Darden Restaurants Inc Q3 FY2023 Earnings Call

Good day and welcome to the Darden Fiscal Year 2023 Third Quarter Earnings Call. Please note 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. Thanks, Todd. Good morning, everyone, and thank you for participating in today's call. Joining me today 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 include certain non-GAAP measurements, and reconciliations of these measurements are included in the presentation. Looking ahead, we plan to release fiscal 2023 fourth quarter earnings on Thursday, June 22nd, 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’s, casual dining benchmark, excluding Darden, specifically Olive Garden, LongHorn Steakhouse, and Cheddar’s Scratch Kitchen. During our third fiscal quarter, industry same-restaurant sales increased 7.2% and industry same-restaurant guest counts decreased 3%. 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.

Thanks, Kevin. Good morning, everyone. We had a strong quarter on both the top and bottom line. We significantly exceeded the industry benchmarks for same-restaurant sales and traffic, outperforming more on traffic than we did on sales. We also continued to underprice inflation, resulting in lower overall check growth relative to the industry. Our ability to make this investment and provide strong value to our guests reinforces the power of our strategy, which comes to life through our four competitive advantages and executing our back-to-basics operating philosophy. I am particularly proud of the way our restaurant teams continue to execute at a high level by being brilliant with the basics. This intense focus on providing great food, service and atmosphere enables them to consistently create memorable guest experiences. During the holiday season, Olive Garden and LongHorn Steakhouse set new all-time weekly sales records, only to break them during Valentine's week. In fact, all of our brands achieved record total sales for the quarter. Of course, none of this would be possible without having the right people in the right roles ready to serve our guests. Our restaurants continue to be well staffed and our manager staffing remains at historic highs. Our leaders work hard to ensure each of our restaurants is a great place to work. During the quarter, several of our brands were recognized as industry leaders by Black Box Intelligence. LongHorn and Eddie V's received the Best Practices Award, which evaluates the brand's employee retention as well as sales and traffic performance. Olive Garden, The Capital Grille and Seasons 52 were honored with the Employer of Choice Award, which is based on workforce data, including employee turnover and gender and racial diversity. We know from our recent engagement survey results that our overall level of engagement is very high, and our team members understand what is expected of them at work. This is helping drive high guest satisfaction metrics, both internally and externally. Data from the American Customer Satisfaction Index shows customer satisfaction is down across all industries. However, across all of our brands, our internal guest satisfaction ratings remain exceptionally strong. In fact, Cheddar's Scratch Kitchen, Yard House and Bahama Breeze achieved all-time highs during the quarter. Additionally, for the second consecutive quarter, the Darden brand was ranked number one among major casual dining brands in each measurement category within Technomic’s industry tracking tool. Even with the traffic growth we achieved during the quarter, to-go sales remained strong, accounting for 26% of total sales at Olive Garden, 14% at LongHorn and 12% at Cheddar's. We continue to leverage technology to make it easier to order, pick up and pay without having to pass the added expense of third-party delivery on to our guests. Our teams are executing the off-premise experience at a high level. For example, to-go orders accounted for 33% of Olive Garden's total sales on Valentine's Day, and they significantly improved their ratings for both on-time and order accuracy for that day. For the quarter, digital transactions accounted for more than 62% of all off-premise sales and 10% of Darden's total sales. Finally, we opened 7 new restaurants during the quarter across 7 states. Our new restaurant opening teams continue to do an excellent job of hiring and training new team members and successfully opening these locations. We are on track to open 25 net new restaurants during the fourth quarter, and I am confident in our ability to do so because of our well-prepared leadership pipeline and the tremendous support teams we have in place. We are fortunate to have the best team members in the industry, and I am proud of the focus and commitment they continue to display. On behalf of our senior leadership team and the Board of Directors, I want to thank all of our team members for everything you do to nourish and delight our guests and each other. Now, I will turn it over to Raj.

