The Cheesecake Factory Incorporated: Q1 Fiscal 2017 Form 10-Q Summary
Business context and reporting period
The filing covers the 13 weeks ended April 4, 2017, compared with the 13 weeks ended March 29, 2016. Fiscal 2017 contains 52 weeks, while fiscal 2016 contained 53 weeks; the extra 2016 week increased prior-year revenue by approximately $54.7 million and diluted EPS by approximately $0.07. As of May 11, 2017, the company operated 208 company-owned restaurants, 16 internationally licensed Cheesecake Factory restaurants, and two bakery facilities.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $563.4 million | $553.7 million | +1.8% |
| Income from operations | $43.6 million | $48.6 million | -10.3% |
| Operating margin | 7.7% | 8.8% | -110 bps |
| Income before taxes | $42.3 million | $46.3 million | -8.6% |
| Net income | $35.0 million | $34.0 million | +3.2% |
| Diluted EPS | $0.71 | $0.68 | +4.4% |
| Cash flow from operations | $48.1 million | $82.3 million | -41.6% |
| Capital expenditures | $19.2 million | $22.4 million | -14.3% |
Net margin was 6.2%, compared with 6.1% in the prior-year quarter. The effective tax rate declined to 17.2% from 26.6%, primarily because new share-based compensation accounting guidance required tax effects from stock option exercises and vested restricted stock to be recorded in income tax expense. This reduced the current-quarter tax provision by $3.9 million.
Comparable sales increased 0.3% at The Cheesecake Factory restaurants, driven by 2.6% average-check growth, including 2.4% menu pricing and 0.2% mix, partly offset by a 2.3% traffic decline. Grand Lux Cafe comparable sales declined 2.8%. External bakery sales increased to $12.2 million from $11.3 million.
Liquidity, debt and capital allocation
Cash and cash equivalents were $65.7 million at April 4, 2017, up from $53.8 million at January 3, 2017. Current assets were $201.6 million and current liabilities were $323.1 million. The company had no borrowings under its $200 million unsecured revolving credit facility and reported $178 million of net borrowing availability after $22 million of standby letters of credit. The facility matures December 22, 2020. The company was in compliance with its covenants, including a 2.4 Net Adjusted Leverage Ratio versus a 4.0 maximum and a 3.0 EBITDAR Ratio versus a 1.9 minimum.
Operating cash flow of $48.1 million less capital expenditures of $19.2 million produced approximately $28.9 million of free cash flow. Financing uses included $11.7 million of dividends and $9.3 million of treasury-stock purchases. The company declared a quarterly dividend of $0.24 per share and had cumulatively repurchased 47.1 million shares for $1.419 billion through April 4, 2017.
Material changes versus the prior comparable period
- Revenue grew modestly, but operating income and operating margin declined because of labor inflation, higher insurance and repairs costs, depreciation deleverage, and the loss of the high-volume holiday week that occurred in fiscal 2016's 53rd week.
- Labor expense increased to 34.4% of revenue from 33.5%, primarily because of higher wage rates and deleverage.
- Other operating costs increased to 24.1% of revenue from 23.4%, primarily due to higher general liability insurance and repairs expense.
- Cost of sales improved to 22.9% of revenue from 23.6%, primarily due to lower dairy, meat and grocery costs.
- Preopening costs declined to $1.0 million from $2.3 million because the company had no restaurant openings in the quarter.
- Operating cash flow declined substantially, primarily reflecting unfavorable changes in other accrued expenses and lower tax-related benefits compared with the prior year.
- The company recorded $0.8 million of accelerated depreciation related to the planned relocation of one restaurant and expects an additional $0.4 million in the second quarter.
Guidance, outlook, risks and unusual items
Management forecast second-quarter adjusted diluted EPS of $0.85 to $0.88, assuming Cheesecake Factory comparable sales growth of 1.0% to 2.0%. Fiscal 2017 adjusted diluted EPS guidance was $2.93 to $3.02, based on comparable sales growth of 0.5% to 1.5%, food-cost inflation of approximately 1% to 2%, wage inflation of approximately 5%, and an estimated corporate tax rate of approximately 23%.
The company planned as many as eight company-owned restaurant openings in fiscal 2017, including one relocation and a second Rock Sugar Pan Asian Kitchen location, plus four to five international licensed openings. Expected fiscal 2017 capital expenditures were $125 million to $140 million, excluding $12.8 million of expected non-capitalizable preopening costs. Management expected to use substantially all free cash flow and employee stock-option proceeds for dividends and share repurchases.
Key risks include customer traffic weakness, labor and commodity-cost inflation, insurance claims, execution of new restaurant openings and relocations, international expansion and licensing risks, foreign exchange and supply-chain exposure, and potential changes in consumer demand. A hypothetical 1% increase in food costs would have reduced quarterly cost of sales by approximately $1.3 million. The filing also identifies multiple employment, wage, gratuity, credit-card data and other class-action matters, as well as an IRS examination disputing $12.9 million of historical domestic production activity deductions. Except for an immaterial litigation settlement reserve, the company had not reserved for these matters because potential outcomes could not be reasonably estimated.
Subsequent events included a $9 million additional growth-capital contribution to North Italia and Flower Child on April 26, 2017, a $0.24 per-share dividend declaration, and additional planned share-repurchase programs.
Important facts for investors to verify
- Whether comparable-sales and traffic trends improve sufficiently to support the fiscal 2017 EPS guidance.
- Whether approximately 5% wage inflation, projected food inflation and insurance costs pressure operating margins further.
- The timing, cost and returns of planned restaurant openings, the restaurant relocation, bakery infrastructure investments, and international expansion.
- Future cash requirements for dividends, share repurchases, North Italia and Flower Child growth capital, and capital expenditures.
- The resolution and potential financial exposure from the pending employment, consumer-protection, data-security and IRS matters.
- The impact of the new lease accounting standard, scheduled for adoption in fiscal 2019, which management expects to materially affect the financial statements.