Cheesecake Factory F4Q07 (Qtr End 1/1/08) Earnings Call Transcript

The Cheesecake Factory Incorporated (CAKE)

F4Q07 Earnings Call

February 5, 2008 5:00 pm ET

Executives

Michael J. Dixon - Chief Financial Officer, Senior Vice President, Finance

David Overton - Chairman of the Board, Chief Executive Officer

Analysts

Steven Kron - Goldman Sachs

Lawrence Miller - RBC Capital Markets

David Tarantino - Robert W. Baird & Co.

Joseph Buckley - Bear, Stearns & Co.

Bryan Elliott - Raymond James & Associates

Sharon Zackfia - William Blair & Company

Matthew DiFrisco - Thomas Weisel Partners

Paul Westra - Cowen & Co.

Christopher O'Cull - SunTrust Robinson Humphrey

John Ivankoe - J. P. Morgan Securities

Howard Penney - Friedman, Billings, Ramsey & Co.

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 The Cheesecake Factory earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Michael Dixon, CFO of The Cheesecake Factory Incorporated. Please proceed.

Michael J. Dixon

Thank you, Erik. Hello, everyone. I am Michael Dixon, CFO of The Cheesecake Factory Incorporated and welcome to our quarterly investor conference call, which is also being broadcast live over the Internet.

Also with us today is David Overton, our Chairman of the Board and Chief Executive Officer, and Jill Peters, our Vice President of Investor Relations.

Before we get into the details of our results, let me briefly cover our cautionary statement regarding risk factors and forward-looking statements in general. I will also note that our press release is available in the investors section of our website at thecheesecakefactory.com.

Throughout our call today, items may be discussed that are not based on historical fact and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those stated or implied in forward-looking statements as a result of the factors detailed in today’s press release and in our filings with the Securities and Exchange Commission.

All forward-looking statements made on this call speak only as of today’s date and the company undertakes no duty to update any forward-looking statements.

So we finished a somewhat disappointing fourth quarter as the consumer slowdown felt by most retailers and casual dining restaurant operators impacted us as well. However, our results held up reasonably well on a sequential basis relative to overall casual dining industry trends. While we are looking forward to and planning for the future, I think it is important to give you a little color on the fourth quarter results.

We also announced an update to our business plan for fiscal 2008 today. I will provide some details on the rationale for this plan, as well as some line item guidance for modeling purposes. Finally, we’ll open the call to questions and we’ll be happy to answer as many questions as time allows. We’d like to finish this call up in about 45 minutes.

Before I get into our operating results, let me spend just a minute on the non-operating charges we incurred in the fourth quarter. As mentioned in our press release, we recorded approximately $2.6 million in one-time pretax charges related to the settlement of various legal matters. Of this total, $0.5 million related to employment practice issues and $2.1 million related to the pending settlement of federal and state shareholder derivative actions filed against the company and related parties.

Now there is the potential for some additional insurance recovery against the settlement charges that is not yet determined.

These one-time items had about a $0.03 impact on our results for the quarter.

Okay, on to the operating results -- total revenues at The Cheesecake Factory for the fourth quarter increased 13% to $406.3 million. Our revenue growth this quarter was comprised of an approximately 14% increase in restaurant revenues and a 9% decrease in bakery revenues. I’ll talk more about the bakery business in a moment.

The 14% increase in restaurant revenues represents an approximate 18% increase in total restaurant operating weeks, resulting primarily from the opening of 34 new restaurants during the trailing 15 month period, coupled with an approximately 4% decrease in average sales per restaurant operating week.

Overall comparable sales of The Cheesecake Factory and Grand Lux Café restaurants decreased approximately 0.4% for the quarter, including an approximate $1.2 million impact from inclement weather during the quarter.

Now, excluding the estimated weather related impact, comparable sales of The Cheesecake Factory and Grand Lux Cafe would have increased approximately 0.1%. By concept, that translates into a 0.1% decrease at The Cheesecake Factory restaurants and a 2.1% increase at the Grand Lux Cafes.

While restaurant traffic was lower than we expected, from a competitive standpoint we believe our comparable sales held up relatively well in light of the trends experienced by many casual dining operators during the fourth quarter.

Average weekly sales at The Cheesecake Factory restaurants decreased about 2.8%, which is still slightly behind the change in comparable restaurant sales. As we’ve discussed in the past, there are a number of factors that impact this comparison, from the age of the restaurant to the restaurant size.

We continue to be very pleased with the progress of our Grand Lux Cafes. Comparable sales at Grand Lux increased 2.1% in the fourth quarter, excluding the weather impact, and that’s lapping a very strong 7.8% comp in the fourth quarter of 2007.

We continue to view this as an incredibly strong performance, particularly in light of the soft operating environment the industry has experienced for the past few years and for a young concept with no advertising or promotions.

As sales volumes grow at Grand Lux, we will continue to leverage operating costs and improve this concept’s restaurant level margins. Grand Lux Cafe is a strong, viable, second concept for The Cheesecake Factory.

Longer term, we feel very confident there is plenty of high quality growth from the openings of both Cheesecake Factory and Grand Lux Cafe brands. In addition, we recognize there is an opportunity in a normalized operating environment to drive comparable restaurant sales growth in excess of our menu price increase as we work to recoup some of the traffic lost during this challenging economic period.