Thank you, Rick. Good morning, everyone. We had high expectations for the third quarter sales growth as we were wrapping up last January’s Omicron outbreak and several weeks of severe winter weather that combined to reduce sales by over $100 million in the third quarter of last year. Exceeded those high expectations, posting record total sales of $2.8 billion, which was 13.8% higher than last year, driven by 11.7% same-restaurant sales growth along with the addition of 35 net new restaurants. This same-restaurant sales performance outpaced the industry by 450 basis points, and our same-restaurant guest counts performed even more as they exceeded the industry benchmark by 700 basis points. Diluted net earnings per share from continuing operations were $2.34, an increase of 21.2% above last year. Total EBITDA was $448 million, and we returned $272 million of cash to our shareholders this quarter, consisting of $148 million in dividends and $124 million in share repurchases. Total pricing for the quarter was approximately 6.3%, 70 basis points below total inflation of roughly 7%. Now looking at our margin performance compared to last year. Food and beverage expenses rose 110 basis points, driven by commodities inflation of approximately 9%, which was higher than we anticipated going into the quarter and significantly outpaced pricing of 6.3%. Chicken, dairy and grains continue to be categories experiencing the highest levels of inflation, but each improved versus prior quarter as we expected. However, beef inflation increased from the second quarter level and drove the majority of our higher-than-anticipated commodities inflation this quarter. Restaurant labor was 120 basis points better than last year as we benefited from sales leverage and our restaurants continue to run efficient labor despite hourly wage inflation of 8%. Total restaurant labor inflation was 7%. Restaurant expenses were 40 basis points favorable to last year as we leveraged higher sales that more than offset elevated inflation on utilities as well as higher repairs and maintenance expense. Marketing expenses were 10 basis points lower than last year, driven by sales leverage. G&A expenses were 40 basis points higher than last year, driven by the timing of our incentive compensation accrual and other expenses. Operating income margin of 12.6% was 30 basis points better than last year. Our effective tax rate for the quarter was 13.2%, and we ended the quarter with earnings from continuing operations of $287 million. Now looking at our margin performance versus pre-COVID, we grew operating income by 70 basis points, while underpricing inflation by more than 400 basis points since pre-COVID. 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 grew 13.9% above last year, driven by same-restaurant sales growth of 12.3%. Average weekly sales at Olive Garden were 108% of pre-COVID level. Segment profit margin of 22.5% was 150 basis points better than last year, driven by sales leverage and labor efficiencies. LongHorn sales grew 13.5% above last year, with same-restaurant sales growth of 10.8%. Average weekly sales at LongHorn were 127% of the pre-COVID level. Segment profit margin of 17.4% was 80 basis points below last year, driven by elevated commodities inflation. Sales in our Fine Dining segment grew 13.2% over last year driven by same-restaurant sales growth of 11.7% and average weekly sales were 113% of the pre-COVID level. Segment profit margin of 21.8% was 110 basis points below last year, driven by elevated commodities inflation. Our other segment sales grew 14.1% above last year with the same restaurant sales growth of 11.7% and average weekly sales were 109% of the pre-COVID level. Segment profit margin of 14% was 20 basis points better than last year, driven by sales leverage and labor efficiencies. Turning to our financial outlook for fiscal 2023. We have increased our guidance to reflect our year-to-date results and expectations for the fourth quarter. We now expect total sales of $10.45 billion to $10.5 billion, same-restaurant sales growth of 6.5% to 7%, approximately 55 new restaurant openings, capital spending between $550 million to $575 million, total inflation of 7% to 7.5% and annual pricing of 6% to 6.5%. Furthermore, we expect commodities inflation between 9.5% and 10%, the 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 $7.85 and $8. This outlook implies fourth quarter sales between $2.73 billion and $2.78 billion, same-restaurant sales between 3% and 5%, diluted net earnings per share between $2.43 and $2.58. It also implies higher commodities inflation than we last communicated. We now expect commodities inflation that is solidly in the low-single-digit range for the fourth quarter versus the closer to flat estimate we shared with you on the last earnings call. The increase in commodities inflation is primarily due to higher-than-anticipated beef costs. For fiscal 2024, we anticipate opening 50 to 55 new restaurants and capital spending between $300 million and $325 million related to new restaurants and another $200 million to $225 million related to ongoing restaurant maintenance, refresh and technology spending. And while we don't normally provide a commodity outlook this early for the next fiscal year, we are anticipating low-single-digit inflation for the total commodities basket in fiscal 2024 led by high single-digit inflation on beef and produce. We expect all other categories to range from slight deflation to low single-digit inflation. With that, 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. Now, we'll open it up for questions.

