CHEESECAKE FACTORY INC - Quarter Report: 2010 September (Form 10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 28, 2010
		or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 0-20574

 

THE CHEESECAKE FACTORY INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

(818) 871-3000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No x

 

As of October 29, 2010, 59,259,358 shares of the registrant’s Common Stock, $.01 par value, were outstanding.

 

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

INDEX

 

			Page Number
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements:
		Consolidated Balance Sheets	1
		Consolidated Statements of Operations	2
		Consolidated Statement of Stockholders’ Equity	3
		Consolidated Statements of Cash Flows	4
		Notes to Consolidated Financial Statements	5
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
	Item 4.	Controls and Procedures	22
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	22
	Item 1A.	Risk Factors	22
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
	Item 5.	Other Information	23
	Item 6.	Exhibits	24
Signatures			26

 

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PART I.         FINANCIAL INFORMATION

Item 1.            Financial Statements

 

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

		September 28, 2010			December 29, 2009
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	59,794		$	73,715
Accounts receivable		9,744			11,352
Income tax receivable		5,874			1,875
Other receivables		16,371			27,475
Inventories		29,924			22,202
Prepaid expenses		23,232			27,871
Deferred income taxes		8,257			7,737
Total current assets		153,196			172,227
Property and equipment, net		761,422			788,402
Other assets:
Trademarks		4,451			4,338
Prepaid rent		51,387			54,243
Other		30,256			27,541
Total other assets		86,094			86,122
Total assets		$	1,000,712		$	1,046,751
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	29,450		$	33,948
Other accrued expenses		143,612			166,513
Total current liabilities		173,062			200,461
Deferred income taxes		93,045			87,048
Deferred rent		66,418			64,209
Deemed landlord financing liability		50,879			51,802
Long-term debt		40,000			100,000
Other noncurrent liabilities		25,433			27,118
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued		¾			¾
Junior participating cumulative preferred stock, $.01 par value, 150,000 shares authorized; none issued		¾			¾
Common stock, $.01 par value, 250,000,000 shares authorized; 84,126,026 and 83,377,092 issued at September 28, 2010 and December 29, 2009, respectively		841			834
Additional paid-in capital		409,004			386,562
Retained earnings		699,392			639,544
Accumulated other comprehensive loss		¾			(4,619		)
Treasury stock, 25,168,961 and 23,100,079 shares at cost at September 28, 2010 and December 29, 2009, respectively		(557,362		)	(506,208		)
Total stockholders’ equity		551,875			516,113
Total liabilities and stockholders’ equity		$	1,000,712		$	1,046,751

 

See the accompanying notes to the consolidated financial statements.

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Thirteen Weeks Ended September 28, 2010			Thirteen Weeks Ended September 29, 2009			Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
Revenues		$	418,352		$	400,640		$	1,242,694		$	1,201,378
Costs and expenses:
Cost of sales		102,073			95,777			303,428			293,147
Labor expenses		137,268			131,987			408,475			400,370
Other operating costs and expenses		104,208			102,341			303,910			303,354
General and administrative expenses		23,957			23,917			71,147			71,402
Depreciation and amortization expenses		17,902			18,688			54,083			56,046
Preopening costs		1,535			594			4,270			2,783
Total costs and expenses		386,943			373,304			1,145,313			1,127,102
Income from operations		31,409			27,336			97,381			74,276
Interest expense		(1,748		)	(5,594		)	(15,304		)	(18,083		)
Interest income		20			40			188			349
Other (expense)/income, net		(391		)	236			146			691
Income before income taxes		29,290			22,018			82,411			57,233
Income tax provision		7,337			5,760			22,563			14,387
Net income		$	21,953		$	16,258		$	59,848		$	42,846
Net income per share:
Basic		$	0.38		$	0.27		$	1.01		$	0.72
Diluted		$	0.37		$	0.27		$	0.99		$	0.71
Weighted average shares outstanding:
Basic		58,427			59,359			59,057			59,337
Diluted		59,743			60,328			60,453			60,224

 

See the accompanying notes to the consolidated financial statements.

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)

 

		Shares of Common Stock		Common Stock			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income/(Loss)			Treasury Stock			Total
Balance, December 29, 2009		83,377		$	834		$	386,562		$	639,544		$	(4,619	)	$	(506,208	)	$	516,113
Comprehensive income:
Net income		—		—			—			59,848			—			—			59,848
Net unrealized loss on derivative financial instrument		—		—			—			—			41			—			41
Loss reclassified into income due to cancellation of derivative financial instrument		—		—			—			—			4,578			—			4,578
Total comprehensive income																			64,467
Issuance of common stock from stock options exercised		652		6			12,843			—			—			—			12,849
Tax impact of stock options exercised, net of cancellations		—		—			(24		)	—			—			—			(24		)
Stock-based compensation		—		—			9,623			—			—			—			9,623
Issuance of restricted stock, net of forfeitures		97		1			—			—			—			—			1
Purchase of treasury stock		—		—			—			—			—			(51,154		)	(51,154		)
Balance, September 28, 2010		84,126		$	841		$	409,004		$	699,392		$	—		$	(557,362	)	$	551,875

 

See the accompanying notes to the consolidated financial statements.

