Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the thirteen and twenty-six weeks ended June 28, 2016, compared with the periods ended June 30, 2015. Fiscal 2016 is a 53-week year ending January 3, 2017. As of August 4, 2016, the company operated 202 company-owned restaurants, 12 internationally licensed locations, and two bakery production facilities.
Financial Results and Key Metrics
| Metric | Q2 2016 | Q2 2015 | First Half 2016 | First Half 2015 |
|---|---|---|---|---|
| Revenue | $558.9 million | $529.1 million | $1,112.6 million | $1,047.1 million |
| Income from operations | $55.2 million | $49.8 million | $103.8 million | $90.8 million |
| Operating margin | 9.9% | 9.4% | 9.3% | 8.7% |
| Net income | $38.6 million | $34.7 million | $72.5 million | $63.1 million |
| Diluted EPS | $0.78 | $0.69 | $1.46 | $1.25 |
| Cash flow from operations | Not separately provided | Not separately provided | $151.8 million | $121.0 million |
| Capital expenditures | Not separately provided | Not separately provided | $40.2 million | $59.5 million |
Q2 revenue increased 5.6%, operating income increased 10.9%, net income increased 11.1%, and diluted EPS increased 13.0%. First-half revenue increased 6.3%, operating income increased 14.3%, net income increased 14.9%, and diluted EPS increased 16.8%.
Q2 net margin was 6.9%, compared with 6.6% in the prior-year quarter. First-half net margin was 6.5%, compared with 6.0%. Cost of sales improved to 22.7% of revenue in Q2 from 23.9%, while labor expense increased to 33.2% from 31.8%, primarily because of higher hourly wages, paid time off costs, and payroll-tax timing.
Cash and cash equivalents were $79.6 million at June 28, 2016, up from $43.9 million at December 29, 2015. The company had no outstanding borrowings under its $200 million revolving credit facility and reported $178.2 million of net borrowing availability after $21.8 million of standby letters of credit. The facility matures December 22, 2020. The company was in compliance with its financial covenants.
Free cash flow, defined by management as operating cash flow less capital expenditures, was approximately $111.6 million in the first half of 2016, compared with approximately $61.5 million in the prior-year period. Financing uses included $76.6 million of treasury-stock purchases and $19.6 million of cash dividends.
Material Changes Versus the Prior Comparable Period
- The Cheesecake Factory restaurant comparable sales increased 0.3% in Q2 and 1.0% in the first half. Average check increased 3.0% in Q2 and 2.6% in the first half, while customer traffic declined 2.7% and 1.6%, respectively.
- Total Cheesecake Factory operating weeks increased 6.0% in Q2 and 5.9% in the first half, reflecting unit growth.
- Revenue benefited from restaurant growth, while external bakery sales declined to $11.8 million in Q2 from $12.7 million and to $23.1 million in the first half from $24.9 million.
- Lower seafood, grocery, and poultry costs and a higher mix of restaurant sales reduced cost of sales as a percentage of revenue.
- Labor pressure partially offset cost-of-sales benefits, with labor expense increasing 140 basis points in Q2 and 80 basis points in the first half as a percentage of revenue.
- Preopening costs declined to $2.3 million in Q2 from $4.1 million and to $4.6 million in the first half from $5.5 million, reflecting fewer openings.
- Interest and other expense increased to $2.2 million in Q2 from $1.4 million and to $4.5 million in the first half from $3.3 million, primarily because of higher interest associated with deemed landlord financing liabilities.
- The company repurchased approximately 0.5 million shares for $26.6 million during Q2. Cumulative repurchases totaled 45.6 million shares for $1.34 billion through June 28, 2016.
Guidance, Outlook, Risks, and Unusual Items
- Management forecast Q3 diluted EPS of $0.59 to $0.62, based on Cheesecake Factory comparable-sales growth of 0.5% to 1.5%.
- Fiscal 2016 diluted EPS guidance was $2.70 to $2.76, based on approximately 1.0% comparable-sales growth. The estimate includes $0.05 to $0.08 of benefit from the additional fiscal week.
- Management expected fiscal 2016 food-cost inflation to be approximately flat, wage inflation of approximately 5%, an effective tax rate of approximately 27% to 28%, and operating margins to improve versus fiscal 2015.
- The company planned to open as many as eight new company-owned restaurants, including one Grand Lux Cafe, and expected four to five additional international licensed openings.
- Fiscal 2016 cash capital expenditures were estimated at $100 million to $110 million, excluding $14 million of expected non-capitalizable preopening costs. Management expected to use substantially all free cash flow and employee stock-option proceeds for dividends and repurchases.
- Key operating risks include customer-traffic declines, competition, macroeconomic and weather effects, wage inflation, commodity-price volatility, credit-card fees, occupancy costs, and the ability to maintain restaurant-level margins.
- The company does not currently use financial instruments to hedge commodity prices. Interest-rate exposure on funded debt was not material at period-end because the revolving facility had no outstanding borrowings.
- Several wage-and-hour, employment, and consumer-related class or collective actions were pending. A California uniform-purchase settlement received final court approval, and the company had reserved an immaterial amount. No reserves were recorded for several other matters; management did not expect pending matters to have a material adverse effect, although individual periods could be affected.
- The company stated that cash, operating cash flow, available revolver capacity, and expected landlord contributions should be sufficient for anticipated capital expenditures, dividends, repurchases, and other capital-allocation initiatives over the following 12 months.
- Subsequent to quarter-end, the board declared a $0.24 per-share dividend and increased the share-repurchase authorization to 56 million shares.
Important Facts for Investors to Verify
- Whether comparable-sales growth can improve without further traffic deterioration, given that recent growth was primarily check-driven.
- The effect of approximately 5% wage inflation and future labor-market changes on restaurant-level and consolidated margins.
- Execution of the planned restaurant openings, international licensing expansion, and the targeted approximately 20% unit-level cash return on investment.
- Actual fiscal 2016 capital expenditures, free cash flow, share repurchases, and compliance with facility-based distribution limits.
- Progress toward the $2.70 to $2.76 fiscal 2016 diluted EPS outlook and the assumptions concerning the 53rd week.
- Developments in pending employment, wage-and-hour, and consumer litigation, including potential changes to currently unreserved exposures.
- The eventual financial-statement effects of new accounting standards, including share-based payment, lease accounting, inventory measurement, and revenue recognition requirements.