Our first question comes from Chris Carril with RBC Capital Markets.

So, I just wanted to talk or ask first about the top line trends. Given the choppiness in the comparison to last year, could you talk about the progression of sales through the quarter? Maybe specifically what you saw following the Omicron lap, and perhaps what you're seeing in the current quarter just as we're trying to get a sense of where trends are shaking out on a normalized basis? I know, Rick, you spoke of the strength around Valentine's Day. Any detail beyond that point would be great.

Hey Chris, this is Raj. Good morning. When we actually look at our underlying traffic trends versus pre-COVID, excluding the noise from holidays and weather and promotions, they've actually been fairly stable month-to-month, and that has continued into the fourth quarter. Basically, everything we know for the quarter-to-date is incorporated in our guidance. But when you step back and look at it versus pre-COVID, it's pretty stable.

I appreciate the preliminary commodity inflation outlook for FY24. Do you have any thoughts or guidance on how you plan to manage pricing in relation to that commodity inflation outlook for FY24?

Yes. Chris, the way we think about pricing is we look at total inflation. Over the last three years, we’ve underpriced inflation by over 400 basis points. Also, we’ve underpriced full-service CPI by over 600 basis points. So, we created a significant gap between our competitors, and it positions us well as we head into the next year. We'll share more thoughts on our fiscal 2024 pricing plans in the June call.

Our next question comes from Brian Harbour with Morgan Stanley.

Yes. Thank you. I have a question regarding labor. I know you are currently in a strong position with staffing. As you look ahead to next year, do you anticipate continuing to increase wages? It’s crucial to retain employees and offer better pay than your competitors. How does this influence your expectations for wage inflation moving forward?

Hey Brian, this is Rick. Let's talk about our staffing. We're very well staffed. We have more managers per restaurant than we’ve ever had. So, we feel really good about where we are. We’re not going to talk necessarily about what our wage growth will be next year. I will say that even before COVID, wage inflation was in the mid-single-digit range. We'll work with whatever the economy brings and how we can handle that. We have a great employment proposition. Our turnover is significantly reducing. It's getting closer to pre-COVID levels. We still think we've got room to improve our turnover. We're hiring great people and we're being as discerning as we had been before COVID. We feel really good about where we are. We'll talk about our inflation targets and our pricing in June.

Thank you. Regarding capital spending, I see you've increased the lower range. What factors are influencing this? Is it primarily due to inflation, or is there a specific area of spending that has increased?

Well, I think we've talked about inflation being a big factor. Construction costs have gone up quite a bit, especially when compared to pre-COVID, and we're ramping up growth. This year, we're expecting approximately 55 new units and then we talked about next year being in that 50 to 55 range as well. It's a function of the increase in construction costs. The FF&E for new restaurants has been growing quite a bit. You're seeing a 25-plus-percent increase in those costs related to pre-COVID. But given the improvements we've made to our business models and where our unit economics are, we still have pretty strong returns on our new units, and we continue to want to grow that. So, we are being a little bit more selective, but we feel we have the opportunity to take market share.

Our next question comes from David Tarantino with Baird.

My question, I guess, Raj, if you could just tell us what level of pricing you are running in the fourth quarter. Can you also comment on the comp guidance of 3% to 5% and what might be implied from a traffic perspective in that number?

Yes. David, we're going to be under 6%. Call it, 5.5% to 6% is probably what we're running or expect to be running in Q4.

Got it. The guidance implies slightly negative traffic. I was wondering if you or Rick could comment on why you think that is? Is it a macro issue or something else in your view? Rick, I'd love to hear your thoughts on the current macro environment given all the volatility we've seen lately. Just how are you thinking about kind of the outlook for the next several quarters?

