Fool by Numbers will walk you through the third-quarter results. They weren't pretty, as store comps fell 1.6% and earnings fell nearly 15%. Management attributed the weakness to a "challenging year for many of us in the restaurant industry." In addition, it has been reviewing its stock option practices. On Nov. 20, Cheesecake announced that it concluded its investigation and would be recording after-tax compensation expenses of $5.5 million to take care of any past errors. The review also delayed the reporting of second-quarter results that were finally reported on Thursday.
Overall, higher labor, other, and general and administrative expenses offset an 11% increase in sales for the third quarter. Second-quarter earnings grew slightly, but both quarters saw negative comps from Cheesecake Factory stores. Fortunately, the company has a burgeoning new concept called Grand Lux Cafe, which is a bit more upscale than the namesake stores, and offers only 150 menu items versus 200 at the Cheesecake Factories.
Grand Lux saw a 5.5% and 6.7% jump in comps during the second and third quarters, respectively, across its eight stores versus 118 Cheesecake Factories currently. So far for 2006, management has opened 15 namesake stores and only one Grand Lux, with five more of the latter planned by the end of the fiscal year. Growth at Grand Lux looks to be ramping up, as six are scheduled to be opened next year, with approximately 15 Cheesecake Factories in the hopper for 2007.
With exposure to maybe only half of the top 100 metropolitan markets in the U.S., Cheesecake Factory has plenty of room to expand both restaurant concepts. Comps remain a bit challenging and may be due to a weak casual-dining environment, but they also speak to the fact that the restaurants are very popular and located in high-traffic areas. As a result, they tend to operate at full capacity, making it hard for comps to increase indefinitely.
The company also generates impressive cash flow. For the last three fiscal years, operating cash flow has exceeded reported net income by a wide margin. Management ploughs that capital into expanding the store base, but if one looks at depreciation and amortization as a proxy for maintenance capex, it's clear that existing stores throw off plenty of cash. I also like the fact that the company grows via internally generated capital, leaving minimal debt in the capital structure.
The restaurant space is extremely crowded and competitive, but Cheesecake Factory has somehow found a way to differentiate itself from other chains such as Applebee's
As long as current comparable weakness isn't indicative of growing underlying weakness at the namesake stores, expect plenty of expansion opportunities to drive shareholder value going forward.
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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.