McCormick & Schmick’s (MSSR)

Q3 2008 Earnings Call

November 5, 2008 5 pm ET

Executives

Manny Hilario, CFO

Douglas Schmick, Chairman, CEO

Analysts

Jeff Farmer – Jefferies & Company

Matt DeFrisco – Oppenheimer

Jeff Omohundro - Wachovia

Paul Westrop – Callan & Company

Michael Pothorser – Sedona and Company, LLC

Chris O'Cull – SunTrust

Ryan Sewer – RBC Wealth Management

Presentation

Operator

Ladies and gentlemen thanks for standing by. The McCormick & Schmick’s Seafood Restaurants, Inc., Third Quarter Earnings Conference Call will begin momentarily. Thanks for your patience and please do not disconnect. Once again, please continue to stand by, your conference will begin momentarily.

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the McCormick & Schmick’s Seafood Restaurants, Inc. Third Quarter Earnings Conference Call. During today’s presentation, all parties will be in a listen only mode. Following the presentation, the conference will be open for questions. If you have a question, please press the star followed by the one on your touch tone phone. Please press star zero for operator assistance at any time. For participants using speaker equipment, it may be necessary to pick up your handset before making your selection. As a reminder, this conference is being recorded, today, Wednesday, November 5, 2008.

I would like to turn the conference over to Mr. Manny Hilario, Chief Financial Office, please go ahead sir.

Manny Hilario

Thank you. Good afternoon. By now everyone should have access to our Third Quarter 2008 Earnings Press Release, and it may also be found at www.mccormickandSchmicks.com under the investment relations section. Before we begin our formal remarks, I need to remind everyone that part of our discussions today will be forward looking statements. These statements are not guarantees of future performances. Therefore you should not put undue reliance on them. We refer all of you to our recent filings with the SEC for more detailed discussion of the risk that could impact our future operating results and financial conditions. With that, I would like to turn the call over to Doug Schmick, Chairman and Chief Executive Officer of McCormick & Schmick’s.

Douglas Schmick

Thank you Manny, and good afternoon everybody. We have a number of things to discuss on our call today. I’ll provide some commentary on our third quarter results, the current restaurant landscape, as well as our current activities in the areas of menu offerings, marketing and development. Manny will then conduct a more detailed review of our financials, as well as our annual guidance. After that, we’ll be happy to answer any questions you might have.

For the third quarter, we delivered revenue growth of 13.4% including a comparable sales decline of 5.5%. You might recall our comps began trending downward in September of last year. This year we had the benefit of having grown accustomed to operating in the challenging environment, and have continued to focus our attention on cost management, as well as staying true to our brand. We featured a wild fish section on our menu during the period which proved to have great appeal with our most affluent guests, and enabled us to drive our average check, which helped our margin. I’ll talk more about our wild fish promotion in a few moments.

Our guest counts seemed to stabilize at our suburban restaurants as well as some Friday and Saturday dinner parts. The middle sum inspirational consumer seems to have leveled out, while it was a little weaker than we had expected going into the quarter. The business traveler held up fairly well in spite of falling hotel occupancy rates. We believe that our national advertising campaign and price points relative to some of the higher end options in the industry, make us an even more attractive dining option compared with many of our peers and have enabled us much better as a result.

With that being said, we believe the current gyrations in the financial markets have put further psychological pressure on the consumer. Even if their own immediate situation is not directly impacted, it's resulted in another downturn in spending over the past few weeks. We are clearly not out of the woods just yet and our expectations for the year reflect this phenomenon.

The fall of in oil prices is certainly a positive to our industry, but will likely prove insufficient to stave off the negativity stemming from a borage of sour headline news we are seeing every day.

Our earnings per share for the third quarter we $.09 which reflects the challenging environment we currently find ourselves in, as well as our effective management of operations, especially with regards to labor, restaurant operating costs and G&A. On a regional basis, our comparable restaurant sales in the Northwest and Southwest, held up best. With California, Nevada and Florida the weakest areas in the country. Except for our Houston restaurant which experienced partial closure for several days in the aftermath of Hurricane Ike, have quickly resumed normal operations thereafter. We did not experience any significant weather-related issues during the third quarter.

During the period we opened four restaurants, in Raleigh, North Carolina, Atlantic City, New Jersey, Edina, Minnesota, Rosemont, Illinois. And have since opened our Scottsdale Arizona and Houston Texas locations in the fourth quarter. All these restaurants are performing at or above expectations. We expect bodes very well for our company as we look upon our immediate challenges.

While all cycles of economic activity shares some commonalities, we believe that the homogenization of the casual dining industry over the past few years and the proliferation of operators competing for the same customers pans out as unique in the current downturn. At the same time, it offers us opportunities to showcase what sets McCormick & Schmick’s apart in a crowded space.

Besides doing all the obvious tactics and strategies in an economic downturn to preserve capital and continue to grow our customer base, probably the most important thing that we are doing right now is emphasizing the distinct nature of McCormick & Schmick’s experience. There’s simply no other upscale, affordable restaurant concept that focuses on fresh seafood like we do. It's probably the most complex commodity to manage, but also the most exciting.

It has literally taken us years to develop the skill set with regard to the necessary distribution channels, transportation food handling, and cooking techniques that need to go into place to make this successful. One of the great strengths besides being distinctive is that there's a very tremendous theory to competition to what we're doing.

