Darden Restaurants, Inc. (NYSE:DRI) Q3 2024 Earnings Call Transcript

Darden Restaurants, Inc. (NYSE:DRI) Q3 2024 Earnings Call Transcript March 21, 2024

Darden Restaurants, Inc. misses on earnings expectations. Reported EPS is $2.62 EPS, expectations were $2.64. DRI isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and welcome to the Darden Fiscal Year 2024 Third Quarter Earnings Call. Your lines have been placed on a listen-only mode until the question-and-answer session. [Operator Instructions] This conference is being recorded. If you have any objections, please disconnect at this time. I’ll now turn the call over to Mr. Kevin Kalicak. Thank you. You may begin, Kevin.

Kevin Kalicak: Thank you, Kevin. Good morning, everyone, and thank you for participating on today’s call. Joining me today are Rick Cardenas, Darden’s President and CEO; and Raj Vennam, CFO. As a reminder, comments made during the call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to 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.

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 2024 fourth quarter earnings on Thursday, June 20, before the market opens, followed by a conference call. During today’s call, any reference to pre-COVID when discussing third quarter performance is a comparison to the third quarter of fiscal 2020. Additionally, all references to industry results during today’s call refer to Black Box Intelligence, casual dining benchmark, excluding Darden, specifically Olive Garden, LongHorn Steakhouse, and Cheddar’s Scratch Kitchen. During our fiscal third quarter, industry same-restaurant sales decreased 4.2% and industry same-restaurant guest counts decreased 6.5%.

This morning, Rick will share some brief remarks on the quarter, and Raj will provide details on our financial results and an update to our fiscal 2024 financial outlook. Now, I’ll turn the call over to Rick.

Rick Cardenas: Thank you, Kevin. Good morning, everyone. I’m proud of our results this quarter. Each one of our segments grew total sales and profit in an operating environment that was tougher than we anticipated. We continued to outperform the industry benchmarks for same-restaurant sales and traffic. Total sales were $3 billion, an increase of 6.8%, and adjusted diluted net earnings per share were $2.62, which was in line with our expectations. We opened 16 restaurants during this quarter. Fiscal year-to-date, we have opened 43 restaurants in 22 states, seven of which were reopenings. The quarter started well with strong holiday performance in December, but unfavorable winter weather negatively impacted January traffic. And while February results improved, we experienced some underlying softness we had not seen in the months leading up to January.

The lower income consumer does appear to be pulling back, and the mix of guests based on income is now in line with pre-COVID. I am proud that even as industry traffic trends weakened, we were able to gain share. We continue to focus on controlling what we can control, leveraging and strengthening our four competitive advantages of significant scale, extensive data and insights, rigorous strategic planning, and our results-oriented culture, and executing our back-to-basics operating philosophy anchored in food, service, and atmosphere. Our restaurant teams continue to perform at their best, especially during our busiest times. In December, the Capital Grille set their all-time total monthly sales record. In February, Eddie V’s set their all-time total weekly sales record, and Olive Garden established a new sales record for Valentine’s Day.

Our internal guest satisfaction metrics reflect our team’s focus on being brilliant with the basics. All of our brands remained at or near all-time highs for overall guest satisfaction during the quarter. Additionally, within the casual dining, polished casual and fine dining segments of Technomic’s industry tracking tool, the Darden brand was ranked number one for overall experience. The brands were LongHorn Steakhouse, Seasons 52, and Ruth’s Chris Steak House. Our team’s ability to execute at a high level is driven by strong leadership and team member engagement across our brands. We work hard to ensure our results-oriented culture is a competitive advantage for us, and our industry-leading retention rates confirm it is in an area of strength.

During the quarter, we completed our biannual engagement survey, and a result showed that our overall level of engagement is at an all-time high. Also, during the quarter, three of our brands were recognized as industry leaders in Black Box Intelligence, LongHorn, the Capital Grille, and Seasons 52 each received the Employer of Choice Award. Now let me provide a quick update on Ruth Chris. We are in the final stage of integration and remain on track to complete the major changes by the end of the fiscal year. We successfully completed the migration onto our HR platform at the end of December, and all restaurants have now successfully transitioned to our distribution network. Currently, we are halfway through converting the restaurants over to our point of sale system, and we are on track to complete that work by the end of May.

This is the most challenging part of integration, and I’m really proud of the focus the Ruth’s Chris team continues to have on delivering exceptional guest experiences. This can be seen in the fact that Ruth’s Chris was named America’s favorite chain restaurant in Technomic’s annual survey that was released during the quarter. The survey measures perceptions of service and hospitality, unit appearance and ambiance, food and beverage, convenience and value. In addition to Ruth’s Chris, Seasons 52, Bahama Breeze, LongHorn and the Capital Grille were all ranked in the top 10. Overall, I am pleased with our performance this quarter. We continue to manage the business for the long-term by executing against our strategy and controlling what we can control.

