UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 2006
or
£		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 0-20574

THE CHEESECAKE FACTORY INCORPORATED
(Exact name of registrant as specified in its charter)

 

Registrant’s telephone number, including area code:  (818) 871-3000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No x

As of December 1, 2006, 77,817,118 shares of the registrant’s Common Stock, $.01 par value, were outstanding.

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

INDEX

			Page Number
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements:
		Consolidated Balance Sheets as of October 3, 2006 (unaudited) and January 3, 2006, as restated	1
		Consolidated Statements of Operations for the thirteen and thirty-nine weeks ended October 3, 2006 and September 27, 2005, as restated (unaudited)	2
		Consolidated Statement of Stockholders’ Equity for the thirty-nine weeks ended October 3, 2006 (unaudited)	3
		Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 3, 2006 and September 27, 2005, as restated (unaudited)	4
		Notes to Consolidated Financial Statements	5
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	30
	Item 4.	Controls and Procedures	31
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	32
	Item 1A.	Risk Factors	33
	Item 6.	Exhibits	34
Signatures			35
Index to Exhibits			36

 

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

		October 3, 2006			January 3, 2006
					(restated)
ASSETS
Current assets:
Cash and cash equivalents		$	19,571		$	31,052
Investments and marketable securities		66,388			63,222
Accounts receivable		6,250			8,108
Other receivables		33,195			26,390
Inventories		26,312			19,119
Prepaid expenses		15,317			14,583
Deferred income taxes		10,083			10,339
Total current assets		177,116			172,813
Property and equipment, net		698,598			609,918
Other assets:
Marketable securities		39,903			83,700
Trademarks		3,061			2,730
Prepaid rent		42,575			38,673
Other		23,417			18,416
Total other assets		108,956			143,519
Total assets		$	984,670		$	926,250
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	40,998		$	32,150
Income taxes payable		11,147			6,015
Other accrued expenses		84,299			94,937
Total current liabilities		136,444			133,102
Deferred income taxes		68,318			73,375
Deferred rent		40,121			35,977
Deemed landlord financing liability		43,382			26,273
Other noncurrent liabilities		13,483			10,824
Commitments and contingencies (Note 7)
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued		¾			¾
Junior participating cumulative preferred stock, $.01 par value, 150,000 shares authorized; none issued		¾			¾
Common stock, $.01 par value, 150,000,000 shares authorized; 81,396,250 and 80,910,422 issued at October 3, 2006 and January 3, 2006, respectively		814			809
Additional paid-in capital		311,964			287,080
Retained earnings		451,362			390,516
Accumulated other comprehensive loss		(753		)	(1,235		)
Treasury stock, 3,627,217 and 2,078,617 shares at cost at October 3, 2006 and January 3, 2006, respectively		(80,465		)	(30,471		)
Total stockholders’ equity		682,922			646,699
Total liabilities and stockholders’ equity		$	984,670		$	926,250

 

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

		Thirteen Weeks Ended October 3,  2006			Thirteen  Weeks Ended September 27,  2005			Thirty-Nine Weeks Ended October 3,  2006			Thirty-Nine  Weeks Ended September 27,  2005
					(restated)						(restated)
Revenues		$	325,337		$	296,873		$	954,629		$	853,433
Costs and expenses:
Cost of sales		81,420			74,660			238,742			217,935
Labor expenses		104,931			90,986			306,594			263,941
Other operating costs and expenses		77,072			67,102			223,411			193,503
General and administrative expenses		18,418			14,050			50,924			38,549
Depreciation and amortization expenses		13,465			11,386			38,859			32,243
Preopening costs		5,369			3,760			12,916			10,280
Total costs and expenses		300,675			261,944			871,446			756,451
Income from operations		24,662			34,929			83,183			96,982
Interest income, net		1,044			1,133			3,545			2,857
Other income, net		168			114			1,969			400
Income before income taxes		25,874			36,176			88,697			100,239
Income tax provision		7,747			12,572			27,851			34,849
Net income		$	18,127		$	23,604		$	60,846		$	65,390
Net income per share:
Basic		$	0.23		$	0.30		$	0.78		$	0.84
Diluted		$	0.23		$	0.29		$	0.76		$	0.82
Weighted average shares outstanding:
Basic		77,757			78,511			78,299			78,228
Diluted		78,695			80,235			79,576			80,063

 

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)

		Shares of  Common Stock		Common Stock			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive  Income/(Loss)			Treasury Stock			Total
Balance, January 3, 2006, as restated		80,910		$	809		$	287,080		$	390,516		$	(1,235	)	$	(30,471	)	$	646,699
Comprehensive income:
Net income		—		—			—			60,846			—			—
Unrealized gain on available-for-sale securities		—		—			—			—			482			—
Total comprehensive income																			61,328
Issuance of common stock from stock option exercises		486		5			7,636			—			—			—			7,641
Tax benefit related to stock options exercised		—		—			3,165			—			—			—			3,165
Stock-based compensation		—		—			14,083			—			—			—			14,083
Purchase of treasury stock		—		—			—			—			—			(49,994		)	(49,994		)
Balance, October 3, 2006		81,396		$	814		$	311,964		$	451,362		$	(753	)	$	(80,465	)	$	682,922

 

See the accompanying notes to the consolidated financial statements.

