The Cheesecake Factory Incorporated (NASDAQ:CAKE) Q3 2023 Earnings Call Transcript

The Cheesecake Factory Incorporated (NASDAQ:CAKE) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good afternoon. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to The Cheesecake Factory Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Thank you. Etienne Marcus, Vice President of Finance and Investor Relations, you may begin your conference.

Etienne Marcus: Good afternoon and welcome to our third quarter fiscal 2023 earnings call. On the call with me today are David Overton, our Chairman and Chief Executive Officer; David Gordon, our President; and Matt Clark, our Executive Vice President and Chief Financial Officer. Before we begin, let me quickly remind you that during this call, items will be discussed that are not based on historical facts and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could be materially different from those stated or implied in forward-looking statements as a result of the factors detailed in today’s press release, which is available on our website at investors.thecheesecakefactory.com and in our filings with the Securities and Exchange Commission.

A close-up of a table of people enjoying their meal and conversing in a Denny’s restaurant.

All forward-looking statements made on this call speak only as of today’s date, and the company undertakes no duty to update any forward-looking statements. In addition, during this conference call, when discussing comparable sales, we will be referring to comparable sales on an operating week basis, unless specifically stated otherwise. We will also be presenting results on an adjusted basis, which excludes impairment of assets, lease terminations and acquisition-related expenses. An explanation of our use of non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures appear in our press release on our website as previously described. David Overton will begin today’s call with some opening remarks, and David Gordon will provide an operational update.

Matt will then review our third quarter results and provide a financial update. Following that, we’ll open the call to questions. With that, I’ll turn the call over to David Overton.

David Overton: Thank you, Etienne. Third quarter consolidated revenues increased 5.9% over the prior year to $830 million, led by comparable sales growth The Cheesecake Factory restaurants of 2.4% versus the prior year and 12.6% versus 2019, exceeding the Knapp-Track and Black Box casual dining indices for both time periods. Our strategy will always revolve around what we do best, delivering exceptional service and hospitality and delicious, memorable experiences for our valued guests. We believe our position as an experiential dining leader will continue to differentiate us in the industry and drive profitable sales growth over the long term. And with the improved restaurant staffing levels, our best-in-class operators have been able to increase their focus on consistently executing our strategy.

We believe this contributed to third quarter comparable sales at The Cheesecake Factory, increasing sequentially despite the softening sales environment and importantly, traffic at The Cheesecake Factory meaningfully outperformed the broader casual dining industry. On the development front, we opened 2 Cheesecake Factory restaurants to strong demand during the third quarter and subsequent to quarter end 2 FRC locations. We continue to make progress against our pipeline and construction is ongoing on all of our restaurants we had previously planned to open this year. However, consistent with the trends seen throughout the industry, we continue to experience challenges beyond our control, particularly with permitting delays, pushing some of our opening dates to late December.

In order to adhere to our proven development process and ensure new restaurants open well positioned to succeed, we have strategically decided to move some of our openings into the first quarter of next year. As such, we now expect to open as many as 16 new restaurants in 2023 and 4 to 6 new restaurants in the first quarter of 2024. Thus, between 16 openings for this year and 4 to 6 for next quarter, we are effectively at the 20 to 22 new restaurant openings we had previously anticipated earlier this year. The new restaurant openings for 2023 include as many as 5 Cheesecake Factories, 4 North Italia and 7 FRC restaurants, including 1 Flower Child location. Last week, our fifth location in Mainland China opened, including this location, we now expect 2 Cheesecake Factory restaurants to open internationally under licensing agreements in 2023.

Despite the ongoing permitting challenges, we continue to accelerate our development activity and build our pipeline. At this time, our expectations for 2024 are to take another measurable step towards achieving our objective of 7% annual unit growth. I’m also excited to share that last week, we announced plans to develop our third bakery production facility in Charlestown, Indiana. Upon completion, the facility will produce the Cheesecake Factory’s cheesecakes and Signature bakery products for our restaurants and other retailers in addition to providing anticipated distribution efficiencies. Our vertically integrated bakery is a distinct competitive advantage with our desserts driving the strong affinity for The Cheesecake Factory brand as illustrated by our industry-leading dessert sales.

