Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 39 weeks ended September 27, 2016. Fiscal 2016 contains 53 weeks and ends January 3, 2017. As of November 3, 2016, the company operated 205 company-owned restaurants, 13 internationally licensed locations, and two bakery production facilities.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 39 Weeks 2016 | 39 Weeks 2015 |
|---|---|---|---|---|
| Revenue | $560.0 million | $526.7 million | $1,672.6 million | $1,573.8 million |
| Income from operations | $50.1 million | $35.6 million | $153.8 million | $126.5 million |
| Operating margin | 8.9% | 6.8% | 9.2% | 8.0% |
| Net income | $34.6 million | $26.2 million | $107.1 million | $89.3 million |
| Diluted EPS | $0.70 | $0.52 | $2.16 | $1.76 |
| Cash provided by operations | Not separately provided | Not separately provided | $216.5 million | $161.1 million |
Third-quarter revenue increased 6.3%, operating income increased approximately 40%, and net income increased approximately 32%. For the first 39 weeks, revenue increased 6.3%, operating income increased approximately 22%, and net income increased approximately 20%.
- Q3 comparable sales increased 1.7% at The Cheesecake Factory and 3.4% at Grand Lux Cafe. The Cheesecake Factory increase reflected 3.1% average check growth, including 2.6% menu pricing and 0.5% mix, offset by a 1.4% traffic decline.
- For the first 39 weeks, The Cheesecake Factory comparable sales increased 1.2%, with a 2.8% average check increase offset by a 1.6% traffic decline.
- Q3 cost of sales declined to 23.0% of revenue from 23.9%, primarily due to lower grocery, seafood, dairy, and poultry costs.
- Q3 labor expense increased to 33.3% of revenue from 32.7%, primarily due to wage increases, minimum-wage mandates, and higher group medical costs.
- Q3 other operating costs decreased to 24.1% of revenue from 24.4%, while general and administrative expense increased slightly to 6.4% from 6.3%.
- The effective tax rate increased to 27.3% in Q3 from 25.0%; the 39-week rate was 27.1% versus 27.0%.
Cash Flow, Balance Sheet, Debt, and Capital Allocation
- Cash and cash equivalents were $65.8 million at September 27, 2016, compared with $43.9 million at December 29, 2015.
- Operating cash flow for the first 39 weeks was $216.5 million, compared with $161.1 million in the prior-year period. Capital expenditures were $70.6 million versus $108.6 million.
- Financing activities used $122.6 million, including $119.0 million for treasury stock purchases and $31.0 million for dividends. The company received $18.9 million from employee stock-option exercises.
- The company had no outstanding borrowings under its $200 million unsecured revolving credit facility and had $182.7 million of net borrowing availability, after $17.3 million of standby letters of credit.
- The facility matures December 22, 2020 and includes a potential $100 million commitment increase feature. The company was in compliance with its financial covenants; its Net Adjusted Leverage Ratio was 2.4 versus a maximum of 4.0, and its EBITDAR Ratio was 3.1 versus a minimum of 1.9.
- The company repurchased 0.8 million shares for $42.4 million in Q3 and had cumulatively repurchased 46.5 million shares for $1.38 billion through September 27, 2016. The board increased the repurchase authorization to 56 million shares.
- The quarterly dividend was $0.24 per share. A subsequent $0.24 per-share dividend was declared on October 20, 2016.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially, aided by revenue growth, lower food costs, lower workers' compensation expense, and the absence of the $6.0 million RockSugar Pan Asian Kitchen impairment charge recorded in Q3 2015.
- Preopening costs declined to $2.0 million from $4.3 million in Q3 and to $6.6 million from $9.8 million for the first 39 weeks. The company opened no restaurants in Q3 2016 versus two in Q3 2015.
- Labor cost pressure increased because of wage inflation, minimum-wage changes, and medical costs, partially offsetting commodity cost benefits.
- Capital expenditures declined year over year, while share repurchases and dividends increased in aggregate.
- Total assets declined to $1.20 billion from $1.23 billion at December 29, 2015, while stockholders' equity was broadly stable at $589.5 million.
Guidance, Outlook, Risks, and Unusual Items
- For Q4 2016, management estimated diluted EPS of $0.65 to $0.68, based on The Cheesecake Factory comparable-sales growth of 1.0% to 2.0%.
- For fiscal 2016, management estimated diluted EPS of $2.81 to $2.84, comparable-sales growth of 1.0% to 1.5%, approximately 5% wage inflation, an effective tax rate of approximately 27%, and $100 million to $105 million of cash capital expenditures.
- Management planned up to eight new company-owned restaurants in fiscal 2016 and up to four international licensed openings. It expected to repurchase up to $150 million of stock and return approximately $190 million to shareholders through repurchases and dividends.
- For fiscal 2017, management estimated diluted EPS of $2.95 to $3.11, comparable-sales growth of 1.0% to 2.0%, commodity inflation of 1.5% to 2.0%, wage inflation of approximately 5%, and a 23% to 24% tax rate following adoption of new stock-compensation accounting guidance.
- Fiscal 2017 plans included eight to nine company-owned openings, four to five international licensed openings, and $125 million to $140 million of capital expenditures.
- Key risks include customer traffic declines, wage and benefit inflation, commodity-price volatility, labor and employment litigation, competition, macroeconomic conditions, weather, and execution of restaurant openings. Management noted that future impairment charges could arise from underperforming locations.
- Several employment-related and consumer-related lawsuits remained pending. The company had reserved an immaterial amount for one wage-statement matter and no reserves for several other matters; management did not expect pending matters to have a material adverse effect, although individual periods could be affected.
- The company expects lease accounting changes to have a material effect on its financial statements when adopted in fiscal 2019. It expected stock-compensation accounting changes adopted in fiscal 2017 to reduce the annual effective tax rate by approximately 3% to 4%.
Important Facts for Investors to Verify
- Whether comparable-sales growth can continue despite declining customer traffic.
- The effect of approximately 5% wage inflation and future minimum-wage increases on restaurant-level and consolidated margins.
- Whether commodity-cost benefits persist or reverse, particularly for seafood, produce, meat, poultry, and dairy.
- Progress against fiscal 2016 and fiscal 2017 restaurant-opening, capital-expenditure, and EPS guidance.
- The sustainability of large share repurchases and dividends relative to free cash flow and credit-facility distribution limits.
- Potential financial exposure from pending employment, wage-and-hour, gratuity, and other litigation.
- The impact of adopting stock-compensation and future lease-accounting standards on reported earnings, taxes, assets, and liabilities.