CHEESECAKE FACTORY INC - Quarter Report: 2014 July (Form 10-Q)

Table of Contents

 

 

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 July 1, 2014

 

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 July 30, 2014, 49,538,583 shares of the registrant’s Common Stock, $.01 par value per share, were outstanding.

 

 

Table of Contents

 

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

INDEX

 

			Page Number
PART I.	FINANCIAL INFORMATION
	Item 1.	Unaudited Financial Statements:
		Consolidated Balance Sheets	3
		Consolidated Statements of Comprehensive Income	4
		Consolidated Statement of Stockholders’ Equity	5
		Consolidated Statements of Cash Flows	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
	Item 4.	Controls and Procedures	20
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	21
	Item 1A.	Risk Factors	21
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
	Item 6.	Exhibits	22
Signatures			23

 

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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)

(Unaudited)

 

		July 1, 2014			December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents		$	25,577		$	61,751
Accounts receivable		9,158			10,081
Income tax receivable		2,767			4,529
Other receivables		31,505			55,461
Inventories		36,379			35,478
Prepaid expenses		42,021			42,595
Deferred income taxes		16,008			16,008
Total current assets		163,415			225,903
Property and equipment, net		810,855			795,379
Other assets:
Intangible assets, net		19,084			18,647
Prepaid rent		46,178			47,064
Other		40,989			37,121
Total other assets		106,251			102,832
Total assets		$	1,080,521		$	1,124,114
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	47,494		$	35,418
Other accrued expenses		207,419			228,829
Total current liabilities		254,913			264,247
Deferred income taxes		97,047			97,237
Deferred rent		74,082			74,690
Deemed landlord financing liability		72,470			66,197
Long term debt		25,000			—
Other noncurrent liabilities		47,871			44,390
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value, 250,000,000 shares authorized; 91,136,323 and 90,632,325 issued and outstanding at July 1, 2014 and December 31, 2013, respectively		911			906
Additional paid-in capital		619,049			602,469
Retained earnings		1,027,838			989,451
Treasury stock, 41,460,270 and 38,865,951 shares at cost at July 1, 2014 and December 31, 2013, respectively		(1,138,660		)	(1,015,473		)
Total stockholders’ equity		509,138			577,353
Total liabilities and stockholders’ equity		$	1,080,521		$	1,124,114

 

See the accompanying notes to the consolidated financial statements.

 

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands, except per share data)

(Unaudited)

 

		Thirteen Weeks Ended July 1, 2014			Thirteen Weeks Ended July 2, 2013			Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
Revenues		$	496,406		$	470,118		$	977,837		$	933,136
Costs and expenses:
Cost of sales		120,667			112,947			240,029			227,240
Labor expenses		160,777			151,162			320,227			302,145
Other operating costs and expenses		119,577			113,805			235,210			224,783
General and administrative expenses		29,042			27,811			60,284			56,600
Depreciation and amortization expenses		20,534			19,215			40,785			38,445
Impairment of assets and lease terminations		510			1,505			696			2,149
Preopening costs		2,608			2,503			4,842			3,817
Total costs and expenses		453,715			428,948			902,073			855,179
Income from operations		42,691			41,170			75,764			77,957
Interest and other expense, net		(1,544		)	(1,271		)	(2,935		)	(2,581		)
Income before income taxes		41,147			39,899			72,829			75,376
Income tax provision		11,098			11,316			20,262			21,501
Net income		$	30,049		$	28,583		$	52,567		$	53,875
Net income per share:
Basic		$	0.61		$	0.54		$	1.05		$	1.02
Diluted		$	0.59		$	0.52		$	1.01		$	0.99
Weighted average shares outstanding:
Basic		49,349			52,892			50,044			52,574
Diluted		51,358			55,073			52,098			54,692
Cash dividends declared per common share		$	0.14		$	0.12		$	0.28		$	0.24

 

