Why did net earnings rise so much in fiscal 1996 if sales barely grew?

Net earnings rose to $74.4 million from $52.4 million mainly because of margin improvement. Food and beverage costs fell 1.3 percentage points as a share of sales, and restaurant expenses declined as the company closed China Coast and cut back on new openings. Fiscal 1995 earnings were also depressed by a $59.1 million after-tax restructuring charge, though fiscal 1996 also carried a $44.8 million charge of its own. Excluding restructuring, earnings rose about 10%.

What is the China Coast restructuring and what does it cost going forward?

In August 1995 the company decided to close all 51 China Coast restaurants and took a pre-tax charge of $75 million ($44.8 million after tax, or $0.28 per share) in the first quarter of fiscal 1996. About $60.4 million was non-cash, mainly write-downs of buildings and equipment. Roughly $14.6 million is cash-related, including carrying costs, lease buy-outs and severance. Management expects the restructuring to be substantially complete in 1997, and the remaining liability was $37.8 million at year-end.

How is Darden's growth outlook for fiscal 1997?

Growth is expected to slow. Darden plans 21 new restaurant openings in fiscal 1997 (14 Red Lobster, 6 Olive Garden, and 1 Bahama Breeze), down from 39 openings in fiscal 1996. Management has said it will focus on operational execution at Olive Garden and Red Lobster and limit expansion to the highest-potential sites. Capital spending is correspondingly lower than the $358 million spent in fiscal 1995.

Is Darden's debt load a concern for investors?

No, based on this filing. Total debt is $373.8 million against $1.22 billion of stockholders' equity, a 23% debt-to-capital ratio, or 34% when capitalized lease obligations are included. Fixed-charge coverage is 5.6 times. The company issued $250 million of 10-year and 20-year notes in January 1996 at effective rates of 7.57% and 7.82%, and it has about $600 million in bank credit lines available. Its publicly traded debt carries investment-grade ratings from all three major agencies.

What risks does the filing highlight for the business?

The filing points to several risks. Restaurant labor costs rose to 29.9% of sales from 29.5% due to wage inflation and training costs. Same-store sales at Red Lobster declined. The casual-dining segment faces growing competition from supermarket 'convenient meals,' and sales are seasonal, with lower volumes in the fall. Roughly 8% of revenue comes from alcohol, which exposes the company to licensing rules and dram-shop liability. Finally, the company's ability to keep restructuring costs contained through 1997 will affect future margins.

DRI 10-K FY1996 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed August 16, 1996. Cited figures are marked; the original filing is the authoritative source.

Darden Restaurants, Inc. (NYSE: DRI) filed its first annual report as an independent public company for the fiscal year ended May 26, 1996, following its May 1995 spin-off from General Mills.

The company is the world's largest full-service restaurant operator, running 1,217 company-operated Red Lobster, Olive Garden and Bahama Breeze restaurants in the U.S. and Canada, with Red Lobster and The Olive Garden accounting for nearly all units. Fiscal 1996 sales were $3.19 billion^a, up about 1% from $3.16 billion, with growth held back by the closure of all 51 China Coast restaurants and a slowdown in new Olive Garden openings. Net earnings were $74.4 million ($0.47 per share), up from $52.4 million ($0.33) in fiscal 1995, but this figure includes a $44.8 million after-tax ($0.28 per share) restructuring charge tied to the China Coast closures.

Excluding that charge, earnings before restructuring rose about 10% to $119.2 million^b ($0.75 per share) versus a pro forma $108.3 million ($0.68). Margin improvement drove the profit gains. Food and beverage costs fell to 33.3% of sales from 34.6% a year earlier, and restaurant expenses declined to 14.3%.

These gains were partly offset by higher restaurant labor (29.9% of sales) and selling, general and administrative expenses, which rose to 11.7% of sales on higher marketing spend. Operating cash flow was $294 million and capital expenditures fell sharply to $214 million^c from $358 million, reflecting a deliberate slowdown in new unit growth. Management plans only 21 new openings in fiscal 1997, concentrated in its two core brands.

The balance sheet is conservative. Total debt was $374 million^d against stockholders' equity of $1.22 billion, a 23% debt-to-capital ratio (34% including capitalized operating leases).