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THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

		Thirty-Nine Weeks Ended October 3, 2006			Thirty-Nine Weeks Ended September 27, 2005
					(restated)
Cash flows from operating activities:
Net income		$	60,846		$	65,390
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		38,859			32,243
Loss on sale of available-for-sale securities		11			15
Loss (gain) on asset sale		54			(8		)
Deferred income taxes		(5,070		)	17,370
Stock-based compensation		14,083			639
Tax benefit related to stock options exercised		3,165			5,930
Excess tax benefit related to stock options exercised		(1,744		)	¾
Changes in assets and liabilities:
Accounts receivable		1,858			1,689
Other receivables		(6,805		)	2,282
Inventories		(7,193		)	(9,958		)
Prepaid expenses		(734		)	390
Other		(9,417		)	(8,635		)
Accounts payable		8,848			(6,770		)
Income taxes payable		5,132			1,088
Other accrued expenses		(4,032		)	7,884
Cash provided by operating activities		97,861			109,549
Cash flows from investing activities:
Additions to property and equipment		(128,436		)	(111,770		)
Investments in available-for-sale securities		(50,336		)	(64,772		)
Sales of available-for-sale securities		91,708			55,027
Cash used in investing activities		(87,064		)	(121,515		)
Cash flows from financing activities:
Deemed landlord financing proceeds		18,847			14,290
Deemed landlord financing payments		(516		)	(227		)
Proceeds from exercise of employee stock options		7,641			8,975
Purchase of treasury stock		(49,994		)	(3,986		)
Excess tax benefit related to stock options exercised		1,744			¾
Cash provided by (used in) financing activities		(22,278		)	19,052
Net change in cash and cash equivalents		(11,481		)	7,086
Cash and cash equivalents at beginning of period		31,052			14,041
Cash and cash equivalents at end of period		$	19,571		$	21,127
Supplemental disclosures:
Interest paid		$	1,333		$	588
Income taxes paid		$	24,596		$	10,372

 

See the accompanying notes to the consolidated financial statements.

4

THE CHEESECAKE FACTORY INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Presentation and Significant Accounting Policies

The accompanying consolidated financial statements include the accounts of The Cheesecake Factory Incorporated (referred to herein as the “Company” or in the first person notations “we,” “us” and “our”) and its wholly owned subsidiaries prepared in accordance with generally accepted accounting principles and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  The financial statements presented herein have not been audited by an independent registered public accounting firm, but include all material adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial condition, results of operations and cash flows for the period.  However, these results are not necessarily indicative of results for any other interim period or for the full fiscal year.  The consolidated balance sheet data presented herein for January 3, 2006 was derived from our audited consolidated financial statements for the fiscal year then ended, but does not include all disclosures required by generally accepted accounting principles.  The preparation of financial statements in accordance with generally accepted accounting principles requires us to make certain 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.  Actual amounts could differ from these estimates.

Certain information and footnote disclosures normally included in financial statements in accordance with generally accepted accounting principles have been omitted pursuant to the rules of the Securities and Exchange Commission.  The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K/A for the fiscal year ended January 3, 2006.

Reclassification

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.  On the Consolidated Balance Sheets, our restaurant smallware balance, previously included in inventories, was moved to property and equipment.

Restatement of Financial Statements due to Review of Stock Option Grants and Procedures

On July 18, 2006, we announced that the Audit Committee of our Board of Directors, which is comprised solely of independent directors, was reviewing the Company’s practices relating to its stock option grants with the assistance of special outside legal counsel from the law firm of Cooley Godward Kronish LLP. This voluntary review was initiated in response to media and Wall Street reports regarding the option granting practices at numerous publicly traded companies.

On November 20, 2006, we announced the conclusion of the Audit Committee’s review, which covered the period beginning with the Company’s initial public offering registration in 1992 to the present.  The Audit Committee reported that its special counsel received full cooperation from Company management, was given complete access to all necessary and relevant electronic and other documents, and interviewed all persons involved in the stock option granting process at the Company, as well as the Company’s advisors.

Based upon the Audit Committee’s findings, we concluded that we selected the grant date of options based upon the lowest price, generally within a 30-day window because we incorrectly believed that the applicable accounting guidance allowed us to establish the grant date within a certain window from authorization.  As a result, we incorrectly applied the measurement date, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” with respect to certain option grants made to executive officers in fiscal years 1997 through 2001, to non-executive officers and other employees in fiscal years 1997 through 2004, and to outside directors in fiscal years 2000 and 2001.  Because we incorrectly selected grant dates which resulted in a cumulative adjustment of $5.4 million expense on an after-tax basis through fiscal 2005, we amended our Annual Report on Form 10-K for the fiscal year ended January 3, 2006 to restate the Consolidated Balance Sheets at January 3, 2006 and December 28, 2004 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the years ended January 3, 2006, December 28, 2004 and December 30, 2003.  We also restated the Consolidated Balance Sheet at April 4, 2006 and the Consolidated Statements of Operations, Stockholders’ Equity and Cash Flows for the quarterly periods ended April 4, 2006 and March 29, 2005.