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			Treasury Stock			Total
Balance, December 31, 2013		90,632		$	906		$	602,469		$	989,451		$	(1,015,473	)	$	577,353
Net income		—		—			—			52,567			—			52,567
Cash dividends declared		—		—			—			(14,180		)	—			(14,180		)
Issuance of common stock from stock options exercised		449		4			8,616			—			—			8,620
Tax impact of stock options exercised, net of cancellations		—		—			5,032			—			—			5,032
Stock-based compensation		—		—			7,836			—			—			7,836
Issuance of restricted stock, net of forfeitures		55		1			—			—			—			1
Treasury stock purchases		—		—			—			—			(123,187		)	(123,187		)
Payment for future treasury stock purchases under accelerated stock repurchase agreement		—		—			(4,904		)	—			—			(4,904		)
Balance, July 1, 2014		91,136		$	911		$	619,049		$	1,027,838		$	(1,138,660	)	$	509,138

 

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)

 

		Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
Cash flows from operating activities:
Net income		$	52,567		$	53,875
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		40,785			38,445
Deferred income taxes		(190		)	4,718
Impairment of assets and lease terminations		617			1,505
Stock-based compensation		7,738			6,813
Tax impact of stock options exercised, net of cancellations		5,032			2,372
Excess tax benefit related to stock options exercised		(4,923		)	(3,265		)
Other		897			(713		)
Changes in assets and liabilities:
Accounts receivable		923			3,614
Other receivables		23,956			20,251
Inventories		(901		)	(6,854		)
Prepaid expenses		574			1,765
Other assets		(2,945		)	614
Accounts payable		12,076			(11,363		)
Income taxes receivable/payable		1,762			(3,110		)
Other accrued expenses		(15,860		)	(20,021		)
Cash provided by operating activities		122,108			88,646
Cash flows from investing activities:
Additions to property and equipment		(57,810		)	(37,517		)
Additions to intangible assets		(646		)	(811		)
Cash used in investing activities		(58,456		)	(38,328		)
Cash flows from financing activities:
Deemed landlord financing proceeds		5,105			2,947
Deemed landlord financing payments		(1,246		)	(1,009		)
Proceeds from exercise of stock options		8,620			49,421
Excess tax benefit related to stock options exercised		4,923			3,265
Cash dividends paid		(14,137		)	(12,605		)
Borrowings on credit facility		25,000			—
Treasury stock purchases		(123,187		)	(45,283		)
Payment for future treasury stock purchases under accelerated stock repurchase agreement		(4,904		)	—
Cash used in financing activities		(99,826		)	(3,264		)
Net change in cash and cash equivalents		(36,174		)	47,054
Cash and cash equivalents at beginning of period		61,751			83,569
Cash and cash equivalents at end of period		$	25,577		$	130,623
Supplemental disclosures:
Interest paid		$	2,605		$	2,253
Income taxes paid		$	13,703		$	17,515
Construction payable		$	3,342		$	1,628

 

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 and its wholly owned subsidiaries (referred to herein collectively as the “Company,” “we,” “us” and “our”) 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.  Certain information and footnote disclosures normally included in financial statements prepared 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 31, 2013 filed with the SEC on February 27, 2014.

 

The preparation of financial statements in conformity with GAAP requires us to make 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 results could differ from these estimates.

 

We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31st for financial reporting purposes.  Fiscal year 2014 consists of 52 weeks and will end on December 30, 2014.  Fiscal 2013, which ended on December 31, 2013, was also a 52-week year.

 

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

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued accounting guidance that provides a comprehensive new revenue recognition model. This will supersede most of the existing revenue recognition requirements and will require entities to recognize revenue at an amount that reflects the consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer. This guidance is effective for us beginning in the first quarter of fiscal 2017 and will not have a material impact on our financial statements.

 

In July 2013, the FASB issued guidance that requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. This guidance was effective for us beginning in the first quarter of fiscal 2014.  The adoption of this new guidance did not have any effect on our financial statements.