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
Cash flows from operating activities:
Net income		$	59,848		$	42,846
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		54,083			56,046
Realized loss on derivative financial instrument		7,376			5,264
Deferred income taxes		(430		)	(2,800		)
Stock-based compensation		9,473			10,483
Tax impact of stock options exercised, net of cancellations		(24		)	(872		)
Excess tax benefit related to stock options exercised		(1,934		)	(277		)
Other		(467		)	1,601
Changes in assets and liabilities:
Accounts receivable		1,608			2,111
Other receivables		11,104			17,319
Inventories		(7,722		)	(5,558		)
Prepaid expenses		4,639			229
Other assets		(266		)	4,646
Accounts payable		(4,498		)	(10,273		)
Income taxes payable		(3,999		)	24,726
Termination of derivative financial instrument		(7,376		)	(5,264		)
Other accrued expenses		(11,119		)	6,256
Cash provided by operating activities		110,296			146,483
Cash flows from investing activities:
Additions to property and equipment		(29,415		)	(24,449		)
Sales of available-for-sale securities		—			1,000
Cash used in investing activities		(29,415		)	(23,449		)
Cash flows from financing activities:
Deemed landlord financing proceeds		2,707			3,860
Deemed landlord financing payments		(1,138		)	(1,067		)
Proceeds from exercise of employee stock options		12,849			832
Excess tax benefit related to stock options exercised		1,934			277
Repayment on credit facility		(60,000		)	(125,000		)
Purchase of treasury stock		(51,154		)	—
Cash used in financing activities		(94,802		)	(121,098		)
Net change in cash and cash equivalents		(13,921		)	1,936
Cash and cash equivalents at beginning of period		73,715			80,365
Cash and cash equivalents at end of period		$	59,794		$	82,301
Supplemental disclosures:
Interest paid		$	15,981		$	16,227
Income taxes paid		$	22,935		$	5,404

 

See the accompanying notes to the consolidated financial statements.

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  Basis of Presentation and Significant Accounting Policies

 

The accompanying consolidated financial statements include the accounts of The Cheesecake Factory Incorporated (referred to herein as the “Company,” “we,” “us” and “our”) and its wholly owned subsidiaries prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  The financial statements presented herein have not been audited by an independent registered public accounting firm, but include all material adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for the fair statement of the financial condition, results of operations and cash flows for the period.  However, these results are not necessarily indicative of results for any other interim period or for the full fiscal year.  The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions for the reporting periods covered by the financial statements.  These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent liabilities.  Actual amounts could differ from these estimates.

 

Certain information and footnote disclosures normally included in financial statements in accordance with GAAP have been omitted pursuant to the rules of the Securities and Exchange Commission (“SEC”).  The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2009 filed with the SEC on February 26, 2010.

 

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.

 

Fair Value of Financial Instruments

 

For cash and cash equivalents, the carrying amount approximates fair value because of the short maturity of these instruments.  The fair value of our long-term debt and deemed landlord financing liabilities are determined using current applicable rates for similar instruments as of the balance sheet date.  During the second quarter of fiscal 2010, we performed a review of market conditions and the borrowing rates currently available to us for facilities with similar terms and maturities.  Based on this analysis, we believe the carrying value of our long-term debt approximates fair value.  The fair value of our deemed landlord financing liabilities at September 28, 2010 is $50.7 million versus a carrying value of $52.5 million.

 

Recent Accounting Pronouncements

 

In October 2009, the Financial Accounting Standards Board issued guidance on revenue arrangements with multiple deliverables effective for us in fiscal 2011, although early adoption is permitted.  The guidance revises the criteria for measuring and allocating consideration to each component of a multiple element arrangement.  The guidance requires companies to allocate revenue using the relative selling price of each deliverable, which must be estimated if the company does not have either a history of selling the deliverable on a stand alone basis or third-party evidence of selling price.  For our company, this guidance will only impact the pattern of revenue recognition for our marketing programs that include multiple elements.  As the timing and content of future promotions is not determinable at this time, we are unable to estimate the impact of this guidance on our financial statements.

 

2.  Inventories

 

Inventories consisted of (in thousands):

 

		September 28, 2010			December 29, 2009
Restaurant food and supplies		$	12,342		$	12,619
Bakery finished goods		12,641			5,530
Bakery raw materials and supplies		4,941			4,053
Total		$	29,924		$	22,202

 

3.  Long-Term Debt

 

Long-term debt consisted of (in thousands):

 

		September 28, 2010			December 29, 2009
Credit facility		$	40,000		$	100,000

 

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In April 2007, we entered into a five-year revolving credit facility (“Facility”) with a maximum available borrowing commitment of $200 million.  In March 2008, we amended the Facility to increase the maximum available borrowing commitment to $300 million.  In January 2009, we entered into a second amendment, which reset our financial covenants and pricing, and also limited cash distributions with respect to our equity interests, such as cash dividends and share repurchases, based on a liquidity threshold.  Borrowings under the amended Facility bear interest at a floating rate based on the London Interbank Offering Rate (LIBOR) plus a spread ranging from 2.50% to 2.75%, depending on our ratio of debt to trailing 12-month earnings before interest, taxes, depreciation, amortization and noncash stock option expense (“EBITDA”), as defined in the agreement.  In addition, we pay a commitment fee ranging from 0.40% to 0.45%, also depending on our ratio of debt to EBITDA, calculated on the average unused portion of the Facility.  The Facility restricts unsecured borrowings to $15 million and includes a pledge of our outstanding equity interests in The Cheesecake Factory Bakery Incorporated and The Cheesecake Factory Assets Co. LLC, which had carrying values of $86.5 million and $69.6 million, respectively, at September 28, 2010.

