Ruth's Hospitality Group Inc (RUTH) 2007 Q2 法說會逐字稿

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to today's Ruth's Chris Steak House, Inc. Second Quarter 2007 Conference Call.

(OPERATOR INSTRUCTIONS)

And now, for opening remarks and introductions, I would like to turn the call to Tom Pennison. Please go ahead, sir.

Thank you. Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be put upon them.

We refer all of you to our recent filings with the SEC for a more detailed discussion of the risks that could impact our future operating results and financial condition.

With that, I'd like to turn the call over to Mr. Craig Miller, Chairman, President, and Chief Executive Officer for Ruth's Chris Steak House.

Thanks very much, Tom and good afternoon everyone.

First I want to reference our second quarter earnings release, which was issued after the market closed this afternoon. I will focus my comments today on what I feel are the most aspects of our business and our current trends.

For the 13 week fiscal quarter, restaurant sales grew 28.4% to $73.6 million. All of this increase came from additional Company restaurant operating weeks, which increased 28.9% to 687 weeks.

Average unit volumes were down modestly, 0.4%. It is noteworthy that sales from the seven units we acquired last year averaged 15.5% higher volumes versus a year ago when they were franchise operated.

We still have significant facilities work to accomplish in two of the seven units, which when completed are expected to drive further volume increases. I should also note that five of the seven units will join our comparable base at the beginning of the fourth quarter.

On a comparable calendar basis, after adjusting for the fiscal week shift, comparable restaurant sales increased 1%, marking the 17th consecutive quarter of comparable sales growth. On a fiscal basis, second-quarter 2007 Company-owned same-store sales decreased 0.4%, equal to our average unit volumes.

In our view, this was a function of some macroeconomic issues that particularly affected California and Florida, our two largest markets, both of which have seen several years of very impressive growth. The entree slowdown may also be a function of some changes in year-over-year in our marketing expenditures, as we have shifted our focus a bit more to the back-half of 2007.

It may be important to some -- for us to reiterate and highlight the composition of our guest base, which we feel is the most diverse of all major fine dining competitors.

Recently completed research corroborates what we have known empirically for years that our brand has broad consumer appeal and that our guests mix falls into one of three primary categories.

We estimate that about a third are special occasion diners who dine with us once or at most a few times a year for birthdays, anniversaries, and around the holiday season. About a third of our business comes from business diners or corporate credit cards, with the remainder being our frequent diners who come from above average disposable income and income families.

History has shown that the diversity in our guest profile is a long-term competitive strength in our segment and is a major contributor to significantly higher per unit volumes than many of our counterparts, while lowering the risk concentration of appealing to one primary audience.

In fact, Nation's Restaurant News, in their ranking of the top 100 chains recently listed Ruth's Chris as having the second highest volume units behind the upscale casual dining Cheesecake Factory chain. Our Company was also recognized as the ninth fastest growing chain out of a 100 leading U.S. chains.

That said, we do believe that many of our special occasion diners are being slightly more cautious for the reasons that I mentioned earlier and may be causing some of the current entree traffic weakness.

Against this backdrop, we believe that our operations teams are focused and delivering the highest quality of food and service, and our internal shopping scores attest to that, as well as the 33.8% year-over-year growth in operating income before pre-opening costs.

We look for entree growth to improve slightly later this year as we lap some macro issues from a year ago, and as our marketing efforts both locally and nationally take hold. In addition to our beverage initiatives and private dining business, both of which are still in the early stages of additional growth, there are a number of other options we have to drive sales.

While Ruth's Chris has always been synonymous with sizzling steaks, 12% of our restaurant sales actually come from high margin seafood offerings, and we think we can raise our seafood mix to 15% without negatively affecting our average check.

We consider an upgrade in seafood menu as significant opportunity as it offers more people more reasons to dine with us. In the coming weeks, we will be introducing what we call a fresh eat section to our regular menu to enable us to promote more specials both seafood as well as product introductions similar to the successful -- recent successful Australian Kobe Steak.

We are also in the test phase of what we are calling Ruth's Chris Friday Power Lunch, which is designed to target professionals looking for a more upscale lunch experience to finish off the week.

Our restaurants are generally open for only seven weekly meal occasions, and this has worked well for us in attracting and retaining high quality management and wait staff. That said, we see an opportunity to add one more day part in certain restaurants without overtaxing our operations and thereby further leveraging our fixed costs.

With this in mind, we developed a scaled-down menu with an approximate $40 to $50 average check and have eight restaurants running this test. If deemed successful, we would consider rolling it out to other locations, as well as encouraging our franchise partners to implement a power lunch daypart.

We appreciate that adding a lunch option, even on Friday does require a delicate balance, as we do not want to dilute the overall Ruth's Chris experience. So, we are cautious in how we execute this program and we will be selective in expanding it.

Turning to new restaurant openings, on April 18th, we opened our 106th restaurant located in Anaheim, California and 11th in the state. This location features our luxury lounge concept, which offers a gathering place for friends, couples, small groups, and individuals who desire a comfortable environment to relax and enjoy their favorite beverage and fine cuisine.

Then, on July 1st, the last day of our fiscal second quarter, we opened our long-awaited location in Biloxi, Mississippi, which was originally set to open two days after Hurricane Katrina devastated the area. The restaurant is situated in the new Hard Rock Hotel & Casino, and is similar to the Anaheim location and includes our luxury lounge concept. This is our first casino restaurant and seventh hotel unit.

As we stated before, we consider the lounge feature a key element to meeting the involving needs of our guests, as well as generating trial from new guests. All of our new facilities feature a larger bar and lounge area with private dining opportunities. And in places like Bonita Springs and others, we're able to greatly increase what we call non-reservation a la carte dining.

