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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended July 2, 2013

or

Commission File Number: 0-20574

THE CHEESECAKE FACTORY INCORPORATED

(Exact name of registrant as specified in its charter)

(818) 871-3000

(Registrant’s telephone number, including area code)

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of July 31, 2013, 53,838,117 shares of the registrant’s Common Stock, $.01 par value, were outstanding.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

INDEX

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PART I.         FINANCIAL INFORMATION

Item 1.           Financial Statements

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands, except per share data)

(Unaudited)

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Presentation and Significant Accounting Policies

The accompanying consolidated financial statements include the accounts of The Cheesecake Factory Incorporated and its wholly owned subsidiaries (referred to herein collectively as the “Company,” “we,” “us” and “our”) prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  The financial statements presented herein have not been audited by an independent registered public accounting firm, but include all material adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for the fair statement of the financial condition, results of operations and cash flows for the period.  However, these results are not necessarily indicative of results for any other interim period or for the full fiscal year.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to the rules of the Securities and Exchange Commission (“SEC”).  The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 1, 2013 filed with the SEC on February 28, 2013.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions for the reporting periods covered by the financial statements.  These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent liabilities.  Actual results could differ from these estimates.

We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31st for financial reporting purposes.  Fiscal 2013 consists of 52 weeks and will end on December 31, 2013.  Fiscal 2012, which ended on January 1, 2013, was a 52-week year.

We determined that the three Grand Lux Cafe locations that we closed in March 2013 do not meet the requirements for discontinued operations reporting.  Although we discontinued cash flows at these restaurants, we have significant continuing involvement with respect to operations, based on our expectation of guest transfer (an increase in guests at another location as a result of the closure of a location).

Recent Accounting Pronouncements

In July 2012, the Financial Accounting Standards Board (“FASB”) issued guidance that provides entities with an option to perform a qualitative assessment to determine whether further impairment testing of indefinite-lived intangible assets is necessary.  If an entity concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, quantitative impairment testing is required.  However, if an entity concludes otherwise, quantitative testing is not required.  This standard became effective for us in the first quarter of fiscal 2013.  The adoption of this standard did not have a material impact on our financial statements.

In June 2011, the FASB issued guidance that eliminated the previous option to report other comprehensive income and its components in the statement of changes in equity.  Companies can elect to present items of net income and other comprehensive income in one continuous statement or in two separate but consecutive statements.  There are no changes to the accounting for items within comprehensive income.  This standard impacts presentation only and became effective for us in the first quarter of fiscal 2012.  In February 2013, the FASB issued additional guidance that requires companies to present information about reclassification adjustments from accumulated other comprehensive income in a single note or on the face of the financial statements.  This standard also impacts presentation only and became effective for us in the first quarter of fiscal 2013.

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2.  Inventories

Inventories consisted of (in thousands):

3.  Long-Term Debt

In December 2010, we entered into a five-year credit agreement (“Facility”) that provides us with revolving loan commitments totaling $200 million, including letter of credit subfacility commitments that total $35 million.  The Facility contains a commitment increase feature that could provide for an additional $50 million in available credit upon our request and the satisfaction of certain conditions.  We had no outstanding borrowings under the Facility at July 2, 2013 or January 1, 2013, and we did not withdraw or repay any amounts under this Facility during the first half of fiscal 2013 or 2012.

Borrowings under the Facility bear interest at a floating rate based on LIBOR, plus a spread ranging from 1.75% to 2.25%, depending on our ratio of debt plus eight times rent (“Adjusted Debt”) to trailing 12-month earnings before interest, taxes, depreciation, amortization, rent and noncash stock option expense (“EBITDAR”), as defined in the agreement.  In addition, we pay a commitment fee ranging from 0.3% to 0.4%, also depending on our ratio of Adjusted Debt to EBITDAR, calculated on the average unused portion of the Facility.