On the development front, we entered four new markets this year as we successfully extended our brand into Rochester, New York; Tulsa, Oklahoma; West Hartford, Connecticut; and Salt Lake City, Utah. In fact, our Salt Lake City location is averaging in excess of $265,000 in weekly sales during the 13 weeks since it opened.

In addition, our strategy of returning to those markets that we know well and have been successful in is delivering solid performance against our expectations.

As we noted in our press release, the new restaurants that we’ve opened to date in the Northeast have delivered average weekly sales as a group of roughly $235,000 since opening, consistent with our expectations for high volumes in this region.

On the Grand Lux Cafe front, our newest location in the Palazzo Hotel Resort and Casino in Las Vegas is averaging about $295,000 in weekly sales since its opening.

In total, we met our target of opening 21 new restaurants in 2007, including five Grand Lux Cafes. In the fourth quarter, we opened eight Cheesecake Factory restaurants and three Grand Lux Cafes as planned.

I’ll talk about our 2008 development plans shortly, but I do want to remind investors of the risks to achieving our opening schedule as we currently lease all of our restaurant locations, many of which are in newly constructed or to be constructed retail developments, such as shopping malls, entertainment centers, cityscape strip centers, and so forth.

As a result, we rely heavily on our landlords to deliver our leased spaces to us and according to their original commitments, so that we can build them out in a timely manner.

Our locations are upscale and highly customized, which helps to create the non-chain image that we enjoy with consumers and which we believe represents a significant competitive advantage for us. But that also creates some unique design and permitting challenges.

Once we get the spaces from the landlords and obtain our building permits, our construction and pre-opening processes are typically consistent, usually taking four to six months to complete on average.

So the result of these factors, is it not uncommon to have planned openings move a few weeks, or even a month, due to various factors outside of our control. Having said that, we have consistently achieved our stated opening targets. We have an incredible development team that consistently manages through these challenges to deliver restaurants on time and an equally talented operations team that gets these restaurants opened and running like a Cheesecake Factory from day one.

After opening, it takes about 90 to 120 days on average for our new restaurants to work through their normal grand opening inefficiencies and for food and labor costs to reach their targeted operating profit margins.

Now moving on to our bakery operations, bakery sales net of inter-company bakery sales decreased 9% in the fourth quarter from the year-ago period to $22.8 million versus $24.9 million in the prior year. The decrease was due primarily to lower sales to the warehouse clubs, which is our largest sales channel for outside bakery sales. Clearly the macro pressures impacting dining out occasions continue to affect dessert purchases as well.

While we remain optimistic with respect to opportunities to build our bakery sales volumes over time, I remind investors that this is a small part of our business and that third-party bakery sales are not as predictable as our restaurant sales.

Our ability to predict the timing of bakery product shipments and contribution margins is very difficult due to the nature of that business and the purchasing plans of our larger customers, which may fluctuate from quarter to quarter.

In our view, the bakery’s most important contribution to our business will continue to be its service as a dependable, high quality producer of desserts for sale in our own restaurants, which will sell in excess of $220 million of desserts made in our bakery production facilities during 2008.

Approximately 15% of our restaurant sales consist of dessert sales, which is a much larger percentage than achieved by most other casual dining restaurant concepts.

So that covers our top line performance for the fourth quarter. So now I’ll briefly review the individual components of our operating margin for the fourth quarter.

Cost of sales decreased slightly to 26.2% of revenues for the fourth quarter, compared to 26.3% in the same quarter last year. The 10 basis point improvement over the prior year is attributable to favorable costs in the produce, meat, and seafood categories partially offset by the ongoing pressure from higher dairy costs as well as a slight increase in poultry prices.

As you may recall, we extended our poultry contract last summer to the end of fiscal 2008 in exchange for a slight price increase. I’ll point out that despite the increase in dairy prices for fiscal 2007, we managed to improve our commodity costs on a full-year basis by 20 basis points relative to the prior year as a result of very strong commodity price management and negotiation.

The principal commodity categories for our restaurants include fresh produce, poultry, meat, fish and seafood, cheese, other fresh dairy products, bread, and general grocery items.

Total labor expenses were 32.3% of revenues for the fourth quarter. That’s up from the 31.7% in the prior quarter. This increase reflects the deleveraging effect from the lower level of sales, as well as higher costs stemming from minimum wage increases.

Other operating costs and expenses were 23.1% of revenues for the fourth quarter. That’s up from the 22.1% reported in the same quarter last year. The increase reflects the benefit last year from a favorable adjustment to our self-insurance reserve, as well as the deleverage effect on the lower level of sales in the fourth quarter of 2007.

G&A expenses for the fourth quarter were 6% of revenues, down slightly from the 6.1% in the prior year. Excluding the $2.6 million of legal settlements that were recorded in the fourth quarter of 2007, G&A expenses were 5.3% of revenues. The decrease relative to the year-ago quarter was primarily due to about $800,000 in professional fees related to the stock option review incurred in the fourth quarter of the prior year.

Our G&A expenses consist of two major components -- the cost for our corporate, bakery, and field supervision support team, which should grow at a less rate than revenues, and the cost for our restaurant management, recruiting and training program, which should grow at a rate close to our unit growth rate.

For the full year, after adjusting for the one-time costs I just mentioned, G&A as a percent of revenues was 5.4% in both fiscal 2007 and 2006. So in spite of the fairly significant deleverage effect from lower sales, we still managed to open our target restaurants and effectively control our G&A costs.

