Business Context and Reporting Period
Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-K (Annual Report)
Period Ended: January 2, 2007 (Fiscal Year 2006)
Operations: As of February 13, 2007, the Company operated 123 upscale, full-service restaurants under The Cheesecake Factory mark and 8 under the Grand Lux Cafe mark across 32 states and D.C. Additionally, it operates two bakery production facilities (Calabasas Hills, CA and Rocky Mount, NC) and one "express" location at DisneyQuest. The Company also licenses two bakery cafes.
Key Financial Metrics (Fiscal 2006)
| Metric | Value (in millions) |
|---|---|
| Total Revenues | $1,315.3 |
| Net Income | $81.3 |
| Income from Operations | $106.8 |
| Operating Margin | 8.1% |
| Cash Provided by Operations | $152.7 |
| Capital Expenditures | $185.7 |
| Total Assets | $1,039.7 |
| Total Stockholders' Equity | $711.5 |
| Long-Term Debt (Deemed Landlord Financing) | $40.4 |
| Cash and Cash Equivalents | $44.8 |
| Investments and Marketable Securities | $89.5 |
Note: The Company has no funded debt; the "Long-Term Debt" figure represents deemed landlord financing liabilities related to construction contributions.
Material Changes vs. Prior Period (Fiscal 2005)
- Revenue Growth: Revenues increased 11% to $1,315.3 million from $1,182.1 million. On a 52-week comparable basis, revenue growth was 14%.
- Comparable Sales: Comparable restaurant sales decreased 0.6% overall. The Cheesecake Factory concept saw a 1.1% decline, while Grand Lux Cafe saw a 6.1% increase. The decline was attributed to macroeconomic factors and a reduction in dining occasions, partially offset by a 1% effective menu price increase.
- Profitability: Net income decreased 7.6% to $81.3 million from $87.9 million. Operating margin declined to 8.1% from 11.0% in the prior year.
- Expense Increases:
- Stock-Based Compensation: A significant factor in margin compression was the adoption of SFAS 123(R), resulting in $18.2 million of stock-based compensation expense (1.4% of revenue) compared to $0.8 million in 2005.
- Labor Expenses: Increased 16% to $421.0 million (32.0% of revenue) due to revenue growth and lower average sales per week.
- General & Administrative (G&A): Increased 36% to $72.8 million, driven by infrastructure growth and the new stock-based compensation accounting standard.
- Expansion: Opened 21 new restaurants in 2006 (20 Cheesecake Factory, 1 Grand Lux Cafe) compared to 18 in 2005.
Guidance, Outlook, and Risks
Outlook and Guidance
- Expansion Plan: The Company plans to open as many as 21 new restaurants in Fiscal 2007 (15-16 Cheesecake Factory, 5-6 Grand Lux Cafe). Most openings are expected in the second half of the year.
- New Concepts: Developing an upscale Asian cuisine concept, targeted to open by Labor Day 2007.
- Capital Expenditures: Estimated at $200 million to $210 million for Fiscal 2007, net of landlord contributions.
- Preopening Costs: Estimated at $25 million to $26 million for Fiscal 2007.
- Bakery Sales: Expected to increase 8% to 10% in Fiscal 2007.
- Pricing: Implemented a 1.5% effective menu price increase in early 2007 to offset cost increases; further reviews planned for the summer menu change.
Risks and Contingencies
- SEC Inquiry and Litigation: The SEC is conducting an informal inquiry regarding the Company's historical stock option granting practices. Additionally, eight shareholder derivative actions have been filed alleging improper dating of stock options. The Company intends to vigorously defend these actions.
- Stock Option Correction: The Company initiated a tender offer to amend exercise prices of certain options to comply with Internal Revenue Code Section 409A.
- Commodity Costs: Profitability is sensitive to fluctuations in food, labor, and energy costs. The Company cannot guarantee that menu price increases will fully offset these costs.
- Seasonality: Business is seasonal, with higher revenues typically in Q2 and Q3. Weather conditions can impact patio seating (19% of capacity).
- Self-Insurance: The Company is self-insured for significant portions of workers' compensation, general liability, and health benefits, creating exposure to claim severity and frequency.
Investor Verification Checklist
- Stock Option Accounting: Verify the financial impact of the SEC inquiry and the status of the shareholder derivative lawsuits regarding stock option backdating.
- Comparable Sales Trends: Monitor the trend of comparable sales, which declined in 2006, to assess the effectiveness of menu price increases and the impact of macroeconomic conditions.
- Operating Margin Recovery: Track the Company's ability to return operating margins to the 12% target, considering the permanent increase in stock-based compensation expenses under SFAS 123(R).
- Capital Allocation: Review the execution of the $200M+ capital expenditure plan and the timing of new restaurant openings to ensure they align with revenue growth projections.
- Liquidity Position: Confirm the stability of cash flows given the high capital intensity of new openings and the reliance on landlord construction contributions.