 

We are obligated to maintain certain financial covenants, which include a maximum debt to EBITDA ratio of 1.75 as of the fiscal quarter ending March 31, 2009 or 1.50 as of the end of any fiscal quarter thereafter, as well as a minimum EBITDAR (EBITDA plus rental expense), as defined in the Facility, to interest and rental expense ratio of 1.90 as of any of the fiscal quarters ending March 31, 2009 through September 28, 2010 or 2.00 as of the end of any fiscal quarter thereafter.  At September 28, 2010, our EBITDA and EBITDAR ratios were 0.19 and 2.49, respectively.  Therefore, we were in compliance with the financial covenants in effect under the Facility at that date.

 

Availability under the Facility is reduced by outstanding standby letters of credit, which are used to support our self-insurance programs.  As of September 28, 2010, we had net availability for borrowings of $244 million, based on outstanding debt of $40 million and $16 million in standby letters of credit.  Since we have the contractual ability to maintain the outstanding balance on our Facility, the debt is classified as long-term on our consolidated balance sheets.

 

4.        Derivative Financial Instruments

 

At December 29, 2009, we held one zero-cost interest rate collar that hedged interest rate variability on the $100 million outstanding balance on our Facility as of that date.  This instrument consisted of a combination of a purchased cap option with a three-month LIBOR cap rate of 5.35% and a sold floor option with a three-month LIBOR floor rate of 4.69%, and had a maturity date of April 3, 2012.  During the second quarter of fiscal 2010, we unwound this collar at a cost of $7.4 million.  See Note 3 for further discussion of our credit facility.

 

This derivative qualified for hedge accounting as a cash flow hedge and, accordingly, was recognized at fair value as either an asset or liability on the consolidated balance sheets.  Changes in fair value were recorded in accumulated other comprehensive income (“AOCI”) and subsequently reclassified into earnings when the related interest expense on the underlying borrowing was recognized.  We do not hold any derivative financial instruments for trading or speculative purposes.

 

The fair value and balance sheet locations of our derivative are as follows (in thousands):

 

				Fair Value of Liability Derivatives
		Balance Sheet Location		September 28, 2010			December 29, 2009
Interest rate contracts		Other accrued expenses		$	—		$	4,299
Interest rate contracts		Other noncurrent liabilities		—			3,945
Total				$	—		$	8,244

 

We had no derivative financial instruments in asset positions as of September 28, 2010 or December 29, 2009.  The fair value of our derivative financial instruments is estimated using the net present value of a series of cash flows on both the cap and floor components of the interest rate collars.  These cash flows are based on yield curves which take into account the contractual terms of the derivatives, including the period to maturity and market-based parameters such as interest rates and volatility.  We incorporated nonperformance risk by adjusting the present value of each liability position utilizing an estimation of our credit risk.

 

The effects of derivative instruments on our consolidated statements of operations are as follows (in thousands):

 

		Gain/(Loss) Recognized in AOCI on Derivative						Location of Gain/(Loss) Reclassified from AOCI into Income		Gain/(Loss) Reclassified from AOCI into Income
		Thirteen Weeks Ended								Thirteen Weeks Ended
		September 28, 2010			September 29, 2009					September 28, 2010			September 29, 2009
Interest rate contracts		$	—		$	(395	)	Interest expense		$	—		$	(3,500	)

 

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		Gain/(Loss) Recognized in AOCI on Derivative						Location of Gain/(Loss) Reclassified from AOCI into Income		Gain/(Loss) Reclassified from AOCI into Income
		Thirty-Nine Weeks Ended								Thirty-Nine Weeks Ended
		September 28, 2010			September 29, 2009					September 28, 2010			September 29, 2009
Interest rate contracts		$	41		$	238		Interest expense		$	(9,638	)	$	(9,002	)

 

5.  Fair Value Measurement

 

The following table presents our financial assets and liabilities that were accounted for at fair value as of September 28, 2010 (in thousands):

 

		Fair Value Measurements Using
		Quoted Prices in Active Markets			Significant Other Observable Inputs			Significant Unobservable Inputs
Assets:
Cash invested in money market funds		$	16		$	—		$	—

 

For assets that are measured using quoted prices in active markets, fair value is the published market price per unit multiplied by the number of units held without consideration of transaction costs.  At September 28, 2010, we had less than $0.1 million of cash invested in tax-exempt money market funds compared to $25.2 million as of December 29, 2009.  These funds purchase only first-tier securities, and we have not experienced any losses in these accounts.  Therefore, we believe we are not exposed to significant risk on these investments.

