Darden Restaurants - Earnings Call - Q2 2021

Transcript

Speaker 2

Ladies and gentlemen, thank you for standing by, and welcome to the Fiscal 2021 Second Quarter Earnings Conference call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, there will be a question-and-answer session. To ask a question during the session, you'll need to press star one on your telephone keypad. If you require operator assistance during the call, please press star zero. I'd now like to turn the call over to your speaker today, Kevin Kalicak. Thank you. Please go ahead, sir.

Speaker 1

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 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 those measurements are included in the presentation.

We plan to release Fiscal 2021 third quarter earnings on March 25 before the market opens, followed by a conference call. This morning, Gene will share some brief remarks about our quarterly performance and business highlights. Rick will then provide more detail on our financial results and share our outlook for the third quarter. Gene will share some closing comments. Now, I'll turn the call over to Gene.

Speaker 0

Thank you, Kevin, and good morning, everyone. As we continue to operate in a very fluid environment, I was pleased with our ability to once again deliver strong profitability in an unpredictable sales environment. Total sales from continuing operations were $1.7 billion, a decrease of 19.4%. Same restaurant sales decreased 20.6%, and diluted net earnings per share from continuing operations were $0.74. The last two weeks of the quarter negatively impacted our same restaurant sales by approximately 200 basis points, as we quickly went from 97% of our dining rooms being open in the middle of the quarter to only 80% being open at the end of the quarter. As a reminder, Thanksgiving shifted back into our second quarter this year, and we believe guests modified their behavior in advance of the holiday.

During the quarter, we remained focused on four key priorities: the health and safety of our team members and guests, in-restaurant execution in a complex operating environment, deploying technology to improve the guest experience, and transforming our business model. The health and safety of our team members and guests has always been our top priority. We continue to follow the latest guidance from the CDC, as well as our own enhanced safety protocols to create a safe environment for everyone. This includes daily team member health monitoring, requiring masks for every team member, enhanced cleaning procedures, and social distancing protocols. I am proud of the commitment our teams make every day to keep our guests and each other safe.

Second, our restaurant teams remain focused on our back-to-basics operating philosophy to drive restaurant-level execution that results in great guest experiences, whether our guests are dining with us or ordering curbside to go. Our teams have been operating in this environment for 10 months, and they've become very adept at adjusting to the ever-changing COVID restrictions, but it's still not easy. That is why we remain committed to our simplified operations, including streamlined menus, processes, and procedures, which continue to strengthen our execution. Our guest satisfaction metrics confirm that our restaurant teams are doing a great job delivering exceptional guest experience in this challenging environment. Third, we continue to deploy technology to improve the guest experience.

Our brands benefit from the technology platform Darden provides, allowing each of them to compete more effectively by harnessing the power of our digital tools, including the 25 million email addresses in our marketing database. During the quarter, Olive Garden and LongHorn Steakhouse launched refreshed websites, and all our brands continue to use their digital storefronts effectively. More than 55% of our off-premise sales during the quarter were fully digital transactions where guests ordered and paid online. At Olive Garden, 20% of our total sales for the quarter were digital. During the quarter, we also rolled out Curbside I'm Here, which allows our guests to easily notify the restaurant that they've arrived to pick up their curbside to-go order by simply tapping on a link embedded in a text message.

As a result, our operators are spending less time on the phone and more time focused on ensuring orders are accurate and on time, which is leading to improved guest satisfaction scores. We also introduced waitlist visibility, allowing guests to see their place on the waiting list using their phone regardless of whether they've checked in online or in person. We are working on several other initiatives, including streamlining our online checkout process and adding additional mobile payment options to provide even more convenience for our guests. We continue to celebrate our digital journey, and I'm encouraged by the progress we are making. Finally, we continue to view this environment as a rare opportunity to transform our business model for long-term growth. We continue to make investments in our team members, product quality, and portion sizes to ensure we emerge even stronger and better positioned to grow share.

Olive Garden's same-restaurant sales declined 19.9% as capacity restrictions continue to limit their top-line sales. Olive Garden began November with 56 dining rooms closed, and that number accelerated to 208 by the end of the month. However, they were able to deliver strong average weekly sales during the quarter of more than $73,000 per restaurant, retaining 80% of last year's sales. Olive Garden also continued to realize operational efficiencies and strengthened margin as a result of their simplified menu and the elimination of promotional activity, including discounts. In the current limited capacity environment, their reduced marketing spend was focused on showcasing the convenience of their off-premise experience while featuring compelling core menu items rather than limited-time promotions. This led to increased segment profit margin while making additional investments in abundance and value. Additionally, off-premise sales grew 83% in the quarter, representing 39% of total sales.

