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CAKE > SEC Filings for CAKE > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for CHEESECAKE FACTORY INC

Form 10-K for CHEESECAKE FACTORY INC


27-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

General

This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 15 of this report, the "Risk Factors" included in Part I, Item 1A of this report, and the cautionary statements included throughout this report. The inclusion of supplementary analytical and related information herein may require us to make estimates and assumptions to enable us to fairly present, in all material respects, our analysis of trends and expectations with respect to our results of operations and financial position.


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As of February 27, 2014, we operated 181 Company-owned restaurants: 169 under The Cheesecake Factory® mark, 11 under the Grand Lux Cafe® mark and one under the RockSugar Pan Asian Kitchen® mark. We also operated two bakery production facilities.

The Cheesecake Factory is an upscale casual dining concept that offers more than 200 menu items including appetizers, pizza, seafood, steaks, chicken, burgers, specialty items, pastas, salads, sandwiches, omelettes and desserts, including approximately 50 varieties of cheesecakes and other baked desserts. Grand Lux Cafe and RockSugar Pan Asian Kitchen are also upscale, casual dining concepts offering approximately 200 and 75 menu items, respectively. In contrast to many chain restaurant operations, substantially all of our menu items, except those desserts manufactured at our bakery production facilities, are handmade daily at our restaurants with high quality, fresh ingredients using innovative and proprietary recipes. We believe our The Cheesecake Factory and Grand Lux Cafe restaurants are recognized by consumers for offering value with freshly prepared menu items across a broad array of price points and generous food portions at moderate prices. Our restaurants' distinctive, contemporary design and decor create a high-energy ambiance in a casual setting. Our restaurants typically range in size from 7,000 to 17,000 interior square feet, provide full liquor service and are generally open seven days a week for lunch and dinner, as well as Sunday brunch.

We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31st for financial reporting purposes. Fiscal years 2013 and 2012 each consisted of 52 weeks, while fiscal 2011 consisted of 53 weeks. The estimated impact of the 53rd week in fiscal 2011 was an increase in revenue of approximately $43 million. While certain expenses increased in direct relationship to additional revenue from the 53rd week, other expenses are incurred on a calendar month basis.

In fiscal 2011, we announced our initial expansion plans outside of the United States and entered into an exclusive licensing agreement with a restaurant and retail operator based in Kuwait to develop The Cheesecake Factory restaurants in the Middle East. This licensee currently operates four locations, two in the United Arab Emirates, and one each in Kuwait and the Kingdom of Saudi Arabia. Our licensee has plans to open additional restaurants in these countries as well as in Lebanon, Qatar and Bahrain. In February 2013, we entered into an exclusive licensing agreement with a restaurant operator based in Mexico to develop The Cheesecake Factory restaurants in Mexico and Chile. These licensing agreements include initial development fees, site and design fees and ongoing royalties on our licensees' restaurant sales. In addition, our licensees purchase bakery products branded under The Cheesecake Factory® trademark from us.

Overview

Our strategy is driven by our commitment to guest satisfaction and is focused primarily on menu innovation, service and operational execution to continue to differentiate ourselves from other restaurant concepts, as well as to drive competitively strong performance that is sustainable. Financially, we are focused on prudently managing expenses at our restaurants, bakery facilities and corporate support center, and leveraging our size to make the best use of our purchasing power.

We are also committed to allocating capital in a manner that will deliver returns that meet our high hurdle rates, which are significantly above our cost of capital. Returns are affected by the cost to build restaurants, the level of revenues that each restaurant can deliver and our ability to maximize the profitability of restaurants. Investing in new restaurant development that meets our return on investment criteria creates value for our Company. It is our top capital allocation priority with a focus on opening our restaurant concepts in premier locations within both new and existing markets in the United States, and potentially new markets internationally.

Our goal is to deliver average annual 'mid-teens' earnings per share growth over the next five years while also achieving our return objectives. The following are the key performance levers that we believe will contribute to achieving our earnings per share goal:

† Growing Comparable Restaurant Sales and Overall Revenue. Our overall revenue growth is primarily driven by increases in comparable restaurant sales, revenue from new restaurant openings, and royalties and bakery sales from additional licensed international locations.

