Darden Restaurants Inc Q2 FY2023 Earnings Call

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. Thank you, Todd. Good morning, everyone, and thank you for participating in 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. 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 is 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.

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 four 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, four 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 number one 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, namely never-ending pasta. As you may recall, when I last spoke, I shared that any promotional activity or brands introduced should be evaluated against the following three 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-ending pasta checked all three 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 pasta exceeded expectations, and we saw a step change in Olive Garden's positive gap to industry traffic during the seven weeks it ran. I am even more encouraged by this performance, given that it was supported with about three-quarters 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 orders. 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% at 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 records 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. We embrace 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 eight 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 weekly 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. I am delighted that our teams are helping to make a difference in communities across the country. I'm so proud of the focus and commitment our teams continue to display. Their disciplined approach in executing 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.

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 outpaced the industry by 370 basis points, and our same-restaurant guest counts performed even better, exceeding 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 in 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, which was 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 lettuce, was much higher than expected due to poor growing conditions and weather-related events during the quarter. However, our scale and vendor partnerships helped 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 and 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 pasta. 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 expenses on our deferred compensation. 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 the 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 over 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 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-restaurant sales of 5.9%, with average weekly sales at 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 of $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, with 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.

We'll take our first question from Eric Gonzalez with KeyBanc Capital Markets.

Just a real quick one on the promotional strategy. I think you said that never-ending pasta will be the only limited time offer that you run this year. But you also brought back that $6 take-home offer, which I'm guessing you would consider to be a limited time offer. 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.

Eric, thanks for the question. Never-ending pasta, as we said in our prepared remarks, is likely the only limited time offer. As you talk about the $6 take-home, that's on our core menu, so it's not considered limited time. For competitive reasons, we're not going to discuss any more promotional plan details. We're going to continue to use our filters that we mentioned: first, elevating brand equity by bringing the brand's competitive advantages to life; 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. We're going to stick to our strategy, as Raj said, core growth, core discount growth, and we're going to react accordingly.

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

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.

We'll take our next question from Brian Bittner with Oppenheimer & Co.

Congratulations on strong results. I have a 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 three-year comp accelerated to above 11%. How much of this dynamic would you attribute directly to bringing back never-ending pasta at the strong price point you did, and how much would you attribute to other factors? Do you believe this kind of underlying trend on a three-year basis is sustainable? Or should we be modeling a more conservative three-year term moving forward for Olive Garden?

Yes, Brian. First, let me say how proud I am of 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 pasta, and that gap increased when we brought never-ending pasta back for seven weeks. So it ran about half of the quarter. We're not going to discuss how much never-ending pasta contributed to the quarter, but it was a good jump for us. 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 never-ending pasta. Remember, this is an iconic limited time offer, uniquely positioned, and it covers all three filters that we mentioned. And as I said in our prepared remarks, we have exceeded our expectations. That's a pretty pleasant surprise for us. If you think about the higher price point, the lower media support, it does speak to how iconic that brand offer is and the things that Olive Garden brings in such a compelling way. We haven't run it in three years, so guests were really excited for the return, and it fits well in our second quarter. If you think about our lowest volume quarter of the year, the second quarter, never-ending pasta 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 are really appreciative of the work that Olive Garden did and where never-ending pasta was. But that doesn't mean that our three-year stack is going to stay the same as it did in Q2.

Rick, just more broadly, 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 are a lot of different views on where the consumer is going into calendar 2023. Can you describe your view of the consumer and how you're feeling about the overall consumer into '23 and maybe some puts and takes?

