Feb 5, 2008
Executives
Michael J. Dixon - Chief Financial Officer, Senior VicePresident, Finance David Overton - Chairman of the Board, Chief ExecutiveOfficer
Analysts
Steven Kron - Goldman Sachs Lawrence Miller - RBC Capital Markets David Tarantino - Robert W. Baird & Co.
Joseph Buckley - Bear, Stearns & Co. Bryan Elliott - Raymond James & Associates Sharon Zackfia - William Blair & Company Matthew DiFrisco - Thomas Weisel Partners Paul Westra - Cowen & Co.
Christopher O'Cull - SunTrust Robinson Humphrey John Ivankoe - J. P.
Morgan Securities Howard Penney - Friedman, Billings, Ramsey & Co.
Operator
Good day, ladies and gentlemen, and welcome to the fourthquarter 2007 The Cheesecake Factory earnings conference call. (OperatorInstructions) I would now like to turn the presentation over to your host fortoday’s call, Mr.
Michael Dixon, CFO of The Cheesecake Factory Incorporated.Please proceed.
Michael J. Dixon
Thank you, Erik. Hello, everyone.
I am Michael Dixon, CFO ofThe Cheesecake Factory Incorporated and welcome to our quarterly investorconference call, which is also being broadcast live over the Internet. Also with us today is David Overton, our Chairman of theBoard and Chief Executive Officer, and Jill Peters, our Vice President ofInvestor Relations.
Before we get into the details of our results, let mebriefly cover our cautionary statement regarding risk factors andforward-looking statements in general. I will also note that our press releaseis available in the investors section of our website atthecheesecakefactory.com.
Throughout our call today, items may be discussed that arenot based on historical fact and are considered forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995.Actual results could differ materially from those stated or implied in forward-lookingstatements as a result of the factors detailed in today’s press release and inour filings with the Securities and Exchange Commission. All forward-looking statements made on this call speak onlyas of today’s date and the company undertakes no duty to update anyforward-looking statements.
So we finished a somewhat disappointing fourth quarter asthe consumer slowdown felt by most retailers and casual dining restaurantoperators impacted us as well. However, our results held up reasonably well ona sequential basis relative to overall casual dining industry trends.
While weare looking forward to and planning for the future, I think it is important togive you a little color on the fourth quarter results. We also announced an update to our business plan for fiscal2008 today.
I will provide some details on the rationale for this plan, as wellas some line item guidance for modeling purposes. Finally, we’ll open the callto questions and we’ll be happy to answer as many questions as time allows.We’d like to finish this call up in about 45 minutes.
Before I get into our operating results, let me spend just aminute on the non-operating charges we incurred in the fourth quarter. Asmentioned in our press release, we recorded approximately $2.6 million inone-time pretax charges related to the settlement of various legal matters.
Ofthis total, $0.5 million related to employment practice issues and $2.1 millionrelated to the pending settlement of federal and state shareholder derivative actionsfiled against the company and related parties. Now there is the potential for some additional insurancerecovery against the settlement charges that is not yet determined.
These one-time items had about a $0.03 impact on our resultsfor the quarter. Okay, on to the operating results -- total revenues at TheCheesecake Factory for the fourth quarter increased 13% to $406.3 million.
Ourrevenue growth this quarter was comprised of an approximately 14% increase inrestaurant revenues and a 9% decrease in bakery revenues. I’ll talk more aboutthe bakery business in a moment.
The 14% increase in restaurant revenues represents anapproximate 18% increase in total restaurant operating weeks, resultingprimarily from the opening of 34 new restaurants during the trailing 15 monthperiod, coupled with an approximately 4% decrease in average sales perrestaurant operating week. Overall comparable sales of The Cheesecake Factory and GrandLux Café restaurants decreased approximately 0.4% for the quarter, including anapproximate $1.2 million impact from inclement weather during the quarter.
Now, excluding the estimated weather related impact,comparable sales of The Cheesecake Factory and Grand Lux Cafe would haveincreased approximately 0.1%. By concept, that translates into a 0.1% decreaseat The Cheesecake Factory restaurants and a 2.1% increase at the Grand LuxCafes.
While restaurant traffic was lower than we expected, from acompetitive standpoint we believe our comparable sales held up relatively wellin light of the trends experienced by many casual dining operators during thefourth quarter. Average weekly sales at The Cheesecake Factory restaurantsdecreased about 2.8%, which is still slightly behind the change in comparablerestaurant sales.
As we’ve discussed in the past, there are a number of factorsthat impact this comparison, from the age of the restaurant to the restaurantsize. We continue to be very pleased with the progress of ourGrand Lux Cafes.
Comparable sales at Grand Lux increased 2.1% in the fourthquarter, excluding the weather impact, and that’s lapping a very strong 7.8%comp in the fourth quarter of 2007. We continue to view this as an incredibly strongperformance, particularly in light of the soft operating environment theindustry has experienced for the past few years and for a young concept with noadvertising or promotions.
As sales volumes grow at Grand Lux, we will continue toleverage operating costs and improve this concept’s restaurant level margins.Grand Lux Cafe is a strong, viable, second concept for The Cheesecake Factory. Longer term, we feel very confident there is plenty of highquality growth from the openings of both Cheesecake Factory and Grand Lux Cafebrands.
In addition, we recognize there is an opportunity in a normalizedoperating environment to drive comparable restaurant sales growth in excess ofour menu price increase as we work to recoup some of the traffic lost duringthis challenging economic period. On the development front, we entered four new markets thisyear as we successfully extended our brand into Rochester, New York; Tulsa,Oklahoma; West Hartford, Connecticut; and Salt Lake City, Utah.