Yes. David, let's talk about the macro consumer. If you think about our guide for the next quarter, if you look at it versus pre-COVID, taking out the Omicron change and the Never-Ending Pasta Bowl change we did in Q2, our trends are very similar to what we're thinking about for Q4. As for the state of the consumer and the state of the economy, we've said this in previous calls, there's been a shift in spending from durable goods to services, and restaurant businesses are benefiting from that. For most of calendar year 2022, customer sentiment was poor, but consumer spending remained significantly high. As long as the unemployment rate is low and wages are increasing, consumers should continue to spend. Casual dining same-restaurant sales improved sequentially each quarter during the fiscal year, and our positive gap to the industry improved, especially in traffic. The data from our proprietary brand health tracker suggests that most consumers are not pulling back from restaurant visits and do not appear to be trading down from full service to limited service brands. There is tension between what people want and what they can afford, but going out to restaurants remains an affordable luxury for many. Operators delivering on brand promise and value will continue to appeal to consumers, despite economic challenges. That is what we're focused on doing, regardless of what's happening in the industry or the category.

Makes sense. Thank you.

Thank you. Our next question comes from Jeffrey Bernstein with Barclays.

Great. Thank you very much. Two questions. The first one, just on the implied fourth quarter earnings guidance, looks like there's growth of maybe 8% to 15%. I know last quarter, you talked about the third and fourth quarters should be pretty even in terms of growth both quarters. The third quarter grew 21%. So, it looks like you're tempering the earnings growth algorithm for the fourth quarter relative to the third. Is that conservatism or perhaps the modest uptick in inflation? How do you think about the sequential trend from an earnings perspective in the fourth versus the third quarter?

It's actually what you said. It's the commodities inflation. We thought Q4 would be flat and now that we're saying that's solidly in the low single digits. When you layer that in, that's where the growth is a little bit less.

Understood. Then just following up on the macro question with interest rates still on the rise. How does that impact your business or how you manage it, if at all, in terms of new unit growth, and how you think about borrowings or whether you think it impacts consumer behavior, maybe any return of cash decisions?

Yes. Jeff, this is Rick. The interest rates really aren’t making a huge impact in our business. We actually have a significant balance in cash, so higher interest rates have given us a little more interest over time. For new restaurant openings, we've seen inflation, as Raj mentioned. We're being prudent and looking at some deals and might wait to see if we can get a second bid on some sites. But the interest rates really haven't changed much for us. As for the consumer, they are still spending. We'll see what happens when credit card balances come due, but so far, nothing in our space. Regarding return of cash, we have a strong dividend and feel that's one way we return our cash to shareholders. We'll talk about our capital returns in June, but it hasn't really changed our outlook.

Got it. And Rick, just to clarify, you've seen relative stability in sales through the fiscal third quarter and into March. With the recent banking noise and things like that, does that lead to greater volatility day-to-day or week-to-week, or do you really not see it in the restaurant sales line, despite the headlines creating so much noise in the broader macro?

If you think about March, volatility can occur due to shifts in spring break. But our trends are fairly consistent. When you think about the state of consumer spending, there have been shifts, but generally, we feel like trends haven't changed much.

Our next question comes from Josh Long with Stephens.

In terms of the context of visibility in your business, how are you thinking about the marketing and messaging opportunity as we go into the back half of the year and then into fiscal '24? Marketing spend is still at lower levels versus prior years. Are you comfortable with that? Is there any reason to adjust that strategy as we potentially face a more challenging macroeconomic environment?

Hey Josh, this is Rick. We're not going to get into too much detail on our promotional plans, but our marketing spend isn't going to be significantly different year-over-year. It might be 10 to 20 basis points either way, up or down as we think about next year. Advertising will always be part of Olive Garden's mix because of the scale advantage they have. We'll continue to leverage that and evaluate any marketing activity based on elevation of brand equity, ensuring simplicity, and it's not going to be at a deep discount. We'll stick to that strategy, but if things change dramatically, we'll react accordingly.