Because we don't take reservations for the tables in these areas, it gives people the opportunity to visit Ruth's Chris on an impulse, stop in and have an appetizer at the bar, or a full meal if they desire. We should note that this business does not factor in to our entree traffic.

In terms of performance, the ten restaurants that have opened since 2004, with this new generation look and feel, exceed the older base of restaurants by some 15%, as we tracked this incremental business. And these results in our view validate the appeal of the concept and more generally our continued relevancy and growth strategy.

Over the next 18 months, we intend to undergo eight major remodels at our older facilities that will include adding additional seats in some instances as well as implementing a modified version of our luxury lounge concept. Furthermore, we have already selected a number of existing restaurants where the bar had been expanded and/or modified. We look forward to updating you on the progress of these investments.

For more details on our financials, I will now turn the call over to Tom Pennison, our CFO. Tom?

Thank you, Craig. During the second quarter, which ended July 1, 2007, total revenues increased 29.5% to $78.4 million from $60.5 million last year. The primary component of this growth came from Company-owned restaurant sales, which grew 28.4% to $73.6 million, from $57.4 million in the second quarter 2006, and as Craig mentioned, was primarily the result of a 28.9% increase in Company restaurant operating weeks. This includes approximately an additional 12 restaurants in operation year-over-year.

Our average weekly sales for all Company-owned locations were 107,297 for the quarter. Average weekly sales for the 40 restaurants in the comp base during the quarter were 106,645, while newly opened restaurants experienced slightly lower average weekly sales of 102,155 due in part to the seasonality of our Naples and Bonita Springs, Florida restaurants.

We were pleased with the progress of our seven acquired restaurants, whose current average weekly volume of 114,567 exceeded the comparable restaurant base. As Craig noted, five of these seven restaurants will enter the comp base in the fourth quarter of this year.

Company-owned restaurant sales in the comp base decreased 0.4% on a fiscal basis, which was impacted by the seasonality variance of the one week calendar shift during the period. However, adjusting for this fiscal week shift, Company-owned comparable restaurant sales increased 1%.

By this measurement, comparable sales growth consisted of an average check increase of 4.1%, driven by non-entree increases in bar and lounge traffic, menu selection shifts and year-over-year menu pricing of just shy of 3%. This was partially offset by an entree reduction of 3.1%.

As Craig alluded, one note of distinction for us is that we calculate traffic as equivalent to ordering an entree, not by counting the actual guests that walk through the door. If an individual sits at the bar, orders a few drinks and some appetizers and could potentially spend as much if not more than our average check, they are not counted in our traffic calculation. This non-entree traffic has continued to increase our average check, especially in our new restaurants.

Please note also that Company-owned comparable restaurant sales lapped last year second quarter growth of 6% and accumulative three-year growth from 2004 through 2006 of 27.6% in the second quarter.

Franchise income decreased slightly to $2.9 million from $3 million during the prior year. This was due primarily to our acquisition of seven franchise locations in the second half of 2006, and was partially offset by a net increase in comparable franchise restaurant sales of 0.1%. This was comprised of a domestic decrease of 0.4%, and an international increase of 7.7%. We'll continue to see great strength in our international units, which excites over the upcoming growth we see in that area.

The franchise income decrease was also offset by an additional nine franchise owned locations added to the system year-over-year.

Other operating income increased to $1.9 million in the second quarter of fiscal 2007 from $100,000 in the second quarter of fiscal 2006. This increase was due primarily to $1.8 million of gift card breakage recognized during the quarter versus $48,000 in the prior year period. As a reminder, the Company recognizes gift card breakage for the remaining value of those cards that have not been redeemed following 18 months from the date of last activity, and for which there is no third-party claim.

As we discussed in our fourth quarter 2006 conference call, as the result of the Company entering into an agreement with an unrelated third-party last year, recognition of gift card breakage and related fee income for 2007 and beyond will be greater than historical levels. This amount is expected to be approximately $2 million to $2.2 million on an annual basis and will grow in relation to our gift card sales growth.

Due to the seasonally high volume of gift cards that are purchased during the October through December period of each fiscal year, the second quarter which is 18 months following this period, in this case the fourth quarter of 2005, will have the highest amount of gift card breakage recognition each fiscal year.

Food and beverage costs were $23.4 million compared to $18 million in the second quarter of 2006. As a percentage of restaurant sales, food and beverage cost increased 50 basis points to 31.8% from 31.3% in the prior-year period. Higher lobster, produce, and dairy costs were partially offset by modestly favorable beef and seafood costs, mix shifts, and a combined 3% price increase.

While higher than the prior year, food and beverage costs came in the low side of our annual expectation of 31.8% to 32.2%. As a reminder, we continue to have 50% of our entire meat purchase contracted for 2007 and still expect to be at or below the 2006 percentage on an annual basis.

We have been very pleased to have seen sequential monthly improvement this year, despite starting off a little high. In part, due to the prices and exposure we had in the beef markets last year during the third quarter, we are now enjoying several of our beef cuts with lower cost than the prior year and in some cases below our hedge price. We expect this to continue into the third quarter and then increase into the fourth quarter.

Restaurant operating expenses increased $9 million to $34.1 million in the second quarter from $25.1 million in the second quarter of 2006. Restaurant operating expenses as a percentage of restaurant sales increased 260 basis points to 46.4% from 43.7% in the prior year.

This increase was due to higher labor management education cost and property insurance in core restaurants as well as higher labor and operating expenses in our newly opened restaurants as we limited the door and their sales volumes.

Property insurance, which was mentioned a few quarters now, which significantly increased upon our July renewal last year following the 2005 hurricane season, will moderate on a year-over-year basis in the second half of 2007 as a result of our recent insurance renewal.