Depreciation expense was 4.3% of total revenues for the fourth quarter compared to 3.9% for the fourth quarter of the prior year.

Actual pre-opening costs incurred during the fourth quarter were a bit higher than we expected at approximately $11 million compared to $12 million for the same quarter last year. Our back-ended opening schedule required us to hire managers early in order to have the appropriate number of trained managers in place to support our openings. This pushed pre-opening expenses a little higher than originally planned, combined with increased costs for staff relocation.

In addition, we experienced higher costs related to the Grand Lux Cafe Palazzo opening as the opening date for that hotel and casino was rescheduled several times.

We opened eight Cheesecake Factory restaurants and three Grand Lux Cafes in the fourth quarter of 2007, compared to 13 Cheesecake Factory restaurants in the year-ago quarter.

That covers our review of the major line item components of our operating margins for the fourth quarter. Again, please refer to the full discussion of risks and uncertainties associated with our forward-looking statements included in our filings with the SEC.

Included in interest expense is $2.4 million of interest expense on $175 million in outstanding debt we had under the revolving credit facility during the quarter. We have an interest rate collar agreement on $150 million of this outstanding revolver balance that mitigates the risk from interest rate variation and keeps our LIBOR rate within a range of 4.6% to 5.4%.

We also pay a bank margin on top of LIBOR which will vary based on our debt to EBITDA ratio.

Our effective tax rate for the fourth quarter was 30.2%, in line with our expectations.

Let me provide a brief recap of our stock-based compensation expense for those investors who are tracking it as a separate line item. Our total stock-based compensation expense reflected in the income statement for the fourth quarter was approximately $4.8 million, of which $1.8 million was charged to labor expenses and $2.9 million was charged to G&A expenses.

Lastly, before I move off of the income statement, let me comment on our recent share repurchases. During the fourth quarter of 2007, our board of directors increased our share repurchase authorization by 5 million shares to 21 million shares.

In 2007, we returned approximately $250 million of capital to shareholders through share repurchases, including 2.2 million shares that were bought back in the fourth quarter of 2007 for an aggregate price of $49 million.

The 2.2 million shares we purchased were funded by a combination of cash on hand and borrowings available under our revolver.

There are approximately 7.5 million shares remaining in our repurchase authorization and we expect continued buy-backs going into 2008.

On the balance sheet, our liquidity position and financial flexibility continue to remain strong. As of January 1, 2008, our cash and marketable securities on hand were approximately $49 million. Our cash flow from operations through the fourth quarter was approximately $160 million, and our cash and accrued CapEx through the fourth quarter, as reported in the statement of cash flows, was approximately $211 million, which includes construction in progress for 2008 openings.

Adjusting for the mechanics of lease accounting, actual cash CapEx expenditures for 2007 was approximately $204 million.

As I mentioned earlier, we have $175 million in funded debt in our capital structure. We expect to be able to finance our CapEx requirements for fiscal 2008 through expected operating cash flow, agreed upon landlord construction contributions, and/or cash on hand.

We do have $25 million available on a credit facility for back-up liquidity purposes and to support standby letters of credit for our insurance arrangement.

To wrap up our business and financial review for the fourth quarter, there is no doubt that the operating environment has gotten a little tighter. Our total revenues were lower than we expected as a result of both weather and the macro-environment and cost pressures have not moderated.

Even for a best-in-class concept such as The Cheesecake Factory, which operates at very high levels of efficiency and productivity, it’s clear that the current economic environment has impacted and will continue to impact operating results. That being said, we continue to have confidence in the strength of our concepts and consumer demand for both of our brands and we believe we are well-positioned for the eventual recovery of the economy.

We remain committed to the long-term healthy growth of The Cheesecake Factory and Grand Lux Cafe and as always, we’ll continue to look for ways to enhance our productivity and profitability.

With that as a backdrop, let me share with you the details of our fiscal 2008 plan.

As we discussed in today’s press release, we are updating our business plan for fiscal 2008, focused on a prudent allocation of capital intended to enhance overall earnings per share growth and increase returns on invested capital. Tactically, this means we are targeting revenue growth of 10% to 12% for 2008 and we adjusted our planned new restaurant openings for the year to between 7 and 9.

While we expect margin pressures to continue in 2008, we believe the combination of lower pre-opening costs from fewer openings and the benefits from the improvements we made to our capital structure last year, as well as our ongoing focus on returning capital to shareholders, will result in diluted earnings per share growth of between 10% and 15%.

A lot has changed in the macroeconomic environment over the past three-and-a-half months since we announced our preliminary plan for 2008 in late October. Unfortunately, these changes have not been positive. Confidence in the economy is falling. The housing market has further deteriorated and concerns about a recession have escalated. This has significantly impacted consumer discretionary spending, resulting in a decrease in traffic across the casual dining segment. In addition, casual dining stocks, along with most of the market, have experienced significant pressure over the past several months.

All of these factors went into our decision to revisit our plans for fiscal 2008.

We will continue to drive earnings per share growth through a prudent allocation of capital. Historically, this was accomplished primarily through new restaurant openings. However, based on the macro pressures I just mentioned, and the expected returns from buying back our stock at current levels, we believe the most effective way to drive earnings per share growth and increase incremental returns on invested capital in 2008 is to scale back our new restaurant growth and increase our emphasis on returning capital to shareholders.