In fact, ourSalt Lake City location is averaging in excess of $265,000 in weekly sales duringthe 13 weeks since it opened. In addition, our strategy of returning to those markets thatwe know well and have been successful in is delivering solid performanceagainst our expectations.
As we noted in our press release, the new restaurants thatwe’ve opened to date in the Northeast have delivered average weekly sales as agroup of roughly $235,000 since opening, consistent with our expectations forhigh volumes in this region. On the Grand Lux Cafe front, our newest location in the PalazzoHotel Resort and Casino in Las Vegas is averaging about $295,000 in weeklysales since its opening.
In total, we met our target of opening 21 new restaurants in2007, including five Grand Lux Cafes. In the fourth quarter, we opened eightCheesecake Factory restaurants and three Grand Lux Cafes as planned.
I’ll talk about our 2008 development plans shortly, but I dowant to remind investors of the risks to achieving our opening schedule as wecurrently lease all of our restaurant locations, many of which are in newlyconstructed 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 ourleased spaces to us and according to their original commitments, so that we canbuild them out in a timely manner.
Our locations are upscale and highly customized, which helpsto create the non-chain image that we enjoy with consumers and which we believerepresents a significant competitive advantage for us. But that also createssome unique design and permitting challenges.
Once we get the spaces from the landlords and obtain ourbuilding permits, our construction and pre-opening processes are typicallyconsistent, usually taking four to six months to complete on average. So the result of these factors, is it not uncommon to haveplanned openings move a few weeks, or even a month, due to various factorsoutside of our control.
Having said that, we have consistently achieved ourstated opening targets. We have an incredible development team thatconsistently manages through these challenges to deliver restaurants on timeand an equally talented operations team that gets these restaurants opened andrunning like a Cheesecake Factory from day one.
After opening, it takes about 90 to 120 days on average forour new restaurants to work through their normal grand opening inefficienciesand for food and labor costs to reach their targeted operating profit margins. Now moving on to our bakery operations, bakery sales net ofinter-company bakery sales decreased 9% in the fourth quarter from the year-agoperiod to $22.8 million versus $24.9 million in the prior year.
The decreasewas due primarily to lower sales to the warehouse clubs, which is our largestsales channel for outside bakery sales. Clearly the macro pressures impactingdining out occasions continue to affect dessert purchases as well.
While we remain optimistic with respect to opportunities tobuild our bakery sales volumes over time, I remind investors that this is asmall part of our business and that third-party bakery sales are not aspredictable as our restaurant sales. Our ability to predict the timing of bakery productshipments and contribution margins is very difficult due to the nature of thatbusiness and the purchasing plans of our larger customers, which may fluctuatefrom quarter to quarter.
In our view, the bakery’s most important contribution to ourbusiness will continue to be its service as a dependable, high quality producerof desserts for sale in our own restaurants, which will sell in excess of $220million of desserts made in our bakery production facilities during 2008. Approximately 15% of our restaurant sales consist of dessertsales, which is a much larger percentage than achieved by most other casualdining restaurant concepts.
So that covers our top line performance for the fourthquarter. So now I’ll briefly review the individual components of our operatingmargin for the fourth quarter.
Cost of sales decreased slightly to 26.2% of revenues forthe fourth quarter, compared to 26.3% in the same quarter last year. The 10basis point improvement over the prior year is attributable to favorable costsin the produce, meat, and seafood categories partially offset by the ongoingpressure from higher dairy costs as well as a slight increase in poultryprices.
As you may recall, we extended our poultry contract lastsummer to the end of fiscal 2008 in exchange for a slight price increase. I’llpoint out that despite the increase in dairy prices for fiscal 2007, we managedto improve our commodity costs on a full-year basis by 20 basis points relativeto the prior year as a result of very strong commodity price management andnegotiation.
The principal commodity categories for our restaurantsinclude fresh produce, poultry, meat, fish and seafood, cheese, other freshdairy products, bread, and general grocery items. Total labor expenses were 32.3% of revenues for the fourthquarter.
That’s up from the 31.7% in the prior quarter. This increase reflectsthe deleveraging effect from the lower level of sales, as well as higher costsstemming from minimum wage increases.
Other operating costs and expenses were 23.1% of revenuesfor the fourth quarter. That’s up from the 22.1% reported in the same quarterlast year.
The increase reflects the benefit last year from a favorableadjustment to our self-insurance reserve, as well as the deleverage effect onthe lower level of sales in the fourth quarter of 2007. G&A expenses for the fourth quarter were 6% of revenues,down slightly from the 6.1% in the prior year.
Excluding the $2.6 million oflegal settlements that were recorded in the fourth quarter of 2007, G&Aexpenses were 5.3% of revenues. The decrease relative to the year-ago quarterwas primarily due to about $800,000 in professional fees related to the stockoption review incurred in the fourth quarter of the prior year.
Our G&A expenses consist of two major components -- thecost for our corporate, bakery, and field supervision support team, whichshould grow at a less rate than revenues, and the cost for our restaurantmanagement, recruiting and training program, which should grow at a rate closeto our unit growth rate. For the full year, after adjusting for the one-time costs Ijust mentioned, G&A as a percent of revenues was 5.4% in both fiscal 2007and 2006.
So in spite of the fairly significant deleverage effect from lowersales, we still managed to open our target restaurants and effectively controlour G&A costs. Depreciation expense was 4.3% of total revenues for thefourth quarter compared to 3.9% for the fourth quarter of the prior year.
