The Cheesecake Factory Incorporated
Q3 2009 Earnings Call Transcript

Published: 23 Oct 2009

[Operator:]

Good day, ladies and gentlemen, and welcome to the third quarter fiscal 2009 earnings conference call. My name is Britney and I will be your operator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a remainder this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Jill Peters. Please proceed.

[Jill Peters:]

Good afternoon and welcome to our third quarter earnings call. I’m Jill Peters, Vice President of Investor Relations. With us today are David Overton, Chairman and Chief Executive Officer; and Doug Benn, Executive Vice President and Chief Financial Officer. Before we begin, let me quickly remind you that during this call, items may be discussed that are not based on historical facts 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, which is available in the ‘Investors’ section of our website at thecheesecakefactory.com 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. David will start off the call today with some opening remarks. Doug will then take you through our operating results in detail and provide our current expectations for the fourth quarter as well as our initial thoughts on 2010. Following that, we will open the call to questions. Without further delay, I will turn the call over to David.

[David Overton:]

Thank you, Jill. Our results for the third quarter were better than we expected due to stronger comparable sales as well as lower cost of goods sold and restaurant operating expenses. Guest traffic was stable with second quarter levels and we saw a nice improvement in menu mix, particularly through increased dessert sales. At The Cheesecake Factory, the comparable sales pressure was again slightly more pronounced in the west, particularly in California and the northwest. The southwest region, which includes Arizona and Nevada is starting to stabilize on a sequential basis and Florida and the southeast were actually both slightly positive. Given these geographic trends and our demographics of attracting a higher end guest, we believe that recent gains in the stock market could have a positive impact on our guests. We introduced our Stefanie's Ultimate Red Velvet Cheesecake on July 30th and it is the top-selling cheesecake in nearly all of our restaurants. It represented nearly 12% of dessert sales for the third quarter, which is quite remarkable given it was only in the restaurants for two months of the quarter. It’s this level of menu and product innovation that continues to define The Cheesecake Factory and that I believe is helping us to deliver a moderate sequential improvement in comparable sales at a time when the industry as a whole is not. In addition to the Red Velvet Cheesecake, we also introduced a number of new items during our summer menu change, which was completed in mid-September. Given the success we have seen with our more value-oriented Small Plates & Snacks, we expanded this menu with eight new items. We also introduced a Kid’s menu to further satisfy our guests’ needs. Strategically, increasing the Small Plates offerings keeps the menu fresh and helps focus guests’ interest and attention in this category. Importantly, our average check in the third quarter grew slightly. On the topic of value, we were pleased to be recognized by Zagat as the ‘Best Value in Full-Service Chain’ during a recent survey that they conducted. Value is an important determination for consumer right now when deciding where to dine out. In the upcoming Grand Lux menu change, we will likewise be focused on the concept of value. It’s one of the most extensive menu changes we’ve ever done at Grand Lux with dozens of new items being introduced. Another critical factor in our comparable sales performance is guest satisfaction. We continue to make strides in overall satisfaction scores with another modest increase from the June quarter. As we’ve said in the past, guest satisfaction scores are very important to us, but the continual step-up is particularly significant right now, because it demonstrates that we are achieving the right balance between cost savings and service. Our cost management initiatives are progressing well and we captured over $8 million in savings during the third quarter for a year-to-date total of nearly $19 million. This is relative to our target of between $22 million and $24 million in cost savings for this year, so we are right on track and we continue to look at additional opportunities to further align our operations with current sales volumes. The third quarter was a busy one for our marketing team with campaigns related to National Cheesecake Day and Hunger Action Month. We believe these campaigns were successful in engaging guests and driving brand awareness. The publicity surrounding National Cheesecake Day generated substantial advertising value, which is excellent leverage on our marketing budget. The Drive Out Hunger Tour was unlike anything we’ve ever done before. The tour visited 30 restaurants in 30 cities in 30 days in September, beginning in Los Angeles and culminating in Washington, D.C. Along the way we collected more than 30,000 cans of soup for local food banks. We garnered local publicity and energized our staff. Finally, some comments on development. While we don’t plan any opening – opening any additional restaurants this year, at this time our plan for 2010 calls for as many as three new Cheesecake Factory restaurants and we continue to look for additional sites. At this time, I will turn the call over to Doug, who will review our results, discuss our outlook for the fourth quarter, and provide some thoughts on 2010.