Looking ahead, we will continue to leverage our competitive strength, including the scale of our business, our differentiated brands, best-in-class operators and balance sheet to drive shareholder value and market share gains. With that, I will now turn the call over to David Gordon to provide some additional details on our operations and marketing.

David Gordon: Thank you, David. Since the start of the year, our operating team’s training and development have been firmly centered on the fundamentals of the restaurant industry, great food, great service and great ambience as well as on reinforcing the operational standards that Cheesecake Factory has been built on. We believe these to be foundational for running successful restaurants and delivering consistent performance. This year’s General Managers Conference content was designed with the same principles of focus in mind. The theme was cultivating excellence, and we held several informative programs, panels, speaker-led trainings and leadership seminars focused on hospitality, leadership, executing and performance management with the intent that our general managers take these insights and learnings back to their restaurants to improve operational execution, celebrate wins and further develop their people.

As David alluded to earlier, we believe our increased focus on consistent execution and operational excellence is yielding positive results across multiple key areas. Let me just share a couple. First, we have seen measurable improvements in guest satisfaction. Our internally measured net promoter score metrics across both the dine-in and off-premise are consistently exceeding pre-pandemic levels. In addition, our volume of reviews on third-party sites has not only increased since the start of the year, but the aggregate rating of these reviews has meaningfully improved and continued to trend incrementally more positive. Second, our enviable staffing position continues to improve. Our industry-leading retention rates are now running above pre-pandemic levels.

Furthermore, our already high staff engagement scores improved significantly from a year ago. These improvements have supported the continued moderation in wage inflation, which is now trending below pre-pandemic levels. As David mentioned earlier, we believe these operational improvements contributed to both comparable sales and traffic outperforming the industry in the latest quarter. Now turning to sales trends. The Cheesecake Factory off-premise sales for the third quarter totaled 21% of sales, just below second quarter levels, consistent with historical seasonality of lower off-premise mix during the summer months, potentially indicating a return to more normal seasonal patterns. On-premise incident rates remained above 2019 levels with no material change to daypart mix.

However, incident rates continue to normalize on a year-over-year basis as we lap the heightened spending from the prior year. North Italia third quarter comparable sales increased a solid 8% from the prior year and 28% versus 2019. The 4-wall margins for the adjusted mature North Italia locations, was 12.5%, down from 15.4% in the previous quarter. North Italia margins were impacted by seasonally lower sales and higher utility costs, which were exacerbated by record high temperatures in the Southwest where North Italia has a higher level of concentration. We just rolled out a 3.7% menu price increase in October in part to support our margin objectives for this concept. We remain excited about the potential growth trajectory of various concepts within FRC’s portfolio, including culinary dropout.

We just opened our newest culinary dropout in Charlotte, North Carolina to strong demand with average sales of $175,000 over the first couple of weeks. We now have 9 locations open, averaging over $200,000 per week so far this year. Culinary dropout strong cash-on-cash returns positions this concept as one of the more promising experiential concepts within FRC’s portfolio given the attractive unit economics. We are testing the geographic portability and currently have plans to open another location this year in Atlanta as well as another 2 to 3 locations a year over the next 2 years across the Southeast, Texas and Southern California. Before I turn the call over to Matt, let me provide a brief update on our rewards program. As a reminder, our overarching objective is to leverage data analytics and insights to engage more effectively with our guests and drive incremental sales while maintaining our restaurant level margins.

While we are just now entering our fifth month of the program following the national launch of Cheesecake Rewards on June 1, we continue to be encouraged by the level of member activity and engagement we are seeing. As we have previously stated, we’re taking a very deliberate approach as we expand the program and therefore, do not anticipate seeing a measurable impact to sales for the first year or so. That being said, early demand continues to exceed our internal expectations and member satisfaction scores are over-indexing, reinforcing our belief that we are on the right path. During the fourth quarter, we will be testing additional acquisition tactics and activation campaigns to better understand the key elements of our various strategies that resonate well with rewards members and are the most effective in increasing membership enrollment and engagement and driving frequency.