Actual pre-opening costs incurred during the fourth quarterwere a bit higher than we expected at approximately $11 million compared to $12million for the same quarter last year. Our back-ended opening schedulerequired us to hire managers early in order to have the appropriate number oftrained managers in place to support our openings.
This pushed pre-openingexpenses a little higher than originally planned, combined with increased costsfor staff relocation. In addition, we experienced higher costs related to theGrand Lux Cafe Palazzo opening as the opening date for that hotel and casinowas rescheduled several times.
We opened eight Cheesecake Factory restaurants and threeGrand Lux Cafes in the fourth quarter of 2007, compared to 13 CheesecakeFactory restaurants in the year-ago quarter. That covers our review of the major line item components ofour operating margins for the fourth quarter.
Again, please refer to the fulldiscussion of risks and uncertainties associated with our forward-lookingstatements included in our filings with the SEC. Included in interest expense is $2.4 million of interestexpense on $175 million in outstanding debt we had under the revolving creditfacility during the quarter.
We have an interest rate collar agreement on $150million of this outstanding revolver balance that mitigates the risk frominterest rate variation and keeps our LIBOR rate within a range of 4.6% to5.4%. We also pay a bank margin on top of LIBOR which will varybased on our debt to EBITDA ratio.
Our effective tax rate for the fourth quarter was 30.2%, inline with our expectations. Let me provide a brief recap of our stock-based compensationexpense for those investors who are tracking it as a separate line item.
Ourtotal stock-based compensation expense reflected in the income statement forthe fourth quarter was approximately $4.8 million, of which $1.8 million wascharged to labor expenses and $2.9 million was charged to G&A expenses. Lastly, before I move off of the income statement, let mecomment on our recent share repurchases.
During the fourth quarter of 2007, ourboard of directors increased our share repurchase authorization by 5 millionshares to 21 million shares. In 2007, we returned approximately $250 million of capitalto shareholders through share repurchases, including 2.2 million shares thatwere bought back in the fourth quarter of 2007 for an aggregate price of $49million.
The 2.2 million shares we purchased were funded by acombination of cash on hand and borrowings available under our revolver. There are approximately 7.5 million shares remaining in ourrepurchase authorization and we expect continued buy-backs going into 2008.
On the balance sheet, our liquidity position and financialflexibility continue to remain strong. As of January 1, 2008, our cash andmarketable securities on hand were approximately $49 million.
Our cash flowfrom operations through the fourth quarter was approximately $160 million, andour cash and accrued CapEx through the fourth quarter, as reported in thestatement of cash flows, was approximately $211 million, which includes constructionin progress for 2008 openings. Adjusting for the mechanics of lease accounting, actual cashCapEx expenditures for 2007 was approximately $204 million.
As I mentioned earlier, we have $175 million in funded debtin our capital structure. We expect to be able to finance our CapExrequirements for fiscal 2008 through expected operating cash flow, agreed uponlandlord construction contributions, and/or cash on hand.
We do have $25 million available on a credit facility forback-up liquidity purposes and to support standby letters of credit for ourinsurance arrangement. To wrap up our business and financial review for the fourthquarter, there is no doubt that the operating environment has gotten a littletighter.
Our total revenues were lower than we expected as a result of bothweather and the macro-environment and cost pressures have not moderated. Even for a best-in-class concept such as The CheesecakeFactory, which operates at very high levels of efficiency and productivity,it’s clear that the current economic environment has impacted and will continueto impact operating results.
That being said, we continue to have confidence inthe strength of our concepts and consumer demand for both of our brands and webelieve we are well-positioned for the eventual recovery of the economy. We remain committed to the long-term healthy growth of TheCheesecake Factory and Grand Lux Cafe and as always, we’ll continue to look forways to enhance our productivity and profitability.
With that as a backdrop, let me share with you the detailsof our fiscal 2008 plan. As we discussed in today’s press release, we are updatingour business plan for fiscal 2008, focused on a prudent allocation of capitalintended to enhance overall earnings per share growth and increase returns oninvested capital.
Tactically, this means we are targeting revenue growth of 10%to 12% for 2008 and we adjusted our planned new restaurant openings for theyear to between 7 and 9. While we expect margin pressures to continue in 2008, webelieve the combination of lower pre-opening costs from fewer openings and thebenefits from the improvements we made to our capital structure last year, aswell as our ongoing focus on returning capital to shareholders, will result indiluted earnings per share growth of between 10% and 15%.
A lot has changed in the macroeconomic environment over thepast three-and-a-half months since we announced our preliminary plan for 2008in late October. Unfortunately, these changes have not been positive.
Confidencein the economy is falling. The housing market has further deteriorated andconcerns about a recession have escalated.
This has significantly impactedconsumer discretionary spending, resulting in a decrease in traffic across thecasual dining segment. In addition, casual dining stocks, along with most ofthe market, have experienced significant pressure over the past several months.
All of these factors went into our decision to revisit ourplans for fiscal 2008. We will continue to drive earnings per share growth througha prudent allocation of capital.
Historically, this was accomplished primarilythrough new restaurant openings. However, based on the macro pressures I justmentioned, and the expected returns from buying back our stock at currentlevels, we believe the most effective way to drive earnings per share growthand increase incremental returns on invested capital in 2008 is to scale backour new restaurant growth and increase our emphasis on returning capital toshareholders.
