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CAKE > SEC Filings for CAKE > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for CHEESECAKE FACTORY INC

Form 10-Q for CHEESECAKE FACTORY INC


8-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Certain information included in this Form 10-Q and other materials filed or to be filed by us with the SEC, as well as information included in oral or written statements made by us or on our behalf, may contain forward-looking statements about our current and expected performance trends, growth plans, business goals and other matters. These statements may be contained in our filings with the SEC, in our press releases, in other written communications, and in oral statements made by or with the approval of one of our authorized officers. Words or phrases such as "believe," "plan," "will likely result," "expect," "intend," "will continue," "is anticipated," "estimate," "project," "may," "could," "would," "should," and similar expressions are intended to identify forward-looking statements. These statements, and any other statements that are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as codified in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Acts").

In connection with the "safe harbor" provisions of the Acts, we have identified and are disclosing important factors, risks and uncertainties that could cause our actual results to differ materially from those projected in forward-looking statements made by us, or on our behalf. (See Part II, Item 1A of this report, "Risk Factors," and Part I, Item 1A, "Risk Factors," included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.) These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the SEC. Because of these factors, risks and uncertainties, we caution against placing undue reliance on forward-looking statements. Although we believe that the assumptions underlying forward-looking statements are reasonable, any of the assumptions could be incorrect, and there can be no assurance that forward-looking statements will prove to be accurate. Forward-looking statements speak only as of the date on which they are made. Except as may be required by law, we do not undertake any obligation to modify or revise any forward-looking statement to take into account or otherwise reflect subsequent events or circumstances arising after the date that the forward-looking statement was made.

General

This discussion and analysis should be read in conjunction with our interim unaudited consolidated financial statements and related notes included in this Form 10-Q in Part I, Item 1, and with the following items included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013: the audited consolidated financial statements and related notes in Part IV, Item 15; the "Risk Factors" included in Part I, Item 1A; and the cautionary statements included throughout the 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.

As of August 8, 2014, we operated 184 Company-owned restaurants: 172 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.

In fiscal 2011, we 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. In fiscal 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. This licensee opened its first restaurant in Guadalajara, Mexico in July 2014. In April 2014, we entered into an exclusive licensing agreement with a restaurant operator based in Hong Kong to develop The Cheesecake Factory restaurants in Hong Kong, Macao, Taiwan and the People's Republic of China. 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.


Table of Contents

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 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 revenue from new restaurant openings, increases in comparable restaurant sales, 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.

† 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 substantially all 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. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any other interim period or for the full fiscal year.

                                      Thirteen        Thirteen       Twenty-Six      Twenty-Six
                                    Weeks Ended     Weeks Ended     Weeks Ended     Weeks Ended
                                    July 1, 2014    July 2, 2013    July 1, 2014    July 2, 2013

Revenues                                   100.0 %         100.0 %         100.0 %         100.0 %

Costs and expenses:
Cost of sales                               24.3            24.0            24.5            24.3
Labor expenses                              32.4            32.2            32.7            32.4
Other operating costs and
expenses                                    24.1            24.2            24.1            24.1
General and administrative
expenses                                     5.9             5.9             6.2             6.1
Depreciation and amortization
expenses                                     4.1             4.1             4.2             4.1
Impairment of assets and lease
terminations                                 0.1             0.3             0.1             0.2
Preopening costs                             0.5             0.5             0.5             0.4
Total costs and expenses                    91.4            91.2            92.3            91.6
Income from operations                       8.6             8.8             7.7             8.4
Interest and other expense, net             (0.3 )          (0.3 )          (0.3 )          (0.3 )
Income before income taxes                   8.3             8.5             7.4             8.1
Income tax provision                         2.2             2.4             2.0             2.3
Net income                                   6.1 %           6.1 %           5.4 %           5.8 %


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Thirteen Weeks Ended July 1, 2014 Compared to Thirteen Weeks Ended July 2, 2013

Revenues

Revenues increased 5.6% to $496.4 million for the thirteen weeks ended July 1, 2014 compared to $470.1 million for the thirteen weeks ended July 2, 2013. Comparable restaurant sales increased by 1.2%, or $5.2 million, from the second quarter of fiscal 2013, driven by average check growth of 2.3% (based on an increase of 2.0% in pricing and 0.3% change in mix), partially offset by a decrease in guest traffic of 1.1%. A shift of the Easter holiday and spring breaks into April 2014 from March in the prior year positively impacted comparable sales by approximately 0.6%.