Marketing and advertising cost increased to $2.2 million or 2.8% of total revenue from $2.1 million last year or 3.5% of total revenue. This percentage decrease was primarily due to reduced utilization of television in select markets in the second quarter of fiscal 2007 versus the prior year as well as the timing of expenditures in the fiscal 2007 marketing plan, which is more evenly distributed throughout the year. We expect marketing and advertising not to exceed 3% total revenue for the full year.

For a nice twist, since we have been public, general and administrative costs decreased slightly to $5.8 million in the second quarter of 2007. This decrease was the result of reduced levels of incentive compensation earned as well as certain open positions during the quarter, which have now been partially filled for the third quarter.

This decrease was significantly offset by additional costs associated with our operations at our home office as well as higher stock option compensation expense under FAS 123R.

The good news is that G&A costs, as a percentage of total revenues, decreased by 230 basis points to 7.2% in the second quarter from 9.5% last year as a result of leverage from strong revenue gains. Going forward, G&A expansion is expected to rise at less than half the rate of revenue growth and that margin improvement will play a larger role in our EPS growth as we move ahead. That said, G&A for the most part is a fixed expense and will vary as a percentage from quarter to quarter, with the highest percentage during our seasonally low third quarter.

Depreciation and amortization increased to $2.9 million in the second quarter compared to $2.1 million last year. This increase was due primarily to the addition of new Company-owned restaurants and the seven acquired restaurants during 2006, as well as investments in remodeling activities at our existing Company-owned restaurants and the corporate headquarters.

For the second quarter of 2007, pre-opening costs were $1.1 million versus $43,000 last year. We opened two Company restaurants during the period, one in Anaheim, California and one in Biloxi, Mississippi, which opened on July 1, the last day of our fiscal quarter. There were no openings during the second quarter last year.

Similar to what we have described before, we plan approximately $500,000 of pre-opening costs per Company-owned restaurant, although the timing of certain of these costs can be up to 90 to 120 days before a scheduled opening, and therefore may be in preceding quarters. These costs also include certain non-cash lease cost expensed during the construction period.

Operating income grew by 19.4% to $9 million in the second quarter this year or 11.5% of total revenue versus $7.6 million last year or 12.5% of total revenue for the reasons just described. Excluding pre-opening expenses, operating income grew by 33.8%, as Craig mentioned.

Interest expense increased to $1.2 million from $500,000 last year. This increase was primarily due to the additional borrowings year-over-year for the seven acquired restaurants as well as the purchase of our corporate office. Additionally, higher interest rates impacted the cost also. Our total debt as of the end of the quarter was $75.5 million.

Our effective income tax rate for the second quarter of 2007 was approximately 32.3%, which was above the 30.4% rate we experienced last year. As noted previously, our 2006 effective tax rate benefited from one-time Federal tax credits we received related to continued employment associated with hurricane Katrina last year.

Net income available to common shareholders for the quarter was $5.4 million or $0.23 per diluted share on a 23.4 million share base compared to net income of $4.9 million or $0.21 per diluted share the prior year.

One last note before I discuss our guidance. We rolled off an approximate 1.5% price increase in July and we do expect to implement an equivalent price increase in September with our new menu rollout associated with the fresh sheets that Craig mentioned previously.

In reviewing our annual guidance, we have considered our results for the first half of the year and considered many of the continuing macroeconomic concerns that exist domestically. With that in mind, for the full 52-week fiscal year 2007, the Company now estimates that same-store sales will increase approximately 1% to 2%. This sales assumption implies better second half performance due to the favorable calendar shift and numerous sales initiatives underway.

Additionally, we expect our comparable growth to be more heavily weighted toward the fourth quarter when we will add the five of our acquired locations into the comp base.

System-wide restaurant operating weeks will grow by greater than 20% resulting in year-over-year increases in pre-opening expenses, as well as higher operating cost in the initial stages of these new locations.

The Company anticipates the opening of eight Company-owned and eight franchise locations of which four Company-owned and three franchise locations respectively have opened through July 2007.

As I previously mentioned, we have contracted 50% of all beef needs for 2007, as well as maintained agreements on our other key commodities. We still expect that our food and beverage costs as a percentage of restaurant sales will range between 31.8% and 32.2% representing a 10 to 50 basis point reduction versus our fiscal 2006.

Annual marketing and advertising expenditures are still expected not to exceed 3%, and as I noted, the effective tax rate for 2007 is expected to be 32.3% versus a 30% in 2006.

While we remain optimistic about our strategic progress and various sales initiatives, we would rather be more conservative than aggressive at this time and are therefore expecting full year 2007 diluted earnings per share of between $0.92 and $0.97 including the impact of FAS 123R.

This guidance considers the assumed annual range of same store sales growth between 1% and 2%, modest margin erosion from higher operating cost, the addition of four new restaurants in the second half of the year, and the resulting pre-opening cost and lower initial margins, and the short-term cost we expect to incur to complete the upcoming franchise acquisition in the third quarter.

We expect these items to more significantly impact our seasonally low third quarter and the fourth quarter of the year.

And with that, I will return the call back to Craig for some concluding thoughts.

Thanks, Tom. We are excited with the progress our Company has made over the past several years, and look forward to bringing the Ruth's Chris experience to great locations throughout the world. We believe our industry leading unit economics and distinct business model within the fine dining segment will enable us to realize that objective.

Our plan consists of balanced domestic Company-owned development, primarily in top tier markets with complementary franchise development in secondary markets.

On the international front, we will focus exclusively on franchised operations as it allows us to grow the brand faster with limited capital risk. To that point, we have already signed agreements with Japan, Central America, and additional Canadian locations and will be opening our first location in Japan and fourth in Canada later this year. We are also in discussions with experienced operators in other parts of Asia, as well as the Middle East to bring the Ruth's Chris dining experience to these geographies.

In aggregate, we are developing a robust international franchise pipeline and are set on expanding our international unit base by some 30% annually beginning in 2008.