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These restated financial statements are included in the Quarterly Report on Form 10-Q/A for the quarter ended April 4, 2006.  Throughout this Form 10-Q, all referenced amounts for prior periods and prior period comparisons reflect the balances and amounts on a restated basis. 

Correction of Other Matters

As part of the restatement process resulting from the review of our stock option granting practices, we assessed generally whether there were other matters, which should be corrected in our previously issued financial statements.  We concluded that three additional errors should be corrected.

·                  We recognize a liability upon the sale of a gift card and recognize revenue when the gift card is redeemed in our restaurants or on our website.  Beginning in 2001, we adjusted the gift card liability upon the sale of a gift card for the estimated portion of the gift card value that would not be redeemed (“breakage”).  We have now determined that the appropriate accounting is to record breakage ratably over the estimated time period that our gift cards are generally redeemed and that no breakage should be recognized until there is sufficient history to establish the estimated redemption period. As a result, we are restating the periods 2001 through the second quarter of 2005 to reverse breakage that was previously recognized since we did not have sufficient data to estimate the redemption periods.  For the third and fourth quarters of 2005, we are restating to recognize breakage both cumulatively and prospectively over a thirty-six month period based on an ability to estimate breakage due to a full cycle of redemptions being tracked since 2002.  As part of this restatement, we are also correcting our classification of breakage income.  The adjustment to the gift card liability account for breakage was previously classified as a reduction of general and administrative expenses in our consolidated statements of operations.  As part of this restatement, we are reclassifying gift card breakage to revenue.  The impact of these breakage related adjustments was an understatement of net income by $1.1 million in fiscal 2005 and an overstatement of net income by $0.4 million and $0.7 million in fiscal 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.7 million and $3.4 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  We previously recorded expense for our operations bonuses on a one-quarter lag. While our Consolidated Statements of Operations reflected four quarters of bonus-related expense, our Consolidated Balance Sheet did not reflect the accrued bonus liability for the most recent quarter.   The impact of this error was an overstatement of net income by $0.2 million, $0.1 million and $0.2 million in fiscal 2005, 2004 and 2003, respectively, and an understatement of other accrued expenses of $1.6 million and $1.3 million at January 3, 2006 and December 28, 2004, respectively.  Net income for the first quarter of fiscal 2006 was understated by $0.1 million.

·                  Historically, we did not amortize the cost of liquor licenses as we had considered them indefinite-lived assets.  We have now concluded that certain liquor licenses are not transferable and therefore have finite lives corresponding with the terms of the related operating lease. These non-transferable liquor licenses are now amortized over the primary lease terms of the respective leases plus any exercised extensions of those lease terms. The impact of this error was an overstatement of net income by $27,000, $25,000 and $22,000 in fiscal 2005, 2004 and 2003, respectively, and an overstatement of other assets of $0.2 million at both January 3, 2006 and December 28, 2004.  Net income for the first quarter of fiscal 2006 was overstated by $8,000.

The aggregate adjustments increased net income by $0.4 million in fiscal year 2005 and reduced net income by $1.2 million and $1.6 million in fiscal years 2004 and 2003, respectively.  Net income for the first quarter of fiscal 2006 increased by $6,000.  Diluted net income per share increased by $0.01 for the year ended January 3, 2006 and decreased by $0.02 and $0.03 for the years ended December 28, 2004 and December 30, 2003, respectively, and was unchanged for the first quarter of fiscal 2006.  The restatement also resulted in a $5.2 million, or 2.8%, reduction in retained earnings as of December 31, 2002.  The restatement adjustments were non-cash and had no impact on net cash flow.

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The following table reflects the impact of the restatement on the Consolidated Statements of Operations (in thousands, except per share data):

		Thirteen Weeks  Ended September 27,  2005			Thirteen Weeks  Ended September 27,  2005			Thirty-Nine Weeks  Ended September 27,  2005			Thirty-Nine Weeks  Ended September 27,  2005
		(as previously  reported)			(restated)			(as previously  reported)			(restated)
Selected Statement of Operations Data:
Revenues		$	292,807		$	296,873		$	849,367		$	853,433
Labor expenses		90,910			90,986			263,704			263,941
Other operating costs and expenses		67,080			67,102			193,486			193,503
General and administrative expenses		12,653			14,050			36,612			38,549
Depreciation and amortization expenses		11,375			11,386			32,211			32,243
Total costs and expenses		260,438			261,944			754,228			756,451
Income from operations		32,369			34,929			95,139			96,982
Income before income taxes		33,616			36,176			98,396			100,239
Income tax provision		11,698			12,572			34,241			34,849
Net income		21,918			23,604			64,155			65,390
Net income per share:
Basic		$	0.28		$	0.30		$	0.82		$	0.84
Diluted		$	0.27		$	0.29		$	0.80		$	0.82

 

The following table reflects the impact of the restatement on the Consolidated Statements of Cash Flows (in thousands):

		Thirty-Nine Weeks  Ended September 27, 2005			Thirty-Nine Weeks  Ended September 27, 2005
		(as previously  reported)			(restated)
Selected Cash Flow Data:
Net income		$	64,155		$	65,390
Depreciation and amortization		32,211			32,243
Deferred income tax		16,631			17,370
Stock-based compensation		—			639
Tax benefit related to stock options exercised		6,050			5,930
Income taxes payable		1,099			1,088
Other accrued expenses		10,398			7,884

 

There was no impact to the subtotals for the operating, investing or financing sections of the consolidated statements of cash flows, because all adjustments occurred within the operating activities component.

