Cheesecake Factory Inc (CAKE) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to The Cheesecake Factory quarterly conference call. [OPERATOR INSTRUCTIONS] Thank you, Mr. Dixon you may begin your conference.

Thank you, operator. Hello, everyone I'm 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, let me briefly cover our cautionary statement regarding risks factors and forward-looking statements in general, as well as a couple of housekeeping items. 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. Now, it's been a little while since we held a conference call or talked in depth about our business so we have a lot of cover. However, before I get into the details of our results, let me remind everyone that fiscal 2006 is a 52 week year for us and fiscal 2005 was a 53 week year. With an extra week in the fourth quarter in 2005. The fourth quarter of fiscal 2006 will have 13 weeks and will end on January 2, 2007.

Secondly, although the press release we issued this afternoon includes our financial results for both the second and third quarters of fiscal 2006, we will primarily focus our comments today on today's call on our third quarter results and outlook for the fourth quarter and beyond, although we would be happy to answer questions related to either quarter during the Q&A. So, our agenda for the call will be as follows. We'll start out with a few details about the recently completed internal review of our stock option granting practices. Then we'll discuss The Cheesecake Factory's financial results for the third quarter of fiscal 2006, which ended on October 3, 2006. We'll refer to that quarter as the third quarter in our comments today.

Next, we'll provide some commentary on sales expectations for the remainder of the year. And after that we'll answer as many questions as the time remaining allows. We would like to finish up this call in about an hour, so let's get into the detail. As for the stock option review, I think this is pretty well covered in our press release but as this topic did delay our filings for several months and that is the first time we have spoken publicly on the matter, I think it is worth a recap. On July 18, 2006, we announced that the audit committee of our Board of Directors began a review of the Company's practices as related to stock option grants. This voluntary review was initiated at management's request, in response to media and reports regarding the stock option granting practices at numerous publicly traded companies. And was conducted with the assistance of special outside legal counsel. The review spanned the 14-year period from our IPO registration in 1992 to the present. The conclusion of the review was announced on November 20, 2006.

The audit committee found no evidence that any person acted with intent to deceive or mislead and did not recommend the termination of any current Company management or the resignation of any member of our Board. The audit committee did find that we incorrectly applied the measurement date, as defined in APB 25, to certain stock option grants issued between 1997 and 2004. With over 90% of those affected option grants occurring prior to January 2003 and no affected options granted to executive officers since early in 2001. The Cheesecake Factory has successfully used equity compensation as an integral part of our overall compensation strategy since going public. This strategy allowed us to attract and retain the best operators in the restaurant industry, which in turn allowed us to develop and operate the busiest and most productive restaurant in the industry. Our stock option grants generally fall into two buckets; grants based on promotion or hire into an options eligible position, and annual grants to corporate management, including executive management.

We started a formal equity compensation program for our restaurant operations team in 1998. The specifics of this program called for participants in the program to receive a grant of stock options within 30 days after their promotion. In application, this was translated into the lowest price in that 30-day period. A similar philosophy was applied to other grants made by the Company.

Based on a current interpretation of grant dates, the audit committee deemed this methodology to be incorrect. Accordingly, we calculated the compensation expense as the difference between the stock price at the date of actual grant approval and the stock price at the grant date. Under the guidelines of APB 25 this in-the-money difference should have been recognized compensation expense in the financial statements over the vesting periods of the options. The total after-tax compensation expense to be recognized was $5.5 million. A large portion of the expense, about $3.5 million, will be recorded as a reductions to retained earnings as of December 31, 2002, as many of the grants in question date back to 1999 and earlier. The remainder will be recorded to the labor and G&A expense lines spread across fiscal years 2003, 2004, and 2005.

There's also slight adjustment to our first quarter of fiscal 2006, about $140,000 as we adjusted our FAS 123-R calculation for these options as well. I think it's important to note that the amount recorded in any one fiscal year or fiscal quarter, as a result of this restatement, is not material for that period and does significantly change diluted earnings per share in any of those fiscal years. In any event, we will be restating our Form 10-K for fiscal 2005 and our Form 10-Q for the first quarter of fiscal 2006 to reflect these adjustments. Under our current option granting practices all option grant dates are determined in accordance with the guidelines outlined in the Statement of Financial Accounting Standards Number 123R share-based payments.

Okay. With that over, let's move on to our most recent operating results. As we reported on October 9, total revenues at The Cheesecake Factory for the third quarter increased approximately 11% from the comparable period of the prior year. Our total restaurant sales increased approximately 11% also during the third quarter to $311.6 million. This increase was comprised of an approximate 15% increase in total restaurant operating weeks, resulting primarily from the openings of 20 new restaurants during the trailing 15-month period, coupled with an approximate 3% decrease in average sales per restaurant operating week.

Overall, comparable sales at the Cheesecake Factory and Grand Lux Cafe restaurants decreased approximately 1.6% for the quarter, also as previously reported. We believe the decrease in comparable restaurant sales was primarily attributable to general economic conditions and their impact on the consumer, as we and many others in the restaurant and retail sectors have discussed at length. We did not take a menu price increase in our recent summer menu change, so we have an approximate 1% affected menu price increase in the menu from July through the remainder of fiscal 2006. While we believe the decision not to raise prices was the right move for the long-term benefit of this Company, this decision, along with the slightly lower traffic in general, did impact our margins. And I'll talk about this in a few minutes.

We are currently in the process of reviewing menu pricing for our winter 2007 menu, which will roll out in January and February of 2007. I will remind everyone that we view menu prices as a defensive measure to protect our margins against sustained or long term cost pressures. As we demonstrated with our last menu change, we do not use menu price increases to drive short term revenue increases or to cover temporary cost increases. Having said that, we recognize that there is considerable wage pressure in 2007 with the large number of minimum wage increases going into effect in January. At that time, we expect to take an approximately 1.5% effective menu price increase in our winter menu change to help offset this labor pressure and other cost pressures as well.

