The Cheesecake Factory Incorporated
Q3 2007 Earnings Call Transcript

Published: 24 Oct 2007

[Operator:]

Good day, ladies and gentlemen and welcome to The CheesecakeFactory's third quarter 2007 earnings conference call. (Operator Instructions)I would like to turn the call over to Mr. Michael Dixon. Please proceed, sir.

[Michael Dixon:]

Hello, everyone. I'm Michael Dixon, CFO of The CheesecakeFactory Incorporated, and welcome to our quarterly investor conference callwhich is also being broadcast live over the Internet. Also with us today is David Overton, our Chairman of theBoard and Chief Executive Officer who is actually joining us from Tukwila, Washington -- just outside of Seattle-- where we will open our 134th Cheesecake Factory restaurant laterthis week. Joe Peters, our Vice President of Investor Relations, is also withus. Before we get into the details, let me briefly cover ourcautionary statement regarding risk factors and forward-looking statements ingeneral. Throughout our call today items may be discussed that are not based onhistorical fact and are considered forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Actual resultscould differ materially from those stated or implied in forward-lookingstatements as a result of the factors detailed in today's press release and inour filings with the Securities and Exchange Commission. All forward-looking statements made on this call speak onlyas of today's date and the company undertakes no duty to update anyforward-looking statements. We have a lot to cover today. In addition to reportingresults for the third quarter of fiscal 2007, we also announced our growth planfor fiscal 2008 today. Our agenda for this call will be as follows

[Operator:]

Your first question comes from John Glass – CIBC.

[John Glass:]

Mike, I get the reduction in The Cheesecake Factory growthgiven the pressures you have, et cetera, but why slow the Grand Lux as well? I thoughtyou were in an expansion mode, maybe you were going to continue to swap outmore Cheesecakes for Grand Luxs, you could still do that within the confines ofa lower absolute growth this year. Could you maybe talk about the thoughtprocess behind slowing down Grand Lux Cafe as well?

[Michael Dixon:]

I think – and David can chime in on this – really, we are notlooking to slow down Grand Lux, it is really just getting the right spots andhaving them available at the right time. The locations that we have looked atfor 2008 for Grand Lux locations, just getting the right spots, the number thatare available in the areas we want to go to is just a little bit lower. We arenot intentionally trying to slow down Grand Lux Cafe. It is a function of thespace available, at the right time.

[John Glass:]

Do you think that over time those will always be a littlebit harder to get? What gives you confidence you can grow that at a faster clipif you are having difficulties now just trying to open three to four?

[David Overton:]

I don't think it's a matter of difficulty. Again, it's just finding the exact right site wherewe want to go following the growth pattern that we have with The CheesecakeFactory. There's lots of sites all over the country, but we are very particularabout how we're growing it and building our reputation with cities, going inand the sites we are looking for are incredible sites in incredible cities. Wehave a lot of them planned. We have sites that are planned for '09 and '10 thatare the absolute best in Boston,the best here and there. But they are all over the board in terms of when we goingto get those very special sites we are looking for, for Grand Lux.

[Operator:]

Your next question comes from Jeffrey Bernstein - LehmanBrothers.

[Jeffrey Bernstein -Lehman Brothers:]

Just a question on traffic trends. It looks like pricingwould now be running in the 3% range for both brands, slightly above yourhistorical averages. I was wondering if you could talk about any noticeableimpact to sales, traffic or mix? Yousaid you saw a slowdown back in September, early October. I was wondering ifthat was attributable to macro or ifthere is any issue from a near term pull back on pricing? If not, I am wondering if you may considermaintaining those levels closer to the 3% range in future years, given the factthat the consumer is giving you a lot of credit for your value scores?

[Michael Dixon:]

Jeff, I think the answer to the first part of your questionis, I believe it is still due to the macro trends. You hit on it. We did seetraffic slow down in the second half of September and continuing in the firstcouple weeks of October which is again reflected in the guidance we gave onrevenues for the full year. Our average check is really still tracking right along thelines of our menu price increases. So Idon’t feel that we are being impacted there. Having said that, I don’t thinkthat we will change our pricing strategy. I think we will continue to pricewhat we need to do to effectively offset some of the margin pressures. It isstill obviously a very competitive environment, and we want to be very carefulwith the guest out there.