For 2008, that translates into seven to nine new restaurant openings, combined with an ongoing share repurchase program.

We still believe there are plenty of high quality sites available for our brands and we will continue to select premier sites for our concepts. However, the best sites are not always available when we’d like them to be. We will open fewer new locations, renew focus on exceptional sites based upon their availability and again, return the excess capital resulting from a reduction in openings to our shareholders.

Let me give you some more specifics on the 2008 plan. We plan to open six to eight Cheesecake Factory locations in 2008, as well as the initial unit of our newest concept, Rock Sugar Pan-Asian Kitchen. We do not have any new Grand Lux Cafe locations in the 2008 plan at this time.

Based on the locations that are available and the site selection discipline I just discussed, we did not find any Grand Lux sites that met our criteria. However, we remain committed to Grand Lux Cafe as our second concept and fully intend to continue rolling it out at exceptional locations.

The 2008 plan will also provide us with an increased opportunity to focus on the investment side of the Grand Lux returns equation, as well as allow additional time to explore opportunities for operational refinement and margin enhancement.

As I mentioned earlier, we are targeting sales growth of 10% to 12% in 2008. While we are optimistic about the long-term potential of The Cheesecake Factory brand, we are also realistic about the current state of the consumer.

As such, we are expecting continued pressure on guest traffic in the casual dining sector and are assuming our comparable restaurant sales will decrease between 1% and 2% in 2008 from 2007 levels.

This reduced traffic, combined with ongoing margin pressures in several areas that I’ll get into in more detail in a moment, will result in some definite operating margin pressure before pre-opening expenses. However, the reduced pre-opening costs resulting from fewer openings will offset this pressure to keep our overall operating margin relatively flat with 2007.

In terms of menu pricing, we are implementing an approximate 1.5% effective menu price increase in our winter menu change, which will be rolled out by the end of this month, to help offset known cost pressures primarily related to commodity, labor, and energy costs.

As we have always done, we will consider additional menu price increases later in the year to help offset additional margin pressures that may arise, as well as drive margin enhancement.

We are always cautious about menu price increases as we strive to maintain the value proposition of The Cheesecake Factory. This is even more important when faced with a very difficult consumer environment, as we are today.

The company is in the process of performing additional price studies with the help of outside consultants to better understand the pricing parameters of our brand. The results of these studies will help establish our pricing philosophy for the future.

As for the capital allocation portion of the plan, we expect to generate between $80 million and $90 million of free cash flow. To be clear, this is operating cash flow after tax and net of our estimated CapEx requirement. These funds, along with additional leverage opportunities, will be used primarily to repurchase our stock in 2008. As I detailed earlier, our board of directors increased our share repurchase authorization to bring our total shares available for repurchase to approximately $7.5 million and may consider additional authorizations.

The combination of these elements gets us to earnings per share growth of between 10% and 15%. For 2008 and beyond, our objective is to maintain a financial structure that gives us the flexibility to continue to actively pursue the best return on capital through both selecting premier sites when they become available and returning excess capital to shareholders.

Through a continued execution of a high quality growth plan and prudent allocation of our capital, we believe we can grow earnings per share in the 10% to 15% range for several years.

In summary, we feel very optimistic about our plan for 2008 and believe we are making the right choices for the long-term health of our business. We will continue to grow our concepts using a disciplined approach and selecting only those sites that are high quality and high margin. Opening fewer units will also have the effect of limiting saturation in any market, preserving the uniqueness of our concept and mitigating the risk of cannibalization.

With less emphasis on new restaurant openings, our operations team can focus more on sales and margin enhancing opportunities at our existing base of restaurants. As we have always done, we will also evaluate our infrastructure to ensure we are properly structured to support our current level of business and the planned growth.

All in, we believe our plan balances the needs for short-term results and allows us to return a meaningful amount of capital to shareholders while also strategically positioning us for the long-term.

To assist investors with their financial models, I will now briefly run through, by income statement line item, our expectations for the first quarter and full year 2008. As I mentioned, we are targeting full year earnings per share growth of 10% to 15%. However, as you would expect, the majority of that growth comes in the second half of the year as we lap the higher pre-opening expenses from 2007.

Our expectation of total revenue growth, which includes both restaurants and third-party bakery sales in the first quarter of fiscal 2008 is 10% to 12% relative to the first quarter of fiscal 2007.

As outlined in today’s press release, our targeted revenue growth for the full year 2008 is also 10% to 12%.

Based on the contracts we have in place and our current expectations for those items that we cannot contract, we expect cost of sales as a percent of revenues to be 50 to 60 basis points higher in the first quarter of 2008, compared to the prior year first quarter, and approximately 25 to 35 basis points higher for the full year compared to the prior year.

We have contracted with suppliers for those expected commodity requirements for 2008 that can be contracted. Regardless, we do anticipate continued cost pressure in produce as the poor growing season in 2007 is expected to impact 2008 as well.

We have contracted a portion of our cream cheese requirements through 2008 at a fairly modest, mid-single-digit increase versus the prior year and we’ll evaluate opportunities to contract the remaining requirements based on market movement throughout the year.

Labor expense are anticipated to be approximately 20 to 30 basis points higher in the first quarter of 2008 relative to the comparable quarter of the prior year, due primarily to deleverage from the slower anticipated traffic.

