Item 2. Management’s Discussion and Analysis
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 (“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 presently 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. These statements 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 (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (together with the Securities Act, the “Acts”). This includes, without limitation, the effects of the COVID-19 pandemic on our financial condition and our results of operation, including our expectation with respect to our ability to reopen and keep open our restaurants, financial guidance and projections and statements with respect to the acquisition of North Italia and Fox Restaurant Concepts LLC and expectations regarding accelerated and diversified revenue growth as a result of the acquisition of North Italia and FRC, as well as expectations of our future financial condition, results of operations, sales, cash flows, plans, targets, goals, objectives, performance, growth potential, competitive position and business; and our ability to: leverage our competitive strengths, including investing in or acquiring new restaurant concepts and expanding The Cheesecake Factory® brand to other retail opportunities; deliver comparable sales growth; provide a differentiated experience to customers; outperform the casual dining industry and increase our market share; leverage sales increases and manage flow through; manage cost pressures, including increasing wage rates, insurance costs and legal expenses, and stabilize margins; grow earnings; remain relevant to consumers; attract and retain qualified management and other staff; manage risks associated with the magnitude and complexity of regulations in the jurisdictions where our restaurants are located; increase shareholder value; find suitable sites and manage increasing construction costs; profitably expand our concepts domestically and in Canada, and work with our licensees to expand our concept internationally; support the growth of North Italia and other FRC restaurants; operate Social Monk Asian Kitchen; and utilize our capital effectively and continue to increase cash dividends and repurchase our shares. These forward-looking statements may be affected by various factors including: the rapidly evolving nature of the COVID-19 pandemic and related containment measures, including the potential for a complete shutdown of our restaurants, international licensee restaurants and our bakery operations; demonstrations, political unrest, potential damage to or closure of our restaurants and potential reputational damage to us or any of our brands; economic, public health and political conditions that impact consumer confidence and spending, including the impact of the COVID-19 pandemic and other health epidemics or pandemics on the global economy; acceptance and success of The Cheesecake Factory in international markets; acceptance and success of North Italia and the FRC concepts, Social Monk Asian Kitchen and other concepts; the risks of doing business abroad through Company-owned restaurants and/or licensees; foreign exchange rates, tariffs and cross border taxation; changes in unemployment rates; changes in laws impacting our business, including laws and regulations related to COVID-19 impacting restaurant operations and customer access to off- and on-premises dining; increases in minimum wages and benefit costs; the economic health of our landlords and other tenants in retail centers in which our restaurants are located, and our ability to successfully manage our lease arrangements with landlords; unanticipated costs that may arise in connection with a return to normal course of business, including potential negative impacts from furlough actions; the economic health of suppliers, licensees, vendors and other third parties providing goods or services to us; the timing of the resumption of our new unit development; compliance with debt covenants; strategic capital allocation decisions including share repurchases and dividends; the ability to achieve projected financial results; economic and political conditions that impact consumer confidence and spending; impact of tax reform legislation; adverse weather conditions in regions in which our restaurants are located; factors that are under the control of government agencies, landlords and other third parties; the risk, costs and uncertainties associated with opening new restaurants; and other risks and uncertainties detailed from time to time in our filings with the SEC. Such forward-looking statements include all other statements that are not historical facts, as well as statements that are preceded by, followed by or that include 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. These statements are based on our current expectations and involve risks and uncertainties which may cause results to differ materially from those set forth in such statements.
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In connection with the “safe harbor” provisions of the Acts, we have identified and are disclosing important factors, risks and uncertainties that could cause our actual results to differ materially from those projected in forward-looking statements made by us, or on our behalf. (See Part II, Item 1A of this report, “Risk Factors,” and Part I, Item 1A, “Risk Factors,” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.) 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 currently reasonable, any of the assumptions could be incorrect or incomplete, 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, and we undertake no obligation to publicly update or revise any forward-looking statements or to make any other forward-looking statements, whether as a result of new information, future events or otherwise, unless required to do so by law.
The below discussion and analysis, which contains forward-looking statements, should be read in conjunction with our interim unaudited condensed consolidated financial statements and related notes in Part I, Item 1 of this report and with the following items included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019: the audited consolidated financial statements and related notes in Part IV, Item 15; the "Risk Factors" included in Part I, Item 1A; the "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II, Item 7; and the cautionary statements included throughout this Form 10-Q. 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.
COVID-19 Pandemic
The Company is subject to risks and uncertainties as a result of the outbreak of, and local, state and federal governmental responses to, the COVID-19 pandemic which was declared a National Public Health Emergency on March 13, 2020. We have experienced significant disruptions to our business due to suggested and mandated social distancing and shelter-in-place orders, which resulted in the temporary closure of a number of restaurants across our portfolio while the remaining locations shifted to an off-premise only operating model on an interim basis. In late April 2020, certain jurisdictions began allowing the reopening of restaurant dining rooms , and we began to reopen dining rooms across our concepts the second week of May. However, restrictions on the type of operating model and occupancy capacity continue to change. The following table presents the number of restaurants and their operating model as of October 29, 2020:
The Cheesecake
Factory
North Italia
Other FRC
Other
Total
Indoor dining with limited capacity
187
(1)
21
24
36
268
Outdoor only with social distancing
17
2
—
1
20
Off-premise only
1
—
—
1
2
Currently closed
—
—
1
4
5
Total
205
23
25
42
295
(1) On average, The Cheesecake Factory restaurants with reopened dining rooms are operating at 50% capacity.
