ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), which contains forward-looking statements, should be read in conjunction with our audited consolidated financial statements and related notes in Part IV, Item 15 of this report, the “Risk Factors” included in Part I, Item 1A of this report and the cautionary statements included throughout this 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.
We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31 for financial reporting purposes. Fiscal year 2022 consisted of 53 weeks, while fiscal year 2021 consisted of 52 weeks. Fiscal year 2023 will consist of 52 weeks. The following MD&A includes a discussion comparing our results in fiscal 2022 to fiscal 2021. For a discussion comparing our results from fiscal 2021 to fiscal 2020, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 28, 2021, filed with the SEC on February 22, 2022.
COVID-19 Pandemic, Geopolitical and Other Macroeconomic Impacts to our Operating Environment
We have experienced significant disruptions to our business as federal, state and local restrictions have fluctuated over time to mitigate the spread of the COVID-19 virus. While most of our restaurants operated with no restrictions on indoor dining during fiscal years 2021 and 2022, our revenues were negatively impacted during periods of accelerating case counts during which we incurred increased restaurant staff absenteeism and temporary shifts in consumer behavior, such as changes in customer traffic or the mix between on-premise and off-premise channels. We have incurred and may continue to incur additional costs to address government regulations and the safety of our staff members and customers.
In addition, we experienced labor shortfalls relative to our sales levels in certain parts of our workforce and/or geographies as we reopened our dining rooms after the lifting of mandatory social-distancing regulations related to the COVID-19 pandemic. During fiscal 2021, we also began to experience certain supply shortages and transportation delays largely attributable to impacts of the COVID-19 pandemic. These shortages continued in fiscal 2022 and were exacerbated by geopolitical unrest. The aggregate impact of these and other geopolitical and macroeconomic factors contributed to significantly increased commodity and wage inflation and other increased costs. We have also encountered delays in opening new restaurants due to supply chain challenges, as well as to longer lead times in obtaining licenses and permits and in the timeline required to complete the overall leasing process with landlords.
The ongoing effects of COVID-19 and its variants, along with other geopolitical and macroeconomic events could lead to further government mandates, including but not limited to capacity restrictions, shifts in consumer behavior, wage inflation, staffing challenges, product and services cost inflation, disruptions in the supply chain and delay in new restaurant openings. If these factors significantly impact our cash flow in the future, we may again implement mitigation actions such as suspending share repurchases, not declaring future dividends, increasing borrowings under our credit facility or modifying our operating strategies. Any of these measures may have an adverse impact on our business and materially adversely affect our financial performance.
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 318 restaurants throughout the United States and Canada under brands including The Cheesecake Factory® (210 locations), North Italia® (33 locations), Flower Child® (30 locations) and a collection of other FRC brands (35 locations). Internationally, 30 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.
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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. We plan to continue expanding The Cheesecake Factory and North Italia concepts, and in addition, our FRC subsidiary serves as an incubation engine, creating additional concepts for potential future growth. For The Cheesecake Factory concept, we target an average cash-on-cash return on investment of approximately 20% to 25% at the unit level, calculated by dividing restaurant-level profit (earnings before interest, taxes, depreciation and amortization and preopening costs) by our cash investment. We target an average cash-on-cash return on investment of approximately 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.
Our overall revenue growth is primarily driven by revenues from new restaurant openings and increases in comparable restaurant sales.
For The Cheesecake Factory concept, our strategy is to increase comparable restaurant sales by growing average check and maintaining 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, as we believe there is opportunity for a longer-term elevation of our off-premise mix compared to pre-COVID-19 pandemic levels. We are continuing our efforts on a number of initiatives, including menu innovation, a greater focus on increasing customer throughput in our restaurants, leveraging 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.
Average check variations are driven by menu price increases and/or changes in menu mix. We generally update The Cheesecake Factory menus twice each year, and our philosophy is to use price increases to help offset key operating cost increases in a manner that balances supporting both our margin objectives and customer traffic levels. In prior years, 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. Due to the inflationary cost pressures we are experiencing, we implemented menu price increases above our historical levels in the first and third quarters of fiscal 2022 and also implemented an incremental price increase in the fourth quarter of fiscal 2022 to support our longer-term restaurant-level margin objectives. Future near-term pricing actions are likely to be at levels above historical norms to keep pace with any significant cost increases. In addition, on a regular basis, we carefully consider opportunities to adjust our menu offerings or ingredients to help manage product availability and cost.
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 pandemic margins and longer-term to drive margin expansion, by leveraging incremental sales to increase 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.
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 Revolver Facility and returning capital to shareholders through our dividend and share repurchase programs, the latter of which offsets dilution from our equity compensation program and supports our earnings per share growth. Future decisions to pay or to increase or decrease dividends or to repurchase shares are at the discretion of the Board and will be dependent on a number of factors, including limitations pursuant to the terms and conditions of the Loan Agreement and applicable law.
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Longer-term, we believe our domestic revenue growth (comprised of our targeted annual unit growth of 7%, in aggregate across concepts, and comparable sales growth), combined with margin expansion, planned debt repayments 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. (See Item 1A — Risk Factors — “Our stock price could be adversely affected if our performance falls short of our financial guidance and/or market expectations.”)
Results of Operations
The following table presents, for the periods indicated, information from our consolidated statements of income/(loss) expressed as percentages of revenues.
Costs and expenses:
Food and beverage costs 24.6 22.3
Other operating costs and expenses 26.7 27.0
General and administrative expenses 6.2 6.4
Depreciation and amortization expenses 2.8 3.1
Impairment of assets and lease termination expenses 1.0 0.6
Preopening costs 0.4 0.5
Total costs and expenses 98.8 97.2
Income/(loss) from operations 1.2 2.8
Interest and other expense, net (0.2) (0.4)
Income/(loss) before income taxes 1.0 2.4
Income tax benefit (0.3) (0.1)
Net income/(loss) 1.3 2.5
Dividends on Series A preferred stock — (0.6)
Undistributed earnings allocated to Series A preferred stock — (0.2)
Net income/(loss) available to common stockholders 1.3 % 1.7 %
Fiscal 2022 Compared to Fiscal 2021
Revenues
Revenues increased 12.8% to $3,303.2 million for fiscal 2022, including approximately $78.4 million contributed by the 53rd week, compared to $2,927.5 million for fiscal 2021, primarily due to an increase in comparable restaurant sales, reflecting the impact of the COVID-19 pandemic in fiscal 2021, as well as additional revenue related to new restaurant openings.
The Cheesecake Factory comparable sales increased by 7.0%, or $162.5 million, from fiscal 2021 and increased 10.6% from fiscal 2019. The increase from fiscal 2021 was primarily driven by increased customer traffic of 6.8% primarily due to the impact of the COVID-19 pandemic in the prior year, and an increase in average check of 0.2% (based on an increase of 5.9% in menu pricing, partially offset by a 5.7% negative change in mix). Sales through the off-premise channel comprised approximately 25% of our restaurant sales during fiscal 2022 as compared to 32% in fiscal 2021. However, off-premise sales mix remains elevated versus the pre-pandemic level of 16% during fiscal 2019, even as customers continue to return to on-premise dining. We account for each off-premise order as one customer for traffic measurement purposes. Therefore, average check is generally higher for off-premise orders as most of these orders are for more than one customer. In turn, the lower mix of sales in the off-premise channel during fiscal 2022 compared to fiscal 2021 comprised approximately 2% of the negative change in mix with a positive correlative impact to traffic. We implemented effective menu price increases of approximately 3.25%, 4.25% and 2.8% in the first, third and fourth quarters of fiscal 2022, respectively. The Cheesecake Factory average sales per restaurant operating week increased 7.3% to $228,741 in fiscal 2022 from $213,165 in fiscal 2021. Total operating weeks at The Cheesecake Factory restaurants increased 2.7% to 11,052 in fiscal 2022 compared to 10,758 in the comparable prior year period. Excluding the impact of the 53rd week in fiscal 2022, total operating weeks increased 0.8% to 10,841.
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North Italia comparable sales increased approximately 15% from fiscal 2021 and increased approximately 22% compared to fiscal 2019. The increase from fiscal 2021 was primarily driven by increased customer traffic of 11% primarily due to the impact of the COVID-19 pandemic in the prior year, and an increase in average check of 4.0% (based on an increase of 5.5% in menu pricing, partially offset by a 1.5% negative impact from mix). North Italia average sales per restaurant operating week increased 12.1% to $142,532 in fiscal 2022 from $127,146 in fiscal 2021. Total operating weeks at North Italia increased 18.6% to 1,604 in fiscal 2022 compared to 1,352 in the prior year. Excluding the impact of the 53rd week in fiscal 2022, total operating weeks increased 16.2% to 1,571.
Restaurants become eligible to enter the comparable sales base in their 19th month of operation. At January 3, 2023, there were four The Cheesecake Factory restaurants and eight North Italia 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.