Now returning back to Q3, average weekly sales at The Cheesecake Factory restaurants decreased approximately 3%. This is slightly behind the change in comparable restaurant sales. There are a number of reasons for this, in addition to the honeymoon effect we have discussed many times in the past. First, when we open in existing markets, we generally do not experience nor do we expect to experience the honeymoon sales trends of roughly 130% of sustainable volumes that we often see in new markets. Eight of the 14 restaurants opened since the third quarter of last year are in existing markets. The strategy of capturing additional profitable market share in areas that we know very well and where our brand recognition is high has worked well for us and we will continue to maximize this opportunity in the future.

Second, the restaurants we have opened over the last 18 months are considerably smaller on average than those opened prior to that time period. The average number of productive seats is about 5% less at those restaurants not in the comp based compared to those restaurants in the comp base. This is a function of opening restaurants in great markets as our preferred sites become available and appropriately fitting the restaurant size to those markets. Most importantly, the returns at these locations are in excess of our cost to capital and deliver a fully capitalized turn in excess of our 25% threshold.

Finally, the slightly slower traffic resulting from the general macrofactors impacts these non-comp locations just like it impacts the restaurants in the comp base. Having said that, we have some stellar restaurants in a number of new markets. Albany, New York is averaging approximately $280,000 per week. Oklahoma City is averaging over $240,000 per week. And Omaha, Nebraska is averaging a very strong $250,000 per week after its first four weeks. These are impressive sales in a generally tough environment and in slightly smaller markets. This give us us a lot of confidence as we pencilled out our goal of 200 Cheesecake Factory restaurants.

We also continue to be very pleased with the sales at our Grand Lux Cafes. Comparable sales at the Grand Lux Cafes increased 6.7% in the third quarter. Our newest location in Boca Raton, Florida is doing well. Averaging nearly $220,000 in weekly sales, which we believe is a solid performance over a nine week period for a young concept without any advertising or promotions. Grand Lux continues to solidify itself as a strong viable second concept for the Cheesecake Factory.

Longer term, we feel very confident there is plenty profitable growth ahead for both The Cheesecake Factory and Grand Lux Cafe concepts. With only 126 restaurants opened to date, we remind our investors that the majority of our expected revenue growth for the next few years will continue to come from the openings of new restaurants. Our current expectation of restaurant revenues for the fourth quarter is approximately 6% to 7% higher than the prior year reported restaurant revenues. Remember, that the prior year fourth quarter was a 14 week quarter and this year's fourth quarter is only 13 weeks.

Moving to our restaurant growth plan. We have opened 16 restaurants year-to-date and we will achieve our restaurant growth plan for fiscal 2006 of opening 21 new restaurants. We have five Cheesecake Factory restaurants opening over the next three weeks with locations in Dulles, Virginia; Boise, Idaho; Buffalo, New York; San Anita, California; and Riverside, California. This will make 13 restaurant openings for the quarter, which is a new record for us. Obviously a challenge, but we are confident that we open these restaurants at the level of quality and operational excellence expected of The Cheesecake Factory.

As a reminder, 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 us 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 preopening processes are typically consistent, usually taking four to six months to complete on average.

So, as a result of these factors it is not uncommon to have planned openings move a few weeks or even a month due to various factors outside of our control. In addition, the nature of the sites we choose lends itself to our opening schedule being more loaded to the back of of the year. And we have properly staffed our development and new restaurant operations teams to accommodate this. 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.

As for 2007, based on the information we have as of today, our preliminary goal is to open as many as 21 new restaurants, including as many as five to six Grand Lux Cafes. Now, this is a bit of a departure from our earlier goals for next year but this is really more of a timing issue. There are plenty of great locations for our restaurants but as usual, the majority of the sites available for next year are not available until the fourth quarter.

Rather than overburden that quarter for a minimal number of incremental operating weeks, we have elected to keep our number of targeted openings to as many as 21. However, with the large number of late openings in 2006 and the perfected square footage of next year's openings, we are still projecting operating growth and square footage growth of approximately 18%. We will give additional information as to the proposed timing of these openings by quarter when we report our fourth quarter financial results.

Now briefly, I've heard some questions about our development intentions with regard to Grand Lux, given that we only opened one new location this year. We did encounter delay with the site that was to be our second Grand Lux Cafe in fiscal 2006 and that location slipped into next year. However, with five to six new locations planned for fiscal 2007, there should be no question about our commitment to this concept. We always like to remind our investors that 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.

Before I move on to our bakery operations, I will note, that we have no meaningful update on the Asian test concept we discussed earlier this year. We have not yet signed a lease for this restaurant but we are very close and we are still targeting to open it mid-next year. This location is not included in the targeted 21 locations I just mentioned.

Now, moving to our bakery operations, as most of you know we opened our East Coast bakery facility in Rocky Mountain, North Carolina near the end of the first quarter. And this plant has been in production for about six months now. We are currently producing about 7,000 to 8,000 cakes per day and the state-of-the-art technology in this facility is producing cakes that are of the high consistent quality in both appearance and taste that we expect. Bakery sales, net of inter-Company bakery sales, decreased in the third quarter to $13.7 million versus $14.3 million in the prior year. This decrease was due primarily to lower sales to our warehouse club customers and much of it was timing related, as one large shipment moved a week into the fourth quarter.

Our plan for outside bakery sales is focused on generating consistent and predictable sales and contribution margins. We will leverage the added capacity from our East Coast facility to continue to meet the increasing requirements for our warehouse club customers and pick up new profitable business as it becomes available. We expect bakery sales to increase approximately 7% to 8% in fiscal 2006 compared to the prior year. Again, this is comparing a 53 week year in 2005 to a 52 week year in 2006. Please remember also, the bakery sales will account for only about 5% of our total sales for the fiscal year.