Total restaurant operating weeks increased 4.1% to 2,355 for the thirteen weeks ended July 1, 2014 compared to the prior year period. Average sales per restaurant operating week increased approximately 1.5% to $205,050 in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013.

Comparable sales at The Cheesecake Factory restaurants increased by 1.5% from the prior year second quarter driven by average check growth, partially offset by a decrease in guest traffic. We implemented effective menu price increases of approximately 1.0% during the third quarter of fiscal 2013 and the first quarter of fiscal 2014. On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 2.0% increase in pricing for the thirteen weeks ended July 1, 2014.

Comparable sales at our Grand Lux Cafe restaurants decreased by 2.7% from the prior year second quarter driven by lower 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 from quarter to quarter. We implemented effective menu price increases of approximately 1.3% and 1.2% during the fourth quarter of fiscal 2013 and the second quarter of fiscal 2014, 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 2.3% increase in pricing for the thirteen weeks ended July 1, 2014.

Restaurants become eligible to enter our comparable sales base in their 19th month of operation. At July 1, 2014, there were 12 The Cheesecake Factory restaurants 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. In the first quarter of fiscal 2013, our The Cheesecake Factory location in Hawaii was closed for approximately four weeks for repairs due to fire damage. This restaurant was also excluded from our comparable sales calculations for the time period it was closed. 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," of our Annual Report on Form 10-K for the year ended December 31, 2013, 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.

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 24.3% for the second quarter of fiscal 2014 compared to 24.0% for the comparable period of fiscal 2013. This variance was driven primarily by higher dairy, shrimp and salmon costs, partially offset by lower poultry 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). Where we are not contracted, commodities can be subject to unforeseen supply and cost fluctuations.


Table of Contents

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 32.4% and 32.2% in the second quarter of fiscal 2014 and the second quarter of fiscal 2013, respectively. Increased group medical costs driven by both higher claims activity and more participants staying on our medical plans was partially offset by better labor productivity and lower payroll taxes.

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 and distribution expenses. As a percentage of revenues, other operating costs and expenses were 24.1% for the thirteen weeks ended July 1, 2014 and 24.2% for the thirteen weeks ended July 2, 2013. Leverage on rent expense and timing of marketing costs were offset by higher workers' compensation expenses and utilities.

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 were 5.9% for both the thirteen weeks ended July 1, 2014 and July 2, 2013.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.1% for the thirteen weeks ended July 1, 2014 and the comparable period of last year.

Impairment of Assets and Lease Terminations

In the second quarter of fiscal 2014, we incurred $0.5 million of accelerated depreciation, future rent and other closing costs related to the relocation of one The Cheesecake Factory restaurant. In the second quarter of fiscal 2013, we incurred $1.5 million of impairment expense related to the planned relocation of two The Cheesecake Factory restaurants.

Preopening Costs

Preopening costs were $2.6 million for the thirteen weeks ended July 1, 2014 compared to $2.5 million in the comparable period of the prior year. We opened two The Cheesecake Factory restaurants in the second quarter of fiscal 2014 and one The Cheesecake Factory restaurant in the second quarter of 2013. 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 increased to $1.5 million for the second quarter of fiscal 2014 compared to $1.3 million for the comparable period last year. Interest expense included $0.9 million in the second quarter of fiscal 2014 and the second quarter of fiscal 2013 associated with landlord construction allowances deemed to be financing in accordance with applicable accounting guidance.

Income Tax Provision

Our effective income tax rate was 27.0% for the second quarter of fiscal 2014 compared to 28.4% for the comparable prior year period. The decrease was primarily attributable to a higher proportion of FICA tip credit in relation to pre-tax income as well as changes in the value of our investments in variable life insurance contracts used to support our Executive Savings Plan, a non-qualified deferred compensation plan.


Table of Contents

Twenty-Six Weeks Ended July 1, 2014 Compared to Twenty-Six Weeks Ended July 2, 2013

Revenues

Revenues increased 4.8% to $977.8 million for the twenty-six weeks ended July 1, 2014 compared to $933.1 million for the twenty-six weeks ended July 2, 2013. Comparable restaurant sales increased by 1.0%, or $8.9 million, from the second quarter of fiscal 2013, driven by average check growth of 2.2% (based on an increase of 2.0% in pricing and 0.2% change in mix), partially offset by a decrease in guest traffic of 1.2%.