 

6. Commitments and Contingencies

 

The Internal Revenue Service (“IRS”) audited our tax returns for fiscal years 2003 through 2006 with respect to the deductibility, under the provisions of Internal Revenue Code Section 162(m), of certain compensation in excess of $1 million per year paid to three current executive officers and one former executive officer resulting from their respective exercises of stock options later determined to be misdated (the “162(m) Dispute”).  In May 2008, the IRS issued a Notice of Proposed Adjustment to us disallowing the deduction of approximately $5.1 million of compensation expense with respect to the exercise of stock options by such executive officers.  We believe that such stock option compensation qualifies as performance-based compensation that is not subject to the limitations on deductibility under Internal Revenue Code Section 162(m).  We received a Statutory Notice of Deficiency from the IRS for fiscal 2005 only and petitioned for redetermination of this notice with the United States Tax Court.  In May 2010, we conducted a settlement conference with the IRS Office of Appeals resulting in an agreement to resolve the 162(m) Dispute as to tax year 2005 only.  That agreement was approved by the United States Tax Court in August 2010 (Docket No. 23591-09).  This court order resolved the 162(m) Dispute as to tax year 2005, and because the 162(m) Dispute as to tax year 2006 consisted solely of a reduction to tax credits carried over from tax year 2005 resulting from the IRS Notice of Deficiency, such court order also resolved the 162(m) Dispute as to tax year 2006.  In October 2010, we filed a complaint with the United States District Court for the refund of income taxes with respect to tax years 2003 and 2004, including interest and penalties.  While we believe that all stock option compensation in the as yet unresolved years of the 162(m) Dispute qualifies as performance-based compensation under Internal Revenue Code Section 162(m) and is not subject to the limitations on deductibility, we have reserved $1.3 million for estimated taxes, interest and penalties due through September 28, 2010.

 

On August 10, 2010, the Equal Employment Opportunity Commission (EEOC) for the Cleveland Field Office issued a determination letter in EEOC Charge 532-2009-1050 in favor of the Charging Party and a class of 15 unidentified employees, alleging that we subjected them to a hostile work environment based on national origin and/or race in violation of Title VII of the Civil Rights Act of 1964 (Title VII).  The EEOC is seeking payment of alleged actual damages incurred by the claimants as well as compensatory and/or punitive monetary costs and remedial actions.  The parties failed to reach a conciliated settlement in September 2010 and, to date, no further action has been taken by the EEOC with respect to Charge No. 532-2009-1050.   We intend to vigorously defend against this Charge.  Based upon the current status of this matter, we have not reserved for any potential future payments.

 

On May 10, 2010, three current hourly restaurant employees in the State of California filed a class action lawsuit in the California Superior Court, Placer County, against us alleging violations of the California Labor Code by requiring employees to purchase uniforms and other work tools to perform their jobs, among other claims (Reed v. The Cheesecake Factory Restaurants, Inc. et al; Case No. S CV 27073).  In October 2010, we gave notice to the respective courts in Case No. S CV 27073 and Case No. BC360426 that such cases may be related.  The lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the respective plaintiffs and other purported class members. The plaintiffs also seek attorneys’ fees.  We intend to vigorously defend this action.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

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On November 18, 2009, one former hourly restaurant employee in the State of Illinois filed a lawsuit in the U.S. District Court for the Northern District of Illinois (Morales v. The Cheesecake Factory, Inc.; Case No. 09 CV 7005) against us alleging violations of the Fair Labor Standards Act and Illinois Minimum Wage Law for alleged failure to pay overtime and minimum wages, among other claims.  This lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the respective plaintiff and other purported class members.  The plaintiff also seeks attorneys’ fees.  On June 11, 2010, the Plaintiff filed a motion for conditional class certification.  We filed our response to the motion on July 12, 2010.  No hearing date has been set by the Court.  We intend to vigorously defend this action.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

On August 5, 2009, two former hourly restaurant employees in the State of California filed a class action lawsuit in the Los Angeles County Superior Court (Luque v. The Cheesecake Factory Restaurants, Inc.; Case No. BC415640) against us alleging violations of California’s wage and hour laws with respect to alleged failure to pay proper vacation wages at termination, failure to furnish wage statements, and violations of the California Business and Professions Code, among other claims. This lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the respective plaintiffs and other purported class members. The plaintiffs also seek attorneys’ fees.  The plaintiffs’ deadline for filing their motion for class certification was June 11, 2010, and they failed to timely file.  On October 12, 2010, the parties conditionally settled Case No. BC415640 for a nominal amount.  The final settlement agreement is subject to court approval.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

On January 20, 2009, one former hourly restaurant employee in the State of California filed a lawsuit in the San Diego County Superior Court (Giradin v. The Cheesecake Factory, Inc.; Case No. 37-2009-00081696-CU-OE-CTL) against us alleging violations of California’s wage and hour laws with respect to alleged failure to pay proper wages, failure to furnish accurate wage statements and violations of the California reporting time laws, among other claims.  This lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the respective plaintiff and other purported class members.  The plaintiff also seeks attorneys’ fees.  On January 8, 2010, the plaintiff filed a First Amended Complaint naming a new class representative and asserting additional claims under the California Labor Code Private Attorneys General Act of 2004.  We filed a demurer to the First Amended Complaint on February 22, 2010.  On April 23, 2010, the Court granted our motion and dismissed the plaintiff’s complaint.  If an appeal is filed, or the case is not otherwise fully dismissed, we intend to vigorously defend this action.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

