Business Context and Reporting Period
Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 4, 2006 (13 and 26 weeks)
Operations: The Company operates upscale, high-volume casual dining restaurants (The Cheesecake Factory and Grand Lux Cafe) and a bakery segment producing desserts for internal and external customers. As of December 1, 2006, the Company operated 118 Cheesecake Factory restaurants and 8 Grand Lux Cafes.
Key Financial Metrics
| Metric (in thousands) | 13 Weeks Ended July 4, 2006 |
13 Weeks Ended June 28, 2005 (Restated) |
26 Weeks Ended July 4, 2006 |
26 Weeks Ended June 28, 2005 (Restated) |
|---|---|---|---|---|
| Revenues | $322,573 | $288,336 | $629,292 | $556,560 |
| Net Income | $23,445 | $23,060 | $42,719 | $41,786 |
| Diluted EPS | $0.30 | $0.29 | $0.53 | $0.52 |
| Operating Cash Flow | N/A | N/A | $65,642 | $74,133 |
| Cash & Equivalents | $20,599 | $31,052 | $20,599 | $31,052 |
| Total Assets | $939,029 | $926,250 | $939,029 | $926,250 |
| Debt (Deemed Landlord Financing) | $35,324 | $26,273 | $35,324 | $26,273 |
Note: The Company has no funded debt. The "Debt" line item represents deemed landlord financing liability related to construction allowances.
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 12% ($32.2 million) for the 13-week period and 13% ($72.7 million) for the 26-week period compared to the prior year. This growth was driven primarily by new restaurant openings ($34.2 million and $76.0 million respectively), which offset a decline in comparable restaurant sales (-0.8% and -1.1% respectively) due to reduced guest traffic.
- Profitability: Net income increased slightly (1.7% for 13 weeks; 2.2% for 26 weeks). However, operating margins declined from 11.9% to 10.2% (13 weeks) and 11.1% to 9.3% (26 weeks). This compression was largely due to the adoption of SFAS 123R (stock-based compensation), which added $4.2 million (13 weeks) and $8.8 million (26 weeks) in expenses.
- Expense Increases: Labor expenses rose 14% (13 weeks) and 17% (26 weeks), and General & Administrative (G&A) expenses rose 33% in both periods. The G&A increase was primarily attributable to the new stock-based compensation accounting standard.
- Liquidity: Cash and cash equivalents decreased by $10.5 million over the 26-week period, primarily due to $50.0 million in treasury stock repurchases and $61.9 million in capital expenditures, partially offset by operating cash flows.
Guidance, Outlook, Risks, and Unusual Items
Restatement of Financial Statements
The Company restated prior period financial statements due to an Audit Committee review of stock option granting practices. The review found that grant dates were incorrectly selected based on the lowest price within a 30-day window. This resulted in a cumulative after-tax expense adjustment of $5.4 million through fiscal 2005. Additionally, errors regarding gift card breakage accounting, bonus accruals, and liquor license amortization were corrected. All prior period comparisons in this filing reflect restated figures.
Legal Proceedings and Contingencies
- SEC Inquiry: The Company is cooperating with an informal SEC inquiry regarding its stock option granting practices.
- Shareholder Litigation: Eight shareholder derivative actions have been filed alleging improper dating of historical stock options.
- Wage and Hour Lawsuits: Various class action and individual lawsuits regarding meal breaks, tip pooling, and minimum wage violations are pending in California, North Carolina, Tennessee, Texas, and Arizona.
- Nasdaq Compliance: The Company received a staff determination letter regarding potential delisting due to delayed filing of previous 10-Q reports. An appeal is pending.
Outlook and Guidance
- Expansion: The Company expects to open as many as 21 new restaurants in fiscal 2006.
- Capital Expenditures: Estimated cash outlays for capital expenditures in fiscal 2006 range between $190 million and $195 million.
- Tax Rate: The effective tax rate is estimated to be approximately 31% for the full fiscal year.
- Stock Repurchases: The Company repurchased 1.55 million shares for $50.0 million in the second quarter. It remains authorized to repurchase up to 6 million shares total.
Investor Verification Checklist
- Restatement Impact: Verify the specific impact of the stock option restatement on historical earnings per share and the timeline for the resolution of the SEC inquiry.
- Comparable Sales Trend: Monitor the trend of declining comparable sales (-1.2% in Q2) to determine if the reduction in guest traffic is a temporary anomaly or a structural shift.
- Legal Exposure: Assess the potential financial impact of the eight shareholder derivative suits and the ongoing wage and hour class actions.
- Capital Allocation: Review the balance between aggressive capital expenditures ($190M+), share repurchases ($50M in Q2), and the maintenance of liquidity given the Nasdaq listing uncertainty.
- Stock-Based Compensation: Analyze the ongoing impact of SFAS 123R adoption on future operating margins, as this represents a significant non-cash expense increase.