Our twice daily printed menu of anywhere from 20 to 40 fresh species of seafood offers us a tremendous competitive advantage. One is the ability to price items, literally, twice a day. So we're able to stay abreast of commodity changes. The fresh seafood market is very much a spot buying market where prices are changing and moving around and allows us, in each region and locale where we operate, the ability within preset parameters to price accordingly.

Within those 20 to 40 species, no one item sells much more than 5% or 6%. So we're really able to focus on those seafood items that at a particular time are most cost effective and put them on the menu. We're also able to move a resource base from coast to coast and around the world literally to take advantage of sustainability issue.

Without strong runs of a particular product we are able to buy big and immediate distribute to all of our restaurants. We're also able to pull back in areas where we have had pricing or resource issues. So there's a tremendous amount of flexibility. We also allow up to 35% of the menu to be very specific to a location or region that we're in, which is very much in line with today's food trends. People are looking more and more for local products, as there is a tremendous amount of pride in the way local communities serve their food.

The right side of our menu is currently focused on wild products with price points between $18 and $37. And this section is selling about 15% of our menu mix. It's proven successful in satisfying the dining needs of the higher end consumer who still, even in this economy, has a predisposition to spend. At an average price within the box of around $28, there is still a great deal of value relative to higher end steak houses and gourmet restaurants.

For every high end product we put on the menu, we've also offered our middle income consumers some appealing value oriented choices with around 10 to 15 items that are priced between $8.95 and $13. These are easy to prepare items that come off our lunch menu. And since they only account for approximately 3% of our total sales mix, they really have not had a detrimental impact to our profitability, but they do demonstrate value to our customer.

We've also broadened out appeal while at the same time remaining very true to concept. Though we are seafood centered, we've enhanced our steak offerings to eliminate the (inaudible) and go after the higher frequency steak consumer. Our steak selection with improved cooking techniques and higher quality product, now drive approximately 14% of our sales mix which compares to about 8% last year when we began rolling out a better steak product.

I should note something for you with respect to our cost of sales. In the past we were really managing our pricing to achieve a preset cost of sales objective. However, more recently, what we've decided that with the premiere products, for instance, the higher, such as the higher end wild salmon, the king crab which is our current focus in the fourth quarter or for that matter our steak program, which has higher average menu pricing for around $30, which is actually $7 to $8 more per person than our average entrée price, is that we're willing to eat a couple points in food costs as we did in the third quarter.

In other words, we're focused on flow through penny process as opposed to more of a purist approach to food costs. And we feel that's definitely the correct strategy for this point in time.

We continue to promote our wine by the glass program, which consists of a five ounce and an eight ounce pour. The majority of our guests are trading up to the eight ounce which we are currently seeing positive comp on wine by the glass sales, despite the overall fall off in cost. The wine program is particularly important given the fact that there are softer wait times because of lower traffic, resulting in lower spill over into the bar. Which has enabled us to effectively market the wine program at the dining room table.

Our $1.95 food program in the bar is probably more relevant today than at any other point since we rolled it out in the 1980s. Our bar menu allows people to meet with friends, to enjoy a beverage and sample our fresh, high quality food which goes beyond fried menu items. And encompasses some of our seafood specialties and other bar favorites.

With regard to pricing, it should be noted, everybody from grocery stores to casual dining to high end have obviously been checking price this year. And we've been no exception. However, pricing for us has been more in the mid-point of our menu where we do not believe it is even noticeable to a consumer. And have not let the high end of our menu go any higher.

In addition, we have felt a little room and opportunity in our lunch program to the point where it's actually a bit underpriced relative to the market. And took some modest increases there as well.

Our third quarter pricing was approximately 3%, which it continued through the fourth quarter and the first half of next year as well. However, we expect to see more check growth from mixed shift versus pricing.

On the marketing front, we're appealing to the business traveler with ads in both the USA Today and the Business Journal. Our preferred guest program also continues to grow and we're reaching them with targeted one-on-one conversation emails to keep our brand, front and center of their minds.

The data confirms that our restaurants with over 400 preferred guests on the average spend approximately 28% more than our typical guests. They're also coming out to our restaurants 12 times a year, compared to our basic guest who visits us three to five times year. We're already reached our target of signing up 50,000 to 60,000 in our preferred database this year. And currently have 54,000 members with almost two months left in '08.

Earlier this year we put together a national sales campaign for our private dining and banquets sales, which historically makes up about 10% to 12% of our revenue. Reservations can now be centralized across multiple locations and are primarily targeting road shows. We believe that over time we can drive this private dining and banquet business up to 15% to 16% of our sales. This program is now being rolled out in earnest and we are seeing some very positive results for the upcoming holiday bookings. The program is still getting off the ground, but it'll be totally in place and merchandised by the first of the year.

With the holiday season approaching, we are ensuring that our gift cards are readily available in as many points of distribution as possible, including grocery stores, Costco, and over the internet. We have sold $8.5 million worth of gift cards last year through Costco and have already had commitments for up to $10 million of gift cards this year.