[Jeffrey Bernstein -Lehman Brothers:]

I think you had mentioned that Grand Lux was running 2% to3% pricing, and you took the 1% increase in the spring. Is now the point intime that you would take the full menu roll out, I am wondering where pricingis going to end up for Grand Lux.

[Michael Dixon:]

You are right on the current pricing on Grand Lux. Grand Lux is just undergoing a menu changewith I think slight menu price increase, if I am not mistaken, David?

[David Overton:]

Right. We are right at about 1 point.

[Jeffrey Bernstein -Lehman Brothers:]

So 1 point now, in addition to?

[David Overton:]

In addition to what is in there.

[Jeffrey Bernstein -Lehman Brothers:]

So what would it be running in total, going forward?

[Michael Dixon:]

I think it is still going to be between 2% and 3%.

[Operator:]

Your next question comes from the line of Ashley Woodruff –FBR.

[Ashley Woodruff:]

Just a question on your comments on 2008. The 22% to 24% EPSgrowth goal seems especially ambitious, given what you've seen recently in termsof your same-store sales trends and traffic weakening. When you are looking into 2008 what are you expecting to reachthat? What do you need to see in terms of your same-store sales trends? On that 30 to 50 basis point improvement in margins, are youexpecting that other line items like cost of sales, bakery and restaurant, areyou expecting those are flat?

[Michael Dixon:]

From a big picture perspective, Ashley, I think relativelyflat on all of those line items. As Imentioned, we should get a little bit of G&A leverage. Obviously we willget some fairly good pre-opening expense leverage with just the fewer openings,which will drive that operating margin growth that I talked about. I think the real leverage you get from that net income downto the earnings per share is just the benefit of the share repurchase programthat we have just completed, as well as additional share repurchases that wecontemplate going forward.

[Ashley Woodruff:]

Is that premise of same-store sales similar to what you haveseen recently, or improving in 2008?

[Michael Dixon:]

I think it is relatively similar to what we have experiencedlately. We are not being overly aggressive in assuming that the traffic isgoing to resume.

[Operator:]

Your next question comes from Larry Miller – RBC CapitalMarkets.

[Larry Miller:]

Thanks. If I could follow up on John’s question, does thatmean that going forward it would be something like 10 to 12 Cakes and then youwould think to reaccelerate Grand Lux, given the opportunities, and that is howwe should think about planning the model, not necessarily the 17 stores peryear?

[Michael Dixon:]

I think that is a reasonable assumption, Larry. I think asDavid indicated, we want to accelerate the growth at Grand Lux, but we alsowant to be right about picking the best spots. So our goal would be to continueto ramp up Grand Lux Café growth. We aretargeting the 17 total openings for 2008 and then we will ramp up again fromthat in 2009, and I would expect the Grand Lux Cafes will play a bigger part inthat growth.

[Larry Miller:]

I get how you can get to 14%, 15% revenue growth bybalancing out fiscal 2008 relative to 2007, which only had a few openings inthe first half of the year. Wouldn’t that necessarily normalize in fiscal ’09and beyond, and therefore you wouldn’t get the big productivity adjustment?Muted opening or capacity growth at that point?

[Michael Dixon:]

I think you will see certainly in the first half of ’09,once you get that far out, you will see some of the lower growth in ’08 willhave an impact on the first half of ’09. I still think that there are opportunities for us to continue to drivethat revenue growth into the mid to high teens number with comparable EPSgrowth. Certainly we get a benefit on that EPS growth in fiscal 2008just from the slowdown or the lowering of the pre-opening costs.

[Larry Miller:]

Does that mean then that you are expecting traffic growth?Normally you have said that you wouldn’t be able to grow sales ahead ofpricing. I guess I am confused on how we get to 14% in the out years.