We are obligated to maintain certain financial covenants, which include a maximum Adjusted Debt to trailing 12-month EBITDAR ratio (“Adjusted Debt Ratio”) of 4.0, as well as a trailing 12-month minimum EBITDAR to interest and rental expense ratio (“EBITDAR Ratio”) of 1.9.  At July 2, 2013, our Adjusted Debt and EBITDAR Ratios were 2.7 and 2.9, respectively.  Therefore, we were in compliance with the financial covenants in effect under the Facility at that date.  The Facility limits cash distributions with respect to our equity interests, such as cash dividends and share repurchases, based on these ratios.

Availability under the Facility is reduced by outstanding standby letters of credit, which are used to support our self-insurance programs.  As of July 2, 2013, we had net availability for borrowings of $179 million, based on a zero outstanding debt balance and $21 million in standby letters of credit.

4. Commitments and Contingencies

On April 11, 2013, a current restaurant hourly employee filed a class action lawsuit in the California Superior Court, Placer County, alleging that the Company violated the California Labor Code and California Business and Professions Code, by requiring employees to purchase uniforms for work.  (Sikora v. The Cheesecake Factory Restaurants, Inc., et al; Case No SCV0032820).  A similar lawsuit covering a different period of time is also pending in Placer County. (Reed v. The Cheesecake Factory Restaurants, Inc. et al; Case No. S CV 27073).  We are also arbitrating similar uniform and related issues under federal law in separate collective actions in Alabama, Colorado, Ohio, Tennessee, and Texas.  (Smith v. The Cheesecake Factory Restaurants, Inc. et al; Case No. 3 06 0829).  These lawsuits and arbitrations seek unspecified amounts of penalties and other monetary payments on behalf of the respective plaintiffs and other purported class members. The plaintiffs also seek attorneys’ fees.  We intend to vigorously defend these actions.  Based on the current status of these matters, we have not reserved for any potential future payments.

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

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5. Stockholders’ Equity

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

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Stock Options

We did not issue any stock options during the second quarter of fiscal 2013.  The weighted average fair value at the grant date for options issued during the second quarter of fiscal 2012 was $12.34 per option and was estimated utilizing the Black-Scholes valuation model with the following weighted average assumptions: (a) an expected option term of 6.1 years, (b) expected stock price volatility of 39.8%, (c) a risk-free interest rate of 1.1%, and (d) a dividend yield on our stock of 0.0%.

Stock option activity during the twenty-six weeks ended July 2, 2013 was as follows:

The total intrinsic value of options exercised during the thirteen and twenty-six weeks ended July 2, 2013 was $11.7 million and $19.8 million, respectively.  The total intrinsic value of options exercised during the thirteen and twenty-six weeks ended July 3, 2012 was $3.7 million and $8.1 million, respectively.  As of July 2, 2013, the total unrecognized stock-based compensation expense related to unvested stock options was $14.8 million, which we expect to recognize over a weighted average period of approximately 2.2 years.

Restricted Shares and Restricted Share Units

Restricted share and restricted share unit activity during the twenty-six weeks ended July 2, 2013 was as follows:

Fair value of our restricted shares and restricted share units is based on our closing stock price on the date of grant.  The weighted average fair value at the grant date for restricted shares and restricted share units issued during the second quarter of fiscal 2013 and fiscal 2012 was $39.75 and $31.08, respectively.  The fair value of shares that vested during the thirteen and twenty-six weeks ended July 2, 2013 was $6 thousand and $2.4 million, respectively.  The fair value of shares that vested during the thirteen and twenty-six weeks ended July 3, 2012 was $1.2 million and $2.4 million, respectively.  As of July 2, 2013, total unrecognized stock-based compensation expense related to unvested restricted shares and restricted share units was $28.1 million, which we expect to recognize over a weighted average period of approximately 3.7 years.