We also continue to work in pursuit of our shared purpose to nourish and delight everyone we serve. One of the ways we do this is for our team members and their families is through our Next Course Scholarship program. Earlier this month the Darden Foundation awarded more than 100 post-secondary education scholarships worth $3,000 each to children of Darden team members. Education is one of the greatest equalizers in our country, and I’m thrilled that we can create a lasting impact on the lives of our team members’ families through this program. Finally, I want to thank our 190,000 team members for everything you do to create exceptional experiences for our guests. You are the reason brands continue to be recognized as great places to work and top dining destinations.

Now, I will turn it over to Raj.

Raj Vennam: Thank you, Rick, and good morning, everyone. Third quarter earnings were in line with our expectations, although our sales were softer than we anticipated. We were pleased with December’s strong holiday performance as the month’s same-restaurant sales were in line with our second quarter results. However, winter weather in January negatively impacted traffic results by approximately 100 basis points for the quarter. As we moved into February, sales trends improved, but were below our expectations, exposing some underlying consumer weakness. Despite the unexpected variability in our sales trends, our teams did a great job managing their businesses. In the third quarter, we generated $3 billion of total sales, 6.8% higher than last year, driven by the acquisition of Ruth’s Chris Steak House and 55 net new restaurants, which was partially offset by negative same-restaurant sales of 1%.

We outperformed the industry again this quarter with same-restaurant sales that were 320 basis points better than the industry and same-restaurant guest counts that were 270 basis points better. And on a two-year basis, we have outperformed on same-restaurant sales by 770 basis points and by 970 basis points on same-restaurant guest counts. Our focus on managing the business and controlling costs resulted in adjusted diluted net earnings per share from continuing operations of $2.62 in the quarter, an increase of 12% from last year’s reported earnings per share. We generated $512 million of adjusted EBITDA and returned approximately $190 million of capital to our shareholders through $157 million in dividends and $33 million of share repurchases.

Now looking at our adjusted margin analysis, compared to last year, food and beverage expenses were 90 basis points better, driven by pricing leverage. Total commodities inflation of approximately 1.5% was below our total pricing of approximately 3.5%. Restaurant labor was 10 basis points unfavorable to last year due to total labor inflation of approximately 4.5%, partially offset by pricing and productivity improvements at our brand. Restaurant expenses were 10 basis points higher as sales deal average was partially offset by strong cost management by our teams. Marketing expenses were 10 basis points higher than last year, consistent with our expectations. All of this resulted in restaurant-level EBITDA of 20.6%, 70 basis points better than last year.

G&A as a percent of sales was 40 basis points lower than last year, and total expense was slightly favorable to our previous guidance related to lower incentive compensation and ongoing synergies from the integration of Ruth’s Chris. Interest expense increased 50 basis points versus last year, due to the financing expenses related to the Ruth’s Chris acquisition. And for the quarter, adjusted earnings from continuing operations was 10.6% of sales, 30 basis points better than last year. Looking at our segments, Olive Garden increased total sales by 0.7%, driven by new restaurant growth, partially offset by negative same-restaurant sales of 1.8%. Olive Garden same-restaurant sales outperformed the industry benchmark by 240 basis points, and their traffic outperformed the industry by 270 basis points.

Despite the negative same-restaurant sales, Olive Garden segment profit margin of 22.5% was flat to last year. At LongHorn, total sales increased 5.1%, driven by new restaurant growth and same-restaurant sales growth of 2.3%. LongHorn same-restaurant sales outperformed the industry by 650 basis points. Segment profit margin of 18.7% was 130 basis points above last year, driven by pricing leverage and improved labor productivity. Total sales at fine dining segment increased with the addition of Ruth’s Chris company-owned restaurants. Same-restaurant sales at both Capital Grille and Eddie V’s were negative as the fine dining category continued to be challenged year-over-year. Fine dining segment profit margin was flat year-over-year at 21.8%.

The other business segment sales increased with the addition of Ruth’s Chris franchise and managed location revenue, but was partially offset by combined negative same-restaurant sales of 2.6% for the brands in the other segment. However, this was still 160 basis points above the industry benchmark. Segment profit margin of 14.9% was 90 basis points better than last year, driven by the additional royalty revenues and higher overall pricing relative to inflation. Turning to our financial outlook for fiscal 2024, we have updated our guidance to reflect our year-to-date results and expectations for the fourth quarter. We now expect total sales of approximately $11.4 billion, same-restaurant sales growth of 1.5% to 2%, 50 to 55 new restaurants, capital spending of approximately $600 million, total inflation of approximately 3%, including commodities inflation of approximately 1.5%, an annual effective tax rate of 12% to 12.5%, and approximately 121 million diluted average share outstanding for the year.

This results in an increased or adjusted diluted net earnings per share outlook of $8.80 to $8.90, which excludes approximately $55 million of pre-tax transaction and integration related costs. For the fourth quarter specifically, our annual outlook implies sales of $2.95 billion to $2.99 billion, same-restaurant sales between negative 0.5% and positive 1%, and adjusted diluted net earnings per share between $2.58 and $2.68. Now looking forward into fiscal 2025, we plan on opening between 45 and 50 new restaurants and spending between $250 million and $300 million of capital for those new restaurants. Additionally, we anticipate approximately $300 million of capital spending related to ongoing restaurant maintenance, refresh, and technology.