Yes, Brian. I won't necessarily talk about '23. I'll just talk about what we're seeing, not being an economist, but I listen to what they have to say. As everyone on this call knows, consumer spending drives the U.S. economy. We've seen a shift in spending though, from durable goods to leisure services, and the restaurant industry has benefited from that shift. Casual dining same-restaurant sales improved from Q1 to Q2, and our positive gap to the industry improved even more during that time. One of the benefits of our portfolio, as you mentioned, is we serve a wide range of consumers all across the spectrum. Our data indicates the higher-end consumer hasn't seen the same impact as consumers at the lower end of the spectrum. If you think about the prepared remarks, sales at Thanksgiving were a record for Fine Dining and Seasons 52, and bookings for this holiday season are encouraging. It seems like the higher-end consumer is doing pretty well. I know there's been a lot of talk throughout the year about consumers below $50,000 in income because high inflation impacts that consumer disproportionately, but we've seen a little softness in that consumer over the last six months, but the mix of the $50,000 income and under is still above pre-COVID levels for us. Even though that shift has come down a little bit, we're still above pre-COVID levels at the $50,000 and below income bracket. I would say keep in mind that many of our consumers below $50,000 are single, retirees, or living in multigenerational households. So maybe $50,000 goes a little bit further for that consumer. Without commenting on the future, we've seen pretty good performance across all of those consumers over the last few months, other than the fact that the consumers below $50,000 are lower than they were six months ago but still higher than pre-COVID levels.

We'll take our next question from Andrew Charles of Cowen.

Great. Notwithstanding the strong 2Q performance and the higher fiscal 2023 guidance, if we were to see some macro deterioration impacting the industry in fiscal 2023, what's the pecking order or your preference of magnitude of how you'd respond to that? Should we expect perhaps a tighter taking of the belt and just more of a focus on reducing overhead? Will we expect you guys to potentially invest more in the marketing, potentially invest more to value? How do you think about the contingency plan if we were to see some deterioration in calendar 2023?

Andrew, this is Rick again. If we see deterioration in calendar 2023, we always look at ways to tighten and find ways to improve productivity and improve our administrative expenses. We think we're really good at doing that. If something shifts badly, we're going to find ways to at least find places to tighten. On the marketing spend, Raj talked about what our marketing spend is for the rest of this year and for the whole year. We don't anticipate making a big change in that no matter what happens over the next six months. We're going to continue to use the filters that we mentioned. I will say Olive Garden, as I said before, will always have advertising in their mix because of their scale. We're going to stick to our strategy of core growth. We'll react accordingly to whatever happens. As we've said in the past, if and when we increase our marketing spend, we'll expect it to earn a return compared to what it would have been without the spend. So we will react when things happen, and we think we'll do the same thing going forward.

Very helpful. If I could sneak one in to Raj, what's the small increase in CapEx guidance as you maintain new store openings? Is it that construction costs were perhaps running a bit higher than expected, or are there some incremental investments in technology or something else we should be thinking about?

It's truly inflation on the construction costs and some equipment costs as well. A lot of it is new restaurant related. Some is even on the facilities CapEx that’s experiencing a little bit higher inflation.

We'll take our next question from David Palmer with Evercore ISI.

Just a question on traffic, particularly on-premise. If you look at the industry numbers, on-premise traffic is down double digits for casual dining. Even Olive Garden is not back to where it was. I wonder how that informs your strategy? Do you feel like that's an opportunity? Or do you just have to be patient, particularly with some lapsed users, maybe that under $75,000 household income user? Maybe this isn't something you want to chase either. I'm wondering how you view that as an opportunity that informs the strategy.

David, if you think about what we've done over the last few years, we have significantly reduced marketing spending at Olive Garden. We've talked in the past about how that could be about a 10-point drop in traffic for us. But we're focusing on driving core users to Olive Garden, core guests versus promotional users. What we see as an opportunity is that we have more capacity in our restaurants than we did before. A lot of that in-restaurant experience has moved to the off-premise experience. As you see Olive Garden still at 25% off-premise, prior to COVID, it was much lower than that. We see it as an opportunity to continue to focus on our strategy of pricing below our competition, pricing below inflation by finding other cost savings to help offset that and give our consumers a great value so they don't need a promotional message to come in, and they just get a great value every time they come.

Actually, on your slide deck, I just had a quick question on Slide 20. Your food inflation outlook looks like it's less inflationary on many of those line items—beef, chicken, dairy oil—versus what you had previously, but your food inflation outlook is still the same at 7%. Is there some offset to what we're seeing? And I'll pass it on.

