Darden Restaurants, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, the three months ended August 26, 2018; comparisons are with the three months ended August 27, 2017, unless otherwise noted. Darden operates full-service restaurant brands including Olive Garden, LongHorn Steakhouse, Cheddar’s Scratch Kitchen and Yard House.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Sales | $2,061.4 million | $1,936.1 million |
| Operating income | $189.1 million | $174.5 million |
| Operating margin | 9.2% | 9.0% |
| Earnings from continuing operations | $168.9 million | $121.3 million |
| Net earnings | $166.2 million | $119.0 million |
| Diluted EPS from continuing operations | $1.34 | $0.95 |
| Diluted net EPS | $1.32 | $0.93 |
| Operating cash flow from continuing operations | $206.4 million | $179.4 million |
| Capital expenditures | $106.4 million | $95.7 million |
- Sales grew 6.5%, reflecting 3.3% combined same-restaurant sales growth, 41 net new company-owned restaurants since the prior-year quarter, and the acquisition of 11 Cheddar’s restaurants.
- Food and beverage costs fell to 28.3% of sales from 28.7%; restaurant labor costs rose to 33.0% from 32.2%. Total operating costs declined to 90.8% of sales from 91.0%.
- Net cash used in investing activities was $109.2 million; net cash used in financing activities was $92.4 million. Cash increased $4.9 million to $151.8 million during the quarter.
- At August 26, 2018, long-term debt was $926.8 million. Darden had no borrowings under its $750 million revolving credit facility and reported compliance with its covenants. Current assets were $544.6 million and current liabilities were $1,324.3 million.
Changes and drivers
- Continuing-operations earnings increased 39.2%; diluted EPS from continuing operations increased 41.1%. The 4.0% effective tax rate, versus 23.9% a year earlier, primarily reflected the Tax Cuts and Jobs Act, equity-compensation tax effects and stock-option exercise benefits. Management estimated the lower tax rate added approximately $0.14 to current-quarter diluted EPS.
- Olive Garden same-restaurant sales increased 5.3%, and LongHorn Steakhouse increased 3.1%. Cheddar’s Scratch Kitchen declined 4.0%; Seasons 52 declined 1.9%. Segment profit margins improved for Olive Garden, LongHorn and Fine Dining, but fell to 14.5% from 15.7% for Other Business, reflecting negative comparable sales, workforce investments and the accounting presentation of franchisee inventory sales.
- Restaurant labor costs increased as a share of sales due primarily to inflation, workforce reinvestment and market-driven equity-compensation expense. Stock-based compensation expense rose to $17.9 million from $8.4 million, primarily due to higher expense on Darden stock units.
- Discontinued operations, primarily the run-off of retained rights and obligations from the Red Lobster disposition, recorded a $2.7 million after-tax loss, compared with a $2.3 million loss.
Outlook, risks and other matters
- For fiscal 2019, management expected continuing-operations sales growth of 5.0%–5.5%, combined same-restaurant sales growth of 2.0%–2.5%, and approximately 45–50 new restaurants. Expected effective tax rate was 10.0%–11.0%; planned capital expenditures were $425–$475 million.
- The board declared a $0.75 per-share dividend payable November 1, 2018. During the quarter, Darden repurchased 310,661 shares for approximately $31.3 million; $480.4 million remained under its then-current repurchase authorization.
- Contingencies include standby letters of credit and guarantees on assigned leases. Lease guarantees had a maximum potential future payment of $144.1 million; the company recorded no liability because default was considered remote. Management said pending ordinary-course legal matters were not expected to have a material adverse effect.
- Key disclosed risks include food safety, hiring and retaining employees, labor and commodity cost inflation, competition, cyber and technology failures, adverse weather, lease obligations, and potential goodwill or trademark impairment. Management noted that sufficiently large impairment charges could cause a covenant breach, with the threshold affected by business seasonality.
- Darden expects adoption of the new lease standard in fiscal 2020 to materially affect balance-sheet presentation through recognition of operating-lease assets and liabilities, but does not expect a material effect on earnings. Fiscal-year results may vary with seasonality.
Important facts for investors to verify
- Whether comparable-sales momentum and the fiscal 2019 sales outlook are sustained, particularly at Cheddar’s and Seasons 52.
- Whether labor inflation, workforce investments and stock-based compensation continue to pressure operating margins.
- How much of the earnings and EPS increase reflects the lower tax rate and equity-compensation tax benefits, rather than operating performance; the quarter’s 4.0% tax rate was below the 10.0%–11.0% full-year outlook.
- Whether operating cash generation can fund planned capital spending, dividends and repurchases while maintaining debt-covenant headroom.
- Potential outcomes of legal matters, lease guarantees and future impairment testing, and the financial-statement impact of adopting lease accounting.