On July 2, 2008, the Equal Employment Opportunity Commission (EEOC) for the Cleveland Field Office issued determination letters in Charges 532-2006-01040, -01030, -01042 in favor of three former employees alleging that we engaged in a pattern and practice of sex discrimination, and in the case of one claimant, racial discrimination, in violation of Title VII of the Civil Rights Act of 1964 (Title VII).  The determination alleges that our actions resulted in females as a class being denied entry and progression into upper ranks of management at our restaurants.  We deny these allegations.  The EEOC is seeking payment of alleged actual damages incurred by the claimants as well as compensatory and/or punitive monetary costs and remedial actions.  The parties failed to reach a conciliated settlement in 2008 and, to date, no further action has been taken by the EEOC with respect to these charges.  On July 30, 2008, the EEOC Cleveland District Office also filed a Commissioner’s Charge 532-2008-01856 alleging we violated Title VII for failing or refusing to select females for management positions in our restaurants because of their sex.  This Charge arises out of the facts alleged in EEOC Charges 532-2006-01040, -01030, -01042.  The EEOC is currently conducting its investigation into this Commissioner’s Charge.  While we are cooperating with the EEOC’s investigation, we deny these allegations and intend to vigorously defend against these charges.  Based upon the current status of these matters, we have not reserved for any potential future payments.

 

On January 9, 2007, two former hourly restaurant employees in the State of California filed a lawsuit in the Los Angeles County Superior Court against us alleging violations of California’s wage and hour laws with respect to alleged failure to pay proper wages, improper payroll deductions, and violations of the California meal and break period laws, among other claims (Guardado v. The Cheesecake Factory Restaurants, Inc. et al; Case No. BC360426).  This case was previously stayed by the parties through December 2008, pending the California Supreme Court’s decision to review Brinker Restaurant Corp. v. Superior Court of San Diego County (No. S166350, 2008). Subsequently, the parties entered into mediation proceedings that, to date, have not been successful. On February 23, 2009, an additional lawsuit with similar allegations was filed by another hourly restaurant employee in Santa Clara County Superior Court (Benitez v. The Cheesecake Factory Restaurants, Inc., et al; Case No. 109CV135687). In April, 2009, we gave notice to the respective courts in Case No. 109CV135687 and Case No. BC360426 that such cases may be related matters.  In March, 2010, we settled Case No. 109CV135687 for a nominal amount. On March 30, 2010, the Court set a trial date in Case No. BC360426.   On June 1, 2010, the plaintiffs in Case No. BC360426 filed their motion for class certification, and on July 6, 2010, the Court denied such motion.  A notice of appeal was subsequently filed by the plaintiffs in Case No. BC360426 on August 3, 2010. 

 

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We intend to vigorously defend against this action.  On July 28, 2010, a lawsuit was filed against us in the Santa Clara County Superior Court (Rusteen v. The Cheesecake Factory Restaurants, Inc. et al; Case No. 1-10-CV-178233) claiming similar and additional allegations to those asserted in Case No. BC360426 including, among other things, violations of California’s wage and hour laws with respect to alleged failure to pay the plaintiff overtime, reporting time pay and minimum wages, allow proper meal breaks or rest periods, and provide adequate pay statements.  In October 2010, we gave notice to the respective courts in Case No. 1-10-CV-178233 and Case No. BC360426 that such cases may be related.  The plaintiff in Case No. 1-10-CV-178233 seeks unspecified amounts of penalties and other monetary payments on behalf of himself and other purported class members.  The plaintiffs also seek attorneys’ fees.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

On August 29, 2006, five present and former hourly restaurant employees in the States of Tennessee, Texas and Arizona filed a lawsuit in the U.S. District Court for the Middle District of Tennessee against us alleging violations of the Fair Labor Standards Act with respect to alleged minimum wage violations, improper payroll deductions and requiring work “off the clock,” among other claims (Smith v. The Cheesecake Factory Restaurants, Inc. et al; Case No. 3 06 0829).  The lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the plaintiffs and other purported class members. The plaintiffs also seek attorneys’ fees.  On February 4, 2010, the Court granted our motion to compel arbitration and issued an order dismissing all individual defendants in the case.  The plaintiffs filed their demand for arbitration on April 19, 2010.  On July 16, 2010, we filed a Motion to Appoint Arbitrators for the individual plaintiffs with the U.S. District Court.  We intend to vigorously defend this action.  Based on the current status of this matter, we have not reserved for any potential future payments.

 

We are also subject to other private lawsuits, administrative proceedings and claims that arise in the ordinary course of our business.  These claims typically involve claims from guests, staff members and others related to operational issues common to the foodservice industry.  A number of these claims may exist at any given time and some of the employee claims may be pled as class actions.  We could be affected by adverse publicity and litigation costs resulting from such allegations, regardless of whether these allegations are valid or whether we are determined to be liable.  From time to time, we are also involved in lawsuits with respect to infringements of, or challenges to, our registered trademarks.  At this time, we believe that the final disposition of these lawsuits, proceedings and claims will not have a material adverse effect on our financial position, results of operations or liquidity.  It is possible, however, that our future results of operations for a particular quarter or fiscal year could be impacted by changes in circumstances relating to lawsuits, proceedings or claims.

