Darden Restaurants, Inc. — Form 10-Q Summary
Business context and period. Darden owns and operates full-service restaurant brands including Olive Garden, LongHorn Steakhouse, Yard House and The Capital Grille. This unaudited report covers the first quarter of fiscal 2017, the three months ended August 28, 2016, compared with the three months ended August 30, 2015. Darden operated 1,539 company-owned restaurants at quarter-end, up five year over year.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Sales | $1,714.4 million | $1,687.0 million |
| Operating income / margin | $161.3 million / 9.4% | $134.2 million / 8.0% |
| Earnings from continuing operations | $111.1 million | $81.0 million |
| Net earnings | $110.2 million | $86.4 million |
| Diluted EPS from continuing operations | $0.88 | $0.63 |
| Diluted net EPS | $0.87 | $0.67 |
| Operating cash flow from continuing operations | $173.1 million | $138.0 million |
Sales grew 1.6%, supported by a 1.3% combined same-restaurant sales increase and five net new company-owned restaurants. Food and beverage costs fell to 28.8% of sales from 29.8%; restaurant labor remained 31.8%; restaurant expenses rose to 17.7% from 16.1%. Management attributed the food-cost improvement to favorable mix, food-cost deflation (particularly beef) and savings initiatives. Higher rent following real estate transactions contributed to increased restaurant expenses.
Segment profit was $308.0 million versus $310.7 million. Olive Garden segment margin declined to 19.4% from 20.3%, LongHorn improved to 15.6% from 14.9%, Fine Dining declined to 14.8% from 15.7%, and Other Business edged down to 17.7% from 17.9%. Net interest expense declined to $9.9 million from $22.4 million, mainly reflecting lower average debt after repayments. The effective tax rate was 26.6%, versus 27.5%.
Cash, debt and liquidity
Cash and cash equivalents were $114.7 million at August 28, 2016, down from $274.8 million at May 29, 2016. Operating cash flow from continuing operations was $173.1 million; continuing-operations investing used $63.1 million, including $60.1 million of capital expenditures; financing used $263.1 million, including $195.6 million of share repurchases and $70.5 million of dividends. Cash declined by $160.1 million overall.
Long-term debt, less current portion, was $440.2 million. The company had no borrowings under its $750 million revolving credit facility and reported compliance with its covenants. Current assets were $610.8 million and current liabilities $1,132.1 million; management notes that restaurant cash sales and normal payment cycles allow current liabilities to exceed current assets. Darden stated that operating cash generation and the revolving facility should fund fiscal 2017 needs. Contractual obligations include $3.04 billion of lease payments; this amount is not balance-sheet debt.
Changes, outlook and notable items
Continuing-operations earnings improved substantially, while net earnings growth also reflects the prior-year comparison: Q1 FY2016 included $5.4 million of after-tax discontinued-operations earnings, including Red Lobster-related gains, compared with a $0.9 million loss in Q1 FY2017. Q1 FY2017 included $7.8 million of net disposal gains, primarily from restaurant property sales and favorable lease terminations. Share repurchases reduced cash and equity; Darden bought back 3.2 million shares for $195.6 million. On September 29, 2016, the board authorized a new program to repurchase up to $500 million of shares and declared a $0.56-per-share dividend.
For fiscal 2017, management expects combined same-restaurant sales growth of 1.0%–2.0%, continuing-operations sales growth of 1.7%–2.7%, approximately 24–28 new restaurants, and capital expenditures of $310–$350 million. Management cautions that quarterly results are seasonal and not necessarily indicative of full-year performance.
Risks cited include restaurant competition and consumer demand, food safety and supply interruptions, labor and commodity cost pressures, regulation and litigation, long-term lease commitments, cyber and technology risks, adverse weather, and possible impairment of goodwill or trademarks. Darden said existing legal matters are not expected to have a material adverse effect. It has $136.8 million of standby letters of credit and $149.0 million of guarantees on assigned leases; management deemed default under the latter arrangements remote. Disclosure controls were assessed as effective, with no material change in internal control reported.
Important facts for investors to verify
- Whether same-restaurant sales and guest counts sustain the guidance: Olive Garden same-store sales rose 2.0% with guest counts down 1.0%; LongHorn rose 0.6% with guest counts down 1.3%.
- Whether rent and other restaurant expenses continue to pressure margins following real estate transactions, particularly at Olive Garden.
- How cash levels and liquidity evolve after substantial buybacks, dividends and planned capital expenditures; confirm the $500 million repurchase authorization and subsequent purchases.
- Whether disposal gains, discontinued operations and tax items materially affect comparisons of reported earnings with ongoing operating performance.
- Progress toward fiscal 2017 sales, restaurant-opening and capital-expenditure outlook, while accounting for seasonality and the risks identified by management.