For the full year, we expect labor expenses to be about 10 to 20 basis points higher than the prior year.

We expect other operating costs as a percent of revenues to be approximately 30 to 40 basis points higher in the first quarter of 2008, again related primarily to the deleverage from slower traffic, combined with ongoing utility and janitorial cost pressures.

For the full year, we also expect other operating expenses to be 30 to 40 basis points higher compared to fiscal 2007.

Our expectations for G&A expenses as a percent of revenues to be about 20 basis points higher in the first quarter of 2008 as compared to the first quarter of the prior year, and about 10 to 20 basis points higher for the full year 2008 relative to the full year 2007.

We expect depreciation expense to be approximately 20 to 25 basis points higher in the first quarter of 2008 compared to the first quarter of 2007 and about 10 to 20 basis points higher for the full year, based on our expected growth and investment plans. We anticipate cash CapEx in 2008 to be between $90 million and $100 million.

Our expectation for fiscal 2008 total pre-opening costs is $13 million to $15 million in support of the seven to nine new restaurant openings that I discussed earlier, including the pre-opening costs associated with our initial Rock Sugar location. About $2 million to $3 million of the total pre-opening costs should fall in the first quarter.

We do not plan to open any restaurants in the first quarter but do expect to have at least two new restaurants opening early in the second quarter. We will give additional guidance on our planned restaurant openings by quarter on our quarterly updates during the year.

As a reminder, we usually incur most of our pre-opening costs during the two months before an opening and the month of a restaurant’s opening. As a result, the timing of restaurant openings and their associated pre-opening costs will always have an impact on our quarterly earnings comparisons.

Absent any additional leverage in the first quarter, which has not yet been determined, we expect net interest expense to be about $2.5 million to $3 million. We expect our tax rate in 2008 to be in the range of 31% to 32%.

And lastly, we anticipate a weighted average outstanding share count for the first quarter of 2008 of approximately 69 million shares.

I realize that’s a lot of detail but that represents our best estimates at this time. Of course, we will update you further throughout the year on our quarterly conference calls.

That wraps up our prepared remarks and at this time, we’ll be happy to answer your questions. In order to accommodate as many questions as possible in the time we have left on this call, please be courteous and limit yourself to one question and the re-queue with any additional questions. And if we aren’t able to get to your question on this call, please feel free to call us at our offices after the call.

Operator, we’re now ready for a few questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Kron with Goldman Sachs. Please proceed.

Steven Kron - Goldman Sachs

Thanks. Good afternoon. One question on just your development slowdown -- I just want to be certain that I understand it, that the idea here is not so much that you are backing off long-term unit development targets but more so that it seems as though you are raising the bar, at least from a return hurdle standpoint, as to what you are willing to look at. Can you just comment on that?

And then just as a second piece to that, the earnings growth profile of 10% to 15%, it sounds as if you are saying that that is what you expect for the next couple of years. Should we take that to mean that we will likely be sitting at this kind of 7 to 9 unit development for the foreseeable future? Thanks.

Michael J. Dixon

Good question, Steven. I think the first half of your question is right on. I think what we are saying with this plan is that we are focusing on really a prudent allocation of capital, and as we look at the best allocation of that capital to drive earnings per share and returns in general, today we feel that translate into the seven to nine restaurants with an aggressive share repurchase program as a way to return capital to shareholders.

On a go-forward basis, keeping that same mentality and, as you mentioned, targeting the 10% to 15% EPS growth, that balance will change based on the dynamics of the market at that time. So if great sites are available and they are out there, we want to take them, so that could end up being a few more or a few less sites in this year, with an allocation of the remaining capital towards returning it to shareholders.

David Overton

Our plan is really never to turn down an A site and as they come up for either concept, we will absolutely be taking them.

Operator

Your next question comes from the line of Lawrence Miller with RBC Capital Markets. Please proceed.

Lawrence Miller - RBC Capital Markets

Thank you. If I could first follow-up a little bit on that and then ask a question -- as it related to Grand Luxes that you decided not to open this year, you said there was something about the criteria it didn’t meet. Could you elaborate on that point?

And then also, can you just talk about this generally speaking -- your traffic has been slowing for a while now and yet we haven’t really heard from you guys an articulate plan about driving traffic growth. I understand the macro is probably worse than anybody would have guessed here but how do you think about pulling some levers to drive traffic growth over the next 12 to 24 months? Thanks.

David Overton

On the Grand Lux Café, a couple of them moved from ’08 to ’09 that we really loved. Others we felt were not the icon sites that we really want to start Grand Lux with. We’ve got some incredible sites in downtown Chicago, Las Vegas, the sites we have in Miami, but the sites that we were looking at for ’08 and early ’09 were just not at the level we want. So we are going to wait for even beyond that A site, that icon site, to make sure that Grand Lux continues to get launched in the same way we launched Cheesecake Factory years ago, to make sure that we really get a reputation going in the city and then move out to the suburb.

So we have about -- a number of sites that we’ve been looking at for a while, tracking -- some of them have moved to 2010 because of new construction and so they got put off. And we’ll see how many we really can get in ’09 but we are extremely happy with the returns, we’re extremely happy with Grand Lux, and I wish we could get some open for ’08. We are actually disappointed but they will be great when we open them.