Changes in comparable restaurant sales come from variations in guest traffic, as well as in check average. Our strategy is to grow guest traffic by continuing to offer innovative, high quality menu items that offer guests a wide range of options in terms of flavor, price and value. In addition, we focus on service and hospitality with the goal of delivering an exceptional guest experience. Check average is impacted by menu price increases and/or changes in menu mix. Our philosophy with regard to menu pricing is to use price increases to help offset key operating costs in a manner that balances protecting both our margins and guest traffic levels. In fiscal 2012, our menu mix was influenced by check management by our guests and a shifting of menu preferences as we evolved our menu and our guests tried new items. Over the last year, as the economy slowly improved, our menu mix stabilized, allowing us to capture more of the menu price increases we implemented.


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† Increasing Our Operating Margins (Income from Operations Expressed as a Percentage of Revenues). Operating margins are subject to fluctuations in commodity costs, labor, restaurant-level occupancy expenses, general and administrative expenses ("G&A"), and preopening expenses. Our objective is to gradually increase our operating margins to return to peak levels by capturing fixed cost leverage from increases in comparable restaurant sales, growth in international royalties, maximizing our purchasing power as our business grows and operating our restaurants as productively as possible.

By efficiently scaling our restaurant and bakery support infrastructure and improving our internal processes, we work toward growing G&A expenses at a slower rate than revenue growth over the long-term, which also should contribute to operating margin expansion. However, G&A as a percentage of revenues may vary from quarter to quarter and may increase on a year-over-year comparative basis in the near term as we ramp up our infrastructure to support our growth.

† Share Repurchases. We have historically generated a significant amount of free cash flow, which we define as cash flow from operations less capital expenditures. We utilize a substantial amount of our free cash flow for dividends and for share repurchases, the latter of which supports our earnings per share growth and offsets dilution from our equity compensation program.

Results of Operations

The following table sets forth, for the periods indicated, information from our consolidated statements of comprehensive income expressed as percentages of revenues.

                                                   Fiscal Year
                                              2013    2012    2011
Revenues                                      100.0 % 100.0 % 100.0 %

Costs and expenses:
Cost of sales                                  24.2    24.9    25.5
Labor expenses                                 32.1    32.1    32.3
Other operating costs and expenses             24.1    24.3    24.3
General and administrative expenses             6.1     5.7     5.5
Depreciation and amortization expenses          4.2     4.1     4.1
Impairment of assets and lease terminations       †     0.5     0.1
Preopening costs                                0.7     0.7     0.6

Total costs and expenses                       91.4    92.3    92.4

Income from operations                          8.6     7.7     7.6
Interest and other expense, net                (0.3 )  (0.3 )  (0.3 )
Income before income taxes                      8.3     7.4     7.3
Income tax provision                            2.2     2.0     1.9
Net income                                      6.1 %   5.4 %   5.4 %

Fiscal 2013 Compared to Fiscal 2012

Revenues

Revenues increased 3.8% to $1,877.9 million for fiscal 2013 compared to $1,809.0 million for fiscal 2012.

Comparable restaurant sales increased by 1.0%, or $16.2 million, from fiscal 2012 to fiscal 2013, driven by average check growth of 1.8% (based on an increase of 1.8% in pricing and flat mix), partially offset by a decrease in guest traffic of 0.8%.

Comparable sales at The Cheesecake Factory restaurants increased by 1.1% from the prior fiscal year driven by average check growth, partially offset by a decrease in guest traffic. We implemented effective menu price increases of approximately 1.0% during both the first and third quarter of fiscal 2013. On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 1.8% increase in pricing for fiscal year 2013. We plan to continue targeting menu price increases of 1% to 2% annually.


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Comparable sales at our Grand Lux Cafe restaurants decreased by 1.1% from the prior fiscal year driven by a decrease in guest traffic, partially offset by average check growth. With fewer restaurants in operation than The Cheesecake Factory and a number of locations that are proportionately larger in size, Grand Lux Cafe can experience greater variability in its comparable sales. We implemented effective menu price increases of approximately 0.7% and 1.3% during the second and fourth quarter of fiscal 2013, respectively. On a weighted average basis, based on the timing of our menu roll outs within each quarter, the Grand Lux Cafe menu included a 1.7% increase in pricing for fiscal year 2013. We plan to continue targeting menu price increases of 1% to 2% annually.

Restaurants become eligible to enter our comparable sales base in their 19th month of operation. At December 31, 2013, there were 14 The Cheesecake Factory restaurants and one Grand Lux Cafe not yet in our comparable sales base. International licensed locations and restaurants that are no longer in operation, including those which we have relocated, are excluded from our comparable sales calculations. Factors outside of our control, such as macroeconomic conditions, weather patterns, timing of holidays, competition and other factors, including those referenced in Part I, Item lA, "Risk Factors," can impact comparable sales.