Yes, David. It's really the fact that the last two quarters were 15% in the first quarter, second quarter was 13%. As you look at the back half, Q3 is going to be mid- to high-single digits and then Q4 is closer to flat. So if you do that, what that translates into on the year is closer to that 8% to 9%. When we spoke last time, we expected a step change from the first half to the second half, and we are seeing that. However, it's not as big as we thought. It’s still a pretty big change—going from mid-teens to mid- to high-single digits and getting into Q3 and closer to flat for Q4. It’s a pretty significant change, but there are a few items that are higher than we would have expected, namely dairy grains and produce, and quite a bit of this is weather-related, and that’s actually baked into our expectations going forward.

Our next question comes from Jared Garber with Goldman Sachs.

Great. Thanks for the question. I think this was the first quarter that we've seen or the largest quarter of openings at Cheddar's in several years. I just wanted to get a sense of an update on the brand. I know it's a little bit of a lower-income skew there as well. Some commentary on the performance there and what you're seeing from a customer standpoint and if there's anything in terms of regionality where these new units were opened. Just any update on the brand would be great.

Jared, let me talk high level about Cheddar's and talk a little bit about the opening. Cheddar's has made significant improvements in their business model. Versus pre-COVID, even with significant inflation, they had a lot of productivity enhancements with the simplified menu, which made us feel more comfortable opening restaurants at a quicker pace. They have also built their leadership pipeline and been able to staff all of these restaurants with managing partners that have run Cheddar's, and we have a pipeline of more ready to go as we open restaurants. So yes, this was our highest quarter of openings for Cheddar's—we opened seven restaurants.

Yes, versus last year. We had seven restaurants versus four in the quarter at Cheddar's. Those restaurants are performing really well. They are primarily in markets close to where Cheddar's already exists. It’s not like we have many restaurants opening in brand-new markets. But we are looking at newer markets to open Cheddar's in. As we mentioned early on in the acquisition of Cheddar's, we thought we had more room to infill markets where they already have restaurants. This helps us leverage our scale in those markets, our supply chain, and our people.

We'll take our next question from Brian Harbor of Morgan Stanley.

Maybe just to follow up quickly on the commodity comments. Do you see any kind of risk to the second half just based on some of those items that have surprised to the upside recently? Or are those things that can't necessarily be contracted? How do you feel about that at this point?

I think there's always risk. As you think about that, that's why we have a range of 8% to 9% as our assumption going in. We'll have to see how this plays out. Some of the items, like I mentioned earlier in my prepared remarks, the second quarter impact on produce, especially lettuce, that no one expected it. It came out of nowhere; it was weather-related. Two hurricanes in Florida, two hurricanes in Mexico—they just really destroyed the crops. That cyclical stuff is always a risk. We contemplated some of that in our guidance.

Okay. You made the comment about just sharing some of the lessons from never-ending pasta at your other brands. What are you thinking about there? Is it kind of a change to promotional architecture? Or are there things you’re not doing at some of those brands that you could be doing to kind of echo never-ending pasta?

As you think about never-ending pasta, there were other things that we did during that time. We did a little bit more digital testing and those kinds of things that we can leverage across our brands. More importantly, those filters that we use on what we’re going to communicate were very strong and helped our brand build—helped Olive Garden continue to build their business, elevating brand equity, which is very important. We’ve learned that. We simplified the offer. We’ve learned that; and we’re not at a deep discount. All the investments we’ve made over the last few years to price below what consumers are seeing in inflation means that we don’t have to really go into the net discounting range. The never-ending pasta was $3 more expensive than it was in the past, and it remained a strong promotion for us. But that doesn’t mean that everybody is going to be on television now, right? So Olive Garden is the one that has the real scale to be on television. The other brands have learned things about the digital testing we did and just the facts of how we construct the promotion.

Our next question comes from David Tarantino of Baird.

My question is on unit development and your comment, Raj, about construction costs escalating. I just wondered if you could comment specifically on the returns you're getting on the recent openings or the expected returns you're getting on your upcoming openings. I know there's a lot of moving parts, and I guess the main question is, is the numerator of the return equation keeping up with the escalation in the denominator? Are you seeing similar returns, or are you getting to a point where the returns are starting to come down? Any color there would be great.

