Business context and reporting period
Brinker International, Inc. operates and franchises Chili’s Grill & Bar and Maggiano’s Little Italy. This Form 10-Q covers the 13-week second quarter and 26 weeks to date of fiscal 2018, both ended December 27, 2017; comparisons are with periods ended December 28, 2016. The company had 1,682 restaurants at quarter-end.
Financial performance
Amounts below are in millions except per-share data and percentages.
| Metric | Q2 FY2018 | Q2 FY2017 | 26 weeks FY2018 | 26 weeks FY2017 |
|---|---|---|---|---|
| Total revenue | $766.4 | $771.0 | $1,505.8 | $1,529.5 |
| Operating income | $54.4 | $61.5 | $83.0 | $103.0 |
| Operating margin | 7.1% | 8.0% | 5.5% | 6.7% |
| Net income | $25.4 | $34.6 | $35.2 | $57.9 |
| Diluted EPS | $0.54 | $0.69 | $0.74 | $1.09 |
| Operating cash flow | — | $119.7 | $142.8 | |
| Capital expenditures | — | $48.6 | $60.1 |
Quarter revenue declined 0.6%; net income declined 26.8%. Year-to-date revenue fell 1.6% and net income fell 39.1%. Higher operating costs relative to sales, increased interest expense, and a one-time tax charge weighed on earnings. Restaurant labor was 33.7% of company sales in Q2 versus 33.3% a year earlier; cost of sales was 26.0% versus 25.8%.
At December 27, cash was $14.7 million, current assets $194.5 million and current liabilities $451.9 million. Long-term debt, including current installments, had a carrying amount of $1,373.5 million; $436.3 million was outstanding on the revolving facility, with $563.8 million available. The company reported compliance with debt covenants. Shareholders’ deficit was $552.9 million.
Changes versus prior period
- Company-owned comparable sales fell 1.0% in Q2: Chili’s declined 1.5%, while Maggiano’s grew 1.8%. Company-owned traffic fell 4.1%; price and mix partly offset the traffic decline.
- For the 26 weeks, system-wide comparable sales declined 2.2%. Hurricanes Harvey and Irma reduced first-quarter company sales by an estimated $5.4 million and diluted EPS by about $0.03.
- Chili’s segment operating margin declined to 9.4% in Q2 from 10.1%; Maggiano’s increased to 17.4% from 16.0%.
- Year-to-date operating cash flow declined $23.1 million, primarily due to lower earnings and gift-card sales, partly offset by lower tax payments. Interest expense rose $5.8 million year over year for the 26-week period, primarily due to higher average borrowings and rates.
- Net revolver borrowings increased $44.0 million during the first half. Brinker repurchased approximately 2.2 million shares for $71.8 million and paid $35.4 million in dividends.
Outlook, management commentary and notable items
- Management cited casual-dining competition, discounting, pressured consumer spending and wage growth as challenges. Initiatives include a simplified Chili’s menu, digital ordering and curbside service, stronger to-go and delivery capabilities, and a Chili’s reimage program planned over three years. No overall revenue or earnings guidance is stated in the provided filing text.
- Management expects an annual effective tax rate of 20%–22%; the federal statutory rate is 21% from January 1, 2018. Tax reform caused an $8.7 million noncash increase in Q2 tax expense from remeasurement of deferred tax assets. The filing notes a positive expected effect on future effective tax rates and cash taxes.
- Q2 other gains and charges were $9.3 million, including $4.3 million of closure costs for nine underperforming Alberta Chili’s restaurants, $2.0 million of restaurant impairments, and $1.4 million of lease-guarantee charges. First-half charges also included $7.2 million of impairments related primarily to those Alberta closures and $5.2 million of hurricane-related costs.
- Brinker sold its interest in the Mexico Chili’s joint venture for $18.0 million, payable in 72 installments under a peso-denominated note. The note was initially recorded at an estimated fair value of approximately $16.0 million; currency movements resulted in a Q2 transaction loss.
- Lease guarantees or secondary liability totaled $65.0 million; the company recorded a $2.0 million liability related to leases of bankrupt Romano’s Macaroni Grill owner Mac Acquisition LLC. Management said it would monitor the bankruptcy and did not expect pending or threatened legal matters to materially adversely affect the company.
- Disclosure controls were deemed ineffective because of an unremediated material weakness in deferred-tax reporting, primarily involving property and equipment. Management reported remediation steps and expected to complete testing during the year-end close, but the weakness was not yet remediated at quarter-end.
- The company expects lease-accounting changes to materially increase reported assets and liabilities; operating lease payments remaining at fiscal 2017 year-end were approximately $606.9 million. Revenue-recognition standard implementation effects, particularly for gift cards, loyalty programs and franchise agreements, remained under evaluation.
Most important facts for investors to verify
- Whether Chili’s traffic and comparable-sales trends improve, and whether the menu, digital, off-premise and reimage initiatives deliver the returns management expects.
- How much of the earnings decline reflects recurring operating pressure versus tax reform, hurricane costs, impairments, closures and other charges.
- Debt, interest costs, covenant headroom and the company’s ability to fund dividends and repurchases while maintaining liquidity.
- Progress in remediating the deferred-tax internal-control weakness and the eventual balance-sheet effect of lease-accounting adoption.
- Recoveries, if any, from hurricane insurance claims; exposure under lease guarantees and the Mexico note; and further developments in the Mac Acquisition bankruptcy.