Understood. That's helpful. One follow-up for me. In terms of the restaurant manager pipeline and the significantly higher number of restaurant managers, can you talk about the benefits and opportunities that unlocks from a service component and how that positively impacts guest experience over time?

Yes, Josh. The manager role is the most important in our restaurants, particularly the general manager or managing partner. Having them fully staffed allows them to spend more time with their team and train them. This, in turn, means they can forecast better and spend time with guests. If you're understaffed with managers, the restaurant runs less efficiently. This staffing level allows us to open more restaurants; we have about 25 net openings coming in this quarter, and we're ready for it with our managers. There are substantial benefits of having fully staffed managers.

Our next question comes from Danilo Gargiulo with Bernstein.

Rick, you mentioned the ability to price below inflation is allowing Darden to grow faster than the market in terms of sales and traffic. Are you expecting the same momentum to continue if inflation decelerates and food at home inflation maybe increases at a lower pace compared to the food away from home inflation?

Our strategy has been in place for quite a while, and we plan on sticking with it. This approach has helped us in the long term regardless of whether inflation is high or low. If inflation comes down, a lot of our pricing is already built in for next year based on our current status. We'll be able to react accordingly. In the long term, we plan on pricing below inflation. But in any 12-month period, it may be higher or lower than inflation. Our scale advantage provides us opportunities for cost savings, enabling us to offer lower pricing to deliver better value to our guests.

A couple of things. The new units, we talked about, part of it is just the construction delays and challenges we've had. We expect approximately 55 new openings this year. Our recent new units have outperformed our expectations on the top line, opening at volumes exceeding what we would have estimated when we approved the capital for the project. Overall, we have a lot of headroom regarding the returns versus our cost of capital, and we're exceeding the hurdle by a wide margin even with increased construction costs.

Thank you. Our next question comes from Dennis Geiger with UBS.

I wanted to ask one more on margin and maybe Raj, if there's any update to how you're thinking about holding on to gains longer-term since the pandemic. You've spoken more to a long-term total return algorithm rather than an annual margin growth number. Do you have any new observations on longer-term margin trajectory given what you've seen recently?

We've been purposeful in choosing to price where we price over the last few years. Our intent would be to try to grow from these levels. In any year, it might be different, but ultimately, we aim for that 10% to 15% total shareholder return, which combines EPS growth and dividend yield. How we achieve that may vary each year, but we expect to build margins over time.

That's great. I appreciate that. Can you also speak to whether the breakdown by brand for the 24 new openings will look similar to prior years?

Yes. You will see a little bit more Olive Garden openings since they have the best returns in the portfolio. We've shared that we believe there are more growth opportunities for them coming out of the pandemic. You might see about 20 openings for them, mid-teens for LongHorn, and then others making up the rest.

Our next question comes from Jeff Farmer with Gordon Haskett.

Just following up on margins, some of the stuff you discussed earlier. Your restaurant expense and G&A as a percent of revenue are running at roughly 100 basis points below pre-COVID levels. Do you think that lower cost structure at both restaurant and corporate levels is sustainable moving forward?

We always focus on that opportunity. When discussing scale benefits, we think about restaurant expenses and G&A. We do expect those to maintain a positive gap to pre-COVID levels.

One more on the lower income customer demand profile. You've pointed to some slowing demand there, but how does that manifest itself? Is that through reduced visits or check management? How does that show up when a lower income customer changes their behavior?

We've talked about our lower income consumer seeing a shift down a bit, but still being above pre-COVID levels. We haven't seen significant changes from the last time we spoke. If it manifests, it typically starts with managing check and then arches into reducing visits. So far, we haven't seen much check management, which implies that despite poor sentiment in '22, consumers still spent. As spending pressures continue, we may see this change. It may impact lower-end consumer brands more than higher-end ones, but that's the advantage of our diversified portfolio.

Our next question comes from Andrew Charles with TD Cowen.

One quick bookkeeping question. Raj, as we think about 2023 EPS guidance, is roughly $390 million still the right number for G&A?

Yes. That's right.

