the first three quarters of 2008 and the last quarter of 2007. The increase was also due to an increase in revenues of $1.0 million generated by restaurants that opened during the third quarter of 2007, which is primarily a result of a full three months of revenues during the third quarter of 2008. Revenues for stores that opened prior to the first quarter of 2007 declined by $7.7 million as a significant reduction in overall guest traffic more than offset the benefit of a four to five percent average check increase, reflecting the net impact of price increases and menu mix changes. Additionally, the impact of Hurricane Ike resulted in $0.4 million of lost revenue during the third quarter of fiscal 2008 as a result of temporary store closures at five Bistro locations in the Houston area.
Pei Wei: The increase in revenues was attributable to revenues of $10.4 million generated by the 28 new Pei Wei restaurants that opened during the first three quarters of 2008 and the last quarter of 2007. The increase was also due to an increase in revenues of $1.3 million generated by restaurants that opened during the third quarter of 2007, which is primarily a result of a full three months of revenues during the third quarter of 2008. Revenues for stores that opened prior to the first quarter of 2007 decreased by $1.5 million primarily due to a significant reduction in overall guest traffic partially offset by the benefit of a slightly higher average check, reflecting the net impact of price and menu mix changes. Additionally, the impact of Hurricane Ike resulted in $0.5 million of lost revenue during the third quarter of fiscal 2008 as a result of temporary store closures at 13 Pei Wei locations in the Houston area. Costs and Expenses
Cost of Sales
Cost of sales is comprised of the cost of food and beverages. Each segment contributed as follows:
Bistro: Cost of sales as a percentage of revenues decreased from the prior year primarily due to lower poultry expense resulting principally from recognition of anticipated rebate benefits, as well as lower seafood costs resulting from product mix shifts and favorable pricing. The decrease was partially offset by an increase in meat expense due to product mix shifts, grill menu promotions and increased pricing, as well as higher wok oil costs.
Pei Wei: Cost of sales as a percentage of revenues decreased primarily due to lower seafood expense resulting from the deletion of scallops from the Pei Wei menu, partially offset by higher wok oil costs and higher poultry costs, including the benefit of anticipated rebate benefits.

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Labor
Labor expenses consist of restaurant management salaries, hourly staff payroll costs, other payroll-related items and imputed partner bonus expense. Imputed partner bonus expense represents the portion of restaurant level operating results that are allocable to minority partners, but are presented as bonus expense for accounting purposes. Each segment contributed as follows:
Bistro: Labor expenses as a percentage of revenues decreased primarily due to improved labor efficiency in culinary and hospitality positions. The decrease was partially offset by higher management incentive costs principally resulting from the 2007 change in the Bistro partnership structure, the benefit of reduced workers' compensation insurance liabilities in the third quarter of 2007 resulting from lower than anticipated claim development from prior claim years and the impact of decreased leverage on lower average weekly sales on the portion of labor expenses that is fixed in nature.
Pei Wei: Labor expenses as a percentage of revenues decreased primarily due to improved labor efficiency in culinary and hospitality positions as well as lower management salaries resulting from reduced management headcount. The decrease is partially offset by higher hourly labor costs resulting from the utilization of additional key hourly employees as well as the benefit of reduced workers' compensation insurance liabilities in the third quarter of 2007 resulting from lower than anticipated claim development from prior claim years and the impact of decreased leverage on lower average weekly sales on the portion of labor expenses that is fixed in nature.
Operating
Operating expenses consist primarily of various restaurant-level costs such as repairs and maintenance, utilities and marketing, certain of which are variable and fluctuate with revenues. Our experience to date has been that operating costs during the first four to nine months of a newly opened restaurant are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Each segment contributed as follows:
Bistro: Operating expenses as a percentage of revenues increased primarily due to higher marketing spend, higher utility costs and the impact of decreased leverage on lower average weekly sales on the portion of operating costs that is fixed in nature.
Pei Wei: Operating expenses as a percentage of revenues increased primarily due to higher marketing spend, higher utility costs and the impact of decreased leverage resulting from lower average weekly sales on the portion of operating costs that is fixed in nature as well as higher menu printing costs related to a new menu roll-out.
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 slightly primarily due to lower building rent expense resulting from a greater number of contingent rent-only locations as well as lower general liability insurance. The benefits resulting from these declines were partially offset by the impact of decreased leverage on lower average weekly sales.
Pei Wei: Occupancy costs as a percentage of revenues increased slightly primarily due to the impact of decreased leverage resulting from lower average weekly sales, partially offset by lower property taxes.