 

Stock-Based Compensation

Prior to the January 4, 2006 adoption of Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment” (“SFAS 123R”), we accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  Historically, no compensation expense was recognized for Company-issued stock options.  As permitted by SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements.

However, as further discussed above, the Audit Committee of our Board of Directors initiated earlier this year a voluntary review of our stock option granting practices from 1992 to the present.  The review encompassed all grants made under our various stock option plans in effect during this period.  Based on the results of this review, we restated our historical accounting to correct the application of the measurement date, as defined in APB Opinion No. 25, for certain grants of stock options to directors, officers and employees, resulting from administrative oversight and the date selection methods used by the Company.  The restatement adjustments were non-cash and had no impact on net cash flow.

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Effective January 4, 2006, we adopted SFAS 123R using the modified prospective transition method and, as a result, did not retroactively adjust results from prior periods. Under this transition method, stock-based compensation was recognized for: 1) expense related to the remaining unvested portion of all stock option awards granted prior to January 4, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and 2) expense related to all stock option awards granted on or subsequent to January 4, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  We apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees, which is then amortized on a straight-line basis over the requisite service period.  See Note 4 of the Notes to Consolidated Financial Statements in this Form 10-Q for further discussion of stock-based compensation.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements.  The Statement applies whenever other statements require or permit assets or liabilities to be measured at fair value.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”  This Statement requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income to report the funded status of defined benefit pension and other postretirement benefit plans.  The Statement requires prospective application, and the recognition and disclosure requirements are effective for companies with fiscal years ending after December 15, 2006.  Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date.  This requirement is effective for fiscal years ending after December 15, 2008.  We are currently evaluating the impact this Statement will have on our consolidated financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance regarding the consideration given to prior year misstatements when determining materiality in current year financial statements.  SAB No. 108 is effective for fiscal years ending after November 15, 2006.  We do not expect SAB No. 108 to have any impact on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes.”  This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, on a tax return.  This Interpretation also provides guidance on derecognition, classification, interest, penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with this Interpretation will be a two-step process.  The first step will determine if it is more likely than not that a tax position will be sustained upon examination and should therefore be recognized.  The second step will measure a tax position that meets the more likely than not recognition threshold to determine the amount of benefit to recognize in the financial statements.  This Interpretation is effective for fiscal years beginning after December 15, 2006.  We are currently evaluating the impact this Interpretation will have on our consolidated financial statements.

In March 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).”   A consensus was reached that entities may adopt a policy of presenting sales taxes in the income statement on either a gross or net basis.  If taxes are significant, an entity should disclose its policy of presenting taxes and the amounts of taxes. The guidance is effective for periods beginning after December 15, 2006. We present company sales net of sales taxes. This issue will not impact the method for presenting these sales taxes in our consolidated financial statements.

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In November 2005, the FASB issued Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” (“FSP 115-1”) which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is required to be applied to reporting periods beginning after December 15, 2005.  We adopted FSP 115-1 on January 4, 2006 and included the required disclosures in Note 2 of Notes to the Consolidated Financial Statements in this Form 10-Q.  There was no impact to our consolidated financial statements as the result of our adoption of FSP 115-1.

In October 2005, the FASB issued Staff Position FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period,” which requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense.  This Staff Position is effective for reporting periods beginning after December 15, 2005, and retrospective application is permitted but not required. We adopted FAS 13-1 on January 4, 2006 on a prospective basis.  Prior to adoption, we capitalized rent incurred during the tenant improvement construction phase, which averaged approximately $45,000 per new restaurant opened during fiscal 2005.

2. Investments and Marketable Securities

Investments and marketable securities, consisted of the following in thousands:

Classification		Cost			Gross Unrealized Gains			Gross Unrealized Losses			Fair Value			Maturity
At October 3, 2006:
Current assets:
Available-for-sale securities:
Corporate debt securities		$	18,303		$	¾		$	(75	)	$	18,228		October 2006 to September 2007
U.S. government agency obligations		48,602			¾			(442		)	48,160			October 2006 to August 2007
Total		$	66,905		$	¾		$	(517	)	$	66,388
Other assets:
Available-for-sale securities:
Corporate debt securities		$	14,792		$	¾		$	(185	)	$	14,607		October 2007 to January 2011
U.S. government agency obligations		25,727			¾			(431		)	25,296			November 2007 to September 2010
Total		$	40,519		$	¾		$	(616	)	$	39,903
At January 3, 2006:
Current assets:
Available-for-sale securities:
Corporate debt securities		$	29,922		$	2		$	(222	)	$	29,702		January 2006 to December 2006
U.S. government agency obligations		33,738			1			(219		)	33,520			February 2006 to November 2006
Total		$	63,660		$	3		$	(441	)	$	63,222
Other assets:
Available-for-sale securities:
Corporate debt securities		$	27,861		$	11		$	(291	)	$	27,581		January 2007 to May 2010
U.S. government agency obligations		57,286			17			(1,184		)	56,119			January 2007 to September 2010
Total		$	85,147		$	28		$	(1,475	)	$	83,700