Yes, David. Let me start by saying that, on average, our new restaurants exceed the cost of capital by quite a bit. We had a big margin to begin with. Now the construction costs have gone up; so have our unit economics. If you look at the overall performance of where we are, I just mentioned earlier that our operating income this quarter was 160 basis points higher than pre-COVID. Our four-wall unit-level economics have gotten better, which helps mitigate some of the construction cost increases. Now, with that said, we obviously want to continue to maintain our pace of opening, but we continue to monitor inflation in construction costs. We are being very disciplined. There are a few times we have walked away from some deals because the cost was too high, even though that would have probably exceeded our cost of capital. We're just being a little bit more selective on that front. That said, we're starting to see some green shoots on the construction side. The last few bids, I think, were closer to or slightly below heightened budget, which is a positive sign. There could potentially be some decrease in the level of inflation over time.

Great. And I guess a follow-up to that—are there projects going on inside the company to try to trim costs out of the box? I know a prior question commented the dine-in traffic has been softer for the industry. Are you thinking about building smaller dining rooms or anything of that nature to get the cost equation down?

David, as we think about our prototype designs for the future, we always look for ways to trim costs out of our prototypes and find new ways to build. We have built some slightly smaller prototypes in all of our brands, not necessarily because of the to-go versus the dining room, but because it makes the to-go experience a little easier by shifting where that to-go area is. Remember, the dining room is the least expensive part of the building. So if you really want to take a lot of the cost out of the building, you've got to take the cost out of the kitchen. We think we've got a great kitchen, but we'll find ways to right-size the prototypes for the market that they're in without overcomplicating so that we have 50 different prototypes. Our development team is focusing on finding the most efficient building in the markets we compete in. We've also taken some existing sites where restaurants have closed or their leases have expired for other brands. We've actually gone in and filled those restaurants, which are slightly less expensive because you don't have some of the framing costs and some of the plumbing. So it helps us in that respect.

Our next question comes from Dennis Geiger with UBS.

Curious as it relates to pricing. If you could speak a bit more to what you've seen to date as it relates to the customer response to pricing. Obviously, with the strong sales trends, I'm assuming not a whole lot, but any thoughts with respect to resistance or customer feedback to pricing and how that impacts how you think about pricing going forward?

Dennis, I think the reaction is not that dissimilar to historical meaning we are getting a pretty decent flow-through from pricing north of 90%. We're not seeing any major pushback. We haven't seen any moderation on the check mix. While there have been things here and there—where maybe advertiser pricing, we may not have gotten the exact level of flow-through, overall, when you look big picture, it doesn't look like there's a lot of resistance. We're pricing a lot less than our competitors. So I don't know what is happening with the industry itself, but our pricing is well below the industry. That may be why we're not seeing a lot of resistance.

Great. I appreciate that, Raj. Just one more. Just wondering if you could speak a bit more to the staffing situation and the execution in the restaurant. I think it's very encouraging that you spoke to being fully staffed, manager staffing levels at all-time highs, feedback scores from the customers sound strong. But as it relates to the level of execution currently versus the potential, is there anything with respect to maybe the tenure of your average employee right now, maybe shorter than pre-COVID, that can build going forward? Anything there as it relates to where operations are now versus maybe where you would like them to go?

Dennis, we have a lower tenure today than we did before COVID because of the turnover experience during COVID. Our turnover is still elevated from pre-COVID levels, but it's getting better and we're working on getting it closer to our pre-COVID turnover levels. As we've mentioned in prior calls, our focus is on training these new team members and getting them more efficient and productive. As we continue to get our turnover levels down, that will be a focus for us. Also, training our existing team members to improve their skills helps give them more opportunities to learn and grow. We will continue to train. Your point about slightly lower tenure is true, and we think as our tenure gets closer to more historical levels, which will take a while, our productivity will improve slightly from there too.

Our next question comes from Chris Carril of RBC Capital Markets.

So clearly, a lot of focus on Olive Garden this morning, but I was hoping you could provide some more thoughts on LongHorn and just the continued momentum you're seeing there. Maybe just any thoughts on how the brand is performing relative to the category? And then just anything else you're seeing that's driving the continued strong sales there.