We generally update and reprint our menus twice a year. As part of these menu updates, we evaluate the need for price increases based on those operating cost increases of which we are aware or that we can reasonably expect. While menu price increases can contribute to higher comparable restaurant sales in addition to offsetting margin pressure, we carefully consider all potential price increases in light of the extent to which we believe they will impact guest traffic.

Total restaurant operating weeks increased 2.3% to 9,160 in fiscal 2013 compared to the prior year. Average sales per restaurant operating week increased approximately 2.0% to $198,535 in fiscal 2013 compared to fiscal 2012.

External bakery sales were $55.3 million for fiscal 2013 compared to $65.2 million in fiscal 2012, primarily due to lower sales to warehouse club customers.

Cost of Sales

Cost of sales consists of food, beverage, retail and bakery production supply costs incurred in conjunction with our restaurant and bakery revenues, and excludes depreciation, which is captured separately in depreciation and amortization expenses. As a percentage of revenues, cost of sales was 24.2% for fiscal 2013 compared to 24.9% for fiscal 2012. This improvement was driven primarily by a benefit from a higher mix of restaurant sales as compared to bakery sales, as well as lower general grocery costs.

Our restaurant menus are among the most diversified in the foodservice industry and, accordingly, are not overly dependent on a few select commodities. Changes in costs for one commodity sometimes can be offset by cost changes in other commodity categories. The principal commodity categories for our restaurants include produce, poultry, meat, fish and seafood, dairy, bread and general grocery items.

We attempt to negotiate short-term and long-term agreements for our principal commodity, supply and equipment requirements, depending on market conditions and expected demand. However, we are currently unable to contract for extended periods of time for certain of our commodities such as some fish and certain dairy items (excluding cream cheese used in our bakery operations). Consequently, these commodities can be subject to unforeseen supply and cost fluctuations.

As has been our past practice, we will carefully consider opportunities to introduce new menu items and implement selected menu price increases to help offset any expected cost increases for key commodities and other goods and services utilized by our operations. For new restaurants, cost of sales will typically be higher during the first three to four months of operations until our management team becomes more accustomed to predicting, managing and servicing the sales volumes at the new restaurants.

Labor Expenses

As a percentage of revenues, labor expenses, which include restaurant-level labor costs and bakery direct production labor, including associated fringe benefits, were 32.1% in both fiscal 2013 and fiscal 2012.

Other Operating Costs and Expenses

Other operating costs and expenses consist of restaurant-level occupancy expenses (rent, common area expenses, insurance, licenses, taxes and utilities), other operating expenses (excluding food costs and labor expenses, which are reported separately) and bakery production overhead, selling and distribution expenses. As a percentage of revenues, other operating costs and expenses decreased to 24.1% for fiscal 2013 from 24.3% for fiscal 2012. This decrease was primarily due to a benefit from a higher mix of restaurant sales as compared to bakery sales.


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General and Administrative Expenses

General and administrative ("G&A") expenses consist of the restaurant management recruiting and training program, as well as the restaurant field supervision, corporate support and bakery administrative organizations. As a percentage of revenues, G&A expenses increased to 6.1% for fiscal 2013 versus 5.7% for fiscal 2012 due to an increase in stock-based compensation expense and higher professional and legal fees, primarily stemming from recoupment of legal expenses in fiscal 2012 resulting from an insurance settlement.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.2% for fiscal 2013 compared to 4.1% for fiscal 2012.

Impairment of Assets and Lease Terminations

In fiscal 2013, we incurred final expenses of $0.6 million for future rent and other closing costs associated with the closure of three Grand Lux Cafe restaurants and $3.7 million of impairment, accelerated depreciation and closing costs related to the relocation of four The Cheesecake Factory restaurants, three of which were relocated during fiscal 2013. We also recorded $4.9 million in income from a landlord in connection with the early termination of one of these leases and for waiving our right to exercise renewal options. During 2014, we expect to incur an additional $0.3 million of expense related to the relocation of the fourth restaurant.