The company holds investment-grade ratings (A3/BBB+/A-) and maintains $600 million of bank revolving credit lines. Investors should watch the pace of restaurant-level margin recovery, the cost of the ongoing restructuring (which management expects to be substantially completed in 1997), and the company's ability to sustain same-store sales growth in a competitive casual-dining segment.

02—Key points

Key Highlights

Largest full-service restaurant company in the world, with 1,217 company-operated units (Red Lobster 729 in North America, Olive Garden 487, Bahama Breeze 1), all owned and operated by the company with no franchising in North America
Fiscal 1996 sales of $3.19 billion, up 1% year over year, with the China Coast closure (51 units) offsetting new-unit and same-store gains
Net earnings of $74.4 million ($0.47 per share), including a $44.8 million after-tax ($0.28/share) restructuring charge for closing China Coast; earnings before restructuring rose about 10% to $119.2 million ($0.75/share)
Food and beverage costs improved to 33.3% of sales (down 1.3 points) and restaurant expenses fell to 14.3% of sales, lifting restaurant-level margins; SG&A rose to 11.7% of sales on higher marketing
Capital expenditures reduced to $214 million from $358 million as the company slowed Olive Garden growth; operating cash flow was $294 million, fully funding capex and dividends internally
Conservative balance sheet: total debt of $374 million, 23% debt-to-capital (34% lease-adjusted), investment-grade ratings (A3 / BBB+ / A-), and $600 million in bank credit facilities
Initial dividend of $0.08 per share paid in fiscal 1996, a shareholder return of about 0.7% at the $11.75 year-end close, with a $6.5 million share repurchase program authorized (1.9 million shares bought in fiscal 1996)

03—Questions

Frequently Asked Questions

Why did net earnings rise so much in fiscal 1996 if sales barely grew?
Net earnings rose to $74.4 million from $52.4 million mainly because of margin improvement. Food and beverage costs fell 1.3 percentage points as a share of sales, and restaurant expenses declined as the company closed China Coast and cut back on new openings. Fiscal 1995 earnings were also depressed by a $59.1 million after-tax restructuring charge, though fiscal 1996 also carried a $44.8 million charge of its own. Excluding restructuring, earnings rose about 10%.
What is the China Coast restructuring and what does it cost going forward?
In August 1995 the company decided to close all 51 China Coast restaurants and took a pre-tax charge of $75 million ($44.8 million after tax, or $0.28 per share) in the first quarter of fiscal 1996. About $60.4 million was non-cash, mainly write-downs of buildings and equipment. Roughly $14.6 million is cash-related, including carrying costs, lease buy-outs and severance. Management expects the restructuring to be substantially complete in 1997, and the remaining liability was $37.8 million at year-end.
How is Darden's growth outlook for fiscal 1997?
Growth is expected to slow. Darden plans 21 new restaurant openings in fiscal 1997 (14 Red Lobster, 6 Olive Garden, and 1 Bahama Breeze), down from 39 openings in fiscal 1996. Management has said it will focus on operational execution at Olive Garden and Red Lobster and limit expansion to the highest-potential sites. Capital spending is correspondingly lower than the $358 million spent in fiscal 1995.
Is Darden's debt load a concern for investors?
No, based on this filing. Total debt is $373.8 million against $1.22 billion of stockholders' equity, a 23% debt-to-capital ratio, or 34% when capitalized lease obligations are included. Fixed-charge coverage is 5.6 times. The company issued $250 million of 10-year and 20-year notes in January 1996 at effective rates of 7.57% and 7.82%, and it has about $600 million in bank credit lines available. Its publicly traded debt carries investment-grade ratings from all three major agencies.
What risks does the filing highlight for the business?
The filing points to several risks. Restaurant labor costs rose to 29.9% of sales from 29.5% due to wage inflation and training costs. Same-store sales at Red Lobster declined. The casual-dining segment faces growing competition from supermarket 'convenient meals,' and sales are seasonal, with lower volumes in the fall. Roughly 8% of revenue comes from alcohol, which exposes the company to licensing rules and dram-shop liability. Finally, the company's ability to keep restructuring costs contained through 1997 will affect future margins.

04—Continue

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