Enabled by the technology investments I mentioned earlier, Olive Garden improved their to-go experience and achieved another all-time high in guest satisfaction for having orders ready to pick up at the time promised. Finally, Olive Garden successfully opened three new restaurants in the quarter. LongHorn Steakhouse had another solid quarter. Same restaurant sales declined 11.1%. Almost 20% of their restaurants grew same restaurant sales in the quarter. They also successfully opened three new restaurants during the quarter. The LongHorn team remains laser-focused on their strategy of increasing the quality of their guest experience, simplifying operations to drive execution, and leveraging their unique culture to increase team member engagement. During the quarter, the team did a great job of managing controllable costs, while their simplified menu drove improved labor productivity. Finally, LongHorn grew off-premise sales by more than 175%, representing 22% of total sales.

I'll turn it over to Rick.

Speaker 3

Thank you, Gene, and good morning, everyone. For the second quarter, total sales were $1.7 billion, a decrease of 19.4%. Same restaurant sales declined 20.6%. EBITDA was $206 million, and diluted net earnings per share from continuing operations were $0.74. Our second quarter start was encouraging, with weekly sales building on results from the first quarter. However, as COVID-19 cases began increasing in November and many state and local governments reimposed dining room restrictions, the last two weeks of the quarter trended down significantly. We estimate that this downward shift in sales over the last two weeks negatively impacted operating income by approximately $15 million. Turning to the P&L, food and beverage expense was 30 basis points higher than last year, primarily driven by investments in food quality and increased to-go packaging.

Restaurant labor was 140 basis points lower than last year, with hourly labor improving by over 310 basis points driven by operational simplification. This was partially offset by deleverage in management labor due to sales declines and $3 million of emergency pay net of retention credits, as we reinstated our emergency pay program for our team members impacted by dining room closures. Restaurant expense per operating week was 13% lower than last year, driven by lower repairs, maintenance, and utilities expenses. However, sales deleverage resulted in restaurant expense as a percent of sales coming in 170 basis points higher than last year. We reduced marketing spend by almost $50 million this quarter, with total marketing 210 basis points favorable to last year. Restaurant-level EBITDA margin was 17.9%, 140 basis points above last year despite the sales decline of 19%.

General and administrative expenses were negatively impacted by $8 million of mark-to-market expense on our deferred compensation. This is related to significant appreciation in both the Darden share price and equity markets this quarter. As a reminder, due to the way we hedge this expense, it is mostly offset in the tax line. Page 12 of this quarter's presentation illustrates the $8.1 million reduction of operating income and corresponding operating income margin reduction of 50 basis points from mark-to-market expense. Our hedge reduced income tax expense by $6.4 million, resulting in a net mark-to-market reduction to earnings after tax this quarter of $1.7 million. The effective tax rate of 8.3% this quarter was lower by 5.1 percentage points due to the tax benefits from the deferred compensation hedge I just mentioned. After adjusting for this, the normalized effective tax rate for the second quarter would have been 13.4%.

Looking at our segment performance this quarter, Olive Garden, LongHorn Steakhouse, and our other segment all saw a segment profit margin increase despite sales declines. This was driven by our continued focus on simplified operations, which significantly reduced direct labor and lower marketing expenses. Our fine dining segment profit margin of 18.8% was impressive, although below last year, driven by a 30% sales decline. We ended the second quarter with $770 million in cash and another $750 million available in our untapped credit facility, giving us over $1.5 billion of available liquidity. We generated over $150 million of free cash flow in the quarter and improved our adjusted debt to adjusted capital to 58% at the end of the quarter, well within our debt covenant of 75%.

The board declared a quarterly cash dividend of $0.37 per share, 50% of our Q2 diluted EPS, within our long-term framework for value creation. We will continue to have regular discussions with the board on our future dividends. As I mentioned earlier, the quarter started with sales building upon first quarter results. As dining room closures increased, these improving sales trends reversed. As of today, we have approximately 77% of our restaurants operating with at least partial dining room capacity versus a peak of 97% in the middle of the second quarter. Moving forward, we may experience further dining room closures and increasing capacity restrictions in the third quarter.