And then in terms of I guess you are asking about increased marketing. We are certainly looking at various marketing things. Again, part of the increase in our gift cards and our 40% increase was really -- we look at that as marketing because there is an expense to that where in the old days we probably never would have marketed in that way. We do it today to increase our sales at the discount through that, and we have a number of other things with MasterCharge, American Express, Visa, and other things that we are doing -- increased visibility, giving to community causes to drive more business in the individual communities, and we are considering other things.

We are -- at this moment, we don’t have any kind of massive radio or TV spot. We think we’re too spread out to have that be effective.

Michael J. Dixon

And I would just follow that up -- clearly you are swimming against the tide in trying to drive traffic in this environment. We would like to see it come back but again, relatively speaking when you look at the traffic decline across casual dining in general, we’ve probably held up as well or better than anybody, so we’ve got to be very careful in how we allocate costs towards driving incremental traffic in this environment.

Operator

Your next question comes from the line of David Tarantino with Robert W. Baird.

David Tarantino - Robert W. Baird & Co.

Good afternoon, everyone. A question on your guidance assumptions for ’08 -- Mike, you said you were assuming comps down 1% to 2%, if I heard that correctly, and that’s below what you saw in Q4. I’m just wondering if you are seeing anything now that might cause you more concern than what you had in Q4 or just if you could give some more detail on what your thought process is there.

Michael J. Dixon

Well, I think again, we’re trying to trend off what we’ve seen most recently and I think we saw, absent a little bit of a holiday pick-up, a decelerating traffic through the fourth quarter and I think that’s the trend that we are trying to be relatively cautious in planning our expectations for 2008.

David Tarantino - Robert W. Baird & Co.

Okay, and if I could ask one other question -- just wondering what you think your opportunity is in the existing restaurants in terms of increasing margin for those. I think that was mentioned previously. I’m just wondering what the thought process is there. Thanks.

Michael J. Dixon

I think it’s fair to say we do believe there are opportunities. Our restaurants operate pretty darn well but when you lose some traffic, you’ve to reevaluate your operating procedures look for some margin enhancements. And clearly when you look at our operating margin trends over the past few years, for lots of reasons there’s been a decrease in those margins.

So we recognize that with less of a focus on growth certainly in 2008, we have an opportunity to focus more on the operating efficiencies of each of our restaurants and that’s one of our primary objectives in this year and beyond. So I couldn’t put a dollar or a percent increase on it for you but we certainly recognize that there are some opportunities to drive the margin.

Operator

Your next question comes from the line of Joseph Buckley with Bear, Stearns. Please proceed.

Joseph Buckley - Bear, Stearns & Co.

Thank you. Just a question -- obviously you were planning just a couple of months ago to many more sites. Are there any costs associated with changing those plans, any leases that have been signed already or up-front costs that will be recognized?

David Overton

No, Joe, everything we signed we wanted to keep. We were able to move some of those sites to 2009 and any of the others that we decided not to go forward with, we had no cost to get out of.

Joseph Buckley - Bear, Stearns & Co.

Okay, and then just one other quick one -- Mike, the net interest expense number for the first quarter actually looks a little lower than what it was for the fourth quarter.

Michael J. Dixon

I’m sorry, which expense?

Joseph Buckley - Bear, Stearns & Co.

The net interest expense number for the first quarter.

Michael J. Dixon

Right.

Joseph Buckley - Bear, Stearns & Co.

That you mentioned, $2.5 million to $3 million, I think. It looks a little bit lower than the fourth quarter. Is that just a function of year-end cash balances or --

Michael J. Dixon

Well, it’s a combination of that. I think also in that interest expense number is the portion of interest associated with deemed landlord financing on the leases, which kind of skewed that up a little bit in the fourth quarter, so I think we’ll -- I think the number coming down in the first quarter is more in line with where we expect it to be.

Joseph Buckley - Bear, Stearns & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Bryan Elliott with Raymond James. Please proceed.

Bryan Elliott - Raymond James & Associates

Good afternoon. Just wondered, as you look forward with the slower growth, whether you would expect to see, and if you don’t, why you wouldn’t, expect to see the average weekly sales, the same-store sales gap close?

Michael J. Dixon

I think over time, that’s a fair statement. We would expect to see that happen, sure.

Bryan Elliott - Raymond James & Associates

Thank you.

Operator

Your next question comes from the line of Sharon Zackfia with William Blair. Please proceed.

Sharon Zackfia - William Blair & Company

Can you talk somewhat about your new unit returns? It looks like there may have been some deterioration in new unit productivity, particularly in this quarter and maybe how you are assessing in a more normal consumer environment your appetite for growth at this stage?

Michael J. Dixon

Well, I think the returns certainly, whether it’s new units or existing, were impacted obviously by the lower traffic across the board in 2007, so our focus on the slightly slower growth in 2008 is to make sure that we focused on those premiere sites that we feel from a traffic perspective have less risk, are going to be able to drive the returns in excess of our expectations, which we’ve targeted that mid 20% fully capitalized cash on cash return and that stays the same. We just want to make sure that we are picking the premiere sites that we feel very confident are going to deliver that. Again, it’s harder to do in an environment with the traffic declines as we saw in 2007.

Sharon Zackfia - William Blair & Company

When you are pulling back on the new unit openings, is there any particular region where you’ve seen enough softness that it just doesn’t make sense to redeploy capital in that area?

