Business Context and Reporting Period
The Cheesecake Factory Incorporated filed its Form 10-K for the 52-week fiscal year ended December 31, 2019. The company operated 294 company-owned restaurants in the United States and Canada under The Cheesecake Factory, North Italia, Fox Restaurant Concepts and other brands, plus 26 internationally licensed Cheesecake Factory restaurants and two bakery facilities.
On October 2, 2019, the company acquired North Italia and the remaining business of Fox Restaurant Concepts, including Flower Child. Acquired results were consolidated from the acquisition date. Fourth-quarter 2019 included $92.0 million of acquired revenue and a $1.5 million net loss from the acquired businesses.
Financial Results and Key Metrics
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Revenue | $2.483 billion | $2.332 billion | 6.5% increase |
| Income from operations | $103.6 million | $118.9 million | 12.9% decrease |
| Operating margin | 4.2% | 5.1% | Down 0.9 percentage points |
| Net income | $127.3 million | $99.0 million | 28.5% increase |
| Net margin | 5.1% | 4.2% | Up 0.9 percentage points |
| Diluted EPS | $2.86 | $2.14 | 33.6% increase |
| Cash flow from operations | $218.8 million | $291.3 million | Decrease of $72.6 million |
| Capital expenditures | $73.8 million | $102.9 million | Decrease of $29.1 million |
| Cash and equivalents | $58.4 million | $26.6 million | Increase of $31.8 million |
| Long-term debt | $290.0 million | $10.0 million | Increase primarily funding acquisition |
The increase in net income included a $39.2 million gain on investments in unconsolidated affiliates, principally a $52.7 million gain from remeasuring previously held interests in North Italia and Flower Child. Fiscal 2019 also included $5.3 million of acquisition-related costs, $1.0 million of acquisition-related contingent consideration, compensation and amortization expense, and $18.2 million of impairment and lease termination expense.
Cost of sales improved to 22.6% of revenue from 22.8%, while labor expense increased to 36.3% from 35.8%, primarily due to higher hourly wage rates. Other operating costs increased to 25.5% from 24.3%, principally due to lease accounting adoption and higher marketing costs. The Cheesecake Factory comparable sales increased 0.8%, driven by 4.0% average-check growth, partly offset by a 3.2% traffic decline.
The fourth quarter generated $694.0 million of revenue, $6.4 million of operating income and $48.7 million of net income. Fourth-quarter operating income included $18.2 million of impairment and lease termination expense and acquisition-related expenses.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by the North Italia and FRC acquisition, new restaurant openings and positive comparable sales.
- The company opened nine restaurants in 2019 versus five in 2018, including five Cheesecake Factory, one Social Monk, one North Italia and two Flower Child locations.
- Operating profitability declined despite higher revenue because of labor inflation, higher occupancy and marketing costs, impairment charges and acquisition expenses.
- Net income and EPS increased substantially, but the improvement was influenced by the $52.7 million acquisition-related gain and lower interest expense associated with lease accounting changes.
- The company adopted ASC 842 lease accounting in 2019, recognizing $1.241 billion of operating lease assets and $1.318 billion of operating lease liabilities and reducing beginning retained earnings by $41.5 million, net of tax.
- The company entered a new $400 million unsecured revolving credit facility maturing July 30, 2024. At year-end, $290.0 million was outstanding, $19.4 million supported standby letters of credit and reported net borrowing availability was $90.6 million.
- Dividends declared increased to $1.38 per share from $1.24. The company repurchased 1.1 million shares for $51.0 million during 2019 and had cumulatively repurchased 52.9 million shares for $1.693 billion.
Guidance, Outlook, Risks and Unusual Items
Management forecast fiscal 2020 adjusted diluted EPS of $2.70 to $2.86, based on 1% to 2% comparable-sales growth at The Cheesecake Factory and approximately $425 million of North Italia and FRC revenue. The outlook excluded approximately $8 million of acquisition-related costs and $4 million of acquisition-related contingent consideration, compensation and amortization expense.
- Expected fiscal 2020 food inflation was approximately 2%, wage inflation approximately 5.5% and the effective tax rate approximately 9%.
- Management planned as many as 20 new company-owned restaurants: six Cheesecake Factory, six North Italia and eight FRC locations, including up to four Flower Child restaurants. Up to four additional international licensed locations were expected.
- Planned fiscal 2020 capital expenditures were $130 million to $140 million, with an additional $17.3 million cash outflow for acquisition-related deferred consideration.
- Major risks include declining customer traffic, intense restaurant and off-premise competition, labor and commodity inflation, food safety events, adverse weather and health epidemics, cybersecurity incidents, regulatory and wage-and-hour litigation, lease obligations, impairment risk and difficulty integrating the acquired businesses.
- The filing specifically references the coronavirus outbreak as a risk to international licensee operations, royalties, staffing, supply chains and restaurant traffic.
- The acquisition included contingent consideration with an undiscounted modeled outcome ranging from $0 to $69.2 million and required financing support for certain FRC targets during the five years after closing.
- The company disclosed a $4.2 million California wage citation under appeal and an $8.0 million IRS tax deficiency dispute. No reserves were recorded because the outcomes could not reasonably be estimated.
- Management reported effective disclosure controls and internal control over financial reporting, but excluded North Italia and FRC from the 2019 internal-control assessment. Those businesses represented 28.3% of consolidated assets and 3.7% of consolidated revenue.
Important Facts for Investors to Verify
- Reconcile the filing's inconsistent references to fiscal 2019 net income: the audited consolidated statements report $127.3 million, while one selected-data table states $127.9 million.
- Assess whether comparable-sales growth can overcome persistent traffic declines and labor-cost inflation.
- Verify the sustainability of reported EPS after excluding the acquisition-related gain and other unusual items; adjusted diluted EPS was $2.61 for 2019.
- Monitor leverage, covenant compliance and liquidity under the new credit facility, including the $90.6 million reported net borrowing availability.
- Evaluate integration progress, unit economics and cash requirements for North Italia and FRC, including contingent consideration and required financing support.
- Review lease commitments of $2.03 billion, including $867.2 million related to renewal options considered reasonably certain to be exercised.
- Track impairment, closure and lease-termination charges, as well as wage-and-hour, tax, food-safety and cybersecurity exposures.
- Confirm the impact of the coronavirus-related risks and any subsequent changes to fiscal 2020 guidance, restaurant openings or international operations.