In our initial response to the pandemic, the Company and its Board implemented the following measures to preserve liquidity and enhance financial flexibility:
● Eliminated non-essential capital expenditures and expenses;
● Suspended new unit development;
● Reduced Board, executive and corporate support staff compensation;
● Furloughed approximately 41,000 hourly staff members;
● Engaged in discussions with our landlords regarding ongoing rent obligations, including the potential deferral, abatement and/or restructuring of rent otherwise payable during the period of the COVID-19 pandemic related closure;
● Increased borrowings under our revolving credit facility;
● Raised additional equity capital; and
● Suspended the dividend on our common stock and share repurchases.
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During the third quarter of fiscal 2020, we called back to work a majority of our staff members who were previously furloughed, and restored Board, executive and corporate support staff compensation. In addition, we resumed new unit development on a limited basis and will continue to evaluate the pace and quantity of new unit development as more clarity on the restaurant industry operating environment emerges.
We cannot predict how long the COVID-19 pandemic will last or whether it will reoccur, what additional restrictions may be enacted, to what extent we can maintain off-premise sales volumes or if individuals will be comfortable returning to our dining rooms during or following social distancing protocols and what long-lasting effects the COVID-19 pandemic may have on the full-service segment of the restaurant industry. The extent of the reopening process, along with the potential impact of the COVID-19 pandemic on economic conditions and consumer spending behavior, will determine the significance of the impact to our operating results and financial position.
In the first quarter of fiscal 2020, these considerable developments triggered the need to perform impairment assessments of our long-lived assets, goodwill and other intangible assets and a revaluation of contingent consideration associated with the Acquisitions. Future changes in estimates could further impact the carrying value of these items. (See Notes 3 and 4 for further discussion of impairment of long-lived and intangible assets, respectively. See Note 9 for further discussion of the revaluation of contingent consideration.)
See "Risk Factors" included in Part II, Item 1A for further discussion of risks associated with the COVID-19 pandemic.
General
The Cheesecake Factory Incorporated is a leader in experiential dining. We are culinary forward and relentlessly focused on hospitality. We currently own and operate 295 restaurants throughout the United States and Canada under brands including The Cheesecake Factory®, North Italia® and a collection within our FRC subsidiary. Internationally, 26 The Cheesecake Factory® restaurants operate under licensing agreements. Our bakery division operates two facilities that produce quality cheesecakes and other baked products for our restaurants, international licensees and third-party bakery customers.
Overview
Our strategy is driven by our commitment to customer satisfaction and is focused primarily on menu innovation, service and operational execution to continue to differentiate ourselves from other restaurant concepts, as well as to drive competitively strong performance that is sustainable. Financially, we are focused on prudently managing expenses at our restaurants, bakery facilities and corporate support center, and leveraging our size to make the best use of our purchasing power.
Investing in new Company-owned restaurant development is our top long-term capital allocation priority, with a focus on opening our concepts in premier locations within both new and existing markets. For The Cheesecake Factory concept, we target an average cash-on-cash return on investment of approximately 20% to 25% at the unit level. We target an average cash-on-cash return on investment of about 35% for the North Italia concept and 25% to 30% for the FRC concepts. Returns are affected by the cost to build restaurants, the level of revenues that each restaurant can deliver and our ability to maximize the profitability of restaurants. Investing in new restaurant development that meets our return on investment criteria is expected to support achieving mid-teens Company-level return on invested capital. In light of the COVID-19 pandemic, we will continue to evaluate the pace and quantity of new unit development as more clarity on the restaurant industry operating environment emerges.
Our overall revenue growth is primarily driven by revenues from new restaurant openings and increases in comparable restaurant sales. Changes in comparable restaurant sales come from variations in customer traffic, as well as in average check.
For The Cheesecake Factory concept, our strategy is to increase comparable restaurant sales by growing average check and stabilizing customer traffic through (1) continuing to offer innovative, high quality menu items that offer customers a wide range of options in terms of flavor, price and value (2) focusing on service and hospitality with the goal of delivering an exceptional customer experience and (3) continuing to provide our customers with convenient options for off-premise dining. We are continuing our efforts on a number of initiatives, including a greater focus on increasing customer throughput in our restaurants, leveraging the success of our gift card program, working with a third party to provide delivery services for our restaurants, increasing customer awareness of our online ordering capabilities, augmenting our marketing programs, enhancing our training programs and leveraging our customer satisfaction measurement platform.