And finally, we anticipated effective tax rate of approximately 13% for fiscal 2025. And now I’d like to close by saying that we continue to be very proud of how our teams are managing their businesses to deliver strong results in this dynamic environment. With that, we’ll open the call for questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Eric Gonzalez from KeyBanc Capital Markets. Your line is now live.

Eric Gonzalez: Hey, thanks for taking the question. Maybe if you could unpack the comments about the low-income consumer pulling back? And maybe specifically talking about what behaviors you’re seeing that lead you to that conclusion? And how the brands are differing from all of Darden Cheddar’s to maybe some of the higher-end brands, how that low-income consumer is changing their usage of those brands? Thanks.

Rick Cardenas: Hey, Eric. We’re clearly seeing consumer behavior shifts. Our data shows we’re essentially back to our normal pre-COVID mix across all income groups. But specifically your question, for the third quarter, transactions from households with incomes above $150,000 were higher than last year. Transactions from incomes below $75,000 were much lower than last year. And at every brand, transactions fell from incomes below $50,000. Similar to Q2, this shift was most pronounced in our fine dining segment.

Eric Gonzalez: Great. And then may be just a follow-up, if you could just talk about from a margin perspective, this year has been pretty strong. I’m wondering if you could maybe tease out how much that margin improvement is related to commodities versus what you’ve achieved from a productivity perspective? And if you look to next year, do you see that being a year of additional productivity gains or is some of that pulled forward into this year?

Raj Vennam: Hey, Eric. This is Raj. So, from a margin perspective, if you look at where — what we talked about at the beginning of the year, we — this was one of the years where we had a pricing a little bit above inflation going into the fiscal year. But as the year progressed, inflation came down — inflation came in better than we expected for both commodities and labor. And then that combined with our team’s strong cost management that improved productivity on the labor front. We also improved our waste. We had some favorability on the mix in terms of how the trading happened between the items. So all of these were contributors to our margin improvement versus our plan. Now, as we look at next year, we’ll share more details in June, but the way we look at as we’re going through the planning process right now, but we’ll always use our long-term framework as a guidepost to inform how we think of our plan.

So we’ll share more details in June. And — but we have — if you look back over the last four years, we were underpriced a lot.

Operator: Thank you. Our next question is coming from Brian Bittner from Oppenheimer. Your line is now live.

Brian Bittner: Thank you. Good morning. I wanted to follow-up on the lowering consumer and your comments about this cohort pulling back because it was a pretty pronounced commentary there. I know you talked to Eric’s question about what you’re seeing, but I think this is reflected in your 4Q same-store sales outlook? But do you anticipate this dynamic that you’re seeing with the low-end consumer to be powerful enough to impact industry sales throughout the rest of the calendar year? And if so, how are you thinking about updating your strategy to deal with this?

Rick Cardenas: Hey, Brian. Yes, we can’t determine whether it’s going to be impacting the rest of the year. What we can say — what I can say is that impact to the low-end consumer was a year-over-year phenomenon. And now we’re back to our pre-COVID mix. And so if you think about where we were before COVID, what percent of our guests were below 50,000, what percent of our below 75%, et cetera, across all of our segments, all of our brands, it’s almost exactly the same as it was before COVID. So at least that makes us feel like we know how to operate in this environment. The other thing is if you look at Black Box, according to Black Box, every segment in the industry, from QSR and up was negative in same-restaurant traffic in our third quarter, every one of them.

So that’s also a year-over-year phenomenon. And so we’ll continue to monitor what we see with the guest and what we see on that lower end consumer. But we’re pleased that it’s back to our normal or normal pre-COVID levels. And in respect to marketing, as we’ve talked about often, we’re focused on profitable sales growth. And our brands, all of our segments improved sales and profits for the quarter year-over-year. And we, even with the increase in competitive activity, we expected — we exceeded, I’m sorry, industry traffic by 270 basis points on top of the 700 basis point gap we had in Q3 last year, so almost 1,000 points, so 970-point gap in two years. So we’re going to stick to our strategy of everyday value to our guests and continue to use our filters to evaluate any marketing activity.

If that means that we’re going to spend a little bit more in a quarter or a little bit less in a quarter, that’s what we’ll do. But we’re going to focus on our strategy and stick to it as long as we can. Thanks.

Brian Bittner: And just as my follow-up, as it relates to the third quarter specifically, your ability to manage the margins was very impressive despite where the comps shook out. Can you just talk a little more specifically about how you nimbly manage that labor and other operating expense line? And just, Raj, as we look to 4Q, I think you had previously said you expect to underprice inflation by about 150 to 200 basis points in the fourth quarter? Is that still kind of the range you want us thinking about pricing versus inflation for 4Q? Thanks.