[Doug Benn:]

Thank you, David. Total revenues of the The Cheesecake Factory for the third quarter were down slightly at $400.6 million. Restaurant revenues reflect the 2% in total restaurant operating weeks, primarily from the opening of three new restaurants during the trailing 15-month period, offset by an approximate 2% decrease in average weekly sales. Overall, comparable sales at The Cheesecake Factory and Grand Lux Café restaurants decreased 2.8% for the quarter. By concept, comparable sales decreased 2.4% and 6% at The Cheesecake Factory and Grand Lux Café, respectively. At The Cheesecake Factory, we implemented an effective menu price increase of just under 1% in our summer menu change, which gives us about 2% of price in our menu as compared to last year for the remainder of 2009. Our average check at The Cheesecake Factory was higher this quarter compared to the third quarter of last year. Dessert sales continue to be positive although sales of beverages are down. Additionally, we continue to see a slightly higher check average for guests ordering from the Small Plates menu. Comparable sales in the third quarter at Grand Lux Café were a little weaker sequentially. While we have a couple of locations that are delivering positive comparable sales, others have sales levels that are below average, which we are working to improve through specific marketing and other initiatives, including the extensive new menu roll-out that David spoke about earlier. We continue to closely monitor these units and evaluate their performance. At the bakery, third-party bakery sales were down about 1% versus the prior year at $14.1 million. Cost of sales decreased to 23.9% of revenue for the third quarter of 2009 compared to 25.7% in the same quarter last year. The 180 basis point improvement was driven primarily by lower restaurant comp sales. We continue to capture cost savings associated with our cost of sales initiatives, which accounted for about one-half of the favorability in the third quarter. Our menu development efforts along with other things such as negotiating more favorable pricing for commodities and ordering more efficiently to reduce partial truckload deliveries are delivering meaningful savings. The other half of the cost of sales benefit stem primarily from lapping [ph] the commodity price spikes that occurred in the summer of 2008. During this timeframe, prices were significantly higher for a number of items, including pastas, grains, cooking oils, produce, and dairy. Additionally, our bakery continued to benefit from its favorable year-over-year contracted price for cream cheese. Total labor was 32.9% of revenue for the third quarter, down 30 basis points from 33.2% in the prior year. We continue to experience higher health insurance cost in the third quarter. Absent this, our direct operating labor was about 80 basis points better than the third quarter of last year, due to our operational initiatives, which resulted in improving our overall productivity. Other operating costs and expenses were 25.5% of revenues for the third quarter of 2009, down 10 basis points from 25.6% reported in the third quarter last year. Utilities were favorable by about 50 basis points, offsetting higher marketing expenses as compared to last year of about the same amount. Savings from cost management initiatives slightly more than offset deleverage from lower sales. G&A expense for the third quarter was 6% of revenues, up 70 basis points as compared to the third quarter of 2008. The majority of this increase came from performance bonus accruals, which we did not have last year. Interest expense included a $2 million charge to unwind a portion of one of the two remaining interest rate collars we have on the outstanding balance on our revolving credit facility. Our liquidity position continues to be solid. Our cash balance stands at approximately $82 million at quarter-end, despite using $50 million during the quarter to reduce the balance on our outstanding debt. After paying down an additional $25 million early in the fourth quarter, our revolving credit balance now stands at $125 million. We have repaid $150 million since year-end, exceeding our previously stated goal of reducing our debt by $125 million this year. Cash flow from operations through the end of the third quarter was approximately $146 million. Net of roughly $24 million of cash used for capital expenditures, we generated about $122 million in free cash flow in the first nine months of the year. That wraps up our business and financial review for the third quarter. Now, I’ll spend a few minutes on our outlook for the fourth quarter and preliminary comments on 2010. As I’ve said in the past, sales visibility remains low due to both last year’s volatility and the ongoing economic uncertainty, particularly with regard to unemployment levels and weak consumer confidence. However, we will continue to provide our best estimate for earnings per share ranges based on our comparable sales assumption. Because earnings per share are highly correlated to our assumed levels of comparable sales, I continue to urge you to consider our estimates to be more of a sensitivity analysis than an absolute prediction. With that said, for the fourth quarter of 2009, we expect diluted earnings per share of between $0.18 and $0.20 based on an assumed range of comparable sales between minus 2% and minus 3%. There are two items that we expect will negatively impact our fourth quarter comparable sales range by a total of approximately 1%. The first is the holidays. Halloween will fall on a Saturday and Christmas will fall on a Friday, both of which we expect will be detrimental for us compared to last year. In addition, our holiday marketing strategy has shifted away from retail sales toward a focus on gift card sales to bring guests back into our restaurants in the future. While this will dampen our fourth quarter’s comparable sales a little, we believe this approach will help us achieve our goal of building future guest visits. Our fourth quarter estimates imply diluted earnings per share for the full year 2009 on a GAAP basis of between $0.89 and $0.91 and full year comparable sales of about minus 3%. On a non-GAAP basis, our implied full year earnings per share estimate is $0.96 to $0.98, excluding the previously discussed items that we recorded in the second and third quarters. The combined impact from these items cost us approximately $0.07 in diluted earnings per share. The last page of our press release contains a description of these items. Excluding a projected 50 basis point benefit from lower pre-opening costs, we expect our operating margins in 2009 to be about flat to slightly lower as compared to 2008, depending on where we fall within our assumed range of comparable sales. We now expect our tax rate to be between 25% and 26% for 2009, based on a higher level of profitability, resulting in less leverage from the (inaudible) tax credit. Our projection for capital spending in 2009 remains between $35 million and $40 million. Now, for some preliminary thoughts on 2010. Our initial 2010 estimate calls for diluted earnings per share between $1.00 and $1.10 based on an assumed range of comparable sales between minus 1% and minus 2%. With about 60% of our commodities contracted on an annual basis for the next year, we currently expect food cost inflation to be between flat and up 1% in 2010. This reflects lower contracted prices for poultry and meat, offset by expected higher costs for some of our non-contracted items such as dairy and general grocery. Based on opening as many as three Cheesecake Factory restaurants next year, we estimate capital expenditures in the range of $55 million to $65 million. With that said, we’ll take your questions. In order to accommodate as many questions as possible, please limit yourself to one question and then re-queue with any additional questions. Operator?

