Business Context and Reporting Period
Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 3, 2006 (Thirteen and Thirty-Nine Weeks)
Business Overview: The Company operates upscale, high-volume casual dining restaurants (The Cheesecake Factory and Grand Lux Cafe) and a bakery segment supplying desserts to restaurants and third-party retailers. As of December 1, 2006, the Company operated 118 Cheesecake Factory restaurants and 8 Grand Lux Cafes.
Key Financial Metrics
| Metric (in thousands) | 13 Weeks Ended Oct 3, 2006 | 39 Weeks Ended Oct 3, 2006 |
|---|---|---|
| Revenues | $325,337 | $954,629 |
| Net Income | $18,127 | $60,846 |
| Diluted EPS | $0.23 | $0.76 |
| Operating Cash Flow | N/A | $97,861 |
| Cash & Cash Equivalents | $19,571 | $19,571 |
| Total Assets | $984,670 | $984,670 |
| Debt (Deemed Landlord Financing) | $43,382 | $43,382 |
| Current Ratio | 1.3:1 | 1.3:1 |
Note: The Company has no funded debt in its capital structure; the "Debt" line item represents deemed landlord financing liability.
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 10% ($29.1 million) for the 13 weeks and 12% ($101.2 million) for the 39 weeks compared to the prior year periods. This growth was driven primarily by new restaurant openings, offsetting a decline in comparable restaurant sales.
- Comparable Sales: Comparable sales at The Cheesecake Factory restaurants decreased approximately 2.1% (13 weeks) and 1.6% (39 weeks) due to reduced guest traffic. Grand Lux Cafe comparable sales increased 6.7% (13 weeks) and 5.4% (39 weeks).
- Profitability: Net income decreased 23% for the 13 weeks and 7% for the 39 weeks compared to the prior year. Operating margins declined to 7.6% (13 weeks) and 8.7% (39 weeks) from 11.8% and 11.4% respectively in the prior year.
- Expense Increases:
- Labor Expenses: Increased 15% (13 weeks) and 16% (39 weeks), rising to 32.3% and 32.1% of revenue respectively, due to new openings and stock-based compensation.
- G&A Expenses: Increased 30% (13 weeks) and 32% (39 weeks), driven by the adoption of SFAS 123R (stock-based compensation) and professional fees related to the stock option review.
- Restatements: Prior period financial statements have been restated due to the correction of stock option grant date accounting errors, gift card breakage accounting, bonus accrual timing, and liquor license amortization. All comparisons in this filing reflect restated prior period data.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
- Expansion: The Company expects to open as many as 21 new restaurants in fiscal 2006, with approximately 13 planned for the fourth quarter. Capital expenditures for fiscal 2006 are estimated between $190 million and $195 million.
- Pricing: A 1% effective menu price increase was implemented in early 2006. No price increase was included in the summer 2006 menu change.
- Stock Repurchases: The Company has repurchased 3.63 million shares for $80.5 million under an open-ended authorization.
Risks and Contingencies
- Stock Option Misdating: The Audit Committee concluded that the Company incorrectly selected grant dates for stock options to maximize value for recipients. This led to a $5.4 million cumulative after-tax expense adjustment through fiscal 2005. The Company is seeking approximately $1 million in reimbursement from the CEO, former CFO, and certain directors. Eight shareholder derivative lawsuits have been filed regarding this matter.
- SEC Inquiry: The Company is cooperating with an informal SEC inquiry regarding stock option granting practices.
- Nasdaq Listing: The Company received a staff determination from Nasdaq regarding potential delisting due to delayed filings of Form 10-Q. An appeal is pending.
- Legal Proceedings: The Company faces various wage and hour lawsuits (California, North Carolina, Tennessee/Texas/Arizona) and an EEOC discrimination charge. A California class action settlement was approved in August 2006.
- Commodity Costs: The Company is exposed to volatility in food commodity prices (poultry, fish, dairy), though it contracts for some items and adjusts menu prices to offset costs.
Investor Verification Checklist
- Restatement Impact: Verify the full extent of the financial restatements related to stock option misdating and the resulting $5.4 million expense adjustment.
- Comparable Sales Trend: Monitor the decline in comparable sales at The Cheesecake Factory locations (-2.1% Q3) versus the growth at Grand Lux Cafe.
- Legal Exposure: Track the status of the eight shareholder derivative lawsuits and the SEC inquiry regarding stock option practices.
- Nasdaq Status: Confirm the outcome of the Nasdaq appeal regarding the Company's continued listing status.
- Capital Expenditures: Assess the ability to fund the projected $190-$195 million in capital expenditures for 2006 given the cash burn from stock repurchases and new openings.
- Stock-Based Compensation: Review the impact of SFAS 123R adoption on future earnings, noting the $13.1 million expense recognized in the first 39 weeks of 2006.