In regards to the development, our (inaudible) long term growth target has been to grow restaurants at a prudent pace of between 13% and 15% new units per year. Because of the current macro economic environment, particular uncertainty regarding consumer spending and in line with our disciplined capital utilization, we are only accepting locations that provide for superior return on investments, and provide for low revenue risk, low (inaudible) risk, and operating as (inaudible) terms with superlative market presence. We therefore expect to open between five and six locations, which is down from 11, that we'll be opening this year. Of these six, we have five signed leases.

Even when in general guest counts are down, there are still locations with capacity opportunities. Specifically, we have added patio seating at two locations. Plan to expand a banquet facility at one location. And are looking to expand some of our existing banquet facilities as a response to the national sales program.

In addition to our strong set of revenue initiatives I'm very pleased with the progress in managing our current cost structure and the current environment and business needs. Our chief focus has been, and will continue to be, to eliminate all unnecessary costs out of our business model, without impacting the guest's experience. Manny will provide a detail review of those in a minute.

Environment remains extremely volatile, but if there is any consolation, we are thankfully annualizing against weaker sales a year ago comparable. And, at that time, comparables had decreased by 1.4 in the fourth quarter of last year. And we also had great menu initiatives in place.

We are encouraged that our new restaurant openings continue to form in line with our plans. We continue reach out to the strongest and most loyal segment of our customer base with targeted messaging. And we are executing on our initiatives and remain extremely disciplined in controlling costs.

With that, I'd like to turn the call over to Manny to go through financial results, and update our guidance.

Manny Hilario

Thanks Doug. Before we delve into the statistics of the third quarter, let's quickly review our cost saving initiatives. This year we have taken extraordinary close look at how we can minimize our expenditures without impacting guest service.

First we have been actively managing our product mix, based upon items that are presented on the menus to last through the inflation impacts in our pro teams. We have price graded emphasis on shrimp and tilapia which priced in the $4 to $5 per pound range. And much more moderately priced is salmon and halibut, which are typically above $10 per pound.

We have locked in prices on shrimp which accounts for 5% to 7% of our product mix, as well as 85% of our (inaudible). We also have just negotiated a deal for about 140,000 pounds of raw king crab legs from the boat called Early Down, which is featured in the (inaudible) catch.

One of our major distribution partners has recently lowered mark ups from groceries, while items such as dairy and certain produce were added to our contracts, so we can realize the benefits of more consistent pricing as a result of our increased sales.

We have also streamlined our delivered process by reducing our weekly (inaudible) by half to take advantage of large and drop shipments. Which, in turn, have resulted in lower freight and fuel source charges. With respect to labor, we believe we are appropriately staffed at both the corporate and the restaurant levels for current volume.

About 30% of our restaurants are not yet in the comp phase, who are particularly focused on bringing these new locations up to speed faster, so that we can reach efficiencies with respect to food and labor costs. We remain relentless in examining all facets of our operation.

On the marketing side, we are putting a lot of focus on items that are lower cost, still yield high returns for us. Such as our e-market and our preferred guest program. We have also moved our public relations model from individual source, to a regional basis, which is saving us over $250,000 in operating costs.

In terms of G&A we are tightly controlling travel costs and put certain restrictions on travel. Also, we are reviewing carefully any replacement (inaudible) G&A and we have frozen all new head count additions.

Next I'll review in detail the financial results. For the third quarter, ending September 27, 2008, total revenues increased 13.4% to $99.9 million from $88.1 million in the third quarter of 2007. Our comparable restaurant sales decreased of 5.5%, was comprised of a 9.8% decrease in traffic, offset by a 3% increase in price and a 1.3% increase due to change in profit mix. Please note that the restaurants are included in the comparable restaurant base, in the first quarter following the 18th month of operation. During the third quarter of 2008, we had a total 63 locations in comparable base.

With regards to our restaurant operating costs and expenses, as well as profitability for the period, not surprisingly our comparable sales results were the main cause of the leveraging across much of our P and L.

Food and beverage costs increased to 34.1% of revenue in the third quarter 2008 from 29.1% in the prior year, primarily due to the inflationary environment impacting our commodity costs, primarily the price of fish. Our mid-August price increase of 3% did help alleviate some of the pressure, however.

In addition, we had a higher percentage of new restaurants within our portfolio which typically run less efficiently during their first 18 months of operation compared to more mature counterparts.

Labor costs increased to 32.4% of revenues in the third quarter of 2008 from 32.2% in the prior year. Primarily this is sales to leveraging, comparable to higher run, labor run rates at our newer restaurants. However, as I said earlier, finances on labor management did mitigate the full effect of the decline in comparable sales.

Operating costs were slightly favorable at 15.7% of revenues in the third quarter, compared to 15.8% in the prior year, primarily due to some of the initiatives I spoke of earlier.

Occupancy costs increased to 9.2% of revenues in the third quarter from 9.1% in the prior year, primarily due to the leveraging of revenues on fixed costs. (Inaudible) on administrative expenses decreased to 5.2% of revenues in the third quarter from 5.3% in the prior year, primarily due to the effective control at the corporate levels, including the many costs (inaudible) that I have already discussed.

(Inaudible) costs were $1.5 million in the third quarter of 2008, compared to $2.1 million in the third quarter last year. We opened four restaurants in the third quarter. Raleigh, North Carolina, Atlantic City, New Jersey, Edina, Minnesota, Rosemont, Illinois. And have since opened our Scottsdale, Arizona and Houston facilities location in the fourth quarter.