Yes, Chris. Todd and his team, as we've said in the past, have been on a journey investing in quality and portion, and that continues to pay off. They had over 7% same-restaurant sales this quarter, coming off a very strong result last year. It was a pretty strong performance for Longhorn. Raj mentioned average weekly sales at LongHorn were 125% of the pre-COVID levels. Now the state categories benefit over time, but LongHorn is holding their own in that state category. They're doing really well. I would say traffic, unlike most casual dining traffic, in the LongHorn dining room is up versus pre-COVID. It's one of the only full-service restaurant companies with positive traffic in the dining room at scale. We are really proud of what they've done. Remember, they were on the journey of simplification before COVID, so they're ahead of everyone else in our portfolio in that regard. They didn't have to worry about flushing out that promotional guest that had already happened. We are going to continue to provide great value at LongHorn and all of our brands, especially with the quality focus they've had, the simplicity that they've always maintained, and the culture that Todd is building.

Great. And then maybe just following up on the earlier comments around the consumer. Can you provide any more detail in terms of what you're seeing regarding mix contribution to the comp? Any kind of trade-up or trade-down, any shifts in behavior there, if any?

Yes, Chris. Regarding the mix, we're not going to comment as much about the mix impact to comp. We did have a strong performance for never-ending pasta that helped our comp. We haven't seen a big check management. We haven't seen a lot of shifting in the mix because we've got a very strategic, methodical way we price so that we don’t experience mix changes when we take pricing—this has been learned over time with our data scientists here. We haven't seen a lot of mix shift. The economy has seen a shift from goods to services, which may explain why you haven't observed a lot of shift in the mix in our business or in competitors' businesses.

Our next question comes from Jeffrey Bernstein with Barclays.

Great. Two questions. The first one is just on the competitive outlook. I'm just wondering whether you've seen any change in competitive behavior. Again, you are servicing all ends of the spectrum here. So just wondering what you're seeing from the competition. I know some are concerned about a potential uptick in discounting to drive traffic if commodity inflation were to continue to ease. I know that's contrary to your strategy—to make sure not to deep discount—but just wondering what you're seeing across the competitive landscape? And then I had one follow-up.

Jeff, we haven't really seen a lot of deep discounting in the competitive landscape. There aren't many that are even on television. One of the brands that had gone off TV over the years indicated they might come back on, but they’re not discussing discounting when they do that. I think, as Raj mentioned, our margins are about pre-COVID levels. We were one of maybe two companies in the public space that had improvements in margin versus pre-COVID, and most of them are discussing trying to improve their margins. I can't really comment on what I think they'll do, but I can emphasize what we’ll do. We're going to continue to focus on our filters to evaluate our promotional messaging or any messaging we do—elevating brand equity, executing simply, and not at deep discounting. Sticking to our strategy of core guest growth and reacting accordingly. We'll observe competitors while continuing our strategy.

Understood. As you look at your fiscal '23 guidance, whether Raj, on the specific numbers or Rick, in terms of the broader thought process, what do you think is to prioritize best to worst line of—or in terms of all your guidance components, whether it's comps, inflation, or earnings. What do you find more or less difficult to potentially forecast as you think about the next few quarters going into potentially slowing economy?

I think the biggest—well, the one that's going to have the most uncertain data is the traffic. What kind of traffic are we going to see? We've used a wide range of roughly 3% in the back half to accommodate consumer shifts, but there’s a meaningful change. That’s something that could have an impact. That's really the big one. Inflation has been harder to foresee—multiple factors impacting inflation like supply shortages and other issues, labor impact. As labor begins to normalize, we have weather events and global events. So what's going on with inflation is tough to predict. Those two things are really the big considerations, but I think outside of that everything else probably allows us to be more certain.

Our next question comes from Peter Saleh with BTIG.

Great. Just two questions. First, on the never-ending pasta promotion. Do you feel that the benefit of that promotion extends beyond the promotional window of seven weeks? Are you able to hold on to those guests even though they might be purchasing something else on the menu?

Yes, Peter. As we think about any promotional activity or any limited time offer activity more specifically, we want to ensure that the limited time offer elevates brand equity as we've said before. We think there's a little bit of halo over that. Now, it’s probably not going to be as strong as when you've got the promotional message out there, but as we said in our prepared remarks, our year-to-date comp sales are equivalent to our year-to-date comp sales. We haven’t experienced a big slowdown since we stopped never-ending pasta. That’s across Darden, not necessarily across Olive Garden, but that’s the idea of marketing or messaging—should endure longer than the limited-time offer, and we think this one did.