7.  Net Income Per Share

At July 2, 2013 and July 3, 2012, 1.5 million and 1.1 million shares, respectively, of restricted stock issued to employees were unvested, and therefore excluded from the calculation of basic earnings per share for the fiscal quarters ended on those dates.  Diluted net income per share includes the dilutive effect of outstanding equity awards, calculated using the treasury stock method.  Assumed proceeds from in-the-money options include windfall tax benefits, net of shortfalls, calculated under the “as-if” method as prescribed by FASB Accounting Standards Codification (“ASC”) 718, “Compensation — Stock Option Compensation.”

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Shares of common stock equivalents of 0.5 million and 1.1 million for the thirteen and twenty-six weeks ended July 2, 2013, respectively, and 2.7 million and 2.9 million for the thirteen and twenty-six weeks ended July 3, 2012, respectively, were excluded from the diluted calculation due to their anti-dilutive effect.

Certain of our restricted stock awards are considered participating securities as these awards include non-forfeitable rights to dividends with respect to unvested shares.  As such, they must be included in the computation of earnings per share pursuant to the two-class method.  Under the two-class method, a portion of net income is allocated to participating securities, and therefore is excluded from the calculation of earnings per share allocated to common shares.  For the thirteen and twenty-six weeks ended July 2, 2013, the calculation of basic and diluted earnings per share pursuant to the two-class method resulted in an immaterial difference from the amounts displayed in the consolidated statements of comprehensive income.

8.  Segment Information

For decision-making purposes, our management reviews discrete financial information for The Cheesecake Factory, Grand Lux Cafe and RockSugar Pan Asian Kitchen restaurants, our bakery division and our international licensing operations.  Based on quantitative thresholds set forth in ASC 280, “Segment Reporting,” The Cheesecake Factory is our only business that meets the criteria of a reportable operating segment.  We formerly disclosed segment information for our bakery operations.  However, as we expanded our domestic restaurants and international licensing arrangements, our bakery segment became a smaller proportion of our operations and now falls below the thresholds of a reportable segment.  Therefore, we are no longer reporting this component separately. Grand Lux Cafe, RockSugar Pan Asian Kitchen and international licensing were previously combined with The Cheesecake Factory in a segment named Restaurants. These components are now combined with our bakery operations in Other. Unallocated corporate expenses, assets and capital expenditures are presented below as reconciling items to the amounts presented in the consolidated financial statements.

Segment information is presented below (in thousands):

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(1)         Includes $1.5 million of pre-tax impairment expense in the second quarter of fiscal 2013 related to the planned relocation of two of our restaurants.  This item was recorded in impairment of assets and lease terminations.

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

9.  Subsequent Events

On August 8, 2013, we executed an agreement waiving our right to exercise lease renewal options at one of our The Cheesecake Factory locations.  In consideration, the landlord has agreed to pay us $4,875,000.

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

Forward-Looking Statements

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

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

General

This discussion and analysis should be read in conjunction with our interim unaudited consolidated financial statements and related notes included in this Form 10-Q in Part I, Item 1, and with the following items included in our Annual Report on Form 10-K for the fiscal year ended January 1, 2013: the audited consolidated financial statements and related notes in Part IV, Item 15; the “Risk Factors” included in Part I, Item 1A; and the cautionary statements included throughout the report.  The inclusion of supplementary analytical and related information herein may require us to make estimates and assumptions to enable us to fairly present, in all material respects, our analysis of trends and expectations with respect to our results of operations and financial position taken as a whole.

As of August 9, 2013, we operated 175 upscale, casual, full-service dining restaurants: 163 under The Cheesecake Factory® mark; 11 under the Grand Lux Cafe® mark; and one under the RockSugar Pan Asian Kitchen® mark.  We also operated two bakery production facilities.