Overall, we currently have 20 distinct franchise partnerships including ten new relationships just since 2003. Commitments from our -- from these franchise partners consist of 36 locations less of half of which have opened in the past two years. Therefore, there is ample growth within our current franchise system, let alone attracting additional partners.

For 2007, we will end the year with 116 restaurants across 35 states and four foreign countries with four Company-owned locations and five franchise locations currently under construction, including the two aforementioned international restaurants.

Given the Ruth's Chris brand potential we have laid out, we are less than half way to our domestic opportunity and I have just discussed, we have even longer runway internationally.

Finally, we are committed to creating long-term shareholder value and we will do so through a continuation of our 42 year history of our offering the Ruth's Chris experience through Company-owned and franchise partnerships.

Despite some short-term macro challenges, we are extremely excited about the business and comfortable with our long-term's earnings growth rate between 17% and 20%.

Thanks for being with us today, and operator, let's open the lines for any questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question will come from Larry Miller with RBC Capital Markets.

Hey guys, can you hear me?

Yes, Larry.

Yes, Larry.

How you are doing?

Very good.

Okay. Can I ask a question about your guidance, first of all, Tom? Initially, you have been giving GAAP guidance because of the gain in the first quarter. Is that included in that guidance or is that now excluded in that guidance?

No. All of our guidance is GAAP guidance.

Okay, that's helpful, thank you. And just one other small clarification. You are going to be running at about an effective 1.5% price increase for the months of July through September. Is that approximately right?

Yes. With September, then coming back to just shy of 3%.

That's 3%? Okay, just wanted to make sure. And then Craig, are you guys able to quantify the impact of the last year, year-over-year marketing and when would you guys bring that marketing back in, I think you said Q4?

Well, what we did is we ran TV marketing last year in the latter part of the second quarter.

In the first half of the third quarter.

Yes, in the first few weeks of the third quarter. And, we chose not to do that this year for couple of reasons.

One is, we have been going through some very in-depth research, trying to learn more about some of the habits of some of our guests. And we weren't really, totally excited last year about the volume increases that we got from the TV.

What we have done is we got a much more focused market driven strategy. And we are also able because of the resources that we have with not running the national TV, to be able to target those markets where we think we can have the most opportunity, particularly where we have large concentrations of units like DC, LA, and Florida. Most of those dollars will be spent in the latter part of the third quarter and in the fourth quarter.

In those select markets where you didn't do the TV, were comps materially different?

They were, well -- they were lower than they were last year and in the weeks -- the peak weeks that we ran the TV, overall the system was -- was more negatively impacted than in the weeks prior to the TV running and subsequent to the TV running. Particularly early week, which leads me to believe that the -- that the impulse diner or the special occasion type of consumer might have been influenced to try us a little bit more based on media advertising.

Okay. I guess I am not clear on why -- why it wasn't successful then in your view then?

Well, it may have been, Larry, more successful than we gave it credit for.

Okay.

Last year in '06, our comps in the second quarter were up about 6%, which was actually a little bit lower than what we have experienced in the previous quarter. So, we weren't jumping up and down last year about the results, but we were up against some headwinds from a macro standpoint last year that we may not have judged as accurately in terms of how much pressure -- downward pressure that was putting on some of our guests.

So, in hindsight, I will say that it was probably more impactful than what we had given it credit for last year.

Got you. That makes sense.

And additionally, Larry, some of those items, while it helps the top-line depending on the cost to do it, in the end everyone is concerned with the earnings per share.

No, I would get you there too. Hey, can I just -- Tom, maybe you can help me understand the gift card breakage? I guess I didn't follow it in your comments. Was it an annual recurring phenomenon?

This is going to be -- we didn't have as much visibility last year as we entered into the agreement and had the catch up in the fourth quarter of 2006.

On an annual basis and just as a reminder, our system and this includes Company and franchise, sold over $37 million in gift cards last year. And of that number, while we have a high redemption rate, our redemption rate is in the lower 90 percentile.

So, if you look at 10% of $37 million number, granted about $25 million of that was Company, you have a large annual amount that will continue each year to probably go unredeemed at that 10% level.

And what we do is basically, it's really 18 months following the last date of activity, which -- if you look at most of the activations and purchases take place in the fourth quarter, 18 months following that will put the lion's share of that each year in our second quarter.

So, as you look at the number that we had in our second quarter this year, that's really the fourth quarter of 2005, a year from now we will be dealing with the breakage of the fourth quarter of 2006.

And one of the items as we just entered into the agreements last year, we didn't have as great a level of visibility with it and we had really planned, I know, in the speaking to some as more of a -- maybe into the third quarter, that I know in some of the modeling, some players have put it more in the third quarter than the second.

Okay, thanks. That's helpful, I get it.

But the annual number will be reoccurring. The majority of that will come in the second quarter each year, which this year, it's a little bit of a mismatch year-over-year but in following years, it will be really matching up Q2.

Thanks guys, I appreciate it.

You bet, Larry.

We will go next to Nicole Miller with Piper Jaffray.

Good afternoon.

Hi.

Hi, Nicole.

I just -- help us understand what actually your target in terms of marketing in the back half of the year. For example, I am thinking is seafood going to be the focus or is Friday Power Lunch going to be a focus?

It's going to vary, Nicole, by -- by markets. What we are doing in terms of current activities, we are doing some, what we call sponsorship radio in several markets. We are also doing some print advertising, you may have seen us recently in USA Today. The message is going to vary depending on the market and the -- how it's being placed.

We will try some limited marketing of the Power Lunch in those test markets. That's only currently in eight units, although we are looking to expand it to a couple of more units that have a profile for some of the best performing lunch stores. So, this strategy gives us a lot of flexibility.

