Darden Restaurants, Inc. — Q1 FY2018 Form 10-Q
Business context and period. The unaudited quarter ended August 27, 2017, compared with the quarter ended August 28, 2016. Darden operates full-service restaurant brands in the U.S. and Canada. Results include Cheddar’s Scratch Kitchen from its April 24, 2017 acquisition; the prior-year comparison does not include Cheddar’s.
Financial performance
| Metric | Q1 FY2018 | Prior-year quarter |
|---|---|---|
| Sales | $1,936.1 million | $1,714.4 million |
| Operating income / margin | $174.5 million / 9.0% | $161.3 million / 9.4% |
| Continuing-operations earnings | $121.3 million | $111.1 million |
| Net earnings | $119.0 million | $110.2 million |
| Diluted EPS from continuing operations / net earnings | $0.95 / $0.93 | $0.88 / $0.87 |
| Operating cash flow, continuing operations | $179.4 million | $173.1 million |
| Capital expenditures | $95.7 million | $60.1 million |
| Cash and cash equivalents at quarter-end | $146.8 million | $233.1 million at May 28, 2017 |
| Long-term debt | $936.6 million | $936.6 million at May 28, 2017 |
Sales rose 12.9%, primarily from Cheddar’s, 22 net new company-owned restaurants since the prior-year quarter, and a 1.7% combined Darden same-restaurant sales increase excluding Cheddar’s. Continuing-operations earnings increased 9.2%; diluted EPS increased 8.0%. Food and beverage costs declined slightly as a share of sales, while restaurant labor rose to 32.2% from 31.8%. Net interest expense rose to $15.0 million from $9.9 million. The effective tax rate decreased to 23.9% from 26.6%, primarily reflecting tax benefits from stock-based compensation accounting changes.
Changes, acquisition and cash returns
- Cheddar’s acquisition consideration was $799.8 million, funded with $500 million of senior notes and cash on hand. Preliminary purchase accounting included $299.9 million of goodwill, none expected to be tax deductible. Darden incurred approximately $6.4 million of integration expenses; management said these reduced continuing-operations diluted EPS by approximately $0.04.
- Combined same-restaurant sales excluding Cheddar’s increased 1.7%. Olive Garden and LongHorn same-restaurant sales rose 1.9% and 2.6%, respectively; Cheddar’s reported a 1.4% decrease. Other Business segment margin fell 200 basis points, to 15.7%, primarily due to Cheddar’s margin mix and a consumer-packaged-goods reporting reclassification.
- Operating cash flow increased modestly, while capital spending increased with new restaurant construction and remodeling. Financing used $164.4 million, including $79.1 million of dividends and $100.2 million of share repurchases. Cash declined by $86.3 million during the quarter.
- Quarterly dividends declared were $0.63 per share versus $0.56 a year earlier. A further $0.63-per-share dividend was declared September 21, 2017, payable November 1, 2017.
Liquidity, outlook and risks
Current assets were $483.0 million and current liabilities were $1.26 billion at August 27, 2017. Darden stated that cash generated from operations is its principal liquidity source and that operating cash generation and its revolving credit agreement should be sufficient for fiscal 2018 needs. The $750 million revolving facility had no outstanding balance, and the company reported compliance with its covenants. Public debt ratings were Baa3 from Moody’s and BBB from S&P and Fitch.
For fiscal 2018, management expects combined same-restaurant sales growth of 1.0%–2.0%, continuing-operations sales growth of 11.5%–13.0% including Cheddar’s, approximately 35–40 new restaurants, and capital expenditures of $400–$450 million. These are forward-looking estimates and actual results may differ.
Risks highlighted include integrating Cheddar’s and realizing expected benefits; wage, labor, commodity and utility cost pressures; competition and consumer demand; food safety and supply interruptions; cybersecurity and technology; severe weather; leases; and potential goodwill or intangible-asset impairment. Darden disclosed $153.2 million of guarantees for assigned leases, with no liability recorded because default was considered remote, as well as standby letters of credit. It said pending ordinary-course legal matters were not expected to have a material adverse effect. No material risk-factor changes were reported. Disclosure controls were concluded effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported sales and earnings growth reflects the Cheddar’s acquisition rather than comparable-store performance, and whether integration costs and expected synergies develop as management anticipates.
- Whether same-restaurant sales and restaurant-level margins meet the fiscal 2018 outlook, particularly given labor inflation and Cheddar’s margin mix.
- Capital spending, share repurchases and dividends relative to operating cash flow, and the resulting cash and borrowing needs.
- Final Cheddar’s purchase-price allocation, including goodwill and asset valuations, and any subsequent impairment indicators.
- Potential exposure from lease guarantees, litigation, commodity and interest-rate risks, and compliance with revolving-credit covenants.