The Cheesecake Factory is an upscale, casual dining concept that offers more than 200 menu items including appetizers, pizza, seafood, steaks, chicken, burgers, pasta, specialty items, salads, sandwiches, omelettes and desserts, including approximately 50 varieties of cheesecake and other baked desserts.  Grand Lux Cafe and RockSugar Pan Asian Kitchen are also upscale, casual dining concepts offering approximately 200 and 80 menu items, respectively.  In contrast to many chain restaurant operations, substantially all of our menu items, except those desserts manufactured at our bakery production facilities, are prepared from scratch daily at our restaurants with high quality, fresh ingredients based on innovative and proprietary recipes.  We believe our restaurants are recognized by consumers for offering value with generous food portions at moderate prices.  Our restaurants’ distinctive, contemporary design and decor create a high-energy ambiance in a casual setting.  Our restaurants typically range in size from 7,000 to 17,000 interior square feet, provide full liquor service and are generally open seven days a week for lunch and dinner, as well as Sunday brunch.

In 2011, we announced our initial expansion plans outside of the United States.  We entered into an exclusive licensing agreement to build and operate The Cheesecake Factory restaurants in the Middle East.  In the second quarter of fiscal 2013, we expanded this arrangement to include the country of Lebanon.  This licensee opened its first three locations in fiscal 2012.  In February 2013, we entered into an exclusive licensing agreement to build and operate The Cheesecake Factory restaurants in Latin America.

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These licensing agreements include initial development fees, site and design fees and ongoing royalties on our licensee’s restaurant sales.  In addition, our licensees will purchase bakery products branded under The Cheesecake Factory trademark from us.  We continue to review additional opportunities to expand in markets outside of the United States.

Overview

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

Our strategy is driven by our commitment to guest satisfaction and is focused primarily on menu innovation and operational execution to continue to differentiate ourselves from other restaurant concepts, as well as drive competitively strong performance that is sustainable.  Financially, we are focused on prudently managing expenses at our restaurants, bakery facilities and corporate support center.  We are also committed to allocating capital in a manner that will maximize profitability and returns.  Investing in new restaurant development that meets our return on investment criteria is our top capital allocation priority with a focus on opening our restaurant concepts in premier locations within both new and existing markets in the United States and new markets internationally.

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

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

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

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

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

·                  Return on Investment.  Return on investment measures our ability to make the best decisions regarding our allocation of capital.  Returns are affected by the cost to build restaurants, the level of revenues that each restaurant can deliver and our ability to maximize the profitability of restaurants through operational execution and disciplined cost management.  Our objective is to deploy capital in a manner that will maximize our return on investment.

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Results of Operations

The following table sets forth, for the periods indicated, information from our consolidated statements of comprehensive income expressed as percentages of revenues.  The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any other interim period or for the full fiscal year.

Thirteen Weeks Ended July 2, 2013 Compared to Thirteen Weeks Ended July 3, 2012

Revenues

Revenues increased 3.4% to $470.1 million for the thirteen weeks ended July 2, 2013 compared to $454.7 million for the thirteen weeks ended July 3, 2012.

Comparable sales at The Cheesecake Factory and Grand Lux Cafe restaurants increased by 0.8%, or $3.5 million, from the second quarter of fiscal 2012, driven by an increase in average check of 1.7% and menu mix of 0.1%, partially offset by a decrease in guest traffic of 1.0%.  Comparable sales in the first quarter of fiscal 2013 benefitted from a timing shift due to spring break and Easter holidays taking place earlier than in the prior year, moving approximately $2 million in sales forward into our first quarter from the second quarter of fiscal 2013 on a year-over-year basis.

Comparable sales at The Cheesecake Factory restaurants increased by 0.9% from the prior year second quarter driven by an increase in average check growth, partially offset by a decrease in guest traffic.  We implemented effective menu price increases of approximately 1.0% and 0.8% during the first quarter of fiscal 2013 and third quarter of fiscal 2012, respectively.  On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 1.8% increase in pricing for the thirteen weeks ended July 2, 2013.  We currently anticipate taking a menu price increase of approximately 1.0% in our summer The Cheesecake Factory menu change.