Great. And then just on the competitive environment relating to new restaurant formation, there's been a lot of discussion around the surge in construction costs. Can you talk a little bit about what you're seeing specifically on new restaurant formation from the competition, maybe more specifically independents? Are you seeing newer restaurants being built, or is there a pullback in development given the surge in construction costs? Any insight would be helpful.

Yes, Peter. There are always new restaurants being built. The question is how many are closing to offset the new restaurants being built. As trade areas evolve, you're going to see restaurants open. We think about the net closures that have happened since pre-COVID. It’s still double digits; we’re not seeing that number get smaller or larger. It is starting to level off a bit. Some strong competitors are still opening restaurants on a net basis, and we are opening restaurants on a net basis, but we're not witnessing a whole lot of net unit growth in the full-service restaurant space. As construction costs rise, and as Raj mentioned, you may see some adjustment but the margins make it somewhat more challenging.

Our next question comes from Lauren Silberman with Credit Suisse.

Rick, you mentioned four of the brands that are running at all-time high internal guest satisfaction levels. What do you think is driving these record levels? Any sense of how this might compare to guest satisfaction across the industry broadly?

Well, Lauren, I would say what's driving it is the things we've been doing over the last few years. We talk about simplicity and how it makes it easier for our teams. They don’t have to learn and execute a lot of different things. We have streamlined our menu over the last few years. As Gene mentioned a year ago, streamlined the menu means more items being made more often. This helps the team get better at those items versus having one or two items that you sell in a week. This enhances experience. Our team members have the opportunity to learn on the selling side with fewer items. What we see in our performance is our brands becoming stronger. We aren't necessarily seeing the competitors’ situation move; they may have flattened out or negative overall. Our satisfaction, we're proud of. The significant investments we've made over the last few years in our food and in our people will eventually show up in guest satisfaction, and it has. We're feeling really good and our brands being number one in all categories for Technomic—having a Darden brand being number one for the first time ever—is fantastic. We’ll continue to improve satisfaction, ease for our restaurant teams, and invest in our people and food.

Great. And just a follow-up on the holiday season. Gift card sales are generally pretty important for early calendar '23. Anything you can share on what you've seen with gift card sales so far this season?

I see they're pretty consistent with last year. There’s also a significant amount on the day before Christmas. There’s still a little bit of time remaining. We haven’t discounted—many of our brands, we no longer provide discounts on gift cards. So it is encouraging to see strength without any discounts.

Our next question comes from Sara Senatore with Bank of America.

Just a follow-up on the capacity comments, I appreciate the detail on the net growth. My sense is, though, that there's growth coming from chains and shrinkage coming from independents. So maybe capacity, if you will, hasn't come down quite as much as unit count would suggest, given the chains tend to have bigger boxes and higher volumes. So I guess I'm just wondering if you have any kind of thoughts on that—this idea that maybe it's been more of the chains that have gotten hurt and therefore, there's still a fair amount of capacity out there being added. And then I just have a quick follow-up question on labor; that was, I guess, in line with expectations of the wage inflation, but we've been seeing such moderation in wages, I guess I’m trying to understand for some concepts perhaps. I'm trying to understand if there's a difference across markets or geographical segments, full service versus limited service where statutory minimum wage increases have more of an impact. Any color you can give on that because I would have expected, I guess, a bit more moderation there.

Sara, this is Rick. I’ll take the capacity question, and then I’ll let Raj answer the labor question. On the capacity, you're absolutely right. We've seen more independents, which in some cases are a little smaller in total seats than the chains. However, I don’t know if you can conclude that 11% of restaurants, even with adjustments for capacity by seats, are still closing. We have seen chains opening restaurants but not at the intensity they were previously, and it's not helping offset all the other capacities exiting the system. With inflation on construction costs and the margins many brands have, it's difficult to open new restaurants. As Raj mentioned earlier, we walked away from some big deals because the cost was too high despite exceeding our capital costs. I don’t believe that everyone can do that and still open restaurants while attaining the same returns as before. Long answer, but capacity is impacted by what kind of restaurants open or close and you're correct. Independents are generally smaller, so the overall capacity of seats is probably not down as much as units.

