Business Context and Reporting Period
The Cheesecake Factory Incorporated filed its Form 10-K for the 52-week fiscal year ended January 1, 2019. The company operated 218 company-owned restaurants as of March 4, 2019, including 201 Cheesecake Factory, 14 Grand Lux Cafe, two RockSugar Southeast Asian Kitchen and one Social Monk Asian Kitchen locations. It also had 21 internationally licensed Cheesecake Factory restaurants and two bakery facilities.
The filing includes fourth-quarter data for the 13 weeks ended January 1, 2019, but the primary financial discussion is for fiscal 2018 versus fiscal 2017.
Financial Performance and Key Metrics
| Metric | Fiscal 2018 | Fiscal 2017 |
|---|---|---|
| Revenue | $2.332 billion | $2.261 billion |
| Income from operations | $118.9 million | $152.8 million |
| Operating margin | 5.1% | 6.8% |
| Net income | $99.0 million | $157.4 million |
| Diluted EPS | $2.14 | $3.27 |
| Cash provided by operating activities | $291.3 million | $238.8 million |
| Capital expenditures | $102.9 million | $120.8 million |
| Cash and cash equivalents | $26.6 million | $6.0 million |
| Long-term debt | $10.0 million | $10.0 million |
Fiscal 2018 comparable sales at Cheesecake Factory restaurants increased 1.7%, driven by 3.3% average-check growth, including 2.8% menu pricing and 0.5% favorable mix, partly offset by a 1.6% traffic decline. Average check was approximately $22.60, compared with $21.85 in fiscal 2017.
Cost of sales improved to 22.8% of revenue from 23.0%, primarily due to lower seafood costs. Labor expense increased to 35.8% from 34.4%, reflecting wage and overtime inflation and higher medical costs. General and administrative expense increased to 6.6% of revenue from 6.2%.
At January 1, 2019, total assets were $1.314 billion and stockholders’ equity was $571.1 million. Total long-term debt and deemed landlord financing liability, including current portions, were $118.6 million. The company had $169.3 million of net borrowing availability under its $200 million unsecured revolving facility, after $10.0 million of borrowings and $20.7 million of standby letters of credit.
Material Changes Versus the Prior Comparable Period
- Revenue increased 3.2%, primarily from new restaurant openings and positive comparable sales.
- Income from operations declined 22.2%, and operating margin fell 170 basis points, mainly because of labor inflation, higher medical costs, increased corporate expenses and impairment charges.
- Net income decreased 37.1% and diluted EPS decreased 34.6%.
- Fiscal 2018 included $17.9 million of impairment and lease termination expense, compared with $10.3 million in fiscal 2017.
- Losses from North Italia and Flower Child investments increased to $4.8 million from $0.5 million, primarily because of preopening costs.
- Operating cash flow increased by $52.5 million, principally because of the timing of income tax payments and working-capital changes, despite lower pretax income.
- The company opened four Cheesecake Factory restaurants and one Grand Lux Cafe in fiscal 2018, versus seven Cheesecake Factory and one RockSugar location in fiscal 2017.
- Fiscal 2018 adopted ASC 606 revenue recognition, resulting in a $3.6 million net-of-tax reduction to opening retained earnings. Complimentary meals were reclassified from revenue and certain operating expense categories without affecting operating income, net income or EPS.
- Fiscal 2017 results benefited from a $38.5 million tax benefit related to the Tax Cuts and Jobs Act, making year-over-year net income comparisons less representative of underlying operating performance.
Guidance, Outlook, Risks and Unusual Items
Management forecast fiscal 2019 adjusted diluted EPS of $2.54 to $2.70, based on comparable sales growth of 1% to 2%. The forecast excludes gains or losses on unconsolidated affiliates and includes approximately $4 million of additional expense from the new lease accounting standard. Management expected commodity inflation of approximately 1% to 2%, wage inflation of approximately 6% and an effective tax rate of approximately 10%.
The company planned to open as many as six Cheesecake Factory restaurants and the first Social Monk location in fiscal 2019, with as many as five additional international licensed restaurants. Planned cash capital expenditures were $90 million to $100 million, and growth capital contributions to North Italia and Flower Child were expected to be $20 million to $25 million, excluding a potential North Italia acquisition.
Based on North Italia’s performance, management indicated that it was likely to acquire the remaining interest in the concept near the end of the third quarter of fiscal 2019 for an estimated $150 million and was evaluating financing alternatives. The company also could be obligated to provide additional Flower Child capital and potentially acquire the remaining Flower Child interest under specified conditions.
- Principal operating risks include labor and wage inflation, healthcare claims, commodity volatility, declining restaurant traffic, competition, food safety incidents, adverse weather, lease obligations and regulatory changes.
- The company had no commodity hedging contracts at fiscal year-end; a hypothetical 1% increase in commodity costs would have increased fiscal 2018 cost of sales by approximately $5.4 million.
- Minimum lease payments totaled $938.4 million, including $93.8 million due in fiscal 2019. The company leases all restaurant locations.
- Self-insurance liabilities were approximately $72.2 million, and standby letters of credit supporting these programs totaled $20.7 million.
- Pending matters included wage-and-hour and PAGA claims, a tax dispute involving an $8.0 million IRS deficiency notice, a wage citation of $4.2 million involving a janitorial vendor and data-privacy litigation. The company stated that reasonably possible aggregate losses were not expected to materially affect financial position, results or liquidity, but several matters were not reasonably estimable and had no reserve.
- The company’s disclosure controls and internal control over financial reporting were assessed as effective, and KPMG LLP issued an unqualified audit opinion.
Important Facts for Investors to Verify
- Whether comparable-sales growth can continue despite ongoing traffic declines and planned menu price increases.
- The extent to which approximately 6% wage inflation and medical-cost volatility pressure restaurant-level and consolidated margins.
- The final fiscal 2019 impact of ASC 842 lease adoption, including the expected approximately $1 billion increase in recognized right-of-use assets and lease liabilities.
- The financing, purchase price and integration consequences of the potential approximately $150 million North Italia acquisition.
- Whether the company can fund capital expenditures, dividends, share repurchases and growth investments while maintaining credit-facility covenant compliance.
- The ultimate exposure from pending employment, tax, privacy and vendor-related legal matters.
- The sustainability of cash flow, given $938.4 million of minimum lease commitments and the company’s reliance on operating cash flow to fund obligations and shareholder returns.