 

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The following tables present the length of time available-for-sale securities were in continuous unrealized loss positions, but were not deemed to be other-than-temporarily impaired (in thousands):

		Less Than 12 Months						Greater Than or Equal to 12  Months
		Gross  Unrealized  Holding  Losses			Fair Value			Gross  Unrealized  Holding  Losses			Fair Value
At October 3, 2006:
Corporate debt securities		$	(24	)	$	14,492		$	(236	)	$	17,842
U.S. government agency obligations		(103		)	15,117			(770		)	58,339
Total		$	(127	)	$	29,609		$	(1,006	)	$	76,181
At January 3, 2006:
Corporate debt securities		$	(131	)	$	13,582		$	(382	)	$	29,019
U.S. government agency obligations		(120		)	25,007			(1,283		)	56,229
Total		$	(251	)	$	38,589		$	(1,665	)	$	85,248

 

Gross unrealized holding losses of $0.1 million for less than twelve months and $1.0 million for greater than or equal to twelve months as of October 3, 2006, pertain to 27 and 45 fixed income securities, respectively, and were primarily caused by interest rate increases.  Since we have the ability and intent to hold these securities until a recovery of fair value, which may be at maturity, and because the unrealized losses were primarily due to higher interest rates, we do not consider these securities to be other-than-temporarily impaired.  In addition, the U.S. government agency obligations are rated “AAA,” and the contractual terms of these securities do not permit the issuer to settle at a price less than the par value of the investment, which is the equivalent of the amount due at maturity.

There were no realized losses recorded for other than temporary impairments during fiscal 2005, nor the first three quarters of fiscal 2006.

3.  Inventories

Inventories consisted of (in thousands):

		October 3, 2006			January 3, 2006
Restaurant food and supplies		$	9,890		$	9,026
Bakery finished goods		12,630			7,836
Bakery raw materials		3,792			2,257
Total		$	26,312		$	19,119

 

4.  Stock-Based Compensation

We maintain performance incentive plans under which incentive stock options, non-qualified stock options, stock appreciation rights, restricted shares, deferred shares, performance shares and performance units may be granted to employees, consultants and non-employee directors.  To date, we have only granted non-qualified stock options under these plans.  Stock options generally vest at 20% per year, expire ten years from the date of grant, and become exercisable provided that we meet or exceed certain performance criteria approved by our Board of Directors.

Historically, no compensation expense was recognized for Company-issued stock options.  As permitted by SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements.

However, as further discussed in Note 1, earlier this year the Audit Committee of our Board of Directors initiated a voluntary review of our stock option granting practices from 1992 to the present.  The review encompassed all grants made under our various stock option plans in effect during this period. Based on the results of this review, we restated our historical accounting to correct the application of the measurement date, as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” for certain grants of stock options to directors, officers and employees, resulting from administrative oversight and the date selection methods used by the Company.  The restatement adjustments were non-cash and had no impact on net cash flow.

 

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Effective January 4, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method, and as a result, did not retroactively adjust results from prior periods.  Under this transition method, stock-based compensation was recognized for: 1) expense related to the remaining unvested portion of all stock option awards granted prior to January 4, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and 2) expense related to all stock option awards granted on or subsequent to January 4, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.  We apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees.  The resulting compensation expense is recognized over the requisite service period, which is generally the option vesting term of five years.  Prior to fiscal 2006, stock-based compensation was included as a pro forma disclosure in the Notes to the Consolidated Financial Statements as permitted by SFAS 123.

Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on our historical experience and future expectations.  Prior to the adoption of SFAS 123R, the effect of forfeitures on the pro forma expense amounts was recognized as the forfeitures occurred.

As a result of adopting SFAS 123R, the impact to the Consolidated Statement of Operations for the thirteen weeks ended October 3, 2006 on income before income taxes and net income was $4.3 million and $3.0 million, respectively, and $0.04 on both basic and diluted earnings per share.  For the thirty-nine weeks ended October 3, 2006, the impact of stock-based compensation expense on income before income taxes and net income was $13.1 million and $9.0 million, respectively, and $0.11 and $0.12 on basic and diluted earnings per share, respectively.  Capitalized stock-based compensation for the thirteen and thirty-nine weeks ended October 3, 2006 was $0.3 million and $1.0 million, respectively, and was included in property and equipment, net and other assets on the Consolidated Balance Sheet.  In addition, prior to the adoption of SFAS 123R, we presented the tax benefit resulting from the exercise of stock options as operating cash inflows in the Consolidated Statements of Cash Flows.  Upon the adoption of SFAS 123R, the excess tax benefits for those options are classified as financing cash inflows.