While we remain optimistic with respect to opportunities to steadily build our bakery sales volumes over time, we always remind our investors that bakery sales are not as predictable as our restaurant sales are. Our ability to predict the timing of bakery product shipments and contributions 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 impactful role 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 $160 million in desserts made in our bakery production facilities during fiscal 2006. Approximately 15% of our restaurant sales consists of dessert sales, which is a much larger percentage than achieved by most other casual dining restaurant concepts.

Now, that covers our top line performance for the third quarter and our new restaurant opening plan for the remainder of fiscal 2006 and into fiscal 2007. So now, let me briefly review the individual components of our operating margins for the third quarter. Cost of sales decreased to 25% of revenues for the third quarter, compared to 25.4% for the same quarter last year and essentially flat with the June quarter. The principal commodity categories for our restaurants include fresh produce, poultry, meat, fish and seafood, cheese and other fresh dairy products, bread and general grocery items.

We're currently able to contract for the majority of the food commodities used in our operations for periods up to one year. The remaining items consist primarily of fresh fish, dairy and some produce and poultry commodities that we have historically been unable to contract for periods longer than 30 days, in most cases. We saw continued favorability in poultry commodities during the third quarter, in the sequential quarter and both quarters showed considerable improvement from the comparable periods of the prior year. We've contracted with suppliers for those expected commodity requirements for fiscal 2006 that can be contracted.

We were also able to contract for the majority of our cream cheese requirements in our bakery operations for the full year, at a price per pound slightly less than the actual cost per pound in fiscal 2005. We will also purchase cream cheese on the spot market as necessary to supplement our agreement. Based on the contracts and our current expectations for those items that we cannot contract, we continue to expect cost of sales for the full year, as a percentage of revenues, to be approximately 50 to 60 basis points lower in fiscal 2006 compared to the prior year. We're in the process of contracting commodities for fiscal 2007 but at this time, do not expect much change from the current fiscal year.

Total labor expenses as reported were 32.3% of revenues for the third quarter. And this includes $1.7 million of stock-based compensation expense. Excluding this impact, labor expenses were 31.7% of revenues, which is up from 30.9% for the same quarter last year, as well as the 31.2% in the sequential quarter, also excluding stock-based compensation expense. The year-over-year increase in labor expenses as a percent revenues was primarily due to the de-leveraging of labor costs at the lower average sales per week.

Given this service is a significant part of our overall value proposition, we strive to balance restaurant staffing appropriately to achieve reasonable labor costs but we will never sacrifice the guest experience for short term labor cost savings. For fiscal 2006, we expect labor expenses before the estimated 50 basis point impact from stock option expensing to be approximately 40 to 50 basis points higher than the prior year. Primarily due to the lost leverage experienced in the first nine months of the year and the slightly lower traffic predicted for the remainder of the year.

Other operating expenses were 23.7% of revenues for the third quarter, an increase over 22.8% reported for the same quarter last year and from the 23% in the sequential quarter. The 90 basis point increase from the prior year was mainly due to higher utility costs and the de-leveraging of fixed cost maintenance contracts, as a result of lower average weekly sales at our restaurants. For the full year of fiscal 2006, we currently expect other operating costs, as a percent of revenues, to be up 50 to 60 basis points higher than fiscal 2005. Primarily as a result of increased costs for gas and electric service to our restaurants and the de-leveraging I just mentioned.

G&A expenses as reported for the third quarter were 5.7% of revenues, which included $2.5 million of stock-based compensation expense and approximately $1 million in expenses related to the internal stock option review. Excluding the stock-based compensation expense and the expenses incurred in conjunction with the internal review, G&A expenses were 4.6% of revenues, an improvement over the prior year but up slightly from the sequential quarter. As we have always done, we continue to effectively manage our overhead costs in line with our revenues.

Our G&A expenses consist of two major components; The costs for our corporate, bakery and field supervision support team, which should grow a lesser rate than revenues. And the costs for our restaurant management, recruiting and training program, which should grow at a rate closer to our unit growth rate. During fiscal 2006, we added and will continue to add resources as planned to the corporate support, training and supervision activities of our business, to properly support our restaurant and bakery operations for the planned 21 new restaurant openings. Our current expectation for total G&A expenses, as a percent of revenues for fiscal 2006 before the impact of stock option expense, is approximately 10 to 20 basis points higher than the prior year due primarily to professional service costs associated with the stock option investigation.

Depreciation expense was 4.1% of total revenues for the third quarter, compared to 3.9% for the third quarter of the prior year and 4% for the sequential quarter. For the full year, our current expectation for total depreciation expense, as a percentage of revenues, is in the 3.9% to 4% range, based on our expected growth and investment plans and taking into account the new bakery plant that came online this year. Actual preopening costs incurred during the third quarter were approximately $5.4 million, compared to $3.8 million for the same quarter last year.

We opened three Cheesecake Factory restaurants, all of which were in new markets, plus one Grand Lux Cafe in the third quarter this year, compared to opening three Cheesecake Factory restaurants, only one of which was in a new market in the same quarter last year. We also incurred stock-based compensation expense of $43,000 in the third quarter of fiscal 2006. And preopening costs in both the current and prior year quarters for other openings in progress. We usually incur most of our preopening costs in the two months before an opening and the month of a restaurant's opening. As a result, the timing of a restaurant openings and their associate preopening costs will always have an impact or our quarterly earnings comparisons.

The preopening costs for our upscale highly customized and operationally compact restaurant are higher than most restaurant concepts in terms of absolute dollars, but are in line with other upscale concepts, relative to the scope of operations. We estimate our direct preopening costs from 11,000 square foot, single story restaurant in an established Company market to average approximately $785,000. We will also incur indirect preopening cost associated with our corporate support team's involvement in new restaurant openings. Our expectation for full year fiscal 2006 preopening cost is $24 to $25 million. Slightly higher than originally planned due to some shifts in the opening dates throughout the year and the compressed time line at year end for a large number of openings.