For 2008, that translates into seven to nine new restaurantopenings, combined with an ongoing share repurchase program. We still believe there are plenty of high quality sitesavailable for our brands and we will continue to select premier sites for ourconcepts.
However, the best sites are not always available when we’d like themto be. We will open fewer new locations, renew focus on exceptional sites basedupon their availability and again, return the excess capital resulting from areduction in openings to our shareholders.
Let me give you some more specifics on the 2008 plan. Weplan to open six to eight Cheesecake Factory locations in 2008, as well as theinitial unit of our newest concept, Rock Sugar Pan-Asian Kitchen.
We do nothave any new Grand Lux Cafe locations in the 2008 plan at this time. Based on the locations that are available and the siteselection discipline I just discussed, we did not find any Grand Lux sites thatmet our criteria.
However, we remain committed to Grand Lux Cafe as our secondconcept and fully intend to continue rolling it out at exceptional locations. The 2008 plan will also provide us with an increasedopportunity to focus on the investment side of the Grand Lux returns equation,as well as allow additional time to explore opportunities for operationalrefinement and margin enhancement.
As I mentioned earlier, we are targeting sales growth of 10%to 12% in 2008. While we are optimistic about the long-term potential of TheCheesecake Factory brand, we are also realistic about the current state of theconsumer.
As such, we are expecting continued pressure on guesttraffic in the casual dining sector and are assuming our comparable restaurantsales will decrease between 1% and 2% in 2008 from 2007 levels. This reduced traffic, combined with ongoing margin pressuresin several areas that I’ll get into in more detail in a moment, will result insome definite operating margin pressure before pre-opening expenses.
However,the reduced pre-opening costs resulting from fewer openings will offset thispressure to keep our overall operating margin relatively flat with 2007. In terms of menu pricing, we are implementing an approximate1.5% effective menu price increase in our winter menu change, which will berolled out by the end of this month, to help offset known cost pressuresprimarily related to commodity, labor, and energy costs.
As we have always done, we will consider additional menuprice increases later in the year to help offset additional margin pressuresthat may arise, as well as drive margin enhancement. We are always cautious about menu price increases as westrive to maintain the value proposition of The Cheesecake Factory.
This iseven more important when faced with a very difficult consumer environment, aswe are today. The company is in the process of performing additional pricestudies with the help of outside consultants to better understand the pricingparameters of our brand.
The results of these studies will help establish ourpricing philosophy for the future. As for the capital allocation portion of the plan, we expectto generate between $80 million and $90 million of free cash flow.
To be clear,this is operating cash flow after tax and net of our estimated CapExrequirement. These funds, along with additional leverage opportunities, will beused primarily to repurchase our stock in 2008.
As I detailed earlier, ourboard of directors increased our share repurchase authorization to bring ourtotal shares available for repurchase to approximately $7.5 million and mayconsider additional authorizations. The combination of these elements gets us to earnings pershare growth of between 10% and 15%.
For 2008 and beyond, our objective is tomaintain a financial structure that gives us the flexibility to continue toactively pursue the best return on capital through both selecting premier siteswhen they become available and returning excess capital to shareholders. Through a continued execution of a high quality growth planand prudent allocation of our capital, we believe we can grow earnings pershare in the 10% to 15% range for several years.
In summary, we feel very optimistic about our plan for 2008and believe we are making the right choices for the long-term health of ourbusiness. We will continue to grow our concepts using a disciplined approachand selecting only those sites that are high quality and high margin.
Openingfewer units will also have the effect of limiting saturation in any market,preserving the uniqueness of our concept and mitigating the risk ofcannibalization. With less emphasis on new restaurant openings, ouroperations team can focus more on sales and margin enhancing opportunities atour existing base of restaurants.
As we have always done, we will also evaluateour infrastructure to ensure we are properly structured to support our currentlevel of business and the planned growth. All in, we believe our plan balances the needs forshort-term results and allows us to return a meaningful amount of capital toshareholders while also strategically positioning us for the long-term.
To assist investors with their financial models, I will nowbriefly run through, by income statement line item, our expectations for thefirst quarter and full year 2008. As I mentioned, we are targeting full yearearnings per share growth of 10% to 15%.
However, as you would expect, themajority of that growth comes in the second half of the year as we lap thehigher pre-opening expenses from 2007. Our expectation of total revenue growth, which includes bothrestaurants and third-party bakery sales in the first quarter of fiscal 2008 is10% to 12% relative to the first quarter of fiscal 2007.
As outlined in today’s press release, our targeted revenuegrowth for the full year 2008 is also 10% to 12%. Based on the contracts we have in place and our currentexpectations for those items that we cannot contract, we expect cost of salesas a percent of revenues to be 50 to 60 basis points higher in the firstquarter of 2008, compared to the prior year first quarter, and approximately 25to 35 basis points higher for the full year compared to the prior year.
We have contracted with suppliers for those expectedcommodity requirements for 2008 that can be contracted. Regardless, we doanticipate continued cost pressure in produce as the poor growing season in2007 is expected to impact 2008 as well.
We have contracted a portion of our cream cheeserequirements through 2008 at a fairly modest, mid-single-digit increase versusthe prior year and we’ll evaluate opportunities to contract the remainingrequirements based on market movement throughout the year. Labor expense are anticipated to be approximately 20 to 30basis points higher in the first quarter of 2008 relative to the comparablequarter of the prior year, due primarily to deleverage from the sloweranticipated traffic.
For the full year, we expect labor expenses to be about 10to 20 basis points higher than the prior year. We expect other operating costs as a percent of revenues tobe approximately 30 to 40 basis points higher in the first quarter of 2008,again related primarily to the deleverage from slower traffic, combined withongoing utility and janitorial cost pressures.