We are enthusiastic I guess about some of the things we are doing with our menu. The addition of a fresh sheet, which kind of takes it out of the servers' communication, of verbal communication and puts in print is something that we have not done before. We have had that in a few stores for the last several weeks and are very enthusiastic about the preferences we are getting on some of these items, in particular if they will take a little pressure off of the higher cost prime -- prime products that are currently still under pressure in terms of the beef market.

And just to be clear, is the fresh sheet seafood only?

No, it's not. They can include items like our Kobe Steak, it can include a steak and seafood combination. It will have, we traditionally had a couple of off-menu seafood items. So, it will continue to have those.

But this fresh sheet can be changed on a -- literally on a daily basis, if we choose, to take advantage of purchasing opportunities and also give latitude to -- to our culinary team to develop exciting new products that we can -- we can put into selective markets, not necessarily chain-wide.

And just thinking about seafood specifically, if it were to become approximately 15% of the mix, what would be the implication to price and margin?

Well, what we try to do is have these items generate average or slightly above average margins. But the strategy is two-fold; one is to broaden further our already substantial appeal, eliminate the veto vote in case of some of our guests that may choose not to have a beef item.

But we are also not -- not blind to the fact that the beef market is tight. And if we can shift 300 basis points of preference and most likely these would -- this preference shift would come from beef, then we have the ability to have more control over our food cost and more stability.

And we have seen great success with that even in our second quarter, where we came in at the low end of our annual range for cost of sales. Part of achieving that had to do with some pretty strong mix shifts from meat to seafood, more so with our normal quarterly specials that we do.

The one burden we have is we have had some very creative items that we have put in place, however it's a great burden in our servers to go through a long list of all these great items.

And what this allows us to do is really highlight it for the guests to see it, where it gives our servers the flexibility to really focus on great items and more on the overall service experience rather than having to go through that opening, being longer than even the guest would like at times.

It also allows us, Nicole, the ability to do some pairings with some of our great wines and influence the buying decision that can -- we can pair up a great wine with a specific new dish.

I think what might be helpful, and let me know if I am going down the wrong road, but should beef prices come down, and let's just talk in theory for a moment and you would see a normalized beef commodity where you could purchase that in normalized price, then would a seafood at 15% of mix still be an average to beneficial margin or could it work against you at that point?

We don't see it working against us. And with the increased demand, you got to keep in mind that there is only about 2% of the beef supply is -- grades out at U.S. prime.

So, long-term, as we grow our brand, we influence the market, probably as much as anybody. So, what we want to try to do is not only be responsible, but also be able to ensure the supply of product for us long-term and also not put ourselves in a position where the market gets undue influenced by demands that we are placing on it.

So, this is a -- this is a long-term strategy as well as short-term guest strategy. And it has a rationale that extends to our ability to deliver on our growth plans and be able to bring all these new restaurants to the market.

And help us think about your strategy of locking in further or how you plan to tackle '08 in terms of the beef commodities?

We are going to continue to do -- approach that just like we have historically, we are going to stay very close to the market. The hedge we made this year worked very well for us in the second half of the year.

Tenderloins right now are -- are more favorable than they have been, but there is still a very tight market in prime. And being in the -- having hedged that has been something good for us, but the market is very tight and we are watching it very closely. If we think that the price and the supply are -- will work for us, then we will -- we will hedge. But we won't be making that decision until we get a little bit further into the fall.

And to help put this in context because it was a very difficult quarter, and you -- we keep hearing mention of seafood here, it has seen success and Friday Power Lunch is -- there could be a success. How do third quarter comps look today?

Third quarter comps are fairly consistent with the -- with what we experienced in the second quarter. We have not seen any material change. Better than the weeks than we were comparing against TV, but overall, pretty consistent.

So, it should be the same plus the price then?

That's a -- yes, that's a good characterization.

And a significant component there is we did have TV going through the -- pretty much the first -- first three weeks of our July period. So, that's a big player there and we have seen improvements once the TV component has been removed.

And my very last question, I will jump off, I apologize, at the very end I didn't understand your 30% question, where you were, Craig, giving guidance the very end, and I didn't understand in '08 if you are going to expand the unit base 30% in '08, or in a certain region or -- I didn't catch that. I am sorry.

That was relative to our international expansion. We will have 12 international units by the end of this fiscal year. And starting in '08, we expect to open three to five new international -- new international units annually. So, that's -- that 30% is related to our growth in international restaurants.

Thank you very much.

You bet.

Thanks, Nicole.

We will go next to John Glass with CIBC.

John?

Hello, can you hear me?

Yes, I can hear you now.

Okay, good. I am sorry. I want to talk a little bit on the -- about top-line first and maybe, Craig, you could talk a little bit about the disconnect between your sales and Mortons -- maybe some others in the high-ends category.

Do you think it relates to factors like the geography and customer base or do you think there is also may be some share shift going on within the high-end steak category right now?

Well, I don't think that there is a share shift going on. To be honest with you, John, I think that there is a couple of factors that you need to keep in mind.

First of all, we feed significantly more guests than some of the competitors that you have mentioned. In some cases, as many -- as much as 15% higher traffic, numbers of people coming in our restaurants. Our volumes are significantly higher.

We have a more diverse consumer base, which I think everybody tends to understand. My belief is that we are seeing some pressure from the folks that the overall price of dining at a restaurant like ours or any fine dining restaurant may be a bigger barrier today than it was in 2005.

We have raised the average unit volume of Ruth's Chris restaurants from $4.2 million to almost $5.8 million in three years. So we have a significant kind of recent history of ramp up in sales.

So when I see traffic moderating a bit and I see the macroeconomics and I watch what is going on, both in casual dining and high-end casual, which is probably closer to some of our guests, I don't think it is much of a leap to say that we may be a bit more impacted than some competitors who don't have the diversity of consumer base that we have.