As you may recall, in our last earnings call, we mentioned that the third quarter is historically our peak seasonal sales quarter, driven by the Christmas, New Year's, and Valentine's Day holidays, as well as travel time during this time of year. At that time, we also stated that it will be more difficult to increase on-premise averaging volumes if capacity restrictions do not ease. Current dining room closures, capacity restrictions, and reductions in travel will exacerbate our same-restaurant sales comparison to last year due to the higher seasonal sales from last year. Additionally, there are still uncertainties surrounding further capacity limitations and dining room closures and the duration of these impacts. Given all these factors, we are providing a broad range of expectations for the third quarter.

We expect total sales to be between 65% and 70% of prior year levels, resulting in total sales of between $1.53 billion and $1.65 billion, EBITDA between $170 million and $210 million, and diluted net earnings per share from continuing operations between $0.50 and $0.75 on a diluted share base of 132 million shares. With dining rooms closures increasing, we are focusing on our playbook of expense management and off-premise sales. While there is encouraging news on the broad distribution of COVID-19 vaccine in the spring, we currently do not anticipate meaningful sales trend improvements until sometime in the fourth quarter of fiscal 2021. Despite the short-term headwinds we faced with sales trends, operational complexity, and impacts to our team members, I am confident we are making the right decisions for the long term to create a better guest experience and strengthen our business.

Consistent with our messaging last quarter, we continue to believe we can achieve 100% of our pre-COVID EBITDA dollars at approximately 90% of pre-COVID sales, while continuing to make appropriate investments in our business. Now, with that, I'll turn it back to Gene.

Speaker 0

Thanks, Rick. This morning, we also announced that Rick will become our President and Chief Operating Officer. Rick's career represents what our industry is all about. He joined Darden as a busser at Red Lobster in 1984 and has worked extremely hard mastering many functions. On January 4th, he will become the President of the world's largest full-service restaurant company. He's been a great partner to me over the last five years, and I look forward to working side by side with him in his new role. Additionally, we announced that Raj Vennam will become our Chief Financial Officer. Raj began his career at Darden in 2003 and has done an exceptional job in every role he has held. His promotion recognizes the significant contributions he has made to our individual brands as well as the greater organization.

With a brilliant mind and a keen understanding of our industry, Raj is the perfect person to take over for Rick. I'm excited to see him expand his role in the company as CFO. Rick and Raj are here with me in the room today, and I want to take this opportunity to congratulate both of them. I want to close by recognizing our team members in the restaurants and at the support center. I can't say enough about the dedication they've demonstrated throughout the year. Their focus, commitment, and determination are exceptional. With multiple jurisdictions implementing dining room closures, we know many team members will not get the hours they needed during this holiday season. That is why we have reintroduced our emergency pay program that will provide three weeks of emergency pay to team members who are furloughed from their restaurant when dining rooms are closed.

Our people are our greatest competitive advantage, and we're committed to taking care of them. On behalf of the management team and the board of directors, I want to thank all our team members for your tireless effort to serve our community by providing the comfort of a warm meal. Thank you for going to the extraordinary lengths to take care of our guests and each other. I wish you all a safe and a happy holiday season. With that, we'll take your questions.

Speaker 2

Thank you. We will now take questions. If you'd like to ask a question, please press star, followed by the number one on your telephone keypad. If you'd like to withdraw your question, please press the pound key. Ladies and gentlemen, for today's session, we do ask that you limit yourself to one question and one follow-up question only to allow everyone a chance to ask a question. Our first question comes from the line of David Tarantino with Baird. Go ahead, please. Your line is open.

Speaker 3

Hi, good morning. First, Gene, congratulations on being elected to Chair of the Board. Rick and Raj, also congratulations on your promotions. Very well-deserved. Gene, my question is about those changes. I wanted maybe to hear your thoughts on how your day-to-day involvement will change as a result of Rick taking on the President and COO role and just your thoughts on whether investors should interpret this as a signal that you'll be less involved in the business going forward.

Speaker 0

No, absolutely not. I plan on being as involved operationally as I ever have. That's my strength. I mean, I see this as an opportunity to create growth for both Rick and Raj. I think it's going to give Rick an opportunity to understand operations more deeply. Obviously, he has a great relationship with our presidents today, but I think it's important for him and his development to get a little deeper into the operations and get to know and oversee a lot of the other people that make things happen, just not the president. I also think it's important for him to partner with me on making sure that we are leveraging all the non-consumer-facing parts of our business and to see if there's an opportunity to continue to find additional synergies to enable us to further invest in our business.

