Darden Restaurants, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2014, ended November 24, 2013; comparisons are with the periods ended November 25, 2012. Darden operated 2,174 company-owned restaurants across its full-service brands. Financial statements are unaudited.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Sales | $2,049.9 million | $1,960.0 million | $4,208.4 million | $3,994.8 million |
| Earnings from continuing operations | $19.8 million | $33.7 million | $90.1 million | $144.8 million |
| Diluted continuing-operations EPS | $0.15 | $0.26 | $0.68 | $1.10 |
| Operating cash flow from continuing operations | Not provided for the quarter | Not provided for the quarter | $303.1 million | $267.6 million |
| Capital expenditures | Not provided for the quarter | Not provided for the quarter | $344.0 million | $355.2 million |
Q2 sales rose 4.6%, while continuing-operations earnings fell 41.2% and diluted EPS fell 42.3%. For the six months, sales increased 5.3%, but continuing-operations earnings declined 37.8% and diluted EPS declined 38.2%. Net earnings were $19.8 million in Q2 and $90.0 million for the six months.
Profitability weakened: total costs and expenses were 99.1% of sales in Q2 versus 97.8% a year earlier, and 97.5% for the six months versus 95.3%. Earnings before tax were 0.9% of sales in Q2 (2.2% prior year) and 2.5% for the six months (4.7% prior year). Food, labor, and restaurant expenses together were 81.5% of Q2 sales and 80.1% of six-month sales, compared with 80.0% and 78.1%, respectively, in the prior periods.
Balance sheet, cash flow, and liquidity
- At November 24, cash was $84.6 million; current assets were $834.3 million and current liabilities were $1,646.5 million. Management attributed the increase in current assets mainly to inventory timing, and higher current liabilities mainly to accounts payable timing and short-term borrowing.
- Debt comprised $324.2 million of short-term debt, $15.0 million of current long-term debt, and $2,480.1 million of long-term debt, totaling approximately $2.82 billion, excluding capital leases. At May 26, the corresponding total was approximately $2.66 billion.
- Six-month operating cash flow was $303.1 million; capital spending was $344.0 million. Cash decreased $3.6 million to $84.6 million. Investing cash outflow was $353.3 million; financing cash inflow was $46.7 million.
- Darden had no revolver borrowings and $425.8 million of remaining availability under its $750 million revolving facility after backing $324.2 million of commercial paper. The facility maturity was extended to October 24, 2018. The company reported compliance with its covenants.
- Dividends paid were $143.3 million for the six months; the declared quarterly dividend was $0.55 per share, up from $0.50 a year earlier.
Material changes and operating trends
- Restaurant additions and the full-period impact of Yard House acquisition-related growth supported sales. Darden had 99 net additional company-owned restaurants compared with the prior-year quarter.
- U.S. same-restaurant sales for Olive Garden, Red Lobster, and LongHorn combined fell 1.0% in Q2 and 2.2% for the six months. Q2 brand results included Olive Garden -0.6%, Red Lobster -4.5%, and LongHorn +5.0%.
- Red Lobster’s Q2 sales fell 4.9%; guest counts declined 7.4%, partly offset by a 2.9% increase in average check. LongHorn Q2 same-restaurant sales rose 5.0%, with gains in both guest counts and average check.
- Food and beverage costs rose as a share of sales, primarily due to seafood and beef costs. Labor pressure reflected wage inflation, manager incentives, insurance claims, lower labor efficiency, and lost sales leverage. Restaurant expenses also increased as a share of sales.
- Six-month operating cash flow improved year over year, mainly because accounts payable increased due to payment timing, partly offset by lower earnings. Prior-year investing cash flow included $578.4 million for the Yard House acquisition.
Outlook, commentary, and risks
- For fiscal 2014, management expected combined U.S. same-restaurant sales for Olive Garden, Red Lobster, and LongHorn to decline 1%–2%; total sales were expected to grow 4%–5%, including a full year of Yard House operations.
- Management forecast fiscal 2014 diluted continuing-operations EPS 15%–20% below fiscal 2013, excluding anticipated one-time Red Lobster separation costs. It expected food, labor, restaurant, and depreciation expenses to be higher as a percentage of sales, while SG&A was expected to be relatively flat as a percentage of sales.
- A September 2013 workforce and spending reduction incurred $11.7 million of Q2 costs. Management expected net savings of approximately $15 million in fiscal 2014, $50 million–$55 million in fiscal 2015, and approximately $60 million annually beginning in fiscal 2016.
- On December 19, 2013, after quarter-end, Darden announced a plan to separate Red Lobster, expecting a tax-free spin-off but retaining a possible sale as an alternative. Completion was expected in early fiscal 2015 and remained subject to customary approvals and conditions. Management cautioned that transaction costs and execution risks could be significant.
- Q2’s effective tax rate was negative 9.4%, versus 21.8% a year earlier, primarily due to tax credits and favorable resolution of prior-year tax matters; this helped offset operating pressures.
- Two wage-and-hour collective actions were conditionally certified. Darden said it believed it had meritorious defenses, but could not estimate possible losses. Other disclosed risks included commodity and labor costs, competition, food safety, litigation, impairment of goodwill or trademarks, and activist shareholder actions.
Important facts for investors to verify
- Whether same-restaurant sales and guest-count trends, especially at Red Lobster and Olive Garden, improve or further weaken.
- Whether food, labor, and restaurant cost inflation continues to erode margins and whether the planned cost reductions deliver the stated savings after restructuring costs.
- Progress, final structure, tax treatment, costs, approvals, and timing of the proposed Red Lobster separation.
- Commercial-paper refinancing and liquidity needs, debt levels, covenant headroom, and the company’s ability to fund capital spending and dividends.
- Developments in the wage-and-hour lawsuits, for which the filing provides no clear loss estimate.