Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 26 weeks ended July 1, 2014, compared with July 2, 2013. The company operated 184 company-owned restaurants as of August 8, 2014, including 172 Cheesecake Factory, 11 Grand Lux Cafe and one RockSugar Pan Asian Kitchen location, plus two bakery facilities.
Fiscal 2014 consists of 52 weeks and is scheduled to end December 30, 2014. The company also had international licensing operations in the Middle East, Mexico and, beginning in April 2014, Hong Kong, Macao, Taiwan and mainland China.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | First Half 2014 | First Half 2013 |
|---|---|---|---|---|
| Revenue | $496.4 million | $470.1 million | $977.8 million | $933.1 million |
| Income from operations | $42.7 million | $41.2 million | $75.8 million | $78.0 million |
| Operating margin | 8.6% | 8.8% | 7.7% | 8.4% |
| Net income | $30.0 million | $28.6 million | $52.6 million | $53.9 million |
| Net margin | 6.1% | 6.1% | 5.4% | 5.8% |
| Diluted EPS | $0.59 | $0.52 | $1.01 | $0.99 |
| Cash flow from operations | Not separately provided for the quarter | $122.1 million | $88.6 million |
Q2 comparable restaurant sales increased 1.2%, with average check growth of 2.3% offset by a 1.1% decline in guest traffic. First-half comparable sales increased 1.0%, with average check growth of 2.2% offset by a 1.2% traffic decline. Total restaurant operating weeks increased 4.1% in the quarter and 3.2% year to date.
Q2 cost of sales increased to 24.3% of revenue from 24.0%, primarily because of higher dairy, shrimp and salmon costs. Labor expense increased to 32.4% from 32.2%, largely because of higher group medical costs. Other operating costs improved slightly to 24.1% from 24.2%, while G&A remained 5.9% of revenue. The effective tax rate declined to 27.0% from 28.4%.
Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $25.6 million at July 1, 2014, down from $61.8 million at December 31, 2013.
- Total assets were $1.081 billion, compared with $1.124 billion at year-end 2013.
- The company had $25.0 million of long-term debt under its $200 million unsecured revolving credit facility, which matures October 16, 2018.
- Net borrowing availability was approximately $154 million after the outstanding debt and $21 million of standby letters of credit.
- Net adjusted leverage and EBITDAR ratios were 2.6 and 3.0, respectively, versus covenant limits of 4.0 maximum leverage and 1.9 minimum EBITDAR coverage; the company was in compliance.
- Year-to-date capital expenditures were $57.8 million, compared with $37.5 million in the prior-year period. Free cash flow, defined by management as operating cash flow less capital expenditures, was approximately $64.3 million.
- Year-to-date financing cash outflows included $123.2 million of treasury stock purchases and $14.1 million of dividends, partially offset by $25.0 million of borrowings and $8.6 million of stock-option proceeds.
Material Changes Versus the Prior Comparable Period
- Q2 revenue increased 5.6% and first-half revenue increased 4.8%, primarily reflecting new restaurant operating weeks and modest comparable-sales growth.
- Q2 net income increased 5.1% and diluted EPS increased 13.5%, helped by lower diluted shares outstanding following substantial share repurchases.
- Despite revenue growth, operating income declined 4.4% in the first half and operating margin contracted from 8.4% to 7.7%, reflecting food-cost and labor pressure, higher preopening costs and increased G&A.
- First-half operating cash flow increased $33.5 million, benefiting in part from working-capital changes, including higher accounts payable and other receivables collections.
- Share repurchases totaled $123.2 million in the first half, versus $45.3 million in the prior-year period. Cumulative repurchases reached 41.5 million shares at a total cost of $1.139 billion through July 1, 2014.
- The company opened three Cheesecake Factory restaurants in the first half of 2014, compared with one in the prior-year period, and incurred $4.8 million of preopening costs versus $3.8 million.
- Impairment and lease-termination charges declined to $0.5 million in Q2 and $0.7 million year to date, compared with $1.5 million and $2.1 million, respectively, in the comparable periods.
Guidance, Outlook, Risks and Unusual Items
- Management forecast Q3 adjusted diluted EPS of $0.55 to $0.58, assuming comparable sales growth of 1.0% to 2.0%.
- Fiscal 2014 adjusted diluted EPS guidance was $2.19 to $2.25, based on comparable sales growth of 1.0% to 1.5% and an approximately 28% tax rate.
- Management expected food-cost inflation of 3% to 4% for fiscal 2014, primarily from shrimp, salmon and dairy, and projected operating margins to be slightly below fiscal 2013 levels at the midpoint of its assumptions.
- The company planned as many as 10 new restaurants in fiscal 2014, including one relocation, and expected three to four licensed international openings. Fiscal 2014 cash capital expenditures were estimated at $105 million to $115 million, excluding $14 million of non-capitalizable preopening costs.
- Management expected to use substantially all free cash flow and employee stock-option proceeds for dividends and share repurchases, while also expecting to repay the $25 million facility borrowing during fiscal 2014.
- A $0.165 per-share dividend was approved on July 21, 2014, an 18% increase from the prior declared quarterly dividend. The company also received 0.2 million additional shares upon settlement of its accelerated stock repurchase agreement.
- Commodity prices, particularly for fish and dairy products, are volatile and some commodities cannot be contracted for extended periods. The company does not use financial instruments to hedge commodity prices.
- Pending employment-related litigation and arbitrations sought unspecified amounts. A confidential settlement of related uniform claims was approved in May 2014, with an immaterial expense recorded in the first quarter. Management believed remaining claims would not materially affect financial position, results or liquidity, but noted that circumstances could affect a future period.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing stated that there were no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Confirm the sustainability of comparable-sales growth given continued declines in guest traffic and reliance on menu pricing and check-average increases.
- Monitor food-cost inflation, labor and medical costs, and their effect on operating margins and fiscal 2014 EPS guidance.
- Assess liquidity after planned restaurant construction, dividends, share repurchases and repayment of the credit-facility borrowing.
- Review credit-facility covenants and distribution limits, particularly as share repurchases and dividends continue.
- Evaluate whether projected openings, international licensing activity and capital expenditures remain on schedule and within the stated ranges.
- Reconcile adjusted EPS guidance and adjusted results with GAAP results, noting that impairment and lease-termination charges are excluded from the non-GAAP measures.
- Track employment litigation, commodity exposure and other claims for potential changes in financial impact.