[Operator:]

(Operator instructions) Our first question comes from the line of Steven Kron with Goldman Sachs.

[Steven Kron:]

Hey guys. Question, I guess first on the guidance, Doug, just real quick. Does that include any additional cost-saves as you guys look to expand potentially on that $22 million to $24 million that you laid out? And then secondly, David, on the unit development front, three units next year, it sounded as if you are going to look for sites to may be go above that. Can you maybe just talk about your current thinking on where you stand for reaccelerating growth down the road and how you are thinking about that?

[Doug Benn:]

The guidance does include the cost savings initiatives that will bring us the $22 million to $24 million for the year. It also includes $8 million to $10 million of cost. The 2010 guidance assumes $8 million to $10 million of continuing cost savings from the cost savings initiatives that we’ve already put in place.

[Steven Kron:]

But nothing new beyond that?

[Doug Benn:]

Nothing new.

[Steven Kron:]

Okay.

[David Overton:]

I – and Steven, you know I personally am committed to growth. I like to grow the Company. We have our 8000 foot Cheesecake Factory done. We have plans for 7200. So, as landlords, and I think some of them are starting to consider accelerating their building plan, but as great sites come up, we will be very interested in them. I certainly like to see as do somewhere between 10 and as many as 15 or so, but they all have to be great sites. But we have no reason to grow – just to grow right now. The great sites are still very expensive. They haven’t really come down. There is all kinds of people that are always willing to take great sites whether they are clothing or for every 21 can take 40,000 square feet and wipe out some great sites for potential restaurant sites. Having said that, we are still looking. These three sites were old sites that landlords move. We still have sites that they are – have moved into 2010 and 2011 that we’ve committed and I will fill in as many as I can.

[Steven Kron:]

Great. Thank you.

[Operator:]

Our next question comes from the line of Destin Tompkins with Morgan Keegan.

[Destin Tompkins:]

Thank you. Doug, my first question was on same-store sales. You gave us the guidance for the fourth quarter, but the last couple of quarters, you’ve kind of given us an update quarter-to-date if you are in that range or can you give us any specifics there?

[Doug Benn:]

Well, I don’t think we’ve given you any real specifics on quarter-to-date guidance. I think what we have told you is that the – what we – when we gave guidance, we’ve always factored in every thing that we knew at the time we gave the guidance and so we have three weeks of fourth quarter same-store sales under our build and that’s been factored in. The additional thing that I would say about the fourth quarter that you should take into account is what I said in my remarks about Halloween shifting and Christmas shifting and this small shift from – to more of a focus on gift card sales from retail sales. That’s about a 1% type of impact on the fourth quarter. So, if you look at the minus two to minus three guidance that we gave, you could really look at that on a comparable basis as minus one to minus two if you wanted to ignore these other things that are happening as far as assessing the – what we think about our operations and our ability to generate sales.

[Destin Tompkins:]

Okay. So, with those two I guess the calendar shift ahead of us it’s possible that you could be running above that trend and expecting those to be – negatively impact your trend, going forward. Is that fair?

[Doug Benn:]

Well, that’s fair, but it’s not necessarily true, but that could be true. I mean I am just saying to you that we took those three weeks, we know what those are, we know what we think the next ten can be or we don’t really know, but we are giving our best guess to what the next ten could be and that’s how we came up with it. So, the holiday shift would – are yet to come.

[Destin Tompkins:]

Okay. Great. And on the 2010 guidance, the sales guidance of negative one and negative two and earnings per share $1.00 to $1.10, it wouldn’t’ seem – I hadn’t run the numbers in detail, but it wouldn’t seem like that factors in a whole lot of margin improvement from 2009. Can you give us what the margin assumptions are and is that driven by the fact that there could be some sales deleverage with that comp assumption.

[Doug Benn:]

Well there is definitely going to be sales deleverage if you run negative comps, a negative one, a negative two, you’ll definitely have some sales deleverage. So, just by – in order to keep margins reasonable you are going to have to have continued focus on cost savings initiatives. So, as I said, $8 million to $10 million of cost savings initiative we already identified are in that number, but we are still trying to identify other ones. I don’t want to get into what individual margin assumptions are for now except for – with respect to cost of sales we did give some color on that.