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Average check is driven by menu price increases and/or changes in menu mix. We generally update The Cheesecake Factory restaurant menus twice a year, and our philosophy is to use price increases to help offset key operating cost increases in a manner that balances protecting both our margins and customer traffic levels. We have targeted menu price increases of approximately 2% to 3% annually, utilizing a market-based strategy to help mitigate cost pressure in higher-wage geographies. Currently, our menu pricing is at the higher end of this range. We will continue to evaluate future pricing decisions in light of the COVID-19 operating environment.
On October 2, 2019, we completed the acquisitions of North Italia and FRC, including Flower Child (the “Acquisitions”), which we expect will accelerate and diversify our revenue as once the restaurant operating environment stabilizes following the COVID-19 pandemic.
Margins are subject to fluctuations in commodity costs, labor, restaurant-level occupancy expenses, general and administrative (“G&A”) expenses and preopening expenses. Our objective is to recapture our pre-COVID-19 margins, and longer-term to drive margin expansion, by maintaining flat restaurant-level margins at The Cheesecake Factory concept, leveraging our bakery operations, international and consumer packaged goods royalty revenue streams and G&A expense over time, and optimizing our restaurant portfolio.
At the Company level, we generated $2.9 million of positive cash flow from operating activities during the third quarter of fiscal 2020. Our future cash flow performance will depend on the evolving COVID-19 regulatory landscape, as well as economic conditions and consumer behavior. We would expect cash generation to increase as the operating environment for the full-service segment of the restaurant industry normalizes from the COVID-19 impact. Longer-term, we plan to employ a balanced capital allocation strategy, comprised of: investing in new restaurants that are expected to meet our targeted returns, repaying borrowings under our $400 million unsecured revolving credit facility (the “Facility”) and reinstating our dividend and share repurchase program, the latter of which offsets dilution from our equity compensation program and supports our earnings per share growth. At present, our dividends on our common stock and share repurchases are suspended. Our ability to declare dividends and repurchase shares in the future will be subject to financial covenants under the Amended Facility, among other factors.
Longer-term, we believe our domestic revenue growth (comprised of our annual unit growth and comparable sales growth), combined with international expansion, planned debt repayment and an anticipated capital return program will support our long-term financial objective of 13% to 14% total return to shareholders, on average. We define our total return as earnings per share growth plus our dividend yield.
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Results of Operations
The following table presents, for the periods indicated, information from our consolidated statements of 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
Thirteen
Thirty-Nine
Thirty-Nine
Weeks Ended
Weeks Ended
Weeks Ended
Weeks Ended
September 29, 2020
October 1, 2019
September 29, 2020
October 1, 2019
Revenues
100.0
%
100.0
%
100.0
%
100.0
%
Costs and expenses:
Cost of sales
22.8
22.7
23.2
22.6
Labor expenses
38.7
36.4
39.2
36.3
Other operating costs and expenses
30.7
25.5
31.4
25.2
General and administrative expenses
7.3
6.2
8.2
6.3
Depreciation and amortization expenses
4.4
3.6
4.8
3.6
Impairment of assets and lease expiration
2.0
—
14.3
—
Acquisition-related costs
—
0.6
0.2
0.2
Acquisition-related contingent consideration and amortization
0.3
—
(0.3)
—
Preopening costs
0.5
0.4
0.6
0.4
Total costs and expenses
106.7
95.4
121.6
94.6
(Loss)/income from operations
(6.7)
4.6
(21.6)
5.4
Loss on investments in unconsolidated affiliates
—
(1.8)
—
(0.7)
Interest and other expense, net
(0.6)
—
(0.5)
—
(Loss)/income before income taxes
(7.3)
2.8
(22.1)
4.7
Income tax (benefit)/provision
(1.8)
0.1
(6.6)
0.3
Net (loss)/income
(5.5)
%
2.7
%
(15.5)
%
4.4
%
Thirteen Weeks Ended September 29, 2020 Compared to Thirteen Weeks Ended October 1, 2019
Revenues
Revenues decreased 11.7% to $517.7 million for the fiscal quarter ended September 29, 2020 compared to $586.5 million for the comparable prior year period, primarily due to a decrease in comparable restaurant sales, reflecting the effect of the COVID-19 pandemic, partially offset by additional revenue related to the acquired restaurants and new restaurant openings.