We continue to target approximately $350,000 of preopening expenses for each of our openings. We believe this type of investment should (inaudible) for the company over time, in terms of generating and maintaining strong sales volumes at the very beginning, as well as enabling us to reach operation sufficiency's as soon as possible.

Depreciation among (inaudible) expenses were 3.9% of revenues in the third quarter of 2008, compared to 3.3% in the prior year. The increase was due to the large number of new restaurants in our portfolio, compared to last year. And also coupled with sale leveraging at the comp restaurants.

Taking together, operating income was $1.9 million in the third quarter, or 1.9% of revenues, compared to $2.4 million, or 2.8% of revenues in the third quarter of last year. Interest expense was $270,000 in the third quarter of 2008, compared to $70,000 of interest income last year.

As of September 27, 2008 we had an outstanding balance of $27.5 million on our $150 million credit facility, and had $3.6 million in cash. Our board of directors previously authorized the repurchase of up to $20 million of our common stock in an effort to create long term value for our shareholders. It is not however repurchase any shares during the quarter due to our desire to maximize financial flexibilities of the current economic environment.

Let's now discuss our 2008 financial guidance. This has been an unusually difficult business environment to produce traffic and resulting revenues. For the month of October, comparable sales declined approximately 10%. Based on such performance, if comparable sales trends do not change meaningfully for the balance of the fourth quarter, the company believes that the fourth quarter revenues would be approximately $104 to $106 million and diluted earnings per share would be approximately $0.15 to $0.20. For every one percentage point change in the quarterly comparable sales, the estimated impact to earnings to share is approximately $0.02 to $0.03 per share.

In terms of development, we will open 11 domestic McCormick & Schmick's restaurant this year, of which we have already opened 10 year to date. The company intends to open five to six new restaurants in fiscal year 2009. These locations have been carefully screened and meet our stringent criteria for expected performance. And are spread evenly between suburban and urban locations.

Generally it takes a year, a year to a year and a half to, from the time a place is identified to the actual build out. We will not allow the current economics to compromise what we believe is a well balanced approach to development.

Not surprisingly we have (inaudible) development communities of a tremendous number of projects being pushed back into 2010. We certainly want to share that we don't end up opening locations in premature real estate, and in fact, we're able to renegotiate three deals that had originally been scheduled for next year, and moved them into 2010, which should be a much better time for us.

I should note that while we're limiting our new restaurant growth in 2009, we'll be investing capital expansion into some of our existing restaurants in areas such as banquet space and patios.

Given the high (inaudible) in interest in (inaudible) let me summarize our expected capitalization for next year. Direction of sales of (inaudible) will be between $15 million, $18 million. While Mason's capX will be somewhere around the $5 million range.

Our focus right now is to be sure that our balance sheet remains solid and opening only five to six restaurants next year, decreases our capital investments, and saves us a tremendous amount on preopening expenses. We think the combination of savings on preopenings, the number of size and the fact that we only have very little debt on our balance sheet, really gives us increased flexibility.

At this point, I would like to turn the call back over to Doug Schmick.

Doug Schmick

Thank you Manny. As part of our board's executive succession planning responsibility, there's been an on-going process to identify my replacement as CEO. Over the past several months we have thoroughly vetted a number of highly qualified candidates with the assistance of an outside search firm. We are winding down that process and have identified a quality candidate. We are in late stage negotiations to hire this individual, and board and I expect that that process to conclude very shortly.

I'm also very excited to announce that my fellow co-founder Bill McCormick, who has been on a leave of absence while serving as the United States Ambassador to New Zealand, will be rejoining the company as an active contributor. And also the board, as chairman of (inaudible). I'm very enthused to be rejoining him in our rewarding collaboration.

This business has been Bill and my passion for over three decades and we expect to redouble our efforts in providing an executive and team member development, corporate culture and strategic planning, all of which have been keys to McCormick & Schmick's longevity and success.

As on-going chairman of the board, I feel that recruiting my successor, combined with the addition of Bill McCormick and the continuous loyalty and efforts of our management team will ensure our ability to navigate through these challenging economic times. And remain the nation's premiere, affordable, up-scale seafood restaurant company.

Thank you very much. And with that, operator, we can turn it over to questions.

Question-and-Answer Session

Operator

Thank you sir. Ladies and gentlemen, we'll now begin the question and answer session. As a reminder, if you do have a question, please press the star, followed by one at this time. If you'd like to remove your question, please press the star, followed by the zero. As a reminder, if you are using speaker equipment, please pick up the handset before making your selection.

Our first question comes from the line of Jeff Farmer with Jefferies & Company, please go ahead.

Jeff Farmer – Jefferies & Company

Great. thank you and good afternoon. Apologize if I missed some of this, but I was hoping to get a better read on the weekly (inaudible) for sales trends over the last, I guess, five weeks. More specifically where your (inaudible) for sales turning down 10% into November.

Manny Hilario

We haven't reported in November, but in October it was very much down, 10% almost every single one of the weeks. So there was not unusual up and down spikes during this period. So it was a constant just down 10.

Jeff Farmer – Jefferies & Company

Okay, and then, I guess in terms of an early read on your holiday banquet this year versus last, at this point have you seen cancelled reservations or anything like that?

