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 4, 2006

 

 

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)

Delaware

 

51-0340466

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification No.)

 

 

 

26901 Malibu Hills Road

 

 

Calabasas Hills, California

 

91301

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (818) 871-3000


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 o  No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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 December 1, 2006, 77,817,118 shares of the registrant’s Common Stock, $.01 par value, were outstanding.

 




THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

INDEX

 

 

Page
Number

PART I.

FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements:

 

 

 

Consolidated Balance Sheets as of July 4, 2006 (unaudited) and January 3, 2006, as restated

1

 

 

Consolidated Statements of Operations for the thirteen and twenty-six weeks ended July 4, 2006 and June 28, 2005, as restated (unaudited)

2

 

 

Consolidated Statement of Stockholders’ Equity for the twenty-six weeks ended July 4, 2006 (unaudited)

3

 

 

Consolidated Statements of Cash Flows for the twenty-six weeks ended July 4, 2006 and June 28, 2005, as restated (unaudited)

4

 

 

Notes to Consolidated Financial Statements

5

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

30

 

Item 4.

Controls and Procedures

31

 

 

 

 

PART II.

OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

32

 

Item 1A.

Risk Factors

33

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33

 

Item 4.

Submission of Matters to a Vote of Security Holders

33

 

Item 6.

Exhibits

34

 

 

 

 

Signatures

 

35

Index to Exhibits

 

36

 




PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

 

July 4,
2006

 

January 3,
2006

 

 

 

 

 

(restated)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

20,599

 

$

31,052

 

Investments and marketable securities

 

87,259

 

63,222

 

Accounts receivable

 

6,117

 

8,108

 

Other receivables

 

20,602

 

26,390

 

Inventories

 

23,649

 

19,119

 

Prepaid expenses

 

14,827

 

14,583

 

Deferred income taxes

 

10,473

 

10,339

 

Total current assets

 

183,526

 

172,813

 

 

 

 

 

 

 

Property and equipment, net

 

645,498

 

609,918

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Marketable securities

 

42,585

 

83,700

 

Trademarks

 

2,897

 

2,730

 

Prepaid rent

 

43,219

 

38,673

 

Other

 

21,304

 

18,416

 

 

 

 

 

 

 

Total other assets

 

110,005

 

143,519

 

 

 

 

 

 

 

Total assets

 

$

939,029

 

$

926,250

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

28,648

 

$

32,150

 

Income taxes payable

 

11,218

 

6,015

 

Other accrued expenses

 

83,892

 

94,937

 

Total current liabilities

 

123,758

 

133,102

 

 

 

 

 

 

 

Deferred income taxes

 

69,969

 

73,375

 

Deferred rent

 

38,248

 

35,977

 

Deemed landlord financing liability

 

35,324

 

26,273

 

Other noncurrent liabilities

 

12,846

 

10,824

 

Commitments and contingencies (Note 7)

 

 

 

 

 

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, 150,000,000 shares authorized; 81,362,736 and 80,910,422 issued at July 4, 2006 and January 3, 2006, respectively

 

814

 

809

 

Additional paid-in capital

 

306,737

 

287,080

 

Retained earnings

 

433,235

 

390,516

 

Accumulated other comprehensive loss

 

(1,437

)

(1,235

)

Treasury stock, 3,627,217 and 2,078,617 shares at cost at July 4, 2006 and January 3, 2006, respectively

 

(80,465

)

(30,471

)

 

 

 

 

 

 

Total stockholders’ equity

 

658,884

 

646,699

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

939,029

 

$

926,250

 

 

See the accompanying notes to the consolidated financial statements.

1




THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

Thirteen
Weeks Ended
July 4, 2006

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

 

 

(restated)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

322,573

 

$

288,336

 

$

629,292

 

$

556,560

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

80,374

 

74,357

 

157,322

 

143,275

 

Labor expenses

 

102,236

 

89,859

 

201,663

 

172,955

 

Other operating costs and expenses

 

74,129

 

64,439

 

146,339

 

126,401

 

General and administrative expenses

 

16,769

 

12,624

 

32,506

 

24,499

 

Depreciation and amortization expenses

 

12,990

 

10,654

 

25,394

 

20,857

 

Preopening costs

 

3,250

 

2,127

 

7,547

 

6,520

 

 

 

 

 

 

 

Total costs and expenses

 

289,748

 

254,060

 

570,771

 

494,507

 

 

 

 

 

 

 

Income from operations

 

32,825

 

34,276

 

58,521

 

62,053

 

Interest income, net

 

977

 

928

 

2,501

 

1,724

 

Other income, net

 

147

 

149

 

1,801

 

286

 

 

 

 

 

 

 

Income before income taxes

 

33,949

 

35,353

 

62,823

 

64,063

 

Income tax provision

 

10,504

 

12,293

 

20,104

 

22,277

 

 

 

 

 

 

 

Net income

 

$

23,445

 

$

23,060

 

$

42,719

 

$

41,786

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.30

 

$

0.29

 

$

0.54

 

$

0.53

 

Diluted

 

$

0.30

 

$

0.29

 

$

0.53

 

$

0.52

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

78,221

 

78,211

 

78,570

 

78,108

 

Diluted

 

79,467

 

80,067

 

79,994

 

79,998

 

 

See the accompanying notes to the consolidated financial statements.

2




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
Loss

 

Treasury
Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 3, 2006, as restated

 

80,910

 

$

809

 

$

287,080

 

$

390,516

 

$

(1,235

)

$

(30,471

)

$

646,699

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

42,719

 

 

 

 

 

Unrealized loss on available-for-sale securities

 

 

 

 

 

(202

)

 

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

42,517

 

Issuance of common stock from stock option exercises

 

453

 

5

 

7,089

 

 

 

 

7,094

 

Tax benefit related to stock options exercised

 

 

 

3,098

 

 

 

 

3,098

 

Stock-based compensation

 

 

 

9,470

 

 

 

 

9,470

 

Purchase of treasury stock

 

 

 

 

 

 

(49,994

)

(49,994

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, July 4, 2006

 

81,363

 

$

814

 

$

306,737

 

$

433,235

 

$

(1,437

)

$

(80,465

)

$

658,884

 

 

See the accompanying notes to the consolidated financial statements.

3




THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

42,719

 

$

41,786

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

25,394

 

20,857

 

Loss on sale of available-for-sale securities

 

6

 

11

 

Gain on asset sale

 

(1

)

¾

 

Deferred income taxes

 

(3,419

)

(136

)

Stock-based compensation

 

9,470

 

434

 

Tax benefit related to stock options exercised

 

3,098

 

4,512

 

Excess tax benefit related to stock options exercised

 

(1,730

)

¾

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

1,991

 

3,015

 

Other receivables

 

5,788

 

3,814

 

Inventories

 

(4,530

)

(6,760

)

Prepaid expenses

 

(244

)

519

 

Other

 

(7,724

)

(3,924

)

Accounts payable

 

(3,502

)

(6,905

)

Income taxes payable

 

5,203

 

7,541

 

Other accrued expenses

 

(6,877

)

9,369

 

Cash provided by operating activities

 

65,642

 

74,133

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Additions to property and equipment

 

(61,879

)

(59,118

)

Investments in available-for-sale securities

 

(49,843

)

(37,801

)

Sales of available-for-sale securities

 

66,594

 

25,027

 

Cash used in investing activities

 

(45,128

)

(71,892

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Deemed landlord financing proceeds

 

10,522

 

5,041

 

Deemed landlord financing payments

 

(319

)

(140

)

Proceeds from exercise of employee stock options

 

7,094

 

7,171

 

Purchase of treasury stock

 

(49,994

)

(3,986

)

Excess tax benefit related to stock options exercised

 

1,730

 

¾

 

Cash provided by financing activities

 

(30,967

)

8,086

 

Net change in cash and cash equivalents

 

(10,453

)

10,327

 

Cash and cash equivalents at beginning of period

 

31,052

 

14,041

 

Cash and cash equivalents at end of period

 

$

20,599

 

$

24,368

 

 

 

 

 

 

 

Supplemental disclosures:

 

 

 

 

 

Interest paid

 

$

835

 

$

368

 

Income taxes paid

 

$

15,313

 

$

10,214

 

 

See the accompanying notes to the consolidated financial statements.

4




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” or in the first person notations “we,” “us” and “our”) and its wholly owned subsidiaries prepared in accordance with generally accepted accounting principles 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 a 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 consolidated balance sheet data presented herein for January 3, 2006 was derived from our audited consolidated financial statements for the fiscal year then ended, but does not include all disclosures required by generally accepted accounting principles.  The preparation of financial statements in accordance with generally accepted accounting principles 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.  Actual amounts could differ from these estimates.

Certain information and footnote disclosures normally included in financial statements in accordance with generally accepted accounting principles have been omitted pursuant to the rules of the Securities and Exchange Commission.  The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K/A for the fiscal year ended January 3, 2006.

Reclassification

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.  On the Consolidated Balance Sheets, our restaurant smallware balance, previously included in inventories, was moved to property and equipment.

Restatement of Financial Statements due to Review of Stock Option Grants and Procedures

On July 18, 2006, we announced that the Audit Committee of our Board of Directors, which is comprised solely of independent directors, was reviewing the Company’s practices relating to its stock option grants with the assistance of special outside legal counsel from the law firm of Cooley Godward Kronish LLP. This voluntary review was initiated in response to media and Wall Street reports regarding the option granting practices at numerous publicly traded companies.

On November 20, 2006, we announced the conclusion of the Audit Committee’s review, which covered the period beginning with the Company’s initial public offering registration in 1992 to the present.  The Audit Committee reported that its special counsel received full cooperation from Company management, was given complete access to all necessary and relevant electronic and other documents, and interviewed all persons involved in the stock option granting process at the Company, as well as the Company’s advisors.

