Earnings Call Transcript - DRI Q4 2020

Operator, Operator

Welcome to the Darden Fiscal Year 2020 Fourth Quarter Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. I will now turn the call over to Mr. Kevin Kalicak. Thank you. You may begin.

Kevin Kalicak, Investor Relations

Thank you, James. Good morning, everyone, and thank you for participating on today’s call. Joining me on the call today are Gene Lee, Darden’s CEO; and Rick Cardenas, 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 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. We plan to release fiscal 2021 first quarter earnings on September 24 before the market opens, followed by a conference call. Now, I’ll turn the call over to Gene.

Gene Lee, CEO

Thank you, Kevin, and good morning, everyone. It has been 14 weeks since our last earnings call. I don’t know about all of you, but it’s felt more like 14 months, so much has happened. Over the past three months, our business changed in ways we never imagined, so I want to spend my time with you this morning trying to put it all in perspective for you, then Rick will share some of our fourth quarter and year-end results and provide our outlook for the first quarter. When I look back on all that has transpired, one thing that stands out is the resiliency of the full service dining industry. Prior to the pandemic, total annual sales for the casual dining industry was approximately $108 billion. And while I do not know how long it will take the industry to recover from the significant impact it experienced, I am confident that this category will get back to the size it once was. Our industry plays a vital role in our communities, and that was evident in how the consumer relied on restaurants over the last several months, even in a to-go-only environment. And while off-premise will continue to play an important role as we recover, we know that the consumer still wants to enjoy an in-restaurant experience. In fact, going out to a restaurant with friends and family is the number one activity consumers say they look forward to doing as the economy opens back up, and we've seen that as our dine-ins reopen across the country. As this vital industry continues to rebuild, there is tremendous opportunity to increase market share through increased on-premise demand and incremental off-premise sales. Those executing at the highest level are going to continue to win, and Darden is well positioned to take advantage of the opportunity. When we last spoke in March, we knew the pandemic was going to have a significant impact on our business. Our ability to manage through this crisis has been driven by our commitment to prioritize guest and team member safety, invest in our team members, provide frequent and transparent communication, leverage our digital platform, and be brilliant with the basics. The health and safety of our guests and team members has always been our top priority, and we've taken a number of steps to create a safe environment in our restaurants. From sourcing masks and other personal protective equipment for our team members to developing a contactless curbside pickup process at our brands while our dine-ins were closed. We are mindful of the trust our guests and team members place in us. Today, our health and safety commitments are focused on team member health checks, personal protective equipment, enhanced sanitation processes, social distancing, and frequent hand washing. We also provide paid sick leave for all our team members so they can stay home if they're ill. But we can't do it alone, and that is why we encourage our guests to join the online waitlist or make reservations, not enter our restaurants if they are symptomatic, wear a mask, and utilize contactless or mobile payment options where available. We continued to invest in our team members as our dine-ins closed. In addition to rolling out permanent paid sick leave, we introduced a three-week emergency pay program that provided nearly $75 million of pay during the fourth quarter for our hourly team members who could not work. When emergency pay ended, we covered insurance payments and benefit deductions for hourly team members who were furloughed. As we brought hourly team members back to work to support increased to-go volume, we introduced an additional payment to help cover unexpected costs such as transportation and child care incurred as a result of the pandemic. And to recognize the unbelievable work our managers did during the quarter, we paid their target bonus for the fourth quarter. We know our people are our greatest competitive advantage. Not only were these investments the right thing to do to take care of our team members, they've also created a deeper loyalty and strengthened engagement while we've seen this pay-off as we bring our people back to work. Communication is the most important aspect of leadership during a crisis. We knew frequent and transparent communication with our team members and investors was important. Beyond daily meetings with all of our brand presidents who in turn met with their operational leaders on a daily basis, we have maintained a consistent communication cadence with our team members. Since this crisis began, I have provided regular business updates to our people and have been open and honest about the impacts to our business, and consequently the impacts to them. We took the same approach with our shareholders and the analysts by providing four business updates during the quarter. The pandemic accelerated the consumer's desire for convenience, and we saw a significant increase in digital engagement. The work we have done over the past few years investing in our digital platform to reduce friction prepared us to quickly adapt to consumer behavior and deliver on their expectations of convenience in our to-go-only environment. During this time, we have strengthened our digital platform and made meaningful progress against our digital strategy. In addition to improving the guest experience across our digital channels, our strategy is focused on using technology to help our guests easily order outside and inside the restaurant, improve the wait to be seated, streamline the order pickup process, and speed up how they pay. We've been building on our digital platform to support increased demand, and we certainly tested it like never before. During the quarter, online ordering at Olive Garden grew by more than 300% over the prior year and accounted for 58% of To Go sales. And at LongHorn, online ordering grew by 400% and accounted for 49% of To Go sales. Additionally, we accelerated our timeline and rolled out online ordering at our brands that had not yet deployed it. We also added the ability to order alcohol online for all of our brands and markets where that was allowed. Our commitment to being brilliant with the basics allowed us to remain focused on operational execution even as the environment forced us to radically change how we serve our guests. Each one of our brands did a phenomenal job delivering a new guest experience by collaborating and sharing best practices. This involved creating contactless curbside pickup that included designing what was essentially a drive-thru in our parking lots while this execution in this environment meant enabling our guests to order and pay online and have our team members seamlessly place their sealed orders in their vehicles. Our operators displayed tremendous innovation, flexibility, and passion as they continue to serve our guests. And to ensure we consistently executed at the highest level, we took the opportunity to streamline our menus, and improve our processes and procedures. With these changes, we are seeing improvements in execution and direct labor productivity. So what have we learned from all this? We've learned a lot. But most importantly, this situation has reinforced that our strategy that we developed five years ago grounded in our back-to-basics operating philosophy leveraging our four competitive advantages and cultivating a portfolio of iconic brands is still the right one today. Strong brands with loyal guests have fared better, and the trust we have earned from our guests is critical. Being brilliant with the basics by consistently delivering exceptional food, service, and atmosphere is imperative. However, we know how important safety is to our guests right now, and we must continue to earn their trust every day. And throughout this unprecedented time we have been benefited greatly from our four competitive advantages. Our significant scale, our extensive data and insights, our regular strategic planning and our culture; whether sourcing PPE for our team members, ensuring we're not impacted by supply chain issues or sharing best practices across eight brands, the ability to leverage scale has allowed us to quickly react to constant change. Finally, as I said earlier, we know our people are our greatest competitive advantage. And I'm impressed by how our team members responded and continue to respond to take care of our guests and each other. Having a strong culture has been part of our DNA since we were founded. We were able to keep the majority of our managers employed and we stayed connected with our furloughed hourly team members. This allowed us to bring our people back quickly and get our dining rooms opened safely without any delays. As you saw in our press release, 91% of our dining rooms have reopened with at least limited capacity. We have also brought 60,000 furloughed restaurant team members back to work and we expect to bring at least another 40,000 back as business continues to improve. I'm incredibly proud that our culture is actually strengthened during this most difficult period in our company's history. This, above all else is what gives me confidence in Darden's future. Now, I'll turn it over to Rick.