Analysts and investors should factor enough preopening costs into their models for as many as 21 new restaurant openings during fiscal 2007, including five or six Grand Lux Cafes, which we currently expect preopening costs to approximately 10% to 15% higher than our normal preopening costs for a Cheesecake Factory restaurant. As well as approximately $1 million in preopening costs associated with the Asian test concept. We'll give more color on our preopening expenses in our fourth quarter call.

That covers our review of the major line item components of our operating margins for the third quarter. Again, please refer to the full discussion of risks and uncertainties associated with our forward-looking statements included in the Company's filings with the SEC. Our effective tax rate year to date was 31.4%. We currently expect our effective tax rate for the year to be approximately 31%.

Now, before I move off of the income statement, let me recap the accounting for stock-based compensation. Our total stock-based compensation expense reflected in the income statement for the third quarter was approximately $4.3 million. This is in line with our full fiscal year 2006 estimate of $19 million, of which $6 to $7 million will be charged to labor expense, $10 to $11 million be will charged to general and administrative expense, with the remainder being split between other operating expenses, preopening expenses and a little bit to property and equipment. This amount is consistent with the prior year's expense, as reflected in the footnote to our filings and adjusted for year over year growth.

Our liquidity position and financial flexibility continue to remain very strong. As of October 3, our cash and marketable securities on hand were $126 million, which is about where we are today as well. Our year to date cash flow from operations was approximately $98 million and our year to date cash and accrued CapEx, net of $18 million of deemed landlord financing, was approximately $110 million, which includes construction in progress for upcoming 2007 openings. We estimate our cash CapEx for fiscal 2006 to be in the range of $190 to $195 million. Based on our current expansion plans and current expectations of the operating environment, we expect to be able to finance our CapEx requirement for fiscal 2006 through expected operating cash flow, agreed upon landlord construction contributions and our cash on hand.

We continue to believe that maintaining the liquidity position in our current range makes good business sense in this operating environment, so that both we and our investors can have continued confidence in our ability to execute our growth plan with maximum financial flexibility. Knowing that we have the capital already in place to do so. There may be a small financial cost associated with the capital resources that we currently carry. But in our view, this small cost is offset by the benefits of reduced risk and flexibility, in terms of our abilities to execute our growth plan. We have no funded debt in our capital structure and currently do not anticipate a need for funded debt or any other external financing during the remainder of fiscal 2006, other than landlord construction contributions.

We do have a $35 million credit facility in place for back-up liquidity purposes and to support standby letters of credit per our insurance arrangement. We also have a share repurchase authorization from our Board of Directors to buy back up to 6 million shares in the open market. We did not repurchase any shares during the third quarter. We have approximately 2.4 million shares remaining in our current repurchase authorization, though the authorization does not require us to purchase any shares and may be terminated at any time.

Before I wrap up, I want to reiterate our current thought on sales for the remainder of fiscal 2006. Like many other operators in the casual and upscale-casual dining segment, we also also expect that in the short term we will continue to experience slightly lower traffic. While we have seen some improvement and our comparable sales for the fourth quarter to date are flat to slightly positive, we expect overall revenue growth, including bakery sales, to be in the 7% to 8% range for the fourth quarter. Again, this is comparing a 13-week quarter in 2006, to a 14-week quarter in 2005. And longer term, our expectation for annual comparable restaurant sales remains in the -- restaurant sales growth remains in the range of 1% to 2%.

To conclude our business and financial review, in spite of the ongoing traffic weakness that continue to affect casual dining operators, and the resources expanded -- expended on the internal stock option review; we focused on controlling those areas of our P&L that we could affect. And, as we always do, we focused on operational execution and delivering a great guest experience. We also concentrated on executing our development plan for fiscal 2006, which we fully expect to achieve. We certainly recognize that the lower average weekly sales have impacted our margins. While we will confident that the margin levels will return as average weekly sales increase, we continue to implement efficiency enhancements. Our productivity initiatives, such as the kitchen management system and other labor scheduling tools, continue to progress nicely. And we believe these tools allow us to more efficiently utilize labor and more effectively deliver an even better experience to our guests.

In fact, the kitchen management system will be installed in 34 restaurants by year end, including all eight Grand Lux Cafes. In addition, our growth initiatives, such as our site selection software, are helping us to develop an inventory of potential restaurant locations that we feel will be equally successful to our current roster of industry leading sites. We continue to believe there's room for approximately 200 Cheesecake Factory locations and as many as 150 Grand Lux Cafe locations. With only 126 restaurants open as of day today, we believe that our business has a sustainable period of profitable growth ahead of it for several years to come. And our strong financial position provides us with the capital resources and flexibility to continue executing our growth plan with great confidence.

Well, that concludes our prepared remarks for the third quarter 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 try to limit yourself to one question and then requeue with any additional questions. And remember, if we're unable to get to your questions on this call, please feel to call us at our offices after the call. Operator, we are now ready for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from John Glass.

Thanks. Mike, maybe you can talk about your decision to slow down unit growth in '07. It sounded from your comments like that was more of temporary than permanent change. But can you talk about what you think ongoing or future capacity growth expectations ought to be, maybe at least in percentage? And are we starting to enter a period of shifting where maybe The Cheesecake Factory unit openings are going cap out or even slow down and then Grand Lux will be the bigger portion of the incremental growth going forward?