[Michael Dixon:]

Well again, we can target the revenue growth from the newstore openings. We feel we have plenty of opportunities to grow morerestaurants than 17 beyond 2008.

[Larry Miller:]

I see. I misunderstood. Thanks a lot.

[Operator:]

Your next question comes from Sharon Zackfia – WilliamBlair.

[Sharon Zackfia –William Blair:]

Mike, you commented on the last couple of weeks of Septemberand October slowing. I don’t think anyone asked, but has that been a nationalslowing, or have you seen any geographic concentration there?

[Michael Dixon:]

I would say that we have seen Californiaslow quite a bit, more so. A little bitof slowing everywhere, but I would say Californiahas slowed more so. I think interestingly enough, the Southwest area has sloweddown as well. So both Californiaand Southwest have led the charge in the slowdown from mid-September forward.

[Sharon Zackfia –William Blair:]

Separately, I am assuming, based on your language in thepress release, that the weightings for the restaurants next year will still beback end weighted, and it is really ’09?

[Michael Dixon:]

That is correct. The idea is to really slow the pipeline in’08 so that we have anywhere from 20 to 24 places to choose from; only open the16 or 17 that we talked about, and then move the rest into early ’09.

[Sharon Zackfia –William Blair:]

Just circling back once again on what you have seen inOctober, I think you gave the comps for the first three weeks. Was Octoberpretty similar to your full quarter comps last year, or was it markedlydifferent?

[Michael Dixon:]

I don’t know the answer to that off the top of my head, sorry

[Operator:]

Your next question comes from Matt DiFrisco - Thomas Weisel.

[Matt DiFrisco -Thomas Weisel:]

Thanks. This is a follow-up on Larry’s question earlier. Ithink there was a presumption being made by all of us that you will be morebalanced in ’08. Can you give us a little bit of how the quarter might look --how the quarters might look as you break out and open up those total 17 stores? And then, can you update us on what your estimates are forthe CapEx contribution from the Rock brand?

[Michael Dixon:]

2008, as I think Sharonjust kind of alluded to, will still be back-end loaded. It just won’t be as --there just won’t be as many restaurants to open in the third or fourth quarterbecause we are going to open fewer in total, so it is still -- 2008 is stillgoing to be a back-end loaded schedule, but the idea will be to move some ofthose that we would have tried to open late in ’08 into the first half of ’09to make ’09 more of the balanced opening schedule. As for the capital costs for Rock Sugar, I don’t have afinal number on that so I’m not ready to give that out.

[Matt DiFrisco -Thomas Weisel Partners:]

How about the pre-opening? I mean, typically I think we werelooking for almost double the amount of what a Cheesecake is running at now. Isthat about the same but more in 1Q than some of it falling in 4Q?

[Michael Dixon:]

Yes, that’s true. What we had put in for 2007, I said $1million to $2 million on the Rock Sugar pre-opening. I don’t think it will beat the $2 million number but it will be somewhere, closer to $1.5 million withmost of that falling in the first quarter.

[Matt DiFrisco -Thomas Weisel Partners:]

And then, what are we looking at right now as far as goingon in the G&A line as far as leverage being gained in relation to falling alittle short of original plans and compensation. I’m just curious -- how muchare we getting a benefit from lack of bonus contributions in ’07 that will comeback in ’08 when you do start hitting your plan and getting to 22% profitgrowth? Are we going to see a ramp up in relative G&A, potentially?

[Michael Dixon:]

I think as a percent of revenues, as I indicated, we arestill looking to get some leverage on that G&A line for 2008. We’ve neverreally specifically broken out the bonus costs in that line item. Any assumptions that are based on what I gave for the 2008plan would include our potentially hitting those bonus targets. But I’m stillexpecting to see some year-over-year leverage.