Preopening Costs

Preopening costs were $12.9 million for fiscal 2013 compared to $12.3 million in fiscal 2012. We opened nine The Cheesecake Factory restaurants in fiscal 2013 compared to seven The Cheesecake Factory restaurants and one Grand Lux Cafe in fiscal 2012. Preopening costs include all costs to relocate and compensate restaurant management employees during the preopening period, costs to recruit and train hourly restaurant employees, and wages, travel and lodging costs for our opening training team and other support staff members. Also included in preopening costs are expenses for maintaining a roster of trained managers for pending openings, the associated temporary housing and other costs necessary to relocate managers in alignment with future restaurant opening and operating needs, and corporate travel and support activities. Preopening costs can fluctuate significantly from period to period, based on the number and timing of restaurant openings and the specific preopening costs incurred for each restaurant.

Interest and Other Expense, Net

Interest and other expense, net decreased to $4.5 million in fiscal 2013 compared to $4.7 million in fiscal 2012. This net decrease was primarily due to lower interest expense related to taxes and a benefit in fiscal 2013 related to the exercise of an option to vest our ownership in land adjacent to our North Carolina bakery facility, partially offset by a benefit realized in fiscal 2012 from a variable life insurance contract used to support our Executive Savings Plan. Interest expense included $3.3 million in fiscal 2013 compared to $3.2 million in fiscal 2012 associated with landlord construction allowances deemed to be financing in accordance with accounting guidance.

Income Tax Provision

Our effective income tax rate was 26.9% for fiscal 2013 compared to 26.5% for the comparable prior year period. This increase was attributable to a lower proportion of Federal Insurance Contributions Act ("FICA") tip credits and our manufacturing deduction in relation to pre-tax income, partially offset by higher Work Opportunity Tax Credits due to the reinstatement of the program in 2013 and higher non-taxable gains on our investments in variable life insurance used to support our Executive Savings Plan.

Fiscal 2012 Compared to Fiscal 2011

Revenues

Revenues increased 2.9% to $1,809.0 million for fiscal 2012 compared to $1,757.6 million for fiscal 2011. Excluding the impact of the 53rd week in fiscal 2011, revenues increased 5.5%.


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Comparable restaurant sales increased by 1.9%, or $30.2 million, from fiscal 2011 to fiscal 2012, driven by an increase in guest traffic of 0.7% and average check growth of 1.2%. Increases in menu pricing were partially offset by changes in menu mix due to check management by our guests, as well as some shifting of menu preferences as our guests tried newer items. At January 1, 2013, there were 13 The Cheesecake Factory restaurants and one Grand Lux Cafe not included in the comparable sales base.

Comparable sales at The Cheesecake Factory restaurants increased 2.2% in fiscal 2012 driven primarily by average check growth, as well as improved guest traffic. We implemented effective menu price increases of approximately 1.0% and 0.8% during the first and third quarters of fiscal 2012, respectively. On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 1.9% increase in pricing for fiscal year 2012. This increase in menu pricing was partially offset by changes in menu mix due to check management by our guests, as well as some shifting of menu preferences as our guests tried newer items.

Comparable sales at our Grand Lux Cafe restaurants decreased 2.0% from fiscal year 2011 driven by lower guest traffic, partially offset by an increase in average check. We implemented effective menu price increases of approximately 1.0% and 0.8% during the second and fourth quarters of fiscal 2012, respectively. On a weighted average basis, based on the timing of our menu roll outs within each quarter, the Grand Lux Cafe menu included a 1.5% increase in pricing for fiscal year 2012. This increase in menu pricing was partially offset by changes in menu mix due to check management by our guests, as well as some shifting of menu preferences as our guests tried newer items.

Total restaurant operating weeks increased 2.1% to 8,957 in fiscal 2012 from the prior year due to the opening of ten new restaurants during the trailing 15-month period. Excluding the impact of the 53rd week in fiscal 2011, total operating weeks increased 4.1%. Average sales per restaurant operating week increased approximately 1.4% to $194,700 in fiscal 2012 compared to fiscal 2011 due to an improvement in both guest traffic and average check.

External bakery sales decreased 10.2% to $65.2 million in fiscal 2012 compared to $72.6 million in the prior fiscal year due primarily to a decline in sales to our warehouse club accounts.

Cost of Sales

As a percentage of revenues, cost of sales decreased to 24.9% in fiscal 2012 compared to 25.5% in fiscal 2011. This improvement was primarily due to lower costs for dairy, produce and fish, as well as a benefit from a higher mix of restaurant sales as compared to bakery sales.