Based upon the Audit Committee’s findings, we concluded that we selected the grant date of options based upon the lowest price, generally within a 30-day window because we incorrectly believed that the applicable accounting guidance allowed us to establish the grant date within a certain window from authorization.  As a result, we incorrectly applied the measurement date, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” with respect to certain option grants made to executive officers in fiscal years 1997 through 2001, to non-executive officers and other employees in fiscal years 1997 through 2004, and to outside directors in fiscal years 2000 and 2001.  Because we incorrectly selected grant dates which resulted in a cumulative adjustment of $5.4 million expense on an after-tax basis through fiscal 2005, we amended our Annual Report on Form 10-K for the fiscal year ended January 3, 2006 to restate the Consolidated Balance Sheets at January 3, 2006 and December 28, 2004 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the years ended January 3, 2006, December 28, 2004 and December 30, 2003.  We also restated the Consolidated Balance Sheet at April 4, 2006 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the quarterly periods ended April 4, 2006 and March 29, 2005.  These restated financial statements are included in the Quarterly Report on Form 10-Q/A for the quarter ended April 4, 2006.  Throughout this Form 10-Q, all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts on a restated basis. 

5




Correction of Other Matters

As part of the restatement process resulting from the review of our stock option granting practices, we assessed generally whether there were other matters, which should be corrected in our previously issued financial statements.  We concluded that three additional errors should be corrected.

·                  We recognize a liability upon the sale of a gift card and recognize revenue when the gift card is redeemed in our restaurants or on our website.  Beginning in 2001, we adjusted the gift card liability upon the sale of a gift card for the estimated portion of the gift card value that would not be redeemed (“breakage”).  We have now determined that the appropriate accounting is to record breakage ratably over the estimated time period that our gift cards are generally redeemed and that no breakage should be recognized until there is sufficient history to establish the estimated redemption period. As a result, we are restating the periods 2001 through the second quarter of 2005 to reverse breakage that was previously recognized since we did not have sufficient data to estimate the redemption periods.  For the third and fourth quarters of 2005, we are restating to recognize breakage both cumulatively and prospectively over a thirty-six month period based on an ability to estimate breakage due to a full cycle of redemptions being tracked since 2002.  As part of this restatement, we are also correcting our classification of breakage income.  The adjustment to the gift card liability account for breakage was previously classified as a reduction of general and administrative expenses in our consolidated statements of operations.  As part of this restatement, we are reclassifying gift card breakage to revenue.  The impact of these breakage related adjustments was an understatement of net income by $1.1 million in fiscal 2005 and an overstatement of net income by $0.4 million and $0.7 million in fiscal 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.7 million and $3.4 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  We previously recorded expense for our operations bonuses on a one-quarter lag. While our Consolidated Statements of Operations reflected four quarters of bonus-related expense, our Consolidated Balance Sheet did not reflect the accrued bonus liability for the most recent quarter.   The impact of this error was an overstatement of net income by $0.2 million, $0.1 million and $0.2 million in fiscal 2005, 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.6 million and $1.3 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  Historically, we did not amortize the cost of liquor licenses as we had considered them indefinite-lived assets.  We have now concluded that certain liquor licenses are not transferable and therefore have finite lives corresponding with the terms of the related operating lease. These non-transferable liquor licenses are now amortized over the primary lease terms of the respective leases plus any exercised extensions of those lease terms. The impact of this error was an overstatement of net income by $27,000, $25,000 and $22,000 in fiscal 2005, 2004 and 2003, respectively, and an overstatement of other assets of $0.2 million at both January 3, 2006 and December 28, 2004.  Net income for the first quarter of fiscal 2006 was overstated by $8,000.

The aggregate adjustments increased net income by $0.4 million in fiscal year 2005 and reduced net income by $1.2 million and $1.6 million in fiscal years 2004 and 2003, respectively.  Net income for the first quarter of fiscal 2006 increased by $6,000.  Diluted net income per share increased by $0.01 for the year ended January 3, 2006 and decreased by $0.02 and $0.03 for the years ended December 28, 2004 and December 30, 2003, respectively, and was unchanged for the first quarter of fiscal 2006.  The restatement also resulted in a $5.2 million, or 2.8%, reduction in retained earnings as of December 31, 2002. The restatement adjustments were non-cash and had no impact on net cash flow.

6




The following table reflects the impact of the restatements on the Consolidated Statements of Operations (in thousands, except per share data):

 

Thirteen Weeks
Ended
June 28, 2005

 

Thirteen Weeks
Ended
June 28, 2005

 

Twenty-Six Weeks
Ended
June 28, 2005

 

Twenty-Six Weeks
Ended
June 28, 2005

 

 

 

(as previously
reported)

 

(restated)

 

(as previously
reported)

 

(restated)

 

Selected Statement of Operations Data:

 

 

 

 

 

 

 

 

 

Revenues

 

$

288,336

 

$

288,336

 

$

556,560

 

$

556,560

 

Labor expenses

 

89,775

 

89,859

 

172,794

 

172,955

 

Other operating costs and expenses

 

64,459

 

64,439

 

126,406

 

126,401

 

General and administrative expenses

 

12,350

 

12,624

 

23,959

 

24,499

 

Depreciation and amortization expenses

 

10,643

 

10,654

 

20,836

 

20,857

 

Total costs and expenses

 

253,711

 

254,060

 

493,790

 

494,507

 

Income from operations

 

34,625

 

34,276

 

62,770

 

62,053

 

Income before income taxes

 

35,702

 

35,353

 

64,780

 

64,063

 

Income tax provision

 

12,424

 

12,293

 

22,543

 

22,277

 

Net income

 

23,278

 

23,060

 

42,237

 

41,786

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.30

 

$

0.29

 

$

0.54

 

$

0.53

 

Diluted

 

$

0.29

 

$

0.29

 

$

0.53

 

$

0.52

 

 

The following table reflects the impact of the restatement on the Consolidated Statements of Cash Flows (in thousands):

 

Twenty-Six Weeks
Ended
June 28, 2005

 

Twenty-Six Weeks
Ended
June 28, 2005

 

 

 

(as previously
reported)

 

(restated)

 

Selected Cash Flow Data:

 

 

 

 

 

Net income

 

$

42,237

 

$

41,786

 

Depreciation and amortization

 

20,836

 

20,857

 

Deferred income tax

 

39

 

(136

)

Stock-based compensation

 

 

434

 

Tax benefit related to stock options exercised

 

4,596

 

4,512

 

Income taxes payable

 

7,548

 

7,541

 

Other accrued expenses

 

9,107

 

9,369

 

Cash provided by operating activities

 

74,133

 

74,133

 

 

There was no impact to the subtotals for the operating, investing or financing sections of the consolidated statements of cash flows, because all adjustments occurred within the operating activities component.

 

Stock-Based Compensation

Prior to the January 4, 2006 adoption of Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment” (“SFAS 123R”), we accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  Historically, no compensation expense was recognized for Company-issued stock options.  As permitted by SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements.

However, as further discussed above, the Audit Committee of our Board of Directors initiated earlier this year a voluntary review of our stock option granting practices from 1992 to the present.  The review encompassed all grants made under our various stock option plans in effect during this period.  Based on the results of this review, we restated our historical accounting to correct the application of the measurement date, as defined in APB Opinion No. 25, for certain grants of stock options to directors, officers and employees, resulting from administrative oversight and the date selection methods used by the Company.  The restatement adjustments were non-cash and had no impact on revenues or net cash flow.

7




Effective January 4, 2006, we adopted SFAS 123R using the modified prospective transition method and, as a result, did not retroactively adjust results from prior periods. Under this transition method, stock-based compensation was recognized for: 1) expense related to the remaining unvested portion of all stock option awards granted prior to January 4, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and 2) expense related to all stock option awards granted on or subsequent to January 4, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  We apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees, which is then amortized on a straight-line basis over the requisite service period.  See Note 4 of the Notes to Consolidated Financial Statements in this Form 10-Q for further discussion of stock-based compensation.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements.  The Statement applies whenever other statements require or permit assets or liabilities to be measured at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  This Statement requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income to report the funded status of defined benefit pension and other postretirement benefit plans.  The Statement requires prospective application, and the recognition and disclosure requirements are effective for companies with fiscal years ending after December 15, 2006.  Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date.  This requirement is effective for fiscal years ending after December 15, 2008.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance regarding the consideration given to prior year misstatements when determining materiality in current year financial statements.  SAB No. 108 is effective for fiscal years ending after November 15, 2006.  We do not expect SAB No. 108 to have any impact on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes.”  This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, on a tax return.  This Interpretation also provides guidance on derecognition, classification, interest, penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with this Interpretation will be a two-step process.  The first step will determine if it is more likely than not that a tax position will be sustained upon examination and should therefore be recognized.  The second step will measure a tax position that meets the more likely than not recognition threshold to determine the amount of benefit to recognize in the financial statements.  This Interpretation is effective for fiscal years beginning after December 15, 2006.  We are currently evaluating the impact this Interpretation will have on our consolidated financial statements.

In March 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).”   A consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis.  If taxes are significant, an entity should disclose its policy of presenting taxes and the amounts of taxes. The guidance is effective for periods beginning after December 15, 2006. We present company sales net of sales taxes. This issue will not impact the method for presenting these sales taxes in our consolidated financial statements.

8




In November 2005, the FASB issued Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” (“FSP 115-1”) which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is required to be applied to reporting periods beginning after December 15, 2005.  We adopted FSP 115-1 on January 4, 2006 and included the required disclosures in Note 2 of Notes to the Consolidated Financial Statements in this Form 10-Q.  There was no impact to our consolidated financial statements as the result of our adoption of FSP 115-1.

In October 2005, the FASB issued Staff Position FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period,” which requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense.  This Staff Position is effective for reporting periods beginning after December 15, 2005, and retrospective application is permitted but not required. We adopted FAS 13-1 on January 4, 2006 on a prospective basis.  Prior to adoption, we capitalized rent incurred during the tenant improvement construction phase, which averaged approximately $45,000 per new restaurant opened during fiscal 2005.

