Darden Restaurants, Inc. (NYSE:DRI) Q2 2023 Earnings Call Transcript

Darden Restaurants, Inc. (NYSE:DRI) Q2 2023 Earnings Call Transcript December 16, 2022

Operator: Good day, everyone, and welcome to the Darden Fiscal Year 2023 Second Quarter Earnings Call. Today’s conference is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Mr. Kevin Kalicak. Thank you. You may begin.

Kevin Kalicak: Thank you, Todd. Good morning, everyone, and thank you for participating on today’s call. Joining me are Rick Cardenas, Darden’s President and CEO; and Raj Vennam, CFO. As a reminder, comments made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to the risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Those risks are described in the company’s press release, which was distributed this morning and in its filings with the Securities and Exchange Commission. We are simultaneously broadcasting a presentation during this call, which is posted in the Investor Relations section of our website at darden.com.

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Today’s discussion and presentation includes certain non-GAAP measurements, and reconciliations of these measurements are included in the presentation. Looking ahead, we plan to release fiscal 2023 third quarter earnings on Thursday, March 23, before the market opens followed by a conference call. During today’s call, any reference to pre-Covid when discussing second quarter performance as a comparison to the second quarter of fiscal 2020. Additionally, all references to industry results during today’s call refer to Black Box Intelligence’s casual dining benchmark, excluding Olive Garden, LongHorn Steakhouse and Cheddar’s Scratch Kitchen. During our second fiscal quarter, industry same-restaurant sales increased 3.6% and industry same-restaurant guest counts decreased 5.7%.

This morning, Rick will share some brief remarks on the quarter and our focus moving forward, and Raj will provide more details on our financial results and an update to our fiscal 2023 financial outlook. Now, I’ll turn the call over to Rick.

Ricardo Cardenas: Thank you, Kevin. Good morning and happy holidays, everyone. I’m pleased with our results this quarter. All of our brands performed at a high level by remaining focused on our back-to-basics operating philosophy anchored in food, service and atmosphere. At the Darden level, we continue to strengthen and leverage our 4 competitive advantages of significant scale, extensive data and insights, rigorous strategic planning and our results-oriented culture. Being brilliant with the basics starts with achieving and maintaining appropriate staffing levels in our restaurants. Across our brands, our teams are doing a great job of ensuring we are ready to run 14 great shifts a week. At each of our brands, we are fully staffed at the team member level, and manager staffing is at historic highs.

As a result, our teams are executing more consistently, which in turn is driving strong guest satisfaction across our brands, according to both internal and external sources. During the quarter, 4 of our brands achieved all-time high internal guest satisfaction ratings and the others remain near all-time highs. Also, within Technomic industry tracking tool, a Darden brand was ranked #1 among major casual dining brands in each measurement category. I am particularly proud of Olive Garden’s performance. During the quarter, they brought back their most popular limited time offers, never any possible. As you may recall, when I talked last I shared that any promotional activity or brands introduced should be evaluated with the following 3 filters.

First, it needs to elevate brand equity by bringing the brand’s competitive advantages to life. Second, it should be simple to execute. We will not jeopardize all the work we have done to simplify operations which allows our teams to consistently deliver exceptional guest experiences. And third, it will not be at a deep discount. We are focused on providing great value to our guests, but doing that in a way that drives profitable sales growth. Three years after it was last offered, the 2022 version of never any possible checked all 3 of these boxes. First, it leveraged Olive Garden’s iconic brand equity by perfectly reinforcing their competitive advantage of never-ending abundant craveable Italian food. Next, it was amplified by only offering existing menu items with limited add-on choices, which made it easier to execute, resulting in great guest experiences.

Finally, it was priced $3 higher than in 2019, which significantly improved the margin of this offer while still providing tremendous value for our guests. Never ending possible exceeded expectations, and we saw a step change in Olive Garden’s positive gap to industry traffic during the 7 weeks at ramp. I’m even more encouraged by this performance, given that it was supported with about 3/4 of the media past years. Going forward, the team will build on their learnings and share insights across our brands but this may be the only limited time offer we do at Olive Garden this fiscal year. Across our brands, we continue to drive strong execution of the off-premise guest experience through ongoing investments in technology that reduce friction for our guests and our operators.

For example, many of our guests still prefer to call in their to-go order. However, taking payment over the phone or when the guests arrived is both inefficient for our teams and inconvenient for our guests. To help address this, we rolled out online payment for call-in orders during the quarter, enhancing convenience for our guests and making our to-go specialists more efficient. To-go sales remain sticky across our core casual dining brand, accounting for 25% of total sales at Olive Garden, 14% of Longhorn and 13% at Cheddar’s. Digital transactions accounted for 62% of all off-premise sales during the quarter and 10% of Darden’s total sales. The holidays are the busiest time of the year for our restaurant teams, and they have enjoyed welcoming even more guests back into their restaurants this season.

