CAKE

Business Context and Reporting Period

Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 28, 2005 (13 weeks) and June 28, 2005 (26 weeks)
Operations: The Company operates 94 upscale casual dining restaurants under The Cheesecake Factory mark, 5 Grand Lux Cafes, one express foodservice operation, and a bakery production facility. The Company also licenses bakery cafes to third parties.

Key Financial Metrics

Note: Prior year figures have been restated to correct historical accounting for operating leases and leasehold improvements.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 23% ($53.4 million) for the quarter and 22% ($101.1 million) for the year-to-date period. This growth was driven primarily by new restaurant openings ($49.3 million in Q2) and a 1.8% increase in comparable restaurant sales.
• Profitability: Net income increased 32% for the quarter and 23% year-to-date. Operating margins improved slightly, with income from operations rising to 12.0% of revenue in Q2 2005 compared to 11.3% in Q2 2004.
• Expense Trends:
  • Cost of Sales: Increased 17% in Q2 but decreased as a percentage of revenue to 25.8% (from 27.1%) due to lower commodity costs (poultry, dairy) and menu price increases.
  • Labor Expenses: Increased 25% in Q2, rising to 31.1% of revenue due to new openings, higher minimum wages, and increased medical insurance costs.
  • Other Operating Costs: Increased 22% in Q2, remaining flat at 22.4% of revenue. Higher utility costs were offset by reduced rent expense due to construction allowances.
• Liquidity: Cash and marketable securities increased to $174.4 million from $151.5 million at year-end 2004. Net working capital improved to $32.2 million from $4.7 million.

Guidance, Outlook, and Risks

• Expansion Plans: The Company expects to open up to 18 new restaurants in fiscal 2005 (16 Cheesecake Factory, 2 Grand Lux Cafe). Seven have opened through July 26, 2005.
• Capital Expenditures: Estimated fiscal 2005 capital expenditures range from $158 million to $166 million, net of landlord contributions. This includes funding for new restaurants, a second bakery production facility, and corporate infrastructure.
• Commodity Outlook: Management expects generally flat costs for most commodities, lower costs for poultry and dairy, and slightly higher costs for cream cheese and fresh fish. Menu price increases are expected to offset cost inflation.
• Accounting Changes:
  • Restatement: Fiscal 2004 results were restated to correct lease accounting errors (contingent rent, rent holidays, landlord contributions). The restatement reduced prior year net income slightly but had no impact on cash flows.
  • SFAS 123R: The Company must adopt new share-based payment accounting standards in Q1 2006, which is expected to have a material impact on reported earnings.
• Risks: Key risks include fluctuations in food commodity prices, labor cost increases, the timing of new restaurant openings, and the inability to secure long-term contracts with large bakery customers. The Company is also subject to ongoing class-action litigation regarding meal and rest breaks, for which a $4.5 million reserve was established in 2004.

Investor Verification Checklist

• Restatement Impact: Verify the specific impact of the lease accounting restatement on prior year comparability, particularly regarding rent expense and depreciation.
• Comparable Sales: Confirm the 1.8% comparable sales increase is sustainable given the "honeymoon" effect of new store openings and the shift of the Easter holiday.
• Capital Expenditure Execution: Monitor the timing of the planned 18 new openings and the $158-$166 million capital spend, as delays are common due to leasehold complexities.
• Commodity Hedging: Review the extent of fixed-price contracts for fresh commodities (fish, dairy) which are largely uncontracted beyond 30 days.
• Legal Contingencies: Track the status of the California labor law class-action settlement and any potential revisions to the $4.5 million reserve.
• Share Repurchases: Note the Company repurchased 127,650 shares in Q2 2005; verify remaining authorization under the 6 million share program.