Michael J. Dixon

I wouldn’t say it’s as much regional. Again, there’s fantastic sites everywhere in the country and when those come available, those are the ones we want to make sure that we take.

David Overton

It’s really a site by site rather than any particular regional weakness.

Sharon Zackfia - William Blair & Company

And just to be clear, do you view this internally as more of a macro issue or do you think you are getting to the position where there’s just a scarcity of class A real estate sites for you?

Michael J. Dixon

I don’t know that there is a scarcity. Certainly there’s fewer of them by default. However, there’s plenty of them left but we want to make sure that we are holding out and getting just those sites.

David Overton

Right, and we’re not opening just to hit a number but we are opening because each one is excellent and we 100% believe in it.

Sharon Zackfia - William Blair & Company

Okay, and are there any dangers of any store closures?

Michael J. Dixon

No, all of our stores, as we’ve always said, are profitable. They all deliver positive cash flows so at this point, we wouldn’t consider that.

Sharon Zackfia - William Blair & Company

Thank you.

Operator

Your next question comes from the line of Matthew DiFrisco with Thomas Weisel Partners. Please proceed.

Matthew DiFrisco - Thomas Weisel Partners

Thank you. Why aren’t we going to see more leverage or any leverage on G&A in 2008 if you presumably are cutting back growth and the infrastructure and G&A has been driven also by the up-front investment of development, so if you are having basically half or less than half the number of store openings, I would think G&A also has potential, as well as your growth being slower on the EPS side. I would think bonuses would reflect the similar muted outlook.

Michael J. Dixon

Well, clearly there are opportunities for G&A leverage but I think it’s important to think about our G&A structure. If I look at the cost structure of our G&A, I would say 85%, probably 90% of the costs are really -- they are not geared towards new restaurant openings. They are geared to supporting 150-some restaurants that we have today. So if you look at the costs specifically associated with that growth of new restaurants, there is some room for leverage and I think that’s being reflected in there.

If you look at the overall on a year-over-year basis, we’ve talked about being relatively flat on G&A. I think that’s reflective of at this point we are considering that we would accrue some bonus, which we did not have a bonus in 2007 or 2006.

We also have increased costs associated with our gift card programs, which as David mentioned went from $60 million in sales to nearly $80 million in sales on a year-over-year basis, and so we capture the fee or the commission cost we pay for the third party on that and defer that over the life of the expected redemption period.

So those are the things that are driving that G&A up. I think that we’ve captured quite a bit of the applicable leverage that’s there. There is always going to be more opportunities and we are going to continue to find them.

Matthew DiFrisco - Thomas Weisel Partners

Okay, and just as a bookkeeping, can you just verify -- you said one to two down in traffic or same-store sales for 2008?

Michael J. Dixon

One- to two-percent down in comp sales.

Matthew DiFrisco - Thomas Weisel Partners

In comp sales -- and then also, can you just break out that charge? I missed it if you did in your prepared remarks, the net 1.8 , or it was a little higher, a little over $2 million in the fourth quarter, the $0.03. Where was that in the line items? Where did it impact?

Michael J. Dixon

It’s all in G&A.

Matthew DiFrisco - Thomas Weisel Partners

All in G&A. Thank you.

Operator

Your next question comes from the line of Paul Westra with Cowen & Co. Please proceed.

Paul Westra - Cowen & Co.

Good afternoon. Just another couple of follow-ups on the pricing philosophy I guess for 2008. You said 1.5%. With that, you forecasted about an 80 basis point hit. Was that -- is that a function solely of traffic, meaning if you had guided for flat traffic, 1.5 would have held margins flat? And I guess following up with that, I also have a question of -- it seems like another point price increase of roughly 2.5 next year could have helped margins if it was gone through successful. Why so conservative, I guess, on the other side?

Michael J. Dixon

I think we guided to the 1.5 price increase that’s rolling out now. Of course, as we have always when the summer menu change rolls around, we’ll consider what pricing opportunities are available, what incremental margin pressures are there, taking into account the state of the guest, our guest, state of the consumer, et cetera, and look for opportunities to help offset some of the margin pressures you’ve just identified and depending upon what’s happening at the time, maybe get some margin enhancement. I can’t say that will happen this summer but that certainly is where we want to end up over time, using pricing to get a little of that margin back.

Paul Westra - Cowen & Co.

And I guess related, with that 1.5% pricing for the year, what you are looking at is only a modest 10 or 20 basis point up on labor. That would imply labor inflation rates are down considerably from what you’ve seen. Is that a correct assumption or are you cutting back and making some efficiencies elsewhere?

Michael J. Dixon

No, I think that’s probably true. I’d have to think about that some more but I think that’s true.

Paul Westra - Cowen & Co.

Great. Thanks.

Operator

Your next question comes from the line of Christopher O'Cull with SunTrust. Please proceed.

Christopher O'Cull - SunTrust Robinson Humphrey

Thank you. Mike, I have a couple of questions on the ’08 guidance. It sounds like same-store sales gift cards, gift card sales were pretty strong during the holiday season. Are you seeing unusually low redemptions in January?

