Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 39 weeks ended September 30, 2014, compared with the periods ended October 1, 2013. The company operated 186 company-owned restaurants as of November 7, 2014, including 174 Cheesecake Factory, 11 Grand Lux Cafe and one RockSugar Pan Asian Kitchen location, plus two bakery facilities. International licensees operated six Middle East locations and had opened locations in Mexico.
Financial Performance and Position
| Metric | Q3 2014 | Q3 2013 | 39 Weeks 2014 | 39 Weeks 2013 |
|---|---|---|---|---|
| Revenue | $499.1 million | $469.7 million | $1,477.0 million | $1,402.8 million |
| Income from operations | $34.2 million | $38.6 million | $109.9 million | $116.6 million |
| Operating margin | 6.8% | 8.2% | 7.4% | 8.3% |
| Net income | $24.2 million | $27.5 million | $76.8 million | $81.4 million |
| Diluted EPS | $0.48 | $0.50 | $1.48 | $1.49 |
| Net margin | 4.9% | 5.9% | 5.2% | 5.8% |
- Third-quarter revenue increased 6.3%; year-to-date revenue increased 5.3%. Comparable restaurant sales rose 1.8% in the quarter and 1.3% year to date.
- Comparable sales growth was driven by average check increases, while guest traffic declined 0.8% in the quarter and 1.1% year to date.
- Cost pressure reduced margins. Q3 cost of sales rose to 24.9% of revenue from 24.0%, and labor expense rose to 32.7% from 32.1%. Dairy inflation, medical costs, utilities and marketing timing were principal factors.
- Cash provided by operating activities was $161.0 million year to date, compared with $150.3 million in the prior-year period. Capital expenditures were $87.9 million versus $67.1 million, producing reported operating cash flow less capital expenditures of approximately $73.1 million.
- Cash and cash equivalents declined to $22.1 million at September 30, 2014, from $61.8 million at December 31, 2013. The decline primarily reflected $140.3 million of share repurchases, $22.2 million of dividends and capital expenditures.
- Long-term debt was $25.0 million, compared with none at year-end 2013. The revolving facility provides $200 million of commitments, with $152 million of net borrowing availability at quarter-end after debt and standby letters of credit. The company was in compliance with its covenants.
- Total assets were $1.106 billion and stockholders’ equity was $522.6 million at September 30, 2014.
Material Changes Versus the Prior Comparable Period
- Revenue growth from new restaurant operating weeks and modest comparable-sales growth was more than offset at the profit level by higher dairy costs, group medical costs and other operating expenses.
- Q3 operating income decreased 11.5%, while net income decreased 11.9%. Year-to-date operating income decreased 5.7% and net income decreased 5.6%.
- Average restaurant operating weeks increased 4.2% in Q3 and 3.5% year to date. The company opened two Cheesecake Factory restaurants in Q3 and five during the first three quarters, compared with three in the prior-year period.
- Impairment and lease-termination expense was zero in Q3 2014 versus $1.1 million in Q3 2013; year-to-date expense was $0.7 million versus $3.2 million.
- Share repurchases totaled $140.3 million year to date, including approximately $19.8 million in Q3. Cumulative repurchases reached 41.9 million shares for $1.1585 billion through September 30, 2014.
- The quarterly dividend increased to $0.165 per share from $0.14 in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
- For Q4 2014, management projected adjusted diluted EPS of $0.58 to $0.62, based on comparable-sales growth of 1.0% to 2.0%. Fiscal 2014 adjusted diluted EPS guidance was $2.07 to $2.11, based on approximately 1.5% comparable-sales growth.
- Fiscal 2014 guidance assumed food-cost inflation above 4%, a corporate tax rate of approximately 27%, up to 10 company-owned restaurant openings and $110 million to $115 million of capital expenditures. Management anticipated repurchasing up to $150 million of shares in addition to paying dividends.
- Management expected fiscal 2015 diluted EPS of $2.35 to $2.45, comparable-sales growth of 1.0% to 2.0%, food-cost inflation of 2% to 3%, a tax rate of 28% to 29%, up to 11 company-owned restaurant openings and capital expenditures of $120 million to $130 million.
- Management expected fiscal 2014 operating margins to be lower than fiscal 2013 because dairy and group medical costs were expected to increase by a combined $17.6 million. Fiscal 2015 margins were expected to be somewhat positive relative to fiscal 2014.
- Key risks include commodity-price volatility, particularly dairy and other food inputs; labor and medical-cost inflation; declining guest traffic; competition, weather and macroeconomic conditions; execution and capital requirements for new restaurants; and interest-rate exposure on variable-rate debt.
- Pending labor-related lawsuits and arbitrations involved uniform and related wage issues. A confidential settlement was approved in May 2014, with immaterial expenses recorded in the first and third quarters. Management stated that pending claims were not expected to have a material adverse effect, while noting that outcomes could affect individual periods.
- The company expects available cash, operating cash flow, borrowing capacity and landlord contributions to fund planned capital expenditures, dividends, repurchases and debt repayment over the following 12 months.
Important Facts for Investors to Verify
- Whether comparable-sales growth and guest traffic trends meet the assumptions underlying the 2014 and 2015 EPS outlooks.
- The persistence of dairy, seafood, labor and medical-cost inflation and its effect on restaurant-level and consolidated margins.
- The timing of repayment of the $25 million credit-facility balance and continued compliance with leverage, interest-coverage and distribution covenants.
- Whether planned restaurant openings and capital expenditures generate targeted returns.
- The sustainability of substantial share repurchases and dividends relative to cash balances, free cash flow and debt capacity.
- Developments in labor litigation and other ordinary-course claims, including any settlement or accrual that could become material.
- The filing’s non-GAAP adjusted EPS excludes impairment and lease-termination items; investors should reconcile adjusted results to GAAP results when assessing performance.