Rick Cardenas, CFO

Thank you Gene and good morning everyone. Fiscal 2020 was on track for a solid year of performance and the beginning of Q4 was no different. The first few weeks of sales were strong and then nearly overnight, the impact of COVID-19 required us to pivot to a To Go only format. This posed unprecedented challenges for our restaurant and support center teams and I am proud of how everyone moved quickly to increase To Go sales, reduce costs, manage working capital and improve efficiency. The simplifications Gene referenced helped to reduce key variable expenses in our restaurants especially direct labor. The teams also worked to reduce or eliminate other fixed costs in our restaurants and restaurant support center as well as eliminate non-essential capital spending. Given the significant reduction in cash flow, we also had to work quickly to ensure we had enough cash for whatever might occur. During the quarter we suspended the dividend and share repurchases, fully drew down our $750 million credit facility, took out a $270 million term loan and raised over $500 million in a follow on equity offering. All these efforts, and the strong loyalty of our guests resulted in us tripling our prior To Go sales run rate averages, and materially reducing our cash burn as we disclosed to you through our periodic business updates. Given the confidence in our cash flow trends and the ability to access it in the future, we fully repaid our credit facility in early May. Now turning to the results. The total sales were $1.3 billion, a decrease of 43.0%. Same-Restaurant sales decreased 47.7% and adjusted diluted net loss per share was $1.24. Because of the significant reduction in total sales compared to last year, all of the expense lines experienced sales deleverage, so I'll just touch on a few highlights. First, Food and Beverage costs were higher as a percent of sales given menu mix related to both To Go mix and simplified menus, as well as increased packaging expense and elevated beef cost. As we look at the labor line, there was significant deleverage in management labor, including approximately $25 million in manager bonuses. However, we saw an improvement in hourly labor as a percent of sales of over 150 basis points even with a substantial reduction in sales. Restaurant expenses per operating week decreased over 20% given our focus on cost management, even as we incurred over $5 million in incremental cleaning supplies and PPE related to COVID-19. For marketing and G&A expense, we were able to reduce the absolute spend by $37 million and $17 million respectively versus last year. Included in our restaurant labor, and to a small extent G&A is approximately $50 million of investment net of retention credit. This was related to emergency and furlough pay for our team members while they were not working. This negatively impacted our EPS by $0.30 which was not adjusted out of reported earnings. During the quarter, we impaired $390 million of assets as a result of lower sales, reduced profitability and lower market capitalization. The impairments related to $314 million of Cheddar’s goodwill and trademark assets, $47 million of restaurant level assets and $29 million of other assets. We permanently closed eleven restaurants in the quarter, six of which were already impaired. The entire $390 million of impairment charges were adjusted out of our reported earnings. We ended the quarter with $763 million in cash and another $750 million available in our credit facility. This gives us over $1.5 billion of liquidity available to weather the crisis and make appropriate investments to grow profitably. Our adjusted debt-to-adjusted capital at the end of the quarter was 61% well within our debt covenant of 75%. As we shifted to an off-premise only model, we took a disciplined approach to pursue sales opportunities, with an eye toward incremental profitability and cash flow by focusing on cost management and the guest experience, while ensuring our team members were taken care of. This approach resulted in a better finish to Q4 than anticipated and is the underpinning for the strength of our business model that is reflected in our first quarter financial outlook. Now turning to fiscal 2021 performance. In today's release, we provided quarter-to-date same restaurant sales and the performance of our restaurants with dining rooms at least partially open. These results are encouraging with last week's blended same-restaurant sales down 30%, we are operating cash flow positive at these levels. Our To Go sales remain elevated in restaurants with dining rooms at least partially reopened. Olive Garden To Go sales are approximately double their pre-COVID averages and LongHorn has more than tripled their pre-COVID averages in these restaurants. While it is our normal practice to provide an annual financial outlook, due to the uncertainty in business performance moving forward, we are only providing an outlook for the first quarter. We expect to achieve approximately 70% of prior year sales levels, total EBITDA of at least $75 million and diluted net earnings per share of greater than or equal to zero on a diluted share base of 131 million shares. At this point, we don't intend to further share intra quarter business updates since we have provided our first quarter outlook. For the full year, we intend to open between 35 and 40 net new restaurants. Our first opening of the year is expected to be in early July, with a few others likely to be opened by the end of the first quarter. In total, we expect between $250 million and $350 million of capital spending for fiscal 2021. Turning to other aspects of capital allocation. As you recall we suspended our dividend last quarter due to the level of cash flow uncertainty and the need to preserve as much cash as possible. We have been consistent in our commitment to returning cash to shareholders, and our dividend is a big part of that. As soon as we see the business begin to generate the sustainable cash flows to support a dividend and repay our term loan, we will have discussions with our board on our dividend policy. And now I'll turn it back to Gene for some closing comments.