Yes, and on the labor side, as you look at where we started the year, the hourly wage rate in our first quarter was mid-9s; I think we said 9.5%, and second quarter was 8.5%. We saw a drop by a full point in the rate of inflation; we expect that to continue to go down by 50 basis points a quarter in the next two quarters. We see moderation, obviously, that takes time once you give someone an increase. That’s their impact for the year. When we onboard new people, we see less upwards pressure on starting wages. While it's still high and significantly higher than pre-COVID levels, it’s not continuously going upwards as previously experienced, I hope this clarifies your question.

We'll take our next question from Andrew Strelzik with BMO.

I just had two questions going back to the food cost outlook. The first one as you move towards flat commodity inflation or what have you in the fourth quarter, is there an opportunity to be a little more aggressive locking in where you can to improve that visibility on the cost side? Or are there still challenges doing that or maybe you think prices are going even lower? So that’s at play. So I'm curious how you're thinking about that, number one. Number two, it seems like you're maybe a bit more optimistic on where food inflation is headed than some of the commentary from your peers recently. I know there's the food basket, there're timing differences, but I'm curious if there’s anything else maybe that's driving that divergence, in particularly I'm wondering if this is the scale benefits playing out. So curious how you think about that as well.

Andrew, there's a lot in there, so I will try to address all the pieces. Let's start with the ability to lock in. I think for some products, we have that opportunity; for others we don’t. If you think about beef, for instance, I don’t think a lot of suppliers are innovating more; they want to assess supply challenges and understand the price. Most suppliers are unwilling to lock in beyond 90 days. That’s a structural issue as to why this is the case. However, for other products where we can lock in prices, we are indeed continuing to do so. This is why for chicken, for example, we're at a 90% coverage for the back half—we identified an appropriate price to secure, closer to flat when we get to Q4 of this year. Our supply chain team continues to look for opportunities to lock in at favorable prices while leveraging relationships. Our scale assistance contracts allow us to achieve a better overall pricing, and much of this is a result of the longstanding relationships our teams have built with suppliers that lead us to a better number overall.

Our next question comes from Christopher O'Cull with Stifel.

Question relates to margin. And Raj, EBITDA margin has been up about 110 basis points, I think, relative to 2019 in the first half of the year, and I think your guidance kind of implies that the margin could be up 120 basis points or more in the second half of the year. I'm just wondering if you're expecting G&A to continue driving that improvement. Or are you looking for the restaurant margin to become a bigger contributor to the back half improvement?

Yes, I would say that G&A will likely be higher in the back half compared to the first half due to incentive accruals, while the restaurant-level margin should improve relative to pre-COVID in the back half based on where it was front half. Our overall expectation is growth in the back half; however, we recognize that the baseline is higher for that back half since our margins were quite high back then.

And just secondly, the segment margin at Olive Garden, I think, compressed about 320 basis points year-over-year this quarter. Can you help parse out what drove that? How much of it was intentional in terms of menu or labor investments? How much of it was just due to inflationary pressure?

It's really inflation. If you think about the three items I mentioned that had the highest inflation—chicken, dairy, and lettuce—you experienced over 20% inflation on the commodities this quarter. When you take that into consideration while having only had 6.5% pricing level at Darden, Olive Garden’s pricing would be close to Darden’s pricing overall. So that’s the biggest piece. One other point I wanted to mention is about lettuce; although we did not experience the same level of inflation as the general market, it was nonetheless a surprise. It had about a $4 million to $5 million impact in the quarter, which is meaningful.

Our next question comes from Danilo Gargiulo with Bernstein.

I was wondering, in the context of a potentially slower market environment, what gives you the confidence to raise the outlook for same-store sales? In particular, on which brands you're elevating your expectations?

Let me explain how we got there. Our pricing has been raised in the earlier guidance from 5%, now at 6%. We raised the upper limit of our sales guidance by 0.5 points, and we reduced traffic expectations by around 0.5 points. We brought the lower-end estimate up by the full point, which guides this pricing strategy. This has been our driver for the change in guidance.

Can you also provide some context on perhaps the frequency of visits of your consumers by brand and whether you're seeing the frequency differently today versus historical averages, maybe by some type of consumer cohorts or brands?