[Destin Tompkins:]

Okay. And as you think about working the – working your way back towards margins from 2007 or from some of the stronger years, what kind of comps assumptions do you think you need to see? Can you see some nice leverage with a low single-digit positive same-store sales number?

[Doug Benn:]

I would think so, sure. I think if you look at the margins that we ran this quarter, they are not back at the pinnacle of where we were, but they are certainly a good step back towards where we were at minus 2.8, so certainly comps of plus three would generate some real positive margin improvement.

[Destin Tompkins:]

Okay. And last question, with that being said, as you look at the fourth quarter guidance, the comps don’t appear that much different than what you ran in the third quarter, yet it seems like the margins may not be quite as strong a they were in the third quarter, is that fair, and is there something that maybe we’ll limit the margins, the potential in the fourth quarter relative to the third quarter?

[Doug Benn:]

I think that the – if you want to look on a sequential basis and you understand the 1% holiday shift stuff, I will call it that, and we are really guiding or saying minus one to minus two. And so take the mid-point of that at minus 1.5, that’s a pretty good sequential improvement over minus 2.8, so we are assuming that the sales are getting stronger. Now, the margin assumption, again, we factored in everything. I am not sure I understand the question about the margins.

[Destin Tompkins:]

Okay. I mean it seems as though the margin improvement in the fourth quarter didn’t look as strong as what you just reported in the third quarter and I was just trying to make sure that there wasn’t some expenses you were expecting that might limit the margin improvement in the fourth quarter.

[Doug Benn:]

Well, part of it is, we have KMS in the third quarter. We’ve have had cost savings initiatives, basically help you out compared to the previous year for one year. And so KMS was completely implemented into our system by the end of September of 2008. So, really that particular thing is not going to help us very much in the fourth quarter. When it did help us a lot in the third quarter some – so some of the cost saving initiatives we saw from David’s comments $19 million worth of cost savings through these first three quarters and $22 million to $24 million expected for the year, there is maybe not that many – some of those have rolled off is what I am saying. And then it won't by impacting the fourth quarter. So, I am not assuming that we are going to have deterioration any more than normal deleverage from minus 2% to minus 3% comp store sales.

[Destin Tompkins:]

Thank you. That’s helpful.

[Operator:]

Our next question comes from the line of Joe Buckley with Banc of America

[Joe Buckley:]

Thank you. A question on the three openings, are those full-size Cheesecakes, are those the smaller format?

[David Overton:]

They are full-size.

[Joe Buckley:]

Okay. And, David, did you say you might be able to revert back up to as many as 10 to 15 for next year?

[David Overton:]

I didn’t say for next year, I said I’d like to given in quality sites landlords beginning to remodel sites and as long as we have good – any sites to choose from. But that’s what we’d like to do. Not that we were going to do.

[Joe Buckley:]

Okay. That’s like what you would like to do on an annual basis, looking out a couple of years as opposed to 2010–-.

[David Overton:]

Yes. It could be, although I shall tell you if some – a few more great sites came in right now, tag on to the end of the next year, we’d certainly be willing to build them.

[Joe Buckley:]

Okay. And you made it sound like these were – I think you said it specifically that these were sites that had been previously planned. How many sites like that are there, how many sites might have been in the pipeline if–?

[David Overton:]

There is about four more that we basically committed to, but the landlords have put them either into 2010 or 2011. And as soon as they lock down their opening dates, then we’ll put them on our list. But that we’ve already basically liked and thought were great sites, but they just got – they got held up.

[Joe Buckley:]

Okay. And then just one last one from me. Doug, in the 60% of foods that’s contracted is the cream cheese included in that or is that yet to come?

[Doug Benn:]

No, it’s yet to come.

[Joe Buckley:]

Okay. And I don’t hear any markets have churned up in the last couple of weeks. Do you have any sense on that or is that just too early?

[Doug Benn:]

What – dairy markets. No, I don’t have a sense on where we are with respect to contracting for next year on cream cheese–

[Joe Buckley:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of John Ivankoe with JPMorgan.

[John Ivankoe:]

Great. Hi, thanks. Could you talk about your CapEx on those three new cheesecakes that you are planning for fiscal ’10? You know just optically it looks a little bit high, I mean is it, that you are taking less (inaudible) improvement dollars or are there store level or corporate projects that you are pursuing or could it also just be the fact that you have a lot of money that’s kind of in that number anticipating fiscal ’10 openings?

[Doug Benn:]

So, you are talking about the CapEx projection for next year?

[John Ivankoe:]

That’s correct, Doug.