Douglas Schmick

Yes, it’s a little early to get a full read. Obviously we have seen some cancellation of some of the larger events. The strategy's in place to go after any and all events, and the goal is just to fill up the rooms. We're not going to hold back. As we said earlier, the national sales campaign, we are starting to get some good traction on that. So we hope to make up the difference of whatever, you know, major event might be cancelling.

Jeff Farmer – Jefferies & Company

Okay, so I guess you're hoping to essentially to hold it flat would be a good year, it sounds like?

Douglas Schmick

I would love to hold it flat and we might be able to improve a little bit but it’s a little early right now to…

Jeff Farmer – Jefferies & Company

Okay and then final question for me. Manny can you update us on where you stand with your (inaudible) covenants considering what's going on, on both the top and the bottom line?

Manny Hilario

No issues within the foreseeable future.

Jeff Farmer – Jefferies & Company

Okay, thank you very much.

Operator

Thank you sir. Our next question comes from the line of Matt DeFrisco, with Oppenheimer, please go ahead.

Matt DeFrisco – Oppenheimer

Thank you. I just wanted to get first clarification. I think you said, is it 3% price that is associated with the 10% comp trend down that you saw in the month of October?

Manny Hilario

Actually, no the price we discussed was in the third quarter. So it was 3% price in the third quarter. We did see that same continued trend into the October period. So the answer would be 3% pricing in the third quarter, we also saw it in the first four weeks of the fourth quarter.

Matt DeFrisco – Oppenheimer

And 3% should last throughout the entire fourth quarter?

Manny Hilario

Yes it should last all the way through the next (inaudible), which would be August of 2010.

Matt DeFrisco – Oppenheimer

Okay.

Manny Hilario

We should also have a pretty strong product mix going in for us with the wild (inaudible) as well as the king crab, and that should last us out pretty much throughout, I would say the two-thirds of next year.

Matt DeFrisco – Oppenheimer

Okay, and then also looking at your lower growth ahead for '09, aside from the preopening, what are some other line items that might get, or see a significant benefit? Would it be, is there reduction in G&A, as far as slowing the growth in that, or actually contracting it in absolute dollar terms? Or is there, also the less drag on the restaurant margins from having that new store? Can you help us think in, given your brand is a little different and unique than some of the other brands that we might cover that might be…?

Manny Hilario

Yeah, the biggest line where you'll see outside, obviously of preopenings would be the labor lines, because that's the one that's most compressed by new (inaudible) operations. And then the second line, as you mentioned there earlier is we are holding our G&A headcount down, so you know, theoretically with the continued growth in total sales not at the comp level, but at the total sales, you may see a bit of leveraging there as well.

Matt DeFrisco – Oppenheimer

Okay, and then also, just to better understand your philosophy now, as far as you are looking to more manage like a steak house where its gross profit dollars coming through the door and getting the leverage on labor, rather than try and manage your basket of groceries to a certain growth margin. Or is it just with the steak items and your seafood still is on an individual basis?

Manny Hilario

I think the total focus now is on flow through on the overall basket. Because with the wild mix right now, we do have wild king crab and some other higher priced items that we believe that, you know, they may add 20 or 30 (inaudible) pressure to your costs, but ultimately they would be yielding much better paying profit at the gross margin level. And you know, obviously the labor side also gets helped out. Because they don't drive income, you know labor hours and yields more revenue. So it's somewhat, I don't want to link it back to the steak house, but it's just the fact that now you're, we're focusing more on driving the ultimate penny profit at the gross margin level rather than a percentage.

Matt DeFrisco – Oppenheimer

Right, well I guess what I'm looking at though is that you're unique in doing the twice daily pricing and that was always sort of a, a simplistic formula off of the cogs number, where now, you add a new twist to it, or are you getting away from doing the pricing daily, and…

Douglas Schmick

Well the pricing Matt is still very much responding to the commodity spot buying in the seafood marketplace, exactly as we had in the past. The only caveat to it is that we've added a strategy to allow the higher per person items to jump a bit in food costs. And it gives us the ability to give more range to the menu. But the fundamental pricing, and response strategy is very much in place.

Matt DeFrisco – Oppenheimer

Okay. And then, the last question, are you not inclined to be buying your stock was it, or are you waiting for… I was curious why you didn't get more aggressive with the new authorization to buy stock, certainly at these levels.

Manny Hilario

Well, right now the answer to that question from our perspective was, is that, really want we want right now is maximum financial flexibility. And we believe keeping the debt balance at a minimum and really giving us more flexibility, not taking on additional debt is really paramount to us in this environment. So it's truly our philosophy of capital preservation.

And on the third quarter specifically, right after we announced the repurchase, stocks jumped up substantially about $2 or $3 immediately after the announcement. So there were not as many opportunities in the marketplace as we would have thought in the third quarter, just because of what happens to stock prices as well.

But right now, ultimately our biggest objective is to make sure that we keep the debt to a nominal amount.

Matt DeFrisco – Oppenheimer

Right, but if, you do have a pretty low debt balance right now and you're not, you just mentioned that you're not close to your debt conveyance. So I'm curious, wouldn't it be a (inaudible) to buy back the stock at these levels, given that you're basically not even using your credit facility, it seems like, to any degree.