Labor Expenses

As a percentage of revenues, labor expenses decreased to 32.1% in fiscal 2012 compared to 32.3% in fiscal 2011. This variance is primarily due to lower group medical insurance costs stemming from lower claims experience.

Other Operating Costs and Expenses

As a percentage of revenues, other operating costs and expenses were 24.3% for both fiscal 2012 and fiscal 2011.

General and Administrative Expenses

As a percentage of revenues, G&A expenses increased to 5.7% for fiscal 2012 versus 5.5% for fiscal 2011 due primarily to achievement of a higher corporate bonus target in fiscal 2012 than in the prior year.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.1% for both fiscal 2012 and fiscal 2011.

Impairment of Assets and Lease Terminations

In fiscal 2012, we recorded expense of $5.5 million, representing a reduction in the carrying value of one The Cheesecake Factory restaurant. In fiscal 2011, we recorded expense of $1.5 million, representing reductions to the carrying values of three previously impaired locations, consisting of one Grand Lux Cafe and two The Cheesecake Factory restaurants.


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Also in fiscal 2012, we made the business decision to discontinue operations in three of our Grand Lux Cafe restaurants, each of which had previously been fully impaired, because they were not delivering the necessary sales volumes to drive our required returns. We incurred $4.0 million in the fourth quarter of fiscal 2012 for partial reimbursement to landlords of tenant improvement allowances and broker fees on these leases.

Preopening Costs

Preopening costs were $12.3 million for fiscal 2012 compared to $10.1 million for the prior fiscal year. We incurred preopening costs to open seven The Cheesecake Factory restaurants and one Grand Lux Cafe in fiscal 2012 compared to opening seven The Cheesecake Factory restaurants during fiscal 2011.

Interest and Other Expense, Net

Interest and other expense, net increased to $4.7 million for fiscal 2012 compared to $4.3 million in fiscal 2011. This increase was primarily due to an increase in net interest related to taxes, stemming largely from interest income recorded in fiscal 2011 in conjunction with a partial IRS settlement as described in Note 13 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report, as well as higher expense on asset disposals. These increases were partially offset by proceeds realized from a variable life insurance contract used to support our Executive Savings Plan and lower interest expense associated with landlord construction allowances deemed to be financing in accordance with accounting guidance ($3.2 million in fiscal 2012 compared to $3.8 million in fiscal 2011).

Income Tax Provision

Our effective income tax rate was 26.5% for fiscal 2012 compared to 25.9% for fiscal 2011. This increase was primarily attributable to the expiration of the Hiring Incentives to Restore Employment ("HIRE") Act retention credit at the end of fiscal 2011 and the favorable resolution in fiscal 2011 of litigation we filed against the IRS. These increases were partially offset by non-taxable gains in fiscal 2012 as compared to non-deductible losses in the prior year on our investments in variable life insurance used to support our ESP. The increases were further offset by a higher FICA tip credit in fiscal 2012 as compared to the prior year driven by higher restaurant sales and state minimum wage increases. See Note 13 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further information on our income tax provision.

Fiscal 2014 Outlook

This discussion contains forward-looking statements and should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 15 of this report, the "Risk Factors" included in Part I, Item 1A of this report, and the cautionary statements included throughout this report.

We estimate diluted earnings per share for fiscal 2014 will be between $2.29 and $2.41 based on an assumed increase in comparable restaurant sales of between 1% and 2%. We currently expect food cost inflation of between 3% and 4%, driven primarily by higher shrimp and, to a lesser extent, salmon prices, which we estimate will impact earnings per share for fiscal 2014 in a range of $0.07 to $0.10. We expect operating margins to be flat to slightly positive to fiscal 2013 and anticipate a fiscal 2014 corporate tax rate of approximately 29%.

In fiscal 2014, we plan to open as many as 10 to 12 new restaurants, including one relocation. In addition to these Company-owned locations, we expect as many as three to five restaurants to open in the Middle East and Mexico under our licensing agreements.

We expect cash capital expenditures in fiscal 2014 to range between $110 million and $120 million and anticipate utilizing substantially all of our free cash flow for dividends and share repurchases.

Liquidity and Capital Resources

Our corporate financial objectives are to maintain a sufficiently strong and conservative balance sheet to support our operating initiatives and unit growth while maintaining financial flexibility, to provide the financial resources necessary to protect and enhance the competitiveness of our restaurant and bakery brands and to provide a prudent level of financial capacity to manage the . . .

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