Food and Beverage Costs
Food and beverage costs consist of raw materials and ingredients used in the food and beverage products sold in our restaurants and to our third-party bakery customers. As a percentage of revenues, food and beverage costs were 24.6% for fiscal 2022 compared to 22.3% for fiscal 2021, primarily due to inflation across most categories in excess of menu price increases (1.9%). Beginning in the fourth quarter of fiscal 2022, we retitled this income statement line item from “Cost of Sales” to “Food and Beverage Costs.” This is a title change only, and there is no difference in the classification of items within this category of costs.
The Cheesecake Factory 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 sometimes can be offset by cost changes in other commodity categories. The principal commodity categories for our restaurants include general grocery items, dairy, produce, seafood, poultry, meat and bread. (See the discussion of our contracting activities in Part II, Item 7A — “Quantitative and Qualitative Disclosures About Market Risk.”)
For new restaurants, food and beverage costs are typically higher for a period of time after opening until our management team becomes more accustomed to predicting, managing and servicing the sales volumes at these restaurants.
Labor Expenses
As a percentage of revenues, labor expenses, which include restaurant-level labor costs and bakery production labor, including associated fringe benefits, were 36.7% and 36.6% in fiscal 2022 and fiscal 2021, respectively. This increase was primarily due to wage rate inflation in excess of menu price increases (0.8%), offset by a decrease in group medical insurance costs due to lower claim activity (0.8%) in fiscal 2022.
For new restaurants, labor expenses are typically higher for a period of time after opening while our management team becomes more accustomed to predicting and managing the sales volumes at the new restaurants.
Other Operating Costs and Expenses
Other operating costs and expenses consist of all other restaurant-level operating costs, the major components of which are occupancy expenses (rent, common area expenses, insurance, licenses, taxes and utilities), dining room and to-go supplies, repairs and maintenance, janitorial expenses, credit card processing fees, marketing including delivery commissions, and incentive compensation, as well as bakery production overhead. As a percentage of revenues, other operating costs and expenses were 26.7% and 27.0% in fiscal 2022 and fiscal 2021, respectively. This variance was primarily driven by sales leverage within occupancy and building costs (0.2%) and increased restaurant-level incentive compensation expense (0.2%).
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 6.2% and 6.4% for fiscal 2022 and fiscal 2021, respectively. This variance was primarily driven by lower corporate incentive compensation expense (0.2%).
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Depreciation and Amortization Expenses
As a percentage of revenues, depreciation and amortization expenses were 2.8% in fiscal 2022 compared to 3.1% in fiscal 2021 primarily due to sales leverage.
Impairment of Assets and Lease Termination Expenses
During fiscal 2022, we recorded impairment of assets and lease terminations expense of $31.4 million primarily related to the impairment of long-lived assets for three The Cheesecake Factory, one Other FRC and three Other restaurants that are primarily located in areas which have not fully recovered from the pandemic.
During fiscal 2021, we recorded impairment of assets and lease terminations expense of $18.1 million primarily related to the impairment of long-lived assets for three The Cheesecake Factory and two Other restaurants.
See Notes 1 and 6 of Notes to Consolidated Financial Statements in Part 1V, Item 15 of this report for further discussion of our long-lived and intangible assets.
Acquisition-Related Contingent Consideration, Compensation and Amortization Expense/(Benefit)
We recorded a $13.4 million and $19.5 million of expense during fiscal 2022 and 2021, respectively, of acquisition-related contingent consideration, compensation and amortization. In fiscal 2022, the fair value of the contingent consideration and compensation liability increased by $4.7 million due to a $8.3 million increase in the fair value primarily stemming from a change in the volatility factors, as well as an increase in fiscal 2022 revenues and estimated future revenues utilized in the calculation and amortization, partially offset by a payment of $7.2 million per the FRC acquisition agreement. In fiscal 2021, we recorded a $15.3 million increase in the contingent consideration and compensation liability due to the impact of an amendment to the FRC acquisition agreement that, among other things, extended the measurement period through fiscal 2026, as well as to an increase in fiscal 2021 revenues and estimated future revenues utilized in the fair value calculation.
Preopening Costs
Preopening costs were $16.8 million for fiscal 2022 compared to $13.7 million for fiscal 2021. We opened 13 restaurants in fiscal 2022 comprised of three The Cheesecake Factory, four North Italia, three Other FRC and three Other locations compared to 14 restaurants in fiscal 2021 comprised of two The Cheesecake Factory, six North Italia, four Other FRC and two Other locations. Restaurant-level 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 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. Preopening costs can fluctuate significantly from period to period based on the number, mix and timing of restaurant openings and the specific preopening costs incurred for each restaurant. The increase in preopening cost from fiscal 2021 primarily relates to a higher number of managers in reserve for pending openings, partially offset by decreased number of openings.
Interest and Other Expense, Net
Interest and other expense, net was $6.0 million in fiscal 2022 compared to $10.7 million in fiscal 2021. This decrease was primarily due to higher interest expense in the prior year ($3.5 million), mainly related to our interest rate swap, which was terminated in June 2021.
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Income Tax Benefit
In fiscal 2022, we had an income tax benefit of $10.2 million, an effective tax rate of (31.1%), compared to an income tax benefit of $0.8 million, an effective tax rate of (1.1%), in fiscal 2021. The change was due primarily to a higher proportion of employment credits in relation to income before income taxes (48.7%) and our reserve for uncertain tax positions in fiscal 2021 (12.6%). These favorable factors were partially offset by a higher proportion of non-deductible losses as compared to non-taxable gains in fiscal 2021 on our investments in variable life insurance contracts used to support our non-qualified deferred compensation plan (“Non-Qualified Plans”) in relation to income before income taxes (12.6%), the benefit to our net operating loss carryback recorded in fiscal 2021 of our decision to accelerate payment of certain FICA taxes deferred pursuant to the CARES Act (6.3%), a tax shortfall in fiscal 2022 related to equity compensation (5.5%) and a higher proportion of state taxes expense in relation to income before income taxes (4.7%). (See Note 18 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of income taxes.)
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 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 Series A preferred stock into common stock for the period that it was outstanding prior to the conversion on June 15, 2021, we exclude the preferred dividend and assume all convertible preferred shares have been converted into common stock. (See Note 15 of Notes to Condensed Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of our preferred 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.
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Following is a reconciliation from net income and diluted net income per common share to the corresponding adjusted measures (in thousands, except per share data):
Net income available to common stockholders $ 43,123 $ 49,131
Dividends on Series A preferred stock — 18,661
Net income attributed to Series A preferred stock — 4,581
COVID-19 related costs (1) — 4,917
Impairment of assets and lease termination expenses 31,387 18,139
Termination of interest rate swap — 2,354
Uncertain tax positions — 7,139
Diluted net income per common share $ 0.86 $ 1.01
Dividends on Series A preferred stock — 0.35
Net income attributable to Series A preferred stock — 0.09
COVID-19 related costs (1) — 0.09
Impairment of assets and lease termination expenses 0.62 0.34
Termination of interest rate swap — 0.04
Uncertain tax positions — 0.13
Tax effect of adjustments (2) (0.23) (0.22)
Adjusted net income per share (4) $ 1.51 $ 2.13
(4) Adjusted net income per share may not add due to rounding.
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Fiscal 2023 Outlook
This discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as codified in Section 27A of the Securities Act, and Section 21E of the Exchange Act and should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 15 of this report, the “Risk Factors” included in Part I, Item 1A of this report and the cautionary statements included throughout this report.
Based on recent trends and assuming no material operating or consumer disruptions, we anticipate total revenue for fiscal 2023 to be approximately $3.5 billion to $3.6 billion, with The Cheesecake Factory average sales per location reaching approximately $13 million. Including the 3.5% February 2023 price increase, we will have 10.5% pricing in The Cheesecake Factory menu, and we will evaluate the level of pricing for the summer menu based on inflationary trends.
During fiscal 2023, we currently estimate total inflation across our commodities, total labor (factoring in the latest trends in wage rates and channel mix, as well as in other components such as payroll taxes and benefits) and other operating costs and expenses to be in the mid-single digit range. However, there remains measurable risk associated with cost fluctuations driven by the current environment. We estimate preopening costs of approximately $24 million. Based on these factors, we expect fiscal 2023 net income margin of approximately 4% at the mid-point of the estimated revenue range.
We plan to open as many as 20 to 22 new restaurants in fiscal 2023, including five to six The Cheesecake Factory restaurants, five to six North Italia restaurants and 10 restaurants within our FRC business, which includes three to four Flower Child locations. We anticipate approximately $165 to $175 million in cash capital expenditures to support this level of unit development, as well as required maintenance on our restaurants. Restaurant opening dates may be impacted by supply chain challenges and permit approval delays.
Total revenue for the first quarter of fiscal 2023 are expected to be approximately $850 million to $880 million. We anticipate commodity inflation of approximately 10% to 12% and expect labor inflation of approximately 6%. Based on these factors, we expect first quarter fiscal 2023 net income margin of approximately 3% to 3.5%.