2. Investments and Marketable Securities

Investments and marketable securities, consisted of in thousands:

Classification

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

At July 4, 2006:

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

22,946

 

$

¾

 

$

(143

)

$

22,803

 

July 2006 to April 2007

 

U.S. government agency obligations

 

65,245

 

¾

 

(789

)

64,456

 

July 2006 to March 2007

 

Total

 

$

88,191

 

$

¾

 

$

(932

)

$

87,259

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

16,783

 

$

¾

 

$

(383

)

$

16,400

 

August 2007 to January 2011

 

U.S. government agency obligations

 

27,077

 

¾

 

(892

)

26,185

 

August 2007 to September 2010

 

Total

 

$

43,860

 

$

¾

 

$

(1,275

)

$

42,585

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At January 3, 2006:

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

29,922

 

$

2

 

$

(222

)

$

29,702

 

January 2006 to December 2006

 

U.S. government agency obligations

 

33,738

 

1

 

(219

)

33,520

 

February 2006 to November 2006

 

Total

 

$

63,660

 

$

3

 

$

(441

)

$

63,222

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

27,861

 

$

11

 

$

(291

)

$

27,581

 

January 2007 to May 2010

 

U.S. government agency obligations

 

57,286

 

17

 

(1,184

)

56,119

 

January 2007 to September 2010

 

Total

 

$

85,147

 

$

28

 

$

(1,475

)

$

83,700

 

 

 

 

9




The following tables present the length of time available-for-sale securities were in continuous unrealized loss positions, but were not deemed to be other-than-temporarily impaired (in thousands):

 

Less Than 12 Months

 

Greater Than or Equal to 12
Months

 

 

 

Gross
Unrealized
Holding
Losses

 

Fair Value

 

Gross
Unrealized
Holding
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

At July 4, 2006:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

(185

)

$

19,477

 

$

(341

)

$

19,726

 

 

 

 

 

 

 

 

 

 

 

U.S. government agency obligations

 

(458

)

36,638

 

(1,223

)

54,003

 

Total

 

$

(643

)

$

56,115

 

$

(1,564

)

$

73,729

 

 

 

 

 

 

 

 

 

 

 

At January 3, 2006:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

(131

)

$

13,582

 

$

(382

)

$

29,019

 

 

 

 

 

 

 

 

 

 

 

U.S. government agency obligations

 

(120

)

25,007

 

(1,283

)

56,229

 

Total

 

$

(251

)

$

38,589

 

$

(1,665

)

$

85,248

 

 

Gross unrealized holding losses of $0.6 million for less than twelve months and $1.6 million for greater than or equal to twelve months as of July 4, 2006, pertain to 42 and 48 fixed income securities, respectively, and were primarily caused by interest rate increases.  Since we have the ability and intent to hold these securities until a recovery of fair value, which may be at maturity, and because the unrealized losses were primarily due to higher interest rates, we do not consider these securities to be other-than-temporarily impaired.  In addition, the U.S. government agency obligations are rated “AAA,” and the contractual terms of these securities do not permit the issuer to settle at a price less than the par value of the investment, which is the equivalent of the amount due at maturity.

There were no realized losses recorded for other than temporary impairments during fiscal 2005, nor the first two quarters of fiscal 2006.

3.  Inventories

Inventories consisted of (in thousands):

 

July 4, 2006

 

January 3, 2006

 

 

 

 

 

 

 

Restaurant food and supplies

 

$

9,639

 

$

9,026

 

Bakery finished goods

 

10,805

 

7,836

 

Bakery raw materials

 

3,205

 

2,257

 

Total

 

$

23,649

 

$

19,119

 

 

4.  Stock-Based Compensation

We maintain performance incentive plans under which incentive stock options, non-qualified stock options, stock appreciation rights, restricted shares, deferred shares, performance shares and performance units may be granted to employees, consultants and non-employee directors.  To date, we have only granted non-qualified stock options under these plans.  Stock options generally vest at 20% per year, expire ten years from the date of grant, and become exercisable provided that we meet or exceed certain performance criteria approved by our Board of Directors.

Historically, no compensation expense was recognized for Company-issued stock options.  As permitted by SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements.

10




However, as further discussed in Note 1, earlier this year, the Audit Committee of our Board of Directors initiated a voluntary review of our stock option granting practices from 1992 to the present.  The review encompassed all grants made under our various stock option plans in effect during this period.  Based on the results of this review, we restated our historical accounting to correct the application of the measurement date, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” for certain grants of stock options to directors, officers and employees, resulting from administrative oversight and the date selection methods used by the Company.  The restatement adjustments were non-cash and had no impact on net cash flow.

Effective January 4, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method, and as a result, did not retroactively adjust results from prior periods.  Under this transition method, stock-based compensation was recognized for: 1) expense related to the remaining unvested portion of all stock option awards granted prior to January 4, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and 2) expense related to all stock option awards granted on or subsequent to January 4, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  We apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees.  The resulting compensation expense is recognized over the requisite service period, which is generally the option vesting term of five years.  Prior to fiscal 2006, stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements as permitted by SFAS 123.

Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on our historical experience and future expectations.  Prior to the adoption of SFAS 123R, the effect of forfeitures on the pro forma expense amounts was recognized as the forfeitures occurred.

As a result of adopting SFAS 123R, the impact to the Consolidated Statement of Operations for the thirteen weeks ended July 4, 2006 on income before income taxes and net income was $4.2 million and $3.0 million, respectively, and $0.04 and $0.03 on basic and diluted earnings per share, respectively.  For the twenty-six weeks ended July 4, 2006, the impact of stock-based compensation expense on income before income taxes and net income was $8.8 million and $6.0 million, respectively, and $0.08 on both basic and diluted earnings per share.  Capitalized stock-based compensation for the thirteen and twenty-six weeks ended July 4, 2006 was $0.3 million and $0.7 million, respectively, and was included in property and equipment, net and other assets on the Consolidated Balance Sheet.  In addition, prior to the adoption of SFAS 123R, we presented the tax benefit resulting from the exercise of stock options as operating cash inflows in the Consolidated Statements of Cash Flows.  Upon the adoption of SFAS 123R, the excess tax benefits for those options are classified as financing cash inflows.

The pro forma table below reflects net income and basic and diluted net income per share for the second quarter of fiscal 2005, had we applied the fair value recognition provisions of SFAS 123 (in thousands, except per share data):

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

(restated)

 

(restated)

 

Net income, as reported

 

$

23,060

 

$

41,786

 

Total stock-based compensation included in net income, as reported

 

138

 

265

 

Total stock-based compensation expense, net of taxes, under the fair value method

 

(2,743

)

(5,605

)

Net income, pro forma

 

$

20,455

 

$

36,446

 

 

 

 

 

 

 

Basic net income per share, as reported

 

$

0.29

 

$

0.53

 

Basic net income per share, pro forma

 

$

0.26

 

$

0.47

 

 

 

 

 

 

 

Diluted net income per share, as reported

 

$

0.29

 

$

0.52

 

Diluted net income per share, pro forma

 

$

0.26

 

$

0.46

 

 

Pro forma disclosure for fiscal 2006 is not presented because the amounts are recognized in the consolidated financial statements.

11




The weighted average fair value at the grant date for options issued during the second quarter of fiscal 2006 and 2005 was $10.58 and $13.79 per option, respectively.  For the first three quarters of fiscal 2005, we employed the binomial lattice option valuation model. Upon further review of the various valuation techniques and the relevance of our historical exercise patterns, we believe the Black-Scholes option pricing model is currently a better tool for estimating our stock-based compensation cost.  We utilized the Black-Scholes model beginning with the fourth quarter of fiscal 2005 and will employ it on a go-forward basis.  The fair value of options at date of grant was estimated using the following weighted average assumptions for the second quarter of fiscal 2006 and 2005, respectively: (a) no dividend yield on our stock, (b) expected stock price volatility of 31.4% and 33.1%, (c) a risk-free interest rate of 4.9% and a range of 3.5% to 4.7%, and (d) an expected option term of 4.75 years under the Black-Scholes model for the second quarter of 2006. Under the binomial lattice model for the second quarter of fiscal 2005, we used a termination rate of 0.6% and an exercise multiple of 1.35.

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior.  Expected stock price volatility is based on a combination of the historical volatility of our stock and the implied volatility of actively traded options on our common stock.  The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant with an equivalent remaining term. We have not paid dividends in the past and do not currently plan to pay dividends in the near future.

Stock option activity during the twenty-six weeks ended July 4, 2006 was as follows:

 


Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Term

 

Aggregate
Intrinsic
Value

 

 

 

(in thousands)

 

 

 

(in years)

 

(in thousands)

 

Outstanding at January 3, 2006

 

7,564

 

$

22.96

 

 

 

 

 

Granted

 

1,198

 

$

35.04

 

 

 

 

 

Exercised

 

(453

)

$

15.68

 

 

 

 

 

Cancelled

 

(108

)

$

28.81

 

 

 

 

 

Outstanding at July 4, 2006

 

8,201

 

$

25.01

 

7.1

 

$

36,552

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at July 4, 2006

 

7,917

 

$

24.83

 

7.0

 

$

36,215

 

 

 

 

 

 

 

 

 

 

 

Exercisable at July 4, 2006

 

2,564

 

$

18.31

 

5.3

 

$

24,278

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between our closing stock price on July 4, 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders exercised their options on July 4, 2006.  This amount changes based on the fair market value of our stock.  Total intrinsic value of options exercised for the thirteen and twenty-six weeks ended July 4, 2006 was $3.5 million and $8.2 million, respectively.  As of July 4, 2006, total unrecognized stock-based compensation expense related to nonvested stock options was $44 million, which is expected to be recognized over a weighted average period of approximately 2.8 years.  As of July 4, 2006 there were 8.7 million shares of common stock available for issuance pursuant to future stock option grants.