Gene Lee, CEO

Thanks, Rick. And as you've seen in our 8-K filing this morning, Dave George will be retiring on August 2nd. Dave will celebrate his 65th birthday later this year, and we've been discussing this transition for some time. Dave and I have been partners on this journey for 23 years. He was a joint venture partner for LongHorn when I joined RARE in 1997. I still remember the first time I met him. We're going to visit his restaurant, so he picked me up at the airport in his Volvo, with no air conditioning in the North Carolina heat. I knew at the end of the day that Dave was a special operator. I wasted no time; we bought out his interest in his joint venture and brought him into the company. Over the last 23 years Dave has been successful in every one of his leadership positions. He has led three of Darden’s iconic brands: The Capital Grille, LongHorn Steakhouse and Olive Garden, and most recently he served as our Chief Operating Officer. He built great teams and became a mentor to many operators and executives. His can-do approach and attitude permeates throughout Darden in each of our brands today. For many of the last 23 years, Dave and I have had lunch together on Mondays to discuss what happened the previous week and talk about what needed to get done going forward. Not much has changed over those 23 years except today; we order salads instead of two or three entrees each. And for the last five years, David sat next to me during every earnings call and helped me find the details I need to answer your questions. I'll miss seeing him when I walk into the room on these days. For all the Darden team members listening today, our annual conference which usually happens in August would have been a great opportunity for everyone to see Dave, thank him and wish him well in person. Unfortunately, because of COVID-19, our conference has been postponed until next year. We will however be inviting Dave to our conference in 2021, and he's committed to come so we can celebrate all he's done for Darden and for many of you. In closing, I want to say thank you to all our team members, those currently working and those who remain on furlough. And as I've said to you repeatedly, your ability to adapt, innovate and collaborate during this time has truly been inspiring. Thank you for your on-going commitment to our guests and each other. And now we’ll open it up for questions.

Operator, Operator

I will now open the line for the question-and-answer session. Your first question comes from the line of David Tarantino with Baird. Please go ahead.

David Tarantino, Analyst (Baird)

Hi. Good morning. First, I want to pass on my congratulations to Dave George on a very successful career and wish him the best as he retires. So Gene, I guess my big picture question is related to what you think the environment could look like on the other side?

Gene Lee, CEO

Yes. Good morning, David. Yes, I think that as I said in my prepared remarks, we went into this as a $108 billion category, and I've been really impressed with the resiliency of the consumer and how important full service casual dining has been in the everyday life of our guests. So I think the industry gets back to where it was. I think it's important. I think people really miss it, probably miss it more than they know. There's been a lot of predictions of how much capacity will come out of the system. I'm not going to sit here today and say I know what the exact number is. The one thing I do believe is there will be less competition and fewer restaurants as we move forward, and I think that's a great opportunity for us. I think scale is going to matter more than ever. We believe that we can get back to 2% to 3% unit growth pretty quickly. We're going to continue to open restaurants. We’re going to continue to do new deals. We think the economics going forward here in the short term should get better for us on new restaurant development, and I think we'll go back to our basics. We're going to continue to try to improve our food offerings. We're going to try to make sure we have the right value that we're offering the consumer. As we mentioned in both our comments this morning, we've improved productivity in our restaurants through more streamlined menus. So, we think the opportunity is there. We also think that off-premise will play a bigger role as we move forward. We think our capabilities in that have improved dramatically over the last 14 weeks, and I think a lot of consumers have had the opportunity to maybe use our service off-premise that hadn't used it before. I think they were really pleased with the overall experience.

David Tarantino, Analyst (Baird)

Great. And then, Gene you mentioned kind of streamlining the operations and the menus. Is that something you think will continue longer term or do you see that maybe some of the items coming back that you removed?