Can you talk about your confidence in delivering 10% plus TSR in 2024, especially with the uncertain macro environment combined with stubborn inflation? What avenues could you explore to achieve this if the consumer slows down?

If you think about our confidence in 10% to 15% TSR in any one year, we’ve stated that it could be below or above that. Historically, we haven’t had a 10-year period of less than 10% annualized total shareholder return. Thus, we feel confident over the long run that we'll reach that target. We're not discussing next year specifically, but we believe we should get there.

Our next question comes from Jon Tower with Citi.

I was struck by the commentary about your own consumer survey suggesting that your customers are not trading down from limited service into limited service. This seems contrary to what we've been hearing from several operators. Is that broadly about just your brands or more about the full-service category? What are consumers telling you about why they stick with your brand versus trading down?

Most customers aren't trading down, though some might be. We're not seeing that in our results. We’ve been providing a great value and underpriced inflation compared to our competition. Consumers appreciate our improvement in guest experience. Our satisfaction is growing, and that's critical in tougher environments. We've been successfully delivering value through our pricing strategy and improving experiences.

So, is that brand survey work more specific to your brands than the full-service category?

I'm saying that most consumers are not trading down. When we discuss our brands, their satisfaction is up, and the value proposition is better. Overall, the industry is showing consistency, but we believe that our value and experience sets us apart.

I want to circle back to the marketing question. What sort of triggers are you watching that would warrant a ramp-up in marketing efforts? Would it be based on traffic changes?

We're being prudent with marketing spend. We've simplified our business and tested how marketing drives growth. When drastic changes occur, we'll adjust. Right now, we're following our strategy of elevating brand equity and not engaging in deep discounts. This industry has gone through many strategies; we're focused on strengthening our business.

Our next question comes from John Ivankoe with JPMorgan.

Following up on consumers not trading from full service to limited service. You're guiding for negative same-store traffic. Given that grocery pricing is higher than restaurant pricing, how are you managing that internally and are there plans to address this potentially?

We're not going to risk significant margin declines because of economic fluctuations. A 1% decline in commodity inflation can offset a 2% decline in traffic, all else equal. Long-term, we aim to drive traffic through value and experience, not through discounting.

Does that lead to a greater volatility in sales when facing economic uncertainty?

Movements in traffic are what we expect. Generally, our sales have been consistent. While funding shifts may create volatility, consumer sentiment remains stable. We adjust based on market conditions but don’t expect dramatic shifts.

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

Rick, you've tied traffic outperformance to less pricing than the competition. Why do you think consumers are noticing this relative value now? Did you implement any marketing or advertising efforts that caused this change?

I believe this is not just a recent shift; we have consistently underpriced inflation over time while also adding value. The guest perception of value increases over time rather than overnight. That's why you've seen sustained growth in satisfaction. Our marketing integration includes discussing our unique offerings; not every restaurant offers what we do. Advertising has been steadily supporting this strategy. Regarding younger consumers, we've noticed slight shifts, and our consumer segments remain fairly similar to before. This is positive since the younger demographic seems to be using our services effectively. Frequent visits from our core guests are encouraging.

Our next question comes from Andrew Strelzik with BMO.

I just wanted to ask about the customer satisfaction scores you mentioned. You spoke about records at Cheddar's and Yard House but not at Olive Garden and LongHorn. Can you explain the difference between the two and how that informs your strategy moving forward?

Satisfaction at Olive Garden and LongHorn are significantly high, so it takes more for improvement compared to Cheddar's and Yard House, where substantial operational advancements have been made. Satisfaction metrics are near-record highs, and we continue to monitor metrics to stay on track.

Regarding the value proposition you're positive about, have you assessed where your brands stand within the menu now that things have stabilized? Have you identified opportunities to enhance offerings?

We're constantly assessing menu opportunities, and we feel good about our value pricing compared to competitors. We're in a strong position to adapt, and we’ll act accordingly, continuing to price into strengths and leveraging our data for decision-making.

Our next question comes from David Palmer with Evercore ISI.

Investors feel the industry may flatten in the second half of calendar '23. Is this view too pessimistic based on what you're seeing? If that occurs, you are currently outperforming while guiding for lower growth indicators, would you keep your mix intact?