In fact, the Capital Grille, ADB and CD52 enjoyed all-time daily sales record on Thanksgiving Day, and bookings for this holiday season are encouraging. The holidays are also a great reminder that being of service is at the heart of our business. and we embraced a higher purpose to nourish and delight everyone we serve, our guests, our team members and our communities. One of the ways we serve our communities is through our harvest program. One in 8 households in our country live without consistent access to food. To help fight hunger, our restaurants donate fresh, unused food to local food banks and nonprofits in their communities on a weekly basis throughout the year. Since the inception of this program, more than 131 million pounds of food have been donated, which is the equivalent of more than 100 million meals.

The impact of our harvest program takes on added significance during the holidays. And I am delighted that our teams are helping to make a difference in some in communities across the country. I’m so proud of the focus and commitment our teams continue to display. Their disciplined approach in executing on our strategy is what enables us to succeed regardless of the operating environment. This is evidenced by the fact that just last week, we surpassed $10 billion in sales on a trailing 52-week basis for the first time in Darden’s history. On behalf of our senior leadership team and the Board of Directors, I want to thank our 180,000 team members for everything you do to serve our guests and our communities. I wish you all a wonderful holiday season.

Now I’ll turn it over to Raj.

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Rajesh Vennam : Thank you, Rick, and good morning, everyone. Total sales for the first quarter were $2.5 billion, 9.4% higher than last year, driven by 7.3% same-restaurant sales growth along with the addition of 35 net new restaurants. This same restaurant sales performance outperformed — outpaced the industry by 370 basis points and our same restaurant gas counts are performed even more as they exceeded the industry benchmark by 550 basis points. Diluted net earnings per share from continuing operations were $1.52, an increase of 2.7% above last year. Total EBITDA was $330 million, and we returned $249 million of cash to our shareholders this quarter, consisting of $149 million in dividends and $100 million in share repurchases.

Total pricing for the quarter was approximately 6.5%, 200 basis points below total inflation of roughly 8.5%. Now looking at the details of the P&L compared to last year, Food and beverage expenses were 240 basis points higher, driven by commodities inflation of approximately 13%, which significantly outpaced our pricing. As we expected, chicken dairy and grains continue to be categories experiencing the highest levels of inflation. Produce especially let us was much higher than expected due to poor growing conditions and weather-related events in the quarter. However, our scale and vendor partnerships help minimize this impact relative to the general market. National labor was 30 basis points better than last year, even with total restaurant labor inflation of 7%.

Our restaurants continue to run efficient labor despite hourly wage inflation of 8.5%. National expenses were 20 basis points favorable as we leveraged higher sales that more than offset elevated inflation on utilities as well as higher repairs and maintenance expense. Marketing expenses were 30 basis points higher than last year as we increased media support for the reintroduction of never-ending possible. This was in line with our expectations heading into the quarter. G&A expenses were 40 basis points below last year, driven by sales leverage and a lower incentive accrual, which was in line with our plan. This favorability was partially offset by higher mark-to-market expense on our deferred compensation. And as a reminder, due to the way we hedge this expense, this favorability is largely offset on the tax line.

Page 13 of our presentation illustrates the roughly 20 basis point reduction to operating income from mark-to-market expense and the 150 basis point benefit to the tax rate. The effective tax rate of 12.1% this quarter would have been 13.6% without the impact from the hedge. Now looking at our margin performance versus pre-Covid, we grew operating income margin by 160 basis points, while underpricing inflation by more than 500 basis points. Increased food and beverage costs were more than offset by improved productivity, reduced marketing, and other cost savings initiatives. Looking at our segment performance. All of our segments significantly outperformed their respective industry benchmarks on both traffic and sales. Sales at Olive Garden were 9.2% above last year driven by same-restaurant sales of 7.6%.

Average weekly sales at Olive Garden were 104% of the recovery level. LongHorn sales were 9.7% above last year with same-restaurant sales growth of 7.3%. Average weekly sales at LongHorn were 125% of the pre=COVID level. Sales in our Fine Dining segment were 7% above last year, driven by Same Russian sales of 5.9% and average sales — weekly sales were 117% of the pre-covid level. Our other segment sales were 10.5% above last year — with same-restaurant sales of 7.1% and average weekly sales were 109% of the pre-covid level. Turning to our financial outlook for fiscal 2023. We have updated our guidance to reflect our year-to-date results and expectations for the back half of the year. We now expect Total sales was $10.3 billion to $10.45 billion, same-restaurant sales growth of 5% to 6.5%, 55 to 60 new restaurants; capital spending of $525 million to $575 million, total inflation of approximately 7%, and we plan to continue underpricing total inflation with annual pricing of approximately 6%.