Got you. Okay. And then on the cost side, the restaurant expense line has been growing in the last couple of quarters fairly profoundly, even I guess on a per restaurant basis, sort of straining out for the incremental restaurants you have added. Can you talk about why that is?

I know you mentioned some programs you are adding. Are you doing things differently this year and does that change in the back half of the year or is that just something that we are approaching a new higher level of expenses in that line?

That is a number that we certainly are cognizant of. I think that there is two factors there. One is 30% of the restaurants we are operating today, we were not operating 12 months ago. That is probably the biggest factor.

As you absorb acquired restaurants and you absorb new restaurants into your base, there is some pressure on your operating expense line. These newer restaurants clearly have -- are bigger restaurants, their occupancy cost is higher, their investment is higher, which is leading to depreciation increases.

And also, we have a system that goes back some forty-odd years. So we have many restaurants in our comp base whose depreciation is, in some cases, near their useful life. So any new restaurant that is coming on with all new investment and compared to the book value of probably a third or 40% of our restaurants is significantly different.

We are also having more pressure on the labor line, to the tune, probably half of that increase you are seeing is coming from labor.

Two of the factors there, one is, we put in a new employee benefits program last year. The cost per employee is pretty much equal to what it has historically been. But we are seeing more employees move into the program.

We offer insurance benefits for our employees that are greater than most other restaurant chains do. It is partially due to the nature of our employees, the high-end employees that we have working in fine dining. I think they find those benefit programs attractive and certainly keep our turnover down, but they are also an added cost.

And the second part of that is overall management labor is up. As we have grown our system and we prepare ourselves to operate even higher volume restaurants, we have raised the level of salaries for entry-level managers.

We have gone from a system that wasn't growing very rapidly where you had very low turnover at the General Manager level to a lot of new restaurants where we have to bring in more experienced people that can hit the ground running with this rapid expansion of new restaurants.

John, just to add on to that, a few items that we will be starting to lap on the second half of this year, which I think will help the whole operating expense component, is if you look in these last few quarters, as Craig mentioned, there has been a lot of the new restaurants, but as we have built up for the management staffing of those as well as helping in the education of our franchisees with the amount of growth that really got going the tail-end of last year, a lot of those managers are in our core restaurants, spending time there.

So that has been some build up, as well -- as we are about to lap some of that into our second half of the year, where there won't be as much of an -- as great of an impact. It is still going to be there.

But the property insurance for us -- to put it in perspective, you could imagine what the impact Ruth's Chris had with Hurricane Katrina. We had nearly 70 plus percent increase in our property insurance year-over-year a year ago and that has been -- each quarter that has been by itself almost 60 basis points in our occupancy.

So from that standpoint, we are going to lap that in the second half of the year and we luckily were on a -- while the total dollars will be higher because there are higher exposures, we are not seeing a further increase on our most recent renewals. So that is going to help us on the tail-end of the year to reduce some of that erosion that you have seen.

And I think, John, to be specific to the question you asked relative to, should we see this continue, I think that everyone needs to keep in mind that we had a real step up in growth over the last 12 months.

But now we are kind of on our growth run rate which is around 20% operating week growth and that is our expectation for 2008 compared to 30% operating week growth in our current quarter. So you are not going to see going from three units to 11 units, again, in terms of new restaurants being operated and that is pretty much the comparison we had between '06 and '07.

Even so some of this came from franchise acquisitions, so my guess from the last question is, one, are they as accretive as you initially thought or is it just taking longer to get to the accretion, and secondly, I think Tom you cited specifically there would be some pressure in the third quarter related to the franchise acquisition. Can you quantify that?

Well, we have got the three units, John -- I think that is what Tom was referring to -- that are coming in later this month, the two -- the Seattle, Bellevue and Portland restaurants. So those are going to be integrated in the second half of the year.

We saw significant opportunities in the restaurants that we acquired and moved aggressively last year and moved aggressively to improve their operations, improve their facilities. And as you can see from the volumes, significantly drove average unit sales in those restaurants and profitability.

So in total, probably a little less accretive in the first nine months that we owned them, but now they are exceeding the EPS contribution that we had originally pro forma-ed, and we see that continued as we move into the second half of the year. So I think on balance, they will deliver over time above contributions than what we had pro forma-ed them at.

Thank you.

You bet.

Thanks John.

Our next question will come from Jeff Omohundro with Wachovia.

Thanks. Just another follow-up on this restaurant operating expense line, and fairly significant increase that partially offset the benefit from the higher gift card breakage. I think I understand what you are describing regarding the shift in growth, but was there any extra investment in that line item, given the contribution from gift card breakage?

No. There really wasn't, John. Most of it is in the labor category, some in operating expenses, and then some in just the deleverage impact on kind of flat comps. So you have got those three factors are the primary factors.

And the biggest change in the quarter, to Craig's comment, is the open enrollment period for our health insurance took place in the second quarter, and that was a sizeable piece of the labor component. We did have some small wares enhancements in the quarter too that impacted the operating expenses on a specific basis.

But I'll tell you, John, that line item we have got under a scrutiny right now, and our operating teams are focusing on it.

We are coming off same-store sales increases of 27% over a three-year period. And as we have gone kind of same-store sales neutral, that has caused some pressure on those line items and we are tuned into that, and I personally feel like you will not see as much of an impact on that. And actually there was less in the second quarter, if you break it down by class of units than there was in the first quarter. So we made some progress on that, despite what Tom mentioned on the employee benefits, but I think you are going to see that narrow in terms of its impact.

And if some of the things that we see happening that we expect to happen on our sales side, we expect that line to come back in similar to our historical because if you look at our operating expense line it has been relatively stable until we went into this high growth period and now it has kind of jumped up 150 basis points or so. And I really do believe that over time you are going to see that moderate some as our growth rate comes down closer to 20%, and we are comparing 20% growth to 20% growth as compared to 30% against 10%.

