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CAKE: Company Overview (2016 10-K)

 CAKE is among the very best long term performers in the casual dining space, with highly productive restaurants leading to operating margins and returns on capital that are the envy of most restaurant chains.  At the end of Q2’17, The Cheesecake Factory Company Inc. owned and operated 207 full-service, casual dining restaurants in 39 states and Puerto Rico (193 Cheesecake Factory ‘CCF’ units, 13 Grand Lux Cafés and a single Rock Sugar Southeast Asian Kitchen unit).  Internationally, CCF units are operated under licensing agreements in the Middle East, China and Mexico.   Over 91% of  $2.276B of 2016 consolidated revenues were generated by the domestic CCF units with the balance from sales of the smaller brands, licensing fees  and royalties and external sales of the bakery division.  The Company’s bakery division operates two bakery production facilities, in Calabasas Hills, CA and Rocky Mount, NC, that produce 70 varieties of its namesake cheesecakes and other baked products for its restaurants, international licensees and third-party bakery customers.  The external bakery sales comprise about 2% of total sales. The CCF menu features over 200 items, with a broad selection of freshly prepared appetizers, salads, entreés and its signatures desserts. In addition, it offers specialized menus such as its “SkinnyLicious” menu (all items 590 calorie of less) and its new health conscious “Super Foods,” primarily salads, which it hopes will be popular with millennials. The average ticket in 2016 was $21.40, of which 13% was alcoholic beverages and 16% desserts. In recent years the company has made all menu items available for take-out, which had expanded to 11% of restaurant sales in 2016.  In 2016 it inaugurated a delivery service which was available at 40% of restaurants by 12/31/16, grew to 60% during Q2’17, ultimately expected to be at 90% of locations.

The company expects to grow its domestic CCF concept to around 300 units.  Domestic restaurants occupy prime locations in A-malls, premier lifestyle centers and office complexes. They range from 5K to 17K interior square feet, although the company expects the size of future units will range from 8K-12K sqft.  All CAKE’s restaurants are leased and the company targets total buildout costs of $900/interior sqft.  In 2016 the CCF units generated AUV’s of $10.7M.  However, given the varied layouts of its units, the company believes sales/sqft provides a better measure of unit level productivity.  In the last 5 years CCF sales/sqft of stores in the comp base have grown steadily to $971/sqft from $902/sqft.  This high level of productivity enables CAKE to secure very favorable terms for its premier locations, which we estimate at only $47/sqft, including contingent rent.  In 2016 CCF segment EBIT margins were 14.8% (up 140bps in the last 2 years.  We estimate in 2016 CCF restaurant level EBITDA margins were 19.1% (up 100bps in the last 2 years) and EBITDAR margins were 24.0% (up 90bps in the last 2 years) .  The company targets store-level returns of 18% to 20% on its new units (measured as EBITDAR/cash buildout plus capitalized rent).  Against this target, it reported the average returns of its comp units at 24% in 2016 (averaging 23.5% in the last 5 years).  At this level of store-level profitability the company expects to meet or exceed its ROIC hurdle rate of 15% at the company level.  In the seven years before 2016 it only met this target twice (2013 & 2015), but in 2016 consolidated ROIC was 17%. Before declining 0.5% in Q1’`7, comps had increased for 29 consecutive quarters, bolstered in part by steady price increases.  Consolidated operating margins, at around 8%, were double those of casual dining peers operating at least 80% of their system’s units, although they are well below peak margins averaging 10.6% in 2000-2005, which the company has set itself a five-year goal of re-attaining. (Of course, the ’17 results are making that more of a “reach”.) CAKE’s unique operating competencies are key to the percent of revenue realized on the bottom line.  For example, it employs kitchen technology that maximizes labor productivity, helps track and sequence orders and manages its extraordinarily complex menu.  This back-of-the house skill is especially noteworthy, since it allows CAKE to buck the trend of CAKE’s casual dining peers who are reducing menu items and cutting back on freshly prepared offerings in favor of more “heat and eat” offerings.  (A closely observed description of CAKE’s operational prowess is can be found in this essay in The New Yorker, with the surprising side benefit.   It was written by a Boston-based surgeon, who argues CAKE’s best practices approach could be applied with great benefit to reducing healthcare costs and improving outcomes.)

