Business Context and Reporting Period
Company: Darden Restaurants, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 24, 2008 (First Quarter of Fiscal 2009)
Business Overview: Darden owns and operates full-service dining restaurants in the U.S. and Canada, including Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, and Seasons 52. The quarter includes the full impact of the October 2007 acquisition of RARE Hospitality International, Inc. (RARE).
Key Financial Metrics
| Metric (in millions, except per share) | Q1 FY2009 (Ended Aug 24, 2008) |
Q1 FY2008 (Ended Aug 26, 2007) |
|---|---|---|
| Sales | $1,774.2 | $1,467.5 |
| Net Earnings | $82.1 | $105.9 |
| Diluted EPS (Continuing Ops) | $0.58 | $0.73 |
| Operating Cash Flow | $161.4 | $161.1 |
| Capital Expenditures | $(135.4) | $(86.7) |
| Short-term Debt | $237.3 | $178.4 |
| Long-term Debt | $1,633.3 | $1,634.3 |
| Cash and Equivalents | $45.5 | $43.2 |
Margins: Net earnings from continuing operations as a percent of sales decreased to 4.6% from 7.2% in the prior year. Total costs and expenses as a percent of sales increased to 93.6% from 89.7%.
Material Changes vs. Prior Period
- Sales Growth: Sales increased 20.9% to $1.77 billion, driven primarily by the RARE acquisition, 41 net new Olive Garden restaurants, and a 2.4% increase in U.S. same-restaurant sales at Olive Garden.
- Profitability Decline: Net earnings from continuing operations decreased 22.7% to $82.4 million. This was caused by a ~1% decline in blended same-restaurant sales across Olive Garden, Red Lobster, and LongHorn Steakhouse, increased food and beverage costs, higher wage rates, and increased interest expense.
- Cost Pressures: Food and beverage costs rose 29.0% (30.8% of sales vs. 28.9% prior year) due to higher commodity prices and the mix of acquired RARE concepts. Restaurant labor costs rose 18.4% but decreased as a percent of sales (31.5% vs. 32.1%) due to pricing increases and RARE's lower labor mix.
- Interest Expense: Net interest expense surged 182.5% to $27.4 million due to higher average debt balances from the RARE acquisition.
- Discontinued Operations: The company completed the sale of 73 Smokey Bones restaurants. Losses from discontinued operations were minimal ($0.3 million) compared to the prior year ($0.7 million).
Guidance, Outlook, Risks, and Unusual Items
- Outlook: Management noted that operating results for the quarter are not necessarily indicative of full-year results due to seasonality. The company expects to maintain an investment-grade bond rating.
- Capital Allocation: The company repurchased 2.1 million shares for $68.4 million and increased the quarterly dividend to $0.20 per share (annualized $0.80).
- Legal Proceedings:
- Wage and Hour: Settled two class actions regarding "server banking" and scheduling practices for approximately $4.7 million total, expected to be paid in fiscal 2009.
- Securities Litigation: Facing a shareholder class action and a derivative suit alleging false/misleading statements regarding fiscal 2008 guidance and prospects. The company intends to vigorously defend these actions.
- EEOC: Facing a discrimination lawsuit filed by the EEOC regarding a Bahama Breeze location in Ohio.
- Risk Factors: Added risk regarding disruptions in financial markets affecting credit availability and consumer spending. Other risks include food price inflation, labor costs, and integration of the RARE acquisition.
- Unusual Items: Included $7.1 million in integration costs and purchase accounting adjustments related to the RARE acquisition. Subsequent to the quarter end, the company terminated $150 million of interest rate swaps for a $1.4 million gain.
Investor Verification Checklist
- Same-Store Sales Trends: Verify the sustainability of the 1% blended decline in same-restaurant sales across core brands (Olive Garden, Red Lobster, LongHorn) amidst rising costs.
- Cost Inflation: Monitor the trajectory of food and beverage costs (currently 30.8% of sales) and the ability to pass these costs to consumers via menu pricing.
- Debt Service: Review the impact of the 182% increase in interest expense on future cash flows and the company's ability to maintain its investment-grade credit rating.
- Legal Reserves: Confirm the final settlement amounts for the wage and hour class actions and the potential exposure from the securities litigation and EEOC suit.
- Integration Synergies: Assess the progress of the RARE acquisition integration and the realization of projected cost synergies versus the current integration costs.