Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 26 weeks ended July 2, 2019, compared with July 3, 2018. The company operated 219 company-owned restaurants as of August 5, 2019, primarily under The Cheesecake Factory brand, plus bakery facilities, licensed international restaurants and other concepts.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Revenue | $602.6 million | $587.3 million | +2.6% |
| Income from operations | $40.1 million | $34.5 million | +16.1% |
| Operating margin | 6.7% | 5.9% | +80 bps |
| Net income | $35.5 million | $28.4 million | +25.2% |
| Net margin | 5.9% | 4.8% | +110 bps |
| Diluted EPS | $0.79 | $0.61 | +$0.18 |
| Metric | 26 Weeks 2019 | 26 Weeks 2018 | Change |
|---|---|---|---|
| Revenue | $1,202.1 million | $1,172.0 million | +2.6% |
| Income from operations | $70.2 million | $66.1 million | +6.3% |
| Operating margin | 5.8% | 5.6% | +20 bps |
| Net income | $62.5 million | $54.4 million | +14.9% |
| Net margin | 5.2% | 4.6% | +60 bps |
| Diluted EPS | $1.39 | $1.17 | +$0.22 |
Q2 comparable sales at The Cheesecake Factory restaurants increased 1.0%, driven by a 3.8% increase in average check, partially offset by a 2.8% traffic decline. First-half comparable sales increased 1.2%, with a 3.9% average-check increase and a 2.7% traffic decline. External bakery sales were $12.4 million in Q2 and $25.3 million in the first half.
- Q2 cost of sales was 22.3% of revenue versus 22.5% prior year; labor was 36.2% versus 36.0%; other operating costs were 24.7% versus 23.9%.
- General and administrative expense improved to 6.2% of revenue from 7.1%, primarily due to lower legal costs.
- The effective tax rate declined to 7.6% in Q2 and 6.9% for the first half, versus 10.4% and 11.8%, respectively.
- Cash provided by operating activities was $83.8 million for the first half, down from $140.5 million. Investing cash use was $50.6 million, including $29.4 million of capital expenditures and $21.0 million of investments and loans to unconsolidated affiliates.
- Financing cash use was $37.3 million, including $29.3 million of dividends and $39.2 million of treasury-stock purchases, partially offset by $25.0 million of net credit-facility borrowings.
- Cash and cash equivalents declined to $22.6 million from $26.6 million at January 1, 2019.
- At July 2, 2019, long-term debt was $35.0 million. The company had a $200 million unsecured revolving facility, $19.4 million of standby letters of credit and $145.6 million of net borrowing availability. Financial covenants were satisfied.
- Operating lease assets were $963.7 million and operating lease liabilities were $1,028.3 million at July 2, 2019, following adoption of ASC 842.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected new restaurant openings and positive comparable sales. One Cheesecake Factory restaurant opened in Q2; the first Social Monk Asian Kitchen location and one Cheesecake Factory location opened in the first half.
- Operating income and margins improved despite higher labor, rent, marketing and workers’ compensation costs. The prior-year period included $2.6 million of lease-termination costs, while 2019 had none.
- Interest and other expense declined sharply because ASC 842 eliminated deemed landlord financing liabilities and related interest expense.
- ASC 842 adoption increased recognized assets and liabilities and reduced beginning retained earnings by $41.5 million, net of tax. Prior-period results were not restated.
- The company repurchased approximately 0.6 million shares for $28.1 million during Q2 and had repurchased 52.6 million shares for $1.68 billion cumulatively through July 2, 2019.
- The quarterly dividend increased to $0.33 per share in 2019 from $0.29 per share in the comparable 2018 periods.
Guidance, Outlook, Risks and Unusual Items
- Management projected Q3 adjusted diluted EPS of $0.52 to $0.57, based on flat to 1.0% comparable sales, and fiscal 2019 adjusted diluted EPS of $2.58 to $2.68, based on 1.0% to 1.5% comparable sales.
- The outlook assumed approximately 2% commodity-cost inflation, approximately 6% wage-rate inflation and a 7% to 8% effective tax rate.
- Fiscal 2019 cash capital expenditures were estimated at $85 million to $95 million, with as many as five new Cheesecake Factory restaurants planned.
- On July 30, 2019, after quarter-end, the company agreed to acquire North Italia and the remaining Fox Restaurant Concepts businesses, including Flower Child, for $308 million in cash at closing, $45 million payable over four years and approximately $440 million of total consideration including prior investments. Closing was expected around the end of Q3, subject to regulatory and other conditions.
- On July 30, 2019, the company entered into a new $400 million unsecured revolving facility maturing July 30, 2024, with an option for up to $200 million of additional commitments. Management expected to fund the acquisitions with the new facility and cash on hand.
- The pending acquisitions could increase outstanding debt to approximately $300 million and involve integration costs, contingent consideration and required financing for certain FRC growth targets.
- Material contingencies include a $4.2 million California wage citation, an IRS dispute involving an $8.0 million domestic production activities deduction, and a tentative settlement of a California wage-and-hour class action. The company had not reserved for the wage citation or tax dispute and considered the pending matters not expected to have a material aggregate effect, although outcomes remain uncertain.
- Key operating risks include declining customer traffic, wage and commodity inflation, lease and occupancy costs, adverse weather, regulatory changes, litigation, acquisition execution and integration, increased leverage, and compliance with credit-facility covenants.
Important Facts for Investors to Verify
- Whether the North Italia and FRC acquisitions closed on the expected timetable and the final purchase price, financing and contingent consideration.
- Post-acquisition debt levels, covenant headroom, interest costs and the effect of the new credit facility on dividends and repurchases.
- Comparable-sales trends, particularly customer traffic versus average-check growth.
- Whether labor, commodity, rent and insurance inflation pressures stabilize or reduce restaurant-level margins.
- Actual fiscal 2019 EPS, capital expenditures, restaurant openings and cash flow compared with guidance.
- Resolutions and potential financial exposure related to the wage citation, tax dispute, class action settlement and other legal proceedings.