[Doug Benn:]

Okay, yes. It’s – it looks higher than it should be and looks higher based on three openings. These opening are not more costly than any other opening we’ve done. We spend anywhere between $6 million and $8 million opening each restaurant, but in that CapEx assumption are some assumptions with respect to first quarter 2011 openings and that CapEx number is this early in time is there is a big swag factor to it. So, you have to put in the fourth quarter we’re going to be opening restaurants. In the first quarter 2011, we are going to be spending money in 2010. So there is no big other projects that are assumed in there and there is probably some level of cushion in those numbers.

[John Ivankoe:]

Okay. And when will the units opened throughout the year in fiscal ’10, are you prepared to say that?

[Doug Benn:]

Well, two of them, the two of them that we – two of the three will open in the first half of the year, really both in the first quarter. And the second and third one is still open up – we would hope to open up in the second quarter.

[John Ivankoe:]

Okay. And just one more, if I may, and I guess a little bit bigger picture. I mean when you looked at your rate of development, with hindsight obviously being 2020 kind of ’05, ’06, ’07, I mean were you able to identify any particular properties, you know maybe things that you did wrong, where you kind of said, well may be we penetrated this market too deeply or maybe this other kind of market didn’t deserve a 10,000 square feet unit that you won't see differently in the next cycle?

[David Overton:]

You know, I don’t think there is too much of that. We think a lot of the restaurants that opened up under our projections were because of the economy. They stopped building. Housing developments that were supposed to be built out, stopped. We opened with all the best people with Nordstroms, with great department stores, great names. We didn’t open in any off-sites, anything too far out. We didn’t take any more risk than we normally did. I just think that some of those developments were on the newer site, so you were more dependant on the housing market being filled in and that’s what stopped. So, will we be a little more prudent on some of these deeper suburban sites, probably, but I think when you really look at the sites that are under-performing, I think in the end we’d all say it’s mostly due to the economy.

[John Ivankoe:]

Great. Very helpful. Thank you.

[Operator:]

Our next question comes from the line of Matt DiFrisco with Oppenheimer.

[Matt DiFrisco:]

Thank you. Looking at the – following on to John’s question there on the development, with two openings happening in the first quarter potentially are you going to have then the majority of the pre-opening falling for those stores in the fourth quarter of ’09, so annualized 2010 will have a lower pre-opening as well?

[Doug Benn:]

Well, we would expect pre-opening in the fourth quarter to be somewhere in the neighborhood of $1 million, I think. So, I am not sure I have the breakout. Some of that pre-opening maybe happening then, but most of it will be in the first quarter of next year.

[Matt DiFrisco:]

Okay. So, you will have about $4 million or so in ’09 and I would expect then a lower than $4 million in 2010 given that you will have some of those two stores’ dollars fall into ’09 and you are only having one store really fully open in ’10 – incur the expenses in ’10, correct?

[Doug Benn:]

We are going to have the pre-opening expenses in ’10 of – for pretty much three restaurants. And we had one restaurant in ’09.

[Matt DiFrisco:]

Right. But you are – okay, but your off-site [ph] fall in from – in 1Q from a prior store and also some others–

[Doug Benn:]

Yes, we did have some of that. And the other thing to remember about pre-opening expenses and the way that we account for them is a little bit different maybe than some companies, which is we have relocation costs that are in there. We have manger bench strength that we’re – that we have in there that is not per se directly associated with the opening of restaurants. That’s whey we have – you know you might – another question you might have is why we have pre-opening at all in the third quarter of this year, because we didn’t really, we haven’t spent any pre-opening money. And it had to do with those items like that, the bench strength items and the relocations costs. That’s why there is some expenses. So, it’s a little bit more convoluted to figure it out, but I’d be – we’d be happy to work with you offline on what that would – how you go about looking at that.

[Matt DiFrisco:]

That will be helpful. Also just looking at the comp, if I look back last year, I guess we are all looking at an easier comp for the quarter. Can you describe how that progressed in the three months of 4Q of ’08 to get to that sort of combined down 71, did it start off significantly stronger and then get weaker towards the end as most did in December and I guess we are–

[Doug Benn:]

It started off – the strongest month was November. The weakest month was December. So, it started off at – so that’s – that tells you right there. So, start off weak and got better in November and then real weak in December.

[Matt DiFrisco:]

Okay. I guess are you then trending right now below – are you trending close to those numbers then of what you are guiding to, or you are expecting a little bit more given that November was the strongest month and December was really weak. Are you trending at those number for 4Q that you are guiding, or are you are being a little conservative.

[Doug Benn:]

I am – we’ve – again, I don’t know how many times I have to say it. we have factored in all – everything that we know that’s as of today, everything we know, three weeks worth of sales. Everything that we think is going to happen in weeks following this using the best crystal ball that we have, including what happened last year. We didn’t leave that out, we didn’t leave out holiday shift, and that’s we came up with. And we are not trying to be conservative. And in fact we’ve put a number down that is actually significantly better sequentially than the third quarter was.