Well, John, I think the second half of your question is absolutely correct. We've thought that for awhile, that at some point The Cheesecake Factory growth on a year over year basis in terms of number of units would sort of cap out and Grand Lux would play a bigger role in our growth targets. In terms of the number of units this year it really was, as I mentioned in the comments, a financial decision that as we get so many of those locations that -- they are great locations but they only become available at the back half of the year; it is a little too much of a burden from a financial perspective to have that much trying to accomplish in such a short time period. And you really don't get a whole of benefit in the year. So, we felt that we could spread those out a little bit and hopefully, see some of those fall earlier into 2008. which would help to balance the whole opening schedule.

So would you feel comfortable saying 18% store week growth on an overall enterprise basis is about what you would shoot for in '08 and beyond?

Well, at this point that's a reasonable number but yes, we'll get into more detail on that later. But I think at this point, that's a reasonable estimate.

Got it . Thank you.

Your next question comes from Jeffrey Bernstein.

Great. Thank you. You mentioned encouragement by the recent sales trends. Just wondering if we could dig into that a little bit? Wondering if you can give some color in terms of day parts, what's the regional breakout, traffic versus mix? In a more normalized consumer environment, I'm just wondering if you'd expect comps in '07 perhaps above pricing, obviously, benefiting from the lap of the negative compares in '06? Thanks.

Thanks, Jeff. Let's see I think the -- as we look at the fourth quarter sales to date, it's always been about traffic this whole year, since we have seen the lower comps, it's been traffic. Our average ticket is right up in line with where we expect it to be. The day part that we talked about last time in terms of being more mid-afternoon and late night is still true. I think it's really just the general demand during those peak meal periods is a little bit less. And that's what we're seeing, whether that spills over into those day parts. On a regional basis, I think that it's still the Midwest that tends to be the weakest. The northwest, southwest, Florida, which is benefiting from a little bit of the hurricane overlap from last year, are doing fine. So it's really not that much different than what we have seen since September of last year in terms of a regional break down.

And just to clarify, did you say that the core launch and dinner day parts are still doing well and that it's late afternoon and late night that's still suffering or it's rolling into the lunch and dinner as well?

The core meal periods for us are still really pretty much at capacity at almost all of our restaurants. As we talked earlier in the year, where we saw the softness was in that mid-afternoon late night day part. That's really still the case.

Thanks.

Your next question come from Steve Kron.

Hi, good afternoon, guys. A question on Grand Lux, since we're going to see that as a bigger contributor to the unit growth in the future, I was wondering if you could just talk about a little bit more about kind of the unit level economics there and maybe cash-on-cash returns, if it's in that 30% to 40% that I think you shoot for on a Cheesecake Factory basis?

I think the -- Steven the unit level margins are pretty comparable to a Cheesecake Factory. And certainly as the volume ramps up, when you are doing the 5%, 6%, 7% comp growth that we're experiencing there, we continue to get letter margin leverage on the fixed costs side of that business. So, as that -- our expectation all along has been that the unit level margins in that concept would equate to a Cheesecake Factory. And in many locations we're there and at the newer ones where we continue to ramp-up, I think we're well on our way to getting there. In terms of the overall cash-on-cash returns, we're probably at the low end and slightly below our target but I think that's more of a function of building out these earlier restaurants with a little bit more pizzazz, if you will. And I'll let David talk about that.

Yes, we know that we can get more money out of the Grand Lux buildings but right now that's sort of our marketing fund. We're wowing people with the sites. We have 32-foot ceilings and we know what we're going to do. We'll probably start to do that sometime in the middle of next year, where we start to have sites that we don't feel are flagship sites, if you will, or the first site in Miami. So, we know that we can make progress there and that will be our next step, we just haven't chose to do that just yet.

Can I just squeeze one more in there? On the new unit development, in '07, kind of new versus existing markets and should we expect maybe the level of cannibalization? If you can first quantify what you see there as far as cannibalization in existing markets? And should we see that kind of taper off a little bit?

Well, I think the target markets for next year are primarily existing markets. We've done very well. I think we're going to have a lot of restaurants in the northeast, which with the population density has proven to be a very, very strong market for us. So, in terms of the mix, it will be existing market related -- or weighed. We always experience a little bit of cannibalization in these markets we go to but our experience so far is it's fairly short lived. We'll see a little when first open but then over six months to a year it tends to balance itself out.

Thanks.

Next question?

Your next question comes from Destin Tompkins.

Thanks. As you look at the wage pressure outlook for 2007, is it -- should we expect that that 1.5% menu price increase would be enough to kind of hold the labor margin flat, assuming normal sales levels?

That's our expectation. Certainly, the 1.5% price increase that we're going to try to take at the beginning of the year, we believe will be sufficient to cover the minimum wage pressure, as well as some of the other cost pressures we expect to see. So, that's what we're shooting for.

And then we'll take a look at it in the June, July, menu, and hopefully adjust there if need be.

And then quickly on the share count decline in the quarter, is that just a function of the treasury method?

Well we did do a -- we did a repurchase of about $50 million back in the second quarter, which is reflected in that share count today, as well as partially the treasury method as you mentioned.

Okay. Thank you.

Your next question comes from Sharon Zackfia.

David, I was wondering if you could talk about, this summer you were doing initiatives on the radio and did some menu changes that you were kind of optimistic would bolster customer response. So, could you kind of update us on what happened with the radio and what happened with the menu changes and how that all played out?

Yes. The radio, really didn't do us -- in the couple of test markets that we were in, we didn't think it did as much good as we really wanted it to. I think we chose a couple of bad weeks in there. So we really haven't done very much and we saw that things were getting better. So as they were getting better and as we had our own internal initiatives to work on the business within our four walls, we didn't really do a lot of that. We have something out there with American Express that we joined where -- I think, so far over $1 million worth of gift cards have been requested for Cheesecake Factory. And we have done some other smaller things but we didn't continue with the radio. I think that the -- at least as of yet. I think that the midyear menu change went very well, for not raising prices --.