Gene Lee, CEO

Yes. I think, David, each brand’s in a different place. Each brand went to a different place when they went off-premise only, so some brands I would say right now are probably back to 100% of where they will want to be other than maybe some promotional items here and there. Other brands still have 10% to 15% that they need to add back to their menus to make them competitive. But it was not only the menu. When we basically closed down the operation except for off-premise, we had the chance to rebuild as we opened back up and we had a chance to look at all our processes and procedures, and I think we were able to simplify and eliminate a lot of prep work in some of our businesses that we'll never get back into the business. I think these are costs that we're going to keep out. We've had a lot of discussion around our table that it's been much easier as we build the on-premise business back up to reimagine what the operation in the back of house looks like versus trying to reimagine it while you're operating. And we're really thrilled with the results so far.

David Tarantino, Analyst (Baird)

Great. Thanks very much and good luck.

Operator, Operator

Your next question comes from the line of Brian Bittner with Oppenheimer & Co. Please go ahead.

Brian Bittner, Analyst (Oppenheimer)

Thank you. Good morning. Also would like to wish Dave George a very happy retirement. Congrats on a wonderful career. Gene, I know during this pandemic you've instituted lower order price thresholds for delivery across the Olive Garden portfolio. What are the insights and maybe the impacts you're seeing from this, and what are your updated thoughts on that opportunity as this environment has so rapidly changed these last few months?

Gene Lee, CEO

We've run a lot of tests there, Brian. I think where we're settling in right now is a $50 minimum. We still use the day-before call for larger orders. We find $50 to be the sweet spot. The average order size is still well above that. We didn't see any benefit of going below that threshold. And so, that's where we're settling and we think that opportunity will continue to be there. I will tell you that we did test doing our own delivery and found it inefficient and not additive. So we're really focused on our curbside operation and think that's the future for off-premise.

Brian Bittner, Analyst (Oppenheimer)

Okay. And my follow up is just—it's interesting to see the LongHorn sales recovery occur a bit more rapidly than Olive Garden, particularly in units that have reopened their dining rooms. Gene, what do you really attribute that to? I ask because To Go sales in the open LongHorn units are actually much lower than Olive Garden. So I'm surprised we're seeing such a big recovery in LongHorn versus Olive Garden more recently.

Gene Lee, CEO

Yes. Two things to consider. First, geography is working for LongHorn. We have a large presence in Georgia and business has come back strong there. Second, Olive Garden dining rooms yield a lower percentage of tables available under occupancy restrictions than LongHorn does because of physical layout differences. A lot of people have analyzed occupancy, and once you're past 25% occupancy, the critical factor is maintaining six feet of social distancing. There are always seating inefficiencies—twos, fours, sixes, tables for large parties—our average party size is 2.3. So different layouts yield different seating efficiencies even within the same brand. We will be installing temporary barriers in approximately 100 restaurants in the next two weeks to try to improve this efficiency, especially in Olive Garden, while maintaining social distancing. We'll analyze sales after installing those barriers and decide whether to expand the program. In short, I think there's some confusion out there; once you're past the 25% occupancy threshold, the six-foot social distancing requirement essentially caps you if the facility layout doesn't allow efficient seating.

Brian Bittner, Analyst (Oppenheimer)

Understood. Thanks for the color, Gene.

Operator, Operator

Our next question comes from the line of John Glass with Morgan Stanley. Please go ahead.

John Glass, Analyst (Morgan Stanley)

Thanks. I wanted to ask about incremental margins as you think about the recovery. COVID has made a lot of businesses, including yours, rethink how you do things. You talked about menu simplification, but you also talked about this heavier to-go mix influencing food costs. Do you think as your AUVs recover that you're able to get back to higher margins?

Gene Lee, CEO

Hey John, thanks for the question. As it relates to margins incrementally going forward, if you look at our P&L the way our margins looked, our margins are better on a variable cost basis than they were coming into the pandemic. So if we don't make other investments going forward, you would anticipate our margins to be a little bit better than they were before. However, we're still making decisions on what we'll do as sales continue to grow—whether we bring some things back or invest in our guest even more to grow sales faster. So I don't want to comment too much on what our margin structure will look like in a year or two because we may make choices that take away some of the margin gain that we had or we may let that margin flow to the bottom line. But as of right now, our variable margins are better than they were coming into the pandemic.

John Glass, Analyst (Morgan Stanley)

Okay. Thanks. And then, Gene, just following up on your comment about curbside being the preferred off-premise channel. Did you take the opportunity to test third-party delivery during this period? How do you view third-party versus your own To Go results?

Gene Lee, CEO

John, we've had third-party delivery in some of our restaurants even before the pandemic started, including some Olive Gardens and a lot of Yard House locations. We added some third-party delivery in Yard House in a different state and didn't see that third-party delivery grew faster than our own To Go business. Our own To Go business actually grew faster than the third-party business in those restaurants. So we're still at the point where we believe our off-premise business is really strong and continues to grow. We are not anticipating launching a widespread third-party delivery model. That can change if we see third-party margins equal to ours, but as of now our resolve is strong: we believe that doing off-premise the way we do it, especially with the curbside business, is the way to go.

John Glass, Analyst (Morgan Stanley)

Got it. Thank you.

Operator, Operator

Our next question comes from the line of Gregory Francfort with Bank of America. Please go ahead.