12




Additional information regarding options outstanding as of July 4, 2006 is as follows:

 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

 


Shares

 

Weighted
Average
Remaining
Contractual Life

 

Weighted
Average
Exercise
Price

 


Shares

 

Weighted
Average
Exercise
Price

 

 

 

(in thousands)

 

(in years)

 

 

 

(in thousands)

 

 

 

$  3.58 -  $18.61

 

1,473

 

3.9

 

$

11.71

 

1,243

 

$

10.80

 

$18.75 -  $21.81

 

1,399

 

6.5

 

$

20.29

 

423

 

$

20.24

 

$21.82 -  $26.68

 

1,380

 

6.6

 

$

23.49

 

305

 

$

22.48

 

$26.73 -  $29.45

 

1,430

 

7.8

 

$

28.88

 

395

 

$

29.33

 

$29.55 -  $34.78

 

1,373

 

8.7

 

$

32.24

 

168

 

$

32.28

 

$34.88 -  $38.24

 

1,146

 

9.5

 

$

36.17

 

30

 

$

36.87

 

$  3.58 -  $38.24

 

8,201

 

7.1

 

$

25.01

 

2,564

 

$

18.31

 

 

5.  Net Income Per Share

In accordance with the provisions of SFAS No. 128, “Earnings Per Share,” basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.  Diluted net income per share includes the dilutive effect of potential stock option exercises, calculated using the treasury stock method.  Outstanding stock options issued by us represent the only dilutive effect reflected in diluted weighted average shares outstanding.

(In thousands, except per share data)

 

Thirteen
Weeks Ended
July 4, 2006

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

 

 

(restated)

 

Net Income per Common Share–Basic:

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

78,221

 

78,211

 

78,570

 

78,108

 

Net income

 

$

23,445

 

$

23,060

 

$

42,719

 

$

41,786

 

Net income per share–basic

 

$

0.30

 

$

0.29

 

$

0.54

 

$

0.53

 

 

 

 

 

 

 

 

 

 

 

Net Income per Common Share–Diluted:

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

78,221

 

78,211

 

78,570

 

78,108

 

Effect of dilutive stock options

 

1,246

 

1,856

 

1,424

 

1,890

 

Weighted average shares outstanding–diluted

 

79,467

 

80,067

 

79,994

 

79,998

 

Net income

 

$

23,445

 

$

23,060

 

$

42,719

 

$

41,786

 

Net income per share–diluted

 

$

0.30

 

$

0.29

 

$

0.53

 

$

0.52

 

 

Shares of common stock equivalents of approximately 4.0 million and 3.6 million for the thirteen and twenty-six weeks ended July 4, 2006, respectively, were not included in the diluted calculation because they were anti-dilutive.

6.  Comprehensive Income

Comprehensive income consisted of (in thousands):

 

Thirteen
Weeks Ended
July 4, 2006

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

 

 

(restated)

 

Net income

 

$

23,445

 

$

23,060

 

$

42,719

 

$

41,786

 

Net unrealized gain (loss) on available-for-sale securities

 

72

 

607

 

(202

)

(78

)

Total

 

$

23,517

 

$

23,667

 

$

42,517

 

$

41,708

 

 

13




7. Commitments and Contingencies

On August 1, 2006, we received final approval by the Superior Court of the State of California of a negotiated settlement of consolidated class action wage and hour lawsuits originally filed in December 2002 by two former hourly restaurant employees in California alleging violations of California labor laws with respect to providing meal and rest breaks.  Notices of the settlement were sent to all class members, the claims period has expired, and the administration of claims has been completed.  A number of former and current employees also filed individual wage and hour claims, based upon alleged similar violations, directly with various offices of the California Division of Labor Standards Enforcement (“DLSE”). The DLSE claims filed by employees who joined the approved settlement also will be resolved by such settlement.

On February 22, 2006, a current employee filed a claim in the General Court of Justice - Superior Court Division, Durham County, North Carolina (Chandler v. The Cheesecake Factory Restaurants, Inc. et al.; Case No. 6CVS00724), alleging that the Company unlawfully failed to pay the named plaintiff and similarly situated tipped employees certain wages and tips in violation of the “tip pooling” provisions of the North Carolina wage and hour laws. The Plaintiff seeks class certification and recovery of back wages and liquidated damages under the North Carolina Wage and Hour Act.  It is the Company’s position that the Plaintiff and any other purported class members have been paid all wages and tips owed, the Company does not have any tip pooling arrangement, and the Company’s suggested tip-out guidelines, which are voluntary, comply with all federal, state and local laws.  The Company intends to vigorously defend this action.

On June 23 2006, three current restaurant management employees in Ohio filed a charge of discrimination with the U.S. Equal Employment Opportunity Commission (EEOC) against The Cheesecake Factory Restaurants, Inc. alleging violations of Title VII of the Civil Rights Act resulting from alleged sex discrimination in the Company’s promotion process. The claimants seek unspecified amounts of penalties and other monetary payments.  The Company is cooperating with the EEOC’s investigation of this matter.  The Company intends to vigorously defend against this matter.

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 the Company 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 others 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 for themselves.   Discovery is currently continuing in this matter.  The Company intends to vigorously defend its position.

Following our announcement on July 18, 2006 of the Audit Committee of our Board of Directors’ review of our historical stock option granting practices, a number of purported Company shareholders brought eight separate putative shareholder derivative actions (the “Options Derivative Actions”) against the Company, our entire Board of Directors, and certain of our current and former officers alleging that the defendants improperly dated certain historical stock option grants.  The plaintiffs in these cases, filed in Los Angeles County Superior Court and styled as Siebles v. Deitchle et al. (Case No. BC355872) (subsequently re-filed in federal court), McGee v. Overton et al. (Case No. BC355953); Rigotti v. Overton, et al. (Case No. BC356850), Cullen v. Overton, et al. (Case No. BC356851), Sachs v. Overton et al. (Case No. BC357065), and filed in United States District Court for the Central District and styled as Siebles v. Deitchle et.al. (Case No. CV06 6234), Kuhns v. Deitchle et al. (Case No. SACV06917) and Freed v. Overton et al. (Case No. CV 06 06486) contend, among other things, that the defendants’ conduct violated the California and/or federal securities laws, breached defendants’ fiduciary duties, wasted corporate assets, unjustly enriched the defendants, and caused errors in the Company’s financial statements.  The plaintiffs seek, among other things, unspecified damages and disgorgement of profits from the alleged conduct to be paid to the Company.  The plaintiffs also seek attorneys’ fees for themselves.  The Options Derivative Actions are in the preliminary stages of litigation. We intend to vigorously defend these actions.

We are subject to various legal proceedings that are discussed in our Annual Report on Form 10-K/A for the fiscal year ended January 3, 2006.

14




8.  Segment Information

We operate in two business segments – restaurants and bakery.  Restaurants include both The Cheesecake Factory and Grand Lux Cafe, which have similar investment criteria and economic and operating characteristics.  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, 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 4, 2006

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

 

 

(restated)

 

Revenue:

 

 

 

 

 

 

 

 

 

Restaurants

 

$

308,169

 

$

276,017

 

$

602,006

 

$

530,807

 

Bakery

 

24,357

 

21,265

 

46,703

 

43,589

 

Intercompany bakery sales

 

(9,953

)

(8,946

)

(19,417

)

(17,836

)

Total

 

$

322,573

 

$

288,336

 

$

629,292

 

$

556,560

 

 

 

 

 

 

 

 

 

 

 

Income from operations:

 

 

 

 

 

 

 

 

 

Restaurants

 

$

47,108

 

$

43,973

 

$

87,065

 

$

79,717

 

Bakery

 

3,805

 

2,783

 

6,843

 

6,665

 

Corporate

 

(18,088

)

(12,480

)

(35,387

)

(24,329

)

Total

 

$

32,825

 

$

34,276

 

$

58,521

 

$

62,053

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization:

 

 

 

 

 

 

 

 

 

Restaurants

 

$

11,584

 

$

9,440

 

$

22,759

 

$

18,469

 

Bakery

 

495

 

452

 

972

 

887

 

Corporate

 

911

 

762

 

1,663

 

1,501

 

Total

 

$

12,990

 

$

10,654

 

$

25,394

 

$

20,857

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures:

 

 

 

 

 

 

 

 

 

Restaurants

 

$

26,419

 

$

31,626

 

$

53,105

 

$

50,430

 

Bakery

 

1,967

 

2,433

 

6,608

 

3,124

 

Corporate

 

1,096

 

3,920

 

2,166

 

5,564

 

Total

 

$

29,482

 

$

37,979

 

$

61,879

 

$

59,118

 

 

 

July 4,
2006

 

January 3,
2006

 

 

 

 

 

(restated)

 

Total assets:

 

 

 

 

 

Restaurants

 

$

649,472

 

$

619,814

 

Bakery

 

53,404

 

44,305

 

Corporate

 

236,153

 

262,131

 

Total

 

$

939,029

 

$

926,250

 

 

15




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 Securities and Exchange Commission, in press releases and other written communications and in oral or written statements made by or with the approval of one of our authorized officers, may contain forward-looking statements about our current and expected performance trends, growth plans, business goals and other matters.  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 Securities Exchange Act of 1934, as amended from time to time (the “Act”).

In connection with the “safe harbor” provisions of the Act, we have identified and filed 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 I, Item 1A, “Risk Factors” included in our Form 10-K/A for the fiscal year ended January 3, 2006). 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 Securities and Exchange Commission. 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. 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.

Restatement of Financial Statements due to Review of Stock Option Grants and Procedures

On July 18, 2006, we announced that the Audit Committee of our Board of Directors, which is comprised solely of independent directors, was reviewing the Company’s practices relating to its stock option grants with the assistance of special outside legal counsel from the law firm of Cooley Godward Kronish LLP. This voluntary review was initiated in response to media and Wall Street reports regarding the option granting practices at numerous publicly traded companies.

On November 20, 2006, we announced the conclusion of the Audit Committee’s review, which covered the period beginning with the Company’s initial public offering registration in 1992 to the present.  The Audit Committee reported that its special counsel received full cooperation from Company management, was given complete access to all necessary and relevant electronic and other documents, and interviewed all persons involved in the stock option granting process at the Company, as well as the Company’s advisors.