Okay. And in your food and beverage costs in the release, there was specific -- I think the first mention was higher lobster. I am just curious, was there anything unusual in terms of mix in lobster going on or is that just pure pricing?

Yes, it is the cost of lobster. And it is a high percentage item, but it is a good contributor in terms of gross margin. So it nixes a little bit on percentage but it is still a great dollar contributor. And that item from a sales standpoint is not a huge seller for us. If we were to start promoting lobster a bit more, we may drive our percentage sales up even higher than the impact that we've had in this quarter. But the gross margins will be significantly higher.

Most of that came in dairy and then some in produce year-over-year. And our beef prices were approximately neutral year-over-year, slightly favorable.

Okay. And then my final question, just one more on the gift card breakage, when we think about '08, what I am hearing is that this will be a repeating item likely in Q2, and I presume the magnitude will be similar or higher depending on your gift card sales. Is that --?

Yes, I would say for modeling purposes that you would go with that same annual amount that we have just talked about. It will grow and we will probably have greater visibility of that specifically. We are working on ourselves getting some better reporting from our third parties, so we should be able to project that a lot better ourselves.

And what we will do, Jeff, is in the first quarter after the holiday period when we get most of our sales, we will be making an announcement of our total gift card sales for the year, and then you can factor in that 9% to 10% factor and you will have a number for '08 that is pretty representative of the historical breakage that we see.

And actually the '08 number will more tie into our 2006 number, which was already -- which is as a system basis we will have to communicate with the company component of that (inaudible).

Great. That is helpful. Thank you.

You bet.

Andrew Barish with Banc of America Securities has our next question.

Hey guys.

Hi, Andy.

So I was trying to get my arms around that restaurant operating expense, I guess for the Moran, the acquired stores in the 2Q, were they running at or above kind of the reported restaurant cash flow margins or were they still kind of slightly dilutive and making progress?

They were running about equal in terms of overall margins, but their volumes were higher.

Okay.

So the percentages were still a little bit of a drag, but the dollar margins were equal to slightly above.

But relative to the first quarter, they were significantly --

Oh, yes. Relative to the first quarter, significantly better.

Because they were a much larger drag, Q1, and now they are at the margins, Q2.

You see, one of the things about those restaurants, they had lower average checks, Andy, and they had some portion changes that we implemented. So we actually raised some of the cost of operating those restaurants. At the same time, we were driving a higher average check.

Okay. And then as you look out to the fourth quarter, obviously the third quarter is going to be -- that is a seasonally slow quarter and you have got the other acquisition, but in the fourth quarter, can you get that operating expense line kind of back to the run rate in the first quarter on a percentage basis when you sort of look at all the moving pieces, or is it more going to be starting to get that under control in 2008?

No. The fourth quarter is always our best quarter because of the significantly higher volumes.

The only reason that I would temper that a little bit is we do -- we are going to have four more restaurants opening here toward the end of the third quarter and into the fourth quarter. But we will have another six months of operations of Moran. And the operating expense line in the fourth quarter as a percentage should be lower than in the first quarter.

And then just one final, try to get that, I know that G&A has come under better control. Obviously, though, you guys probably didn't pay much, if any, bonus. So what would have that swing been year-over-year to kind of get a more true run rate on that G&A on a dollar basis?

If we were to -- Andy, if we would have maintained our bonus into that quarter, you would have been looking at a number closer to $6.4 million, between $6.3 million and $6.4 million. And that is also factoring in the open position too.

Our run rate is from a dollar standpoint, I think, was kind of established in the first quarter, which I think the number was around $6.5 million.

Okay, thanks.

$6.3 million I guess, yes.

I appreciate it.

You bet.

Steve Rees with JP Morgan has our next question.

Hi, thanks. I just wanted to ask about --

Hello?

Hello, Tom.

Yes.

Hi. I wanted to ask your thoughts on pricing. Historically, it seems like the high-end steak customer is relatively insensitive to pricing, do you think that still holds in today's environment? And if so, do you see opportunity for pricing beyond 3% to offset the increasing operating cost pressures?

Let me try to answer that. This is Craig. I appreciate that question because it is a very good one and it is one we are studying.

Some of the research that we have been doing indicates that there are some barriers for the third of our guests that come from, I'll call it, middle America, the people that are there on a special occasion. And it has to do with the overall cost of the occasion as compared to how much money they have in their pocket.

The other two segments that we deal with do not seem to react at all and would go along with your theory that there is a lot of elasticity in that guest. So we have to balance our kind of price value.

No one ever questions the value of dining at a Ruth's Chris Steak House, even if they are stretched to be able to afford it. What they do run up against is just an overall barrier to make that commitment to spend that amount of their disposable income on an occasion like Ruth's Chris.

Okay. But it does sound like you are comfortable with the 3%; you're perhaps exploring additional.

Well, what we are trying to do is create a couple of other opportunities for people to dine with us, where maybe the price point is not quite as high. That was one of the theories behind the power lunch.

We have also in some markets tested a prime time dinner, in which we ask our guests to dine with us before peak dining hours. What we don't want to do is create a situation where we disrupt our normal Ruth's Chris guest that wants to dine with us at 7 o'clock and fully is prepared and used to paying the kind of menu prices that a restaurant like ours charges. So it is a little bit of a balancing action.

To get the barrier dropped some, we really have to move the preference of those guests to a little different time frame.

Okay. Thanks. That is helpful. And then on the bar remodels, I think you mentioned you plan to do eight over the next 10 to 15 months. How much on average do you expect to pay for this remodel program?