Liquidity and Capital Resources
Our corporate financial objectives are to maintain a sufficiently strong and conservative balance sheet to support our operating initiatives and unit growth while maintaining financial flexibility to provide the financial resources necessary to protect and enhance the competitiveness of our restaurant and bakery brands and to provide a prudent level of financial capacity to manage the risks and uncertainties of conducting our business operations under various economic and industry cycles. Typically, cash flows generated from operating activities are our principal source of liquidity, which we use to finance our restaurant expansion plans, ongoing maintenance of our restaurants and bakery facilities and investment in our corporate and information technology infrastructures. However, given the impact of the COVID-19 pandemic on our operations, during fiscal 2020 we increased borrowings under our then-existing credit facility and issued convertible preferred stock to increase our liquidity. During fiscal 2021, we used net proceeds from issuing convertible senior notes and additional common stock to fund the repurchase of the majority of our Series A preferred stock and the conversion of the remaining Series A preferred stock into common stock, simplifying our capital structure and eliminating future convertible preferred stock dividends. We also utilized a portion of the net proceeds to reduce borrowings under our then-existing credit facility.
Similar to many restaurant and retail chain store operations, we utilize operating lease arrangements for all of our restaurant locations. Accordingly, our lease arrangements reduce, to some extent, our capacity to utilize funded indebtedness in our capital structure. We are not limited to the use of lease arrangements as our only method of opening new restaurants. However, we believe our operating lease arrangements continue to provide appropriate leverage for our capital structure in a financially efficient manner.
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During fiscal 2022, our cash and cash equivalents decreased by $74.9 million to $114.8 million. The following table presents, for the periods indicated, a summary of our key cash flows from operating, investing and financing activities (in millions):
Fiscal Year
Cash provided by operating activities $ 161.9 $ 213.0
Additions to property and equipment (112.5) (66.9)
Convertible debt issuance, net of issuance cost — 334.9
Common stock issuance, net of issuance cost — 167.1
Borrowings on credit facility 130.0 —
Repayments on credit facility (130.0) (150.0)
Series A preferred stock cash-settled conversion — (443.8)
Series A preferred stock dividends paid — (18.7)
Proceeds from exercises of stock options 0.1 24.8
Common stock dividends paid (42.3) (0.3)
Treasury stock purchases (63.1) (5.8)
Cash Provided by Operating Activities
Cash flows from operations decreased by $51.1 million from fiscal 2021 primarily due to lower net income, the timing of payroll disbursements in relation to the fiscal 2022 versus 2021 year-end dates, higher gift card redemptions and lower accrued incentive compensation. These factors were partially offset by collection of our fiscal 2020 net operating loss carryback refund in fiscal 2022, the payback in fiscal 2021 of payroll taxes that were deferred in fiscal 2020 under the CARES Act and higher non-cash impairment expense in fiscal 2022. 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.
Property and Equipment
Capital expenditures for new restaurants, including locations under development as of each fiscal year-end, were $55.1 million and $31.7 million for fiscal 2022 and 2021, respectively. Capital expenditures also included $51.8 million and $30.1 million for our existing restaurants and $5.6 million and $5.1 million for bakery and corporate capacity and infrastructure investments in fiscal 2022 and 2021, respectively.
We opened 13 restaurants in fiscal 2022 comprised of three The Cheesecake Factory, four North Italia, three Other FRC and three Other locations compared to 14 restaurants in fiscal 2021 comprised of two The Cheesecake Factory, six North Italia, four Other FRC and two Other locations. We expect to open as many as 20 to 22 new restaurants in fiscal 2023 across our portfolio of concepts. We anticipate approximately $165 to $175 million in capital expenditures to support this level of unit development, as well as required maintenance on our restaurants.
Acquisition-Related Deferred Consideration and Compensation
During fiscal 2022 and 2021, we made payments of $11.1 million and $17.0 million, respectively, for deferred consideration related to the FRC acquisition. During fiscal 2022, we also made a payment of $7.2 million for deferred consideration and contingent consideration related to the FRC acquisition.
Convertible Senior Notes
On June 15, 2021, we issued $345.0 million in aggregate principal amount of convertible senior notes (“Notes”), which will mature on June 15, 2026, unless earlier repurchased, redeemed or converted. The net proceeds from the sale of the Notes were approximately $334.9 million after deducting issuance costs related to the Notes. At January 3, 2023, the conversion rate for the Notes was 13.0675 shares of common stock per $1,000 principal amount of the Notes, which represents a conversion price of approximately $76.53 per share of common stock. In connection with the cash dividend that was declared by our Board on February 16, 2023, on March 21, 2023 we will adjust the conversion rate (which is expected to increase) and the conversion price (which is expected to
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decrease) of the Notes in accordance with the terms. (See Note 10 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of the Notes.)
Common Stock Issuance
On June 15, 2021, we issued 3.125 million shares of our common stock for $175.0 million. In connection with the issuance, we incurred direct and incremental costs of $8.0 million.
Credit Facility
On October 6, 2022, we entered into a Fourth Amended and Restated Loan Agreement (the “Loan Agreement” and the revolving credit facility provided thereunder, the “Revolver Facility”). The Loan Agreement amends and restates in its entirety our prior credit agreement. The Revolver Facility, which terminates on October 6, 2027, provides us with revolving loan commitments that total $400 million, of which $50 million may be used for issuances of letters of credit. The Revolver Facility contains a commitment increase feature that, subject to certain conditions precedent, could provide for an additional $200 million in revolving loan commitments. Our obligations under the Revolver Facility are unsecured. Certain of our material subsidiaries have guaranteed our obligations under the Revolver Facility. During fiscal 2021, we utilized a portion of the net proceeds from our Notes and common share offerings to reduce the balance on our then-existing credit facility by $150.0 million. On October 6, 2022, we repaid the outstanding balance under the prior credit facility and borrowed the same amount on the Revolver Facility. As of January 3, 2023, we had net availability for borrowings of $238.5 million, based on a $130.0 million outstanding debt balance and $31.5 million in standby letters of credit under the Revolver Facility.
Under the Revolver Facility, we are subject to financial covenants, as well as to customary events of default that, if triggered, could result in acceleration of the maturity of the Revolver Facility. Subject to certain exceptions, the Revolver Facility also limits distributions with respect to our equity interests, such as cash dividends and share repurchases, based on a defined ratio, and also sets forth negative covenants that restrict indebtedness, liens, investments, sales of assets, fundamental changes and other matters. At January 3, 2023, we were in compliance with all covenants in effect at that date. (See Note 10 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of our long-term debt.)
Series A Preferred Stock
During the second quarter of fiscal 2021, we paid a cash dividend on our Series A preferred stock of $5.1 million. Additionally, during the second quarter of fiscal 2021, we paid $457.3 million in connection with the cash-settled conversion of 150,000 shares of our outstanding Series A preferred stock (effected through a repurchase agreement), and the share-settled conversion of the remaining 50,000 shares of our outstanding Series A preferred stock into 2,400,864 shares of our common stock, of which $13.6 million was deemed to be a dividend. (See Note 15 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of our preferred stock.)
Common Stock Dividends
Common stock dividends of $42.3 million and $0.3 million were paid in fiscal 2022 and 2021, respectively. The increase is primarily due to the resumption of our quarterly dividend in the second quarter of fiscal 2022 after the suspension that began in fiscal 2020 due to the impact of COVID-19 on our business and in conjunction with the terms of our Loan Agreement. As further discussed in Note 15 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report, in February 2023, our Board declared a quarterly dividend to be paid in March 2023. Future decisions to pay or to increase or decrease dividends 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 Loan Agreement and applicable law, and other such factors that the Board considers relevant.
Share Repurchases
On October 26, 2022, our Board increased the authorization to repurchase our common stock by 5.0 million shares to 61.0 million shares. Under this authorization, we have cumulatively repurchased 55.1 million shares at a total cost of $1,765.6 million through January 3, 2023. We repurchased 2.0 million shares at a cost of $63.1 million during fiscal 2022 compared to 0.1 million shares at a cost of $5.8 million fiscal 2021. This increase is primarily due to the resumption of our share repurchase program in the
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second quarter of fiscal 2022 after the suspension that began in fiscal 2020 due to the impact of COVID-19 on our business and in conjunction with the terms of our Loan Agreement.
Our objectives with regard to share repurchases have been to offset the dilution to our shares outstanding that results from equity compensation grants and to supplement our earnings per share growth. Our share repurchase program 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. Future decisions to repurchase shares are at the discretion of the Board and are 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 FRC acquisition, our share price and current market conditions. The timing and number of shares repurchased are also subject to legal constraints and financial covenants under our credit facility that limit share repurchases based on a defined ratio. (See Note 15 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of our repurchase authorization and methods.)
