Business context and reporting period
Brinker International operates and franchises Chili’s Grill & Bar and Maggiano’s Little Italy. This Form 10-Q covers the 13 and 39 weeks ended March 29, 2017, compared with the periods ended March 23, 2016. The request metadata says “2016 Q3,” but the filing is for fiscal 2017 Q3. Brinker had 1,660 restaurants at quarter-end: 1,000 company-owned and 660 franchised.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | 39 weeks FY2017 | 39 weeks FY2016 |
|---|---|---|---|---|
| Total revenue | $810.6 million | $824.6 million | $2,340.2 million | $2,375.8 million |
| Operating income | $72.9 million | $86.3 million | $175.9 million | $218.1 million |
| Operating margin | 9.0% | 10.5% | 7.5% | 9.2% |
| Net income | $42.4 million | $57.5 million | $100.2 million | $138.4 million |
| Diluted EPS | $0.86 | $1.00 | $1.93 | $2.33 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $243.6 million | $299.6 million |
Q3 revenue declined 1.7%; year-to-date revenue declined 1.5%. Q3 diluted EPS fell 14%, while year-to-date diluted EPS fell 17%. Q3 interest expense rose to $13.7 million from $8.4 million; year-to-date interest expense rose to $36.1 million from $24.1 million. The filing attributes the increase primarily to higher average borrowings.
Comparable sales were down 2.3% system-wide in Q3 and year to date. Company-owned comparable sales fell 2.2% in both periods, with traffic down 6.1% in Q3 and 5.3% year to date; price increases and favorable mix partly offset traffic declines. Chili’s operating margin was 13.4% in Q3 versus 14.6% and 11.1% year to date versus 12.8%. Maggiano’s operating margin improved to 9.1% in Q3 from 6.4%, and to 10.1% year to date from 9.2%.
Liquidity, debt and capital allocation
At March 29, 2017, cash was $9.0 million, current assets were $148.2 million and current liabilities were $437.3 million. Long-term debt, including current installments, was $1.329 billion net of unamortized costs and discounts; gross debt was $1.338 billion. The amended $1 billion revolving facility had $597.7 million available, and Brinker was in compliance with its financial covenants. The company reported a 2.36% borrowing rate on the revolver and stable BB+/Ba1 ratings from Fitch, S&P and Moody’s, respectively.
Operating cash flow for the first 39 weeks was down $56.0 million year over year, attributed to tax-payment timing and lower earnings, partly offset by timing of payroll and performance-compensation payments. Capital expenditures were $79.7 million. Cash used in financing was $189.4 million, including $350.8 million of treasury-stock purchases and $54.1 million of dividends. Brinker issued $350 million of 5.0% senior notes due October 2024, using proceeds to fund a $300 million accelerated share repurchase and repay $50 million of revolver borrowings. The quarterly dividend increased 6.25%, from $0.32 to $0.34 per share. An additional $40 million was drawn on the revolver on March 30, after quarter-end.
Changes, outlook and management commentary
- Restaurant cost of sales improved as a percentage of company sales, to 25.5% for Q3 and 25.8% year to date, reflecting menu pricing and favorable beef and poultry costs. Labor and restaurant expenses increased as percentages of sales, reflecting wage increases, sales deleverage, marketing and workers’ compensation costs.
- General and administrative expense increased $5.8 million in Q3, primarily from performance-based compensation, consulting and stock-based compensation.
- Management cited heavy discounting, competitive pressure, weak casual-dining traffic, lower oil prices in some markets, and limited consumer discretionary spending. It described the industry as softer than anticipated.
- Management expects the Q3 reorganization to produce more than $5 million in pretax savings in fiscal 2017 and approximately $12 million annualized. Initiatives include simplifying Chili’s menus and kitchen operations, new menu offerings, digital ordering and curbside service, and Maggiano’s prototype and menu changes.
- The filing projects 45–51 restaurant openings in fiscal 2017, including 9–10 company-owned and 36–41 franchised locations. It provides no clear full-year revenue or EPS guidance.
- Fiscal 2017 Q3 included $5.9 million in severance and accelerated stock compensation and $0.8 million in restaurant closure charges. Year-to-date other gains and charges also included IT restructuring, impairments, closure costs and a property-sale gain.
Risks and contingencies
Brinker reported $71.3 million of maximum potential lease-guarantee exposure, $26.9 million in undrawn standby letters of credit, and a $0.4 million lease liability after a divested brand stopped paying rent on a subleased property. Management stated that pending or threatened legal matters were not expected to have a material adverse effect, based on consultation with counsel. Adoption of the new lease accounting standard is expected to materially increase balance-sheet assets and liabilities; remaining operating-lease payments were approximately $639 million at fiscal 2016 year-end. Other stated risks include competition, consumer demand, food and labor costs, economic conditions, credit ratings, franchisee performance, technology and data security, and litigation.
Most important facts for investors to verify
- Whether traffic and comparable-sales declines stabilize, particularly at Chili’s, and whether pricing can offset traffic weakness.
- Whether the reorganization delivers the stated savings without impairing restaurant service or sales.
- Debt, interest expense, liquidity and covenant headroom after share repurchases and the post-quarter $40 million revolver draw.
- Whether ongoing labor, marketing and other restaurant costs continue to pressure margins, and whether favorable commodity costs persist.
- The status of lease guarantees and the financial viability of the divested brand that stopped rent payments, along with the eventual balance-sheet impact of lease-accounting adoption.