Manny Hilario

Matt to answer that question, it could be and we will play that analysis as we play out the fourth quarter.

Matt DeFrisco – Oppenheimer

Okay. Are there any stores that are, or can you quantify how many stores might be close to meaningful negative free cash flow in this environment, where we're seeing negative (inaudible)?

Manny Hilario

Our negative cash flow, stores have been open for three years, we have a very small amount of those. And you know, obviously being down still puts more pressure on them. But you know, we believe that the pressure is short term in nature. So meaning 12, 18 months, we expect those locations, once the economic environment turns around, to go back to equal or better cash flow position.

Douglas Schmick

And that's been very positive Matt that the new stores over this last year have been performing so well, both at the top line, as well as, you know, actually exceeding our cash flow projections.

Matt DeFrisco – Oppenheimer

Okay, thank you. And Doug, don't go too far, if you're…

Douglas Schmick

No, I just really need to restate that I'm just so excited to be able to spend more time in the field, and with operations and give back to, you know, doing some of the activities I've been doing prior to this last two years. I think it’s a real important role for Bill and myself to play in the company as we go through this period of time. So I'm looking forward to it and I'm going to be, continue to be a big contributor.

Matt DeFrisco – Oppenheimer

Understand. Thank you.

Operator

Thank you sir. Our next question comes from the line of Jeff Omohundro with Wachovia, please go ahead.

Jeff Omohundro – Wachovia

Hi. Not to hammer this share repurchase point too much, but in your current plan I believe you outlined spending over $15 million in new restaurant development. I just wonder how you view the return on that versus your share price which is currently at $4.43 on the close today.

Douglas Schmick

Well, you know, first of all we have taken, obviously a much more conservative stance to developing new unit growth for this next year. But it's our intuition and my feelings that a certain level of conservative development to proceed over the next year is important to the company. And I think it will yield long term results in the form of good locations.

So, you know, we're committed as Manny has shared with you, with five of these locations. And we're going to proceed forward. And again, based on the results of new units that we've opened this next year, we're feeling very optimistic about that investment yielding us good, long term results.

Manny Hilario

Well once again, we will continue to monitor and analyze that.

Jeff Omohundro – Wachovia

Okay. And then, just, I guess more broadly. Certainly within casual dining, we're seeing more aggressive, price drive promotion. I'm just curious Doug, how you view your promotional strategy. How you weigh being more promotional in this environment. Perhaps to drive traffic versus the longer term potential impact on brand value. How you look at that, and what you're thinking is around that.

Douglas Schmick

That's a very good question. It’s a real tight wire to be walking down. On one hand, I think it's very important that a certain amount of value promotion and incentives remain in place during this type of environment. Fundamentally, to keep activity levels up. I mean there's nothing that looks better than a restaurant that's active, and you know, product is moving, and service staff is kept employed and attitudes up. It really does project a positive statement to the consumer. So I do believe in this period of time, there does need to be a certain value and certain price incentive promotions to take place.

Now certainly, though, you have to be very cautious as to not allowing yourself to have that become part of a longer term strategy. And so when it's appropriate, you back off, and when it's necessary you turn it up a bit, and we've done this in the past.

Jeff Omohundro – Wachovia

Okay. And then the last thing is a bit of housekeeping. The tax rate, is a bit lower than I had thought, maybe it just has the tax rate and tax rate outlook, thanks.

Manny Hilario

Yes, this is Manny. The tax rate is low, due to the fact that FICA, tax credit is a pretty stable fixed dollar amount, so is the pre-tax projection, or our pre-tax position goes down, it’s a big incidence on there. Other than that, we're looking at a tax rate somewhere between 20% and 25% for the fourth quarter.

Jeff Omohundro – Wachovia

Thank you very much.

Douglas Schmick

Operator

Thank you sir. Our next question comes from the line of Paul Westrop with Callan and Company, please go ahead.

Paul Westrop – Callan and Company

All right, thanks. Good afternoon gentlemen.

Douglas Schmick

Hello Paul.

Paul Westrop – Callan and Company

Just a couple more questions. Can you give us an idea what monthly comp trends were for the third quarter, if you haven't mentioned it already, (inaudible), starting in October, or just for the entire McCormick quarter.

Manny Hilario

Paul, this is Manny. I think the, July was a tough, tough month particularly with the Fourth of July holiday (inaudible) to a Friday. So that was the weakest of the three periods in the quarter, and then it was pretty much evenly in August and September. Then we had a drop when the stock market started going sideways, we had major drops going into October.

Paul Westrop – Callan and Company

Great that's helpful. And just to, maybe a little more clarification on your food costs, inflation rate, you rattled off, I didn't get all of it. But, give us an idea of what the inflation rate was on the product you did lock in for, and maybe some commentary on what the current fresh fish inflation trends are.

Manny Hilario

Okay, I'll give you, the view was that in the third quarter we were probably somewhere between 4% to 5% overall in inflation in our cost line. I think going into the fourth quarter, we'll be more in the normalized level between 2% and 4%, and we think for the next year it's going to be somewhere between 2% and 3% inflation side on the overall portfolio.

Paul Westrop – Callan and Company

And how about wage rate inflation?

Manny Hilario

Very nominal on the wage, perhaps 2% if that much.