And with that, let me turn the call over to Matt for our financial review.

Matt Clark: Thank you, David. Let me first provide a high-level recap of our third quarter results versus our expectations I outlined last quarter. Total revenues of $830.2 million increased 5.9% over last year despite finishing just under the low end of the range. Adjusted net income margin of 2.3% was also just short of the guidance we provided, predominantly driven by the lower sales. G&A and depreciation combined as a percent of sales were slightly better than expectations. And we returned $27.7 million to our shareholders in the form of dividends and stock repurchases. Over the past 12 months, our financial results have substantially stabilized, forming a foundation we believe we can build from. Over that period, our total revenues were $3.46 billion, with adjusted net income margin of 3.5% and adjusted EPS of $2.44.

Now turning to some more specific details around the quarter. Third quarter sales at the Cheesecake Factory restaurants were $628.1 million. Comparable sales increased 2.4% versus the prior year and 12.6% versus 2019. Sales for North Italia were $62.4 million, a 15% increase over prior year, supported by comparable sales growth of 8% versus prior year. Comparable sales versus 2019 increased 28%. Other FRC sales totaled $58.6 million, up 12% from the prior year, and sales per operating week were $121,900. Flower Child sales totaled $32.2 million, up 11% from the prior year, and sales per operating week were $80,000 and external bakery sales were $17.4 million during the third quarter of fiscal 2023. Now moving to year-over-year expense variance commentary.

With the cumulative menu pricing we have implemented over the past 12 months to help offset inflation, we continue to realize measurable year-over-year improvement across several key line items in the P&L. Specifically, cost of sales decreased 170 basis points, primarily driven by higher menu pricing than commodity inflation. Labor decreased 110 basis points, predominantly driven by pricing leverage, improved staffing levels and slightly lower medical insurance expenses. Other operating expenses decreased 10 basis points, mostly driven by pricing leverage, lapping some elevated utilities and to-go costs and partially offset by marketing costs, including the rewards program launch. G&A increased 10 basis points and depreciation decreased 10 basis points as a percent of sales.

Pre-opening costs were $6.7 million in the quarter compared to $4.3 million in the prior year period. We opened 2 Cheesecake Factory restaurants during the third quarter versus 3 restaurants in the third quarter of 2022. Higher pre-opening costs for the quarter were mostly driven by delays in opening dates and the mix of concepts. And in the third quarter, we recorded a net expense of $1.5 million primarily related to FRC acquisition-related expenses. Third quarter GAAP diluted net income per share was $0.37. Adjusted diluted net income per share was $0.39. Now turning to our balance sheet and capital allocation. The company ended the quarter with total available liquidity of approximately $300.5 million, including a cash balance of about $64 million and approximately $236.5 million available on our revolving credit facility.

Total debt outstanding was unchanged at $475 million in principal. CapEx totaled approximately $37 million during the quarter for new unit development and maintenance. During the quarter, we completed approximately $14.6 million in share repurchases and returned just over $13.1 million to shareholders via our dividend. While we will not be providing specific comparable sales and earnings guidance, we will provide our updated thoughts on our underlying assumptions for Q4 2023 and full year 2024 revenue and net income margin. For Q4, based on our quarter-to-date performance, most recent trends and assuming no material operating or consumer disruptions, we anticipate total revenues to be between $870 million and $890 million. This essentially assumes a continuation of the trends since the end of September, which notably reflects a meaningful improvement versus 2019 sales levels as compared to our Q3 results.

Next, at this time, we expect effective commodity inflation of low single digits for Q4 as our broad market basket continues to stabilize. We are modeling net total labor inflation of about mid-single digits when factoring in the latest trends in wage rates, which, similar to our commodities continues to normalize as well as channel mix and other components of labor. Based on these assumptions, we anticipate net income margin to be about 4.25% at the midpoint of the sales range. This reflects higher pre-opening expense to support our planned restaurant openings, which we expect to be approximately $10 million in the quarter. With regard to development, as David Overton highlighted earlier, we plan to open as many as 16 new restaurants this year across our portfolio of concepts with as many as 9 openings in the fourth quarter.