 

2.  Inventories

 

Inventories consisted of (in thousands):

 

		July 1, 2014			December 31, 2013
Restaurant food and supplies		$	13,396		$	15,648
Bakery finished goods and work in progress		17,658			14,672
Bakery raw materials and supplies		5,325			5,158
Total		$	36,379		$	35,478

 

3.  Long-Term Debt

 

On October 16, 2013, we entered into a new loan agreement (“Facility”) which amended and restated in its entirety our prior loan agreement dated December 3, 2010.  This Facility, which matures on October 16, 2018, provides us with revolving loan commitments totaling $200 million, of which $50 million may be used for issuances of letters of credit.  Availability under the Facility is reduced by outstanding letters of credit, which are used to support our self-insurance programs.  The Facility contains a commitment increase feature that could provide for an additional $100 million in available credit upon our request and the satisfaction of certain conditions.  Our obligations under the Facility are unsecured.  Certain of our material subsidiaries have guaranteed our obligations under the Facility.  At July 1, 2014, we had net availability for borrowings of $154 million, based on an outstanding debt balance of $25 million and $21 million in standby letters of credit.  The borrowings under this Facility were used to fund a portion of the Accelerated Stock Repurchase (“ASR”) program we entered into on February 27, 2014.  See Note 5 for further discussion of our ASR program.  We did not draw or repay any amounts under the current or previous credit facility during fiscal year 2013.

 

We are subject to certain financial covenants under the Facility requiring us to maintain (i) a maximum “Net Adjusted Leverage Ratio” of 4.0, comprised of debt plus eight times rent minus unrestricted cash and cash equivalents in excess of $25 million divided by “EBITDAR” (trailing 12-month earnings before interest, taxes, depreciation, amortization, noncash stock option expense, rent and permitted acquisition costs) and (ii) a trailing 12-month minimum EBITDAR to interest and rental expense ratio (“EBITDAR Ratio”) of 1.9.  Our Net Adjusted Leverage and EBITDAR Ratios were 2.6 and 3.0, respectively, at July 1, 2014, and we were in compliance with the financial covenants in effect at that date.  The Facility also limits cash distributions with respect to our equity interests, such as cash dividends and share repurchases, based on the Net Adjusted Leverage Ratio.

 

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Borrowings under the Facility bear interest, at our option, at a rate equal to either (i) the Adjusted LIBO Rate plus a margin ranging from 1.00% to 1.75% based on our Net Adjusted Leverage Ratio or (ii) the highest of (a) the rate of interest publicly announced by JPMorgan Chase Bank as its prime rate in effect, (b) the Federal Funds Effective Rate from time to time plus 0.5% or (c) the one-month Adjusted LIBO Rate plus 1.0%, plus a margin ranging from 0.00% to 0.75% based on our Net Adjusted Leverage Ratio.  Under the Facility, we paid certain customary loan origination fees and owe a fee on the unused portion of the Facility ranging from 0.15% to 0.30% also based on our Net Adjusted Leverage Ratio.

 

4. Commitments and Contingencies

 