Michael J. Dixon

You know, I don’t think -- you know, historically on a monthly basis, January obviously tends to be the highest redemption month. I don’t have the percents in front of me. I don’t think it’s that different than it’s been in prior years, so our January sales, I don’t think anybody asked so far, we mentioned it, but our comp sales through the first four weeks of 2008 are pretty much in line to the guidance I suggested as comp sales for the year, but that’s taking into account that we’ve had absolutely terrible weather in California for the first several weeks of the year and are down quite a bit in that market. But overall, we are still in that range of negative 1% to negative 2% right now.

Christopher O'Cull - SunTrust Robinson Humphrey

Okay, and does your margin -- let me make sure I’m clear on this -- does your margin guidance for ’08 reflect additional pricing in the summer?

Michael J. Dixon

At this point, it does not.

Christopher O'Cull - SunTrust Robinson Humphrey

Okay, and then if you look at the pre-opening expense per unit that is projected, it seems to be much higher in ’08 than what it was in 2007, and I mean pre-opening per unit. Is this true?

Michael J. Dixon

Well, you know, I think at this point it’s a little higher. I think we’ve got to figure out, and somebody asked earlier about the leverage opportunities, whether there’s opportunities to better manage our manager, planned management growth, which is bringing managers on early and carrying them, waiting for the restaurants to open, will still be, even though it’s fewer units will still be a little bit more back-end loaded, so making sure that we’ve got those costs completely under control.

I think the cost of relocation and moving managers around has increased considerably. I would say the direct cost associated with the restaurant when we get in there for the two months or so before a restaurant opens or the month before a restaurant opening, those are pretty consistent. It’s sort of that management carrying cost and relocation cost associated with -- it has increased in 2007 and that we’ve got to evaluate closely for 2008.

Christopher O'Cull - SunTrust Robinson Humphrey

Okay, and then last question, I know in the last call I think you guys mentioned something about a new prototype in 2008. Could you describe some of the benefits you hope to get from a new prototype?

David Overton

We are trying to have several of these sizes so we can open the appropriate restaurant in the appropriate market, so if there is an A site but it’s in a market that is a little less populated, or that we are limited to maybe 8,000 square feet, we want to have the right box with the right kitchen and the right cost. So we will be working on that. We are pretty much done. We’ll be waiting to open one, make sure that everything is sized properly and then we’ll have one of these boxes. It will be approximately -- I don’t know, 7,800 to 8,000 square feet where we think it will be more economical than the sizes we’ve been opening in the past years.

Christopher O'Cull - SunTrust Robinson Humphrey

And no change to the menu?

David Overton

No change to the menu -- cook everything, just less cost going into a market, a site that needs to be smaller or we deem that it should be smaller.

Christopher O'Cull - SunTrust Robinson Humphrey

Great. Thanks, guys.

Michael J. Dixon

Operator, we have time for about two more calls.

Operator

Your next question comes from the line of John Ivankoe with J. P. Morgan. Please proceed.

John Ivankoe - J. P. Morgan Securities

Thank you. The question is on pricing, especially in light of this current environment. Firstly, it sounds like the pricing that you are taking is fairly cost driven, so I just want you to comment in terms of how you think your consumer will do with pricing.

And secondly, in the contest of communicating consistent value, which a lot of your lower end peers are talking about, we’ve seen in previous years things like smaller lunch portions and we’ve seen the bar menu, for example, I think used in 2007, so can you comment if there is anything that might be upcoming to 2008 to bring back the consumer that might be somewhat fiscally constrained?

David Overton

Right now, we are really -- we’ll just be adding to those categories, keeping them alive and fresh with new items. We are going to add more of the weight management items for those people that are weight conscious, probably some open-faced sandwiches and other meals beside just salads. But we have no more -- we want to be very careful about cheapening, changing our concept, doing things that we may be sorry for later. But continuing to just bolster the sections that are on the menu now and then the consumer -- we think our consumer will be better --

Michael J. Dixon

Well, I think we’ve historically been very successful at getting our price increase, as I think you’re alluding to, John. The point-and-a-half seems -- is relatively modest in this environment but as we balance out our need to cover margin pressures as well as try to find some margin enhancement, we think that’s a reasonable price increase at this point and I don’t anticipate any trouble in getting that.

John Ivankoe - J. P. Morgan Securities

Okay. Thank you.

Michael J. Dixon

Last call, Operator. Operator, our last call?

Operator

Your next question comes from the line of Howard Penney. Please proceed.

Howard Penney - Friedman, Billings, Ramsey & Co.

Thanks very much. You may have answered this question indirectly but I was trying to get at some of the other benefits, other than the obvious to the organization from the slowing growth, meaning obviously the increase in free cash flow and lower pre-opening expenses and just some of the other benefits that accrue to the organization over the next 12 months as you refocus your growth. Thanks.

Michael J. Dixon

Sure. Well, I think you’ve hit on the big ones and the other one, which we talked about, was making sure that our infrastructure is properly suited for that growth, both today and into the future. I think the biggest one, which is harder to put your finger on immediately, is those operational margin -- operating margin enhancements that are available at the restaurant from increased focus and attention from the team who has to spend less time on new restaurants, more time in the restaurant.

You also get the benefit of less cannibalization and then I think maintaining the value of the brand and protecting the long-term strength of The Cheesecake Factory brand. Those are the other benefits that accrue to us, both in 2008 and longer.

Okay, Operator, I think that was our last call.

Operator

Yes, sir. That concludes the Q&A.

Michael J. Dixon

Okay, everybody. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Have a good 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: [e-mail]. Thank you!