Gregory Francfort, Analyst (Bank of America)

Sure. Thank you very much. And Dave, congratulations on retirement. I have two questions. The first is a follow-up on the capacity constraints. I think the 2.3 average party size you mentioned was overall, but should we think about the Olive Garden layout differences contributing to the six-foot distancing issue? Second, on off-premise, how much might off-premise look like in a fully recaptured scenario—how are you thinking about the size of off-premise after this?

Gene Lee, CEO

As far as capacity for Olive Garden goes, the party size isn't the main factor; it's more the physical layout and booth configuration. Olive Garden has many booths and nooks where booth backs are less than six feet apart, and that limits seating efficiency. We can correct yield in many locations, but adhering to local jurisdictions' requirements means we can't create the same percentage occupancy in most Olive Gardens that we can in LongHorn. The temporary barriers we're testing could help increase yield. Regarding off-premise, we believe it will play a bigger role going forward and will be a higher percentage of sales than pre-COVID, but I can't give a precise percentage today. We do expect off-premise to be a lasting contributor to the business.

Gregory Francfort, Analyst (Bank of America)

Thanks, Gene.

Operator, Operator

Our next question comes from the line of Andrew Charles with Cowen and Company. Please go ahead.

Andrew Charles, Analyst (Cowen)

Great. Thanks. And I just also want to extend best wishes to Dave on your next chapter. Two questions. One for Rick — can you talk philosophically how you arrived at the Q1 guidance for sales? Was this more top-down or bottoms-up, given recent news about the virus spreading in some key states for Darden?

Rick Cardenas, CFO

Andrew, it was actually both. We did a top-down look at geography and recent run rates, and our brands did a bottom-up look by geography as well, and those views converged. We are seeing approximately 70% of prior-year sales, which is where we are after three weeks of this quarter. Restaurants with dining rooms open are doing a bit better than that, but we don't know when all dining rooms will open or if there will be another wave of closures. Given our cost control since April, we have a stronger business model, which makes us comfortable with EPS of zero or greater and total EBITDA of at least $75 million for Q1.

Andrew Charles, Analyst (Cowen)

That’s helpful. And Gene, looking beyond the 35 to 40 openings plan for 2021, can you talk about how you'll achieve 2% to 3% restaurant growth in the shorter term? How has the pandemic changed your practices for site selection and restaurant prototype to maximize ROI in a more off-premise, curbside-focused future?

Gene Lee, CEO

It's too early to fully change our approach, but we believe new-restaurant economics should improve. We expect less competition for sites, construction costs to moderate as they did post-recession, and land costs to decline. The best deals often come after a downturn, and we'll push for favorable economics. We're evaluating how to support curbside and pickup in-store—dedicated pickup spaces, rethinking back-of-house workflows, more flexibility in dining room layouts, and temporary barriers—to give us more operational flexibility. We're excited about the opportunity to build restaurants; the cost environment should be more favorable and Darden will likely be one of the few expanding.

Operator, Operator

Our next question comes from the line of Eric Gonzalez with KeyBanc. Please go ahead.

Eric Gonzalez, Analyst (KeyBanc)

Thank you so much. And I also would like to add my congrats to Dave. Based on the discussion about occupancy in Olive Garden versus LongHorn, I'm wondering why off-premise sales perhaps are cannibalizing a bit more at Olive Garden versus LongHorn? Also, the promotional environment seems quiet—few competitors are discounting or advertising. When do you think it's right to restart promotional schedules and how is the competition setting up?

Gene Lee, CEO

On the first point, LongHorn started with lower off-premise penetration, so it's growing at a faster rate but from a smaller base; Olive Garden's absolute To Go dollars are very large. Regarding promotions and advertising, we've pulled back significantly on promotional activity. You saw some Olive Garden TV because we owned the spots purchased in the upfront. We don't think it's prudent to drive guests into dining rooms when there are long waits—doing so could create frustration. We are using this time to cleanse and rethink our marketing spend and understand what drives the highest ROI before layering advertising and promotions back in. Scale will allow us to re-enter the market when the time is right.

Operator, Operator

Our next question comes from the line of Chris Carroll with RBC Capital Markets. Please go ahead.

Chris Carroll, Analyst (RBC)

Thanks. Gene, you referenced Georgia performance regarding recent LongHorn strength. Following up, can you provide any additional detail on states that were among the first to allow dining rooms to reopen? Are you seeing sales in those states meaningfully different than your overall average? How is off-premise mixing in those states now versus the average?

Gene Lee, CEO

Off-premise remains strong and stable in those states. The performance depends more on local brand strength and market share than the timing of reopening. Where LongHorn has deep penetration—like Atlanta—business has come back strongly. Similarly, Cheddar's and Olive Garden in their strong markets reopened well. It's more about brand strength in a given market than the specific timing of reopening.

Operator, Operator

Our next question comes from the line of Jeffrey Bernstein with Barclays. Please go ahead.

Jeffrey Bernstein, Analyst (Barclays)

Great. Thank you very much and congrats, Dave. Just one question and one follow-up. Which of the changes you've implemented during COVID do you think will remain permanent? You mentioned curbside and delivery, but also social distancing, online waitlist, reservations, reduced menus. Which changes are more permanent? And I have one follow-up.