Furthermore, we expect commodities inflation between 8% and 9%. An annual effective tax rate of approximately 13% and approximately 123 million diluted average shares outstanding for the year. All resulting in diluted net earnings per share between $7.60 and $8. Looking at the third and fourth quarters, we expect the EPS growth rate year-over-year to be fairly balanced. In the third quarter, we estimate the outsized sales growth from lapping Omicron last year to be partially offset by underpricing inflation by approximately 50 basis points. In the fourth quarter, we expect inflation to further moderate on our pricing gap drivers contributing to margin growth. Now to wrap up, let me say that we’re very pleased with how our teams are managing their businesses and delivering strong results.

We remain disciplined in adhering to our strategy and providing value to our guests in the face of strong inflation. We’re confident in the underlying strength of our business model and our team’s ability to continue managing through this unpredictable environment effectively. Now we will open it up for questions.

Q&A Session

Operator: We’ll take our first question from Eric Gonzalez with KeyBanc Capital Markets.

Eric Gonzalez: Just a real quick one on the promotional strategy. I think you said that never any possible will be the only LTO that you run this year. But you also brought back that $6 take-home offer, which I’m guessing you would consider to be an LTO. But — so maybe you could talk about your expectations for that offer? Because if I remember correctly, that was a fairly strong comp driver in the past.

Ricardo Cardenas: Eric, thanks for the question. Never any possible, we said in our prepared remarks is maybe the only limited time offer, likely only been a limited time offer. As you talk about the $6 take home, that’s on our core menu. So it’s not considered limited time, it’s on our menu. But for competitive reasons, we’re not going to discuss any more promotional plan details. And so we’re going to continue to use our filters that we mentioned, first, elevating brand equity by bringing the brand’s competitive advantages to live; second, simple to execute; and third, not at a deep discount. As you’ll probably see on ATV today, we’re currently airing our open big pastas, which are core menu items for us. So they’re not a limited time offer, and it includes our new Ravioli Carbonara, none of these items are discounted. So we’re going to stick to our strategy, as Raj said, core growth, core discount growth, and we’re going to react accordingly.

Eric Gonzalez: And then just on the marketing spend, do you still expect to be in that 1% to maybe 1.5% range for the year?

Rajesh Vennam: Yes, Eric, we’re going to be close. So I think that as we said, it should be close to 1 — we said 10 to 20 basis points above last year. That’s how we think about it.

Operator: We’ll take our next question from Brian Bittner with Oppenheimer & Co.

Brian Bittner: Congratulations on strong results. question on Olive Garden also. The underlying same-store sales this quarter showed a clear inflection versus the last few quarters, and particularly relative to the other brands, the 3-year comp accelerated to above 11%. And how much of this dynamic would you attribute directly to bringing back never-ending possible at the strong price point you did in — and how much would you attribute to other factors? And do you believe this kind of underlying trend on a 3-year basis is sustainable? Or should we be tiny modeling a more conservative 3-year term moving forward for Olive Garden?

Ricardo Cardenas: Yes, Brian. First, let me say how proud I handle the work Dan and his team have done working on keeping with our strategy at Olive Garden. As we mentioned in our prepared remarks, Olive Garden already had a positive gap in same-restaurant sales to the industry before never-ending possible, and that gap increased when we brought never-ending possible back for 7 weeks. So it ran about half of the quarter. We’re not going to kind of talk about how much nevering possible and contributed to the quarter, but it was a good jump for us. And so as we think about the rest of the year, our guidance contemplates continued strength in Olive Garden, but probably not at the strength that we had for nevering possible. Remember, this is an iconic limited time offer, uniquely positioned, and it covers all 3 filters that we mentioned.

And as I said in our prepared remarks, we have exceeded our expectations. So — and that’s a pretty pleasant surprise for us. If you think about given the higher price point, the lower media support, but it does speak to how iconic that brand offer is and the things that Olive Garden brings in such a compelling way. And then finally, we haven’t run in 3 years. So guests were really excited for the return, and it fits really well in our second quarter. So if you think about our lowest volume quarter of the year second quarter, never any possible helps keep our traffic a little bit higher so that we don’t have to think about bringing team members hours down and then bringing team members back when the holidays go up. So we really were appreciative and we really love with the work that Olive Garden did and where nevering possible was.

But not to say that our 3-year stack is going to stay the same as it did in Q2.

Brian Bittner: And Rick, just more broadly, just you have a seat where you get to witness the consumer across multiple different brands. You have one of the best seats to kind of see how the consumer is behaving. There’s obviously a lot of cross currents out there, and there’s a lot of different views on where the consumer is going into calendar 2023. Can you just maybe describe your view of the consumer and how you’re feeling about the overall consumer into ’23 and maybe some puts and takes?