For the full year, we also expect other operating expensesto be 30 to 40 basis points higher compared to fiscal 2007. Our expectations for G&A expenses as a percent ofrevenues to be about 20 basis points higher in the first quarter of 2008 ascompared to the first quarter of the prior year, and about 10 to 20 basispoints higher for the full year 2008 relative to the full year 2007.
We expect depreciation expense to be approximately 20 to 25basis points higher in the first quarter of 2008 compared to the first quarterof 2007 and about 10 to 20 basis points higher for the full year, based on ourexpected growth and investment plans. We anticipate cash CapEx in 2008 to bebetween $90 million and $100 million.
Our expectation for fiscal 2008 total pre-opening costs is$13 million to $15 million in support of the seven to nine new restaurantopenings that I discussed earlier, including the pre-opening costs associatedwith our initial Rock Sugar location. About $2 million to $3 million of thetotal pre-opening costs should fall in the first quarter.
We do not plan to open any restaurants in the first quarterbut do expect to have at least two new restaurants opening early in the secondquarter. We will give additional guidance on our planned restaurant openings byquarter on our quarterly updates during the year.
As a reminder, we usually incur most of our pre-openingcosts during the two months before an opening and the month of a restaurant’sopening. As a result, the timing of restaurant openings and their associatedpre-opening costs will always have an impact on our quarterly earningscomparisons.
Absent any additional leverage in the first quarter, whichhas not yet been determined, we expect net interest expense to be about $2.5million to $3 million. We expect our tax rate in 2008 to be in the range of 31%to 32%.
And lastly, we anticipate a weighted average outstandingshare count for the first quarter of 2008 of approximately 69 million shares. I realize that’s a lot of detail but that represents ourbest estimates at this time.
Of course, we will update you further throughoutthe year on our quarterly conference calls. That wraps up our prepared remarks and at this time, we’llbe happy to answer your questions.
In order to accommodate as many questions aspossible in the time we have left on this call, please be courteous and limityourself to one question and the re-queue with any additional questions. And ifwe aren’t able to get to your question on this call, please feel free to callus at our offices after the call.
Operator, we’re now ready for a few questions.
Operator
(Operator Instructions) Your first question comes from the line of StevenKron with Goldman Sachs. Please proceed.
Steven Kron - GoldmanSachs
Thanks. Good afternoon.
One question on just yourdevelopment slowdown -- I just want to be certain that I understand it, thatthe idea here is not so much that you are backing off long-term unitdevelopment targets but more so that it seems as though you are raising thebar, at least from a return hurdle standpoint, as to what you are willing tolook at. Can you just comment on that?
And then just as a second piece to that, the earnings growthprofile of 10% to 15%, it sounds as if you are saying that that is what youexpect for the next couple of years. Should we take that to mean that we willlikely be sitting at this kind of 7 to 9 unit development for the foreseeablefuture?
Thanks.
Michael J. Dixon
Good question, Steven. I think the first half of yourquestion is right on.
I think what we are saying with this plan is that we arefocusing on really a prudent allocation of capital, and as we look at the bestallocation of that capital to drive earnings per share and returns in general,today we feel that translate into the seven to nine restaurants with anaggressive share repurchase program as a way to return capital to shareholders. On a go-forward basis, keeping that same mentality and, asyou mentioned, targeting the 10% to 15% EPS growth, that balance will changebased on the dynamics of the market at that time.
So if great sites areavailable and they are out there, we want to take them, so that could end upbeing a few more or a few less sites in this year, with an allocation of theremaining capital towards returning it to shareholders.
David Overton
Our plan is really never to turn down an A site and as theycome up for either concept, we will absolutely be taking them.
Operator
Your next question comes from the line of Lawrence Miller withRBC Capital Markets. Please proceed.
Lawrence Miller - RBCCapital Markets
Thank you. If I could first follow-up a little bit on thatand then ask a question -- as it related to Grand Luxes that you decided not toopen this year, you said there was something about the criteria it didn’t meet.Could you elaborate on that point?
And then also, can you just talk about this generallyspeaking -- your traffic has been slowing for a while now and yet we haven’treally heard from you guys an articulate plan about driving traffic growth. Iunderstand the macro is probably worse than anybody would have guessed here buthow do you think about pulling some levers to drive traffic growth over thenext 12 to 24 months?
Thanks.
David Overton
On the Grand Lux Café, a couple of them moved from ’08 to’09 that we really loved. Others we felt were not the icon sites that we reallywant to start Grand Lux with.
We’ve got some incredible sites in downtownChicago, Las Vegas, the sites we have in Miami, but the sites that we werelooking at for ’08 and early ’09 were just not at the level we want. So we aregoing to wait for even beyond that A site, that icon site, to make sure thatGrand Lux continues to get launched in the same way we launched CheesecakeFactory years ago, to make sure that we really get a reputation going in thecity and then move out to the suburb.
So we have about -- a number of sites that we’ve beenlooking at for a while, tracking -- some of them have moved to 2010 because ofnew construction and so they got put off. And we’ll see how many we really canget in ’09 but we are extremely happy with the returns, we’re extremely happywith Grand Lux, and I wish we could get some open for ’08.
We are actuallydisappointed but they will be great when we open them. And then in terms of I guess you are asking about increasedmarketing.
We are certainly looking at various marketing things. Again, part ofthe increase in our gift cards and our 40% increase was really -- we look atthat as marketing because there is an expense to that where in the old days weprobably never would have marketed in that way.