The pro forma table below reflects net income and basic and diluted net income per share for the third quarter of fiscal 2005, had we applied the fair value recognition provisions of SFAS 123 (in thousands, except per share data):

		Thirteen Weeks Ended September 27, 2005			Thirty-Nine Weeks Ended September 27, 2005
		(restated)			(restated)
Net income, as reported		$	23,604		$	65,390
Total stock-based compensation included in net income, as reported		125			390
Total stock-based compensation expense, net of taxes, under the fair value method		(2,888		)	(8,493		)
Net income, pro forma		$	20,841		$	57,287
Basic net income per share, as reported		$	0.30		$	0.84
Basic net income per share, pro forma		$	0.27		$	0.73
Diluted net income per share, as reported		$	0.29		$	0.82
Diluted net income per share, pro forma		$	0.26		$	0.72

 

Pro forma disclosure for fiscal 2006 is not presented because the amounts are recognized in the consolidated financial statements.

The weighted average fair value at the grant date for options issued during the third quarter of fiscal 2006 and 2005 was $8.75 and $13.73 per option, respectively.  For the first three quarters of fiscal 2005, we employed the binomial lattice option valuation model.

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Upon further review of the various valuation techniques and the relevance of our historical exercise patterns, we believe the Black-Scholes option pricing model is currently a better tool for estimating our stock-based compensation cost.  We utilized the Black-Scholes model beginning with the fourth quarter of fiscal 2005 and will employ it on a go-forward basis.  The fair value of options at date of grant was estimated using the following weighted average assumptions for the third quarter of fiscal 2006 and 2005, respectively: (a) no dividend yield on our stock, (b) expected stock price volatility of 32.2% and 33.1%, (c) a risk-free interest rate of 4.9% and a range of 4.2% to 4.6%, and (d) an expected option term of 4.75 years under the Black-Scholes model for the third quarter of 2006. Under the binomial lattice model for the third quarter of fiscal 2005, we used a termination rate of 0.6% and an exercise multiple of 1.35.

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior.  Expected stock price volatility is based on a combination of the historical volatility of our stock and the implied volatility of actively traded options on our common stock.  The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant with an equivalent remaining term. We have not paid dividends in the past and do not currently plan to pay dividends in the near future.

Stock option activity during the thirty-nine weeks ended October 3, 2006 was as follows:

		Shares		Weighted  Average  Exercise Price			Weighted  Average  Remaining  Contractual  Term		Aggregate  Intrinsic Value
		(in thousands)					(in years)		(in thousands)
Outstanding at January 3, 2006		7,564		$	22.96
Granted		1,429		$	33.21
Exercised		(486	)	$	15.73
Cancelled		(286	)	$	28.75
Outstanding at October 3, 2006		8,221		$	24.93		6.9		$	34,979
Vested and expected to vest at October 3, 2006		7,929		$	24.76		6.8		$	34,656
Exercisable at October 3, 2006		2,624		$	18.25		5.0		$	24,286

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between our closing stock price on October 3, 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders exercised their options on October 3, 2006.  This amount changes based on the fair market value of our stock.  Total intrinsic value of options exercised for the thirteen and thirty-nine weeks ended October 3, 2006 was $0.3 million and $8.5 million, respectively.  As of October 3, 2006, total unrecognized stock-based compensation expense related to nonvested stock options was $41 million, which is expected to be recognized over a weighted average period of approximately 2.7 years.  As of October 3, 2006 there were 8.7 million shares of common stock available for issuance pursuant to future stock option grants.

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Additional information regarding options outstanding as of October 3, 2006 is as follows:

			Options Outstanding							Options Exercisable
Range of Exercise Prices			Shares		Weighted  Average  Remaining  Contractual Life		Weighted  Average  Exercise  Price			Shares		Weighted  Average  Exercise  Price
			(in thousands)		(in years)					(in thousands)
$   3.58	- $18.61		1,419		3.6		$	11.50		1,294		$	10.89
$ 18.75	- $21.81		1,380		6.2		$	20.28		424		$	20.24
$ 21.82	- $26.37		1,497		6.8		$	23.37		305		$	22.48
$ 26.53	- $29.36		1,376		7.5		$	28.69		368		$	29.30
$ 29.37	- $34.00		1,370		8.4		$	31.86		198		$	31.82
$ 34.02	- $38.24		1,179		9.2		$	36.07		35		$	36.63
$   3.58	- $38.24		8,221		6.9		$	24.93		2,624		$	18.25

 

5.  Net Income Per Share

In accordance with the provisions of SFAS No. 128, “Earnings Per Share,” basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.  Diluted net income per share includes the dilutive effect of potential stock option exercises, calculated using the treasury stock method.  Outstanding stock options issued by us represent the only dilutive effect reflected in diluted weighted average shares outstanding.

(In thousands, except per share data)		Thirteen Weeks Ended October 3, 2006			Thirteen Weeks Ended September 27, 2005			Thirty-Nine Weeks Ended October 3, 2006			Thirty-Nine Weeks Ended September 27, 2005
					(restated)						(restated)
Net Income per Common Share–Basic:
Weighted average shares outstanding		77,757			78,511			78,299			78,228
Net income		$	18,127		$	23,604		$	60,846		$	65,390
Net income per share–basic		$	0.23		$	0.30		$	0.78		$	0.84
Net Income per Common Share–Diluted:
Weighted average shares outstanding		77,757			78,511			78,299			78,228
Effect of dilutive stock options		938			1,724			1,277			1,835
Weighted average shares outstanding–diluted		78,695			80,235			79,576			80,063
Net income		$	18,127		$	23,604		$	60,846		$	65,390
Net income per share–diluted		$	0.23		$	0.29		$	0.76		$	0.82

 

Shares of common stock equivalents of approximately 4.6 million and 4.1 million for the thirteen and thirty-nine weeks ended October 3, 2006, respectively, were not included in the diluted calculation because they were anti-dilutive.