[Matt DiFrisco -Thomas Weisel Partners:]

Last question; what do you think will enable you goingforward to have it more balanced, the schedule, in ’09, aside from justdeferring some openings? The presumption was always the best time to open thestore though is also around the fourth quarter and the holiday, or developersweren’t ready to open up. I’m just curious -- why do you feel more comfortablenow deferring the Christmas opening time schedule or Thanksgiving time scheduleto now maybe January or February, when that’s not been a strong period for youin the past to open?

[David Overton:]

I think we’ve opened very well in the first quarter. We just-- in other words, they just move and they don’t get serious about doing theirwork, so everything backs up. But as far as being -- it’s a fine time for us toopen as long as the landlord gets their work done and we can get open. Doesthat answer your question? We don’t feel the first quarter is any worse to open than thefourth. It’s just that we haven’t been able to because of all of the work thatthe landlord has to do and they don’t get started usually until March.

[Matt DiFrisco -Thomas Weisel Partners:]

Right, but I would think that there was a presumption whenyou got into the site by the developer that you would be opening aroundThanksgiving or Christmas and that would be the time.

[David Overton:]

You know, so often, we try to get it open much earlier butit just gets put off for various reasons -- permitting, landlord getting itdone, not wanting to do work during the Christmas season, so they don’t reallystart until later -- there’s a number of problems that come up, but it’s notthat -- we would open as many stores as we could in the -- we don’t like openingin the beginning of January. It is too hard to get our staff together butcertainly starting the last week in January, February and March is a fine timefor us to open, if we can get it all put together.

[Matt DiFrisco -Thomas Weisel Partners:]

Okay. I just wanted to see if there wasn’t something as faras site selection that’s enabling you to go differently away from strip mallsand lifestyle centers and more independent standalones, or --

[David Overton:]

Those are still not the sites we prefer.

[Matt DiFrisco -Thomas Weisel Partners:]

Okay. Thank you.

[Michael Dixon:]

I think just to follow that up real quick, generallyspeaking, we tended to one of the first locations that opens as part of a newdevelopment, or a refurbished development. We don’t necessarily have to be partof that grand opening. We can open, as David mentioned, a few months later inthe first quarter. By doing that, we’ll be able to balance our schedule alittle better.

[Matt DiFrisco -Thomas Weisel Partners:]

Thank you.

[Operator:]

Your next question comes from the line of Nicole Miller ofPiper Jaffray. Please proceed.

[Nicole Miller:]

Good afternoon. I’m sorry if I missed this in the firstpart, I’m traveling, but what is the comp assumption for 2008 and then what isthe pricing within the assumption?

[Michael Dixon:]

We didn’t give either of those. We just kind of gave thatrevenue target, so you’ve got the 17 restaurant openings with that revenuegrowth of 14% to 16%.

[Nicole Miller:]

And I think I caught the tail end of one of the earlierquestions about the Grand Lux pricing would be 2% to 3% going forward. Couldyou make the same commentary on the Cheesecake Factory units?

[Michael Dixon:]

Well, the Cheesecake Factory right now have 3% in the menu.They have about a weighted 2.2% for the third quarter. As of today, they are3%. We haven’t made any decisions on our first quarter 2008 price increase, butwe continue to evaluate the cost pressures and within the next month or so,we’ll make a finalization on that.

[Nicole Miller:]

Okay, and then just one quick question, first just to makesure that all of your employees and families are safe, given the fire andevacuation issues in Southern California, and if you could, I don’t want to beoverreacting to a situation and it may be too early to tell, but is there anycolor you can give on the impact to your stores at this point?

[Michael Dixon:]

First, thank you for your concern. At this point, none ofour restaurants have been damaged or are being threatened to be physicallydamaged by the fires. As far as I’ve heard, all of our staff members are safeas well, so okay on both counts.

[Nicole Miller:]

Okay, so just one store potentially at this time andnothing’s been closed or -- I’ve heard of some power outage issues today incertain areas and what not, but not for your stores?

[Michael Dixon:]

None of our stores have been impacted.

[Nicole Miller:]

Thank you so much.

[Operator:]

Your next question comes from the line of Joe Buckley ofBear Stearns. Please proceed.

