Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the thirteen and twenty-six weeks ended June 29, 2010, compared with June 30, 2009. The company operated 162 upscale casual restaurants, two bakery production facilities, and two licensed bakery cafes as of August 5, 2010. The business is reported through restaurant and bakery segments.
Financial Performance and Position
| Metric | Q2 2010 | Q2 2009 | First Half 2010 | First Half 2009 |
|---|---|---|---|---|
| Revenue | $418.9 million | $407.9 million | $824.3 million | $800.7 million |
| Income from operations | $37.3 million | $29.0 million | $66.0 million | $46.9 million |
| Operating margin | 8.9% | 7.1% | 8.0% | 5.9% |
| Net income | $19.2 million | $16.6 million | $37.9 million | $26.6 million |
| Diluted EPS | $0.32 | $0.28 | $0.62 | $0.44 |
| Cash flow from operations | Not separately provided | Not separately provided | $76.1 million | $104.1 million |
- Q2 revenue increased 2.7%; first-half revenue increased 2.9%.
- Restaurant revenue increased 2.8% in Q2 and 3.3% in the first half. Comparable sales for The Cheesecake Factory and Grand Lux Cafe increased 1.6% in Q2; first-half comparable sales increased 2.1% for The Cheesecake Factory and 2.5% for Grand Lux Cafe.
- Bakery sales to external customers declined 1.4% in Q2 and 5.8% in the first half, primarily reflecting lower warehouse-club sales.
- Q2 net margin was approximately 4.6%, versus 4.1% in the prior-year quarter. First-half net margin was approximately 4.6%, versus 3.3%.
- Labor expense declined to 32.5% of revenue in Q2 from 33.1%; other operating costs declined to 24.0% from 24.3%; and G&A declined to 5.7% from 6.5%.
- Cost of sales increased slightly to 24.5% of revenue in Q2, reflecting dairy and cheese cost pressure, but declined slightly to 24.5% for the first half.
- Cash and cash equivalents were $86.3 million at June 29, 2010, compared with $73.7 million at December 29, 2009. Net working capital was negative $3.6 million and the current ratio was 1.0:1.
- Capital expenditures were $17.9 million in the first half, compared with $17.1 million in the prior-year period.
- Long-term debt was $70.0 million, down from $100.0 million at year-end. Including deemed landlord financing, debt and related liabilities totaled $124.2 million versus $153.3 million at year-end.
- The company had $214 million of net borrowing availability under its $300 million revolving credit facility, after $16 million of standby letters of credit. It was in compliance with its financial covenants.
Material Changes Versus the Prior Comparable Period
- Operating income increased 28.8% in Q2 and 40.5% in the first half, driven primarily by positive comparable sales, labor productivity, cost controls, lower self-insurance expense, and lower G&A expense.
- Net income increased 16.1% in Q2 and 42.5% in the first half. Diluted EPS increased to $0.32 from $0.28 in Q2 and to $0.62 from $0.44 in the first half.
- Interest expense increased to $10.5 million in Q2 from $7.5 million and to $13.6 million for the first half from $12.5 million. The increase primarily reflected a $7.4 million charge to unwind the remaining interest-rate collar, partly offset by lower average debt.
- The effective tax rate increased to 28.7% from 25.5% in Q2 and to 28.7% from 24.4% in the first half, primarily because of lower employment-related tax credits and lower nontaxable investment gains.
- Operating cash flow declined to $76.1 million from $104.1 million, despite higher net income, due in part to changes in income taxes and accrued liabilities.
- The company repurchased 1.2 million shares for $29.9 million during the first half, including 670,090 shares during the quarter. Cumulative repurchases totaled 24.3 million shares costing $536.2 million.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Fiscal 2010 guidance calls for adjusted diluted EPS of $1.32 to $1.38, assuming comparable restaurant sales growth of 1.0% to 1.5%.
- The company planned to open three Cheesecake Factory restaurants during fiscal 2010; two had opened in the first quarter.
- Fiscal 2010 capital expenditures were expected to be $45 million to $50 million, with approximately $18 million to $20 million for new restaurants, $20 million to $22 million for existing-restaurant maintenance and capacity, and $7 million to $8 million for bakery and corporate infrastructure.
- Management expected free cash flow of approximately $115 million to $125 million and intended to use most of it for debt reduction, share repurchases, or both.
- The $7.4 million interest-rate-collar unwind was treated as an unusual item; management reported adjusted Q2 diluted EPS of $0.39 versus $0.32 on a GAAP basis.
- Commodity costs, especially dairy and cheese, remain exposed to supply, weather, fuel, agricultural, and regulatory conditions. Some commodities cannot be contracted for more than approximately 30 days.
- The company faces multiple wage-and-hour, discrimination, tax, and other legal matters. It reserved $2.5 million for estimated taxes and interest related to the IRS Section 162(m) dispute; other disclosed litigation matters had no specific reserve as of the filing.
- The IRS tax dispute involved approximately $5.1 million of questioned compensation deductions. A tentative settlement for tax year 2005 was pending Tax Court approval, while discussions continued for other years.
- Management stated that cash, operating cash flow, available revolver capacity, and landlord contributions should be sufficient to fund planned activities over the next twelve months.
- Management reported effective disclosure controls as of June 29, 2010, with no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Reconcile adjusted EPS guidance with GAAP EPS, including the treatment of derivative unwind costs and any subsequent unusual items.
- Monitor comparable restaurant sales, guest traffic, menu mix, pricing acceptance, and the pace and returns of new restaurant openings.
- Assess the sustainability of margin gains given commodity inflation, labor costs, occupancy costs, and marketing spending.
- Track operating cash flow, capital expenditures, debt repayments, share repurchases, and compliance with the credit facility’s liquidity restrictions.
- Review developments in the IRS Section 162(m) dispute and wage-and-hour, discrimination, and other litigation, including potential exposure beyond recorded reserves.
- Confirm the effect of lower bakery sales and customer concentration, including the absence of long-term contracts with major bakery customers.