Contractual Obligations and Commercial Commitments
The following table summarizes our undiscounted contractual obligations and commercial commitments as of January 3, 2023 (amounts in millions):
Payment Due by Period
Less than More than
Total 1 Year 1‐3 Years 4‐5 Years 5 Years
Contractual obligations
Recorded contractual obligations:
Long-term debt 468.0 — — 468.0 —
Acquisition-related deferred consideration 11.3 11.3 — — —
Uncertain tax positions (2) 3.8 — 3.8 — —
Unrecorded contractual obligations:
Other commercial commitments
Standby letters of credit $ 31.5 $ 31.5 $ — $ — $ —
The FRC acquisition agreement also included a contingent consideration provision which is payable annually from 2022 through 2027 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) during the five years after Closing. The liability for this contingent consideration provision was $28.6 million at January 3, 2023. See Note 2 in Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for discussion of the fair value measurement for this liability. We are also required to provide financing to FRC in an amount sufficient to support achievement of these targets during the five years after Closing.
Cash Flow Outlook
We believe that our cash and cash equivalents, combined with expected cash flows provided by operations and available borrowings under the Revolver Facility, will provide us with adequate liquidity for the next 12 months and the foreseeable future.
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As of January 3, 2023, 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.
Critical Accounting Estimates
Critical accounting policies are those we believe are most important to portraying our financial condition and results of operations and also require the greatest amount of subjective or complex judgments by management. Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions. We consider the following policies to be the most critical in understanding the judgment that is involved in preparing our consolidated financial statements.
Contingent Consideration and Compensation Liability
The Acquisition agreement included a contingent consideration provision, a portion of which was considered part of the acquisition consideration and the remainder of which was considered future compensation expense. This contingent consideration and compensation is payable annually from 2022 through 2027 and is based on achievement of revenue and profitability targets for the FRC brands other than North Italia and Flower Child. The fair value of the contingent consideration and compensation liability is determined utilizing a Monte Carlo model based on estimated future revenues, margins, volatility factors and discount rates, among other variables and estimates and has no minimum or maximum payment. The undiscounted range of outcomes per the Monte Carlo model was $0 to $276.0 million at January 3, 2023 and $0 to $204.0 million at December 28, 2021. During fiscal 2022, the fair value of the contingent consideration and compensation liability increased by $4.7 million to $28.6 million due to an $8.3 million increase in the fair value primarily stemming from a change in the volatility factors, as well as an increase in fiscal 2022 revenues and estimated future revenues utilized in the calculation and amortization, partially offset by a payment of $7.2 million per the FRC acquisition agreement. The fair value of the contingent consideration and compensation liability is highly subjective, and results could change materially if different estimates and assumptions were used.
Indefinite-Lived Intangible Assets
Goodwill and other indefinite-lived intangible assets are not amortized and are tested for impairment annually as of the first day of our fiscal fourth quarter or on an interim basis if events or changes in circumstances between annual tests indicate a potential impairment. First, we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include, but are not limited to, historical financial performance, assumptions related to the COVID-19 pandemic, wage, product and services inflation, competitive environment, macroeconomic and industry conditions, results of prior impairment tests and share price performance. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed.
The quantitative assessments require the use of estimates and assumptions regarding future cash flows and asset fair values. For the goodwill impairment test, the estimated fair value of the reporting units is determined using a blend of the income approach using a discounted cash flow analysis and the market capitalization approach. The fair value of the trade names and trademarks is estimated using the relief from royalty method. Key assumptions include projected revenue growth and operating expenses, discount rates, royalty rates and other factors that could affect fair value or otherwise indicate potential impairment. Estimates of revenue growth and operating expenses are based on internal projections and consider historical performance and forecasted growth, including assumptions related to the COVID-19 pandemic, the cost environment and macroeconomic and industry conditions. The discount rate is based on the estimated cost of capital that reflects the risk profile of the related business. These estimates, as well as the selection of comparable companies and valuation multiples used in the market approaches, are subjective, and our ability to realize future cash flows and asset fair values is affected by factors such as changes in economic conditions and operating performance. These fair value assessments could change materially if different estimates and assumptions were used.
We did not record any impairment charges related to indefinite-lived intangible assets in fiscal 2022 or 2021. We recorded impairment charges related to indefinite-lived intangible assets of $180.8 million in fiscal 2020. (See Note 1 in Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of these impairments.)
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Long-Lived Assets
We assess the potential impairment of our long-lived assets on an annual basis or whenever events or changes in circumstances indicate that the carrying value of the assets or asset group may not be recoverable. Factors considered include, but are not limited to, negative cash flow, significant underperformance relative to historical or projected future operating results, significant changes in the manner in which an asset is being used, an expectation that an asset will be disposed of significantly before the end of its previously estimated useful life and significant negative industry or economic trends.
Assessing whether impairment testing is warranted and, if so, determining the amount of expense require the use of estimates and assumptions regarding future cash flows and asset fair values. Key assumptions include projected revenue growth and operating expenses, as well as forecasting asset useful lives and selecting an appropriate discount rate. Estimates of revenue growth and operating expenses are based on internal projections and consider the restaurant's historical performance, the local market economics and the business environment. The discount rate is based on the yield curve rate for U.S. Treasury securities with a duration that coincides with the period covered by the cash flows. These estimates are subjective and our ability to realize future cash flows and asset fair values is affected by factors such as changes in economic conditions and operating performance.
In fiscal 2022, we recorded $31.4 million of expense primarily related to the impairment of three The Cheesecake Factory, one Other FRC and three Other restaurants. In fiscal 2021, we recorded $16.3 million of expense primarily related to the impairment of long-lived assets for three The Cheesecake Factory and two Other restaurants. In fiscal 2020, we recorded $36.2 million of expense primarily related to the impairment of one The Cheesecake Factory, one North Italia, two Other FRC and six Other restaurants, as well as lease termination costs and accelerated depreciation for one The Cheesecake Factory and seven Other restaurants. (See Note 1 in Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion related to long-lived asset impairment.)
Leases
Lease terms include the build-out period for our leases where no rent payments are typically due under the terms of the lease, as well as options to renew when we deem we have significant economic incentive to exercise the extension. When determining if we have a significant economic incentive, we consider relevant factors, such as contractual, asset, entity and market-based considerations. Option periods are included in the lease term for the majority of our leases. Termination rights have not been factored into the lease terms since based on our probability assessment we are reasonably certain we will not terminate our leases.
We cannot determine the interest rate implicit in our leases because we do not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, we use our incremental borrowing rate as the discount rate for our leases. Our incremental borrowing rate for a lease is the rate of interest we would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms. Because we do not generally borrow on a collateralized basis, we derive an appropriate incremental borrowing rate using the interest rate we pay on our non-collateralized borrowings, adjusted for the amount of the lease payments, the lease term and the effect of designating specific collateral with a value equal to the unpaid lease payments for that lease.
The reasonably certain lease term and the incremental borrowing rate for each restaurant location require judgment by management and can impact the classification and accounting for a lease as operating or finance, the value of the operating lease asset and liability and the term over which leasehold improvements for each restaurant are depreciated. These judgments may produce materially different amounts of operating lease assets and liabilities, rent expense and interest expense than would be reported if different assumptions were used.
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Income Taxes
We compute income taxes based on estimates of our federal, state and foreign tax liabilities. Our estimates include, but are not limited to, effective state and local income tax rates, allowable tax credits, depreciation expense allowable for tax purposes, the tax deductibility of certain other items and applicable valuation allowances on deferred tax assets. Our estimates are made based on the best available information at the time we prepare our consolidated financial statements. In making our estimates, we consider the impact of legislative and judicial developments. As these developments evolve, we update our estimates, which, in turn, may result in adjustments to our effective tax rate.
We anticipate realization of a significant portion of our deferred tax assets through the reversal of existing deferred tax liabilities. Realization of some of our deferred tax assets, in particular those which have statutorily limited time periods within which they must be used, is dependent on generating sufficient taxable income in the relevant jurisdictions prior to expiration of these time periods. Although realization is not assured, management believes it is more likely than not that our deferred tax assets, net of valuation allowances, will be realized. The amount of deferred tax assets considered realizable could be reduced, however, if estimates of future earnings and taxable income in the carryforward periods are reduced.
Uncertain tax positions taken or expected to be taken in a tax return are recognized (or derecognized) in the financial statements when it is more likely than not that the position would be sustained on its technical merits upon examination by tax authorities, taking into account available administrative remedies and litigation. Assessment of uncertain tax positions requires significant judgments relating to the amounts, timing and likelihood of resolution.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for a summary of new accounting standards.
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion of market risks contains forward-looking statements and should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 15 of this report, the “Risk Factors” in Part I, Item 1A of this report, the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this report and the cautionary statements included throughout this report. Actual results may differ materially from the following discussion based on general conditions in the commodity and financial markets.
The cost of products and services used in our operations is subject to volatility due to the relative availability of labor and distribution, weather, natural disasters, inventory levels and other supply and/or demand impacting events such as the COVID-19 pandemic, geopolitical events, economic conditions or other unforeseen circumstances. Climate change may further exacerbate a number of these factors. During fiscal 2021, we began to experience certain supply shortages and transportation delays largely attributable to impacts of the COVID-19 pandemic. These shortages continued in fiscal 2022 and were exacerbated by geopolitical unrest. The aggregate impact of these and other factors contributed to significant cost inflation.