Yes, the average ticket has held up nicely and actually gone up a little bit.

Right. Our average ticket went up a couple of percent because of what we did on the new menu and the items and our combination plate without raising prices, so I was extremely happy about that. That we could do that well without raising prices during that period

Can I ask a follow-up? Is there anything you learned from that midyear menu change that you'll go even further on in the January/February menu change?

Well, we are testing various things. We're testing organic teas. We're testing organic coffee. We have an actual weight management section, which our new salads for us, all between 400 -- huge salads, as big as any Cheesecake Factory between 490 and 590 calories and with a very, very low-cal dressing. So, that is one we're coming out with that we think a lot of people will appreciate. So again, going into some organic foods, some healthier foods, things that people can get even more choices as healthy alternatives are going to come out. And we're actually introducing them this next Monday here in eight restaurants in Los Angeles and we'll see how they do.

Thank you.

Your next question comes from Bryan Elliott.

Good afternoon. Just wanted to clarify something on the prior years. It appears that you may have restated sales at the restaurant level and I just wondered if I got that right, and if so, what happened?

Yes, Brian, it's part of -- as we were doing the restatement for the stock options, we went back and checked on a few other things that we should house clean on, and one of the them was the way we treated our breakage on our gift cards. So, that was really a reclass from a credit to G&A expense going up into revenue. So, it's a not a ton of money. For the one quarter it was a little bit higher but overall, it's a pretty insignificant change.

Was it a catch-up or one-time in the third quarter, was it really just a more significant one or is this-- ?

It is spread out across each of the quarters and you'll see a little bit of change. Like I said, you are right in the third quarter, I think we probably had about $1 million increase in the revenue there, which was just the way the -- or a $300,000 increase in one of the quarter, $1 million in the other. But that's really reclass out of G&A up into revenue.

And so essentially what -- that's slowing down the rate at which gift cards that aren't redeemed are expired? Is it an expiration issue?

Our practice in the past, most companies if not all companies that have gift cards recognize breakage. So, there's an assumption as to what percentage of gift cards will never be redeemed. Our practice in the past was be to recognize that breakage upon the sale of the gift card. So let's say it's 10%, ours is not 10%, but if it was, $0.10 on every dollar we would deem to be a revenue to the Company. We recognized that upon sale of a gift card as a reduction to general and administrative expenses. New guidance from the SEC has said that that breakage should be recognize over the time period that gift cards are normally redeemed, which for us is about 36 months. So, we're recognizing that breakage instead of upon sale, over an extended period of time. And instead of reflecting it against G&A, we're recording it as revenue. So that's the change that's taken place. So, there's a catch up as we have fixed the amortization as opposed to the immediate recognition. But in the aggregate, it's pretty insignificant.

So you'll break to that out in the amended filings that are coming shortly?

Absolutely, we hope to have those filed in the next day or two.

Okay. Thank you.

Your next question comes from Mike Smith.

Mike?

Good afternoon. My question is back on the price increase. Since we're talking really about eight states that passed their laws raising the minimum wage, are your price increases going to be regionalized or is this across the board?

Well first, Mike, I'll let David answer it. But first, there's 16 states with -- that we operate in, as well as two cities that have minimum wage increases. There was I think six or eight that had -- that voted on increases but there's others that had increases that were already scheduled or didn't got to vote. So, we have about 16 different states in which we operate that will have -- so, a big chunk of our restaurants will be impacted.

Right. And although we hope to capture a 1.5% increase, it will not be even across the board. So, the states that had none will have a little less and those that have bigger increases we will try to pass on those to those states.

And what kind of a price increase might you have to take if the federal minimum wage increased?

Well, I think most of these are going to be equal or greater than the federal, so we don't think that that will be that bad. But whatever happens, everybody is in the same boat. We only pay minimum wage to tipped employees. We don't pay minimum wage to anyone else.

And Mike, actually, the majority of our restaurants are already in states that are above the federal minimum wage. I think probably close to 2/3 if not more are in states that are already above the federal minimum wage.

Thank you.

Your next question comes from [Steve Anderson.]

Yes, good afternoon. As we look ahead to 2007, do we have any kind of color with regard to what the tax rate would be for next year? I notice you were quoting a 31% rate for '06, which is a considerable reduction from what it was in '04 and '05.

Yes, I think that that's probably a pretty good rate to assume for next year as well.

Okay. Thank you. 31%?

Yes. I'm sorry. 31%.

Okay.

Next question?

Your next question comes from Paul Westra.

Just a question to follow up on your commodity cost comments. I just wanted to make sure that you did refer that you thought your '07 outlook was probably going to differ not much materially from your '06 contract pricing and was that in context of some tightening in the chicken and dairy markets? And then the follow-up and the related question was the pricing of 1.5%, on the earlier question, the question was whether it would be to defend labor costs as a percent or is it going to defend Company store margins?

Well let me answer the second half first. That 1.5% is to defend the Company-wide margins, the overall margins, as we look at cost pressures from labor and other areas. Specifically to the commodity segment, at this point as we work on contracts and have extended a few already; we've got a few items that are up, a few that are down, some others are flat. So in the aggregate, I just don't see that moving a whole lot from where we are this year, which is a pretty good sign. So with some menu pricing, I should get a little bit of leverage on that.

If I can just follow up with one more. Can you comment a little bit on your third party gift card sales, seen in a lot more places this year, can you give some idea of the strategy and how it's working?

Yes, and let me go back to Sharon's question earlier, when she talked about the radio spots and this all kind of ties in. We did the -- we tried a couple of different things this year. We did the radio spots and as David mentioned, we didn't see a whole lot but for what we paid it, it really was fine. I was a very minimal investment on our part. What we have tried to do is expand our reach into other areas and I call it more subtle and "Cheesecake-like" ways. In that we are being -- our gift card is now offered on the American Express membership rewards. We are working with a third party that our gift cards are offered in retail outlets, specific Safeway stores and some other chains. And just between those two channels alone, in a relatively short time period, we sold over $7 million worth of gift cards. So, it's a nice way to get the name out there.