6.  Comprehensive Income

Comprehensive income consisted of (in thousands):

		Thirteen Weeks Ended October 3,  2006			Thirteen Weeks Ended September 27,  2005			Thirty-Nine  Weeks Ended October 3,  2006			Thirty-Nine Weeks Ended September 27,  2005
					(restated)						(restated)
Net income		$	18,127		$	23,604		$	60,846		$	65,390
Net unrealized gain (loss) on available-for-sale securities		684			(257		)	482			(335		)
Total		$	18,811		$	23,347		$	61,328		$	65,055

 

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7. Commitments and Contingencies

On August 1, 2006, we received final approval by the Superior Court of the State of California of a negotiated settlement of consolidated class action wage and hour lawsuits originally filed in December 2002 by two former hourly restaurant employees in California alleging violations of California labor laws with respect to providing meal and rest breaks.  Notices of the settlement were sent to all class members, the claims period has expired, and the administration of claims has been completed.  A number of former and current employees also filed individual wage and hour claims, based upon alleged similar violations, directly with various offices of the California Division of Labor Standards Enforcement (“DLSE”). The DLSE claims filed by employees who joined the approved settlement also will be resolved by such settlement.

On February 22, 2006, a current employee filed a claim in the General Court of Justice - Superior Court Division, Durham County, North Carolina (Chandler v. The Cheesecake Factory Restaurants, Inc. et al.; Case No. 6CVS00724), alleging that the Company unlawfully failed to pay the named plaintiff and similarly situated tipped employees certain wages and tips in violation of the “tip pooling” provisions of the North Carolina wage and hour laws. The Plaintiff seeks class certification and recovery of back wages and liquidated damages under the North Carolina Wage and Hour Act.  It is the Company’s position that the Plaintiff and any other purported class members have been paid all wages and tips owed, the Company does not have any tip pooling arrangement, and the Company’s suggested tip-out guidelines, which are voluntary, comply with all federal, state and local laws.  The Company intends to vigorously defend this action.

On June 23, 2006, three current restaurant management employees in Ohio filed a charge of discrimination with the U.S. Equal Employment Opportunity Commission (EEOC) against The Cheesecake Factory Restaurants, Inc. alleging violations of Title VII of the Civil Rights Act resulting from alleged sex discrimination in the Company’s promotion process. The claimants seek unspecified amounts of penalties and other monetary payments.  The Company is cooperating with the EEOC’s investigation of this matter.  The Company intends to vigorously defend against this matter.

On August 29, 2006, five present and former hourly restaurant employees in the States of Tennessee, Texas and Arizona filed a lawsuit in the U.S. District Court for the Middle District of Tennessee against the Company alleging violations of the Fair Labor Standards Act with respect to alleged minimum wage violations, improper payroll deductions, and requiring work “off the clock”, among others claims (Smith v. The Cheesecake Factory Restaurants, Inc. et al; Case No. 3 06 0829).  The lawsuit seeks unspecified amounts of penalties and other monetary payments on behalf of the plaintiffs and other purported class members. The plaintiffs also seek attorneys’ fees for themselves.  Discovery is currently continuing in this matter.  The Company intends to vigorously defend its position.

Following our announcement on July 18, 2006 of the Audit Committee of our Board of Directors’ review of our historical stock option granting practices, a number of purported Company shareholders brought eight separate putative shareholder derivative actions (the “Options Derivative Actions”) against the Company, our entire Board of Directors, and certain of our current and former officers alleging that the defendants improperly dated certain historical stock option grants.  The plaintiffs in these cases, filed in Los Angeles County Superior Court and styled as Siebles v. Deitchle et. al. (Case No. BC355872) (subsequently re-filed in federal court), McGee v. Overton et al. (Case No. BC355953); Rigotti v. Overton, et al. (Case No. BC356850), Cullen v. Overton, et al. (Case No. BC356851), Sachs v. Overton et al. (Case No. BC357065), and filed in United States District Court for the Central District and styled as Siebles v. Deitchle et.al. (Case No. CV06 6234), Kuhns v. Deitchle et al. (Case No. SACV06917) and Freed v. Overton et al. (Case No. CV 06 06486) contend, among other things, that the defendants’ conduct violated the California and/or federal securities laws, breached defendants’ fiduciary duties, wasted corporate assets, unjustly enriched the defendants, and caused errors in the Company’s financial statements.  The plaintiffs seek, among other things, unspecified damages and disgorgement of profits from the alleged conduct to be paid to the Company.  The plaintiffs also seek attorneys’ fees for themselves.  The Options Derivative Actions are in the preliminary stages of litigation. We intend to vigorously defend these actions.

We are subject to various legal proceedings that are discussed in our Annual Report on Form 10-K/A for the fiscal year ended January 3, 2006.

