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 28, 2008 contained in our 2008 Annual Report on Form 10-K.
Some of the statements in this section contain forward-looking statements, which involve risks and uncertainties. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-looking statements contained in this section involve known and unknown risks, uncertainties and situations that may cause our or our industry's actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed under "Risk Factors" in Item 1A (a detailed description of which can be found under the caption "Risk Factors" in our most recently filed Form 10-K) and elsewhere in this Form 10-Q, including, but not limited to, failure of our existing or new restaurants to achieve predicted results, changes in general economic and political conditions that affect consumer spending; our initiatives to improve the operating performance of our Pei Wei concept; changes in food costs; and our dependence on the financial performance of restaurants concentrated in certain geographic areas. 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"). Bistro
As of September 27, 2009, we owned and operated 192 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 noncontrolling interest.
We intend to open eight new Bistros in 2009, three of which were open by the end of the third quarter of 2009. We have signed lease agreements for all planned fiscal 2009 development and we have exercised our lease renewal options for all leases that were scheduled to expire in 2009. Our Bistro restaurants typically range in size from 6,000 to 7,500 square feet and require an average total cash investment of approximately $2.8 million to $3.0 million and total invested capital of approximately $4.0 million per restaurant (net of estimated landlord reimbursements). Total invested capital includes the present value of the operating lease obligation for the initial lease term of each property, which can vary greatly depending on the specific trade area. Preopening expenses are expected to average approximately $350,000 to $400,000 per restaurant during fiscal 2009.
Pei Wei
As of September 27, 2009, we owned and operated 164 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.
We intend to open seven new Pei Wei restaurants in 2009, five of which were open by the end of the third quarter of 2009. We have signed lease agreements for all planned fiscal 2009 development. 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 (net of estimated landlord reimbursements). Total invested capital includes the present value of the operating lease obligation for the initial lease term of each property, which can vary greatly depending on the specific trade area. Preopening expenses are expected to average approximately $140,000 to $160,000 per restaurant during fiscal 2009.

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Global Brand Development
International
We are actively 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 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 is scheduled to open 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 is scheduled to open in Mexico City during the fourth quarter of fiscal 2009. 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. Other Ventures
In August 2009, we entered into an agreement with FRC 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 P.F. Chang's into a majority equity position in True Food Kitchen. As of September 27, 2009, no borrowings were outstanding under the loan facility.
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 2008 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 27, 2009 and September 28, 2008, 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 the amount and timing of 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 where we continue to offer partnership interests and the timing of our purchases of existing partner 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 historically had a meaningful impact on preopening, labor, operating and partner investment expenses.

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Noncontrolling Interests
At the beginning of fiscal 2009, we changed our accounting and reporting for minority interests, which are now recharacterized as noncontrolling interests and classified as a component of equity. Minority interest expense is no longer separately reported as a reduction to net income on the consolidated income statements and is instead shown below net income under the heading "Net income attributable to noncontrolling interests." See Note 1 to our consolidated financial statements for further discussion of noncontrolling interests. Results for the three months ended September 27, 2009 and September 28, 2008 Our consolidated operating results were as follows (dollars in thousands):

                                                                    Three Months Ended
                             September 27,          % of           September 28,          % of                           %
                                 2009             Revenues             2008             Revenues         Change        Change

Revenues                    $       290,329           100.0 %     $       295,877           100.0 %     $ (5,548 )        (1.9 %)
Costs and expenses:
Cost of sales                        76,364            26.3 %              80,368            27.2 %       (4,004 )        (5.0 %)
Labor                                95,713            33.0 %              98,059            33.1 %       (2,346 )        (2.4 %)
Operating                            50,883            17.5 %              52,201            17.6 %       (1,318 )        (2.5 %)
Occupancy                            17,566             6.1 %              17,270             5.8 %          296           1.7 %
General and
administrative                       20,408             7.0 %              18,152             6.1 %        2,256          12.4 %
Depreciation and
amortization                         19,055             6.6 %              17,235             5.8 %        1,820          10.6 %
Preopening expense                    1,550             0.5 %               1,519             0.5 %           31           2.0 %
Partner investment
expense                                  18             0.0 %                  99             0.0 %          (81 )       (81.8 %)