While the review resulted in a conclusion that until 2002, and in some cases after, we incorrectly followed date selection methodologies that were generally limited to 30-day time windows, the Audit Committee found no evidence that any person acted with an intent to deceive or mislead, and did not recommend termination of any current Company management or the resignation of any member of our Board of Directors.  However, the Audit Committee did recommend, among other matters, that we obtain reimbursement from the Company’s Chief Executive Officer and former Chief Financial Officer, who had oversight responsibility for the stock option granting process, as well as from those members of the Compensation Committee of our Board of Directors who received misdated options, in an amount equal to the difference between the stock option proceeds received and the proceeds that would have been received had the proper measurement dates been used, and that any unexercised stock option grants be treated in the same manner.  We will seek reimbursement totaling approximately $1 million from these individuals. All of the affected individuals have indicated that they intend to comply with the Audit Committee’s recommendation.

16




In addition, the Audit Committee recommended that we implement the following Corporate Governance enhancements, all of which we are adopting:

·                  Increase the size of the Board of Directors by at least one additional member (preferably two additional members);

·                  Create a position of Chief Compliance Officer;

·                  Implement more robust stock option granting practices, including approval of all equity-related compensation by the Compensation Committee of the Board of Directors only on regularly scheduled review dates;

·                  Implement tighter controls over the use of unanimous written consents;

·                  Revise the Board of Directors’ compensation arrangements to provide competitive compensation with less emphasis on equity compensation and an automatic mechanism for stock option grants; and

·                  Evaluate the legal department’s resources.

Based upon the Audit Committee’s findings, we concluded that we selected the grant date of options based upon the lowest price, generally within a 30-day window because we incorrectly believed that the applicable accounting guidance allowed us to establish the grant date within a certain window from authorization.  As a result, we incorrectly applied the measurement date, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” with respect to certain option grants made to executive officers in fiscal years 1997 through 2001, to non-executive officers and other employees in fiscal years 1997 through 2004, and to outside directors in fiscal years 2000 and 2001.  Because we incorrectly selected grant dates which resulted in a cumulative adjustment of $5.4 million expense on an after-tax basis through fiscal 2005, we amended our Annual Report on Form 10-K for the fiscal year ended January 3, 2006 to restate the Consolidated Balance Sheets at January 3, 2006 and December 28, 2004 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the years ended January 3, 2006, December 28, 2004 and December 30, 2003.  We also restated the Consolidated Balance Sheet at April 4, 2006 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the quarterly periods ended April 4, 2006 and March 29, 2005.  These restated financial statements are included in the Quarterly Report on Form 10-Q/A for the quarter ended April 4, 2006.  Throughout this Form 10-Q, all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts on a restated basis.  We did not amend and do not intend to amend any other previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods prior to January 1, 2003.

We are considering the application of Section 409A of the Internal Revenue Code to those options for which we incorrectly applied the measurement date as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”  It is possible that these options will not be treated as having been granted at fair market value for federal income tax purposes and thus subject to Section 409A.  Accordingly, we may adopt remedial measures to address the application of Section 409A.  We do not currently know what impact of any remedial measures, if adopted, would have on our results of operations, financial position or cash flows.

Administrative Proceedings and Pending Litigation Related to Options Misdating

Following our announcement of the Audit Committee’s review of our historical stock option granting practices, we received an informal request for information from the staff of the Los Angeles regional office of the Securities and Exchange Commission (SEC) regarding our stock option granting practices.  We are cooperating fully with the SEC in connection with its informal inquiry.  We do not know when this inquiry will be resolved or what, if any, actions the SEC may take as a result of this inquiry.  Response to this inquiry could require expenditure of significant financial resources and an unfavorable outcome could require us to pay damages or penalties, or result in other remedies imposed upon us, any of which could have a material adverse affect our business, results of operations, financial position and cash flows.

In addition, we and certain of our directors and current and former officers are defendants in eight shareholder derivative actions relating to our stock option granting practices. These actions are in preliminary stages and we cannot provide assurance that their ultimate outcome will not have a material adverse effect on our business, financial condition, results of operations or cash flows.

17




 

On August 17, 2006, we received an initial staff determination letter from The Nasdaq Stock Market indicating that we are not in compliance with the filing requirements for continued listing under Marketplace Rule 4310(c)(14) due to the delayed filing of our Quarterly Report on Form 10-Q for the quarter ended April 4, 2006.  We filed a notice of appeal of the staff determination and a hearing was held on September 27, 2006.  No decision has been rendered to date.  On November 15, 2006, we received an additional staff determination letter stating that our failure to file our Quarterly Report on Form 10-Q for the quarter ended October 3, 2006 is an additional basis for delisting.  Until a decision is made by the Nasdaq Listing Qualifications Panel, the Company’s common stock will remain listed on The Nasdaq Global Select Market.  There can be no assurance that the Panel will grant the Company’s request for continued listing.

Correction of Other Matters

As part of the restatement process resulting from the review of our stock option granting practices, we assessed generally whether there were other matters, which should be corrected in our previously issued financial statements.  We concluded that three additional errors should be corrected.

·                  We recognize a liability upon the sale of a gift card and recognize revenue when the gift card is redeemed in our restaurants or on our website.  Beginning in 2001, we adjusted the gift card liability upon the sale of a gift card for the estimated portion of the gift card value that would not be redeemed (“breakage”).  We have now determined that the appropriate accounting is to record breakage ratably over the estimated time period that our gift cards are generally redeemed and that no breakage should be recognized until there is sufficient history to establish the estimated redemption period. As a result, we are restating the periods 2001 through the second quarter of 2005 to reverse breakage that was previously recognized since we did not have sufficient data to estimate the redemption periods.  For the third and fourth quarters of 2005, we are restating to recognize breakage both cumulatively and prospectively over a thirty-six month period based on an ability to estimate breakage due to a full cycle of redemptions being tracked since 2002.  As part of this restatement, we are also correcting our classification of breakage income.  The adjustment to the gift card liability account for breakage was previously classified as a reduction of general and administrative expenses in our consolidated statements of operations.  As part of this restatement, we are reclassifying gift card breakage to revenue.  The impact of these breakage related adjustments was an understatement of net income by $1.1 million in fiscal 2005 and an overstatement of net income by $0.4 million and $0.7 million in fiscal 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.7 million and $3.4 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  We previously recorded expense for our operations bonuses on a one-quarter lag. While our Consolidated Statement of Operations reflected four quarters of bonus-related expense, our Consolidated Balance Sheet did not reflect the accrued bonus liability for the most recent quarter.   The impact of this error was an overstatement of net income by $0.2 million, $0.1 million and $0.2 million in fiscal 2005, 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.6 million and $1.3 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  Historically we did not amortize the cost of liquor licenses as we had considered them indefinite-lived assets.  We have now concluded that certain liquor licenses are not transferable and therefore have finite lives corresponding with the terms of the related operating lease. These non-transferable liquor licenses are now amortized over the primary lease terms of the respective leases plus any exercised extensions of those lease terms. The impact of this error was an overstatement of net income by $27,000, $25,000 and $22,000 in fiscal 2005, 2004 and 2003, respectively, and an overstatement of other assets of $0.2 million at both January 3, 2006 and December 28, 2004.  Net income for the first quarter of fiscal 2006 was overstated by $8,000.

The aggregate adjustments increased net income by $0.4 million in fiscal year 2005 and reduced net income by $1.2 million and $1.6 million in fiscal years 2004 and 2003, respectively.  Net income for the first quarter of fiscal 2006 increased by $6,000.  Diluted net income per share increased by $0.01 for the year ended January 3, 2006 and decreased by $0.02 and $0.03 for the years ended December 28, 2004 and December 30, 2003, respectively, and was unchanged for the first quarter of fiscal 2006.  The restatement also resulted in a $5.2 million, or 2.8%, reduction in retained earnings as of December 31, 2002.  The restatement adjustments were non-cash and had no impact on net cash flow.

18




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 Form 10-K/A for the fiscal year ended January 3, 2006.  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.

Refer to Part II, Item 1A, “Risk Factors” of this report and Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K/A for the fiscal year ended January 3, 2006 filed with the Securities and Exchange Commission for a description of risk factors that could materially affect our business, financial condition or future results.

As of December 1, 2006, we operated 118 upscale, high-volume, casual dining restaurants under The Cheesecake Factoryâ mark.  We also operated eight upscale, casual dining restaurants under the Grand Lux Cafeâ mark; one self-service, limited menu “express” foodservice operation under The Cheesecake Factory Expressâ mark inside the DisneyQuestâ family entertainment center in Orlando, Florida; and two bakery production facilities.  We also licensed two limited menu bakery cafes under The Cheesecake Factory Bakery Cafeâ mark to another foodservice operator.

Our revenues consist of sales from our restaurant operations and sales from our bakery operations to other foodservice operators, retailers and distributors (“bakery sales”).  Revenues from restaurant sales are recognized when payment is tendered at the point of sale.  Revenues from bakery sales to other foodservice operators, retailers and distributors are recognized upon transfer of title to customers.  We recognize a liability upon the sale of our gift cards and recognize revenue when these gift cards are redeemed in our restaurants or on our website. We adjust our gift card liability based on historical and expected non-redemption trends.  These adjustments are classified as revenues in our consolidated statement of operations.

New restaurants become eligible to enter our comparable sales calculations in their 19th month of operation.  We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31st for financial reporting purposes. Fiscal 2006 will consist of 52 weeks and will end on January 2, 2007.  Fiscal 2005 consisted of 53 weeks and ended on January 3, 2006.