And we now anticipate approximately $150 million to $160 million in CapEx to support this year’s and some of next year’s unit development as well as required maintenance on our restaurants. Note the initial cash outlay for the third bakery production facility will be negligible in 2023. Looking ahead to fiscal 2024, as previously mentioned, the macroeconomic backdrop continues to be uncertain. However, we want to provide some initial perspective for next year. Based on our year-to-date performance, more recent trends and assuming no material operating or consumer disruptions, we anticipate total revenues for fiscal 2024 to be between approximately $3.6 billion to $3.7 billion. Total inflation across our commodity baskets and total labor is currently estimated to be in the low to mid-single-digit range.

Based on these assumptions, we anticipate net income margin to be approximately 4% to 4.5%. With regard to development, as David stated earlier, our expectations for 2024 are to take another measurable step towards our objective of 7% annual unit growth. Given the dynamic environment, we continue to face, we are planning to provide additional details on our next earnings call in February. And we would anticipate approximately $175 million to $200 million in CapEx, including required maintenance on our restaurants. This assumes an evenly distributed mix of restaurant openings across the Cheesecake Factory, North Italia, Flower Child and FRC concepts. Additionally, the range includes our preliminary estimate for the initial phase of development for the third bakery production facility.

As we are still in the early stages of this development, I will discuss our initial thoughts, and we will provide additional detail in the coming quarters as the project plans materialize. At this time, we do not expect to incur significant outlays for this project in 2023 or 2024 as we anticipate most of the CapEx to come in 2025 and 2026 in preparation of opening a facility in early 2027. To reiterate David’s earlier remarks, we are pleased to be moving forward with this differentiated capital investment, which we believe will support the future growth of the bakery and enhance our long-term profitability. In closing, we have made significant financial and operational progress over the past four quarters coming out of not only the pandemic but unprecedented supply chain and labor challenges and the highest level of inflation in 50 years.

Our efforts have resulted in a solid position from which we can continue our trajectory of sales growth and margin expansion moving forward. Specifically, the return of predictability to the core operating model and stabilizing guest traffic even inclusive of the macro headwinds and some degree of consumers returning to 2019 behaviors of the lofty spending patterns of the past couple of years, gives us confidence in our ability to make meaningful additional steps in 2024 towards our longer-term goals in the key areas of value creation, growing comparable restaurant sales, expanding restaurant operating margins and accelerating accretive unit growth. And with that said, we will take your questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Andy Barish with Jefferies. Your line is open.

Andy Barish: Hey, guys. Good afternoon. Just wanted to clarify some of the commentary on the same-store sales improving sequentially. Was that referring to during the quarter, the monthly progress? Or as you looked at the full 3Q versus 2Q, I was just a little confused there. And then continuing kind of into October, as you mentioned, with the quarter-to-date assumptions driving your 4Q estimate?

Matt Clark: Sure, Andy. This is Matt. to be hopefully clear, the third quarter followed roughly the industry trends, albeit better in every period than the indices that most people track, both in terms of comp and I think meaningfully in terms of traffic. The traffic was pretty darn stable, but it was sequentially down slightly, right, from July to August to September. And then what we’re referring to is really from sort of the end of September through the current time period, those trends have seen a measurable improvement relatively. So I think that’s also relatively consistent with what you may have heard in the industry as well. But again, I think outpacing.

Andy Barish: Got it. Helpful. And then just one other on wage inflation. I think, again, just some clarification on noting it’s moving below pre-pandemic levels and then your guide, I think, incorporates kind of low to mid-single digits. How does the move to $20 in California next spring kind of factor into that thinking? And is that right that number is below kind of the 2018, 2019 levels, I guess?