It should be $10 million by the end of the year, at least that's our hope.

Okay. Thank you.

Your next question comes from Joe Buckley.

Just to put those gift card sales numbers in perspective, what -- how do they relate to gift card sales in '05 did you just have one -- additional sources that you mentioned?

Those are brand new channels, Joe, from '05. So that's an incremental, through the calendar to date, an incremental seven through new channels that we didn't have in '05. So then obviously, we still sell our gift cards through our own restaurants and online. But those are brand new channels for us.

Have you shared in the past what the in-restaurant and online sales were for '05 or could you?

I don't think we have.

Okay. And then just a couple of questions on on Grand Lux. The same-store sales numbers are impressive. You still have a fairly modest number of restaurants. How many of those restaurants are in the comp base? And maybe if you could compare and contrast Grand Lux in average weekly sales and sales per square foot with Cheesecake? Are you getting near Cheesecake levels do you think?

We try not to really compare everything we do because it really has to stand on itself own with the right investment, the right sales. So when we look at it we're not sitting here comparing every single thing and trying to have a Cheesecake flow. Having said that, Mike, what are --?

We have five Grand Lux Cafe that are in the comp base right now. And to David's point, we don't compare them. Although the average weekly sales at the Grand Lux Cafes is a pretty -- it's a nice number, it's actually greater than Cheesecake Factory. But that's because you have the Grand Lux Venetian in there doing huge volumes. With -- among five restaurants, it's certainly impacting that average.

But with that average, what is it around $13 million?

Yes, it's about $13 million per year.

Average weekly sales --.

Annual.

Average annual sales but that with the Venetian, which is quite incredible. So that is doing well. And again, a lot of them -- a number of them, not the Venetian, but a number of them have capacity to keep on comping up. And they are new and exciting to people and so they're starting to find Grand Lux.

Okay. As you open more stores, and David in your words, some that were less in terms of flagship site, how much will the investment costs change for Grand Lux?

Well, we believe that in this next design building, we can pull $1 million out. And I think we can pull more out but we know where we can get $1 million. And really most of that is just all of the things that have to do with how high we were building. The exterior is 42 feet, even a great Cheesecake Factory I think is only only about 27 feet. So, we know where the costs are. Again, right now, we're building this A site location very grand but we know where to cut that $1 million out. And again, we'll start to have sites that will do that starting the middle of next year.

Okay. Thank you.

Thanks, Joe.

Your next question comes from John Ivankoe.

Actually, can we go back on the tax rate? So, the tax rate, I just wasn't aware of this, I'm sorry, it's going to be 31% in 2007?

That's the preliminary projection today, yes.

And it's, I think, for years it had been kind of returning around 35%?

Well, we have been in the 34's. I think we have been coming down closer to the low 34's. And I think what you're seeing there is some of the tax planning that we have been doing really from a state tax perspective. And we're starting to recognize some of those benefits on a go-forward basis.

And that's going to be a permanent level past '07 as well.

Absent tax rate changes outside of our control, yes.

Okay. And just one more housekeeping if I may. Do you have a preliminary CapEx projection for 2007 since you have given units?

I do not. Not yet.

Okay. That's it for me. Thanks.

Your next question comes from Ashley Woodruff.

Hi, thanks. First a question on the kitchen management system. What are your expectations now in 2007? How many stores do you think will have KMS by the end of '07? And then what -- are the benefits that you are seeing more on the cost side or are you seeing sales improvements as well with that system?

All new Grand Lux and Cheesecake Factories will get KMS. Because the -- it's not retrofit the cost is the same or pretty close to the same as it was. So we'll have 35 next year -- and then we'll probably have maybe 60 restaurants next year, that will have it. We have not pulled the trigger or planned what our retrofitting will be of the other sites or how many we'll do a year. We're still waiting to get some real numbers. Everyone loves it, it's easy to train. We know we have taken two, three minutes off of some orders. How that is translating into sales, we're not sure that we can attribute it all to KMS right now but it is much easier to operate. We have less waste, fresher food. And it's just a great system to work with. We'll have 60 and as many as we can afford, then we'll go ahead and pencil those in. Do you have anything to add, Mike?

No, that's it.

The issue is just trying to figure out if you can actually get a return on --?

Yes, we want to really nail that down and understand exactly what that is in terms of some of the restaurants are more expensive than others to retrofit. Again, going forward, it's an easy decision. We have already made that one.

And then just a follow-up, on the improvement you have seen in same-store sales in the fourth quarter, do you think the consumer is getting a little better in the fourth quarter or do you think it's more of a function of your new menu and lapping easier comparisons from last year?

I think it's all of those things. I think certainly, we are benefiting fitting from some easier comparisons and hurricane comparisons to last year. But I do think that we have seen just a general uptick in general, which is a positive. So I can't put my finger on any one of those and say that's it. I think all of those things are playing a part of it.

Okay. Thank you.

Your next question comes from Matthew Difrisco.

Hi, I have sort of a follow-up regarding the -- looking at the mix of stores next year for '07, a larger percentage being Grand Lux and a little less than initial expectations for The Cheesecake Factory. How should that be reflected in the income statement, as I presume, you are still pretty much below -- a typical Grand Lux is going to be below your incremental Cheesecake Factory? So if you are targeting an 18% growth rate, say for the next couple of years on an operating week basis, what is the probability that you'll have -- that you'll be able to sustain margins or even be able to expand margins in the environment where incrementally, you are growing more Grand Lux's and pulling back the incremental increase rate of cakes?