The Cheesecake Factory is an upscale, casual dining concept that offers approximately 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 is also an upscale, casual dining concept offering approximately 150 menu items.  In contrast to many chain restaurant operations, substantially all of our menu items (except desserts manufactured at our bakery production facility) 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 exceptional 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 often 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 raw materials, labor and energy; purchasing power; and governmental regulations.  Accordingly, as part of our strategy we must constantly evolve and refine the critical elements of our restaurant concepts to protect their longer-term competitiveness and to maintain and enhance the strength of our brand.  Our strategy is to continue to provide guests with exceptional value through a broad menu of freshly prepared, high quality and large portion appetizers, entrees and desserts at moderate prices in an upscale, casual setting.  Operationally, we strive to improve productivity and efficiency through the use of technology and a commitment to selecting, training and retaining high quality employees.

19




 

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

·                  New Restaurant Openings.  We intend to continue developing The Cheesecake Factory and Grand Lux restaurants in high profile locations within densely populated areas in both existing and new markets.  Since most of our established restaurants currently operate close to full capacity during the peak demand periods of lunch and dinner, and given our relatively high average sales per productive square foot, we generally do not expect to achieve increases in comparable sales other than our effective menu price increases.  Therefore, we expect that the majority of our year-over-year revenue growth will come from new restaurant openings.  We have opened new restaurants at a compounded annual growth rate of approximately 26% in the 13 years that we have been a public company.  Based on our review of demographic market data in the U.S. today, we estimate that there is an opportunity to open as many as 200 Cheesecake Factory restaurants and as many as 150 Grand Lux Cafes in the U.S.  In fiscal 2005, we opened 18 new restaurants, including one Grand Lux Cafe.  In fiscal 2006, we expect to open as many as 21 new restaurants, including one Grand Lux Cafe.

·                  General and Administrative Expenses Expressed as a Percentage of Revenues.   Leveraging our restaurant and bakery support infrastructure will allow us to grow general and administrative expenses at a slightly slower rate than revenue growth over the longer-term.  During fiscal 2006, we plan to continue to add resources to the corporate support, training and field supervision activities of our business, in conjunction with the planned openings of as many as 21 new restaurants during the year.

·                  Income from Operations Expressed as a Percentage of Revenues (“Operating Margins”).  Operating margins are subject to fluctuations in commodity costs, labor, other operating costs, such as restaurant-level occupancy expenses, and preopening expenses.  Our objective is to gradually increase our operating margin to 12% on a sustained basis, before the impact of stock option expensing, by continuing our focus on superior guest service and by capturing economies of scale and fixed cost leverage, as well as maximizing our purchasing power as we continue to grow our business.

20




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.  The thirteen and twenty-six weeks ended July 4, 2006 included $4.2 million, or 1.3% of revenues, and $8.8 million, or 1.4% of revenues, respectively, of stock-based compensation expense related to our fiscal 2006 adoption of SFAS 123R.  This amount impacted labor expenses and general and administrative expenses by 0.5% and 0.8%, respectively, for both the thirteen and twenty-six weeks ended July 4, 2006.  Other operating costs and expenses and preopening costs were impacted by less than 0.1% and 0.1 % on a combined basis for the thirteen and twenty-six weeks ended July 4, 2006, respectively.

 

Thirteen
Weeks Ended
July 4, 2006

 

Thirteen
Weeks Ended
June 28, 2005

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

(restated)

 

 

 

(restated)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

24.9

 

25.8

 

25.0

 

25.7

 

Labor expenses

 

31.7

 

31.2

 

32.0

 

31.1

 

Other operating costs and expenses

 

23.0

 

22.3

 

23.3

 

22.7

 

General and administrative expenses

 

5.2

 

4.4

 

5.2

 

4.4

 

Depreciation and amortization expenses

 

4.0

 

3.7

 

4.0

 

3.8

 

Preopening costs

 

1.0

 

0.7

 

1.2

 

1.2

 

Total costs and expenses

 

89.8

 

88.1

 

90.7

 

88.9

 

 

 

 

 

 

 

Income from operations

 

10.2

 

11.9

 

9.3

 

11.1

 

Interest income, net

 

0.3

 

0.3

 

0.4

 

0.3

 

Other income, net

 

0.0

 

0.1

 

0.3

 

0.1

 

Income before income taxes

 

10.5

 

12.3

 

10.0

 

11.5

 

Income tax provision

 

3.2

 

4.3

 

3.2

 

4.0

 

Net income

 

7.3

%

8.0

%

6.8

%

7.5

%

 

Thirteen Weeks Ended July 4, 2006 Compared to Thirteen Weeks Ended June 28, 2005

Revenues

Revenues increased 12% to $322.6 million for the thirteen weeks ended July 4, 2006 compared to $288.3 million for the thirteen weeks ended June 28, 2005.

Restaurant sales increased 12% to $308.2 million compared to $276.0 million for the same period of the prior year.  The resulting sales increase of $32.2 million consisted of a $2.0 million, or a 0.8%, decrease in comparable restaurant sales and $34.2 million increase from restaurants not in the comparable sales base.  The decrease in comparable restaurant sales was driven primarily by a reduction in guest traffic at The Cheesecake Factory restaurants.

Comparable sales at The Cheesecake Factory restaurants decreased approximately 1.2%.  We implemented an approximate 1% effective menu price increase during January and February 2006 and an approximate 1% effective menu price increase during July and August 2005.  Since most of our established restaurants usually operate close to full capacity during the peak demand periods of lunch and dinner, we generally expect to achieve increases in comparable restaurant sales over the long-term in the range of our effective menu price increases.

Comparable sales at the Grand Lux Cafes increased approximately 5.5% and benefited in part from an approximate 2% effective menu price increase implemented in October 2005.  Since Grand Lux Cafe is a relatively newer concept and still building its customer base, we expect comparable sales growth to outpace menu price increases for the foreseeable future.

21




As a result of the openings of new restaurants during the past twelve months, total restaurant operating weeks increased 15% to 1,471 for the thirteen weeks ended July 4, 2006.  Average sales per restaurant operating week decreased 3% to $209,200 compared to $215,900 for the same period last year. This decrease in average weekly sales is due principally to two factors. First, as reflected in our comparable sales results, we have experienced a decrease in traffic at our restaurants.  Second, the majority of our new restaurants over the past 12 months have opened in markets where we already have a presence.  In these instances, we do not expect to achieve significant grand opening or “honeymoon” sales levels.

During 2006, our goal is to open as many as 21 restaurants, including one Grand Lux Cafe. We opened two new Cheesecake Factory restaurants in both the first quarter and the second quarter of fiscal 2006.  Although it is difficult for us to predict the timing of our new restaurant openings by quarter, due to the nature of our leased restaurant locations and our highly customized layouts, our current plans call for as many as four new restaurant openings in the third quarter and as many as thirteen in the fourth quarter.  Based on this opening schedule, we plan to achieve approximately 20% square footage growth in fiscal 2006.  However, since many of these openings are late in the year, we will not realize their full benefit until fiscal 2007. We currently project our operating week growth in fiscal 2006 compared to fiscal 2005 on a 52-week basis to be approximately 14%.

We presently update and reprint the menus in our restaurants twice a year. For Cheesecake Factory restaurants, these updates generally occur during January and February (the “winter menu change”) and during July and August (the “summer menu change”). For our 2006 winter menu change, we implemented an approximate 1% effective menu price increase for the purpose of offsetting those operating cost and expense increases that were known or expected as of January 2006.   Our 2006 summer menu change was completed in mid-August, but does not include any price increase.  All potential menu price increases must be carefully considered in light of their ultimate acceptability by our restaurant guests.  Additionally, other factors outside of our control, such as inclement weather, holidays, general economic and competitive conditions and other factors referenced in the Annual Report on Form 10-K/A for the year ended January 3, 2006 can impact comparable sales comparisons. Accordingly, there can be no assurance that increases in comparable sales will be achieved.

Bakery sales to other foodservice operators, retailers and distributors (“bakery sales”) increased 17% to $14.4 million for the thirteen weeks ended July 4, 2006 compared to $12.3 million for the comparable period of the prior year. This increase was primarily due to higher sales to our warehouse club customers, which accounted for approximately 75% of total bakery sales in the current period compared to approximately 68% for the same period of the prior year.

We strive to develop and maintain long-term, growing relationships with our bakery customers, based largely on our 33-year reputation for producing high quality, creative baked desserts.  However, bakery sales volumes will always be less predictable than our restaurant sales.  It is difficult to predict the timing of bakery product shipments and contribution margins on a quarterly basis.  Additionally, the purchasing plans of our large-account customers may fluctuate from quarter to quarter.  Due to the highly competitive nature of the bakery business, we are unable to enter into long-term contracts with our large-account bakery customers, who may discontinue purchasing our products without advance notice at any time for any reason.  Our objective for 2006 is to grow bakery sales in the range of 7% to 8% for the year.

Cost of Sales

Cost of sales increased 8% to $80.4 million for the thirteen weeks ended July 4, 2006, compared to $74.4 million for the comparable period last year.  The related increase of $6.0 million was primarily attributable to the 12% increase in revenues.  As a percentage of revenues, these costs decreased to 24.9% compared to 25.8% for the same period of the prior year.

The menu at our restaurants is one of the most diversified in the foodservice industry and, accordingly, is not overly dependent on a single commodity.  Changes in costs for one commodity are often, but not always, counterbalanced by cost changes in other commodity categories.  The principal commodity categories for our restaurants include fresh produce, poultry, meat, fish and seafood, cheese, other fresh dairy products, bread and general grocery items.  We experienced considerable improvement in poultry commodities compared to the second quarter of the prior year.

22




 

We are currently able to contract for the majority of the food commodities used in our operations for periods up to one year.  With the exception of cream cheese used in our bakery operations, many of the fresh commodities, such as fish, dairy, and certain produce and poultry products are not currently contractible for periods longer than 30 days in most cases.  As a result, these fresh commodities can be subject to unforeseen supply and cost fluctuations due principally to weather and other general agricultural conditions.  We have entered into agreements with suppliers for those expected commodity requirements for fiscal 2006 that can be contracted.  Cream cheese is the most significant commodity used in our bakery products, with an expected requirement of as much as 13 million to 14 million pounds during fiscal 2006.  We have contracted for the majority of our cream cheese requirements for fiscal 2006 at a fixed cost per pound that is slightly lower than the actual cost per pound in fiscal 2005.  We will also purchase cream cheese on the spot market as necessary to supplement our agreements.