I don't want to comment on the second half of calendar '23. Historically, during slowdowns, Olive Garden has significantly outperformed. Our history shows we tend to become a trusted brand for value, suggesting we could continue this trend.

Thanks, Rick. Regarding Cheddar's, clearly the positive scores indicate growth potential. Why can't the pace of openings increase as the brand continues to grow?

When we acquired Cheddar's, we recognized their growth potential and will remain cautious in our expansion. Some brands grow rapidly, but we need to focus on strategic and sustainable growth rather than excessive expansion. We're focused on refining operations and market presence before increasing openings.

Our next question comes from Lauren Silberman with Credit Suisse.

On traffic outperformance, considering a 700 basis-point gap, do you view this level of outperformance as sustainable? How do you see the future of this performance?

700 basis points of outperformance is significant. We can't expect this every quarter, especially if industry traffic growth stabilizes. We're pleased with this quarter's performance, but I wouldn't claim consistent 700 basis-point outperformance in every quarter. Long-term, we aspire to maintain positive outperformance.

Regarding M&A efforts and finding another brand, what do you see in the current environment?

We don't want to detail calls or valuations. Our competitive advantage is scale, and acquiring more brands is a potential avenue for growth. As volatility declines, we've seen improved price discovery, allowing us to adapt and plan for the future.

Our next question will come from Brian Bittner with Oppenheimer.

Looking at the quarter, your EBIT margins expanded this quarter, primarily driven by Olive Garden. What do you believe drove the difference in margin performance for Olive Garden versus other segments?

Any given quarter, the brand-to-brand differences can arise from pricing versus inflation effects. In the third quarter, beef was the biggest surprise, and some brands were not prepared for that level of inflation. We believe there was temporary volatility that impacted other brands. Olive Garden performed well due to prior inefficiencies caused by Omicron and a reduction in labor inefficiencies this quarter.

Just a follow-up. The labor margin leverage was strong this quarter. Was there anything outside of strong sales that contributed to this labor leverage?

Yes, the sales traction helped, but we also experienced reduced turnover, which has been beneficial. We're seeing that new team members are learning how to perform their roles effectively, improving productivity overall.

Our next question comes from Gregory Francfort with Guggenheim Securities.

Rick, how should we think about margins over the next few years? You've mentioned a target of 10 to 30 basis points, but with significant pressure on margins previously, is this still a realistic goal?

The long-term framework of 10 to 30 basis points of margin expansion holds. We've seen significant expansion during COVID but expected to give some back. Some gains will come from restaurant-level improvements, while G&A will see some savings too. We remain committed to walking our long-term path for margin expansion.

Our next question comes from Brian Vaccaro with Raymond James.

My question was on labor and operations. Given the industry hiring pattern over the last year, do you have metrics that speak to the proficiency of your staff and how that benefits operations? How does this widen your performance gap versus the industry?

We have seen a reduction in turnover which contributes to higher proficiency. Our teams are learning their roles better, leading to improved productivity. Our manager staffing reaches historic levels, allowing more focused training and efficiency.

Thank you. Regarding pricing, Raj, can you help clarify how much you've taken in Q3 and how you view pricing trajectories given commodity pressures?

In Q3, we ran about 6.3% pricing. We expect fourth-quarter pricing to be under 6%, with peak pricing behind us, unless conditions change dramatically.

Our next question comes from John Parke with Wells Fargo.

Are you seeing signs that the middle-income consumer is moving more into your value brands?

We haven't seen many changes in the mix; our brands are performing consistently. Our same-restaurant sales varied between segments, but overall our customer mix remains strong.

Thank you. At this time we have no further questions in queue. I will now turn the call back over to Kevin Kalicak for any additional or closing remarks.

Great. Thanks, Todd. That concludes our call for today. I would like to remind you that we plan to release fourth quarter results on Thursday, June 22nd before the market opens, with a conference call to follow. Thank you for participating in the call today. Have a good day.

This concludes today's call. Thank you for your participation. You may disconnect at any time.