Total costs and expenses            281,557            97.0 %             284,903            96.3 %       (3,346 )        (1.2 %)

Income from operations                8,772             3.0 %              10,974             3.7 %       (2,202 )       (20.1 %)
Interest and other
income (expense), net                    85             0.0 %                (895 )          (0.3 %)         980             -

Income from continuing
operations before taxes               8,857             3.1 %              10,079             3.4 %       (1,222 )       (12.1 %)
Provision for income
taxes                                (2,477 )          (0.9 %)             (2,057 )          (0.7 %)        (420 )        20.4 %

Income from continuing
operations, net of tax                6,380             2.2 %               8,022             2.7 %       (1,642 )       (20.5 %)
Loss from discontinued
operations, net of tax                  (17 )           0.0 %              (4,693 )          (1.6 %)       4,676         (99.6 %)

Net income                            6,363             2.2 %               3,329             1.1 %        3,034          91.1 %
Less: Net income
attributable to
noncontrolling interests                155             0.1 %                 367             0.1 %         (212 )       (57.8 %)

Net income attributable
to PFCB                     $         6,208             2.1 %     $         2,962             1.0 %     $  3,246             -

Certain percentage amounts may not sum due to rounding. Percentages over 100% are not displayed.
Selected operating statistics for the Bistro were as follows (dollars in thousands):

                                                                   Three Months Ended
                             September 27,          % of          September 28,          % of                          %
                                 2009             Revenues            2008             Revenues        Change        Change

Revenues                    $       217,093           100.0 %    $       226,443           100.0 %    $ (9,350 )        (4.1 %)
Costs and expenses:
Cost of sales                        56,624            26.1 %             61,430            27.1 %      (4,806 )        (7.8 %)
Labor                                71,216            32.8 %             74,387            32.9 %      (3,171 )        (4.3 %)
Operating                            37,487            17.3 %             38,556            17.0 %      (1,069 )        (2.8 %)
Occupancy                            12,390             5.7 %             12,536             5.5 %        (146 )        (1.2 %)
Depreciation and
amortization                         13,900             6.4 %             12,771             5.6 %       1,129           8.8 %
Preopening expense                    1,004             0.5 %                732             0.3 %         272          37.2 %
Partner investment
expense                                   -             0.0 %               (103 )           0.0 %         103        (100.0 %)
Net income attributable
to noncontrolling
interests                               104             0.0 %                271             0.1 %        (167 )       (61.6 %)

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

                                                                 Three Months Ended
                            September 27,          % of          September 28,          % of                         %
                                2009             Revenues            2008             Revenues       Change       Change

Revenues                   $        73,236           100.0 %    $        69,434           100.0 %    $ 3,802          5.5 %
Costs and expenses:
Cost of sales                       19,740            27.0 %             18,938            27.3 %        802          4.2 %
Labor                               24,497            33.4 %             23,672            34.1 %        825          3.5 %
Operating                           13,396            18.3 %             13,645            19.7 %       (249 )       (1.8 %)
Occupancy                            5,176             7.1 %              4,734             6.8 %        442          9.3 %
Depreciation and
amortization                         4,647             6.3 %              4,119             5.9 %        528         12.8 %
Preopening expense                     546             0.7 %                787             1.1 %       (241 )      (30.6 %)
Partner investment
expense                                 18             0.0 %                202             0.3 %       (184 )      (91.1 %)
Net income attributable
to noncontrolling
interests                               51             0.1 %                 96             0.1 %        (45 )      (46.9 %)