On April 11, 2013, a current restaurant hourly employee filed a class action lawsuit in the California Superior Court, Placer County, alleging that the Company violated the California Labor Code and California Business and Professions Code, by requiring employees to purchase uniforms for work (Sikora v. The Cheesecake Factory Restaurants, Inc., et al; Case No SCV0032820).  A similar lawsuit covering a different time period was also filed in Placer County (Reed v. The Cheesecake Factory Restaurants, Inc. et al; Case No. S CV 27073).  By stipulation the parties agreed to transfer the Reed and Sikora cases to Los Angeles County.  Both cases (Case Nos. SCV0032820 and S CV 2703) were subsequently coordinated together in Los Angeles County by order of the Judicial Council.  On November 15, 2013, the Company filed a motion to strike certain causes of action raised in Case No. SCV003820, which motion is currently scheduled for hearing on September 10, 2014.  We were also arbitrating similar uniform and related issues under federal law in separate collective actions in Alabama, Colorado, Ohio, Tennessee, and Texas (Smith v. The Cheesecake Factory Restaurants, Inc. et al; Case No. 3 06 0829).  On October 24, 2013, the arbitrator in the Tennessee matter (Case No. 3 06 0829) denied summary judgment motions filed both by the claimants and by us on the uniform issue.  In January 2013, the arbitrator in the Ohio matter (Case No. 3 06 0829) ruled in favor of the Company on the material claims raised in the Ohio arbitration, including uniform, minimum wage and overtime issues, while finding in favor of the claimants on two non-material claims.  The claimants then filed a motion to vacate the Ohio arbitration decision.  These lawsuits and arbitrations sought unspecified amounts of penalties and other monetary payments on behalf of the respective claimants and other purported class members.  On May 29, 2014, the parties agreed to a confidential settlement that was approved by the arbitrator in Case No. 3 06 0829.  We expensed an immaterial amount for this settlement in the first quarter of fiscal 2014.

 

Within the ordinary course of our business, we are subject to private lawsuits, government audits, administrative proceedings and other claims.  These matters 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 claims may be pled as class actions.  From time to time, we are also involved in lawsuits with respect to infringements of, or challenges to, our registered trademarks and other intellectual property, both domestically and abroad.  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 legally determined to be liable.  At this time, we believe that the final disposition of any pending lawsuits, audits, proceedings and claims will not have a material adverse effect individually or in the aggregate 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, audits, proceedings or claims.

 

5. Stockholders’ Equity

 

During the second quarter of fiscal 2014, our Board of Directors approved a cash dividend of $0.14 per share which was paid on May 20, 2014 to stockholders of record as of the close of business on May 7, 2014.  On July 21, 2014, our Board approved a cash dividend of $0.165 per share to be paid on August 19, 2014 to stockholders of record as of the close of business on August 6, 2014, representing an increase of 18% over our previously declared quarterly dividend.  Future decisions to pay, increase or decrease dividends continue to be at the discretion of the Board and will be dependent on our operating performance, financial condition, capital expenditure requirements and other such factors that the Board considers relevant.

 

In July 2013, our Board increased the authorization to repurchase our common stock by 7.5 million shares to 48.5 million shares.  Under this and all previous authorizations, we have cumulatively repurchased 41.5 million shares at a total cost of $1,138.7 million through July 1, 2014, including 0.5 million shares of our common stock at a cost of $24.2 million during the second quarter of fiscal 2014.

 

Our share repurchase 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.  The timing and number of shares repurchased pursuant to the share repurchase authorization are subject to a number of factors, including legal constraints and financial covenants under our Facility that limit share repurchases based on a defined ratio.  See Note 3 for further discussion of our long-term debt.  Shares may be repurchased in the open market or through privately negotiated transactions at times and prices considered appropriate by us.  Purchases in the open market are made in compliance with Rule 10b-18 of the Securities Exchange Act of 1934 (the “Act”).  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, including dividend payments, a review of our capital structure and cost of capital, our share price and current market conditions.  Our objectives with regard to share repurchases are to offset the dilution to our shares outstanding that results from equity compensation grants and to supplement our earnings per share growth.

 

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In October 2013, our Board approved the adoption of a prearranged share repurchase plan under Rule 10b5-1 (“10b5-1 Plan”) of the Act, effective from January 2, 2014 through July 1, 2014.  This 10b5-1 Plan terminated on July 1, 2014 in accordance with its terms.  On July 21, 2014, our Board approved the adoption of a new 10b5-1 Plan, which is effective from September 5, 2014 through December 31, 2014.