We do it today to increase oursales at the discount through that, and we have a number of other things withMasterCharge, American Express, Visa, and other things that we are doing --increased visibility, giving to community causes to drive more business in theindividual communities, and we are considering other things. We are -- at this moment, we don’t have any kind of massiveradio or TV spot.
We think we’re too spread out to have that be effective.
Michael J. Dixon
And I would just follow that up -- clearly you are swimmingagainst the tide in trying to drive traffic in this environment. We would liketo see it come back but again, relatively speaking when you look at the trafficdecline across casual dining in general, we’ve probably held up as well orbetter than anybody, so we’ve got to be very careful in how we allocate coststowards driving incremental traffic in this environment.
Operator
Your next question comes from the line of David Tarantino withRobert W. Baird.
David Tarantino -Robert W. Baird & Co.
Good afternoon, everyone. A question on your guidanceassumptions for ’08 -- Mike, you said you were assuming comps down 1% to 2%, ifI heard that correctly, and that’s below what you saw in Q4.
I’m just wonderingif you are seeing anything now that might cause you more concern than what youhad in Q4 or just if you could give some more detail on what your thoughtprocess is there.
Michael J. Dixon
Well, I think again, we’re trying to trend off what we’veseen most recently and I think we saw, absent a little bit of a holidaypick-up, a decelerating traffic through the fourth quarter and I think that’sthe trend that we are trying to be relatively cautious in planning ourexpectations for 2008.
David Tarantino -Robert W. Baird & Co.
Okay, and if I could ask one other question -- justwondering what you think your opportunity is in the existing restaurants interms of increasing margin for those. I think that was mentioned previously.I’m just wondering what the thought process is there.
Thanks.
Michael J. Dixon
I think it’s fair to say we do believe there areopportunities. Our restaurants operate pretty darn well but when you lose sometraffic, you’ve to reevaluate your operating procedures look for some marginenhancements.
And clearly when you look at our operating margin trends over thepast few years, for lots of reasons there’s been a decrease in those margins. So we recognize that with less of a focus on growthcertainly in 2008, we have an opportunity to focus more on the operatingefficiencies of each of our restaurants and that’s one of our primaryobjectives in this year and beyond.
So I couldn’t put a dollar or a percentincrease on it for you but we certainly recognize that there are someopportunities to drive the margin.
Operator
Your next question comes from the line of Joseph Buckley withBear, Stearns. Please proceed.
Joseph Buckley -Bear, Stearns & Co.
Thank you. Just a question -- obviously you were planningjust a couple of months ago to many more sites.
Are there any costs associatedwith changing those plans, any leases that have been signed already or up-frontcosts that will be recognized?
David Overton
No, Joe, everything we signed we wanted to keep. We wereable to move some of those sites to 2009 and any of the others that we decidednot to go forward with, we had no cost to get out of.
Joseph Buckley -Bear, Stearns & Co.
Okay, and then just one other quick one -- Mike, the netinterest expense number for the first quarter actually looks a little lowerthan what it was for the fourth quarter.
Michael J. Dixon
I’m sorry, which expense?
Joseph Buckley -Bear, Stearns & Co.
The net interest expense number for the first quarter.
Michael J. Dixon
Right.
Joseph Buckley -Bear, Stearns & Co.
That you mentioned, $2.5 million to $3 million, I think. Itlooks a little bit lower than the fourth quarter.
Is that just a function ofyear-end cash balances or --
Michael J. Dixon
Well, it’s a combination of that. I think also in thatinterest expense number is the portion of interest associated with deemedlandlord financing on the leases, which kind of skewed that up a little bit inthe fourth quarter, so I think we’ll -- I think the number coming down in thefirst quarter is more in line with where we expect it to be.
Joseph Buckley -Bear, Stearns & Co.
Okay. Thank you.
Operator
Your next question comes from the line of Bryan Elliott withRaymond James. Please proceed.
Bryan Elliott -Raymond James & Associates
Good afternoon. Just wondered, as you look forward with theslower growth, whether you would expect to see, and if you don’t, why youwouldn’t, expect to see the average weekly sales, the same-store sales gap close?
Michael J. Dixon
I think over time, that’s a fair statement. We would expectto see that happen, sure.
Bryan Elliott -Raymond James & Associates
Thank you.
Operator
Your next question comes from the line of Sharon Zackfia withWilliam Blair. Please proceed.
Sharon Zackfia -William Blair & Company
Can you talk somewhat about your new unit returns? It lookslike there may have been some deterioration in new unit productivity,particularly in this quarter and maybe how you are assessing in a more normalconsumer environment your appetite for growth at this stage?
Michael J. Dixon
Well, I think the returns certainly, whether it’s new unitsor existing, were impacted obviously by the lower traffic across the board in2007, so our focus on the slightly slower growth in 2008 is to make sure thatwe focused on those premiere sites that we feel from a traffic perspective haveless risk, are going to be able to drive the returns in excess of ourexpectations, which we’ve targeted that mid 20% fully capitalized cash on cash return and that stays the same. We justwant to make sure that we are picking the premiere sites that we feel veryconfident are going to deliver that.
Again, it’s harder to do in an environmentwith the traffic declines as we saw in 2007.
Sharon Zackfia -William Blair & Company
When you are pulling back on the new unit openings, is thereany particular region where you’ve seen enough softness that it just doesn’tmake sense to redeploy capital in that area?