Comparable sales at our Grand Lux Cafe restaurants increased by 0.1% from the prior year second quarter driven by an increase in average check growth, partially offset by a decrease in guest traffic.  With fewer restaurants in operation than The Cheesecake Factory and a number of locations that are proportionately larger in size, Grand Lux Cafe can experience greater variability in its comparable sales from quarter to quarter.  We implemented effective menu price increases of approximately 0.7% and 0.8% during the second quarter of fiscal 2013 and fourth quarter of fiscal 2012, respectively.  On a weighted average basis, based on the timing of our menu roll outs within each quarter, Grand Lux Cafe menu included a 1.7% increase in pricing for the thirteen weeks ended July 2, 2013.

Restaurants become eligible to enter our comparable sales base in their 19th month of operation. At July 2, 2013, there were eight The Cheesecake Factory restaurants and one Grand Lux Cafe not yet in our comparable sales base. International licensed locations and restaurants that are no longer in operation are excluded from our comparable sales calculations.

We generally update and reprint our menus twice a year.  As part of these menu updates, we evaluate the need for price increases based on those operating cost and expense increases of which we are aware or that we can reasonably expect. 

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While menu price increases can contribute to higher comparable restaurant sales in addition to offsetting margin pressure, we carefully consider all potential price increases in light of the extent to which we believe they will impact guest traffic.

Other factors outside of our control, such as general economic conditions, inclement weather, timing of holidays, competition and other factors, including those referenced in Part I, Item lA, “Risk Factors,” of our Annual Report on Form 10-K for the year ended January 1, 2013, can impact comparable sales.

Total restaurant operating weeks increased 1.7% to 2,263 for the thirteen weeks ended July 2, 2013 compared to the prior year period.  Average sales per restaurant operating week increased approximately 1.5% to $202,000 in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012.

Our external bakery sales were $11.7 million for the thirteen weeks ended July 2, 2013 compared to $11.8 million for the comparable period of last year.  It is difficult to predict the timing of bakery product shipments on a quarterly basis, as the purchasing plans of our large-account customers, who constitute a majority of our bakery sales, may fluctuate.

Cost of Sales

Cost of sales consists of food, beverage, retail and bakery production supply costs incurred in conjunction with our restaurant and bakery revenues, and excludes depreciation, which is captured separately in depreciation and amortization expenses.  As a percentage of revenues, cost of sales was 24.0% for the second quarter of fiscal 2013 compared to 24.4% for the comparable period of fiscal 2012.  This variance was driven primarily by lower grocery costs, with wheat and corn prices down from their year-ago highs, benefitting items such as pastas and oils.

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

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

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

Labor Expenses

As a percentage of revenues, labor expenses, which include restaurant-level labor costs and bakery direct production labor, including associated fringe benefits, increased to 32.2% in the second quarter of fiscal 2013 compared to 32.1% in the second quarter of fiscal 2012, primarily due to higher payroll taxes and other labor-related costs, partially offset by lower group medical expenses.

Other Operating Costs and Expenses

Other operating costs and expenses consist of restaurant-level occupancy expenses (rent, common area expenses, insurance, licenses, taxes and utilities), other operating expenses (excluding food costs and labor expenses, which are reported separately) and bakery production overhead, selling and distribution expenses.  As a percentage of revenues, other operating costs and expenses increased to 24.2% for the thirteen weeks ended July 2, 2013 from 23.9% for the thirteen weeks ended July 3, 2012.  This increase was primarily due to higher natural gas rates and the timing of marketing costs and restaurant management bonuses.  These factors were partially offset by higher bakery overhead absorption due to increased production versus the second quarter of fiscal 2012.

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General and Administrative Expenses

General and administrative (“G&A”) expenses consist of the restaurant management recruiting and training program, as well as the restaurant field supervision, corporate support and bakery administrative organizations.  As a percentage of revenues, G&A expenses increased to 5.9% for the thirteen weeks ended July 2, 2013 versus 5.8% for the comparable period of fiscal 2012 due to higher labor and legal fees, partially offset by a higher prior year accrual for corporate performance bonuses.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.1% for both the thirteen weeks ended July 2, 2013 and the comparable period of last year.

