Darden Restaurants, Inc. — Form 10-Q Summary
Business context and period: Unaudited results for the first quarter of fiscal 2014, the three months ended August 25, 2013, compared with the three months ended August 26, 2012. Darden operates full-service restaurant brands including Olive Garden, Red Lobster, LongHorn Steakhouse, and Yard House.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Sales | $2,158.5 million | $2,034.8 million | +6.1% |
| Earnings from continuing operations | $70.3 million | $111.0 million | -36.7% |
| Diluted continuing-operations EPS | $0.53 | $0.85 | -37.6% |
| Net earnings | $70.2 million | $110.8 million | |
| Operating cash flow from continuing operations | $217.1 million | $253.2 million | |
| Capital expenditures | $174.3 million | $149.3 million | |
| Cash and cash equivalents | $108.9 million | $88.2 million at May 26, 2013 | |
| Long-term debt, including current portion | $2,491.4 million | $2,496.2 million at May 26, 2013 | |
| Quarterly dividend declared per share | $0.55 | $0.50 |
Margins and cost trends: Net earnings margin fell to 3.3% from 5.4%; earnings from continuing operations were 3.3% of sales versus 5.5%. Total costs and expenses rose to 95.9% of sales from 92.8%. Food and beverage costs were 30.5% of sales versus 30.4%; labor was 31.9% versus 30.8%; restaurant expenses were 16.4% versus 15.0%; depreciation and amortization was 4.9% versus 4.6%; and net interest was 1.5% versus 1.4%.
Liquidity and debt: Current assets were $809.7 million and current liabilities were $1,563.1 million at quarter-end. Short-term debt was $212.0 million; Darden had no borrowings under its $750 million revolving credit facility and reported $538 million of availability after backing commercial paper. The company said it was in compliance with credit-agreement covenants and expected cash generation and the facility to fund fiscal 2014 needs.
Material changes and management commentary
- Sales growth was driven by 109 net new company-owned restaurants and the acquisition of 40 Yard House restaurants, partly offset by a 3.3% blended U.S. same-restaurant sales decline at Olive Garden, Red Lobster, and LongHorn.
- Same-restaurant sales declined 4.0% at Olive Garden and 5.2% at Red Lobster; LongHorn increased 3.2%. Among other brands, results varied: Capital Grille +3.2%, Bahama Breeze +2.7%, Seasons 52 -4.4%, and Yard House -1.5%.
- Management attributed earnings pressure primarily to higher restaurant expenses, labor costs, and depreciation as a share of sales. Cited drivers included food inflation and unfavorable menu mix, wage inflation and lower labor efficiency, repairs and maintenance, and new restaurant and remodel investment. The effective tax rate decreased to 20.7% from 24.1%, partly offsetting the cost pressure.
- Operating cash flow declined year over year, mainly due to lower earnings and timing of income-tax accruals and payments. Investing outflows increased with construction and remodeling. Dividends paid were $71.7 million; share repurchases were $0.4 million, compared with $52.2 million in the prior-year quarter.
Outlook, risks, and contingencies
- Fiscal 2014 outlook: blended U.S. same-restaurant sales expected to be flat for Olive Garden, Red Lobster, and LongHorn; total sales growth expected at 6%–8%, including a full year of Yard House; diluted continuing-operations EPS expected to be 3%–5% below fiscal 2013.
- Management expected food and beverage and labor costs to rise as a percentage of sales; restaurant, SG&A, and depreciation expense were expected to be relatively flat as a percentage of sales.
- A comprehensive review announced in September 2013 is expected to reduce fiscal 2014 expenses by about $15 million net of approximately $10 million in termination and other costs, and reduce annual expenses by about $50 million beginning in fiscal 2015.
- Two wage-and-hour matters, Alequin and ChHab, had conditional nationwide collective-action certifications. Darden disputed the claims and stated that possible loss or loss range could not be estimated at this stage.
- Other disclosed risks include food and labor cost inflation, competition and weak same-store sales, Yard House integration and acquisition-related debt, derivative and interest-rate exposure, and potential impairment of goodwill or trademarks. Management said a write-down exceeding approximately $790 million at quarter-end would have been required to breach the credit agreement’s leverage limit, though seasonality could reduce that threshold in future quarters.
- Subsequent events: the board declared a $0.55-per-share dividend payable November 1, 2013; Darden also entered into $100 million of interest-rate swaps in September 2013.
Most important facts for investors to verify
- Whether same-restaurant sales and traffic stabilize, particularly at Olive Garden and Red Lobster.
- Whether cost inflation, labor efficiency, and restaurant-level expense trends improve enough to support the fiscal 2014 EPS outlook.
- Progress and realized savings from the support-cost reduction plan, including the $10 million expected restructuring-related charge.
- Cash generation, capital spending, dividend coverage, commercial-paper balances, and compliance with debt covenants.
- Developments in the Alequin and ChHab collective actions, whose potential financial exposure was not estimable in the filing.