Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 39 weeks ended October 2, 2018, compared with October 3, 2017. The company operated 215 company-owned restaurants as of November 9, 2018, including 199 Cheesecake Factory, 14 Grand Lux Cafe and two RockSugar locations, plus 21 internationally licensed Cheesecake Factory restaurants and two bakery facilities.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 39 Weeks 2018 | 39 Weeks 2017 |
|---|---|---|---|---|
| Revenue | $580.9 million | $555.4 million | $1.765 billion | $1.689 billion |
| Income from operations | $33.5 million | $34.3 million | $99.6 million | $128.1 million |
| Operating margin | 5.8% | 6.2% | 5.6% | 7.6% |
| Net income | $28.5 million | $26.4 million | $82.9 million | $99.7 million |
| Diluted EPS | $0.61 | $0.56 | $1.79 | $2.05 |
| Operating cash flow | Not separately provided | Not separately provided | $182.1 million | $154.2 million |
- Q3 comparable sales at Cheesecake Factory restaurants increased 1.5%; average check rose 3.5%, while customer traffic declined 2.0%. For the first 39 weeks, comparable sales increased 1.7%, with traffic down 1.5%.
- Q3 labor expense increased to 35.2% of revenue from 34.9%; for the first 39 weeks, labor expense increased to 35.6% from 34.4%, primarily because of wage, overtime and medical-cost inflation.
- Q3 net income margin was 4.9%, compared with 4.8%; year-to-date net income margin declined to 4.7% from 5.9%.
- Cash and cash equivalents were $12.6 million at October 2, 2018, compared with $6.0 million at January 2, 2018.
- Capital expenditures were $78.7 million and investments in unconsolidated affiliates were $25.0 million during the first 39 weeks.
- The company paid $41.4 million in dividends and repurchased $60.9 million of stock during the first 39 weeks. Cumulative repurchases totaled 50.8 million shares at a cost of $1.594 billion.
- Long-term debt was $20.0 million, and deemed landlord financing liabilities were $125.6 million. The $200 million revolving facility had $159.3 million of net borrowing availability, and the company was in compliance with its covenants.
Material Changes Versus Prior Comparable Period
- Revenue increased 4.6% in Q3 and 4.5% for the first 39 weeks, driven by new restaurant openings and positive comparable sales.
- Despite revenue growth, operating income declined 2.4% in Q3 and 22.3% year to date, primarily reflecting higher labor costs, higher G&A and other operating expenses, increased depreciation, and higher interest and other expense.
- Year-to-date interest and other expense increased to $7.7 million from $4.4 million, largely due to losses from North Italia and Flower Child development activities and higher deemed landlord-financing interest.
- The effective tax rate declined to 5.7% from 19.2% in Q3 and to 9.8% from 19.4% year to date, primarily due to the Tax Cuts and Jobs Act and a higher relative FICA tip credit.
- Operating cash flow increased by $27.9 million year to date, while cash used for share repurchases declined from $106.4 million to $60.9 million.
- The company recorded $0.3 million of Q3 and $2.8 million of year-to-date lease termination costs related to closing one Cheesecake Factory restaurant.
- Adoption of the new revenue recognition standard reduced opening retained earnings by $3.6 million, net of tax, principally related to deferred international development and site-fee revenue.
Guidance, Outlook, Risks and Unusual Items
- Q4 fiscal 2018 adjusted diluted EPS guidance was $0.60 to $0.64, based on comparable sales growth of 0.5% to 1.5% and an assumed effective tax rate of approximately 10%.
- Fiscal 2018 adjusted diluted EPS guidance was $2.42 to $2.46, based on approximately 1.5% comparable sales growth, approximately 2.5% commodity inflation, approximately 6% wage inflation and an approximately 10% effective tax rate.
- Fiscal 2018 plans included five new restaurants, $80 million to $85 million of net capital expenditures and $25 million of growth capital contributions to North Italia and Flower Child.
- For fiscal 2019, management targeted 1% to 2% comparable sales growth, 1% to 2% commodity inflation, approximately 6% wage inflation, an approximately 12% tax rate and at least 3% Cheesecake Factory unit growth. Planned net capital expenditures were $100 million to $110 million.
- Management expects to open Social Monk Asian Kitchen’s first location in the first quarter of fiscal 2019 and as many as five to six internationally licensed locations during fiscal 2019.
- Key risks include consumer spending and economic conditions, wage and medical-cost inflation, commodity volatility, traffic declines, weather, construction costs, international and licensing execution, foreign exchange, regulatory exposure and the ability to maintain margins.
- Pending matters include employment-related litigation, a $4.2 million California wage citation, and an IRS notice disallowing $8.0 million of claimed domestic production activities deductions for 2010 through 2012. The company had not reserved for these potential payments, stating that outcomes and liabilities could not reasonably be estimated.
- The company expects lease-accounting adoption in fiscal 2019 to materially increase reported assets and liabilities, with an insignificant impact on net income.
Important Facts for Investors to Verify
- Confirm whether comparable-sales growth and average-check increases can offset continuing traffic declines and approximately 6% wage inflation.
- Reconcile GAAP diluted EPS of $1.79 year to date with adjusted diluted EPS of $1.83 and assess the recurring nature of lease-termination and other excluded items.
- Review liquidity after planned capital expenditures, dividends, share repurchases, investments in North Italia and Flower Child, and any potential North Italia acquisition.
- Assess leverage and covenant headroom, including $20.0 million of revolver borrowings, $20.7 million of standby letters of credit and $159.3 million of net availability.
- Monitor the unresolved wage, employment and tax matters, including the $4.2 million wage citation and $8.0 million IRS deficiency notice.
- Evaluate the impact of the upcoming lease-accounting standard on reported assets, liabilities, leverage metrics and covenant calculations.