Business Context and Reporting Period
The Cheesecake Factory Incorporated filed an unaudited Form 10-Q for the 13 and 39 weeks ended September 27, 2011, compared with the periods ended September 28, 2010. The company operated 169 restaurants as of November 4, 2011, including 155 Cheesecake Factory, 13 Grand Lux Cafe, and one RockSugar Pan Asian Kitchen location, plus two bakery production facilities.
The company operates restaurant and bakery segments. In January 2011, it entered an exclusive Middle East licensing agreement covering development of 22 restaurants over five years; three licensed locations were expected to open in Dubai and Kuwait during fiscal 2012.
Financial Metrics
| Metric | Q3 2011 | Q3 2010 | 39 Weeks 2011 | 39 Weeks 2010 |
|---|---|---|---|---|
| Revenue | $430.4 million | $418.4 million | $1,279.9 million | $1,242.7 million |
| Income from operations | $30.3 million | $31.4 million | $95.3 million | $97.4 million |
| Operating margin | 7.0% | 7.5% | 7.4% | 7.8% |
| Net income | $20.6 million | $22.0 million | $65.8 million | $59.8 million |
| Net margin | 4.8% | 5.2% | 5.1% | 4.8% |
| Diluted EPS | $0.36 | $0.37 | $1.11 | $0.99 |
| Cash provided by operations | Not separately provided | Not separately provided | $121.3 million | $110.3 million |
| Capital expenditures | Not separately provided | Not separately provided | $50.2 million | $29.4 million |
At September 27, 2011, cash and cash equivalents were $19.7 million, compared with $81.6 million at December 28, 2010. The company had no borrowings under its $200 million revolving credit facility and reported $182 million of net borrowing availability after $18 million of standby letters of credit. Both reported debt covenant ratios were 2.8, versus maximum or minimum covenant requirements that remained satisfied.
Total assets were $968.4 million and stockholders’ equity was $532.0 million at quarter-end. Inventory increased to $34.0 million from $23.0 million at year-end, primarily reflecting higher bakery finished goods and work in progress.
Material Changes Versus Prior Comparable Period
- Third-quarter revenue increased 2.9%; restaurant sales increased 2.6% and third-party bakery sales increased 11.8% to $17.1 million.
- Comparable sales for Cheesecake Factory and Grand Lux Cafe restaurants increased 0.8% in the quarter and 1.5% for the first 39 weeks. Third-quarter comparable sales were negatively affected by Hurricane Irene by approximately 0.4%.
- Operating income declined 3.7% in the quarter and 2.2% year to date, as cost of sales rose to 25.4% of revenue from 24.4% in the quarter and to 25.3% from 24.4% year to date, primarily due to dairy, produce, and grocery commodity pressures.
- Labor expense ratios improved to 32.3% from 32.8% in the quarter and to 32.5% from 32.9% year to date. General and administrative expense ratios also improved modestly.
- Preopening costs increased to $4.3 million from $1.5 million in the quarter and to $7.1 million from $4.3 million year to date, reflecting additional restaurant openings and preparation for future openings.
- Net income increased 9.9% year to date despite lower operating income, primarily because interest expense fell to $3.7 million from $15.3 million. The prior-year period included a $7.4 million charge to unwind an interest rate collar and higher average borrowings.
- Year-to-date operating cash flow increased $11.0 million, while capital expenditures rose $20.8 million and treasury-stock purchases increased to $145.1 million from $51.2 million.
- The company repurchased approximately 5.0 million shares for $145.1 million during the first 39 weeks. Treasury stock at quarter-end totaled 30.2 million shares at a cost of $703.4 million.
Guidance, Outlook, Risks and Unusual Items
- For fourth-quarter fiscal 2011, management estimated comparable restaurant sales growth of 1.5% to 2.5% and diluted EPS of $0.51 to $0.53.
- For fiscal 2011, management expected seven new Cheesecake Factory restaurants, capital expenditures of $75 million to $80 million, share repurchases of $145 million to $170 million, and a tax rate of 27% to 28%. Fiscal 2011 contains 53 weeks.
- For fiscal 2012, management planned seven to ten new restaurants, including one Grand Lux Cafe, three Middle East licensed openings, diluted EPS of $1.80 to $1.90, comparable sales growth of 1.0% to 2.0%, and capital expenditures of $105 million to $125 million.
- Principal operating risks include commodity price and availability volatility, especially for fish and dairy; labor and insurance costs; consumer discretionary spending; weather; competition; restaurant opening execution; and fluctuations in bakery customer orders. The company generally cannot enter long-term contracts with large-account bakery customers.
- The company was monitoring a small number of cash-flow-negative restaurants; future impairment charges could result if performance does not improve.
- Legal matters included an EEOC investigation with no reserve recorded, a California wage-and-hour class-action settlement with a maximum amount of $1.275 million and an immaterial reserve, and related stayed wage-and-hour cases with no reserve. The company believed other ordinary-course claims would not materially affect financial position, results, or liquidity.
- The company reserved $1.4 million for estimated taxes, interest, and penalties related to IRS disputes. After quarter-end, it reached an agreement in principle regarding certain 2003 and 2004 tax claims but continued to pursue a 2005 late-payment penalty and interest claim.
- Adjusted year-to-date net income was $65.8 million in 2011 versus $64.3 million in 2010 after excluding the prior-year after-tax impact of the interest-rate-collar unwind. The filing states that adjusted measures are non-GAAP and may not be comparable with other companies.
Important Facts for Investors to Verify
- Whether commodity inflation, particularly dairy and produce costs, continues to pressure gross and operating margins.
- Whether comparable sales meet the fourth-quarter and fiscal 2012 assumptions underlying management’s EPS guidance.
- Whether planned restaurant openings and capital expenditures remain within budget and generate targeted returns.
- Whether substantial share repurchases reduce liquidity or become constrained by credit-facility leverage requirements.
- The status and ultimate cost of the IRS tax claims, EEOC investigation, and California employment litigation.
- Whether cash balances, operating cash flow, landlord contributions, and the undrawn credit facility remain sufficient to fund expansion and repurchases.
- The company’s filing states that disclosure controls were effective as of September 27, 2011 and that no material changes to internal control over financial reporting occurred during the quarter.