Total restaurant operating weeks increased 3.2% to 4,702 for the twenty-six weeks ended July 1, 2014 compared to the prior year period. Average sales per restaurant operating week increased approximately 1.8% to $202,180 in the first half of fiscal 2014 compared to the first half of fiscal 2013.

Comparable sales at The Cheesecake Factory restaurants increased by 1.5% from the prior year first half driven by average check growth, partially offset by a decrease in guest traffic. On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 2.0% increase in pricing for the twenty-six weeks ended July 1, 2014. In the first quarter of fiscal 2013, our The Cheesecake Factory location in Hawaii was closed for approximately four weeks for repairs due to fire damage. This restaurant was excluded from our comparable sales calculations for the time period it was closed.

Comparable sales at our Grand Lux Cafe restaurants decreased by 2.7% from the prior year first half driven by lower guest traffic, partially offset by average check growth. On a weighted average basis, based on the timing of our menu roll outs within each quarter, the Grand Lux Cafe menu included a 2.1% increase in pricing for the twenty-six weeks ended July 1, 2014.

Cost of Sales

As a percentage of revenues, cost of sales was 24.5% for the first half of fiscal 2014 compared to 24.3% for the comparable period of fiscal 2013. This variance was driven primarily by higher dairy, shrimp and salmon costs, partially offset by lower poultry costs.

Labor Expenses

As a percentage of revenues, labor expenses were 32.7% and 32.4% in the first half of fiscal 2014 and the first half of fiscal 2013, respectively. Increased group medical costs driven by both higher claims activity and more participants staying on our medical plans was partially offset by lower payroll taxes.

Other Operating Costs and Expenses

As a percentage of revenues, other operating costs and expenses were 24.1% for the twenty-six weeks ended July 1, 2014 and 24.1% for the twenty-six weeks ended July 2, 2013. Leverage on rent expense was offset by higher utilities costs.

General and Administrative Expenses

As a percentage of revenues, G&A expenses increased to 6.2% for the twenty-six weeks ended July 1, 2014 versus 6.1% for the comparable period of fiscal 2013 primarily due to costs associated with the settlement of a legal claim.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.2% for the twenty-six weeks ended July 1, 2014 and 4.1% for the comparable period of last year.

Impairment of Assets and Lease Terminations

In the first half of fiscal 2014, we incurred $0.7 million of accelerated depreciation, future rent and other closing costs related to the relocation of one The Cheesecake Factory restaurant. In the first half of fiscal 2013, we incurred $0.6 million in future rent and other closing costs associated with the closure of three Grand Lux Cafe restaurants and $1.5 million of impairment expense related to the relocation of two The Cheesecake Factory restaurants.

Preopening Costs

Preopening costs were $4.8 million for the twenty-six weeks ended July 1, 2014 compared to $3.8 million in the comparable period of the prior year. We opened three The Cheesecake Factory restaurants in the first half of fiscal 2014 and one The Cheesecake Factory restaurant in the first half of 2013.


Table of Contents

Interest and Other Expense, Net

Interest and other expense, net increased to $2.9 million for the first half of fiscal 2014 compared to $2.6 million for the comparable period last year. Interest expense included $1.9 million in the first half of fiscal 2014 compared to $1.8 million in the first half of fiscal 2013 associated with landlord construction allowances deemed to be financing in accordance with applicable accounting guidance.

Income Tax Provision

Our effective income tax rate was 27.8% for the first half of fiscal 2014 compared to 28.5% for the comparable prior year period. The decrease was primarily attributable to a higher proportion of FICA tip credit in relation to pre-tax income.

Non-GAAP Measures

Adjusted net income and adjusted diluted net income per share are supplemental measures of our performance that are not required by or presented in accordance with GAAP. These non-GAAP measures may not be comparable to similarly titled measures used by other companies and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. We calculate these non-GAAP measures by eliminating from net income and diluted net income per share the impact of items we do not consider indicative of our ongoing operations. We believe these adjusted measures provide additional information to facilitate the comparison of our past and present financial results. We utilize results that both include and exclude the identified items . . .

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