Darden Restaurants, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2018, ended November 26, 2017. Comparatives are the corresponding periods of fiscal 2017. Amounts are in millions unless noted.
Business context and results
Darden operates full-service restaurant brands, including Olive Garden, LongHorn Steakhouse and Cheddar’s Scratch Kitchen. At quarter-end it operated 1,722 company-owned restaurants. Results include Cheddar’s from its April 2017 acquisition and 11 additional Cheddar’s restaurants acquired in August 2017.
| Metric | Three months | Six months |
|---|---|---|
| Sales | $1,881.5; +14.6% | $3,817.6; +13.7% |
| Operating income | $128.9; +10.6% | $303.4; +9.2% |
| Operating margin | 6.9%, versus 7.1% | 7.9%, versus 8.3% |
| Continuing-operations earnings | $88.6; +11.2% | $209.9; +10.0% |
| Net earnings, including discontinued operations | $84.7; +6.5% | $203.7; +7.4% |
| Diluted EPS from continuing operations | $0.71, versus $0.64 | $1.66, versus $1.52 |
| Diluted net EPS | $0.67, versus $0.64 | $1.61, versus $1.51 |
Financial position, cash flow and capital returns
- Cash and liquidity: Cash was $114.7 at November 26, down from $233.1 at May 28. Current assets were $485.2 and current liabilities $1,418.0, a current ratio of about 0.34. Management notes that cash sales and payment terms allow the business to operate with current liabilities exceeding current assets.
- Debt: Short-term debt was $153.5 and long-term debt $935.6, totaling $1,089.1. Long-term debt carrying value was $935.6 versus fair value of $1.08 billion. Interest expense rose 63.2% for the quarter and 57.2% for the six-month period, primarily due to higher average debt following the April 2017 issuance of $500 million in senior notes.
- Cash flow, first six months: Continuing operating cash flow was $314.1, versus $294.3. Capital expenditures were $197.7, versus $135.3. Continuing investing cash outflow was $240.8; continuing financing cash outflow was $185.5. Cash decreased $118.4 to $114.7.
- Shareholder returns: Dividends paid were $157.0 and share repurchases were $188.9 in the first six months. Dividends declared were $1.26 per share, versus $1.12. The board declared a further $0.63-per-share dividend for payment February 1, 2018.
Material changes and management commentary
- Sales growth primarily reflected acquired Cheddar’s restaurants, same-restaurant sales growth excluding Cheddar’s of 3.1% for the quarter and 2.4% for six months, and 30 net additional company-owned restaurants versus the prior-year quarter.
- Quarter same-restaurant sales were 3.0% at Olive Garden and 3.8% at LongHorn. Cheddar’s same-restaurant sales declined 2.0%; Seasons 52 declined 0.5%. Combined Darden same-restaurant sales figures exclude Cheddar’s.
- Food and beverage costs improved as a percentage of sales, but labor costs rose due to wage inflation and Cheddar’s higher labor-cost mix. Restaurant expenses also increased as a percentage of sales, including higher pre-opening and occupancy costs. G&A rose with integration expenses and an unfavorable legal outcome.
- Cheddar’s integration costs were approximately $4.2 for the quarter and $10.6 for six months; management said these costs reduced diluted continuing-operations EPS by about $0.02 and $0.06, respectively.
- Discontinued-operations losses, primarily from retained Red Lobster disposition rights and obligations, were $3.9 for the quarter and $6.2 for six months.
Outlook, risks and contingencies
- Fiscal 2018 outlook: Management expected combined same-restaurant sales, excluding Cheddar’s, to increase approximately 2.0%; sales from continuing operations to increase approximately 13.0%; about 40 new restaurant openings; and capital expenditures of $400–$450.
- The Tax Cuts and Jobs Act was enacted December 22, 2017, after quarter-end. Management expected the federal corporate tax-rate reduction to materially benefit future effective tax rates and produce a material non-cash deferred-tax credit in fiscal 2018. The filing does not quantify that expected credit.
- Darden had no borrowings under its new $750 revolving credit facility at quarter-end and reported compliance with its covenants. The facility matures October 27, 2022. Management expected operating cash generation and the facility to fund fiscal 2018 needs.
- Principal risks include successful Cheddar’s integration, labor and commodity-cost pressure, food safety, competition, leases, adverse weather, cybersecurity, litigation and impairment of goodwill or trademarks. The filing reports no material change to previously disclosed risk factors. Management stated existing litigation was not expected to have a material adverse effect.
- Potential contingencies include $114.0 of standby letters of credit and $159.2 of maximum potential guarantees on assigned leases; no liability was recorded for the latter because default was considered remote. Management warned that substantial goodwill or intangible-asset impairment could affect results and covenant headroom.
Investor verification points
- Separate underlying same-store performance from sales and earnings added by Cheddar’s acquisitions and new restaurant openings.
- Track whether labor, occupancy and other restaurant costs continue to pressure operating margins, particularly in Other Business, whose segment margin declined 2 percentage points.
- Assess integration costs and progress against the stated sales, unit-opening and capital-spending outlook.
- Review cash use, short-term borrowing, capital expenditure commitments, dividends and repurchases against operating cash flow and revolving-facility capacity.
- Confirm the realized tax benefit from the December 2017 tax law and the accounting impact of preliminary acquisition valuations.