Brinker International, Inc. — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: 13 weeks ended December 28, 2016; year-to-date results cover 26 weeks. Comparisons are with the periods ended December 23, 2015. Brinker owns, operates and franchises Chili’s and Maggiano’s; it had 1,658 restaurants across the U.S. and 30 countries and two territories.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q2 FY2017 | Q2 FY2016 | First half FY2017 | First half FY2016 |
|---|---|---|---|---|
| Total revenue | $771.0 | $788.6 | $1,529.5 | $1,551.2 |
| Operating income | $61.5 | $75.6 | $103.0 | $131.9 |
| Operating margin | 8.0% | 9.6% | 6.7% | 8.5% |
| Net income | $34.6 | $47.7 | $57.9 | $80.9 |
| Diluted EPS | $0.69 | $0.80 | $1.09 | $1.34 |
| Net cash from operations | — | — | $141.1 | $156.2 |
| Capital expenditures | — | — | $60.1 | $52.2 |
Q2 revenue declined 2.2%; first-half revenue declined 1.4%. Company sales were $748.7 million in Q2 and $1,486.1 million year to date. Comparable sales fell 3.1% system-wide in Q2 and 2.1% year to date. Q2 traffic was down 6.5% at company-owned Chili’s and 2.5% at Maggiano’s. Maggiano’s company sales rose 1.7% in Q2, primarily on increased capacity; Chili’s company sales fell 2.9%.
Q2 cost of sales improved to 25.8% of company sales from 26.6%, helped by menu pricing and favorable poultry, burger and prime-rib costs. Labor rose to 33.3% from 32.4%, and restaurant expenses rose to 25.8% from 24.9%, reflecting wage and health-insurance costs, sales deleverage, advertising, and repairs and maintenance. The first-half effective tax rate was 28.8%, versus 30.9%.
Balance sheet, liquidity and capital allocation
- At December 28, 2016, cash was $34.1 million; total assets were $1.498 billion. Long-term debt, net of issuance costs and current installments, was $1.416 billion, versus $1.111 billion at June 29, 2016. Shareholders’ deficit was $530.6 million.
- Debt included $492.3 million outstanding on the revolving facility, $350 million of 5.0% senior notes due October 2024, $300 million of 3.88% notes, and $250 million of 2.60% notes. The amended revolver has $1 billion capacity, with $507.7 million available. Brinker reported covenant compliance. Revolver interest was 2.15% at period end.
- Q2 interest expense rose to $13.6 million from $7.9 million; first-half expense rose to $22.5 million from $15.7 million, primarily due to higher average borrowings. Credit ratings were downgraded to BB+ by Fitch and S&P and Ba1 by Moody’s, all with stable outlooks.
- First-half operating cash flow decreased to $141.1 million, attributed to payment timing for taxes and lower earnings, partly offset by prior-year acquisition-related effects. Investing used $57.0 million, including $60.1 million of capital spending. Financing used $81.5 million.
- Brinker issued $350 million of 5.0% notes and used the proceeds to fund a $300 million accelerated share repurchase and repay $50 million on the revolver. It repurchased 6.1 million shares for $350 million in the first half. The quarterly dividend increased 6.25%, from $0.32 to $0.34 per share; management stated a target payout ratio of 40%.
Changes, outlook and notable items
- Profitability weakened versus the prior year: Q2 operating income fell 18.6% and net income fell 27.4%; first-half operating income and net income fell 21.9% and 28.5%, respectively. Lower weighted-average share counts partly offset the earnings decline in per-share results.
- Management cited intense casual-dining competition, discounting, constrained consumer discretionary spending, and weaker holiday-season traffic. It said the industry was softer than anticipated and that it was reevaluating strategies. Menu value offers, digital ordering, tabletop devices, and menu changes are among initiatives intended to support guest experience, sales and traffic.
- No full-year earnings or comparable-sales guidance is stated in the supplied filing text. Fiscal 2017 planned openings were 48–57 total restaurants: 8–9 company-owned and 40–48 franchised. Management expected the post-quarter workforce reorganization to generate more than $5 million of pretax savings in FY2017 and about $12 million annually.
- A January 2017 reorganization was expected to generate approximately $6 million of severance and accelerated stock-compensation charges, recorded in Q3; substantially all severance was expected to be paid by the end of Q3. Q2 other gains and charges included a $2.6 million property-sale gain, partly offset by $1.9 million of impairments at six underperforming Chili’s restaurants. First-half charges also included restaurant closures and IT restructuring.
- Management said operating cash flow and available credit should fund operations and current debt obligations for the foreseeable future. Contingencies include $75.4 million of maximum potential lease guarantees, with no material liability recorded, and $31.3 million of undrawn standby letters of credit. Management did not expect pending litigation to materially adversely affect the company.
- Brinker expected the new lease-accounting standard to materially increase balance-sheet assets and liabilities; it cited approximately $639 million of remaining operating-lease payments at FY2016 year-end. It was still evaluating the revenue-standard impact, particularly for gift cards, loyalty programs and franchise agreements.
Important facts for investors to verify
- Whether comparable-sales and traffic trends improve, especially at Chili’s, and whether current value, menu and technology initiatives translate into sustained sales.
- Whether labor, health-care, advertising and other restaurant costs continue to pressure margins, and whether planned reorganization savings are realized after the associated charges.
- Debt leverage, interest expense, credit ratings, revolver availability, covenant headroom, and the sustainability of share repurchases and dividends alongside business investment.
- The final share count and settlement of the accelerated repurchase, and the effect of continued capital returns on liquidity and per-share results.
- Potential exposure from lease guarantees, litigation and restaurant impairments, as well as the balance-sheet effect of adopting lease accounting.