The Cheesecake Factory Incorporated — Q3 2010 Form 10-Q
Business context and reporting period
Unaudited quarterly report for the 13 weeks and 39 weeks ended September 28, 2010, compared with the periods ended September 29, 2009. The company operated 163 upscale casual restaurants as of November 4, 2010, two bakery production facilities, and two licensed bakery cafes.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | Change |
|---|---|---|---|
| Revenue | $418.4 million | $400.6 million | Up 4.4% |
| Income from operations | $31.4 million | $27.3 million | Up 14.9% |
| Operating margin | 7.5% | 6.8% | Up 70 basis points |
| Net income | $22.0 million | $16.3 million | Up 35.0% |
| Diluted EPS | $0.37 | $0.27 | Up $0.10 |
| Interest expense | $1.7 million | $5.6 million | Down $3.8 million |
For the first 39 weeks, revenue increased 3.4% to $1.243 billion, operating income increased to $97.4 million from $74.3 million, and net income increased to $59.8 million from $42.8 million. Operating margin improved to 7.8% from 6.2%, while diluted EPS increased to $0.99 from $0.71.
Third-quarter comparable sales at The Cheesecake Factory and Grand Lux Cafe increased 2.8%, driven by improved guest traffic. Restaurant sales rose 4.3%, and third-party bakery sales increased 8.5% to $15.3 million. Cost of sales increased to 24.4% of revenue from 23.9%, primarily because of higher dairy and cheese costs. Labor, other operating costs, general and administrative expense, and depreciation improved as percentages of revenue.
Operating cash flow for the first 39 weeks was $110.3 million, down from $146.5 million. Capital expenditures were $29.4 million, compared with $24.4 million. Financing uses included $60.0 million of credit-facility repayment and $51.2 million of treasury-stock purchases. Cash declined to $59.8 million from $73.7 million at year-end 2009.
At September 28, 2010, the company had $40.0 million outstanding under its $300.0 million revolving credit facility and approximately $244.0 million of net borrowing availability after standby letters of credit. Long-term debt and deemed landlord financing totaled $92.5 million, compared with $153.3 million at December 29, 2009. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Revenue growth reflected positive comparable restaurant sales, three new restaurants opened during the trailing 15-month period, and higher bakery sales in the third quarter.
- Profitability benefited from sales leverage, productivity initiatives, cost management, lower depreciation, and substantially lower interest expense.
- Preopening costs increased to $1.5 million in the quarter and $4.3 million year to date because of new restaurant openings.
- The company unwound its interest-rate collar during the second quarter for a $7.4 million cost; the charge reduced year-to-date adjusted net income by $4.4 million after tax, or $0.07 per diluted share.
- The favorable resolution of part of the IRS Section 162(m) dispute reduced third-quarter tax expense by approximately $0.7 million. The company retained a $1.3 million reserve for unresolved years.
- The company resumed share repurchases in 2010 and repurchased 2.1 million shares for $51.2 million during the first three quarters.
Guidance, outlook, commentary, and risks
Management expected to open three Cheesecake Factory restaurants in fiscal 2010, all of which were opened by the filing date. Fiscal 2010 adjusted diluted EPS guidance was $1.39 to $1.42, based on comparable sales growth of 2.0% to 2.5%. Expected fiscal 2010 capital expenditures were $40 million to $45 million, with free cash flow projected at approximately $125 million to $130 million.
For fiscal 2011, management expected to open as many as six to nine restaurants, including one Grand Lux Cafe, with adjusted diluted EPS of $1.55 to $1.70 based on comparable sales growth of 1.0% to 3.0%. Fiscal 2011 capital expenditures were expected to range from $70 million to $90 million. Management planned to use excess cash for debt reduction, share repurchases, or both.
Key operating risks include discretionary consumer spending, competition, commodity-price volatility, labor and energy costs, weather, regulatory requirements, and the inability to enter long-term contracts with certain bakery customers. Dairy, cheese, fish, and produce costs are particularly subject to fluctuation. The company also faces multiple employment-related, wage-and-hour, discrimination, and other legal claims; most matters had no reserve because potential losses were not estimable, and management did not expect the matters to have a material adverse effect on financial position, results of operations, or liquidity.
The company had no material changes to the risk factors disclosed in its 2009 Form 10-K. Management concluded that disclosure controls and procedures were effective as of September 28, 2010, with no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether comparable-sales momentum and the fiscal 2010 EPS guidance range were achieved.
- Actual free cash flow after capital expenditures, debt repayments, and share repurchases.
- Future commodity, labor, and occupancy-cost trends, particularly dairy and cheese costs.
- Compliance with credit-facility covenants and the liquidity threshold governing share repurchases.
- Potential financial exposure from unresolved IRS, EEOC, wage-and-hour, and other legal proceedings.
- The effect of the fiscal 2011 expansion plan and higher planned capital expenditures on leverage and returns.