[Joe Buckley:]

Thank you. Just a question on the difference between thefour restaurants that are averaging about $7 million in sales and the one youare targeting to open next year that you were targeting in the $8 million to$10 million area. Is there a difference between those prototypes or --

[David Overton:]

I think what we are saying is that we have developed a 7,500 foot store with theappropriate size kitchen, scaled down investment, so if we go into those --when we go into those markets that will have $7 million, $8 million, $9 millionchoices, we will have the appropriate size store. The ones that are doing that currently, some of those are 8,900 square feet, some are9,000. Inother words, we didn’t have a model that small to build into those kinds ofvolumes. So now we do, so if we make that selection going forward, we believethat it’s the right size store for those volumes.

[Joe Buckley:]

Thank you.

[Operator:]

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

[Bryan Elliott -Raymond James:]

Good afternoon. A couple of questions on the growth plans.Would you expect the spreading out into ’09 of the openings to possibly reducepre-opening costs per concept, as we get smoother and don’t have as much of arush at the end of the year?

[Michael Dixon:]

Yes, I would. I think that the, as I mentioned the impact nopre-opening expenses this year, there is a bit of a cost because we can’t hireas many managers as we need all at once, so we hire them throughout the yearand we can carry extra managers as a result. By spreading it out, we should beable to smooth out our hiring needs and reduce some of those costs.

[Bryan Elliott -Raymond James:]

Secondly, would you expect any material changes in the levelof landlord financings that you’ve been getting in recent years as a result ofthis change? In other words, would it be marginally less attractive to alandlord to have you open in February instead of mid-November or earlyDecember?

[David Overton:]

We don’t think it will make any difference to landlords.

[Bryan Elliott -Raymond James:]

Thank you.

[Operator:]

Your next question comes from the line of Steven Kron ofGoldman Sachs. Please proceed.

[Steven Kron:]

Thanks, a couple of follow-ups, first, Mike, on the 22%, 24%EPS growth goals for 2008, you had some one-timers in the first quarter of ’07.I think they equated to around $0.02 to $0.03. I just want to make sure thatthis is inclusive of those things in the first quarter of this past year, soyou are going to get a little bit of a benefit on a year-over-year basis fromthose items?

[Michael Dixon:]

That’s correct.

[Steven Kron:]

Okay, so we shouldn’t carry that forward into 2009 per se,right because you are going to get a little bit of benefit from that?

[Michael Dixon:]

That’s correct.

[Steven Kron:]

And as far as the CapEx guidance of 160 to 170, can youbreak out -- I assume most of it is growth CapEx but what would the maintenancepiece be?

[Michael Dixon:]

I don’t have that. I think it’s fair to assume the sameratio as to what it is in 2007, interms of new restaurants versus the remaining pieces.

[Steven Kron:]

Okay, and then on the 17 units that you targeted, can youjust provide the mix of how many are new geographies versus existing?

[Michael Dixon:]

I can’t do that today, Steven. I think the idea here is thatwe are -- we’ve got a lot of them to choose from and we are going to pick theones that are right for us and that fit best within our opening schedule, sothose markets could change from the roster that we’re going to pick from.

[Steven Kron:]

Thank you.

[Operator:]

Your next question comes from the line of Paul Westra ofCowen & Company.

[Paul Westra:]

Good afternoon. Most of my questions have been answered, butcould you talk a little bit about bakery sales? I know you had a flattishoutlook for this year, lapping last year’s big year. Should we assume aresumption to that 10% level next year as you look out in your forecast?

[Michael Dixon:]

That’s a good question. I think somewhere between 5% and 10%is a reasonable outlook for 2008. Again, I think some of the softness we’veexperienced this year in the warehouse clubs, we’ve got several different ironsin the fire, if you will, both within the clubs as well as some other channels,so I think somewhere in the 5% to 10% range next year is a reasonable estimate.

[Paul Westra:]

But if we look at this year, obviously last year’s fourthquarter was your highest on record, up significantly. It seems you areforecasting for the current fourth quarter a flattish number. I assume thingshaven’t materially slowed than what was feared or expected.

