CAKE

Business Context and Reporting Period

Company: The Cheesecake Factory Incorporated
Filing Type: Form 10-K (Annual Report)
Period Ended: December 30, 2008
Operations: As of February 27, 2009, the Company operated 160 upscale, full-service casual dining restaurants across 34 states and D.C. This includes 146 The Cheesecake Factory locations, 13 Grand Lux Cafes, and one RockSugar Pan Asian Kitchen. The Company also operates two bakery production facilities and licenses two bakery cafes. Restaurant sales accounted for 96% of total revenues in fiscal 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 6% to $1.6 billion, driven by a 10% increase in bakery sales and new restaurant openings, despite a 4.6% decline in comparable restaurant sales.
• Profitability Decline: Net income decreased 29% to $52.3 million. Operating margins compressed from 7.3% to 5.4% due to sales de-leveraging, higher commodity costs (cheese, grocery items), and increased labor costs.
• Comparable Sales: Comparable sales at The Cheesecake Factory dropped 4.5% and at Grand Lux Cafe dropped 5.0%, primarily attributed to reduced guest traffic caused by the global economic crisis.
• Capital Structure: The Company increased borrowings on its revolving credit facility to $275 million (up from $175 million) to fund share repurchases and operations. Total long-term debt increased to $331.3 million (including deemed landlord financing).
• Asset Impairment: Recorded a $3.0 million impairment charge against three underperforming restaurant locations, a non-recurring item not present in 2007.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Fiscal 2009 Guidance: Management anticipates diluted EPS between $0.57 and $0.67, assuming comparable restaurant sales decline between 4% and 6%.
• Expansion Plans: Plans to open up to three new The Cheesecake Factory locations in 2009. No new Grand Lux Cafe or RockSugar Pan Asian Kitchen openings are planned for 2009.
• Capital Allocation: Expected capital expenditures range from $45 million to $50 million. The Company intends to use free cash flow and existing cash to reduce credit facility debt by $75 million to $100 million.
• Share Repurchases: The share repurchase program was temporarily suspended in October 2008 to maintain financial flexibility during the global financial crisis.

Risks and Contingencies

• Economic Conditions: The global economic crisis has reduced consumer confidence and discretionary spending, leading to lower guest traffic. A prolonged recession could materially affect results and covenant compliance.
• Commodity Costs: Profitability is sensitive to fluctuations in food costs (dairy, fish, produce) and energy prices, which cannot always be passed through to consumers via menu price increases.
• Legal Proceedings:
  • IRS Audit: The IRS is auditing tax returns for 2003-2006 regarding the deductibility of executive stock option compensation. A $2.3 million reserve has been established for estimated taxes and interest.
  • EEOC Charges: Facing charges regarding sex discrimination and hostile work environment allegations. The Company denies these allegations and has not reserved for future payments.

Investor Verification Checklist

• Comparable Sales Trend: Verify if the projected 4-6% decline in comparable sales for 2009 materializes or worsens given the economic environment.
• Debt Covenants: Monitor compliance with the credit facility covenants, specifically the maximum debt-to-EBITDA ratio (1.75:1 for Q1 2009, 1.50:1 thereafter) and minimum EBITDAR coverage ratios.
• Commodity Inflation: Track food cost percentages and the Company's ability to implement menu price increases without further depressing traffic.
• Legal Reserves: Monitor the status of the IRS audit regarding executive compensation deductibility and potential additional tax liabilities or penalties.
• Asset Impairments: Watch for additional impairment charges if the economic downturn deepens and more locations fail to meet cash flow thresholds.