We attempt to negotiate short-term and long-term agreements for some of our principal commodity, supply and equipment requirements, such as certain dairy products and poultry, depending on market conditions and expected demand. While we are in the process of contracting for certain key food and non-food supplies for fiscal 2023, these efforts may not be successful or yield our intended benefits. We continue to evaluate the possibility of entering into similar arrangements for other commodities and periodically evaluate hedging vehicles, such as direct financial instruments, to assist us in managing risk and variability associated with such commodities. As of the end of fiscal 2022, we had no hedging contracts in place.
Commodities for which we have not entered into contracts can be subject to unforeseen supply and cost fluctuations, which at times may be significant. Additionally, the cost of commodities subject to governmental regulation, such as dairy and corn, can be especially susceptible to price fluctuation. Goods we purchase on the international market may be subject to even greater fluctuations in cost and availability, which could result from a variety of factors, including the value of the U.S. dollar relative to other currencies, international trade disputes, tariffs, geopolitical unrest and varying global demand. We may not have the ability to increase menu prices or vary menu items in response to food commodity price increases. For fiscal 2022 and 2021, a hypothetical increase of 1% in food costs would have negatively impacted food and beverage costs by $8.1 million and $6.5 million, respectively. (See Item 1A —
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Risk Factors — “Our inability to anticipate and react effectively to changes in the costs of key operating resources may increase our cost of doing business, which could materially adversely affect our financial performance.”)
We are exposed to market risk from interest rate changes on our funded debt. This exposure relates to the component of the interest rate on the Loan Agreement that is indexed to market rates. Based on outstanding borrowings at January 3, 2023 and December 28, 2021, a hypothetical 1% rise in interest rates would have increased interest expense by $1.3 million on an annual basis. (See Note 10 of Notes to Consolidated Financial Statements in Part IV, Item 15 of this report for further discussion of our long-term debt.)
We are also subject to market risk related to our investments in variable life insurance contracts used to support our Non-Qualified Plans to the extent these investments are not equivalent to the related liability. In addition, because changes in these investments are not taxable, gains and losses result in tax benefit and tax expense, respectively, and directly affect net income through the income tax provision. Based on balances at January 3, 2023 and December 28, 2021, a hypothetical 10% decline in the market value of our deferred compensation asset and related liability would not have impacted income before income taxes. However, under such scenario, net income would have declined by $2.0 million and $2.3 million at January 3, 2023 and December 28, 2021, respectively.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements required to be filed hereunder are set forth in Part IV, Item 15 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We have established and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of January 3, 2023.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States (“GAAP”) and includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
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Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our internal control over financial reporting as of January 3, 2023 based on the criteria in “Internal Control - Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of January 3,2023.
The effectiveness of our internal control over financial reporting as of January 3, 2023 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which appears in Part IV, Item 15 of this report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the three months ended January 3, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
ITEM 9C.DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not Applicable.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We have adopted a code of ethics which applies to our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, who are the Company’s principal executive, financial and accounting officers, respectively, and the Company’s other executive officers and members of the Board of Directors, entitled “Code of Ethics for Executive Officers, Senior Financial Officers and Directors.” We have also adopted a code of ethics which applies to other employees entitled “Code of Ethics and Code of Business Conduct.” The codes of ethics are available on our corporate website at www.thecheesecakefactory.com in the “Governance” section of our “Investors” page. The contents of our website are not incorporated by reference into this report. We intend to satisfy disclosure requirements under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Ethics for Executive Officers, Senior Financial Officers and Directors by posting such information on our website, at the address and location specified above, or as otherwise required by the Nasdaq Global Market.
Information with respect to our executive officers is included in Part I, Item 1 of this report. Other information required by this item is hereby incorporated by reference from the sections entitled “Election of Directors,” “The Board and Corporate Governance,” and “Delinquent Section 16(a) Reports” in our definitive proxy statement for the annual meeting of stockholders to be held on June 1, 2023 (the “Proxy Statement”).
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is hereby incorporated by reference to the sections entitled “Directors Compensation,” “Executive Compensation,” “Compensation of Named Executive Officers” and “Compensation Committee Interlocks and Insider Participation” in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is hereby incorporated by reference to the section entitled “Beneficial Ownership of Principal Stockholders and Management” and “Equity Compensation Plan Information” in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is hereby incorporated by reference to the sections entitled “Policies Regarding Review, Approval or Ratification of Transactions with Related Persons” and “The Board and Corporate Governance” in the Proxy Statement.
ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is hereby incorporated by reference to the section entitled “Independent Registered Public Accounting Firm Fees and Services” (in the proposal entitled “Ratification of Selection of Independent Registered Public Accounting Firm”) in the Proxy Statement.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this Report:
(a) 1. Financial statements:
The consolidated financial statements required to be filed hereunder are listed in the Index to Consolidated Financial Statements on page 54 of this report.
2. Financial statement schedules:
All schedules have been omitted because they are not applicable, not required or the information has been otherwise supplied in the financial statements or notes to the financial statements.
3. Exhibits:
The Exhibits required to be filed hereunder are listed in the exhibit index included herein at page 87.
ITEM 16. FORM 10-K SUMMARY
None.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Consolidated Balance Sheets 60
Consolidated Statements of Income/(Loss) 61
Consolidated Statements of Comprehensive Income/(Loss) 62
Consolidated Statements of Cash Flows 64
Notes to Consolidated Financial Statements 65
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
The Cheesecake Factory Incorporated:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of The Cheesecake Factory Incorporated and subsidiaries (the Company) as of January 3, 2023 and December 28, 2021, the related consolidated statements of income/(loss), comprehensive income/(loss), stockholders’ equity and series A convertible preferred stock, and cash flows for each of the years in the three-year period ended January 3, 2023, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of January 3, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 3, 2023 and December 28, 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended January 3, 2023, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 3, 2023 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of long-lived assets for impairment
As discussed in Notes 1, 6 and 11 to the consolidated financial statements, the Company assesses the potential impairment of long-lived assets on an annual basis or whenever events or changes in circumstances indicate the carrying value of the asset or asset group may not be recoverable. If the carrying amount of an asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. The Company’s property and equipment, net, and operating lease asset balances as of January 3, 2023 were $746.1 million and $1,269.0 million, respectively. Based upon the analyses performed, the Company recognized pre-tax impairment charges for long-lived assets of $31.4 million in fiscal 2022.
We identified the evaluation of long-lived assets for impairment as a critical audit matter. The evaluation of the assumptions used in the undiscounted cash flow analysis and determination of fair value of certain long-lived assets resulted in the application of challenging auditor judgment. These assumptions include revenue growth and the operating margin.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s long-lived asset impairment assessment process. This included controls related to the determination of the undiscounted cash flow and fair value of the restaurant asset groups, and the related revenue growth and operating margin assumptions. For certain restauant asset groups, we performed sensitivity analyses over the revenue growth and operating margin assumptions to assess the impact of changes in those assumptions on the Company’s determination of the undiscounted cash flow and fair value of these restaurant asset groups. We compared the Company’s prior year revenue growth and operating margin assumptions to current year actual results to assess the Company’s ability to accurately forecast. We evaluated the Company’s revenue growth and operating margin assumptions for certain restaurant asset groups by comparing the assumptions to the restaurant asset groups’ historical and peer group performance.
/s/ KPMG LLP
We have served as the Company’s auditor since 2018.
Los Angeles, California
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THE CHEESECAKE FACTORY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
January 3, December 28,
ASSETS
Current assets:
Other assets:
Current liabilities:
Commitments and contingencies (Note 14)
Stockholders’ equity:
Accumulated other comprehensive loss (982) (287)
See the accompanying notes to the consolidated financial statements.
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THE CHEESECAKE FACTORY INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME/(LOSS)
(In thousands, except per share data)
Fiscal Year
Costs and expenses:
Acquisition-related costs — — 2,699
Dividends on Series A preferred stock — (18,661) (13,485)
Net income/(loss) per common share:
Weighted-average common shares outstanding:
See the accompanying notes to the consolidated financial statements.
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THE CHEESECAKE FACTORY INCORPORATED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(In thousands)
Fiscal Year
Other comprehensive (loss)/gain:
Foreign currency translation adjustment (695) 34 114
Unrealized gain/(loss) on derivative, net of tax — 3,464 (3,464)
Other comprehensive (loss)/gain (695) 3,498 (3,350)
See the accompanying notes to the consolidated financial statements.
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THE CHEESECAKE FACTORY INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND SERIES A CONVERTIBLE PREFERRED STOCK
(In thousands)
Accumulated
Series A Convertible Additional Other
Shares Amount Shares Amount Capital Earnings Stock Loss Total
Net loss — — — — — (253,365) — — (253,365)
Net income — — — — — 72,373 — — 72,373
Net income — — — — — 43,123 — — 43,123
See the accompanying notes to the consolidated financial statements.