 

On July 21, 2014, our Board also approved the terms of a share repurchase plan (“10b-18 Plan”) under which we are authorized to repurchase shares of our common stock in open market transactions in accordance with Rule 10b-18 of the Act, effective from July 28, 2014 through August 12, 2014.

 

On February 27, 2014, we entered into a collared accelerated stock repurchase (“ASR”) agreement with a financial institution to repurchase $75 million of our common stock.  The minimum number of shares to be repurchased, 1.4 million, was delivered in March  2014.  Upon settlement of the ASR program, we received an additional 0.2 million shares on July 21, 2014.

 

6.  Stock-Based Compensation

 

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

 

		Thirteen Weeks Ended July 1, 2014			Thirteen Weeks Ended July 2, 2013			Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
Labor expenses		$	1,196		$	1,049		$	2,536		$	2,093
Other operating costs and expenses		42			52			89			98
General and administrative expenses		2,661			2,307			5,113			4,622
Total stock-based compensation		3,899			3,408			7,738			6,813
Income tax benefit		1,491			1,304			2,960			2,606
Total stock-based compensation, net of taxes		$	2,408		$	2,104		$	4,778		$	4,207
Capitalized stock-based compensation (1)		$	51		$	41		$	99		$	88

 

(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.

 

Stock Options

 

We did not issue any stock options during the second quarters of fiscal 2014 or fiscal 2013.

 

Stock option activity during the twenty-six weeks ended July 1, 2014 was as follows:

 

		Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value (1)
		(In thousands)		(Per share)			(In years)		(In thousands)
Outstanding at December 31, 2013		4,823		$	23.70		4.1		$	118,505
Granted		330		48.19
Exercised		(449	)	19.22
Forfeited or cancelled		(26	)	30.26
Outstanding at July 1, 2014		4,678		$	25.82		3.9		$	98,824
Exercisable at July 1, 2014		2,649		$	23.74		3.1		$	61,213

 

(1)                            Aggregate intrinsic value is calculated as the difference between our closing stock price at fiscal period end and the exercise price, multiplied by the number of in-the-money options and represents the pre-tax amount that would have been received by the option holders, had they all exercised their options on the fiscal period end date.

 

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The total intrinsic value of options exercised during the thirteen and twenty-six weeks ended July 1, 2014 was $3.8 million and $12.7 million, respectively.  The total intrinsic value of options exercised during the thirteen and twenty-six weeks ended July 2, 2013 was $11.7 million and $19.8 million, respectively.  As of July 1, 2014, the total unrecognized stock-based compensation expense related to unvested stock options was $14.1 million, which we expect to recognize over a weighted average period of approximately 2.3 years.

 

Restricted Shares and Restricted Share Units

 

Restricted share and restricted share unit activity during the thirteen weeks ended July 1, 2014 was as follows:

 

		Shares		Weighted Average Fair Value
		(In thousands)		(Per share)
Outstanding at December 31, 2013		1,672		$	32.81
Granted		307		48.11
Vested		(166	)	23.01
Forfeited		(56	)	36.19
Outstanding at July 1, 2014		1,757		$	36.30

 

Fair value of our restricted shares and restricted share units is based on our closing stock price on the date of grant.  The weighted average fair value at the grant date for restricted shares and restricted share units issued during the second quarter of fiscal 2014 and fiscal 2013 was $48.19 and $39.75, respectively.  The fair value of shares that vested during the thirteen and twenty-six weeks ended July 1, 2014 was $0.1 million and $3.8 million, respectively.  The fair value of shares that vested during the thirteen and twenty-six weeks ended July 2, 2013 was $6 thousand and $2.4 million, respectively.  As of July 1, 2014, total unrecognized stock-based compensation expense related to unvested restricted shares and restricted share units was $37.4 million, which we expect to recognize over a weighted average period of approximately 3.4 years.