[Michael Dixon:]

Again, we came into the year expecting to do a little bitbetter than we are, even last quarter I was still expecting to do a positive 1%or 2%, so now I’m flat to negative one. So there’s certainly been somepressure, again really in that warehouse channel, warehouse club channel. But Ithink the outlook for next year is okay.

[Paul Westra:]

One other question, on tax rate, should we assume 30% forthe fourth quarter and for next year?

[Michael Dixon:]

I think I said 30 to 31 for the full fiscal year, whichwould be the fourth quarter rate, obviously, and it think somewhere in thatrange for next year is reasonable.

[Paul Westra:]

Okay. I must have missed that. Thank you.

[Michael Dixon:]

We’ve got time for two more questions, Operator.

[Operator:]

Yes, sir. Your next question comes from the line of JohnIvankoe of J.P. Morgan. Please proceed.

[John Ivankoe:]

Thanks. The first question that, and I’m sorry if youanswered it maybe in different pieces, has to do with again lowering thedevelopment slightly for ’08. I know one of the reasons is not wanting to openunits back-ended anymore, but in the last couple of years, you’ve actually donea pretty remarkable job with that. I think from a profit and operations pointof view, you’ve been at least in line with what anyone would have thought youcould have done. Is there something that you saw in maybe the second half of’06 or second half of ’07 that made you say that you didn’t want to open somany units in a given time period again?

[Michael Dixon:]

First, thank you for the compliment. I think that ouroperations team, development team have done a phenomenal job of opening thatmany restaurants. I think the challenge for us is not so much getting thembuilt because our development group can do that, or picking the sites, becausethere’s plenty to choose from. It’s really focusing on what’s the right growth ratelong-term for us, and there’s a lot of ancillary costs, sort of the pre-openingcosts that we’ve alluded to, some other softer costs that I think would warrantus to try to take a stab and balancing the schedule a little bit, which willreally again help us longer term, 2009, 2010, et cetera. That’s really thedriving force behind it.

[John Ivankoe:]

Okay, I’ll accept that. And then secondly, Mike, I just wantto make sure I understand how you are calculating the free cash; they are kindof rough numbers, but I think they are easy just to do off the back ofenvelope; in ’08, maybe $100 million of net income, round numbers, $20 millionof options add back, 75 of D&A maybe gets you a cash of like 195 and 165 orso of CapEx, the number’s like 30. Is there a pretty big chunk of working capitalbenefit that you are expecting in that number or is there something I’m notthinking about?

[Michael Dixon:]

No, I don’t think you’re too far off. I think your numbersare about right. We’ll get a little bit of --

[John Ivankoe:]

The number I came up with is like $30 million of free cash,so -- that’s not huge, but it matters to your equity bayou.

[Michael Dixon:]

No, we can go through it. I can try and walk through it withyou later. I don’t have all the details right in front of me right now.

[John Ivankoe:]

Okay. Thank you.

[Operator:]

Your final question comes from the line of Dustin Tompkinsof Morgan Keegan. Please proceed.

[Dustin Tompkins -Morgan Keegan:]

Thanks. Just quickly, you’ve obviously made some assumptionsabout 2008 with your earnings growth ahead of revenue growth. Should we assumethat you are not expecting much benefit in the way of cost of sales or labor?You know, when you said the 30 to 50 basis points is primarily an account oflower pre-opening and G&A, could you just update your commodity and laborpicture in ’08?

[Michael Dixon:]

I think you are pretty much right on. As of right now, weare assuming relatively flat commodity, cost of sales and relatively flatlabor, with the real benefits coming as you just indicated on G&A andpre-opening.

[Dustin Tompkins -Morgan Keegan:]

Thank you.

[Michael Dixon:]

Okay.

[David Overton:]

Thank you, everyone. Bye-bye.

[Operator:]

Thank you for your participation in today’s conference. Thisconcludes the presentation. You may now disconnect. Good day.