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 expected cost increases for key commodities and other goods and services utilized by our operations.  While we have been successful in the past in reacting to inflation and other changes in the costs of key operating resources by gradually increasing prices for our menu items, coupled with more efficient purchasing practices, productivity improvements and greater economies of scale, there can be no assurance that we will be able to continue to do so in the future.

While we have taken steps to qualify multiple suppliers and enter into agreements for some of the key commodities used in our operations, there can be no assurance that future supplies and costs for commodities used in our operations will not fluctuate due to weather and other market conditions outside of our control.  For new restaurants, cost of sales will typically be higher than normal during the first 90 to 120 days of operations until our management team at each new restaurant becomes more accustomed to optimally predicting, managing and servicing the high sales volumes typically experienced by our restaurants.

Labor Expenses

Labor expenses, which include restaurant-level labor costs and bakery direct production labor, including associated fringe benefits, increased 14% to $102.2 million for the thirteen weeks ended July 4, 2006 compared to $89.9 million for the same period of the prior year.  This increase was principally due to the impact of new restaurant openings.  As a percentage of revenues, labor expenses increased to 31.7% versus 31.2% for the comparable period last year.  The thirteen weeks ended July 4, 2006 also included $1.5 million, or 0.5% of revenues, of stock-based compensation expense related to our fiscal 2006 adoption of SFAS 123R.  While we manage our labor judiciously to adapt to revenue fluctuations, we expect to experience some de-leveraging of labor costs at lower sales levels as we are committed to delivering the level of service our guests expect while still achieving reasonable labor costs.

Other Operating Costs and Expenses

Other operating costs and expenses consist of restaurant-level occupancy expenses (rent, insurance, licenses, taxes and utilities), other operating expenses (excluding food costs and labor expenses reported separately) and bakery production overhead, selling and distribution expenses.  Other operating costs and expenses increased 15% to $74.1 million for the thirteen weeks ended July 4, 2006 compared to $64.4 million for the same period of the prior year.  This increase was principally attributable to the 12% increase in revenues.  As a percentage of revenues, other operating costs and expenses increased to 23.0% for the thirteen weeks ended July 4, 2006 versus 22.3% for the same period of fiscal 2005.  Increased utility costs and the de-leveraging of fixed cost maintenance contracts due to lower sales at our restaurants accounted for the majority of this increase.  We currently expect the increased level of utility costs to continue throughout fiscal 2006.  The second quarter of 2006 also included $0.1 million of stock-based compensation expense.

General and Administrative Expenses

General and administrative (“G&A”) expenses increased 33% to $16.8 million for the thirteen weeks ended July 4, 2006 compared to $12.6 million for the same period of fiscal 2005.  As a percentage of total revenues, G&A expenses increased to 5.2% for the thirteen weeks ended July 4, 2006 versus 4.4% for the same period of fiscal 2005. This percentage increase was principally due to the addition of $2.5 million, or 0.8% of revenues, in stock-based compensation expense related to our fiscal 2006 adoption of SFAS 123R.

23




 

G&A expenses consist of the restaurant management recruiting and training program, the restaurant field supervision organization, the bakery administrative organization and the corporate support organization.  During the remainder of fiscal 2006, we plan to continue to add resources to the corporate support, training and field supervision activities of our operations, commensurate with the planned openings of as many as 21 new restaurants during fiscal 2006.

Depreciation and Amortization Expenses

Depreciation and amortization expenses increased 21% to $13.0 million for the thirteen weeks ended July 4, 2006 compared to $10.7 million for the thirteen weeks ended June 28, 2005.  This increase was principally due to property and equipment additions associated with new restaurant openings.  As a percentage of revenues, depreciation and amortization increased to 4.0% for the thirteen weeks ended July 4, 2006 compared to 3.7% for the same period of fiscal 2005.

Preopening Costs

Preopening costs increased to $3.3 million for the thirteen weeks ended July 4, 2006 compared to $2.1 million for the same period of the prior year.  We opened two Cheesecake Factory restaurants during the thirteen weeks ended July 4, 2006 compared to one Cheesecake Factory restaurant opening for the same quarter last year.  In addition, preopening costs were incurred in both periods for restaurant openings in progress.  In addition, we incurred incremental preopening costs in the second quarter of fiscal 2006 for the new bakery production facility.  The second quarter of 2006 also included $0.1 million of stock-based compensation expense.

As a result of the highly customized and operationally complex nature of our upscale, high-volume concepts, the restaurant preopening process for our new restaurants is more extensive, time consuming and costly relative to that of most chain restaurant operations.  The preopening costs for one of our restaurants usually includes costs to relocate and compensate an average of 12 to 13 restaurant management employees prior to opening; costs to recruit and train an average of 250 to 300 hourly restaurant employees; wages, travel and lodging costs for our opening training team and other support employees; costs for practice services activities, and straight-line base rent during the in-restaurant training period.   Preopening costs will vary from location to location depending on a number of factors, including the proximity of our existing restaurants; the size and physical layout of each location; the number of management and hourly employees required to open each restaurant; the relative difficulty of the restaurant staffing process; the cost of travel to and lodging for different metropolitan areas; and the extent of unexpected delay, if any, in construction and/or obtaining final licenses and permits to open the restaurant, which may also be caused by landlord delays.

Our direct preopening costs for a typical single-story Cheesecake Factory restaurant in one of our established markets averages approximately $785,000.  There will also be other preopening costs associated with each restaurant opening, including costs for corporate travel and support activities.  Preopening costs will usually be higher for larger restaurants, our initial entry into new markets and for new concepts such as Grand Lux Cafe, for which we currently expect preopening costs to run 10% to 15% higher than for The Cheesecake Factory restaurants.  We usually incur the most significant portion of preopening costs for a typical restaurant opening within the two-month period immediately preceding and the month of the restaurant’s opening.  Preopening costs are expensed as incurred and fluctuate from period to period, based on the number and timing of restaurant openings and the specific preopening costs incurred for each restaurant, and the fluctuations could be significant.

Based on our planned openings of as many as 17 additional new restaurants during the remaining two quarters of the year (including one Grand Lux Cafe), preopening costs will be higher during the remainder of fiscal 2006 compared to the prior year.

24




Interest Income, Net, Other Income and Income Tax Provision

Interest income, net, increased to $1.0 million for the thirteen weeks ended July 4, 2006 compared to $0.9 million for the comparable prior year period due to an increase in the general level of interest rates, partially offset by lower investment balances due to stock repurchases during the second quarter of fiscal 2006.  We generally invest our excess cash balances in U.S Treasury and government agency securities, investment grade corporate debt securities rated “A” or better and money market mutual funds.  In addition, we recorded interest expense of approximately $0.4 million and $0.2 million for the thirteen weeks ended July 4, 2006 and June 28, 2005, respectively, associated with landlord construction allowances deemed to be financing in accordance with EITF 97-10, “The Effect of Lessee Involvement in Asset Construction” (See Notes to Consolidated Financial Statements included in our Form 10-K/A for the fiscal year ended January 3, 2006).

Other income was $0.1 million for both the thirteen weeks ended July 4, 2006 and June 28, 2005.

Our effective income tax rate was 30.9% for the thirteen weeks ended July 4, 2006 compared with 34.8% for the comparable prior year period.  We currently estimate our effective tax rate to be approximately 31% for the full year. However, the actual effective tax rate for may be different than our current estimate due to actual revenues, pretax income and tax credits achieved during the year.

Twenty-Six Weeks Ended July 4, 2006 Compared to Twenty-Six Weeks Ended June 28, 2005

Revenues

Revenues increased 13% to $629.3 million for the twenty-six weeks ended July 4, 2006 compared to $556.6 million for the twenty-six weeks ended June 28, 2005.

Restaurant sales increased 13% to $602.0 million compared to $530.8 million for the same period of the prior year. The resulting sales increase of $71.2 million consisted of a $4.8 million, or a 1.1%, decrease in comparable restaurant sales and $76.0 million increase from restaurants not in the comparable sales base.  The decrease in comparable restaurant sales was driven primarily by a reduction in guest traffic at The Cheesecake Factory restaurants.

Comparable sales at The Cheesecake Factory restaurants decreased approximately 1.4%.  We implemented an approximate 1% effective menu price increase during January and February 2006 and an approximate 1% effective menu price increase during July and August 2005.  Comparable sales at the Grand Lux Cafes increased approximately 4.7% and benefited in part from an approximate 2% effective menu price increase implemented in October 2005.

Bakery sales to other foodservice operators, retailers and distributors (“bakery sales”) increased 6% to $27.3 million for the twenty-six weeks ended July 4, 2006 compared to $25.8 million for the comparable period of the prior year.  This increase was primarily due to higher sales to our warehouse club customers, which accounted for approximately 72% of total bakery sales in the current period compared to approximately 66% for the same period of the prior year.

Cost of Sales

During the twenty-six weeks ended July 4, 2006, cost of sales increased 10% to $157.3 million compared to $143.3 million for the comparable period last year. This related increase of $14.0 million was primarily attributable to the increase in revenues.  As a percentage of revenues, these costs decreased to 25.0% compared to 25.7% for the same period of the prior year. This decrease was primarily attributable to reduced costs compared to the prior year for a variety of commodities used in our restaurants, particularly poultry and dairy.

Labor Expenses

Labor expenses increased 17% to $201.7 million for the twenty-six weeks ended July 4, 2006 compared to $173.0 million for the same period of the prior year.  The related increase of $28.7 was principally related to the increase in revenues.  As a percentage of revenues, labor expenses for the twenty-six weeks ended July 4, 2006 increased to 32.0% compared to 31.1% for the comparable period last year. While we manage our labor judiciously to adapt to revenue fluctuations, we expect to experience some de-leveraging of labor costs at lower sales levels as we are committed to delivering the level of service our guests expect while still achieving reasonable labor costs. The twenty-six weeks ended July 4, 2006 also included $3.1 million, or 0.5% of revenues, of stock-based compensation expense related to our fiscal 2006 adoption of SFAS 123R.

