Darden Restaurants, Inc. — Form 10-Q Summary
Period clarification: Although the request identifies “2019 Q3,” this filing covers Darden’s fiscal third quarter and nine months ended February 23, 2020, compared with periods ended February 24, 2019. The filing was signed March 31, 2020. Amounts below are in millions of dollars, except per-share data and percentages.
Business context and reporting period
Darden operates full-service restaurant brands including Olive Garden, LongHorn Steakhouse, Cheddar’s Scratch Kitchen, Yard House, The Capital Grille, Seasons 52, Bahama Breeze and Eddie V’s. At quarter-end it reported 1,812 company-owned restaurants. Its fiscal year ends in May; fiscal 2020 includes a 53rd week in the fourth quarter.
Financial performance
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Sales | $2,346.5 | $2,246.5 | $6,536.8 | $6,281.3 |
| Operating income | $278.3 | $265.5 | $640.0 | $602.7 |
| Operating margin | 11.9% | 11.8% | 9.8% | 9.6% |
| Continuing-operations earnings | $233.3 | $225.1 | $430.5 | $509.9 |
| Net earnings | $232.3 | $223.6 | $427.6 | $505.4 |
| Diluted net EPS | $1.89 | $1.79 | $3.46 | $4.02 |
Quarterly sales rose 4.5% and diluted EPS rose 5.6% year over year. Nine-month sales increased 4.1%, while diluted EPS fell 13.9%, largely reflecting a $147.1 million pre-tax pension settlement charge. The charge was reported in other expense; management estimated it reduced nine-month diluted continuing-operations EPS by about $0.90. Nine-month continuing-operations earnings also included $153.3 million of other expense.
Combined same-restaurant sales increased 2.3% in the quarter and 1.8% for the nine months. LongHorn’s quarterly same-restaurant sales rose 3.9%; Olive Garden’s rose 2.1%. Cheddar’s same-restaurant sales declined 1.6% for the quarter and 2.7% for the nine months.
Cash flow, debt and liquidity
- Nine-month cash from continuing operating activities was $922.4, versus $920.0 a year earlier. Investing activities used $447.4, including $374.5 of capital expenditures and $50.1 for restaurant acquisitions. Financing activities used $608.1, including $322.3 of dividends and $300.3 of share repurchases.
- Cash and cash equivalents were $321.7 at February 23, 2020, down from $457.3 at May 26, 2019. Current assets were $686.0 and current liabilities $1,683.1.
- Long-term debt was $928.5 at quarter-end. Darden reported no borrowings on its $750.0 revolving credit facility at February 23; on March 17, it drew the full $750.0 to support liquidity. The filing reports the borrowing rate as 1.773% at the time described.
- Following adoption of lease accounting guidance, the balance sheet included $4,030.4 of operating lease right-of-use assets and $4,317.4 of non-current operating lease liabilities. Total lease liabilities, including finance leases and current amounts, were $4,828.3. These accounting changes materially affect comparison with the prior-year balance sheet.
Material changes and management commentary
- Restaurant and marketing costs increased in dollars. As a share of sales, food and beverage costs improved, but labor and marketing costs rose; management cited inflation and increased media spending. Quarterly operating margin improved modestly.
- Segment margins were mixed: LongHorn improved 40 basis points in the quarter; Olive Garden declined 60 basis points, Fine Dining declined 10 basis points and Other Business declined 60 basis points.
- Darden acquired seven Cheddar’s restaurants from franchisees during the first nine months, for total consideration of $51.8 million. The acquisitions were funded with cash on hand.
- Darden adopted the new lease accounting standard in fiscal 2020, recognizing lease assets and liabilities and recording a $3.8 million cumulative adjustment to retained earnings. Prior-period balance sheets were not recast.
COVID-19, outlook and risks
After quarter-end, COVID-19 caused a significant reduction in guest traffic. By March 20, Darden had closed dining rooms at all restaurants; almost all continued with takeout, and some also offered delivery. The company reported no supplier disruptions at that time, but warned that closures, reduced demand, labor availability, supply interruptions and government restrictions could materially affect results and liquidity.
Darden withdrew its fiscal 2020 financial outlook because the impact of the outbreak was too uncertain. It suspended the quarterly cash dividend and share repurchases, drew the full revolving credit facility and paused nearly all new restaurant construction and certain remodels. Management warned that further liquidity needs and non-cash impairments, including possible goodwill impairments, could arise. The company stated it was in compliance with its credit facility covenants at February 23, 2020; a subsequent impairment or increased debt could pressure covenant compliance.
Other disclosed exposures include long-term lease commitments, guarantees associated with assigned leases, ordinary-course litigation and market risks involving commodities, interest rates and equity hedges. Management did not expect current legal matters, individually or collectively, to have a material adverse effect.
Important facts for investors to verify
- Subsequent-period sales, cash burn and operating results under dining-room closures and takeout/delivery operations.
- Liquidity after the $750 million revolver draw, including any further borrowings, covenant headroom and access to additional financing.
- Whether the dividend suspension, repurchase pause and construction pauses continue, and the effects on capital allocation and growth.
- Potential goodwill, intangible-asset or restaurant-asset impairments and any resulting covenant or earnings impact.
- Underlying operating trends by brand, especially labor and marketing cost pressures and weaker same-restaurant sales at Cheddar’s.
- The distinction between reported debt and substantial lease obligations, and the effect of lease accounting on balance-sheet comparisons.