Darden Restaurants, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended May 28, 2017 (52 weeks). This is an annual report, not a standalone 2016 Q4 filing. Amounts are in U.S. dollars unless stated otherwise.
Business context
Darden operated 1,695 company-owned restaurants in the U.S. and Canada across Olive Garden, LongHorn Steakhouse, Cheddar’s Scratch Kitchen, Yard House, The Capital Grille, Bahama Breeze, Seasons 52 and Eddie V’s; franchisees operated 78 additional restaurants. The company served more than 334 million meals during the year.
On April 24, 2017, Darden acquired Cheddar’s Scratch Kitchen for $799.0 million. The acquisition added 140 company-owned and 25 franchised restaurants. Cheddar’s results were consolidated only from the acquisition date, approximately five weeks before year-end.
Financial performance
| Metric | FY2017 | FY2016 | Change / context |
|---|---|---|---|
| Sales | $7,170.2 million | $6,933.5 million | Up 3.4%; combined same-restaurant sales increased 1.8%, excluding Cheddar’s |
| Operating income | $677.5 million | $622.2 million | Up 8.9%; operating margin 9.4% versus 9.0% |
| Net earnings from continuing operations | $482.5 million | $359.7 million | Up 34.1% |
| Diluted EPS from continuing operations | $3.83 | $2.78 | Up 37.8% |
| Net earnings | $479.1 million | $375.0 million | Includes a $3.4 million discontinued-operations loss in FY2017 |
| Operating cash flow, continuing operations | $918.2 million | $820.4 million | Higher mainly due to increased continuing-operations earnings |
| Capital expenditures | $293.0 million | $228.3 million | Acquisition cash outflow was $764.4 million, net of cash acquired |
Food and beverage costs were 28.9% of sales, down from 29.4%, helped by pricing, cost savings and food-cost deflation, primarily beef. Labor was 31.6% of sales in both years. Restaurant expenses rose to 17.6% from 16.8%, primarily due to higher rent following real-estate transactions. Segment profit margins were 19.3% at Olive Garden (down 0.5 percentage points), 17.3% at LongHorn (flat), 19.6% in Fine Dining (up 0.1 points), and 16.9% in Other Business (flat).
Liquidity, debt and capital
- Cash and cash equivalents were $233.1 million at year-end, compared with $274.8 million. Current assets were $799.8 million and current liabilities $1,289.2 million, resulting in a $489.4 million working-capital deficit.
- Long-term debt, net of discount and issuance costs, was $936.6 million, versus $440.0 million a year earlier. Principal debt was $950.0 million; capital lease obligations were $58.9 million. Darden issued $500.0 million of 3.850% senior notes due 2027, partly financing the Cheddar’s acquisition.
- The company had no borrowings under its $750 million revolving credit facility and reported compliance with its covenants. The facility matures October 24, 2018.
- Reported debt-to-total-capital was 32%; adjusted debt-to-adjusted total capital, including lease-debt equivalents and guarantees, was 59%, compared with 53% in FY2016. Management cited fixed-charge coverage of 5.0 times, up from 2.7 times.
- Cash dividends paid were $279.1 million and share repurchases were $230.2 million. A quarterly dividend of $0.63 per share was declared in June 2017; at that rate, the expected annual dividend was $2.52 per share, subject to Board approval.
- Contractual obligations totaled $5.91 billion, including $3.42 billion of lease obligations. The filing states that operating cash generation, potential debt issuance and commercial paper should be sufficient to fund fiscal 2018 needs.
Material changes versus prior year
- Sales growth reflected 1.8% same-restaurant sales growth excluding Cheddar’s, 19 net new company-owned restaurants, and the acquisition of Cheddar’s; its $63.0 million of sales were included only from April 24 through year-end.
- Continuing-operations earnings improved substantially, with lower net interest expense ($40.2 million versus $172.5 million). FY2016 included $106.8 million of debt-retirement costs; Darden also had lower average debt in FY2017 before the new notes.
- Restaurant expenses increased as a share of sales, principally due to lease costs associated with prior real-estate transactions. FY2017 also recorded net disposal gains of $8.4 million, compared with net impairment and disposal expense of $5.8 million in FY2016.
- FY2017 diluted continuing-operations EPS was reduced by approximately $0.10 from a non-cash pension settlement charge and $0.09 from Cheddar’s acquisition and integration costs. Acquisition and integration expenses were approximately $16.3 million.
Outlook, commentary and risks
For fiscal 2018, management expected combined same-restaurant sales growth of 1.0%–2.0%, continuing-operations sales growth of 11.5%–13.0% including Cheddar’s, and approximately 35–40 new restaurant openings. Planned capital expenditures were $400–$450 million, including new restaurants, remodels, maintenance and technology. Management described its approach as “Back-to-Basics,” emphasizing culinary execution, service, atmosphere and relevant marketing.
Key disclosed risks include successful integration and realization of Cheddar’s expected synergies; intense competition and changes in consumer demand; rising labor, commodity, insurance and utility costs; food safety and supply-chain interruptions; cybersecurity, privacy and technology disruptions; long-term lease commitments; weather and other business interruptions; and regulatory, employment and litigation exposure. Darden said current litigation, individually or in aggregate, was not expected to have a material adverse effect. Management reported effective internal controls, but excluded Cheddar’s controls from its year-end assessment; Cheddar’s represented $980.3 million of assets and $63.0 million of revenue in the consolidated statements.
Other notable items: the company reported no goodwill or trademark impairment in its annual assessment, but Cheddar’s preliminary goodwill and trademark valuations were excluded because of the acquisition’s timing. Its adoption of the new lease standard was expected to materially increase reported assets and liabilities, without a material earnings impact. The auditor issued unqualified opinions on the financial statements and internal control assessment, with the stated Cheddar’s controls exclusion.
Most important facts for investors to verify
- Whether Cheddar’s integration delivers expected purchasing, distribution and support-cost synergies, and how its performance develops after a full year of consolidation.
- Same-restaurant sales and guest traffic trends by brand; FY2017’s combined 1.8% figure excludes Cheddar’s and includes differing brand results.
- The drivers and sustainability of margin improvement, particularly the effects of rent, labor inflation, commodity prices and sales leverage.
- Debt and lease-adjusted leverage after the acquisition, the facility’s October 2018 maturity, and the company’s ability to meet substantial lease and other contractual obligations.
- Final purchase-accounting values for Cheddar’s and whether future impairment testing or integration costs change reported results.
- Fiscal 2018 guidance assumptions, including planned openings, $400–$450 million of capital spending and the expected dividend, which remains subject to Board approval.