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THE CHEESECAKE FACTORY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Fiscal Year
Cash flows from operating activities:
Changes in assets and liabilities:
Cash flows from investing activities:
Additions to intangible assets (680) (606) (585)
Cash flows from financing activities:
Borrowings on credit facility 130,000 — 90,000
Convertible debt issuance — 345,000 —
Convertible debt direct and incremental costs — (10,074) —
Series A preferred stock issuance — — 200,000
Series A preferred stock direct and incremental costs — — (10,257)
Series A preferred stock cash-settled conversion — (443,751) —
Series A preferred stock dividend paid — (18,661) —
Common stock issuance — 175,000 —
Common stock issuance direct and incremental costs — (7,950) —
Proceeds from exercise of stock options 84 24,786 611
Foreign currency translation adjustment (325) (27) (17)
Supplemental disclosures:
See the accompanying notes to the consolidated financial statements.
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THE CHEESECAKE FACTORY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
The Cheesecake Factory Incorporated is a leader in experiential dining. We are culinary forward and relentlessly focused on hospitality. We currently own and operate 318 restaurants throughout the United States and Canada under brands including The Cheesecake Factory® (210 locations), North Italia® (33 locations) and a collection within our Fox Restaurant Concepts (“FRC”) business. Internationally, 30 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.
Basis of Presentation
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”) and are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All intercompany accounts and transactions for the periods presented have been eliminated in consolidation.
We utilize a 52/53-week fiscal year ending on the Tuesday closest to December 31 for financial reporting purposes. Fiscal year 2022 consisted of 53 weeks. Fiscal years 2021 and 2020 each consisted of 52 weeks. Fiscal year 2023 will consist of 52 weeks.
Beginning in the fourth quarter of fiscal 2022, we retitled the income statement line item “Cost of Sales” to “Food and Beverage Costs.” This is a title change only, and there is no difference in the classification of items within this category of costs.
Use of Estimates
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.
COVID-19 Pandemic, Geopolitical and Other Macroeconomic Impacts to our Operating Environment
We have experienced significant disruptions to our business as federal, state and local restrictions have fluctuated over time to mitigate the spread of the COVID-19 virus. While most of our restaurants operated with no restrictions on indoor dining during fiscal years 2021 and 2022, our revenues were negatively impacted during periods of accelerating case counts during which we incurred increased restaurant staff absenteeism and a temporary shift in consumer behavior, such as changes in customer traffic or the mix between on-premise and off-premise channels. We have incurred and may continue to incur additional costs to address government regulations and the safety of our staff members and customers.
In addition, we experienced labor shortfalls relative to our sales levels in certain parts of our workforce and/or geographies as we reopened our dining rooms after the lifting of mandatory social-distancing regulations related to the COVID-19 pandemic. During fiscal 2021, we also began to experience certain supply shortages and transportation delays largely attributable to impacts of the COVID-19 pandemic. These shortages continued in fiscal 2022 and were exacerbated by geopolitical unrest. The aggregate impact of these and other geopolitical and macroeconomic factors contributed to significantly increased commodity and wage inflation and other increased costs. We have also encountered delays in opening new restaurants due to supply chain challenges, as well as to longer lead times in obtaining licenses and permits and in the timeline required to complete the overall leasing process with landlords.
The ongoing effects of COVID-19 and its variants, along with other geopolitical and macroeconomic events could lead to further government mandates, including but not limited to capacity restrictions, shifts in consumer behavior, wage inflation, staffing challenges, product and services cost inflation, disruptions in the supply chain and delay in new restaurant openings. If these factors significantly impact our cash flow in the future, we may again implement mitigation actions such as suspending share repurchases, not declaring future dividends, increasing borrowings under our credit facility or modifying our operating strategies. Any of these measures may have an adverse impact on our business and materially adversely affect our financial performance.
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Cash and Cash Equivalents
Amounts receivable from credit card processors, totaling $19.1 million and $17.5 million at January 3, 2023 and December 28, 2021, respectively, are considered cash equivalents because they are both short-term and highly liquid in nature and are typically converted to cash within three days of the sales transaction. Our cash management system provides for the funding of all major bank disbursement accounts on a daily basis as checks are presented for payment. Under this system, outstanding checks are in excess of the cash balances at certain banks, which creates book overdrafts. Book overdrafts are presented as a current liability in other accrued expenses on our consolidated balance sheet.
Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk are cash and cash equivalents and receivables. We maintain our day-to-day operating cash balances in non-interest-bearing transaction accounts, which are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. We invest our excess cash in a money market deposit account, which is insured by the FDIC up to $250,000. Although we maintain balances that exceed the federally insured limit, we have not experienced any losses related to this balance, and we believe credit risk to be minimal.
We consider the concentration of credit risk for accounts receivable from our bakery customers to be minimal due to the payment histories and general financial condition of our larger bakery accounts. Concentration of credit risk related to other receivables is limited as this balance is comprised primarily of amounts due from our gift card distributors, insurance providers and delivery partner.
Inventories
Inventories consist of restaurant food and other supplies, bakery raw materials and bakery finished goods and are stated at the lower of cost or net realizable value on an average cost basis at the restaurants and on a first-in, first-out basis at the bakeries.
Property and Equipment
We record property and equipment at cost less accumulated depreciation. Improvements are capitalized, while repairs and maintenance costs are expensed as incurred. Depreciation and amortization are calculated using the straight-line method over the estimated useful life of the assets or the reasonably certain lease term, whichever is shorter. Leasehold improvements include the cost of our internal development and construction department. Depreciation and amortization periods are as follows:
Buildings and land improvements 30 years
Leasehold improvements 10 to 30 years
Furnishings, fixtures and equipment 3 to 15 years (1)
Computer software and equipment 5 years
Gains and losses related to property and equipment disposals are recorded in depreciation and amortization expenses.
Impairment of Long-Lived Assets and Lease Termination Expenses
We assess the potential impairment of our long-lived assets on an annual basis or whenever events or changes in circumstances indicate the carrying value of the assets or asset group may not be recoverable. Factors considered include, but are not limited to, negative cash flow, significant underperformance relative to historical or projected future operating results, significant changes in the manner in which an asset is being used, an expectation that an asset will be disposed of significantly before the end of its previously estimated useful life and significant negative industry or economic trends. At any given time, we may be monitoring a number of locations, and future impairment charges could be required if individual restaurant performance does not improve or we make the decision to close or relocate a restaurant.
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Long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Impairment testing is performed at the individual restaurant asset group level, which is inclusive of property and equipment and lease right-of-use assets. Recoverability is assessed by comparing the carrying value of the assets to the undiscounted cash flows expected to be generated by those assets. Impairment losses are measured as the amount by which the carrying values of the assets exceed their fair value, which is determined based on discounted future net cash flows expected to be generated by the assets.
In fiscal 2022, we recorded $31.4 million of expense primarily related to the impairment of long-lived assets for three The Cheesecake Factory, one Other FRC and three Other restaurants. In fiscal 2021, we recorded $16.3 million of expense primarily related to the impairment of long-lived assets for three The Cheesecake Factory and two Other restaurants. In fiscal 2020, we recorded $36.2 million of expense primarily related to the impairment of long-lived assets for one The Cheesecake Factory, one North Italia, two Other FRC and six Other restaurants, as well as lease termination costs and accelerated depreciation for one The Cheesecake Factory and seven Other restaurants. These amounts are recorded in impairment of assets and lease terminations on the consolidated statements of income/(loss).
Intangible Assets
The following table presents components of intangible assets, net (in thousands):
Fiscal year ended
Indefinite-lived intangible assets:
Transferable alcoholic beverage licenses 7,683 7,446
Definite-lived intangible assets, net:
Non-transferable alcoholic beverage licenses 3,221 3,347
Total definite-lived intangible assets 8,313 9,037
Goodwill and other indefinite-lived intangible assets are not amortized and are tested for impairment annually as of the first day of our fiscal fourth quarter or on an interim basis if events or changes in circumstances between annual tests indicate a potential impairment. First, we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include, but are not limited to, historical financial performance, assumptions related to the COVID-19 pandemic, wage, product and services inflation, competitive environment, macroeconomic and industry conditions, results of prior impairment tests and share price performance. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessments require the use of estimates and assumptions regarding future cash flows and asset fair values. Key assumptions include projected revenue growth and operating expenses, discount rates, royalty rates, valuation multiples and other factors that could affect fair value or otherwise indicate potential impairment. Such assessments could change materially if different estimates and assumptions were used.
We performed our annual impairment assessment of indefinite-lived intangible assets as of the first day of the fourth quarters of fiscal 2022 and 2021 and concluded there was no impairment. During the first quarter of fiscal 2020, we determined it was necessary to perform an interim assessment of our goodwill, trade names and trademarks due to the decrease in our stock price coupled with the dining room closures related to the COVID-19 pandemic and significant decline to the equity value of our peers and overall U.S. stock market. Based on the results of this assessment, we recorded goodwill impairment expense related to the Other FRC, North Italia and Flower Child operating segments of $33.8 million, $27.7 million and $17.9 million, respectively. In addition, we recorded impairment expense of $101.0 million related to trade names and trademarks. We performed our annual assessment of indefinite-lived intangible assets as of the first day of our fiscal fourth quarter of fiscal year 2020 and concluded there was no further impairment of these assets, other than $0.4 million of expense related to transferable alcoholic beverage licenses.