Impairment of Assets and Lease Terminations

In the second quarter of fiscal 2013, we incurred $1.5 million of impairment expense related to the planned relocation of two of our restaurants.  We expect to incur an additional $0.4 million during the second half of fiscal 2013 related to the relocation of these restaurants.

Preopening Costs

Preopening costs were $2.5 million for the thirteen weeks ended July 2, 2013 compared to $3.0 million in the comparable period of the prior year.  We opened one The Cheesecake Factory restaurant in the second quarter of both fiscal 2013 and 2012.

Preopening costs include all costs to relocate and compensate restaurant management employees during the preopening period; costs to recruit and train hourly restaurant employees; and wages, travel and lodging costs for our opening training team and other support staff members.  Also included in preopening costs are expenses for maintaining a roster of trained managers for pending openings; the associated temporary housing and other costs necessary to relocate managers in alignment with future restaurant opening and operating needs; and corporate travel and support activities.  Preopening costs can fluctuate significantly from period to period, based on the number and timing of restaurant openings and the specific preopening costs incurred for each restaurant.

Interest and Other Expense, Net

Interest and other expense, net increased to $1.3 million of expense for the second quarter of fiscal 2013 compared to $0.8 million of expense for the comparable period last year.  This increase was primarily due to changes in the value of our investments in variable life insurance contracts used to support our Executive Savings Plan (“ESP”), a non-qualified deferred compensation plan.  Interest expense included $0.9 million in the second quarter of fiscal 2013 compared to $0.8 million in the second quarter of fiscal 2012 associated with landlord construction allowances deemed to be financing in accordance with accounting guidance.

Income Tax Provision

Our effective income tax rate was 28.4% for the second quarter of fiscal 2013 compared to 29.2% for the comparable prior year period.  This decrease was attributable to higher Work Opportunity Tax Credits due to the reinstatement of the program in 2013 and decreased state taxes in relation to pre-tax income, partially offset by a lower proportion of FICA tip credits in relation to pre-tax income.

Twenty-Six Weeks Ended July 2, 2013 Compared to Twenty-Six Weeks Ended July 3, 2012

Revenues

Revenues increased 4.8% to $933.1 million for the twenty-six weeks ended July 2, 2013 compared to $890.5 million for the twenty-six weeks ended July 3, 2012.

Comparable sales at The Cheesecake Factory and Grand Lux Cafe restaurants increased by 1.1%, or $9.2 million, from the first half of fiscal 2012, driven by an increase in average check of 1.8%, partially offset by a decrease in guest traffic of 0.7%.  Storms in the Northeast during the first quarter of fiscal 2013 negatively impacted comparable sales for the first half of the year by approximately 0.3%.

Comparable sales at The Cheesecake Factory restaurants increased by 1.2% from the prior year driven by an increase in average check, partially offset by a decrease in guest traffic.  On a weighted average basis, based on the timing of our menu roll outs within each quarter, The Cheesecake Factory menu included a 1.8% increase in pricing for the twenty-six weeks ended July 2, 2013.  In the first quarter of fiscal 2013, our The Cheesecake Factory location in Hawaii was closed for approximately four weeks for repairs due to fire damage. This restaurant also was excluded from our comparable sales calculations for the time period it was closed.

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Comparable sales at our Grand Lux Cafe restaurants decreased by 0.4% from the prior year first half driven by a decrease in guest traffic, partially offset by an increase in average check.  On a weighted average basis, based on the timing of our menu roll outs within each quarter, Grand Lux Cafe menu included a 1.7% increase in pricing for the twenty-six weeks ended July 2, 2013.

Total restaurant operating weeks increased 2.6% to 4,554 for the twenty-six weeks ended July 2, 2013.  Average sales per restaurant operating week increased approximately 1.6% to $198,750 in the first half of fiscal 2013 compared to the first half of fiscal 2012.