Revenue contribution from the acquired concepts in the third quarter of fiscal 2020 totaled $63.9 million. The Cheesecake Factory comparable sales declined by 23.3%, or $122.7 million, from the third quarter of fiscal 2019 driven by a decline in customer traffic of 40.4%, partially offset by average check growth of 17.1% (based on an increase of 3.0% in menu pricing and a 14.1% positive change in mix). Sales through the off-premise channel comprised approximately 45% of our restaurant sales during the third quarter of fiscal 2020 given the impact of COVID-19. We account for each off-premise order as one guest for traffic measurement purposes. In turn, the high mix of sales in the off-premise channel was the primary driver of the positive change in mix and also contributed to the decline in traffic, along with the broader impact of the COVID-19 pandemic. We implemented effective menu price increases of approximately 1.5% in both the first and third quarters of fiscal 2020, respectively. The Cheesecake Factory average sales per restaurant operating week decreased 23.2% to $156,643 in the third quarter of fiscal 2020 from $203,996 in the third quarter of fiscal 2019. Total operating weeks at The Cheesecake Factory restaurants increased 1.3% to 2,662 in the third quarter of fiscal 2020 compared to 2,628 in the prior year. North Italia comparable sales declined approximately 22% during the third quarter of fiscal 2020. North Italia average sales per restaurant operating week for the third quarter of fiscal 2020 was $94,561 based on 296 operating weeks.
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The Cheesecake Factory restaurants become eligible to enter the comparable sales base in their 19th month of operation. At September 29, 2020, there were five The Cheesecake Factory restaurants not yet in the comparable sales base. International licensed locations and restaurants that are no longer in operation, including those which we have relocated, are excluded from comparable sales calculations. North Italia restaurants become eligible to enter the comparable sales base in their 13th month of operations. At September 29, 2020 there were six North Italia restaurants not yet in the comparable sales base.
External bakery sales were $17.8 million for the third quarter of fiscal 2020 compared to $13.8 million in the comparable prior year period.
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 22.8% and 22.7% in the third quarters of fiscal 2020 and 2019, respectively, reflecting a shift in sales mix.
Labor Expenses
As a percentage of revenues, labor expenses, which include restaurant-level labor costs and bakery direct production labor, including associated fringe benefits, were 38.7% and 36.4% in the third quarters of fiscal 2020 and 2019, respectively. This increase was primarily due to the cost of maintaining our full restaurant management team and group medical benefits in the reduced sales environment, partially offset by lower hourly labor.
Other Operating Costs and Expenses
Other operating costs and expenses consist of restaurant-level occupancy expenses (rent, common area expenses, insurance, licenses, taxes and utilities), other operating expenses (excluding food costs and labor expenses, which are reported separately) and bakery production overhead and distribution expenses. As a percentage of revenues, other operating costs and expenses were 30.7% and 25.5% in the third quarters of fiscal 2020 and 2019, respectively. This variance was primarily driven by sales deleverage, increased marketing expenses and costs associated with COVID-19 such as additional sanitation and personal protective equipment.
G&A Expenses
G&A expenses consist of the restaurant management recruiting and training program, restaurant field supervision, corporate support and bakery administrative organizations, as well as gift card commissions to third-party distributors. As a percentage of revenues, G&A expenses were 7.3% and 6.2% in the third quarters of fiscal 2020 and 2019, respectively. This variance was primarily due to sales deleverage.
Depreciation and Amortization Expenses
As a percentage of revenues, depreciation and amortization expenses increased to 4.4% in the third quarter of fiscal 2020 from 3.6% in the comparable prior year period due primarily to sales deleverage.
Impairment of Assets and Lease Terminations
During the third quarter of fiscal 2020, we recorded impairment of assets and lease terminations expense of $10.4 million related to lease termination costs and accelerated depreciation for two Grand Lux Cafe locations, one that discontinued operations during the quarter and another that is expected to close by the end of the year, RockSugar Southeast Asian Kitchen, which is scheduled to discontinue operations at the end of the year and one Flower Child location that will not reopen following its COVID-related closure.
Acquisition-Related Costs
In the third quarter of fiscal 2020 and fiscal 2019, we recorded $39,307 and $3.2 million, respectively, of costs to effect and integrate the Acquisitions.
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Acquisition-Related Contingent Consideration, Compensation and Amortization
In the third quarter of fiscal 2020, we recorded $1.4 million of acquisition-related contingent consideration, compensation and amortization, reflecting changes in the fair value of the deferred and contingent consideration and compensation liabilities and amortization of acquired definite-lived licensing agreements.
Preopening Costs
Preopening costs were $2.4 million and $2.5 million in the third quarters of fiscal 2020 and 2019, respectively. We opened two Flower Child restaurants in the third quarter of fiscal 2020 compared to one The Cheesecake Factory restaurant in the comparable prior year period. Preopening costs include all costs to relocate and compensate restaurant management staff members during the preopening period, costs to recruit and train hourly restaurant staff members, and wages, travel and lodging costs for our opening training team and other support staff members. Also included 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.
Loss on Investment in Unconsolidated Affiliates
Loss on investment in unconsolidated affiliates, which represented our share of pre-acquisition losses incurred by North Italia and Flower Child was $10.3 million in the third quarter of fiscal 2019. There was no corresponding amount for the third quarter of fiscal 2020 as we acquired the outstanding equity interests in these concepts in the fourth quarter of fiscal 2019.