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Definite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on estimated undiscounted future cash flows. If impaired, the asset or asset group is written down to fair value based on discounted future cash flows. We performed our annual impairment assessment of definite-lived intangible assets as of the first day of the fourth quarters of fiscal 2022 and 2021. We concluded there was no impairment for fiscal 2022 and recorded $1.3 million of impairment expense in fiscal 2021 related to licensing agreements. During the first quarter of fiscal 2020, we determined it was necessary to perform an interim assessment of our licensing agreements and we recorded impairment expense of $2.3 million related to licensing agreements. Amortization expenses related to our definite-lived intangible assets were $0.5 million, $0.7 million and $0.7 million for fiscal 2022, 2021 and 2020, respectively. Definite-lived intangible assets will be amortized over one to 53 years.
We evaluate the useful lives of our intangible assets, other than goodwill, at each reporting period to determine if they are definite or indefinite-lived. A determination on useful life requires judgments and assumptions regarding the future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, legislative action that results in an uncertain or changing regulatory environment and expected changes in distribution channels), the level of required maintenance expenditures and the expected lives of other related groups of assets.
Revenue Recognition
Our revenues consist of sales at our Company-owned restaurants, sales from our bakery operations to our licensees and other third-party customers, royalties from our licensees’ restaurant sales and from consumer packaged goods sales, and licensee development and site fees. Revenues are presented net of sales taxes. Sales tax collected is included in other accrued expenses until the taxes are remitted to the appropriate taxing authorities.
Revenues from restaurant sales are recognized when payment is tendered at the point of sale. Revenues from bakery sales are recognized upon transfer of title and risk to customers. Royalty revenues are recognized in the period the related sales occur, utilizing the sale-based royalty exception available under current accounting guidance. Our consumer packaged goods minimum guarantees do not require distinct performance obligations. Therefore, related revenue is recognized on a straight-line basis over the life of the applicable agreements, ranging from five to seven years. As our development and site fee agreements do not contain distinct performance obligations, related revenue is recognized on a straight-line basis over the life of the applicable agreements, ranging from eight to 30 years. Deferred and recognized revenue for new minimum guarantees for consumer packaged goods and for new site and development agreements were immaterial in all periods presented.
We recognize a liability upon the sale of our gift cards and recognize revenue when these gift cards are redeemed in our restaurants. Based on our historical redemption patterns, we can reasonably estimate the amount of gift cards for which redemption is remote, which is referred to as “breakage.” Breakage is recognized over a three-year period in proportion to historical redemption trends and is classified as revenues in our consolidated statements of income/(loss). We recognized $7.0 million, $6.8 million and $7.6 million of gift card breakage in fiscal years 2022, 2021 and 2020, respectively. Incremental direct costs related to gift card sales, including commissions and credit card fees, are deferred and recognized in earnings in the same pattern as the related gift card revenue.
Certain of our promotional programs include multiple element arrangements that incorporate various performance obligations. We allocate revenue using the relative selling price of each performance obligation considering the likelihood of redemption and recognize revenue upon satisfaction of each performance obligation. During fiscal 2022, we deferred and recognized previously deferred revenue of $27.3 million and $23.6 million, respectively, related to promotional programs. During fiscal 2021, we deferred and recognized previously deferred revenue of $27.5 million and $15.2 million, respectively, related to promotional programs. During fiscal 2020, we deferred and recognized previously deferred revenue of $11.6 million and $11.2 million, respectively, related to promotional programs.
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Leases
We currently lease all of our restaurant locations, generally with initial terms of 10 to 20 years plus twofive-year renewal options. Our leases typically require contingent rent above the minimum base rent payments based on a percentage of revenues ranging from 2% to 10%, have escalating minimum rent requirements over the term of the lease and require payment for various expenses incidental to the use of the property. A majority of our leases provide for a reduced level of overall rent obligation if specified co-tenancy requirements are not satisfied. We expend cash for leasehold improvements and furniture, fixtures, and equipment to build out and equip our leased premises. We may also expend cash for structural additions that we make to leased premises. Generally, a portion of the leasehold improvements and building costs are reimbursed to us by our landlords as construction contributions. If obtained, landlord construction contributions usually take the form of up-front cash, full or partial credits against our future minimum or percentage rents, or a combination thereof. We do not meet any of the accounting criteria under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 842, Leases, for being the owner of the asset under construction. Many of our leases provide early termination rights permitting us to terminate the lease prior to expiration in the event our revenues are below a stated level for a period of time, generally conditioned upon repayment of the unamortized landlord contributions.
In addition to leases for our restaurant locations, we also lease automobiles and certain equipment that is used in the restaurants, bakeries and corporate office. The leases for our restaurant locations, automobiles and certain restaurant equipment are included in our operating lease assets and liabilities. All other leases are immaterial or qualify for the short-term lease exclusion.
The assessment of whether a contract is or contains a lease is performed at contract inception. A lease is defined as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control is defined as having both the right to obtain substantially all the economic benefits from the use of the asset and to direct how and for what purpose the asset is used.
At lease commencement, we evaluate each material lease and those that don’t qualify for the short-term exclusion to determine its appropriate classification as an operating or finance lease. All of the leases evaluated meet the criteria for classification as operating leases. For restaurant leases that existed as of the adoption of ASC 842, we continued to apply our historical practice of excluding executory costs, and only minimum base rent was factored into the initial operating lease liability and corresponding lease asset. For restaurant leases beginning after adoption of ASC 842, we have elected the single lease component practical expedient. Operating lease assets and liabilities are recorded on the balance sheet at lease commencement based on the present value of minimum base rent and other fixed payments over the reasonably certain lease term. The difference between the amounts we expend for structural costs and the construction contributions received from our landlords is recorded as an adjustment to the operating lease asset. Lease terms include the build-out period for our leases where no rent payments are typically due under the terms of the lease, as well as options to renew when we deem we have significant economic incentive to exercise the extension. When determining if we have a significant economic incentive, we consider relevant factors, such as contractual, asset, entity and market-based considerations. Option periods are included in the lease term for the majority of our leases. Termination rights have not been factored into the lease terms since based on our probability assessment we are reasonably certain we will not terminate our leases.
We cannot determine the interest rate implicit in our leases because we do not have access to the lessor’s estimated residual value or the amount of the lessor’s deferred initial direct costs. Therefore, we use our incremental borrowing rate as the discount rate for our leases. Our incremental borrowing rate for a lease is the rate of interest we would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms. Because we do not generally borrow on a collateralized basis, we derive an appropriate incremental borrowing rate using the interest rate we pay on our non-collateralized borrowings, adjusted for the amount of the lease payments, the lease term and the effect of designating specific collateral with a value equal to the unpaid lease payments for that lease.
We monitor for events or changes in circumstances that require reassessment of our leases. When a reassessment results in the re-measurement of a lease liability, a corresponding adjustment is made to the carrying amount of the operating lease asset. We also assess the potential impairment of our operating lease assets under long-lived asset impairment guidance in ASC 360, Property, Plant, and Equipment: Impairment or disposal on long-lived assets.
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Rent expense included in our operating lease assets is recognized on a straight-line basis. Contingent rent expense is recorded as incurred to the extent it exceeds minimum base rent per the lease agreement. Variable lease payments, which primarily consist of real estate taxes, common area maintenance charges, insurance cost and other operating expenses, are not included in the operating lease right-of-use asset or operating lease liability balances and are recognized as incurred. Rent expense is included in other operating costs and expenses in the consolidated statements of income/(loss).
The reasonably certain lease term and the incremental borrowing rate for each restaurant location require judgment by management and can impact the classification and accounting for a lease as operating or finance, the value of the operating lease asset and liability and the term over which leasehold improvements for each restaurant are depreciated. These judgments may produce materially different amounts of operating lease assets and liabilities, rent expense and interest expense than would be reported if different assumptions were used.
Self-Insurance Liabilities
We retain financial responsibility for a significant portion of our risks and associated liabilities with respect to workers’ compensation, general liability, staff member health benefits, employment practices and other insurable risks. The accrued liabilities associated with these programs are based on our estimate of the ultimate costs to settle known claims, as well as claims incurred but not yet reported to us (“IBNR”) as of the balance sheet date and are recorded in other accrued expenses. Our estimated liabilities, which are not discounted, are based on information provided by our insurance brokers and insurers, combined with our judgment regarding a number of assumptions and factors, including the frequency and severity of claims, claims development history, case jurisdiction, applicable legislation and our claims settlement practices. Significant judgment is required to estimate IBNR amounts, as parties have yet to assert such claims. If actual claims trends, including the severity or frequency of claims, differ from our estimates, our financial results could be impacted.