Michael J. Dixon
I wouldn’t say it’s as much regional. Again, there’sfantastic sites everywhere in the country and when those come available, thoseare the ones we want to make sure that we take.
David Overton
It’s really a site by site rather than any particular regionalweakness.
Sharon Zackfia -William Blair & Company
And just to be clear, do you view this internally as more ofa macro issue or do you think you are getting to the position where there’sjust a scarcity of class A real estate sites for you?
Michael J. Dixon
I don’t know that there is a scarcity. Certainly there’sfewer of them by default.
However, there’s plenty of them left but we want tomake sure that we are holding out and getting just those sites.
David Overton
Right, and we’re not opening just to hit a number but we areopening because each one is excellent and we 100% believe in it.
Sharon Zackfia -William Blair & Company
Okay, and are there any dangers of any store closures?
Michael J. Dixon
No, all of our stores, as we’ve always said, are profitable.They all deliver positive cash flows so at this point, we wouldn’t considerthat.
Sharon Zackfia -William Blair & Company
Thank you.
Operator
Your next question comes from the line of Matthew DiFrisco withThomas Weisel Partners. Please proceed.
Matthew DiFrisco -Thomas Weisel Partners
Thank you. Why aren’t we going to see more leverage or anyleverage on G&A in 2008 if you presumably are cutting back growth and theinfrastructure and G&A has been driven also by the up-front investment ofdevelopment, so if you are having basically half or less than half the numberof store openings, I would think G&A also has potential, as well as yourgrowth being slower on the EPS side.
I would think bonuses would reflect thesimilar muted outlook.
Michael J. Dixon
Well, clearly there are opportunities for G&A leveragebut I think it’s important to think about our G&A structure. If I look atthe cost structure of our G&A, I would say 85%, probably 90% of the costsare really -- they are not geared towards new restaurant openings.
They aregeared to supporting 150-some restaurants that we have today. So if you look atthe costs specifically associated with that growth of new restaurants, there issome room for leverage and I think that’s being reflected in there.
If you look at the overall on a year-over-year basis, we’vetalked about being relatively flat on G&A. I think that’s reflective of atthis point we are considering that we would accrue some bonus, which we did nothave a bonus in 2007 or 2006.
We also have increased costs associated with our gift cardprograms, which as David mentioned went from $60 million in sales to nearly $80million in sales on a year-over-year basis, and so we capture the fee or thecommission cost we pay for the third party on that and defer that over the lifeof the expected redemption period. So those are the things that are driving that G&A up.
Ithink that we’ve captured quite a bit of the applicable leverage that’s there.There is always going to be more opportunities and we are going to continue tofind them.
Matthew DiFrisco -Thomas Weisel Partners
Okay, and just as a bookkeeping, can you just verify -- yousaid one to two down in traffic or same-store sales for 2008?
Michael J. Dixon
One- to two-percent down in comp sales.
Matthew DiFrisco -Thomas Weisel Partners
In comp sales -- and then also, can you just break out thatcharge? I missed it if you did in your prepared remarks, the net 1.8 , or itwas a little higher, a little over $2 million in the fourth quarter, the $0.03.Where was that in the line items?
Where did it impact?
Michael J. Dixon
It’s all in G&A.
Matthew DiFrisco -Thomas Weisel Partners
All in G&A. Thank you.
Operator
Your next question comes from the line of Paul Westra withCowen & Co. Please proceed.
Paul Westra - Cowen& Co.
Good afternoon. Just another couple of follow-ups on thepricing philosophy I guess for 2008.
You said 1.5%. With that, you forecastedabout an 80 basis point hit.
Was that -- is that a function solely of traffic,meaning if you had guided for flat traffic, 1.5 would have held margins flat?And I guess following up with that, I also have a question of -- it seems likeanother point price increase of roughly 2.5 next year could have helped marginsif it was gone through successful. Why so conservative, I guess, on the otherside?
Michael J. Dixon
I think we guided to the 1.5 price increase that’s rollingout now. Of course, as we have always when the summer menu change rolls around,we’ll consider what pricing opportunities are available, what incrementalmargin pressures are there, taking into account the state of the guest, ourguest, state of the consumer, et cetera, and look for opportunities to helpoffset some of the margin pressures you’ve just identified and depending uponwhat’s happening at the time, maybe get some margin enhancement.
I can’t saythat will happen this summer but that certainly is where we want to end up overtime, using pricing to get a little of that margin back.
Paul Westra - Cowen& Co.
And I guess related, with that 1.5% pricing for the year,what you are looking at is only a modest 10 or 20 basis point up on labor. Thatwould imply labor inflation rates are down considerably from what you’ve seen.Is that a correct assumption or are you cutting back and making someefficiencies elsewhere?
Michael J. Dixon
No, I think that’s probably true. I’d have to think aboutthat some more but I think that’s true.
Paul Westra - Cowen& Co.
Great. Thanks.
Operator
Your next question comes from the line of Christopher O'Cullwith SunTrust. Please proceed.
Christopher O'Cull -SunTrust Robinson Humphrey
Thank you. Mike, I have a couple of questions on the ’08guidance.
It sounds like same-store sales gift cards, gift card sales werepretty strong during the holiday season. Are you seeing unusually lowredemptions in January?
Michael J. Dixon
You know, I don’t think -- you know, historically on amonthly basis, January obviously tends to be the highest redemption month. Idon’t have the percents in front of me.
