Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 39 weeks ended October 3, 2017, compared with the periods ended September 27, 2016. Fiscal 2017 consists of 52 weeks and ends January 2, 2018; fiscal 2016 included a 53rd week. The company operated 209 company-owned restaurants as of November 8, 2017, 18 internationally licensed restaurants, and two bakery facilities.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 39 Weeks 2017 | 39 Weeks 2016 |
|---|---|---|---|---|
| Revenue | $555.4 million | $560.0 million | $1,688.7 million | $1,672.6 million |
| Income from operations | $34.3 million | $50.1 million | $128.1 million | $153.8 million |
| Operating margin | 6.2% | 8.9% | 7.6% | 9.2% |
| Net income | $26.4 million | $34.6 million | $99.7 million | $107.1 million |
| Diluted EPS | $0.56 | $0.70 | $2.05 | $2.16 |
| Net margin | 4.8% | 6.2% | 5.9% | 6.4% |
- Q3 comparable sales declined 2.3% at The Cheesecake Factory restaurants, driven by a 4.3% traffic decline, partly offset by 2.0% average-check growth. Hurricane activity reduced comparable sales by approximately 0.8% and diluted EPS by approximately $0.04.
- For the first 39 weeks, comparable sales declined 0.8%, with traffic down 3.0% and average check up 2.2%. The company reported 2.8% growth in operating weeks.
- Q3 labor expense increased to 34.9% of revenue from 33.3%, primarily because of wage inflation, sales deleverage and higher self-insured medical claims. Other operating costs increased to 24.9% from 24.1%.
- Q3 cost of sales improved slightly to 22.9% from 23.0%; general and administrative expense remained 6.4% of revenue.
- Cash provided by operating activities was $154.2 million for the first 39 weeks, down from $225.1 million. Capital expenditures were $73.4 million, and the company invested $9.0 million in unconsolidated affiliates, including North Italia and Flower Child.
- Cash and equivalents declined to $19.8 million at October 3, 2017, from $53.8 million at January 3, 2017. Financing cash outflows included $106.4 million of treasury stock purchases and $36.6 million of dividends.
- The company had $30.0 million outstanding under its $200 million unsecured revolving credit facility and $149.3 million of net borrowing availability, after standby letters of credit. It was in compliance with its covenants; the Net Adjusted Leverage Ratio was 2.7 versus a maximum of 4.0, and the EBITDAR Ratio was 2.9 versus a minimum of 1.9.
- Total assets were $1.275 billion and stockholders’ equity was $583.4 million at October 3, 2017. The company had $30.0 million of long-term debt and a $113.6 million deemed landlord financing liability.
Material Changes Versus Prior Comparable Period
- Revenue decreased 0.8% in Q3 but increased 1.0% for the first 39 weeks, primarily reflecting new restaurant openings and bakery sales offset by negative comparable sales.
- Q3 operating income fell 31.5%, and operating margin declined 270 basis points. For the first 39 weeks, operating income fell 16.7%, and margin declined 160 basis points.
- Net income declined 23.5% in Q3 and 7.0% for the first 39 weeks. Lower diluted share counts from repurchases partly mitigated the EPS decline.
- The effective tax rate declined to 19.2% in Q3 from 27.3% and to 19.4% for the first 39 weeks from 27.1%, primarily due to the adoption of share-based compensation accounting guidance, FICA tip credits and nontaxable investment gains.
- The company borrowed $30.0 million during Q3 to fund a portion of share repurchases. It repurchased approximately 1.6 million shares for $75.8 million in Q3 and had cumulatively repurchased 49.1 million shares for $1.516 billion through October 3, 2017.
- The company recorded $1.2 million of accelerated depreciation and impairment expense during the first 39 weeks related to one restaurant relocation and one lease expiration. Preopening costs were $3.4 million in Q3, up from $2.0 million, reflecting one restaurant opening.
Guidance, Outlook, Risks and Unusual Items
- For Q4 fiscal 2017, management forecast diluted EPS of $0.50 to $0.54, based on comparable sales ranging from down 1% to flat at The Cheesecake Factory restaurants.
- For fiscal 2017, management forecast adjusted diluted EPS of $2.57 to $2.61, approximately 1% comparable-sales decline, 1% to 2% food-cost inflation, approximately 5% wage inflation and an approximately 20% effective tax rate. Planned capital expenditures were $110 million to $115 million, growth capital contributions were $10 million to $15 million, and share repurchases were expected to total $125 million to $150 million.
- For fiscal 2018, management forecast diluted EPS of $2.50 to $2.75, comparable sales ranging from flat to up 1%, approximately 5% wage inflation and an approximately 24% effective tax rate before potential tax reform. Planned openings were as many as four to six company-owned restaurants and four to five international licensed restaurants.
- Management cited customer traffic declines, wage and commodity inflation, sales deleverage, repairs and maintenance, marketing, utilities, insurance claims and construction costs as key pressures. Commodity prices, labor costs, weather, competition and macroeconomic conditions may materially affect results.
- Pending matters include wage-and-hour and consumer claims, including class or collective actions. Several matters have unspecified damages and no reserve because the outcomes cannot reasonably be estimated. The company has reserved immaterial amounts for certain matters and believes pending matters are not expected to materially affect financial position, results or liquidity, although quarterly results could be affected.
- The IRS disallowed $12.9 million of claimed Domestic Production Activity Deductions for tax years 2010–2012. The company is contesting the matter through the IRS Appeals Division and has not reserved for potential payments.
- The company expects to shut down its California bakery for several months in fiscal 2018 for an infrastructure upgrade and increased finished-goods inventory to support operations during the shutdown.
- The company plans to adopt the new lease accounting standard in fiscal 2019, which it expects will materially affect the balance sheet. The new revenue recognition standard, effective in fiscal 2018, is not expected to have a material financial statement impact.
Investor Verification Items
- Verify whether comparable-sales and traffic trends improve from the Q3 declines and whether planned menu pricing offsets labor and commodity inflation without further traffic erosion.
- Reconcile the expected fiscal 2017 EPS range with actual Q4 results, the hurricane impact, the impairment adjustment and the lower effective tax rate.
- Monitor operating cash flow, cash balances, credit-facility borrowings and covenant headroom as the company continues dividends, share repurchases, restaurant development and investments in North Italia and Flower Child.
- Assess the financial and operating impact of the California bakery shutdown and related infrastructure spending in fiscal 2018.
- Review developments in the IRS tax dispute and pending employment, gratuity and credit-card information litigation, for which potential liabilities are largely unreserved.
- Confirm the pace and returns of new restaurant openings, international licensing expansion and investments in emerging concepts against management’s stated capital-allocation objectives.