Gene Lee, CEO

The most permanent and significant change will be streamlined menus and simplified processes and procedures—that's forever. Closing operations to off-premise-only gave us the chance to thoroughly review and simplify offerings and back-of-house prep, removing low-value items that drove complexity. This simplification improves execution and reduces costs and will have a lasting impact for years. Curbside and enhanced digital will also remain more permanent, but streamlining menus and operations is the biggest lasting change.

Jeffrey Bernstein, Analyst (Barclays)

Got you. And then following up on the reinfection spikes, given the recent increases in cases, how might your approach to decisions change versus the first time? Will you close faster or longer? Any color where spikes have happened and how you might change process this go-around?

Gene Lee, CEO

We haven't seen a change in business trends yet in states seeing spikes, but we are concerned and focused on it. We will focus on what we can control: guest and team safety, execution, and quickly pivoting operations if local restrictions change. If we need to shift back to off-premise-only in a market, it will be much smoother this time because we've already developed the processes and technology. We expect future changes to be more micro-market specific rather than macro-wide shutdowns, and we have teams set up to manage day-to-day local developments.

Operator, Operator

Our next question comes from the line of Jeff Farmer with Gordon Haskett. Please go ahead.

Jeff Farmer, Analyst (Gordon Haskett)

Thanks. I wanted to follow up on seeing no change so far with the spikes. Has there been any pivot back to off-premise in those markets or reduced frequency? Also, is it possible for some restaurants operating at 50% to 75% capacity to post positive same-store sales? Can you grow year-over-year comps with those capacity constraints?

Gene Lee, CEO

So far we haven't seen a significant change in consumer behavior in markets with recent spikes, but it's only been a short time and we'll continue to monitor. Regarding restaurants at constrained occupancy, yes—about 10% to 15% of our restaurants are currently posting positive same-restaurant sales. Those restaurants typically have strong off-premise sales, favorable trade areas, and different daypart dynamics that allow them to offset on-premise constraints.

Operator, Operator

Our next question comes from the line of Peter Saleh with BTIG. Please go ahead.

Peter Saleh, Analyst (BTIG)

Great. Thank you. Gene, how are you thinking about value? You mentioned labor productivity benefits. You have some margin to potentially invest. With high unemployment and competition coming back, how will you think about value over the next months or quarters?

Gene Lee, CEO

If we have capacity and we see demand softening, we can pivot to value to drive traffic—we have that optionality. Right now, with capacity constraints and demand still significant in many areas, it doesn't make sense to promote heavily because we'd create guest frustration with long waits. We'll be ready to use value as a lever when it's the right time to stimulate demand and capacity allows.

Peter Saleh, Analyst (BTIG)

Understood. And on loyalty, did anything in the data move you more toward or away from a loyalty program? I know you paused a test—any changes there?

Rick Cardenas, CFO

Peter, we canceled our loyalty program test at the end of the fiscal year. We did get useful data—richer than credit-card-based data—but we didn't think it was the right time to continue investing in it. We wanted to streamline efforts to focus on immediate priorities. That said, there's a chance we'll bring a loyalty program back in the future.

Operator, Operator

Our next question comes from the line of Chris O'Cull with Stifel. Please go ahead.

Chris O'Cull, Analyst (Stifel)

Thanks. Dave, best wishes. Rick, the Q1 guidance implies no improvement in the current trend. Are you anticipating potential impact to sales when supplemental unemployment benefits expire?

Rick Cardenas, CFO

Chris, everything we've anticipated is in our guidance. Supplemental unemployment could impact demand, and it could change—extension, modification, or replacement could occur. We factored both positives and negatives into our 70% sales guidance for Q1.

Chris O'Cull, Analyst (Stifel)

Okay. And then you had 43% sales decline in Q4 with adjusted loss; expecting 30% sales decline in Q1 and break-even EPS. Can you explain the key line items driving that improvement in earnings sensitivity?

Rick Cardenas, CFO

A couple of items. We had about $58 million of costs in Q4 we don't expect in Q1—primarily the $50 million of emergency and retention pay that won't recur. Also, it took a little time during the abrupt sales decline to reduce costs; now that we've adjusted the cost structure, at 70% of last year we can be profitable. However, management labor will still show deleverage because it's relatively fixed; but hourly labor is more variable and showing improvement.

Operator, Operator

Our next question comes from the line of Sara Senatore with Bernstein. Please go ahead.

Sara Senatore, Analyst (Bernstein)

Thank you. On unit growth, should we expect openings to be more back-end loaded? Which brands will you open—safe to assume Olive Garden and LongHorn? Also on margins, trying to understand how much of margin improvement is from expense management versus business mix (off-premise vs on-premise).

Rick Cardenas, CFO

We paused construction in Q4; many restaurants were almost complete. The July opening was largely already finished. We'll open a handful by the end of Q1 to ensure teams can be trained under social distancing; beyond that, restaurants can be opened quickly when the environment is appropriate. The year will likely be a bit back-end loaded as we watch the environment. We plan to open at least one restaurant for every brand, but the majority of openings will be Olive Garden and LongHorn. On margins: cost of sales was unfavorable in Q4 due to To Go mix, packaging, and beef costs. Packaging sits in cost of sales for us. Olive Garden ran some value To Go promotions that increased cost of sales. Labor deleverage was a big driver: management labor included emergency-related payments and retained managers; hourly labor improved as a percent of sales. The $58 million of emergency pay and related costs will not recur, which helps margins going forward.