25




Other Operating Costs and Expenses

Other operating costs and expenses increased 16% to $146.3 million for the twenty-six weeks ended July 4, 2006 compared to $126.4 million for the same period of the prior year.  The related increase was principally attributable to the increase in revenues.  As a percentage of revenues, other operating costs and expenses increased to 23.3% for the twenty-six weeks ended July 4, 2006 versus 22.7% for the same period of fiscal 2005.  Increased utility costs and the de-leveraging of fixed cost maintenance contracts due to lower sales at our restaurants accounted for the majority of this increase.  We currently expect the increased level of utility costs to continue throughout fiscal 2006.  The twenty-six weeks ended July 4, 2006 included $0.2 million of stock-based compensation expense.

General and Administrative Expenses

General and administrative (“G&A”) expenses increased 33% to $32.5 million for the twenty-six weeks ended July 4, 2006 compared to $24.5 million for the same period of fiscal 2005.  As a percentage of total revenues, G&A expenses increased to 5.2% for the twenty-six weeks ended July 4, 2006 versus 4.4% for the same period of fiscal 2005. This percentage increase was principally due to the addition of $5.3 million, or 0.8% of revenues, in stock-based compensation expense related to our fiscal 2006 adoption of SFAS 123R.

Depreciation and Amortization Expenses

Depreciation and amortization expenses increased 22% to $25.4 million for the twenty-six weeks ended July 4, 2006 compared to $20.9 million for the twenty-six weeks ended June 28, 2005.  The related increase was principally due to property and equipment additions associated with new restaurant openings.  As a percentage of total revenues, depreciation and amortization increased to 4.0% for the twenty-six weeks ended July 4, 2006 compared to 3.8% for the same period of fiscal 2005.

Preopening Costs

Preopening costs increased to $7.5 million for the twenty-six weeks ended July 4, 2006 compared to $6.5 million for the same period of the prior year.  We incurred preopening costs to open four Cheesecake Factory restaurants and a new bakery production facility during the twenty-six weeks ended July 4, 2006 compared to six Cheesecake Factory restaurant opening for the same quarter last year.  In addition, preopening costs were incurred in both periods for restaurant openings in progress.  The twenty-six weeks ended July 4, 2006 included $0.2 million of stock-based compensation expense.

Interest Income, Net, Other Income and Income Tax Provision

Interest income, net, increased to $2.5 million for the twenty-six weeks ended July 4, 2006 compared to $1.7 million for the comparable prior year period due to an increase in the general level of interest rates, partially offset by lower investment balances due to treasury stock purchases during the second quarter of fiscal 2006.  In addition, we recorded interest expense of approximately $0.8 million for the twenty-six weeks ended July 4, 2006 versus $0.4 million for the comparable prior year period associated with landlord construction allowances deemed to be financing in accordance with EITF 97-10, “The Effect of Lessee Involvement in Asset Construction.”

Other income for the twenty-six weeks ended July 4, 2006 was $1.8 million compared to $0.3 million for the comparable prior year period. This increase was principally due to the contribution of land and a building for our Rocky Mount, North Carolina bakery production facility by the local government, in exchange for commitments from us to create jobs and operate a manufacturing plant in the community.

26




Our effective income tax rate was 32.0% for the twenty-six weeks ended July 4, 2006 compared with 34.8% for the comparable prior year period.  We recognized a $0.5 million benefit in the income tax provision during the twenty-six weeks ended July 4, 2006 related to the resolution of certain income tax liabilities. We currently estimate our effective tax rate to be approximately 31% for the full year. However, the actual effective tax rate for fiscal 2006 may be different than our current estimate due to actual revenues, pretax income and tax credits achieved during the year.

Liquidity and Capital Resources

The following tables set forth, for the periods indicated, a summary of our key liquidity measurements (dollar amounts in millions):

 

July 4, 2006

 

January 3, 2006

 

 

 

 

 

(restated)

 

 

 

 

 

 

 

Cash and marketable securities on hand

 

$

150.4

 

$

178.0

 

Net working capital

 

$

59.8

 

$

39.7

 

Adjusted net working capital (1)

 

$

102.4

 

$

123.4

 

Current ratio

 

1.5:1

 

1.3:1

 

Adjusted current ratio (1)

 

1.8:1

 

1.9:1

 

Long-term debt, including current portion (2)

 

$

36.1

 

$

26.9

 

 


(1)             Includes all marketable securities classified as either current assets ($87.3 million and $63.2 million at July 4, 2006 and January 3, 2006, respectively) or noncurrent assets ($42.6 million and $83.7 million at July 4, 2006 and January 3, 2006, respectively).

(2)             Represents deemed landlord financing liability.

 

Twenty-Six
Weeks Ended
July 4, 2006

 

Twenty-Six
Weeks Ended
June 28, 2005

 

 

 

 

 

 

 

Cash provided by operating activities

 

$

65.6

 

$

74.1

 

Capital expenditures

 

$

61.9

 

$

59.1

 

 

During the twenty-six weeks ended July 4, 2006, our cash and marketable securities on hand decreased by $27.6 million to $150.4 million from the January 3, 2006 balance.  This decrease was primarily attributable to purchases of treasury stock and property and equipment, partially offset by cash provided by operating activities, landlord construction contributions and proceeds from the exercise of employee stock options.  In the table above, we also present adjusted net working capital and current ratio calculations that include all marketable securities classified as either current or noncurrent assets.  We believe these adjusted calculations provide investors with useful information regarding our overall liquidity position because all marketable securities are readily available to meet our liquidity requirements.  We continue to target a weighted average maturity for our marketable securities investment portfolio between one and two years.  Accordingly, a substantial portion of our investments is classified as noncurrent assets, but remains available for our liquidity requirements.

We have no funded debt in our capital structure.  However, landlord construction allowances related to restaurant locations for which we are deemed, for accounting purposes only, to have an ownership interest are reflected in our balance sheets as deemed landlord financing.  This liability is amortized over the lease term based on the rent payments designated in the lease agreement.

We maintain a $35 million revolving credit and term loan facility (the “Credit Facility”), which expires on December 31, 2008. As of July 4, 2006, there were no borrowings outstanding under the Credit Facility.  A portion of the Credit Facility, $15.2 million, has been reserved to support standby letters of credit for our self-insurance programs.  Borrowings under the Credit Facility will bear interest at variable rates based, at our option, on either the prime rate of interest, the lending institution’s cost of funds plus 0.75%, or the applicable LIBOR rate plus 0.75%.  Upon expiration of the Credit Facility, a maximum of $35 million of any borrowings outstanding under the Credit Facility automatically convert into a four-year term loan, payable in equal quarterly installments at interest rates of 0.5% higher than the applicable revolving credit rates.  The Credit Facility is not collateralized and requires us to maintain certain financial ratios and to observe certain restrictive covenants, such as maintaining a minimum effective tangible net worth balance, with respect to the conduct of our operations, with which we are currently in compliance.

27




 

Our new restaurant development model more closely resembles that of a retail business that occupies leased space in shopping malls, office complexes, strip centers, entertainment centers and other real estate developments.  We typically seek to lease our restaurant locations for primary periods of 15 years to 20 years under operating lease arrangements. Our rent structures vary from lease to lease, but generally provide for the payment of both minimum and contingent (percentage) rent based on sales, as well as other expenses related to the leases (for example our share of common area maintenance, property tax and insurance expenses).  In the future, we may also develop more freestanding restaurant locations using both ground leases and built-to-suit leases, which are common arrangements used to finance freestanding locations in the restaurant industry.  We disburse cash for leasehold improvements and furnishings, fixtures and equipment to build out our leased premises.  We may also disburse cash for structural additions that we make to leased premises that generally are reimbursed to us by our landlords as construction contributions pursuant to agreed-upon terms in the respective leases.  If obtained, landlord construction contributions usually take the form of up-front cash, full or partial credits against minimum or percentage rents otherwise payable by us, or a combination thereof.  We do not have any current plans to encumber our existing leasehold interests with secured financing.  We own substantially all of the equipment, furniture and trade fixtures in our restaurants and currently plan to do so in the future.

For fiscal 2006, we currently estimate our cash outlays for capital expenditures to range between $190 million and $195 million, net of agreed-upon, up-front cash landlord construction contributions and excluding $23 million to $24 million of expected noncapitalizable preopening costs for new restaurants and the new bakery facility.  This amount also excludes approximately $10 million of landlord construction contributions to be applied as reductions to minimum or percentage rent over the lease terms. The amount reflected as additions to property and equipment in the Consolidated Statements of Cash Flows may vary from this estimate based on the accounting treatment of each operating lease. This estimate contemplates a net outlay of $163 million to $164 million for as many as 21 new restaurants to be opened during fiscal 2006, estimated construction-in-progress disbursements for anticipated fiscal 2007 openings and estimated collections of up-front cash landlord construction contributions.  Expected capital expenditures for fiscal 2006 also include approximately $13 million to $14 million for maintenance and capacity addition expenditures to our existing restaurants and $9 million to $11 million for bakery and corporate infrastructure investments.  In addition, we expect to spend approximately $5 million to $6 million related to the completion and enhancement of our second bakery production facility in Rocky Mount, North Carolina.  We commenced operations in this facility in the first quarter of 2006 and began producing cakes in the second quarter of 2006.

Based on our current expansion objectives, we believe that our cash and short-term investments on hand, combined with expected cash flow provided by operations, available borrowings under our Credit Facility and expected landlord construction contributions should be sufficient in the aggregate to finance our planned capital expenditures and other operating activities through fiscal 2006.  We may seek additional funds to finance our growth in the future. However, there can be no assurance that such funds will be available when needed or be available on terms acceptable to us.