[Matt DiFrisco:]

I understand. I don’t mean to get you frustrated. I am just – through all the conference calls we’ve heard different things where weather has impacted some people in the first start to October and then some have seen a sequential improvement. I think one of your peers have said that. So, I am just curious on what you were seeing. Sorry to keep hammering the point.

[Doug Benn:]

Just because the comps were low last year, I think you saw in the third quarter that I was asking in the third quarter in September about well what about the low level sales that you had last September. Well, we were fortunate that we were able to compare favorably with that this year, but a number of other restaurant companies when left [ph] around easy comparisons didn’t compare that favorably. So I don’t think you can just – it’s not a guarantee that a lousy year creates a greater year the next year. I think there is a lot of other factors involved.

[Matt DiFrisco:]

100% agree. Can you give us a little indication of what type of pricing environment might be embedded in 2010 as far as your comp guidance is there in (inaudible) price?

[Doug Benn:]

No, we put, here is – yes, that’s a good question. We have assumed that we will get our normal price increase of 2% and again there is really nothing guaranteed about that because what we are obviously going to do when it comes upon each of the menus, the two menu changes that we’ll do next year, is make an evaluation at that point in time whether it’s – we’d like to not have to raise prices. And so we’ll evaluate it then. But what’s embedded in that minus one to minus two is that we’ll take 2% price.

[Matt DiFrisco:]

See, I can come up with a good question without making you mad at me there, Doug. Well I got one in there at the end. And then last question, David, where do we stand and when can we expect to start to see maybe some of the smaller prototypes. I think we were looking at that. Maybe some of us on the Street were looking at that as a vehicle that could reignite the growth at Cheesecake. What’s the governor [ph] on that, why aren’t we seeing that maybe be on of the three or two of the three stores in 2010?

[David Overton:]

Well, remember these three stores in 2010, and I think there is three or four others, were all decided on in 2008 and 2009 or early this year, but they were put off by the landlords. So there aren’t like sites, so we are looking for those sites. We – definitely when we find the right one, and we were looking at a whole bunch of things right now. Want to open one of those 70, 270-300, I do think you are right, it could ignite a whole new level of growth in those markets. And I for one, we have the building design, we just want to put it down, kind of have another Annapolis [ph] where we make sure that we are doing the volume somewhere between $7 million and $8 million and then we will know what we have. So I am anxious to get it built.

[Matt DiFrisco:]

Great. Appreciate the time. Thanks.

[Operator:]

Our next question comes from the line of Brad Ludington with KeyBanc Capital Markets.

[Brad Ludington:]

Thank you. David, I wanted to ask – I missed at the beginning, you talked about California and Nevada and Florida and the southeast, so I didn’t hear the other region and what the trend was on that.

[David Overton:]

I don’t think – I think that was the only one that we said that we stabilized in Nevada and Arizona, that we are still a little bit negative in California. Nice surprises, we were just a little better in Florida and the southeast. And whether that had something to do with the stock market coming back and the number of retirees and so on that they felt better, we weren’t sure, but that’s kind of how we saw. The rest were kind of the way they’ve been.

[Brad Ludington:]

Okay. Thank you. And then, can you comment on some of the stabilization you’ve seen – have you seen any movements in customers back to bar drinks or other drinks other than water or maybe the tea that they have been drinking over the last year?

[David Overton:]

No, you know – go ahead, Doug–

[Doug Benn:]

Yes, I will call it beverages sales and beverage sales in general are down.

[David Overton:]

We are still saving money there. The (inaudible) were up and that helped us quite a bit whether it was because of the Stefanie's Cheesecake or just again we find that with – people order Small Plates & Snacks, they tend to order dessert more often because they take their savings and they continue to buy and make themselves happy. Other than that it’s still the same thing. Bottled water is down a little bit. Alcohol is down a little bit. And again that is where they are managing their check.

[Brad Ludington:]

Okay. And then, Doug, you talked about in previous quarters the COGS impact of the Small Plate menu. I think we’ve started with – we’d estimated it’s up to maybe 60 basis points in benefit last quarter. Is it somewhere similar with the expanded menu or more significant or anywhere around there?

[Doug Benn:]

Well, I think out of our 180 basis points comparative – positive comparison with prior years, that is – about 90 basis points of that has to do with what we call initiatives. And menu development is one of the initiatives. So if you take that 90 I am not sure I know how many I would say 30 to 40 basis points of that 90 basis points has to do with lower cost of sales because we are selling lower cost items. But also on those initiatives are supply chain work, our SKU review, and other things that we did also as part of that 90, so maybe 30 to 40 is menu development piece.

[Brad Ludington:]

Okay. And then finally, I am sorry to drag, just one quick one. We’ve seen that we expected I think our expectation has been around $1 million in amortization of the swaps interest hidden in your interest line through at least the first quarter of fiscal ’10. Should we expect something like that to continue going into second, third, and fourth quarter in ’10?