Interest and Other (Expense)/Income, Net
Interest and other expense, net was $2.9 million of expense for the third quarter of fiscal 2020 compared to $6,051 of income in the comparable prior year period. This variance was primarily due to increased borrowings to effect the Acquisitions and to enhance our financial flexibility in response to the COVID-19 pandemic, as well as a higher interest rate on our Amended Facility.
Income Tax (Benefit)/Provision
Our effective income tax rate was 25.0% and 3.2% for the third quarters of fiscal 2020 and 2019, respectively. The increase resulted primarily from a lower proportion of employment credits in relation to pre-tax (loss)/income and a benefit arising from the expected carryback of our anticipated fiscal 2020 loss to prior years when the federal statutory rate was 35%. Without the carryback provisions of the CARES Act, we would expect the fiscal 2020 loss to provide a tax benefit at the statutory rate of 21%. The 14% rate benefit is reflected primarily in the annual effective tax rate, although the portion representing prior year temporary differences that are estimated to reverse in fiscal 2020 and become part of the fiscal 2020 loss carryback was recognized as a discrete item in the first quarter of fiscal 2020.
Thirty-Nine Weeks Ended September 29, 2020 Compared to Thirty-Nine Weeks Ended October 1, 2019
Revenues
Revenues decreased 20.1% to $1,428.7 million for the first three quarters of fiscal 2020 compared to $1,788.7 million for the comparable prior year period, primarily due to a decline in comparable restaurant sales, reflecting the impact of the COVID-19 pandemic, partially offset by additional revenue related to the acquired restaurants and new restaurant openings.
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Revenue contribution from the acquired concepts in the first three quarters of fiscal 2020 totaled $185.1 million. The Cheesecake Factory comparable sales declined by 31.1%, or $498.4 million, from the first three quarters of fiscal 2019 driven by a decline in customer traffic of 43.5%, partially offset by average check growth of 12.4% (based on an increase of 3.1% in menu pricing and a 9.3% positive change in mix). Sales through the off-premise channel comprised approximately 43% of our restaurant sales during the first three quarters of fiscal 2020 given the impact of COVID-19. In turn, the high mix of sales in the off-premise channel was the primary driver of the positive change in mix and also contributed to the decline in traffic, along with the broader impact of the COVID-19 pandemic. The Cheesecake Factory average sales per restaurant operating week decreased 30.9% to $143,747 in the first three quarters of fiscal 2020 from $208,042 in the first three quarters of fiscal 2019. Total operating weeks at The Cheesecake Factory restaurants increased 1.4% to 7,976 in the first three quarters of fiscal 2020 compared to 7,865 in the prior year. North Italia comparable sales declined approximately 32% during the first three quarters of fiscal 2020. North Italia average sales per restaurant operating week for the first three quarters of fiscal 2020 was $85,315 based on 847 operating weeks.
External bakery sales were $46.3 million for the first three quarters of fiscal 2020 compared to $39.1 million in the comparable prior year period.
Cost of Sales
As a percentage of revenues, cost of sales was 23.2% and 22.6% in the first three quarters of fiscal 2020 and 2019, respectively. The increase was primarily driven by a shift in sales mix, as well as higher dairy costs.
Labor Expenses
As a percentage of revenues, labor expenses were 39.2% and 36.3% in the first three quarters of fiscal 2020 and 2019, respectively. This increase was primarily due to the cost of maintaining our full restaurant management team in the reduced sales environment, as well as higher group medical insurance costs, reflecting both higher large claims activity and the costs associated with healthcare benefits for our furloughed staff members, partially offset by a benefit from the Employee Retention Credit in the CARES Act.
Other Operating Costs and Expenses
As a percentage of revenues, other operating costs and expenses were 31.4% and 25.2% in the first three quarters of fiscal 2020 and 2019, respectively. This variance was primarily driven by sales deleverage, increased marketing expenses and costs associated with COVID-19 such as additional sanitation and personal protective equipment, partially offset by lower restaurant incentive compensation costs.
G&A Expenses
As a percentage of revenues, G&A expenses were 8.2% and 6.3% in the first three quarters of fiscal 2020 and 2019, respectively. This variance was primarily due to sales deleverage, partially offset by lower corporate incentive compensation costs.
Depreciation and Amortization Expenses
As a percentage of revenues, depreciation and amortization expenses increased to 4.8% in the first three quarters of fiscal 2020 from 3.6% in the comparable prior year period due primarily to sales deleverage.
Impairment of Assets and Lease Terminations
During the first three quarters of fiscal 2020, we recorded $204.7 million of impairment of assets and lease terminations expense related to the impairment of goodwill, trade names, trademarks and licensing agreements associated with the Acquisitions and long-lived assets for one The Cheesecake Factory, one North Italia, two Other FRC and four Other restaurants, as well as lease termination costs and accelerated depreciation for one The Cheesecake Factory restaurant, two Grand Lux Cafe locations, RockSugar Southeast Asian Kitchen and one Flower Child location. See Notes 3 and 4 of Notes Condensed Consolidated Financial Statements in Part 1, Item 1 of this report for further discussion of our long-lived and intangible assets, respectively. We recorded no impairment of assets and lease terminations expense in the first three quarters of fiscal 2019.