Operator, Operator

Our next question comes from the line of Nick Setyan from Wedbush Securities. Please go ahead.

Nick Setyan, Analyst (Wedbush)

Thank you. Is there a sense, looking back internally, to what extent the stimulus measures contributed to the sales recovery to date? Also, given unemployment might remain elevated, where do you see stabilized sales eventually and which formats (fine dining, Yard House) might be more challenged?

Gene Lee, CEO

Stimulus has been a positive, but it's hard to quantify precisely. It may change in form going forward, but I expect the government to provide support that will generally be positive for our business. Regarding stabilization, it's hard to predict given many unknowns—competitive dynamics and government stimulus are key variables. Specialty and fine-dining brands will return more slowly, particularly because business travel and events are critical to them. Those businesses may remain more weekend-focused for some time. Yard House and brands tied to entertainment venues will be slower to recover if those venues remain closed. Overall, we believe Darden's scale and strengths position us to gain market share over time.

Operator, Operator

Our next question comes from the line of Dennis Geiger with UBS. Please go ahead.

Dennis Geiger, Analyst (UBS)

Thanks. On capacity constraints and getting customers back, what can you do beyond temporary partitions to increase capacity utilization while distancing? Also, more broadly, what actions can you take to drive AUV recovery with those restrictions in place?

Gene Lee, CEO

Beyond temporary barriers, options are limited without changing the atmosphere. Outdoor seating is one route we encourage, though seasonal weather can limit that. Most solutions will require lifting of local restrictions. We believe the best path to AUV recovery is a combination of off-premise strength, streamlined operations, and unlocking seating constraints as public-health measures allow. We'll continue to be creative but must balance capacity gains with preserving the guest experience.

Operator, Operator

Our next question comes from the line of Nicole Miller with Piper Sandler. Please go ahead.

Nicole Miller, Analyst (Piper Sandler)

Good morning. How are team members feeling as dining rooms reopen? Were you able to bring back the staff you needed and are you leveraging that in reopening?

Gene Lee, CEO

Our investments in emergency pay and benefit coverage have paid off—very little difficulty bringing people back. Team members are excited to return; they value their work and work family. Depending on the brand, initial staffing return rates are between 50% and 70%. Our teams are already skilled in hygiene and food safety; we've implemented social distancing and masks, but our people are confident in the safety of our restaurants. The loyalty we've built will continue to be a long-term competitive advantage.

Nicole Miller, Analyst (Piper Sandler)

To close the loop: if you're at roughly 70% of prior sales, are staffing levels of 50% to 70% in line with that?

Rick Cardenas, CFO

Yes. That's how we are thinking about it.

Operator, Operator

Our next question comes from the line of Andy Barish with Jefferies. Please go ahead.

Andy Barish, Analyst (Jefferies)

Hey guys. Gene, can you give a progress report on Cheddar's? How did it come through this period?

Gene Lee, CEO

Cheddar's has come through well. Two notable changes: we upgraded their phone systems and accelerated online ordering rollout, which materially grew off-premise business. Importantly, the way Darden treated Cheddar's leadership and employees during this time built loyalty and strengthened the integration. They also simplified menus and back-of-house processes, which should have long-lasting positive effects on financial performance. Overall leadership did a great job and team members are excited.

Andy Barish, Analyst (Jefferies)

Thanks. Quick follow-up—was the back-of-house efficiency primarily from menu changes or also supply chain/value-added product changes?

Rick Cardenas, CFO

It was primarily menu simplification and procedural work from the back door to the dining room that removed prep complexity and improved execution. There was some incremental value-added product use, but most gains came from reducing low-value, high-complexity items and improving processes.

Operator, Operator

Our next question comes from the line of Andrew Strelzik with BMO Capital Markets. Please go ahead.

Andrew Strelzik, Analyst (BMO)

Good morning. You mentioned potential investments going forward. How do you decide which to make and when? Anything specific you're prioritizing?

Rick Cardenas, CFO

We can invest in several areas: marketing, bringing some menu items back, investments in quality, or pricing and value offers. Our current margin position gives us flexibility. We'll make investments that maximize ROI and guest satisfaction when appropriate. We may choose to let some margin flow to the bottom line or deploy it to drive sales depending on what optimizes shareholder value and guest experience.

Operator, Operator

Our next question comes from the line of Jon Tower with Wells Fargo. Please go ahead.

Jon Tower, Analyst (Wells Fargo)

Thanks. A follow-up on labor savings—how much of the 150 basis points improvement is stickier as volumes return? Also, you raised capital last quarter—how do you intend to use proceeds?

Rick Cardenas, CFO

Hourly labor is primarily variable, so a portion of those gains can stick as sales rise, unless we decide to bring back roles or items that require additional labor. The first quarter should show hourly labor benefits, offset by management labor deleverage. Regarding capital, the proceeds were used to shore up the balance sheet, invest in growth, and support team and quality investments. We fully repaid our drawn credit facility in early May, and our adjusted debt-to-adjusted capital is about 61% versus a covenant of 75%. We have the balance sheet flexibility to open restaurants and invest where appropriate.