[Doug Benn:]

Well, we took a – when we take the hedge off, there is no more amortization that needs to be done with respect to that piece. Now we – the rest of our debt – all $125 million is all hedged. So there is going to be some amortization. So I would say that if you were amortizing you basically $25 million of $150 million went away, so you have still of the rest of it yet to do.

[Brad Ludington:]

Okay. Thank you very much.

[Doug Benn:]

Welcome.

[Operator:]

Our next question comes from the line of Keith Siegner with Credit Suisse.

[Keith Siegner:]

Thanks. First question, I just want to follow-up on a little bit, so all of the remaining debt is hedged. Can you talk a little bit about maybe what’s your thoughts are regarding additional debt reduction from here? Would you like to reduce the swaps some – I mean the – to hedge somewhat and pay down debt from here, how are you thinking about his level? Because you’ve kind of reached that targeted greater financial flexibility that you’ve talked about in the past.

[Doug Benn:]

Yes, absolutely we have and if you want to look at what we are going to do with our free cash flow next year, that would be one way of asking that question and I think in the short term that it makes sense to continue to pay down our debt. There is certainly certainty in that resolve and the impact – we know what the impact on the P&L is and if we pay down our debt, we have a revolver; we always have the ability to draw it back out any time we want. So it’s not like that once you pay it back you don’t get it back. Longer term, our first priority with respect to free cash flow is always going to be use to fund CapEx for growth, but beyond that we are going to need to make some strategic decisions, share repurchases, the powerful institution as dividend. Those are considerations, but haven’t been decided on. When we – if we do decide as I mentioned to continue to pay down our debt next year, which looks likely then the question is will we take off the hedge each time, because you don’t have to remove the hedge but historically when we have paid off our debt we have removed the hedge and we’ve done that for a number of reasons, one, it gives us cash and accounting certainty, but the real reason is that we are in the restaurant business, not in the interest rate speculation business. So, if you have a hedge in place and no debt in place, that would be a naked hedge. And so we probably – although that would be acceptable to do, it would not be something we would probably want to do. So, with respect to paying off our debt next year, when we pay off our debt, we are going to more than likely remove the hedge as well.

[Keith Siegner:]

That’s perfect. Very helpful. And then the second question. I just wanted to ask just kind of quickly about Grand Lux Café. I mean it’s been underperforming a little bit. Here you talked about some menu changes. Do you think that the difficulties in marketing that concept compared to a Cheesecake are somewhat contributing and what might have to happen to start to talk about growing that concept again?

[David Overton:]

Well, it’s not that we stop. I think we are being very careful. We have a little smaller prototype size that we are waiting to find the right location and build. We’ve filled the menu with value, which is one reason why I think it’s lagging Cheesecake right now in this economy because it’s viewed as being higher priced. Its comps are still better than NapTrack [ph] and many of our competitors. And remember outside of Vegas there is only 11 of them. So we really are having to build its reputation, although we are marketing in a few of those areas. We have not given up on Grand Lux by any means, and – but we think we are in the right track and doing the right things to give it a real push here given that we are in this economy, we don’t know when it’s going to end.

[Keith Siegner:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Jonathan Comp [ph] with Robert W. Baird.

[Jonathan Comp:]

Hi, thanks for taking my call. It’s Jon Comp [ph] for David Tarantino. Looking at The Cheesecake Factory comp ion Q3 that you just reported, can you may be provide a little more color on how the comp improvement progressed throughout the quarter and maybe if you would point to any of the specific marketing initiatives that worked particularly well

[Doug Benn:]

Sure. Just in general, I’ll point out what happened during the quarter. In July and August we are fairly even with each other and September was better than July and August and it was better for a couple of reasons, one, there were easier comparisons in September. And then there was also the – this Labor Day holiday shift. Labor Day was one week later, had the effect of extending the big summer selling season one week. So that was helpful to the quarter. Let’s see, the other part of your question was–

[Jonathan Comp:]

Just marketing initiatives that–

[Doug Benn:]

Yes, in the second quarter, I mean in the third quarter we had a couple of things going on. Interestingly enough there weren’t many direct sales drivers in our marketing program in the third quarter. We did two very significant things that David talked about associated with National Cheesecake Day and some great media publicity that surrounded that. And then Hunger Action Month where there was a lot of very high staff engagement and also us distributing some guest cards for future visits in the fourth quarter. So the third quarter did not have other than some guest cards that we gave out on National Cheesecake Day, which only amounted to about 200,000 pieces, there wasn’t a lot of direct sales drivers in the third quarter. And in spite of that really the strength of our brand and the effort is focused on our guest garnered us slightly better sequential comps than the second quarter.

[Jonathan Comp:]

Okay thanks. And then just a quick follow-up. Thanks for the color on marketing during Q3. Maybe if you could just discuss your expectations for Q4 and 2010 a little bit?

[Doug Benn:]

With respect to marketing?

[Jonathan Comp:]

Yes.

