EYE on Operating Leases

CMG, CAKE and PFCB will all face higher operating lease payments going forward. Each of these companies reported increased margin pressure in 2Q, and these increased expenses add the risk of further complicating margins. The chart below looks at the companies’ minimum operating lease obligations in future years relative to their reported 2007 minimum rent expense.
  • Their high unit growth strategies have likely pushed their respective management teams to compromise their real estate standards, leading to less favorable lease terms. For reference, as of their most recent 10-Ks, JBX, DRI and EAT are all subject to operating lease obligations that decline each year.
  • CMG management addressed this issue on its conference call yesterday, saying:

    “Occupancy costs as a percentage of revenue were up during the quarter, primarily due to our opening proportionally more restaurants in more expensive, densely populated areas such as Boston, New York, Philly, Washington DC, Florida, and San Francisco. In addition to being much more expensive on a square footage basis, these sites typically have significantly higher non-cash straight-line rent expenses associated with them as we lock up these sites for the long term with cap rent escalation. In fact, half of the 20 basis point increase in the quarter is due to an increase in this non-cash straight-line rent. Of the total occupancy rent expense – occupancy expense in the quarter of about 1.6 million or 50 basis points is non-cash, straight-line rent related to future rent escalations. While these rent escalations are expensed today, they typically relate to escalations that are payable 5 to 20 years from today.”
Operating Lease Payments Relative to 2007 Expense

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