Though the CCF operations are by far the company’s dominant concept, the company plans “measured” growth of its more upscale Grand Lux Café and has been tinkering for several years with its single store Rock Sugar Pan Asian Kitchen, it plans on opening a second unit under the newly rebranded Rock Sugar Southeast Asian Kitchen to better reflect its menu focus.  In 2016 the company also entered into a brand development agreement with Fox Restaurant Concepts to develop an upscale Italian concept, North Italia and a fast casual concept (Flower Child).  It has been on the lookout for a cast casual concept for several years and has also allocated resources to develop such a concept internally.

At the end of 2016, still at Q2’17, CAKE was debt free while the ratio of lease-adjusted debt to TTM EBITDAR at 12/31/16 was 2.1X.  These debt levels are well below full service peers whose ratios of debt to T12M EBITDA and lease-adjusted debt to EBITDAR average 1.7X and 3.9X, respectively.  Cash from operations was $302.5M in 2016, which net of $115.8M capex, left free cash flows of $186.7M, or a free cash flow margin of 8.2%.  In the same period the company returned $146M to investors ($106M stock repurchases and $42M dividends).  In 2017 it expects to return all free cash flow to investors.

CAKE: Current Developments (Per Q2’17 Earnings Release and Conference Call)

 CAKE met Q2’17 earnings estimates though sales were less than expected with a comp sales decline (after 29 consecutive positive quarters) of 0.5%. The weather and the ongoing volatility in consumer spending trends were cited as the primary reasons. More important than the reported results were the company indications that sales and traffic continued to be soft, and the guidance for the remainder of ’17 was lowered accordingly.

The details of Q2 included negative traffic of 2.4%, price increase of 2.2% and a slightly negative menu mix of 0.3% combining to create the negative 0.5% comp. It should be noted that CAKE once again outperformed its industry peers relative to minimizing traffic and sales declines, so there is no reason to think that CAKE has lost its competitive edge. Typical of the industry, labor costs increased by 70 bp,  just slightly offset by CGS that was lower by 10 bp.  “Other” operating costs were up 50 bp to 24.1%, the majority of which due to higher utilities and repair expense. D&A was up 30 bp to 4.1%, G&A down 20 bp to 6.2%, pre-opening costs down 20 bp to 0.2%. Income before taxes decreased by 8.2%, down 100 bp to 8.5% of sales. After a much lower tax rate, 21.5% vs. 27.2%, Net Income After Taxes was virtually flat at 6.7% of sales. During the first six months of ’17, cash flow from operations was $114M, of which $53M was used for capex, leaving $61M in free cash flow. During Q2 stock repurchases amounted to $21.3M, as part of $125M to be repurchased for all of ’17. A 21% increase in the dividend was also authorized.

Guidance relative to new locations was largely maintained for 2017: Seven new CCFs, One CCF relocation, the 2nd RockSugar, plus as many as 4 licensed locations. In terms of non-restaurant brand building, the Cheesecake Factory cupcake and cookie mix are now within WalMart stores nationwide and initial consumer response was described as “very strong”. Additional products are going to be similarly launched in ’17 and ’18.

Comp sales, however, are now expected to be down 1-2% in Q3 and down about 1% for the full year. EPS guidance was lowered to the range of $2.62-$2.70. Wage inflation is projected to be about 5%, and commodity inflation is expected at 2% in the back half of ‘17, versus recent deflation. The tax rate is expected to be just under 22% versus 27.2% in 2016 and 26.9% in 2015. The lower tax rate expectation is a result of new accounting rules related to stock based compensation rather than corporate tax reform, and changes from the latter could affect the final tax rate.

Though outperforming virtually all peers in terms of traffic and sales trends, the Company is, predictably, working to re-establish positive trends. They are primarily continuing to provide “every day value” in terms of a dining experience rather than running short lived promotions. Initiatives include a continuing emphasis on delivery and takeout, emphasizing CakePay (their mobile app), enhanced server training, and ongoing menu innovation.


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