Paul Westrop – Callan and Company

Great, and I'm moving, the follow up question on development. At this point are you thinking about, you know, a freeze for 2011 at this point? Or are you still sort of possibly looking for maybe a good deal here and there.

Douglas Schmick

Yeah, for what years did you say?

Paul Westrop – Callan and Company

I'm sorry I said, I meant to say 2010, but I said 2011, so…

Douglas Schmick

Okay yeah, no we're, you know we feel it's important right now to stay, you know, active and looking at opportunities in both '10 and '11. We have to, I mean the one thing here that we have to realize is that we certainly know where the company is, how it's currently being managed and operated both from a cost control perspective as well as the per person growth that we've seen. Any kind of help in terms of traffic is going to turn things back around rather quickly.

And so, I want to make sure that we, without making commitments, definitely stay in front of the development community and make sure that we're actually searching for those opportunities. Because you know, if we get a break in the economy at some point in the future, and I think it's very difficult for anybody to estimate as to when that's going to be, but hopefully it'll be at some point. We definitely want to be able to take advantage, you know, of a good development program.

Paul Westrop – Callan and Company

Okay. And then a question on your G&A. It sounds like you made some incremental cuts during the quarter. We've had back to back quarters here from a gap perspective, just over $5 million per quarter. Are we, are you currently sort of at that rate? Were there any accruals we should think about in the third quarter, that may have affected the reported number?

Manny Hilario

No, actually we still planned the G&A in the fourth quarter to be in the same run rate. Obviously, the only thing that could possibly impact that would be if we do have a strong quarter in case we do have a better than planned quarter, there'll be opportunities for us to recapture some additional bonus for regional management and some corporate personnel. But other than that, there was no unusual will or catch ups at all.

Paul Westrop – Callan and Company

Great. Then the, I'm sorry to take the line too long. But one final question, on the line of credit. You still have a lot of line available. When you mentioned, not in any concerns over covenants, is that safe to assume at current run rates you would still be allowed to take the entire 150, if for some reason you chose to do so?

Manny Hilario

Yeah, I don't have the exact number here. We are limited by the adjusted leverage number and coverage. So I don't have the number here, but we should be, probably not be able to borrow the whole $150 million, and I don't have it in front of me here just due to the fact that we do get a lot of (inaudible) the adjusted average. But we would be able to take a huge amount of that (inaudible) if we wanted to. We could borrow on it if we chose to.

Paul Westrop – Callan and Company

Right, okay, thank you very much.

Douglas Schmick

Thank you.

Operator

Thank you sir. Our next question comes from the line of Michael Pothorser, with Sedona and Company, LLC, please go ahead.

Michael Pothorser – Sedona and Company, LLC

Good afternoon guys and thanks. You guys touched on this a little in an earlier question. Are there any upcoming strategies to address value menu items besides that $9 to $13 basket? And on that basket, is that only offered during lunch?

Douglas Schmick

Oh that, what we're referring to is a listing of items that are on our dinner menus. And these are in fact, our more popular lunch items and so we're offering them at dinner to give that range of offerings. We, you know, I think at this point, through this year, the menu has been strategically developed to really do everything we want it to do. I mean we are definitely giving value to the lower end customer, and also taking advantage of the premiere customer as well.

We continue at lunch to offer daily specials that are anywhere between $6.95 and $9.95 depending on the market. So I think, I think in terms of value commitment on the menus, we're right where we need to be.

Michael Pothorser – Sedona and Company, LLC

All right. And has the wild seafood sales been through October compared to the third quarter?

Manny Hilario

The percentage of the total product mix, no, in total dollars, the whole product mix has been impacted.

Michael Pothorser – Sedona and Company, LLC

Okay. All right, thanks.

Operator

Thank you sir. Once again, ladies and gentlemen, if there are any additional questions please press the star followed by the one at this time. As a reminder, if you are using speaker equipment, you'll need to lift the handset before making your selection. Our next question comes from the line of Chris O'Cull with SunTrust, please go ahead.

Chris O'Cull – SunTrust

Good afternoon guys.

Douglas Schmick

Hello Chris.

Chris O'Cull – SunTrust

Manny my question is regarding your guidance and I may have missed this. But last year in the fourth quarter, if you excluded the impairment and the legal settlement, I think the proforma earnings was about $0.24. And you said in the guidance I believe, that if the comp was down 10% you would be $0.02 to $0.03 of earnings per 1% decline. How do I get back to the $0.15 to $0.20 for the fourth quarter?

Manny Hilario

$0.15 to $0.20 to, for quarter relative to one last year?

Chris O'Cull – SunTrust

Right. It would seem that the earnings would be relatively, you know, you would have a basically a break even quarter if you, if you apply the guides, or if you apply the math.

Manny Hilario

(Inaudible) we can do, we can reconcile that afterwards.

Chris O'Cull – SunTrust

Okay.

Manny Hilario

It will take a couple minutes to go through that.

Chris O'Cull – SunTrust

Okay, great. And then one last question related to some of the labor initiatives. Doug, can you give us some details in terms of, I may have missed this in the presentation. Some details in terms of how you're saving on the labor hours.