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Acquisition-Related Costs
In the first three quarters of fiscal 2020 and fiscal 2019, we recorded $2.3 million and $3.2 million, respectively, of costs to effect and integrate the Acquisitions.
Acquisition-Related Contingent Consideration, Compensation and Amortization
In the first three quarters of fiscal 2020, we recorded a benefit of $4.0 million in acquisition-related contingent consideration, compensation and amortization, reflecting a $5.6 million decrease in the fair value of the contingent consideration and compensation liabilities primarily related to impact of the COVID-19 pandemic, partially offset by an increase of $1.2 million in the deferred consideration liability and $0.4 million in amortization of acquired definite-lived licensing agreements.
Preopening Costs
Preopening costs were $7.6 million and $6.9 million in the first three quarters of fiscal 2020 and 2019, respectively. We opened one North Italia and three Flower Child locations in the first three quarters of fiscal 2020 compared to two The Cheesecake Factory restaurants and our initial location of Social Monk Asian Kitchen in the comparable prior year period.
Loss on Investment in Unconsolidated Affiliates
Loss on investment in unconsolidated affiliates, which represented our share of pre-acquisition losses incurred by North Italia and Flower Child was $13.4 million in the first three quarters of fiscal 2019. There was no corresponding amount for the first three quarters of fiscal 2020 as we acquired the outstanding equity interests in these concepts in the fourth quarter of fiscal 2019.
Interest and Other (Expense)/Income, Net
Interest and other expense, net was $7.0 million of expense for the first three quarters of fiscal 2020 compared to $16,986 in the comparable prior year period. This variance was primarily due to increased borrowings on our Facility to effect the Acquisitions and enhance our financial flexibility in response to the COVID-19 pandemic.
Income Tax (Benefit)/Provision
Our effective income tax rate was 30.0% and 6.2% for the first three quarters of fiscal 2020 and 2019, respectively. The increase resulted primarily from a lower proportion of employment credits in relation to pre-tax (loss)/income and a benefit arising from the expected carryback of our anticipated fiscal 2020 loss to prior years when the federal statutory rate was 35%. Without the carryback provisions of the CARES Act, we would expect the fiscal 2020 loss to provide a tax benefit at the statutory rate of 21%. The 14% rate benefit is reflected primarily in the annual effective tax rate, although the portion representing prior year temporary differences that are estimated to reverse in fiscal 2020 and become part of the fiscal 2020 loss carryback was recognized as a discrete item in the first quarter of fiscal 2020.
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Non-GAAP Measures
Adjusted net income and adjusted 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 (loss)/income and diluted net (loss)/income per common share the impact of items we do not consider indicative of our ongoing operations. To reflect the potential impact of the conversion of our convertible preferred stock into common stock, we exclude the preferred dividend and direct and incremental preferred stock issuance costs, and assume all convertible preferred shares convert to common stock. We use these non-GAAP financial measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. 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 (loss)/income and diluted net (loss)/income per common share to the corresponding adjusted measures (in thousands, except per share data):
Thirteen
Thirteen
Thirty-Nine
Thirty-Nine
Weeks Ended
Weeks Ended
Weeks Ended
Weeks Ended
September 29, 2020
October 1, 2019
September 29, 2020
October 1, 2019
Net (loss)/income available to common stockholders
$
(33,184)
$
16,090
$
(239,837)
$
78,584
Dividends on preferred stock
4,838
—
8,532
—
Direct and incremental preferred stock issuance costs
—
—
10,257
—
COVID-19 related costs (1)
2,558
—
17,579
—
Impairment of assets and lease terminations
10,402
—
204,731
—
Acquisition-related costs
39
3,190
2,343
3,190
Acquisition-related contingent consideration, compensation and amortization expenses
1,439
—
(3,992)
—
Loss on investments in unconsolidated affiliates
—
10,345
—
13,439
Tax effect of adjustments (2)
(3,754)
(3,519)
(57,372)
(4,323)
Adjusted net (loss)/income
$
(17,662)
$
26,106
$
(57,759)
$
90,890
Diluted net (loss)/income per common share
$
(0.76)
$
0.36
$
(5.47)
$
1.76
Dividends on preferred stock
0.09
—
0.17
—
Direct and incremental preferred stock issuance costs
—
—
0.21
—
Assumed impact of potential conversion of preferred stock into common stock (3)
0.13
—
0.60
—
COVID-19 related costs (1)
0.05
—
0.36
—
Impairment of assets and lease terminations
0.20
—
4.16
—
Acquisition-related costs
—
0.07
0.05
0.07
Acquisition-related contingent consideration, compensation and amortization expenses
0.03
—
(0.08)
—
Loss on investments in unconsolidated affiliates
—
0.23
—
0.30
Tax effect of adjustments (2)
(0.07)
(0.08)
(1.17)
(0.10)
Adjusted net (loss)/income per share (4)
$
(0.33)
$
0.59
$
(1.17)
$
2.04
(1) Represents incremental costs associated with the COVID-19 pandemic such as additional sanitation, personal protective equipment, and healthcare benefits and other expenses associated with furloughed staff members. For the thirteen weeks ended September 29, 2020, the Company recorded $2.6 million for these costs with approximately $0.4 million reflected in labor expenses, $2.1 million in other operating expenses and $0.1 million in G&A expenses. For the thirty-nine weeks ended September 29, 2020, the Company recorded $17.6 million for these costs with approximately $2.2 million in cost of sales, $9.9 million reflected in labor expenses, $5.1 million in other operating expenses and $0.4 million in G&A expenses.
