Business Context and Reporting Period
The Cheesecake Factory Incorporated filed this Form 10-K for the 52-week fiscal year ended January 2, 2018. Fiscal 2016 contained 53 weeks, affecting year-over-year comparisons. The company operated 214 company-owned restaurants as of February 28, 2018: 199 The Cheesecake Factory locations, 13 Grand Lux Cafe locations and two RockSugar Southeast Asian Kitchen locations. It also had 20 internationally licensed The Cheesecake Factory restaurants and two bakery facilities.
Key Financial Metrics
| Metric | Fiscal 2017 | Fiscal 2016 |
|---|---|---|
| Revenue | $2,260.5 million | $2,275.7 million |
| Income from operations | $152.8 million | $201.0 million |
| Operating margin | 6.8% | 8.8% |
| Net income | $157.4 million | $139.5 million |
| Diluted EPS | $3.27 | $2.83 |
| Adjusted diluted EPS | $2.60 | $2.83 |
| Cash flow from operations | $238.8 million | $316.4 million |
| Capital expenditures | $120.8 million | $115.8 million |
| Cash and cash equivalents | $6.0 million | $53.8 million |
| Long-term debt | $10.0 million | None |
Net income benefited from a $38.5 million deferred-tax revaluation benefit following enactment of the Tax Cuts and Jobs Act. Excluding this benefit and impairment-related items, adjusted net income was $125.1 million versus $139.6 million in fiscal 2016.
Fiscal 2017 cost ratios were 23.0% for cost of sales, 34.4% for labor, 24.4% for other operating costs, 6.2% for general and administrative expense, 4.1% for depreciation and amortization, and 0.6% for preopening costs.
The Cheesecake Factory comparable restaurant sales declined 0.8%, driven by a 2.9% traffic decline, partly offset by 2.1% average-check growth. External bakery sales increased to $55.1 million from $53.6 million. Cash dividends declared increased to $1.06 per share from $0.88 per share, and the company repurchased 2.6 million shares for $123.0 million.
Material Changes Versus the Prior Comparable Period
- Reported revenue declined 0.7%; excluding the extra week in fiscal 2016, revenue increased approximately 1.8%.
- Income from operations declined 24.0%, and operating margin contracted by 200 basis points, primarily because of labor inflation, sales deleverage, higher repairs and maintenance, utilities, marketing and insurance costs, and $10.3 million of impairment and lease-termination expense.
- Labor expense increased to 34.4% of revenue from 33.4%, reflecting higher wage rates and sales deleverage.
- Cash flow from operations fell $77.6 million, primarily due to lower pretax income and the timing of income-tax payments.
- Cash declined $47.8 million, mainly due to share repurchases, capital expenditures, dividends and investments in North Italia and Flower Child.
- The company opened seven The Cheesecake Factory restaurants and one RockSugar location, compared with seven The Cheesecake Factory restaurants and one Grand Lux Cafe location in fiscal 2016.
- The company invested an additional $18.0 million in North Italia and Flower Child during fiscal 2017, following $42.0 million of initial investments in fiscal 2016.
Liquidity, Debt and Capital Allocation
The company had a $200 million unsecured revolving credit facility maturing December 22, 2020, with potential commitments of up to $300 million. At January 2, 2018, $10.0 million was drawn, $20.7 million of standby letters of credit were outstanding and net borrowing availability was $169.3 million. The company was in compliance with its covenants; its Net Adjusted Leverage Ratio and EBITDAR Ratio were each 2.8, compared with covenant limits of 4.0 and 1.9, respectively.
Fiscal 2017 contractual obligations included $1.025 billion of minimum lease payments, $137.3 million of purchase and construction obligations, $10.0 million of long-term debt and $20.7 million of standby letters of credit. The company was also obligated to provide up to $24 million of additional growth capital to North Italia and Flower Child, subject to specified conditions.
Management stated that cash, operating cash flow, available borrowings and landlord contributions should be sufficient over the following 12 months to fund capital expenditures, dividends, share repurchases and growth investments.
Guidance, Outlook and Unusual Items
- Fiscal 2018 diluted EPS guidance was $2.64 to $2.80, based on comparable sales ranging from flat to up 1% at The Cheesecake Factory restaurants.
- Management expected approximately 3% commodity-cost inflation, approximately 5% wage inflation and a 13% to 14% effective tax rate.
- First-quarter fiscal 2018 diluted EPS guidance was $0.66 to $0.70, based on comparable sales growth of 0.5% to 1.5%.
- The company planned to open as many as four to six company-owned restaurants, including one Grand Lux Cafe and the first location of an internally developed fast-casual concept, plus four to five internationally licensed restaurants.
- Fiscal 2018 cash capital expenditures were expected to be $90 million to $105 million, with $20 million to $25 million of growth capital for North Italia and Flower Child.
- The California bakery was undergoing an infrastructure upgrade expected to be completed in mid-2018. Temporary lost production capacity could create dessert supply risks.
- The company continued to target annual menu price increases of approximately 2% to 3% and long-term company-level return on invested capital of approximately 15%.
Risks, Contingencies and Governance Matters
- Key operating risks include declining customer traffic, competition from restaurants and delivery alternatives, labor and commodity inflation, adverse weather, food safety events, cyber incidents and reputational damage.
- All restaurant locations are leased, creating substantial fixed obligations and renewal, relocation and rent risks.
- The company self-insures significant portions of workers’ compensation, general liability, employment practices and health benefits. Self-insurance liabilities were $66.4 million at year-end.
- Pending and settled employment-related and consumer litigation included wage-and-hour, gratuity, payment-card disclosure and PAGA matters. Management stated that reasonably possible losses were not expected to materially affect financial position, results or liquidity, although quarterly results could be affected by developments.
- The IRS disputed $12.9 million of claimed domestic production activity deductions for tax years 2010 through 2012; the matter was under IRS Appeals review.
- The stockholder rights plan was scheduled to expire August 4, 2018. The board announced an intention not to adopt a replacement plan absent circumstances supporting that action.
- PricewaterhouseCoopers LLP issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective.
Investor Verification Priorities
- Verify the sustainability of reported $3.27 diluted EPS after excluding the $38.5 million tax benefit and considering impairment charges.
- Assess whether comparable-sales and customer-traffic trends improve under the fiscal 2018 guidance assumptions.
- Monitor labor inflation, commodity costs and the company’s ability to recover these costs through pricing without further traffic deterioration.
- Review liquidity after planned capital expenditures, dividends, repurchases and up to $24 million of additional growth capital commitments.
- Evaluate the California bakery upgrade, inventory build and potential effects on dessert supply and third-party bakery sales.
- Track the IRS tax dispute, employment litigation and self-insurance claims for changes in potential exposure.
- Assess the performance and eventual acquisition obligations associated with North Italia and Flower Child.