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8.  Segment Information

We operate in two business segments – restaurants and bakery.  Restaurants include both The Cheesecake Factory and Grand Lux Cafe, which have similar investment criteria and economic and operating characteristics.  The bakery segment produces baked desserts and other products for our restaurants and for other foodservice operators, retailers and distributors.  Bakery sales to the restaurants are recorded at prices similar to third-party national accounts.  Unallocated corporate expenses, which include all stock-based compensation, are presented below as reconciling items to the amounts presented in the consolidated financial statements.

Segment information is presented below (in thousands):

		Thirteen Weeks Ended October 3,  2006			Thirteen Weeks Ended September 27,  2005			Thirty-Nine Weeks Ended October 3, 2006			Thirty-Nine Weeks Ended September 27,  2005
					(restated)						(restated)
Revenue:
Restaurants		$	311,627		$	282,537		$	913,633		$	813,344
Bakery		24,495			23,368			71,198			66,957
Intercompany bakery sales		(10,785		)	(9,032		)	(30,202		)	(26,868		)
Total		$	325,337		$	296,873		$	954,629		$	853,433
Income from operations:
Restaurants		$	40,731		$	44,534		$	127,796		$	124,251
Bakery		3,936			4,517			10,779			11,182
Corporate		(20,005		)	(14,122		)	(55,392		)	(38,451		)
Total		$	24,662		$	34,929		$	83,183		$	96,982
Depreciation and amortization:
Restaurants		$	11,922		$	10,130		$	34,681		$	28,599
Bakery		686			466			1,658			1,353
Corporate		857			790			2,520			2,291
Total		$	13,465		$	11,386		$	38,859		$	32,243
Capital expenditures:
Restaurants		$	65,064		$	50,335		$	118,169		$	100,765
Bakery		607			170			7,215			3,294
Corporate		886			2,147			3,052			7,711
Total		$	66,557		$	52,652		$	128,436		$	111,770

 

		October 3, 2006			January 3, 2006
					(restated)
Total assets:
Restaurants		$	708,583		$	619,814
Bakery		55,835			44,305
Corporate		220,252			262,131
Total		$	984,670		$	926,250

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Certain information included in this Form 10-Q and other materials filed or to be filed by us with the Securities and Exchange Commission, in press releases and other written communications and in oral or written statements made by or with the approval of one of our authorized officers, may contain forward-looking statements about our current and expected performance trends, growth plans, business goals and other matters.  Words or phrases such as “believe,” “plan,” “will likely result,” “expect,” “intend,” “will continue,” “is anticipated,” “estimate,” “project,” “may,” “could,” “would,” “should,” and similar expressions are intended to identify forward-looking statements.  These statements, and any other statements that are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as codified in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended from time to time (the “Act”).

In connection with the “safe harbor” provisions of the Act, we have identified and filed important factors, risks and uncertainties that could cause our actual results to differ materially from those projected in forward-looking statements made by us, or on our behalf (see Part I, Item 1A, “Risk Factors” included in our Form 10-K/A for the fiscal year ended January 3, 2006 and Part II, Item 1A of this Form 10-Q). These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the Securities and Exchange Commission. Because of these factors, risks and uncertainties, we caution against placing undue reliance on forward-looking statements. Although we believe that the assumptions underlying forward-looking statements are reasonable, any of the assumptions could be incorrect, and there can be no assurance that forward-looking statements will prove to be accurate. Forward-looking statements speak only as of the date on which they are made. We do not undertake any obligation to modify or revise any forward-looking statement to take into account or otherwise reflect subsequent events or circumstances arising after the date that the forward-looking statement was made.

Restatement of Financial Statement due to Review of Stock Option Grants and Procedures

On July 18, 2006, we announced that the Audit Committee of our Board of Directors, which is comprised solely of independent directors, was reviewing the Company’s practices relating to its stock option grants with the assistance of special outside legal counsel from the law firm of Cooley Godward Kronish LLP. This voluntary review was initiated in response to media and Wall Street reports regarding the option granting practices at numerous publicly traded companies.

On November 20, 2006, we announced the conclusion of the Audit Committee’s review, which covered the period beginning with the Company’s initial public offering registration in 1992 to the present.  The Audit Committee reported that its special counsel received full cooperation from Company management, was given complete access to all necessary and relevant electronic and other documents, and interviewed all persons involved in the stock option granting process at the Company, as well as the Company’s advisors.

While the review resulted in a conclusion that until 2002, and in some cases after, we incorrectly followed date selection methodologies that were generally limited to 30-day time windows, the Audit Committee found no evidence that any person acted with an intent to deceive or mislead, and did not recommend termination of any current Company management or the resignation of any member of our Board of Directors.  However, the Audit Committee did recommend, among other matters, that we obtain reimbursement from the Company’s Chief Executive Officer and former Chief Financial Officer, who had oversight responsibility for the stock option granting process, as well as from those members of the Compensation Committee of our Board of Directors who received misdated options, in an amount equal to the difference between the stock option proceeds received and the proceeds that would have been received had the proper measurement dates been used, and that any unexercised stock option grants be treated in the same manner.  We will seek reimbursement totaling approximately $1 million from these individuals. All of the affected individuals have indicated that they intend to comply with the Audit Committee’s recommendation.

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