 

7. Stockholders’ Equity

 

We have an outstanding authorization from our Board of Directors to repurchase up to 31 million shares of our common stock.  Under this authorization, we have cumulatively repurchased a total of 25.2 million shares at a total cost of $557.4 million through September 28, 2010; we repurchased 2.1 million of these shares at a total cost of $51.2 million during the first three quarters of fiscal 2010. The authorization does not have an expiration date, does not require us to purchase a specific number of shares and may be modified, suspended or terminated at any time.

 

In October 2008, we suspended our share repurchase program in order to maintain maximum flexibility in our capital decisions in light of the unprecedented crisis in the global financial markets and the indeterminate future impact it could have on the overall economy and on our business.  In February 2010, our Board of Directors reinstated our stock repurchase program and approved the adoption of a trading plan under Rule 10b5-1 (“10b5-1Plan”) under the Securities Exchange Act of 1934, as amended from time to time (“Act”), which became effective in March 2010.  In addition, we may also make purchases in the open market in compliance with Rule 10b-18 under the Act.

 

The timing and number of shares repurchased pursuant to the share repurchase authorization are subject to a number of factors, including current market conditions, legal constraints, available cash or other sources of funding and financial covenants under our credit facility that limit share repurchases based on a liquidity threshold.  Shares may be repurchased in the open market or through privately negotiated transactions at times and prices considered appropriate by us.  We make the determination to repurchase shares based on several factors, including an evaluation of current and future capital needs associated with new restaurant development, current and forecasted cash flows, a review of our capital structure and cost of capital, and our share price.

 

8.  Stock-Based Compensation

 

The following table presents information related to stock-based compensation (in thousands):

 

		Thirteen Weeks Ended September 28, 2010			Thirteen Weeks Ended September 29, 2009			Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
Stock-based compensation expense		$	2,891		$	3,417		$	9,473		$	10,483
Income tax benefit		1,096			907			3,593			2,631
Capitalized stock-based compensation (1)		19			83			151			359

 

(1)          It is our policy to capitalize the portion of stock-based compensation costs for our internal development and construction, legal, and facilities departments that relates to capitalizable activities such as the design and construction of new restaurants, remodeling existing locations, lease, intellectual property and liquor license acquisition activities and equipment installation.  Capitalized stock-based compensation is included in property and equipment, net and other assets on the consolidated balance sheets.

 

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Stock Options

 

The weighted average fair value at the grant date for options issued during the third quarter of fiscal 2010 and 2009 was $9.93 and $8.08 per option, respectively.  The fair value of options at the grant date was estimated utilizing the Black-Scholes valuation model with the following weighted average assumptions for the third quarter of fiscal 2010 and 2009, respectively: (a) no dividend yield on our stock, (b) expected stock price volatility of 43.8% and 49.4%, (c) a risk-free interest rate of 1.7% and 2.5%, and (d) an expected option term of 5.8 and 5.4 years.

 

Stock option activity during the thirty-nine weeks ended September 28, 2010 was as follows:

 

		Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
		(In thousands)		(Per share)			(In years)		(In thousands)
Outstanding at December 29, 2009		10,254		$	22.40
Granted		624		$	22.90
Exercised		(652	)	$	19.71
Cancelled		(341	)	$	23.68
Outstanding at September 28, 2010		9,885		$	22.56		5.4		$	53,555
Exercisable at September 28, 2010		4,769		$	26.37		3.9		$	11,541

 

The total intrinsic value of options exercised for the thirteen and thirty-nine weeks ended September 28, 2010 was $0.4 million and $4.3 million, respectively.  The total intrinsic value of options exercised for the thirteen and thirty-nine weeks ended September 29, 2009 was $0.3 million and $0.5 million, respectively.  As of September 28, 2010, the total unrecognized stock-based compensation expense related to nonvested stock options was $19.7 million, which we expect to recognize over a weighted average period of approximately 2.8 years.

 

Restricted Shares

 

Restricted share activity during the thirty-nine weeks ended September 28, 2010 was as follows:

 

		Shares		Weighted Average Fair Value
		(In thousands)		(Per share)
Outstanding at December 29, 2009		623		$	16.32
Granted		107		22.94
Vested		(171	)	25.35
Forfeited		(11	)	10.36
Outstanding at September 28, 2010		548		$	14.91

 

Fair value of our restricted shares is based on our closing stock price on the date of grant.  There were no restricted shares granted in either the third quarter of fiscal 2010 or 2009.  The fair value of shares that vested during the thirteen weeks and thirty-nine weeks ended September 28, 2010 was $0.6 million and $4.4 million, respectively.  No restricted shares vested during the first three quarters of fiscal 2009.  As of September 28, 2010, total unrecognized stock-based compensation expense related to nonvested restricted shares was $4.9 million, which we expect to recognize over a weighted average period of approximately 3.3 years.

 

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9.  Net Income Per Share

 

At September 28, 2010 and September 29, 2009, 0.5 million and 0.8 million shares, respectively, of restricted stock issued to employees were unvested, and therefore excluded from the calculation of basic earnings per share for the fiscal quarters ended on those dates.  Diluted net income per share includes the dilutive effect of both outstanding stock options and restricted shares, calculated using the treasury stock method.  Assumed proceeds from in-the-money options include windfall tax benefits, net of shortfalls, calculated under the “as-if” method as prescribed by Financial Accounting Standards Codification 718, “Compensation — Stock Option Compensation.”