 

7.  Net Income Per Share

 

At July 1, 2014 and July 2, 2013, 1.8 million and 1.5 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 outstanding equity awards, calculated using the treasury stock method.  Assumed proceeds from the in-the-money options include the windfall tax benefits, net of shortfalls, calculated under the “as-if” method as prescribed by FASB Accounting Standards Codification (“ASC”) 718, “Compensation — Stock Option Compensation.”

 

		Thirteen Weeks Ended July 1, 2014			Thirteen Weeks Ended July 2, 2013			Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
		(In thousands, except per share data)
Net income		$	30,049		$	28,583		$	52,567		$	53,875
Basic weighted average shares outstanding		49,349			52,892			50,044			52,574
Dilutive effect of equity awards		2,009			2,181			2,054			2,118
Diluted weighted average shares outstanding		51,358			55,073			52,098			54,692
Basic net income per share		$	0.61		$	0.54		$	1.05		$	1.02
Diluted net income per share		$	0.59		$	0.52		$	1.01		$	0.99

 

Shares of common stock equivalents of 0.4 million and 0.8 million for the thirteen and twenty-six weeks ended July 1, 2014, respectively, and 0.5 million and 1.1 million for the thirteen and twenty-six weeks ended July 2, 2013, respectively, were excluded from the diluted calculation due to their anti-dilutive effect.

 

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Certain of our restricted stock awards are considered participating securities as these awards include non-forfeitable rights to dividends with respect to unvested shares.  As such, they must be included in the computation of earnings per share pursuant to the two-class method.  Under the two-class method, a portion of net income is allocated to participating securities, and therefore is excluded from the calculation of earnings per share allocated to common shares.  The calculation of basic and diluted earnings per share pursuant to the two-class method resulted in an immaterial difference from the amounts displayed in the consolidated statements of comprehensive income.

 

8.  Segment Information

 

For decision-making purposes, our management reviews discrete financial information for The Cheesecake Factory, Grand Lux Cafe and RockSugar Pan Asian Kitchen restaurants, our bakery division and our international licensing operations.  Based on quantitative thresholds set forth in ASC 280, “Segment Reporting,” The Cheesecake Factory is our only business that meets the criteria of a reportable operating segment.  Grand Lux Cafe, RockSugar Pan Asian Kitchen, bakery and international licensing operations are combined in Other. Unallocated corporate expenses, assets and capital expenditures are presented below as reconciling items to the amounts presented in the consolidated financial statements.

 

Segment information is presented below (in thousands):

 

		Thirteen Weeks Ended July 1, 2014			Thirteen Weeks Ended July 2, 2013			Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
Revenues:
The Cheesecake Factory restaurants		$	451,454		$	424,845		$	888,060		$	837,396
Other		44,952			45,273			89,777			95,740
Total		$	496,406		$	470,118		$	977,837		$	933,136
Income from operations:
The Cheesecake Factory restaurants (1)		$	65,046		$	62,718		$	123,036		$	121,955
Other (2)		4,589			5,106			9,015			9,606
Corporate		(26,944		)	(26,654		)	(56,287		)	(53,604		)
Total		$	42,691		$	41,170		$	75,764		$	77,957
Depreciation and amortization:
The Cheesecake Factory restaurants		$	16,897		$	15,551		$	33,651		$	31,066
Other		2,609			2,605			5,200			5,225
Corporate		1,028			1,059			1,934			2,154
Total		$	20,534		$	19,215		$	40,785		$	38,445
Capital expenditures:
The Cheesecake Factory restaurants		$	25,906		$	20,721		$	54,022		$	33,995
Other		418			1,305			1,412			1,483
Corporate		1,385			910			2,376			2,039
Total		$	27,709		$	22,936		$	57,810		$	37,517

 

		July 1, 2014			December 31, 2013
Total assets:
The Cheesecake Factory restaurants		$	792,709		$	813,780
Other		151,604			155,231
Corporate		136,208			155,103
Total		$	1,080,521		$	1,124,114

 

(1)       Includes $0.2 million and $0.5 million in the first and second quarters of fiscal 2014, respectively, related to the relocation of one restaurant.  Also includes $1.5 million in the second quarter of fiscal 2013 related to the relocation of two restaurants.  These items were recorded in impairment of assets and lease terminations.