Our external bakery sales increased to $26.0 million for the twenty-six weeks ended July 2, 2013 compared to $22.6 million for the comparable period of last year due primarily to the timing of sales to our Middle Eastern licensee and to distributors who sell our bakery products to third party accounts.

Cost of Sales

As a percentage of revenues, cost of sales decreased to 24.3% for the twenty-six weeks ended July 2, 2013 from 24.5% for the comparable period of fiscal 2012.  Lower grocery costs were partially offset by an increase in higher-cost desserts sold in our restaurants.

Labor Expenses

As a percentage of revenues, labor expenses for the twenty-six weeks ended July 2, 2013 decreased to 32.4% from 32.5% in the comparable period of last year, primarily due to lower group medical costs.

Other Operating Costs and Expenses

As a percentage of revenues, other operating costs and expenses were 24.1% for both the twenty-six weeks ended July 2, 2013 and July 3, 2012.

General and Administrative Expenses

As a percentage of revenues, G&A expenses decreased to 6.1% for the twenty-six weeks ended July 2, 2013 versus 6.2% for the comparable period of fiscal 2012 due primarily to a higher prior year accrual for corporate performance bonuses and a $0.8 million charge in the prior year, reflecting an increase in the value of our Chief Executive Officer’s retirement benefit in connection with the extension of his employment agreement.

Depreciation and Amortization Expenses

As a percentage of revenues, depreciation and amortization expenses were 4.1% for both the twenty-six weeks ended July 2, 2013 and the comparable period of last year.

Impairment of Assets and Lease Terminations

In fiscal 2012, we made the business decision to discontinue operations of three of our Grand Lux Cafe restaurants, each of which was previously fully impaired, because they were not delivering the necessary sales volumes to drive our required returns.  We incurred $4.0 million in the fourth quarter of fiscal 2012 for partial reimbursement to the landlords of tenant improvement allowances and broker fees on these leases.  We incurred an additional $0.6 million in the first quarter of fiscal 2013 for future rent and other closing costs associated with these locations.  We do not expect to incur further charges in connection with these locations.

In the second quarter of fiscal 2013, we incurred $1.5 million of impairment expense related to the planned relocation of two of our restaurants.  We expect to incur an additional $0.4 million during the second half of fiscal 2013 related to the relocation of these restaurants.

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Preopening Costs

Preopening costs were $3.8 million for the twenty-six weeks ended July 2, 2013 compared to $5.1 million in the comparable period of the prior year.  We opened one The Cheesecake Factory restaurant in the first half of both fiscal 2013 and 2012.

Interest and Other Expense, Net

Interest and other expense, net increased to $2.6 million of expense for the first half of fiscal 2013 compared to $2.0 million of expense for the comparable period last year. This increase was primarily due to changes in the value of our investments in variable life insurance contracts used to support our ESP.  Interest expense included $1.8 million and $1.7 million in the first half of fiscal 2013 and fiscal 2012, respectively, associated with landlord construction allowances deemed to be financing in accordance with accounting guidance.

Income Tax Provision

Our effective income tax rate was 28.5% for the first half of fiscal 2013 compared to 29.0% for the comparable prior year period.  This decrease was attributable to higher Work Opportunity Tax Credits due to the reinstatement of the program in 2013 and decreased state taxes in relation to pre-tax income, partially offset by a lower proportion of FICA tip credits in relation to pre-tax income.

Non-GAAP Measures

Adjusted net income and adjusted diluted net income per share are supplemental measures of our performance that are not required by or presented in accordance with GAAP.  These non-GAAP measures may not be comparable to similarly titled measures used by other companies and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP.

We calculate these non-GAAP measures by eliminating from net income and diluted net income per share the impact of items we do not consider indicative of our ongoing operations.  We believe these adjusted measures provide additional information to facilitate the comparison of our past and present financial results.  We utilize results that both include and exclude the identified items in evaluating business performance.  However, our inclusion of these adjusted measures should not be construed as an indication that our future results will be unaffected by unusual or infrequent items.  In the future, we may incur expenses or generate income similar to the adjusted items.

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