Darden casting off Red Lobster

by Monica Watrous
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ORLANDO, FLA. — Red Lobster is off the hook.

As part of a comprehensive plan to increase shareholder value, the board of directors for Darden Restaurants, Inc. has approved a tax-free spin-off or sale of the seafood chain.

Other components of the review include reducing unit growth at Olive Garden and LongHorn Steakhouse, lowering capital expenditures and forgoing acquisitions of additional brands. The company expects to increase cost savings through aggressive operating support cost management and enhanced cost efficiencies in order to increase return of capital to shareholders through dividends and its share repurchase program. Compensation and incentive programs for senior management will be refined to emphasize same-restaurant sales growth and free cash flow.

“In developing this plan we assessed a number of alternative ways to segment our portfolio of brands and leverage our other assets, including our real estate,” said Clarence Otis, chairman and chief executive officer, during a Dec. 19 conference call with financial analysts. “We’re excited about the plan we’ve chosen because it enables us to continue to benefit from the complementary strengths of our brands.”

The announcement comes at a time of increasing sales volatility for the casual-dining segment. Darden has implemented other recent changes that have included reducing workforce, slashing operating costs and overhauling its Olive Garden brand to restore sales momentum for the Italian restaurant chain. Darden also this year tested an express-lunch model in some of its Red Lobster restaurants that was dismantled after a few months. On Sept. 23, Barington Capital Group, L.P., which owns 1.4% of Darden’s outstanding common stock, wrote a letter to the board of directors recommending the company split its restaurant operations and real estate properties.

With 705 restaurants in the United States and Canada, Red Lobster had annual sales of approximately $2.6 billion in fiscal 2013. Amidst changing consumer dynamics, the company said Red Lobster’s competitive position and priorities have diverged significantly from those of Darden’s other brands, which also includes The Capital Grille, Yard House, Bahama Breeze, Seasons 52 and Eddie V’s Prime Seafood.

“We talk about pockets of consumer strength,” Mr. Otis said. “One example is more financially secure consumers. Another is younger consumers, even just the sheer size of that category. With the exception of Red Lobster, all of our brands are having success increasing their relevance to these various pockets of strength.”

Following the separation, Kim Lopdrup, president of Specialty Restaurant Group and New Business for Darden, will become chief executive officer of Red Lobster, and Harald Herrmann, president of Yard House, will succeed Mr. Lopdrup as president of the Specialty Restaurant Group in January. Salli Setta, who was named president of Red Lobster in July, will continue in that role.

If Red Lobster is spun off, Brad Richmond, senior vice-president and chief financial officer of Darden since 2006, will become chief financial and administrative officer of Red Lobster upon completion of the transaction. The completion of the contemplated spin-off is subject to customary conditions and is expected to close in early fiscal 2015, which begins May 26, 2014.

Following the separation, Darden expects it will achieve higher and more consistent same-store sales and earnings per share growth and generate significant free cash flow. The company expects to save at least $60 million annually beginning in fiscal 2015, which represents a $10 million increase over its previous projection of $50 million.

“The spin-off will transform Darden into two independent public companies that can each focus on their different opportunities,” Mr. Otis said. “New Darden’s core strategic focus will be on retaining to core customers and expanding our customer base. … New Red Lobster’s focus will largely be on retaining its core customers and on using its strong and consistent cash flow generation to support what will be a more stable rather than growing return of capital to shareholders.”

Strong same-store sales for LongHorn Steakhouse and solid momentum for the Specialty Restaurant Group chains helped offset a drop in second-quarter income due to costs from recent reduction efforts, as well as legal and financial advisory costs associated with the announced strategic review.

For the quarter ended Nov. 24, net earnings fell 41% to $19.8 million, equal to 15c per share, from $33.6 million, or 26c per share, during the same prior-year period. Food and beverage expenses, including an unfavorable price increase driven by higher shrimp and land-based protein costs, negatively impacted profits. Net sales increased 5% to $2,049.9 million from $1,960 million during last year’s second quarter, but same-restaurant sales and guest counts fell below expectations.

During the quarter, Red Lobster’s sales dipped 5%, while LongHorn Steakhouse sales grew 17%, Olive Garden sales climbed 2%, and the Specialty Restaurant Group sales advanced 21%.

For the first half of the fiscal year, net earnings slipped 38% to $90 million, equal to 69c per share, from $144.4 million, or $1.12 per share, during the same period of the previous year. Net sales for the six months grew 5% to $4,208.4 million from $3,994.8 million.
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