[Doug Benn:]

Yes, in the fourth quarter, there is really two parts to the marketing program. And the first part I mentioned. It was the distribution of about two million guest cards during the month of September that are redeemable – there were actually two cards in each guest card that guests got when they were in our restaurants. And one of those cards is good for redemption for a free slice of cheesecake with a $30 purchase on Sunday through Thursday for the first half of the fourth quarter and the other card is good after Thanksgiving. So, those are two things that we think will help us in the fourth quarter. And in addition to that we have another piece of the marketing program we call Share of the Joy, the second part of the program will be implemented after Thanksgiving and it will be focused on our signature items such as cheesecakes and it will be focused on gift card sales. And we’ve not really announced the details yet, so I want to hold off on talking about specifics, but that’s in general what we have going on in marketing. And for next year, we are still developing our plan. We are going to continue to be focused on Cheesecake Factory brand engagement and driving profitable comp store sales growth. We’ll remain on brand with any marketing we do. We’ll resist the temptation to discount. And just the budget what we spend on marketing will be driven by the specifics of that plan. So that’s still in the works.

[Jonathan Comp:]

Great. Thank you.

[Doug Benn:]

Welcome.

[Operator:]

Our final question comes from the line of Jeffrey Bernstein with Barclays Capital.

[Jeffrey Bernstein:]

Great. Thank you. A couple of questions. Just wanted to really – clarification on the guidance for next year. I think you said $1.00 to $1.10; you were talking about lapping your non-GAAP $0.96 to $0.98 guidance in ’09, is that how you look at it?

[Doug Benn:]

Well, actually that number that we gave for next year is GAAP guidance, so, yes, that – however you want to compare that to this year that’s what our GAAP guidance is next year.

[Jeffrey Bernstein:]

Okay. And then just to clarify, 2% price you are expecting at this point, 2010, and I think you said the commodity basket will be flat to may be up one, without getting too much into margin opportunity there. So, that may as well allow for some meaningful restaurant margin expansion.

[Doug Benn:]

That would – if – we talked about incorporating 2% into the guidance, 2% of menu pricing. We didn’t say that we would definitely do that. We are saying that’s what we have done before and that’s what is in the guidance. But if you have 2% – if we are able to get 2% menu pricing and commodity costs and cost of – inflationary cost with respect to food is only about 1%, then there should be – we should have slightly lower cost of sales.

[Jeffrey Bernstein:]

Okay. And then the cost cuts, the $22 million to $24 million in ’09, is there – is any of that cutting that might be required to be reinvested perhaps in 2010 if you were to reaccelerate unit growth or I guess beyond 2010 or is – the cost-cutting that’s been done have no negative impact or not require any reinvestments of reaccelerating unit growth?

[Doug Benn:]

Yes. That’s a good question. A lot of the costs that we – we’ve looked at that. A lot of the cost that we’ve taken out aren’t going to come back. If you think about the initiatives that we’ve taken, we are more efficient now and things like labor because of the KMS system or because our staff has cross-trained or whatever, we won't lose those efficiencies. The piece of the initiatives that could come back is we are fortunate enough to really grow our restaurant sales, there – we might require additional staffing in the restaurants that we don’t have now or we have right-sized, if you will, related to the reduction in sales volume.

[Jeffrey Bernstein:]

But you are like real estate development people and other things related to the actual searching for and opening of new units, and I am assuming those people are no longer or they have been redeployed and will just return to that role.

[Doug Benn:]

Well that – we have the number of real estate development people right now that we need to accomplish any growth that we foresee at least for the next year or more.

[Jeffrey Bernstein:]

Okay. I mean just lastly, I don’t know if you would share this or not, but I know you’ve talked a lot about dessert and alcohol. Can you just talked about may be dessert and alcohol and appetizers each as a percentage of sales or perhaps margin contribution on relative to kind of the core menu?

[Doug Benn:]

Yes, not margin contribution, but desserts as a percentage of sales have actually – David said, were very strong. We – last year, at this time, they were about 14% of sales and now they are about 15% of sales. So, doing very well. Alcohol beverages are more in – let’s see, I am going to put a number – 12% or 13% of sales and that’s been as you might imagine, fallen off a little bit over time. So – what was the other one you asked about?

[Jeffrey Bernstein:]

It’s appetizers relative to (inaudible) and stuff.

[Doug Benn:]

Yes, I don’t really have that information.

[Jeffrey Bernstein:]

And the alcohol, you said is now 12% to 13% or was 12% to 13%?

[David Overton:]

Now, it’s 12% to 13%.

[Doug Benn:]

Now, it’s 12% to 13%.

[Jeffrey Bernstein:]

What had it been in good times?

[David Overton:]

I think the highest we’ve ever gotten is about 15.

[Jeffrey Bernstein:]

Great. Very helpful. Thank you.

[Doug Benn:]

You’re welcome.

[David Overton:]

Alright. Thank you, everyone. Is that it? Alright, bye-bye.

[Operator:]

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.