Matt Clark: Yes, Andy, this is Matt again. That is correct. Like the actual inflation in average wages is running below sort of that whole time period, 3, 4 years leading up to the pandemic. Obviously, a lot of that was also driven by government-mandated pressures as you allude to the California coming legislation. And even inclusive of that, I would say the expectations for wages remains relatively stable and probably at or below pandemic. And I think we will evaluate the market dynamics that play out. Obviously, none of our restaurants will be included in that wage mandate. But obviously, there could be some ripple effect. Today, in the urban areas, we tend to see that many of the QSR locations are already paying in that range.

and people are making choices based on that. Certainly, more in the deep suburbs, there is probably going to be some increases, but we have fewer restaurants there. So I think we will look at it holistically and then see what makes sense. And if we have to address that as part of our overall inflation basket, we will certainly have to consider that with respect to pricing decisions.

Andy Barish: Great. Thank you very much.

Operator: Your next question comes from the line of Sharon Zackfia with William Blair. Your line is open.

Sharon Zackfia: Hi, good afternoon. I guess two questions. Just quickly, if you could give us kind of price mix traffic for the quarter, that would be helpful. And then secondarily, on development, I mean, it sounds like you want to defer to give us number of what’s kind of embedded in that initial look at ‘24, and I know it’s a wide range, but can you talk about kind of what you’re doing internally to kind of, I guess, better buffer the outlook on development that is given versus what you were going to achieve in kind of this difficult to execute environment where permitting and so many other things seem to be much more challenging than 2019.

Matt Clark: Sure, Sharon. Good questions, both of them. This is Matt. I’ll take the first, and then David Gordon can touch on the development side. So specifically, pricing was at 9.5%, mix was a negative 6.1% and then traffic was a negative 1.0%. So the traffic piece represented a pretty good improvement over the last quarter. And I think about 200 basis points better than what we saw in the industry and pretty stable. As I noted in my response to Andy, it was very, very stable throughout the quarter. So that gives us a good baseline. And David Gordon will touch base on the development.

David Gordon: Sharon, this is David. I think as we talked about previously, a lot of the earlier COVID issues on development were more around supply chain and getting heavy large pieces of equipment into the restaurants, etcetera. That really has abated. And as you said, most of the issues today are more around permitting and dealing with local municipalities and their pace is not what it once was, a lot of new people and new positions. So what we try to do is increase our funnel and have more sites in the pipeline to be able to maneuver around that and hit the targets that we are planning to set for next year. I think we feel good about what we said to continue towards that path to 7% unit growth, and we have a good funnel for next year.

And hopefully, the municipalities will get a little bit better, and we will see permitting start to increase at a little bit faster pace because at this point, that’s really the only thing that’s slowing us down. I think this was a good business decision for us to decide to push some of these to Q1 to ensure that we hit the time line, but also that operationally, they are able to open at a good cadence, don’t put too much negative pressure on the business and that we’re really opening at a cadence that’s best for the operators.

Sharon Zackfia: Thank you.

Operator: Your next question comes from the line of Joshua Long with Stephens. Your line is open.

Joshua Long: Great. Thank you for taking the questions. Matt, curious as a follow-up on that pricing comment, it was 9.5% price in the quarter and then what appears to be some stabilization on the food cost and labor cost side of the equation. Curious if you could talk about your forward pricing plans and kind of how you think about maybe the comp construct from a pricing perspective as we go forward into 4Q and in 1Q?

Matt Clark: Sure, Josh. I think it is relevant. And certainly, as we see inflation stabilizing, our objective is to return to a more normal sort of level and cadence of the pricing that we take, which is typically 2x a year, 1.5% to 2% each time. So notably, in the third quarter for Cheesecake Factory, we took 2%, but that was lapping over a I believe, 4.25%. And so on a run rate basis, we dropped off 2.25 points. And then keep in mind, for the fourth quarter, we’re going to lap the incremental catch-up that we did at the beginning of December. So the weighted average for the fourth quarter, Etienne, what is…

Etienne Marcus: 7% to 7.5%.

Matt Clark: Okay. 7% to 7.5%. And then going into next year, it’s going to be more in the range of like 4%, right? And then we will see how all the pieces come together, but it feels like that’s going to be in a more normal range at that point. And again, our objective is really only to take enough pricing to offset inflation.