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Minority Interest
Minority interest represents the portion of our net earnings which is attributable to the collective ownership interests of our minority partners. As previously discussed, in many of our restaurants we employ a partnership management structure whereby we have entered into a series of partnership agreements with our regional managers, certain of our general managers, and certain of our executive chefs. Each segment contributed as follows:
Bistro: Minority interest as a percentage of revenues decreased due to the impact of partnership interest buyouts occurring during fiscal 2007 and the first three quarters of fiscal 2008. These buyouts reduced the number of minority interests from 152 as of September 30, 2007 to 73 as of September 28, 2008.
Pei Wei: Minority interest as a percentage of revenues decreased due to the net impact of partnership interest buyouts occurring during fiscal 2007 and the first three quarters of fiscal 2008, as well as lower restaurant net income. Depreciation and Amortization
Depreciation and amortization expenses include the depreciation and amortization of fixed assets, gains and losses on disposal of assets and the amortization of intangible assets and non-transferable liquor license fees. Each segment contributed as follows:
Bistro: Depreciation and amortization increased primarily due to additional depreciation on restaurants that opened during the last quarter of fiscal 2007 and the first three quarters of fiscal 2008. As a percentage of revenues, depreciation and amortization increased due to the impact of decreased leverage resulting from lower average weekly sales.
Pei Wei: Depreciation and amortization increased primarily due to additional depreciation on restaurants that opened during the last quarter of fiscal 2007 and the first three quarters of fiscal 2008. As a percentage of revenues, depreciation and amortization increased due to the impact of decreased leverage resulting from lower average weekly sales. Preopening Expense
Preopening expenses, which are expensed as incurred, consist of expenses incurred prior to opening a new restaurant and are comprised principally of manager salaries and relocation costs, employee payroll and related training costs. Preopening expenses also include straight-line rent expense for the period between the possession date of leased premises and the restaurant opening date. Each segment contributed as follows:
Bistro: Preopening expenses decreased primarily as a result of there being no Bistro restaurant openings during the third quarter of 2008 compared to five new Bistro restaurants during the third quarter of 2007, as well as the timing of expenses related to a lower number of scheduled new restaurant openings in the remainder of fiscal 2008 and early fiscal 2009 compared to the last quarter of fiscal 2007 and early fiscal 2008.
Pei Wei: Preopening expenses decreased primarily due to the impact of opening six new Pei Wei restaurants during the third quarter of 2008 compared to 11 new Pei Wei restaurants during the third quarter of 2007, as well as the timing of expenses related to a lower number of scheduled new restaurant openings in the remainder of fiscal 2008 and early fiscal 2009 compared to the last quarter of fiscal 2007 and early fiscal 2008.
Partner Investment Expense
Partner investment expense represents the difference between the imputed fair value of our partners' ownership interests at the time the partners invest in their restaurants and our partners' cash contributions for those ownership interests. Additionally, for those partners who are bought out prior to the restaurant reaching maturity (typically after five years of operation), partner investment expense includes a reversal of previously recognized expense for the difference between the fair value of the partner's interest at inception date and the fair value at the date of repurchase, to the extent that the former is greater. Each segment contributed as follows:
Bistro: The change in partner investment expense resulted primarily from changes in partnership structure beginning in 2007 which led to a significant increase in early buyouts of minority partner interests beginning in fiscal 2007. Early buyouts resulted in a $0.1 million reversal of previously recognized partner investment expense during the third quarter of 2008 compared to a $0.4 million reversal during the third quarter of 2007, in each case due to the fair value of the partners' interests at inception date exceeding the fair value of the partners' interests at repurchase date.
Pei Wei: Partner investment expense decreased primarily due to opening six new Pei Wei restaurants during the third quarter of 2008 compared to 11 new Pei Wei restaurants during the third quarter of 2007, partially offset by lower expense reductions related to minority partnership interest buyouts in the third quarter of 2008 compared to the third quarter of 2007.

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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, . . .