The eight restaurants that we have targeted, and I think we said 12 to 18 months, those restaurant renovations can cost from $1 million to $1.5 million, depending on how many seats are being added and how much square footage is going to be added.

And it is also related to the age of those restaurants and the current condition of those restaurants. So it is not just about expansion of square footage. It is a combination of all three things.

Okay. And then perhaps you can talk about what the sales were at the older bar areas versus some of the newer restaurants that have this new luxury lounge positioning?

Well, it really depends on, again, where the restaurants are located. We had several restaurants in our old base.

For example, if you have been, our Manhattan restaurant has a very large bar and can accommodate that type of consumer. But generally speaking, these restaurants are running about $500,000 higher volumes than our core restaurants and that is coming in a combination of ways.

But clearly, the luxury lounges and the square footage that we have devoted to those are attracting a different kind of guest for a little different occasion and we think that that is a vital component to being able to make sure that a new generation of Americans and others enjoy the Ruth's Chris experience.

Okay, great. Thank you very much.

You bet. Thanks.

Barry Stouffer with BB&T Capital Markets has our next question.

Good afternoon.

Hi Barry.

Just had one question, from an accounting standpoint, why is Ruth's Chris the only company recording gift card breakage income, and talking about it. Everybody has gift cards and everybody has cards that are not redeemed, but nobody else that I follow talks about gift card breakage income.

Well, there is two things there, is there was -- we didn't either before we had the ability on the [achievement] aspect of it to sell our liability to be able to recognize it.

Additionally, we sell a much higher dollar volume relative to our size of many concepts. These are large numbers for other concepts, just not relative to their size.

When you look at our size at $37 million in gift card sales, for a brand that is at a $500 million, that is pretty large relative -- there is other -- you don't hear when it is a $1 billion dollar brand because it is much smaller.

And those items have been sitting on our balance sheet. Therefore, it is not like the number is not there, it is through the efforts of our finance team that was able to realize that income and bring it into the income statement.

Okay. Right. Thank you.

And Barry, that's something that I'd be happy to help you understand it in more detail, if you want to, offline.

Okay, thanks.

You bet.

We have one question left in the queue. That will come from Steven Kron with Goldman Sachs.

Thanks. Hi guys. A couple of questions; couple of follow ups first. On the gift card breakage, we should be thinking about that as pure margin, right? So that after taxes was about $0.05 benefit, is that right?

That is correct.

Okay. And then secondly, on an earlier question, in talking about comps to date in the quarter, I think the last thought was -- that you guys agreed to was that it is trending similar, but you will be getting the benefit of some price.

If I think about it, don't you have like 3% in July, 1.5% in August, and 3% in September versus 3% in the prior quarter. So just can you help me understand and make sure that we are thinking about how price are going to influence comps?

Yes, let's review it.

Right now, we are at 1.5% for July and August. September, we will return to 3%, which will go through the end of November and then we will be back at the 1.5%.

And what we were you for the second quarter?

Second quarter was just shy of 3%.

Okay. So you are going to have a little bit -- you are going to have less price during the quarter.

A little bit less in the third quarter. There will be a window of about five or six weeks there.

And just to be clear, because I think this is important, when you say things are tracking similar, were you talking from a traffic standpoint or from a comp perspective?

From a comp perspective.

Okay, okay. And then you guys talked about the three buckets of customers that you have and I think you talked about the special occasion guest is where you are thinking that the traffic weakness has come from a bit.

Can you just maybe describe a bit how you have determined that? And when you think about kind of the local marketing strategy, how are you tailoring the marketing message towards those types of guests, if in fact that's who you are going after?

It is not necessarily who we are going after, Steve, because that may be a guest that given the current macro environment, the barrier -- if the barrier is there, you are going to have a hard time getting them over it.

So we are attacking it in a little different way. We are introducing the power lunch. We are doing some things with the menu and we are re-shifting our marketing to go after those stores where our traffic has been most impacted, which can be getting some of the guests that you talking about, but also can influence overall traffic.

For example, our USA Today print ad campaign was really targeted toward the business traveler because those folks get that newspaper in their hotels everyday they travel.

And so we are not just trying to increase that special occasion diner, we are trying to go after each component. And if we have got more demand coming out of the other two sectors, we want to be able to communicate to them.

Okay. And then just lastly, you guys talked about the fourth quarter, those new stores coming to the comp base that you acquired, I guess how should we be thinking about that? Should we not expect it as these companies enter the comp base after being owned for 12 months that they would perform sort of like a new store opening and lapping their existing initial lift and more kind of steady state and mature?

You seem to be putting a lot of emphasis on fourth quarter same-store sales getting maybe a little bit of a lift from that. So I am just trying to understand that a bit.

Yes, I don't think -- Steve, it will have a visibility in the same-store sales because they are going into the base. But given the fact that 30% of our units are not -- over 30% are not in our comp base, it is already having a positive impact in our average unit volume.

So, it's really -- I don't want to put overdue influence on it other than the fact that it will have visibility on our same-store sales. And same-store sales is a metric that people look at. But if you look at our average unit sales, it is going to show up there as well.

Okay, thanks.

You bet. And by the way, five of the restaurants we bought in July; the other two we bought in the fourth quarter. And these restaurants seem to be gaining more momentum as we move through the year. So it is not just similar to a new store where you might you have a honeymoon impact. I think the compound impact of what we are doing is actually building the momentum.

These stores averaged below our system average in the second half of last year. They have been running 8% to 10% above our system average over recent weeks. So I do believe that we are going to get a lift from those seven restaurants as we move into the second half of the year.

It appears we have no other questions at this time. I would like to turn it back to our presenters for additional or closing remarks.

That concludes our call. We really appreciate you taking the time to visit with us this afternoon. And when you are looking for a great steak, go to Ruth's Chris Steak House.

Thank you. I would like to thank everyone for their participation. Have a great day.