Our casual dining average frequencies still sit at three to four times. We are observing increased customer engagement from the investments we've been making, showing a slight uptick in frequency. However, it's a slow build. Our strategy is directed towards ensuring it takes time.

My question is on Olive Garden. I think you said it was outperforming the industry comp even before the launch of never-ending pasta, which marks a change from the previous quarters. I'm curious what do you attribute that to? Have you seen the lower-end consumer trade down in recent months? Do you have any insights?

Yes, Brian. Olive Garden outperformed in Q1 as well, but improved further in Q2. Our last year, Olive Garden was probably more fully staffed than other brands in the first quarter. We have continued to believe that the investments made in Olive Garden will pay dividends over time, particularly since their staffing levels returned to pre-COVID levels. Secondly, they've implemented enhancements in their food offerings, and the jump in California benefited us significantly. That’s why we believe our gap to the industry improved from Q1 to Q2.

That's helpful. Sorry if I missed it, but on pricing, what was menu pricing in the second quarter? And what's a reasonable expectation moving through Q3 and Q4?

Yes, Brian. It was approximately 6.5% in Q2. For the full year, we expect it will be closer to the low 6s in Q3 and around 5% in Q4.

Guys, it's nice to see you coming back to brilliant with the basics. I think we probably first used that maybe 20 years ago or so. It's definitely like a trademarkable quote for you guys. Especially in the context of increased turnover—where are you seeing that, why are you seeing it first? Are you seeing some of the really high kind of unexplainable fast quits? Or are you seeing a 6-month term over 12-month turnover? Is it happening in front of house, back of house? And is there anything you can do to, I guess—and the answer might be no—but can you make it a better job for them? When they leave Darden, are they going to other restaurants? Or are they just going to other types of employment?

No problem, John. Brilliant with the basics has been here since the earlier days—we remember when that was first coined. So we've been using that for a long time, and we believe it's right to get back to basics. If you think about our turnover today versus pre-COVID, a large part of our turnover in the last six months has seen mostly 90-day turnover, where new employees leave within 90 days. The focus and theme of our general manager conferences in August was about making brand XYZ an even better workplace. We want to make our team member experience better by equipping them with the tools they need to perform and treating them respectfully while listening to their concerns. Our turnover is improving, and while we’re not sure precisely where our turnover is going, I would guess that many are leaving the industry overall.

Over an hour ago, you mentioned that manager staffing is at historic highs. Is that the GM and all assistant manager positions? Just give a little bit more color in terms of stability in that essential role.

Yes, John, that includes all manager positions in our restaurants. While general manager positions are a bit harder to reach historic highs because there’s one general manager for every restaurant, we are at historic staffing levels. We have more managers per restaurant today than pre-COVID. Part of the reason is that we provide opportunities for growth within, which fosters loyalty to that brand among team members. Additionally, throughout COVID, we ensured our managers were retained since we understood how crucial they are for bringing our teams back.

We'll take our next question from Nick Setyan of Wedbush.

Just a follow-up to an earlier question. I think you said you expect total restaurant labor inflation to go down by 50 basis points sequentially through the end of the year from the 7% that we saw in Q2. That would imply for the year something around 7%, maybe slightly lower than 7%. But your total inflation guidance is 7% with 8.5% commodity inflation at the midpoint. Could you reconcile how we get to the combination of where total labor inflation and commodity inflation guidance is versus the total inflation guidance?

Sure. The point here is you need to consider the other line items. Utility costs are probably in the mid to low teens. That contributes to the total inflation. Additionally, we're seeing all other costs being in the low to mid-single digits. When you factor those in, the total inflation expectations align with what we're anticipating. So you are correct; total restaurant labor inflation is approximately 7%. Combining this with 8.5% inflation on food and beverage will push our total inflation closer to our near-target.

Thank you. At this time, it appears we have no further questions in queue. I'd like to turn it back to management for any additional or closing remarks.

Thanks, Todd. That concludes our call. I'd like to remind you that we plan to release third quarter results on Thursday, March 23, before the market opens with a conference call to follow. Thank you for participating in today's call. Have a great holiday and happy new year.

This will conclude our call today. We thank you for your participation. You may disconnect at any time.