Doug Schmick

Well, we therefore manage weekly labor staffing calls with all of our units managers, based on their projections of sales for that week. I mean it all starts with really making labor top of the line in terms of the variable staffing. We've also, you know, through attrition and so on, and as well as we're staffing our new units openings, we're really watching the ratio of fixed management costs per store. I think we're in a, you know, we've been able to do this without lay offs, it's just been a matter of reallocation of existing resources as we open new stores.

So I think we're running management overhead much more effectively than we ever have had in the past. We've also been able to create methodology for our regional chefs and managers to take on larger span of control so we haven't had to really add significantly to that line to these last 11 openings.

So it’s a function of awareness, and everybody's really doing a great job. When you look at the comp down, relative to how well we've controlled labor, I'd say that we've really got our arms around the process at this point.

Chris O'Cull – SunTrust

Yeah, no I would agree. I mean the labor costs per operating week has fallen quite a bit, every quarter. And it looks, I mean obviously the productivities improved quite a bit. Should we expect improvements to continue into 2009?

Douglas Schmick

Well I think, you know, in terms of the basic staffing levels, we're very close. But with that being said, we're continuing to evaluate and, if there's any additional savings that we can enjoy, we're certainly going to go after it. But I would hope, with a little up kick in traffic, you'll see the flow through rewards on that.

Chris O'Cull – SunTrust

Sure, okay, great. Thanks guys.

Operator

Thank you sir. Our next question comes from the line of Ryan Sewer with RBC Wealth Management, please go ahead.

Ryan Sewer – RBC Wealth Management

Good afternoon gentlemen. On your credit facility, is any part of that with Lehman?

Manny Hilario

No.

Ryan Sewer – RBC Wealth Management

And I'm seeing other companies take down part of their credit facilities a little bit defensively. Is that a consideration?

Manny Hilario

It’s a certainly a strategy that we've talked about, but it's not something we have actively on the table right now.

Ryan Sewer – RBC Wealth Management

Okay. Maybe we can flip over to the Costco sales, at 2.5% of total revenues, that's now enough dollars. Do you look at those, and can you track that Costco card that you've sold at a fairly substantial discount and see what kind of items are being purchased? And modify any of the sales literature that goes with that, the book, now at a certain point gets to be, you know, in to people's hands after they've purchased that a number of times. Are you able to analyze that data and go back and see what this purchaser is buying when they come into the restaurant, versus some other purchaser?

Manny Hilario

You know, a couple, just a couple points about that. The answer is yes, we do track the transaction on a one-on-one basis based on the card number. So we do check the analysis on them. The one thing we do know is on the average, the Costco check can be higher than our other checks, if they bring additionally come in with sales to them. The second thing is that we do know about them is that usually bet on those cards than on typical cards. So that, well in terms, that can be a very profitable to come back to us. And then the third element of the program that we think is a huge marketing value that comes out of that from (inaudible) during the Costco, and then fourth, we believe that a large portion of the sale that comes out of the Costco system are incremental. So (inaudible) added discounts, we think those are critical sales for us in terms of driving incremental profitability when we have some capacity available. It's getting cookbooks into people's hands, into their homes, is a great way to keep the brand in front of our customers.

Ryan Sewer – RBC Wealth Management

Well I agree with that. But, after you've got the one cookbook, or the second to give away, is there something that you keep that fresh as a… I mean the first time buyer is going to be stimulated. But what about after that?

Manny Hilario

We revise and update the book every year. We also change the videos. We change some of the content from the packages here as well.

Ryan Sewer – RBC Wealth Management

Is there a limit to how much makes sense for you to do through Costco?

Manny Hilario

We like to, I mean last year we did 8.5 million, this year we're going to do 10 million. As I mentioned earlier, we've got a large portion of the program is incremental. So our benefit is to sell as much as we can through the system as long as we believe it's incremental transactions, that doesn't displace the full paying transaction at the restaurant.

Ryan Sewer – RBC Wealth Management

Great, thank you very much.

Douglas Schmick

Also recognize guys that the majority of these redemptions happen in the first quarter, where you do have excess capacity. So it’s a good program.

Ryan Sewer – RBC Wealth Management

I see, if somebody's buying, your having the goods there for the Christmas selling time and gifts, and then people are using them post-Christmas.

Douglas Schmick

That's correct.

Ryan Sewer – RBC Wealth Management

Great. Thank you.

Douglas Schmick

Thank.

Operator

Thank you sir. And at this time, there are no further questions. I'd like to turn it back to management for any closing remarks.

Douglas Schmick

Once again, thanks, I thank all of you guys for your interest, and we're just really excited by continuing to manage this company forward. So with that said, thank you very much.

Operator

Thank you. Ladies and gentlemen, this does conclude the McCormick & Schmick's Seafood Restaurant, Inc. Third Quarter 2008 Earnings Conference Call. Thank you for your participation, you may now disconnect. Have a pleasant day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Other Articles on MSSR Can Costco Save America's Malls? Dec 16, 2008 Raw Data Report: Bob's Big Boy, McCormick & Schmick's, Landry's, Macaroni Grill Sep 09, 2008 Raw Data Report: McCormick & Schmick's, Carl's Jr., Noah's Bagels Sep 03, 2008 Previous MSSR Transcript: McCormick & Schmick’s Seafood Restaurants, Inc. Q2 2008 Earnings Call Transcript

• Was this positive or negative for the company? Why?
• What is the most important quote from this transcript?