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(2) Based on the federal statutory rate and an estimated blended state tax rate, the tax effect on all adjustments assumes a 26% tax rate.
(3) Represents the impact of assuming the conversion of preferred stock into common stock (9,163,043 shares and 5,394,188 shares for the thirteen weeks and thirty-nine weeks ended September 29, 2020, respectively), resulting in an assumption of 53,062,945. and 49,243,370 weighted-average common shares outstanding for the third quarter and first three quarters of fiscal 2020, respectively. Beginning in the third quarter of fiscal 2020, we revised the method used to calculate the potential impact of the conversion of the Company's preferred stock to common stock for purposes of determining adjusted net (loss)/income per share (non-GAAP). Instead of assuming preferred shares are converted to common shares as of the beginning of each period presented, we now utilize a weighted average shares outstanding approach to be consistent with the approach used for outstanding common shares. Under this methodology, the revised adjusted net loss per share for the second quarter of fiscal 2020 was $0.90.
(4) Adjusted net (loss)/ income per share may not add due to rounding.
Fourth Quarter Fiscal 2020 Outlook
With the number of indoor dining rooms we currently have open and should we continue to generate comparable sales levels under continued capacity restrictions at The Cheesecake Factory restaurants at approximately the quarter-to-date through October 27th level of negative 7%, we anticipate generating positive operating profit and earnings per share for the fourth quarter of fiscal 2020.
Based on the above assumptions, we expect to generate positive cash flow from operating activities and anticipate $10 million to $15 million in capital expenditures for the fourth quarter. A debt repayment of $96.0 million and a $17.3 million acquisition installment payment to FRC were both made in October 2020.
Fiscal 2021 Outlook
For fiscal 2021, we are currently estimating commodity cost inflation of approximately 2%, and while we are still evaluating the potential effects of COVID-19 on the labor environment, we expect hourly wage rate inflation to be slightly more favorable in fiscal 2021 versus recent years based on current governmental roadmaps for minimum wage.
We are in the early stages of developing our initial capital deployment plans for fiscal 2021. Depending on the course of the pandemic, we could open as many as 12 to 14 new restaurants in fiscal 2021 across our portfolio of concepts. We anticipate approximately $105 million in capital expenditures to support this level of unit development, as well as required maintenance on our restaurants. We will refine these assumptions as more clarity on the operating environment emerges. We will also make a $17.3 million acquisition installment payment to FRC.
Liquidity and Capital Resources
The following table presents, for the periods indicated, a summary of our key cash flows from operating, investing and financing activities (in millions):
Thirty-Nine
Thirty-Nine
Weeks Ended
Weeks Ended
September 29, 2020
October 1, 2019
Cash (used in)/provided by operating activities
$
(32.7)
$
116.2
Additions to property and equipment
(38.3)
(46.7)
Growth capital provided to unconsolidated affiliates
—
(25.5)
Net borrowings on credit facility
86.0
325.0
Preferred stock issuance, net of issuance costs
189.7
—
Proceeds from exercise of stock options
0.1
6.5
Cash dividends paid
(15.8)
(45.0)
Treasury stock purchases
(3.2)
(50.6)
During the thirty-nine weeks ended September 29, 2020, our cash and cash equivalents increased by $185.4 million to $243.8 million. This increase was primarily attributable to issuance of preferred stock and borrowings on the Amended Facility, partially offset by additions to property and equipment, cash used in operating activities and dividend payments.
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Cash flows from operations decreased by $148.9 million from the first three quarters of fiscal 2019 primarily due to the impact of the COVID-19 pandemic. Typically, our requirement for working capital has not been significant since our restaurant customers pay for their food and beverage purchases in cash or cash equivalents at the time of sale and we are able to sell many of our restaurant inventory items before payment is due to the suppliers of such items. However, this dynamic shifted during the second quarter of fiscal 2020 as all of our restaurants temporarily closed their dining rooms due to the COVID-19 pandemic. At the Company level, we generated $2.9 million of positive cash flow from operating activities during the third quarter of fiscal 2020. Our future cash flow performance will depend on the evolving COVID-19 regulatory landscape, as well as economic conditions and consumer behavior. We would expect cash generation to increase as the operating environment for the full-service segment of the restaurant industry normalizes from the COVID-19 impact.
