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The impact of advertising;

Optimistic outlook from the conference call - “While the last of our 24 weeks of national advertising ends this--next week, we are very pleased with how guests have responded to our cable advertising this year. The economy may be tough right now, but the guests are telling us more than ever how much they love Red Robin, so we believe that our brand building efforts overall are working.”

In the 10Q things are less clear – “While we believe our brand health and sales are being positively impacted by this media, it is increasingly difficult to judge the effectiveness of advertising in an environment where consumers are pulling back on retail and restaurant spending.”

Looking at Cost of Sales;

On the conference call the company said “Our cost of sales increased by 80 basis points in the third quarter compared to last year. The increase was primarily due to higher raw materials costs in almost every category, somewhat offset by menu price increases, favorable produce and beverage costs, and some mix shift to higher margin menu items.”

In the 10Q the explanation for the increase in COGS was a little different; “cost of sales increased as a percentage of restaurant revenues over prior year due to higher raw material costs in almost every category and a slight shift in the mix of food versus beverage sales, with a decline in the sales of higher priced menu items and beverages, partially offset by menu price increases.”

I see things a little differently; RRGB reported that in 3Q08 same-store sales decreased 2.2% with traffic declining over 6%. Relative to the comment s in the 10Q, the same-store sales decline was also driven by people trading down to lower priced items. On the conference call, management indicated that consumers had shifted to higher margin menu items. For reference, the highest margin items on the menu are in the specialty beverage section so I find these two comments to be somewhat contradictory. How are consumer purchases shifting toward higher margin items, but also shifting away from higher priced menu items, including the high margin beverages?

Increasing rents;

Lastly, the 10Q mentioned that “many of the restaurants acquired from franchisees are ‘build to suit’ locations that typically bear a higher occupancy cost as a percentage of restaurant revenue.” As you can see from the chart, higher rents are going to be an issue for the company in a declining sales environment!