Operator, Operator

Our next question comes from the line of Brett Levy with MKM Partners. Please go ahead.

Brett Levy, Analyst (MKM)

Thanks for taking the call. When thinking about the $250 million to $350 million CapEx, how much is maintenance versus growth? And how are you thinking about IT/digital investments and bringing other brands up to speed?

Gene Lee, CEO

Of the $250 million to $350 million CapEx, approximately $100 million to $125 million is maintenance CapEx. We continue to invest in digital and technology—many investments were made in Q4 (e.g., online ordering, curbside improvements, payment systems). There's more to do, and our technology team remains busy enhancing curbside, ordering, and payment capability. In terms of brands, we plan to support all brands and will open restaurants across the portfolio; the majority of openings will likely be Olive Garden and LongHorn but we will open at least one restaurant for every brand.

Operator, Operator

Our next question comes from the line of David Palmer with Evercore ISI. Please go ahead.

David Palmer, Analyst (Evercore ISI)

Thanks. On seating capacity, you mentioned barriers could boost capacity in Olive Garden because booth backs are lower than LongHorn. Any estimate of the percent boost you might get from those barriers?

Gene Lee, CEO

Temporary barriers in Olive Garden can boost capacity meaningfully because booth backs are low; in some locations we might increase usable seating by up to around 20% depending on layout, because many booths are currently out of play and barriers allow more of them to be used while maintaining social distancing. We'll analyze performance after installing barriers in approximately 100 restaurants and decide on broader rollout.

David Palmer, Analyst (Evercore ISI)

You mentioned 10% to 15% of restaurants are positive same-store sales. Can you explain what that indicates about the potential for other restaurants?

Gene Lee, CEO

Those restaurants typically have strong off-premise businesses and favorable trade-area dynamics, such as less local competition or being in areas where guests have fewer alternatives. It shows that with the right combination of strong off-premise, favorable daypart dynamics, and local demand, restaurants can exceed prior-year sales even with capacity constraints. It underscores that performance varies significantly by market and brand strength.

Operator, Operator

Our next question comes from the line of John Ivankoe with JPMorgan. Please go ahead.

John Ivankoe, Analyst (JPMorgan)

Hi. For the 35 to 40 net openings, how many gross openings is that? How many closures do you expect in 2021, given impairments? And how should we think about maintenance CapEx as a percentage of sales in a post-crisis environment? Also, will G&A structurally change given remote work and less travel?

Rick Cardenas, CFO

The 35 to 40 figure is effectively gross equal to net—there are few expected closures in the year beyond the eleven we closed in Q4. We don't anticipate material additional closures unless lease expirations or other specific events arise. A number of restaurants under construction were paused and many were near completion, which reduces the CapEx needed in FY2021. Maintenance CapEx in the $100 million to $125 million range is near historic norms—maintaining restaurant quality is our top priority. On G&A, we reduced spend in Q4 and will continue to control travel and discretionary spend in the near term. We reduced G&A by $17 million in Q4; while Q1 will not see the full $17 million reduction, we expect some continued G&A savings as we rethink travel and other costs. It won't be a dramatic structural change immediately, but there may be 50 to 100 basis points of difference over time as we rationalize certain expenses.

Operator, Operator

Our next question comes from the line of Matthew DiFrisco with Guggenheim. Please go ahead.

Matthew DiFrisco, Analyst (Guggenheim)

Thanks. One,What's your view for how much capacity might come out of full-service casual dining in the next six months? Two, Rick, on the math—if 30% down equals about $600 million, do you need all that sales back to regain the EBITDA you lost, or could a portion be sufficient given the cost structure changes?

Gene Lee, CEO

On capacity coming out of the system, I won't give a specific percentage—there are many estimates out there. I believe there will be significantly fewer restaurants and that the longer the environment persists, the more fallout we'll see. That is an advantage for scale players like Darden.

Rick Cardenas, CFO

Matthew, you don't need 100% of that $600 million to get back to our previous EBITDA run rate given the variable cost improvements and the one-time expenses in Q4 that won't recur. The exact percentage depends on whether we invest or allow margin to flow through, so I won't provide a precise figure here. But the flow-through to EBITDA should be stronger than before due to cost structure changes.

Operator, Operator

Our next question comes from the line of Katherine Fogertey with Goldman Sachs. Please go ahead.

Katherine Fogertey, Analyst (Goldman Sachs)

Thanks. On menu simplification, can you walk through which brands found the most efficiency and what would catalyze bringing items back? Any quantification of cost savings? Also, any thought on M&A given your balance sheet?

Rick Cardenas, CFO

Cheddar's made significant menu and procedural changes and saw material direct labor improvements. All brands improved direct labor as a percent of sales versus last year. The changes were tailored by brand; we focused on high-value guest items and removed low-value, high-complexity items. I won't provide brand-by-brand dollar breakdowns on this call. Regarding M&A, we will continue to evaluate opportunities in full service dining where our scale creates defensible advantages. Any acquisition would need to make strategic sense for our platform and create long-term value.

Operator, Operator

There are no further questions at this time.

Gene Lee, CEO

Thank you, James. That concludes our call. I'd like to remind everyone that we plan to release first quarter results on Thursday, September 24th before the market opens. Thank you for participating in today's call.

Operator, Operator

This concludes today's conference call. You may now disconnect.