Capital expenditures were $38.3 million in the first three quarters of fiscal 2020 compared to $46.7 million in the comparable prior year period. We opened one North Italia and three Flower Child locations in the first three quarters of fiscal 2020 compared to two The Cheesecake Factory restaurants and our initial location of Social Monk Asian Kitchen in the comparable prior year period. We currently have six locations under development, and we are monitoring operating conditions in their respective markets to determine when to move forward with these new unit openings. We will continue to evaluate the pace and quantity of new unit development as more clarity on the restaurant industry operating environment emerges. We currently estimate cash capital expenditures to be approximately $10 million to $15 million in the fourth quarter of fiscal 2020 for completion of construction of the units under development and for necessary maintenance on our existing restaurants. We expect one The Cheesecake Factory location and two restaurants within our FRC subsidiary to open in the fourth quarter of fiscal 2020.
As of September 29, 2020, we maintained the Amended Facility, a $400 million unsecured revolving credit facility, $40 million of which can be used for issuances of letters of credit. The Amended Facility, which terminates on July 30, 2024, contains a commitment increase feature that could provide for an additional $125 million in available credit upon our request and the satisfaction of certain conditions. Certain of our material subsidiaries have guaranteed our obligations under the Facility. During the first three quarters of fiscal 2020, we increased our borrowings under the Facility to bolster our cash position and enhance financial flexibility. At September 29, 2020, we had net availability for borrowings of $0.6 million, based on a $376.0 million outstanding debt balance and $23.4 million in standby letters of credit. The Facility limits cash distributions with respect to our equity interests, such as cash dividends and share repurchases, and sets forth negative covenants that restrict indebtedness, liens, investments, sales of assets, fundamental changes and other matters. As of September 29, 2020, we were in compliance with the covenants set forth in the Amended Facility. (See Note 7 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for further discussion of our long-term debt.)
In addition, as further discussed in Note 11 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report, to increase our liquidity given the impact of the COVID-19 pandemic on our operations, we issued 200,000 shares of Series A Convertible Preferred Stock on April 20, 2020 for an aggregate purchase price of $200.0 million less issuance costs of $10.3 million.
In fiscal 2012, our Board approved the initiation of a cash dividend to our common stockholders, which is subject to quarterly Board approval. Future decisions to pay or to increase or decrease dividends on our common stock are at the discretion of the Board and will be dependent on our operating performance, financial condition, capital expenditure requirements, limitations on cash distributions pursuant to the terms and conditions of the Facility and applicable law, and other such factors that the Board considers relevant.
Under authorization by our Board to repurchase up to 56.0 million shares of our common stock, we have cumulatively repurchased 53.0 million shares at a total cost of $1,696.4 million through September 29, 2020 with 12,567 repurchased at a cost of $0.4 million during the third quarter of fiscal 2020 to satisfy tax withholding obligations on vested restricted share awards. Our share repurchase authorization does not have an expiration date, does not require us to purchase a specific number of shares and may be modified, suspended or terminated at any time. We make the determination to repurchase shares based on several factors, including current and forecasted operating cash flows, capital needs associated with new restaurant development and maintenance of existing locations, dividend payments, debt levels and cost of borrowing, obligations associated with the Acquisitions, our share price and current market conditions. The timing and number of shares repurchased are also subject to legal constraints and financial covenants under the Facility that limit share repurchases based on a defined ratio. (See Note 11 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for further discussion of our repurchase authorization and methods.)
To preserve liquidity during the COVID-19 pandemic and in conjunction with the terms of our Amended Facility, our Board suspended the quarterly dividend on our common stock, as well as share repurchases. (See Note 7 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for further discussion of our Facility.)
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The Acquisitions included a provision for contingent consideration which is payable on October 2, 2024 and is based on achievement of revenue and profitability targets for the FRC brands other than North Italia and Flower Child, with considerations made in the event we undergo a change in control or divest any FRC brand (other than North Italia and Flower Child). We are also required to provide financing to FRC in an amount sufficient to support achievement of these targets during the five years ending October 2, 2024.
As of September 29, 2020, we had no financing transactions, arrangements or other relationships with any unconsolidated entities or related parties. Additionally, we had no financing arrangements involving synthetic leases or trading activities involving commodity contracts.
Based on our current projections, we believe that during the upcoming 12 months our cash and cash equivalents, combined with expected cash flows provided by operations, anticipated cash refunds from our net operating loss carryback claims and available borrowings under the Amended Facility, should be sufficient in the aggregate to meet our short-term obligations. See Note 13 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for discussion of our income taxes.
See “Risk Factors” included in Part II, Item 1A for further discussion of risks associated with the COVID-19 pandemic.
Recent Accounting Pronouncements
See Note 1 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a summary of new accounting standards.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.