That's a good question. I think, as we mentioned earlier, we start to see the margins at the Grand Lux be equal to a Cheesecake Factory. And certainly as that brand name gets a little more recognition, we'll start to open with stronger volumes as well. So, our expectations are that for 2007, we'll see earnings growth pretty much in line with operating week growth. And then I think as Grand Lux expands and becomes a bigger part of our growth, that the improved margins at that one -- really, we don't expect to see much margin deterioration as a result of Grand Lux playing a bigger role in our growth.

The nice thing that we have going for us is the Grand Lux's are going into all the true A sites in the country. And Cheesecake makes B and C sites into A sites. But these are -- we're able now to go back and pick the urban or the best of the suburban sites. So certainly for the next few years, I think we're in a very good position with Grand Lux to do better than we might .

Okay. And then just a follow-up on one of the questions that was asked about looking into the new menu potential and maybe expanding some of the learnings you have had from the smaller portions during lunch. Is there a opportunity, do you think, to improve the average check and also maybe improve frequency if you were to extend the hours of the availability for the half portions and lunch side salads?

I can't say but I don't think so. I think that those items that we created were smaller portions of our big items and they are perfect for lunch and they are perfect for secretaries and they are perfect for people to get in and out. And we wanted to hold the price point. But I think offering those for dinner could bring our check average price down, even if it brought our comps up. And with the waits we have right now, I think that would be anti-productive, at least at this point.

Okay. Thank you.

Your next question comes from Dennis Forst.

I just wanted to get a clarification on revenues. I think you said, Mike, that bakery sales, was it for the full year '06, would be up 7% to 8%?

That's correct.

And then you said something about a 53/52 week basis.

Well, that's just for comparative purposes. If you're looking at reported revenues from last year, bakery sales for the full year should be up.

Should be up -- even, I think they are up about 2% year to date so far?

You are probably correct.

Yes. Okay so that would indicate even with a 13 week fourth quarter versus 14, bakery sales should be up nicely. Part of that because of that big shipment in the first week of the first quarter.

Yes because third quarter was a little lower than we expected and that fell into the first quarter.

Okay. And then you mentioned that average weekly sales in the third quarter for Cheesecake were down about 3%. And what about the average weekly sales for Grand Lux in the quarter?

Those are obviously down but that's more of a function of the fact that we have got the new restaurants coming on. Again, going back to what we said earlier with having the Grand Lux Venetian and the Grand Lux Chicago, which do pretty huge volumes, and the new restaurants coming on, that this is a new concept, are going to ramp-up slower. So, that average weekly sales came down as expected. I don't have the percentage.

All right. Thank you.

Your next question comes from Nicole Miller.

Good afternoon. Mike, I was wondering if you could give us the second quarter break out for stock option expense like you did for the third quarter?

Nicole, it's almost identical.

Okay. That's what I figured. And any development projections for '07 by quarter?

For new restaurants?

Yes.

We'll give that in the next call. We don't have that right now.

Okay. And one last question sort of bigger picture. With reduced development next year, and obviously a strong cash position, would there ever be a consideration to go back and remodel the original or some original The Cheesecake Factory restaurants or because of the non-chain image, is that just not necessary?

When you say remodel?

Refresh, remodel, like we see with some casual dining chains when they go back.

I really don't think that we would change the look but we certainly are always refreshing them and keeping them looking like new.

We have programs for that right now. We try to keep them like new at 10 years, which we find is the right time, we do back and look at everything we need to do and then bring that restaurant up to current and totally refresh it. So, we're already on a program to do that. But not to make them all look the same or anything too radical.

Your next question comes from Chris [Okoe].

Mike, you mentioned that your -- or that the price increase you expect for the January menu would be about 1.5%. Are you all testing that increase right now in some of your stores?

We start on Monday. We have eight restaurants in Los Angeles that we put out the new menu in for about 45 days and go through and work on everything and get feedback. And then we go ahead and we have time to change the menu and then roll it out to the rest of the country. So,l we start that this Monday.

And let me ask, are you testing any type of labor initiatives in order to mitigate higher minimum wage costs to the system in the restaurant?

Not necessarily to the system. I think the technology items that we talked about, we have some labor planning tools that we're in the process of testing. The KMS system, we believe is -- will help us to generate some labor changes. So, that's the direction we're headed. We're not changing the way we operate the restaurant in that respect.

Okay. And then lastly, are you assuming the worker's opportunity credit gets reinstated for your tax rate?

That is -- we don't assume it will, no. If it does, we'll get the benefit of that.

Okay. But it's not reflected in the 31% guidance.

Correct.

Okay. Thank you.

Operator at this time I think we have time for one more question.

Our final question comes from [Laird Bager.]

Hi, guys my question has been answered, sorry.

All right. We'll do one more, if there is one, then.

We have a question from Mike Smith.

Yes. This is hopefully, not too much of a softball, but you seem stronger on the Grand Lux right now. Can you kind of share with us how the nearby Cheesecake Factories have been comping with the introduction of the Grand Lux? Have you seen any changes there?

Are you talking about whether the Grand Lux's are cannibalizing Cheesecake Factory?

Pretty much, yes.

No, not really. We have seen a little bit but nothing significant. We have always felt, and we have seen in most cases, that a nearby Cheesecake Factory will cannibalize a Cheesecake Factory more than a Grand Lux will. And in some cases where we're across the street or next door, that we've seen a little bit of cannibalization but nothing much.

We're still going through the tests. We're going to open up one in the same center. We're on the same parking lot in Boca. So, we're still testing and through these -- next year, we'll have a good feel as to how far away or how close we can go and be able to test out that cannibalization. So far, we feel very good about it but we have a little more testing to do and then we'll know how close we want to be.

Thank you.

All right. Thank you operator.

Thank you, everyone.

This concludes today's Cheesecake Factory quarterly conference call. You may now disconnect.