 

(2)       Includes $0.6 million in the first quarter of fiscal 2013 for three Grand Lux Cafe locations where we discontinued operations.  This item was recorded in impairment of assets and lease terminations.

 

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9.  Subsequent Events

 

On July 21, 2014, we received 0.2 million shares of our common stock upon settlement of our ASR program.  See Stockholders’ Equity for further discussion of this program.

 

On July 21, 2014, our Board approved a cash dividend of $0.165 per share to be paid on August 19, 2014 to stockholders of record as of the close of business on August 6, 2014, representing an increase of 18% over our previously declared quarterly dividend.

 

On July 21, 2014, our Board approved the adoption of a 10b5-1 Plan, which is effective from September 5, 2014 through December 31, 2014.  On July 21, 2014, our Board also approved the terms of a10b-18 Plan, which is effective from July 28, 2014 through August 12, 2014.

 

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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.

 

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

 

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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.

 

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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.

 

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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 in evaluating business performance.  Our inclusion of these adjusted measures should not be construed as an indication that our future results will be unaffected by unusual or infrequent items.  In the future, we may incur expenses or generate income similar to the adjusted items.

 

Following is a reconciliation from net income and diluted net income per share to the corresponding adjusted measures (in thousands, except per share data):

 

		Thirteen Weeks Ended July 1, 2014			Thirteen Weeks Ended July 2, 2013			Twenty-Six Weeks Ended July 1, 2014			Twenty-Six Weeks Ended July 2, 2013
Net income		$	30,049		$	28,583		$	52,567		$	53,875
After-tax impact from:
Impairment of assets and lease terminations (1)		306			903			418			1,289
Adjusted net income		$	30,355		$	29,486		$	52,985		$	55,164
Diluted net income per share		$	0.59		$	0.52		$	1.01		$	0.99
After-tax impact from:
Impairment of assets and lease terminations (1)		0.01			0.02			0.01			0.02
Adjusted diluted net income per share (2)		$	0.59		$	0.54		$	1.02		$	1.01

 

(1)         Represents lease termination expenses related to one The Cheesecake Factory and three Grand Lux Cafe restaurants. The pre-tax amounts associated with these items are $0.5 million and $0.7 million for the thirteen and twenty-six weeks ended July 1, 2014, respectively, and $1.5 million and $2.1 million for the thirteen and twenty-six weeks ended July 2, 2013, respectively.  Expenses were recorded in impairment of assets and lease terminations. See impairment of assets and lease terminations for further discussion of these charges.

(2)         Diluted net income per share may not add due to rounding.

 

Fiscal 2014 Outlook

 

For the third quarter of fiscal 2014, we estimate adjusted diluted earnings per share will be between $0.55 and $0.58 based on an assumed comparable restaurant sales increase of between 1.0% and 2.0%.  For fiscal year 2014, we estimate adjusted diluted earnings per share will be between $2.19 and $2.25 based on an assumed increase in comparable restaurant sales of between 1% and 1.5%.  Our earnings per share sensitivities also incorporate various assumptions regarding other key performance levers as discussed in the Overview section.  We currently expect food cost inflation of between 3% and 4% for fiscal 2014, due primarily to higher shrimp, salmon and dairy prices.  At the midpoint of our sensitivity range, we expect operating margins to be slightly negative relative to fiscal 2013 driven predominantly by increased food costs.  We anticipate a fiscal 2014 corporate tax rate of approximately 28%.  These earnings per share estimates do not include any charges recorded or anticipated to be recorded in impairment of assets and lease terminations.  For further discussion of the excluded items, see “Impairment of Assets and Lease Terminations” above.

 

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