Darden Restaurants, Inc. — Q3 Fiscal 2014 Form 10-Q
Reporting period: Third quarter and first nine months ended February 23, 2014; comparisons are with the periods ended February 24, 2013. Darden operates full-service restaurant brands including Olive Garden, Red Lobster and LongHorn Steakhouse. Financial statements are unaudited.
Key financial results
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Sales | $2,233.1 million | $2,258.2 million | $6,441.5 million | $6,253.0 million |
| Earnings from continuing operations | $109.5 million | $134.5 million | $199.6 million | $279.3 million |
| Diluted EPS from continuing operations | $0.82 | $1.02 | $1.50 | $2.13 |
| Net earnings | $109.7 million | $134.4 million | $199.7 million | $278.8 million |
| Net interest expense | $33.1 million | $31.9 million | $98.7 million | $92.7 million |
Q3 sales declined 1.1%, while nine-month sales increased 3.0%. Continuing-operations earnings declined 18.6% in Q3 and 28.5% over nine months; diluted continuing-operations EPS fell 19.6% and 29.6%, respectively. Net earnings margins were 4.9% versus 6.0% for the quarter and 3.1% versus 4.5% for nine months. Total costs and expenses rose to 94.6% of sales from 92.3% in Q3, and to 96.5% from 94.2% for nine months. Restaurant cost of sales, excluding restaurant depreciation and amortization, was 78.9% of sales in Q3 versus 77.6%.
- Operating cash flow: $667.0 million from continuing operations for nine months, compared with $690.0 million.
- Capital spending: $468.3 million for nine months, versus $518.5 million. Investing cash outflow was $481.0 million, compared with $1.12 billion in the prior period, which included the Yard House acquisition.
- Cash and liquidity: Cash was $127.0 million at February 23, up from $88.2 million at fiscal year-end. Current assets were $909.2 million and current liabilities $1.64 billion. The company said cash generation and its revolving facility should fund ongoing needs through fiscal 2014.
- Debt: Balance-sheet debt included $181.5 million short-term debt, $15.0 million current long-term debt and $2,481.0 million long-term debt. The $750 million revolving facility had no direct borrowings; $568.5 million remained available after backing commercial paper. Darden reported compliance with its covenants.
- Dividends: $215.7 million was paid in the first nine months. The quarterly dividend was raised to $0.55 per share; a further $0.55 dividend was declared for payment May 1, 2014.
Operating trends and material changes
Q3 blended U.S. same-restaurant sales for Olive Garden, Red Lobster and LongHorn declined 5.6%. Management attributed about 160 basis points of the decline to more severe winter weather and about 100 basis points to Thanksgiving timing. The 83 net new company-owned restaurants since the prior-year quarter partially offset weaker comparable sales.
- Olive Garden: Q3 U.S. same-restaurant sales fell 5.4%, driven by guest counts down 7.8%, partly offset by average check up 2.4%.
- Red Lobster: Q3 U.S. same-restaurant sales fell 8.8%; guest counts declined 14.3%, partly offset by average check up 5.5%.
- LongHorn Steakhouse: Q3 U.S. same-restaurant sales increased 0.3%; average check rose 2.1% while guest counts fell 1.8%.
Food costs rose as a share of sales, primarily from food inflation, particularly seafood, and promotional items. Labor and restaurant expense ratios also increased, reflecting wage inflation and reduced sales leverage. Depreciation rose with new restaurants and remodels. Q3 earnings per diluted share were adversely affected by approximately $0.07 from weather-related sales and costs and $0.06 from strategic-plan expenses, partly offset by a favorable $0.06 tax adjustment related to ESOP dividends. The effective tax rate fell to 9.7% for Q3 and 12.5% for nine months, largely due to tax credits and the ESOP-related adjustment.
Outlook, strategic actions and risks
- For fiscal 2014, management expected U.S. same-restaurant sales to decline 5.5%–6.5% at Red Lobster and 2.5%–3.5% at Olive Garden, and increase 2.0%–3.0% at LongHorn. Total sales were projected to grow 2.5%–3.5%, including a full year of Yard House operations.
- Fiscal 2014 diluted EPS from continuing operations was expected to be 15%–20% below fiscal 2013, excluding anticipated Red Lobster separation costs in Q3 and Q4. Management expected food costs to rise as a percentage of sales, with labor, restaurant expense and depreciation ratios pressured by lost sales leverage; SG&A was expected to be relatively flat as a percentage of sales.
- Workforce reductions and program cuts were expected to reduce fiscal 2014 expenses by approximately $17 million, net of $11.9 million of related costs already incurred, and to save approximately $60 million annually beginning in fiscal 2015.
- Darden planned to separate Red Lobster, expected to close in early fiscal 2015. The company anticipated a tax-free spin-off but had not made a final decision and said a sale remained possible. Completion depends on customary approvals and conditions. Management identified execution, transaction costs, tax treatment, disruption and activist opposition as risks.
- Two wage-and-hour matters, Alequin and ChHab, had conditionally certified collective classes. The company disputed the claims; it could not estimate a possible loss or range at this stage. Management did not expect the ordinary-course legal matters overall to have a material adverse effect.
- Other stated risks include food safety, competition, labor and commodity-cost pressures, severe weather, technology and cybersecurity, goodwill or trademark impairment, and the ability to execute the strategic plan. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether comparable-sales and traffic trends, especially at Olive Garden and Red Lobster, improve relative to management’s fiscal 2014 assumptions.
- Whether the Red Lobster separation proceeds as a tax-free spin-off or sale, its final terms and costs, timing, approvals, and impact on continuing operations.
- Progress toward the stated expense savings and whether food, labor and other restaurant costs continue to pressure margins.
- Cash generation, capital spending, dividend funding, commercial-paper refinancing capacity and compliance with credit-agreement covenants.
- Developments in the Alequin and ChHab cases, for which the filing states potential losses cannot currently be estimated.