Stock-Based Compensation
We maintain stock-based incentive plans under which equity awards may be granted to staff members, consultants and non-employee directors. We account for the awards based on fair value measurement guidance and amortize to expense over the vesting period using a straight-line or graded-vesting schedule, as applicable. (See Note 16 for further discussion of our stock-based compensation.)
Advertising Costs
We expense advertising production costs at the time the advertising first takes place. All other advertising costs are expensed as incurred. Most of our advertising costs are included in other operating costs and expenses and were $21.0 million, $18.3 million and $16.0 million in fiscal 2022, 2021 and 2020, respectively.
Preopening Costs
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. We expense preopening costs as incurred.
Income Taxes
We provide for federal, state and foreign income taxes currently payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. We recognize deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of existing assets and liabilities using the statutory rates expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. Income tax credits are recorded as a reduction of tax expense.
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We routinely evaluate the likelihood of realizing the benefit of our deferred tax assets and record a valuation allowance if, based on all available evidence, we determine that some portion of the tax benefit will not be realized. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies (when applicable) and results of recent operations. If we later determine that we would be able to realize our deferred tax assets in excess of their net recorded amount, we adjust the deferred tax asset valuation allowance and reduce income tax expense.
We evaluate our exposures associated with our various tax filing positions and recognize a tax benefit from an uncertain tax position only if it is more-likely-than-not that the position will be sustained upon examination by the relevant taxing authorities based solely on its technical merits, taking into account available administrative remedies and litigation. If this threshold is met, we recognize only the portion of the tax benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. We record a liability for any portion of the tax benefit that does not meet these recognition and measurement criteria and we adjust this liability through income tax expense in the period in which the uncertain tax position is effectively settled, when the statute of limitations expires for the relevant taxing authority to examine the tax position or when new information becomes available. We recognize interest and penalties related to uncertain tax positions in income tax expense.
Net Income/(Loss) per Share
Basic net income/(loss) per share is computed by dividing net income/(loss) available to common stockholders by the weighted-average number of common shares outstanding during the period, reduced by unvested restricted stock awards. At January 3, 2023, December 28, 2021 and December 29, 2020, 2.5 million shares, 2.1 million shares and 2.0 million shares, respectively, of restricted stock and restricted stock units issued were unvested and, therefore, excluded from the calculation of basic earnings per share for the fiscal years ended on those dates.
Diluted net income/(loss) per share is computed by dividing net income/(loss) available to common stockholders by the weighted-average number of common stock equivalents outstanding for the period. Common stock equivalents for our convertible senior notes due 2026 (“Notes”) are determined by application of the if-converted method, and common stock equivalents for outstanding stock options and restricted stock are determined by the application of the treasury stock method.
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Holders of our Series A Convertible Preferred Stock, par value $0.01 per share (the “Series A preferred stock”) participated in dividends on an as-converted basis when declared on common stock. As a result, our Series A preferred stock met the definition of a participating security which required us to apply the two-class method to compute both basic and diluted net income per share. The two-class method is an earnings allocation formula that treats participating securities as having rights to earnings that would otherwise have been available to common stockholders. In addition, as our Series A preferred stock was a participating security, we were required to calculate diluted net income per share under the if-converted method in addition to the two-class method and utilize the most dilutive result. In periods where there is a net loss, no allocation of undistributed net loss to preferred stockholders was performed as the holders of our Series A preferred stock were not contractually obligated to participate in our losses.
Fiscal Year
(In thousands, except per share data)
Basic net income/(loss) per common share:
Dividends on Series A preferred stock — (18,661) (13,485)
Basic net income/(loss) per common share $ 0.87 $ 1.03 $ (6.32)
Diluted net income/(loss) per common share:
Dilutive effect of equity awards (1) 599 981 —
Diluted weighted-average shares outstanding 50,414 48,510 43,869
Diluted net income/(loss) per common share $ 0.86 $ 1.01 $ (6.32)
Comprehensive Income/(Loss)
Comprehensive income/(loss) includes all changes in equity during a period except those resulting from investment by and distribution to owners. Our comprehensive income consists of net income/(loss), unrealized gains/(losses) on our interest rate swap and translation gains/(losses) related to our Canadian restaurant operations.
Foreign Currency
The Canadian dollar is the functional currency for our Canadian restaurant operations. Revenue and expense accounts are translated into U.S. dollars using the average exchange rates during the reporting period. Assets and liabilities are translated using the exchange rates in effect at the reporting period end date. Equity accounts are translated at historical rates, except for the change in retained earnings which is the result of the income statement translation process. Translation gains and losses are reported as a separate component in our consolidated statements of comprehensive income/(loss) and would only be realized upon the sale or upon complete or substantially complete liquidation of the business. Gains and losses from foreign currency transactions are recognized in our consolidated statements of income/(loss) in interest and other expense, net.
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Recent Accounting Pronouncements
In August 2020, the FASB issued Accounting Standards Update (“ASU”) 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity, which is intended to simplify the accounting and measurement of convertible instruments and the settlement assessment for contracts in an entity’s own equity. This pronouncement was effective for fiscal years beginning after December 15, 2021 and early adoption was permitted. The guidance allowed for either full retrospective adoption or modified retrospective adoption. We adopted this guidance in the first quarter of fiscal 2021 utilizing the modified retrospective method and, accordingly, recorded a $4.8 million cumulative adjustment to retained earnings to reverse previously-recorded beneficial conversion features. As further discussed in Note 10, we issued certain Notes during the second quarter of fiscal 2021, and the accounting for these instruments was based on the guidance in ASU 2020-06. Additionally, the impact on diluted earnings per share of the Notes was calculated based on the if-converted method, as further described in Note 1.
2.Fair Value Measurements
Fair value measurements are estimated based on valuation techniques and inputs categorized as follows:
● Level 1: Quoted prices in active markets for identical assets or liabilities
The following tables present the components and classification of our assets and liabilities that are measured at fair value on a recurring basis (in thousands):
Level 1 Level 2 Level 3
Assets/(Liabilities)
Non-qualified deferred compensation assets $ 78,542 $ — $ —
Non-qualified deferred compensation liabilities (78,286) — —
Acquisition-related deferred consideration — (10,751) —
Level 1 Level 2 Level 3
Assets/(Liabilities)
Non-qualified deferred compensation assets $ 92,588 $ — $ —
Non-qualified deferred compensation liabilities (92,012) — —
Acquisition-related deferred consideration — (21,642) —
Changes in the fair value of non-qualified deferred compensation assets and liabilities are recognized in interest and other expense, net in our consolidated statements of income/(loss). Changes in the fair value of the acquisition-related deferred and contingent consideration and compensation liability are recognized in acquisition-related contingent consideration, compensation and amortization expenses in our consolidated statements of income/(loss).
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The following table presents a reconciliation of the beginning and ending amounts of the fair value of the acquisition-related contingent consideration and compensation liability categorized as Level 3 (in thousands):
Fiscal year ended
Payment (7,187) —
The fair value of the Acquisition-related contingent consideration and compensation liability was determined utilizing a Monte Carlo model based on estimated future revenues, margins and volatility factors, among other variables and estimates and has no minimum or maximum payment. The undiscounted range of outcomes per the Monte Carlo model utilized to determine the fair value of the acquisition-related contingent consideration and compensation liability was $0 to $276.0 million at January 3, 2023 and $0 to $204.0 million at December 28, 2021. Results could change materially if different estimates and assumptions were used. During fiscal 2022, the fair value of the contingent consideration and compensation liability increased by $4.7 million due to an $8.3 million increase in the fair value primarily stemming from a change in the volatility factors, as well as an increase in fiscal 2022 revenues and estimated future revenues utilized in the calculation and amortization, partially offset by a payment of $7.2 million per the FRC acquisition agreement. The increase in the fair value of the contingent consideration and compensation liability during fiscal 2021 was primarily due to a $15.3 million decrease related to the impact of an amendment to the Acquisition agreement that, among other things, extended the measurement period through fiscal 2026, as well as to an increase in fiscal 2021 revenues and estimated future revenues utilized in the fair value calculation, partially offset by amortization.
The fair values of our cash and cash equivalents, accounts receivable, income taxes receivable, other receivables, prepaid expenses, accounts payable, income taxes payable and other accrued expenses approximate their carrying amounts due to their short duration.
At both January 3, 2023 and December 28, 2021, we had $345.0 million aggregate principal amount of Notes outstanding. The estimated fair value of the Notes based on a market approach as of January 3, 2023 and December 28, 2021 was approximately $282.9 million and $309.8 million, respectively, and determined based on the estimated or actual bids and offers of the Notes in an over-the-counter market on the last business day of the reporting period. The decrease in the fair value of the Notes was primarily due to a decline in our stock price from the date of the issuance of Notes. See Note 10 for further discussion of the Notes.
3. Accounts and Other Receivables
Accounts and other receivables consisted of (in thousands):
Fiscal year ended