I don’t think it’s that different thanit’s been in prior years, so our January sales, I don’t think anybody asked sofar, we mentioned it, but our comp sales through the first four weeks of 2008are pretty much in line to the guidance I suggested as comp sales for the year,but that’s taking into account that we’ve had absolutely terrible weather inCalifornia for the first several weeks of the year and are down quite a bit inthat market. But overall, we are still in that range of negative 1% to negative2% right now.
Christopher O'Cull -SunTrust Robinson Humphrey
Okay, and does your margin -- let me make sure I’m clear onthis -- does your margin guidance for ’08 reflect additional pricing in thesummer?
Michael J. Dixon
At this point, it does not.
Christopher O'Cull -SunTrust Robinson Humphrey
Okay, and then if you look at the pre-opening expense perunit that is projected, it seems to be much higher in ’08 than what it was in2007, and I mean pre-opening per unit. Is this true?
Michael J. Dixon
Well, you know, I think at this point it’s a little higher.I think we’ve got to figure out, and somebody asked earlier about the leverageopportunities, whether there’s opportunities to better manage our manager,planned management growth, which is bringing managers on early and carryingthem, waiting for the restaurants to open, will still be, even though it’sfewer units will still be a little bit more back-end loaded, so making surethat we’ve got those costs completely under control. I think the cost of relocation and moving managers aroundhas increased considerably.
I would say the direct cost associated with therestaurant when we get in there for the two months or so before a restaurantopens or the month before a restaurant opening, those are pretty consistent.It’s sort of that management carrying cost and relocation cost associated with-- it has increased in 2007 and that we’ve got to evaluate closely for 2008.
Christopher O'Cull -SunTrust Robinson Humphrey
Okay, and then last question, I know in the last call Ithink you guys mentioned something about a new prototype in 2008. Could youdescribe some of the benefits you hope to get from a new prototype?
David Overton
We are trying to have several of these sizes so we can openthe appropriate restaurant in the appropriate market, so if there is an A sitebut it’s in a market that is a little less populated, or that we are limited tomaybe 8,000 square feet, we want to have the right box with the right kitchenand the right cost. So we will be working on that.
We are pretty much done.We’ll be waiting to open one, make sure that everything is sized properly andthen we’ll have one of these boxes. It will be approximately -- I don’t know, 7,800to 8,000 square feet where we think it will be more economical than the sizeswe’ve been opening in the past years.
Christopher O'Cull -SunTrust Robinson Humphrey
And no change to the menu?
David Overton
No change to the menu -- cook everything, just less costgoing into a market, a site that needs to be smaller or we deem that it shouldbe smaller.
Christopher O'Cull -SunTrust Robinson Humphrey
Great. Thanks, guys.
Michael J. Dixon
Operator, we have time for about two more calls.
Operator
Your next question comes from the line of John Ivankoe withJ. P.
Morgan. Please proceed.
John Ivankoe - J. P.Morgan Securities
Thank you. The question is on pricing, especially in lightof this current environment.
Firstly, it sounds like the pricing that you aretaking is fairly cost driven, so I just want you to comment in terms of how youthink your consumer will do with pricing. And secondly, in the contest of communicating consistentvalue, which a lot of your lower end peers are talking about, we’ve seen inprevious years things like smaller lunch portions and we’ve seen the bar menu,for example, I think used in 2007, so can you comment if there is anything thatmight be upcoming to 2008 to bring back the consumer that might be somewhat fiscallyconstrained?
David Overton
Right now, we are really -- we’ll just be adding to thosecategories, keeping them alive and fresh with new items. We are going to addmore of the weight management items for those people that are weight conscious,probably some open-faced sandwiches and other meals beside just salads.
But wehave no more -- we want to be very careful about cheapening, changing ourconcept, doing things that we may be sorry for later. But continuing to justbolster the sections that are on the menu now and then the consumer -- we thinkour consumer will be better --
Michael J. Dixon
Well, I think we’ve historically been very successful atgetting our price increase, as I think you’re alluding to, John. Thepoint-and-a-half seems -- is relatively modest in this environment but as webalance out our need to cover margin pressures as well as try to find somemargin enhancement, we think that’s a reasonable price increase at this pointand I don’t anticipate any trouble in getting that.
John Ivankoe - J. P.Morgan Securities
Okay. Thank you.
Michael J. Dixon
Last call, Operator. Operator, our last call?
Operator
Your next question comes from the line of Howard Penney.Please proceed.
Howard Penney -Friedman, Billings, Ramsey & Co.
Thanks very much. You may have answered this questionindirectly but I was trying to get at some of the other benefits, other thanthe obvious to the organization from the slowing growth, meaning obviously theincrease in free cash flow and lower pre-opening expenses and just some of theother benefits that accrue to the organization over the next 12 months as yourefocus your growth.
Thanks.
Michael J. Dixon
Sure. Well, I think you’ve hit on the big ones and the otherone, which we talked about, was making sure that our infrastructure is properlysuited for that growth, both today and into the future.
I think the biggestone, which is harder to put your finger on immediately, is those operationalmargin -- operating margin enhancements that are available at the restaurantfrom increased focus and attention from the team who has to spend less time onnew restaurants, more time in the restaurant. You also get the benefit of less cannibalization and then Ithink maintaining the value of the brand and protecting the long-term strengthof The Cheesecake Factory brand.
Those are the other benefits that accrue tous, both in 2008 and longer. Okay, Operator, I think that was our last call.
Operator
Yes, sir. That concludes the Q&A.
Michael J. Dixon
Okay, everybody. Thank you.
Operator
Thank you for your participation in today’s conference. Thisconcludes our presentation.
You may now disconnect. Have a good day.