Revenues
Our revenues are derived primarily from food and beverage sales. Each segment contributed as follows:
Bistro: The decrease in revenues was attributable to an $18.7 million decline in revenues for stores that opened prior to the third quarter of 2008, due to a significant reduction in overall guest traffic combined with a slight decline in the average check. The decrease was partially offset by incremental new store revenues of $9.3 million, comprised of a full quarter of revenues from the seven new stores that opened during the last two quarters of 2008 and revenues generated by the three new Bistro restaurants that opened during 2009. Pei Wei: The increase in revenues was attributable to incremental new store revenues of $4.3 million, comprised of a full quarter of revenues from the 10 new stores that opened during the last two quarters of 2008 and revenues generated by the five new Pei Wei restaurants that opened during 2009. The increase was partially offset by a $0.5 million decline in revenues for stores that opened prior to the third quarter of 2008, as well as a slight decline in the average check, partially offset by a slight increase in overall guest traffic.
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 due to the net impact of favorable product mix shifts combined with operational efficiencies, as well as favorable produce and non-alcoholic beverage costs.
Pei Wei: Cost of sales as a percentage of revenues decreased due to favorable produce costs as well as the net impact of favorable product mix shifts combined with operational efficiencies. These decreases were partially offset by the impact of costs related to limited time offer menu items. 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, the benefit of reduced workers' compensation insurance liabilities resulting from lower than anticipated claim development, and lower management incentive accruals. 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 as well as higher health insurance costs.

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Pei Wei: Labor expenses as a percentage of revenues decreased primarily due to improved labor efficiencies in culinary and hospitality positions, the benefit of reduced workers' compensation insurance liabilities resulting from lower than anticipated claim development, and lower manager salaries resulting from reduced management headcount. These declines were partially offset by higher expenses associated with the utilization of additional key hourly employees and the impact of decreased leverage on lower average weekly sales on the portion of labor expenses that is fixed in nature as well as higher health insurance costs. 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 as well as higher repairs and maintenance expense. These increases were partially offset by lower utilities costs resulting from favorable rates and lower usage, as well as lower marketing spend.
Pei Wei: Operating expenses as a percentage of revenues decreased primarily due to lower utilities costs resulting from favorable rates, partially offset by higher usage. Lower menu and printing costs as well as lower disposables supplies expense contributed to the decrease to a lesser extent. These declines were partially offset by the impact of decreased leverage on lower average weekly sales on the portion of operating costs that is fixed in nature as well as higher repairs and maintenance expense. 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 increased primarily due to the impact of decreased leverage on lower average weekly sales, partially offset by lower contingent rent expense.
Pei Wei: Occupancy costs as a percentage of revenues increased primarily due to 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 share-based compensation expense primarily driven by the performance unit award grants issued to our co-CEOs during the first quarter of 2009 and the cash-settled liability awards issued during the first three quarters of fiscal 2009, as well as additional compensation expense resulting from unrealized holding gains associated with investments in the 401(k) Restoration Plan and higher management incentive accruals.
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 the last quarter of fiscal 2008 and during fiscal 2009 as well as an increase in retirements of assets that had not been fully depreciated. As a percentage of revenues, depreciation and amortization increased at both Bistro and Pei Wei due to the impact of decreased leverage resulting from lower average weekly sales.

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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 expense increased primarily due to the impact of opening two new restaurants during the third quarter of 2009 compared to opening no new restaurants during the third quarter of 2008, partially offset by the timing of expenses for new restaurant openings scheduled for the remainder of fiscal 2009 compared to fiscal 2008.
Pei Wei: Preopening expense decreased primarily due to the impact of opening three new restaurants during the third quarter of 2009 compared to opening six new restaurants during the third quarter of 2008. Partner Investment Expense
Partner investment expense represents the difference between the imputed fair value of noncontrolling interests at the time our partners invest 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 the third quarter of 2009 as compared to the third quarter of 2008.
Pei Wei: Partner investment expense decreased primarily due to the impact of opening fewer new restaurants during the third quarter of 2009 compared to the third quarter of 2008, and, to a lesser extent, the impact of expense reversals related to noncontrolling interest buyouts. Interest and Other Income (Expense), Net Interest expense recognized 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 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 and lower interest expense resulting from the repayment of $40.0 million of outstanding credit line borrowings. We expect 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 28.5% for the third quarter of 2009 compared to 21.2% for the third quarter of 2008. The third quarter of 2008 includes the additional tax benefit of the reduction of forecasted pretax income for the full year. Prior year quarter also includes the impact of a change in estimate related to amended tax returns. Besides the effect of the change in estimate related to amended returns, the income tax rate for the third quarter of 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.
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 . . .