 

		Thirteen Weeks Ended September 28, 2010			Thirteen Weeks Ended September 29, 2009			Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
		(In thousands, except per share data)
Net income		$	21,953		$	16,258		$	59,848		$	42,846
Basic weighted average shares outstanding		58,427			59,359			59,057			59,337
Dilutive effect of stock options and restricted shares		1,316			969			1,396			887
Diluted weighted average shares outstanding		59,743			60,328			60,453			60,224
Basic net income per share		$	0.38		$	0.27		$	1.01		$	0.72
Diluted net income per share		$	0.37		$	0.27		$	0.99		$	0.71

 

Shares of common stock equivalents of 5.4 million and 5.8 million for the thirteen and thirty-nine weeks ended September 28, 2010 and 8.3 million and 9.1 million for the thirteen and thirty-nine weeks ended September 29, 2009, respectively, were not included in the diluted calculation due to their anti-dilutive effect.

 

10.  Comprehensive Income

 

Comprehensive income consisted of (in thousands):

 

		Thirteen Weeks Ended September 28, 2010			Thirteen Weeks Ended September 29, 2009			Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
Net income		$	21,953		$	16,258		$	59,848		$	42,846
Net unrealized gain on available-for-sale securities		—			—			—			1
Unrealized (loss)/gain on derivative financial instruments		—			(395		)	41			238
Loss reclassified into income due to cancellation of financial instrument		—			1,237			4,578			3,368
Total		$	21,953		$	17,100		$	64,467		$	46,453

 

11.  Segment Information

 

We operate in two business segments, restaurants and bakery.  Restaurants consist of The Cheesecake Factory®, Grand Lux Cafe® and RockSugar Pan Asian Kitchen®.  The bakery segment produces baked desserts and other products for our restaurants and for other foodservice operators, retailers and distributors.  Bakery sales to the restaurants are recorded at prices similar to third-party national accounts.  Unallocated corporate expenses, which include all stock-based compensation, assets and capital expenditures, are presented below as reconciling items to the amounts presented in the consolidated financial statements.

 

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Segment information is presented below (in thousands):

 

		Thirteen Weeks Ended September 28, 2010			Thirteen Weeks Ended September 29, 2009			Thirty-Nine Weeks Ended September 28, 2010			Thirty-Nine Weeks Ended September 29, 2009
Revenue:
Restaurants		$	403,025		$	386,546		$	1,201,494		$	1,159,787
Bakery		30,306			27,877			82,836			79,417
Intercompany bakery sales		(14,979		)	(13,783		)	(41,636		)	(37,826		)
Total		$	418,352		$	400,640		$	1,242,694		$	1,201,378
Income from operations:
Restaurants		$	52,349		$	47,545		$	160,076		$	136,075
Bakery		2,437			3,797			7,171			9,909
Corporate		(23,377		)	(24,006		)	(69,866		)	(71,708		)
Total		$	31,409		$	27,336		$	97,381		$	74,276
Depreciation and amortization:
Restaurants		$	15,837		$	16,301		$	47,839		$	48,914
Bakery		776			770			2,315			2,293
Corporate		1,289			1,617			3,929			4,839
Total		$	17,902		$	18,688		$	54,083		$	56,046
Capital expenditures:
Restaurants		$	10,439		$	6,117		$	26,826		$	21,185
Bakery		244			784			599			1,259
Corporate		867			464			1,990			2,005
Total		$	11,550		$	7,365		$	29,415		$	24,449

 

		September 28, 2010			December 29, 2009
Total assets:
Restaurants		$	851,730		$	881,545
Bakery		58,354			53,607
Corporate		90,628			111,599
Total		$	1,000,712		$	1,046,751

 

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 and Section 21E of the Act.

 

In connection with the “safe harbor” provisions of the Act, 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 29, 2009).  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

 

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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 and the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2009.  The inclusion of supplementary analytical and related information herein may require us to make appropriate 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 taken as a whole.

 

As of November 4, 2010, we operated 163 upscale, casual, full-service dining restaurants: 149 under The Cheesecake Factory® mark, 13 under the Grand Lux Cafe® mark and one under the RockSugar Pan Asian Kitchen® mark.  We also operated two bakery production facilities and licensed two limited menu bakery cafes under The Cheesecake Factory Bakery Cafe® mark to another foodservice operator.

 

The Cheesecake Factory is an upscale casual dining concept that offers more than 200 menu items including appetizers, pizza, seafood, steaks, chicken, burgers, pasta, specialty items, salads, sandwiches, omelets and desserts, including approximately 40 varieties of cheesecake and other baked desserts.  Grand Lux Cafe and RockSugar Pan Asian Kitchen are also upscale casual dining concepts offering approximately 200 and 80 menu items, respectively.  In contrast to many chain restaurant operations, substantially all of our menu items (except certain desserts manufactured at our bakery production facilities) are prepared on the restaurant premises using high quality, fresh ingredients based on innovative and proprietary recipes.  We believe our restaurants are recognized by consumers for offering value with generous food portions at moderate prices.  Our restaurants’ distinctive, contemporary design and decor create a high-energy ambiance in a casual setting.  Our restaurants currently range in size from 5,400 to 21,000 interior square feet, provide full liquor service and are generally open seven days a week for lunch and dinner, as well as Sunday brunch.

