Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 26 weeks ended July 3, 2018, compared with July 4, 2017. The company operated 213 company-owned restaurants as of August 6, 2018, including 198 Cheesecake Factory, 13 Grand Lux Cafe and two RockSugar locations, plus 21 internationally licensed Cheesecake Factory restaurants and two bakery facilities.
Financial Highlights
| Metric | Q2 2018 | Q2 2017 | First Half 2018 | First Half 2017 |
|---|---|---|---|---|
| Revenue | $593.2 million | $569.9 million | $1,183.9 million | $1,133.3 million |
| Income from operations | $34.5 million | $50.2 million | $66.1 million | $93.8 million |
| Operating margin | 5.8% | 8.8% | 5.6% | 8.3% |
| Net income | $28.4 million | $38.2 million | $54.4 million | $73.2 million |
| Diluted EPS | $0.61 | $0.78 | $1.16 | $1.49 |
| Cash flow from operations | Not separately provided | Not separately provided | $140.5 million | $113.9 million |
Revenue increased 4.1% in the quarter and 4.5% in the first half. Cheesecake Factory comparable sales increased 1.4% in the quarter and 1.7% in the first half, supported by average-check growth of 3.5% and 3.1%, respectively, but partially offset by traffic declines of 2.1% and 1.4%.
Net income margins declined to 4.8% in the quarter from 6.7% and to 4.6% in the first half from 6.5%. Labor expenses increased to 35.8% of revenue in both periods, versus 33.9% and 34.1%, respectively, primarily because of wage, overtime and medical-cost increases. General and administrative expense also increased as a percentage of revenue because of higher legal costs and corporate bonus accruals.
Cash and cash equivalents were $29.4 million at July 3, 2018, compared with $6.0 million at January 2, 2018. The company generated $140.5 million of operating cash flow, used $66.1 million in investing activities and $51.1 million in financing activities during the first half. Capital expenditures were $51.9 million and investments in unconsolidated affiliates were $14.0 million.
Long-term debt was $20.0 million, supported by a $200 million unsecured revolving facility. Net borrowing availability was $159.3 million after outstanding debt and letters of credit. The company was in compliance with its covenants, with a Net Adjusted Leverage Ratio of 3.0 and an EBITDAR Ratio of 2.6.
Material Changes Versus the Prior Comparable Period
- Revenue grew, but operating income declined 31.2% in the quarter and 29.5% in the first half as labor, medical, legal, bakery and other operating costs increased.
- Interest and other expense increased to $2.9 million in the quarter and $4.4 million in the first half, partly due to losses and preopening costs associated with North Italia and Flower Child.
- The effective tax rate declined to 10.4% in the quarter and 11.8% in the first half, compared with 21.5% and 19.5%, respectively, primarily due to the Tax Cuts and Jobs Act.
- The company recorded $2.6 million of lease termination costs related to closing one Cheesecake Factory restaurant, compared with $0.4 million of impairment and accelerated depreciation in the prior-year quarter.
- Operating cash flow improved by $26.6 million year over year, while capital expenditures and investments in unconsolidated affiliates also increased.
- The company repurchased approximately 0.1 million shares for $7.1 million during the quarter and had cumulatively repurchased 50.4 million shares for $1.575 billion through July 3, 2018.
- The company adopted the new revenue recognition standard, recording a $3.6 million after-tax reduction to retained earnings related primarily to international development and site fees.
Guidance, Outlook, Risks and Unusual Items
Management forecast third-quarter adjusted diluted EPS of $0.56 to $0.60, based on comparable sales growth of 1.5% to 2.5%. Fiscal 2018 adjusted diluted EPS guidance was $2.40 to $2.48, based on comparable sales growth of 1.5% to 2.0%, commodity inflation of approximately 2.5%, wage inflation of approximately 6% to 7% and an effective tax rate of 12% to 13%.
The company planned to open as many as six company-owned restaurants, including one Grand Lux Cafe and the first Social Monk Asian Kitchen location, as well as as many as three internationally licensed restaurants. Fiscal 2018 capital expenditures were expected to be $80 million to $90 million, with $20 million to $25 million of growth capital contributions to North Italia and Flower Child.
Key risks include labor and wage inflation, medical-cost volatility, commodity-price increases, declining customer traffic, competition, adverse economic or weather conditions, construction costs, execution of new concepts and international expansion, foreign exchange exposure, litigation and regulatory claims, and compliance with debt-facility distribution limits. A 1% increase in food costs would have reduced second-quarter cost of sales by approximately $1.3 million and first-half cost of sales by approximately $2.7 million.
Pending matters include wage-and-hour litigation, a $4.2 million California wage citation involving a janitorial vendor, and an IRS tax dispute. The IRS Appeals Division reduced the disputed tax deduction disallowance to $8.0 million; the company plans to petition the Tax Court and has not recorded a reserve. Management stated that reasonably possible losses from pending matters are not expected to have a material adverse effect, although particular periods could be affected.
The California bakery was closed from February through June 2018 for an infrastructure upgrade. Management expects lease accounting adoption in fiscal 2019 to materially increase reported assets and liabilities, with an insignificant impact on the income statement.
Most Important Facts to Verify
- Whether comparable-sales growth and traffic trends support the fiscal 2018 EPS guidance.
- Whether labor, medical, commodity and legal-cost pressures stabilize sufficiently to restore operating margins.
- The cash requirements and performance of North Italia, Flower Child and Social Monk Asian Kitchen, including potential future acquisitions.
- The outcome and financial exposure from wage-and-hour claims, the California wage citation and the $8.0 million IRS dispute.
- Whether planned capital expenditures, dividends and share repurchases remain consistent with operating cash flow and debt covenants.
- The effect of fiscal 2019 lease accounting adoption on reported leverage, assets and liabilities.