CAKE

Business Context and Reporting Period

Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-K (Annual Report)
Period Ended: December 30, 2003
Operations: As of March 4, 2004, the Company operated 75 full-service restaurants under The Cheesecake Factory mark, 3 under the Grand Lux Cafe mark, and one express location. It also operates a bakery production facility in Calabasas Hills, California, supplying its restaurants and outside customers.

Key Financial Metrics (Fiscal Year 2003)

Margins: Operating margin was 10.7% in 2003 (vs. 10.8% in 2002). Net income margin was 7.5% in 2003 (vs. 7.5% in 2002).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 19% to $773.8 million, driven primarily by a 21% increase in restaurant sales ($128.0 million increase). This growth was attributed to 14 new restaurant openings ($57.0 million), non-comparable sales from prior openings ($68.4 million), and a 0.7% increase in comparable restaurant sales ($2.6 million).
• Bakery Decline: Bakery sales to outside customers decreased 13% to $42.6 million. This was due to unusually high sales in the first half of 2002 from new warehouse club relationships and the loss of a large foodservice customer following a voluntary product recall in 2002.
• Cost Pressures: Restaurant cost of sales increased to 24.0% of restaurant sales (from 23.7%) due to higher commodity costs for poultry, fish, and meat. Labor expenses rose to 30.9% of total revenues (from 30.7%) due to health insurance cost increases and weather-related sales volatility.
• Weather Impact: Severe weather in the first six months of 2003 resulted in approximately 22 lost days of sales and reduced patio utilization, slightly dampening average sales per operating week.

Guidance, Outlook, and Risks

• Expansion Plan: The Company plans to open as many as 16 new restaurants in fiscal 2004 (approx. 14 Cheesecake Factory and 2 Grand Lux Cafe). Two have already opened as of March 4, 2004.
• Capital Expenditures: Estimated capital expenditures for 2004 range between $110 million and $115 million, net of landlord contributions.
• Pricing Strategy: An effective menu price increase of approximately 1.8-2.0% was implemented in early 2004 to offset operating cost increases. Further pricing reviews are planned for the summer menu change.
• Liquidity: The Company maintains a strong balance sheet with no long-term debt. It has a $35 million revolving credit facility (amended Dec 2003) with no borrowings outstanding as of March 4, 2004.
• Risks:
  • Commodity Costs: Inability to contract for fresh commodities (produce, poultry, fish, dairy) for long periods exposes the Company to price volatility.
  • Legal Proceedings: Ongoing litigation regarding California labor laws (meal/rest breaks) and Proposition 65 (mercury in fish). Management does not believe these will have a material adverse effect.
  • Seasonality: Sales are subject to seasonal fluctuations, weather conditions affecting patio seating (17% of capacity), and holiday demand.

Investor Verification Checklist

• Comparable Sales Growth: Verify the sustainability of the 0.7% comparable sales increase given the impact of severe weather and the "honeymoon" effect of new openings.
• Bakery Customer Concentration: Monitor the recovery of bakery sales, specifically the resumption of purchases from the large foodservice customer lost in 2002 and the stability of warehouse club sales (62% of bakery revenue).
• Cost Inflation Pass-Through: Assess whether the 1.8-2.0% menu price increase is sufficient to offset rising commodity and labor costs without negatively impacting traffic.
• Capital Allocation: Confirm that the $110-$115 million capital expenditure plan for 2004 is funded by operating cash flow and existing cash reserves without requiring external financing.
• Legal Exposure: Track the status of the California labor law class actions and Proposition 65 settlement negotiations for potential unexpected liabilities.