Darden Restaurants, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Three months ended August 24, 2014; comparative period ended August 25, 2013. Darden operates full-service restaurant brands in the U.S. and Canada. Red Lobster results are presented as discontinued operations for both periods following its sale.
Financial performance
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Continuing-operations sales | $1,595.8 million | $1,531.5 million |
| Continuing-operations earnings (loss) | $(19.3) million | $42.2 million |
| Diluted EPS from continuing operations | $(0.14) | $0.32 |
| Discontinued-operations earnings, after tax | $522.5 million | $28.0 million |
| Net earnings | $503.2 million | $70.2 million |
| Continuing-operations operating cash flow | $77.0 million | $122.4 million |
| Capital expenditures | $81.7 million | $120.4 million |
- Continuing sales increased 4.2%, primarily from 55 net new restaurants, same-restaurant sales growth at several brands, and LongHorn; Olive Garden same-restaurant sales declined.
- Continuing-operations costs and expenses were 102.7% of sales, versus 96.7% a year earlier. Food and beverage costs rose to 31.5% of sales from 29.7%; restaurant labor declined to 31.9% from 32.1%. Continuing-operations net margin was (1.2)% versus 2.8%.
- Continuing-operations results included approximately $80 million of debt retirement costs, including $34.9 million cash premiums and make-whole amounts and $45.1 million of noncash hedge and loan-cost write-offs. Management estimated these costs reduced diluted continuing EPS by about $0.37; other strategic-plan and impairment costs reduced it by about $0.07.
- Discontinued operations included an $817.2 million pretax gain on the Red Lobster sale. Red Lobster contributed $400.4 million of quarterly sales in the discontinued-operations presentation; the large reported net profit therefore does not represent ongoing continuing-operations earnings.
- Cash and equivalents were $413.7 million at quarter-end. Debt was approximately $1.58 billion, comprising $115.0 million current and $1,468.5 million long-term debt; there was no short-term debt outstanding. Darden had no borrowings under its $750 million revolving credit facility and reported compliance with its covenants.
- Cash flows included $1.979 billion of investing proceeds from discontinued operations, principally the Red Lobster sale. Continuing-operations financing cash outflow was $1.628 billion, including about $900 million of long-term debt retirement and a $500 million accelerated share repurchase payment. The declared dividend was $0.55 per share.
Material changes and management commentary
- Darden closed the sale of 705 Red Lobster restaurants on July 28, 2014, receiving $2.08 billion in cash proceeds net of transaction costs as of quarter-end. Thirty-seven properties remained subject to landlord consents and other requirements; related gain recognition was deferred. Nineteen shared-property Darden locations were sold and leased back.
- The company completed retirement of approximately $900 million principal of long-term debt during the quarter. The remaining $100 million of called 7.125% debentures was repaid early in Q2; associated additional expense was $10.5 million. Excluding retirement costs, management expected the debt actions to lower annual interest expense by approximately $49 million.
- A $500 million accelerated share repurchase agreement was funded in August. No shares had been delivered by quarter-end; an initial delivery of approximately 8.6 million shares was expected in October, with final settlement expected by December 2014, subject to adjustments.
- Same-restaurant sales were down 1.3% at Olive Garden, up 2.8% at LongHorn, and up a blended 2.1% at Capital Grille, Bahama Breeze, Seasons 52, Eddie V’s and Yard House. Olive Garden’s decline reflected lower guest counts; LongHorn’s increase was driven by average check growth despite lower traffic.
Outlook, risks and contingencies
- FY2015 outlook: Olive Garden same-restaurant sales flat to up 1%; LongHorn up 1% to 2%; the other listed brands up approximately 2% blended; continuing-operations sales growth of 5% to 7%, including the 53rd week; and diluted continuing-operations EPS growth of 30% to 35% versus FY2014, also including the extra week.
- Management expected food and beverage costs to rise as a percentage of sales because of inflation, particularly seafood, dairy and beef; labor costs were expected to be flat to slightly lower as a percentage of sales. Approximately 37 net new restaurants were planned, with capital expenditures of $325 million to $350 million.
- Key risks include execution of the strategic plan and Red Lobster separation, activist shareholder actions and the 2014 proxy contest, CEO succession, food and labor costs, competition, food safety, litigation, cyber and operational disruptions, and possible impairment of goodwill or trademarks. The CEO was expected to leave by December 31, 2014 or upon appointment of a successor.
- Darden reported that an Olive Garden/other-brand wage-and-hour collective action was decertified in September 2014, dismissing opt-in plaintiffs; appeal remained possible, and the claims of named plaintiffs remained. A separate Capital Grille wage-and-hour matter continued. The company could not estimate potential loss for either matter.
- Guarantees on assigned leased properties had a maximum potential payment of $138.3 million; no liability was recorded because third-party default was considered remote. Management stated it believed liquidity and the revolving facility would support operations, investment, dividends and repurchases through FY2015.
Important facts for investors to verify
- Whether Red Lobster sale proceeds, deferred gains for the remaining properties, and sale-leaseback obligations reconcile to later filings.
- Actual continuing-operations sales, same-restaurant sales and margins against the FY2015 outlook, especially Olive Garden traffic and food-cost inflation.
- Final debt repayment costs and whether the anticipated annual interest savings materialize.
- Final share count and settlement economics of the $500 million accelerated repurchase, alongside the dividend and capital-spending commitments.
- Developments in the proxy contest, CEO succession and wage-and-hour litigation, including any potential financial impact.