 

Overview

 

In addition to being highly competitive, the restaurant industry is affected by changes in consumer tastes and discretionary spending patterns; changes in general economic conditions; public safety conditions; demographic trends; weather conditions; the cost and availability of food products, labor and energy; purchasing power; and government regulations.  Accordingly, as part of our strategy, we must constantly evolve and refine the critical elements of our restaurant concepts to protect our competitiveness and to maintain and enhance the strength of our brands.

 

Our strategy is driven by our commitment to guest satisfaction and is focused primarily on menu innovation and operational execution to continue to differentiate ourselves from other restaurant concepts, as well as drive competitively strong performance that is sustainable.  Financially, we are focused on prudently managing expenses at our restaurants, bakery facilities and corporate support center.  We are also committed to allocating capital in a manner that will maximize profitability and returns.  Investing in our restaurants is our top capital allocation priority with a focus on continuing to develop our concepts in premier locations within both existing and new markets.  Near-term, we plan to deploy our excess capital on hand to either reduce the outstanding balance on our credit facility, repurchase some of our outstanding shares, or a combination of both.

 

In evaluating and assessing the performance of our business, we believe the following are key performance indicators that should be taken into consideration:

 

·                  Comparable Restaurant Sales and Overall Revenue Growth.  Changes in comparable restaurant sales come from variations in guest traffic, as well as changes in check average (as a result of menu price increases and/or changes in menu mix).  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 plan to continue focusing on service and hospitality with the goal of delivering an exceptional guest experience.  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.  Prior to the economic downturn, menu mix generally had a neutral effect on our average check, allowing us to retain the impact of our menu price increases.  As the economy strengthens, we would expect this pattern to resume as guests focus less on check management.

 

Comparable restaurant sales growth, in addition to revenue from new restaurant openings and increases in third-party bakery sales, drive our overall revenue growth.

 

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·                  Income from Operations Expressed as a Percentage of Revenues (“Operating Margins”).  Operating margins are subject to fluctuations in commodity costs, labor, restaurant-level occupancy expenses, general and administrative expenses, and preopening expenses.  Our objective is to gradually increase our operating margins by capturing fixed cost leverage from comparable restaurant sales increases; maximizing our purchasing power as our business grows; and operating our restaurants as productively as possible by retaining the efficiencies we gained through cost management initiatives that have been implemented.

 

In addition, by efficiently scaling our restaurant and bakery support infrastructure and improving our internal processes, we strive to grow general and administrative expenses at a slower rate than revenue growth over the long-term, which should also contribute to operating margin expansion.

 

·                  Return on Investment.  Return on investment measures our ability to make the best decisions regarding our allocation 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 through operational execution and strict cost management.  Our objective is to deploy capital in a manner that will maximize our return on investment.

 

Results of Operations

 

The following table sets forth, for the periods indicated, our consolidated statements of operations 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 the full fiscal year.

 

		Thirteen Weeks Ended September 28, 2010		Thirteen Weeks Ended September 29, 2009		Thirty-Nine Weeks Ended September 28, 2010		Thirty-Nine Weeks Ended September 29, 2009
Revenues		100.0	%	100.0	%	100.0	%	100.0	%
Costs and expenses:
Cost of sales		24.4		23.9		24.4		24.4
Labor expenses		32.8		32.9		32.9		33.3
Other operating costs and expenses		24.9		25.5		24.5		25.3
General and administrative expenses		5.7		6.0		5.7		5.9
Depreciation and amortization expenses		4.3		4.7		4.4		4.7
Preopening costs		0.4		0.2		0.3		0.2
Total costs and expenses		92.5		93.2		92.2		93.8
Income from operations		7.5		6.8		7.8		6.2
Interest expense		(0.4	)	(1.4	)	(1.2	)	(1.5	)
Interest income		—		—		—		—
Other (expense)/income, net		(0.1	)	0.1		—		0.1
Income before income taxes		7.0		5.5		6.6		4.8
Income tax provision		1.8		1.4		1.8		1.2
Net income		5.2	%	4.1	%	4.8	%	3.6	%

 

Thirteen Weeks Ended September 28, 2010 Compared to Thirteen Weeks Ended September 29, 2009

 

Revenues

 

Revenues increased 4.4% to $418.4 million for the thirteen weeks ended September 28, 2010 compared to $400.6 million for the thirteen weeks ended September 29, 2009.

 

Restaurant sales increased 4.3% to $403.0 million compared to $386.5 million in the prior year third quarter.  This increase consisted of a $10.6 million increase in The Cheesecake Factory and Grand Lux Cafe comparable restaurant sales and a $5.9 million increase from restaurants not in the comparable sales base.  Comparable sales at The Cheesecake Factory and Grand Lux Cafe restaurants increased by 2.8% from the third quarter of fiscal 2009 to the third quarter of fiscal 2010.  At September 28, 2010, there were three The Cheesecake Factory restaurants not included in the comparable sales base.  The Cheesecake Factory and Grand Lux Cafe restaurants become eligible to enter our comparable sales calculations in their 19th month of operation.

 

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