I see this as an opportunity to work with people that deserve the opportunity to grow and, more importantly, have an extra set of hands to be able to do some things and look at things maybe a little bit differently. Giving Rick the freedom and the time to look across the organization and see where we can pick up some additional synergy, I think is a good thing. I think that I tried to do that in the position that I was in, but there's a limit to the amount of time you have. I think giving Rick that time will be very beneficial to the organization as we move forward. I'm excited about these changes. I don't think anybody should read anything into it. I am going to still be heavily involved in food service and atmosphere just the way I am today.

I look at it as a great opportunity. I also look forward to working with Raj and giving him a chance to develop into a world-class chief financial officer. I think that's going to be really exciting. Do not read anything into it other than we're creating growth for our people, creating new opportunities, and we have a few things that we want to get done with this change.

Speaker 3

Sounds great. Congrats again to all of you.

Speaker 2

Our next question comes from the line of Chris O'Cull with Stifel. Go ahead, please. Your line is open.

Thanks. Good morning, guys. Gene, how is the company thinking about returning to normalized marketing spend? Meaning, does the company plan to wait until government restrictions on dining usage are lifted, or does the company plan to see what kind of pent-up demand there's going to be as consumer mobility increases to determine how much advertising to utilize? I'm just trying to get a sense for how you guys are thinking about that.

Speaker 0

Yeah, we have no definitive plans to put back marketing at this point in time. Obviously, we have developed multiple options of how to come back and use those resources that we have. I think in part of your question, I think the answer is there is that we're going to look and see what the competitive environment is like. We want to see what the pent-up demand is like. We're going to put back the marketing resources back in the business judiciously. I would love to get to a point where we can grow our business and rely a little less on advertising spend. We really like the P&Ls with the marketing line at the level it's at right now. There's no predetermined outcome on this. We need to get into the competitive environment and then make our decisions then.

We have developed multiple options if needed.

Speaker 2

Great. Congratulations on everyone's promotions. Our next question comes from the line of Andrew Charles with Cowen and Company. Go ahead, please. Your line is open.

Great. Thanks so much. Gene, Rick, and Raj, happy holidays and congrats on the well-deserved promotions. Gene, do the most recent few weeks of sales trends change your view from last quarter that 5-15% of the category is likely to see store closures? What I'm trying to get at is, are you starting to see more favorable terms from landlords and developers that will benefit the development pipeline as you look out to the 2022 and 2023 class of openings?

Speaker 0

No, I don't think. I mean, I think that my position on closure is still in that 5-15% range. And it's unfortunate that a lot of these small businesses are being impacted this way because I do think it'll have a negative impact on the creativity of our industry, so on and so forth. As far as real estate goes, I think that my position on that is still pretty much the same as that there's some more availability out there right now. However, we're not seeing any weakness in the rent deals. I think there's some speculation going on out there right now with some of the REITs. I think as we move forward, we'll continue to try to grow our businesses responsibly. We want to eventually get back into our long-term framework.

We'll give you some more guidance in March exactly how we're thinking about FY22 for development. We reconfirmed our guidance for this year and hoping that we can get the number of restaurants that we talked about in the press release open. We have a bunch of restaurants today sitting there ready to go, that are ready to open. Our guideline here is once we get to approximately 50% occupancy in a jurisdiction, we will go ahead and open that restaurant. We've been very successful doing that.

Thank you so much.

Speaker 2

Our next question comes from the line of Brian Bittner with Oppenheimer & Company. Go ahead, please. Your line is open.

Thanks. Good morning. I echo the congratulations to all three of you on the upcoming move into your new roles. Gene, in the press release and on this call, you talked a lot about the fact that you're taking this opportunity to transform the business for long-term growth. On the call, when you spoke about that in your prepared remarks, you specifically said employee investments and some menu and portion changes. Can you just talk a little bit more beyond that? What else are you doing to truly transform this company for long-term growth? How do you strategically think about growth, both for the AUV recapture opportunity and the unit and portfolio growth of the company in the long term?

Speaker 0

Good question, Brian. I think we think about it in three ways, right? What are we doing to ensure that we can grow the base from the same restaurant sales perspective? I think a lot of the simplification and the efficiencies that we're creating, but more importantly, and I think I talked about this in the last call, is as we brought our menus down, we learned a lot about guest behavior and what the guests wanted to buy without our nudge. I think that's really been eye-opening for us. I think that that's going to strengthen the operation and day-to-day operation on that side. I really think that we're well-positioned there. We've done a lot of good work to ensure that our brand is set up for success.

Secondly, when we talk about transformation and when we go to the second bucket of growth, which is new restaurants, the key here is that we believe that the business model from a cost side is much stronger than it was pre-pandemic, which should enable us to be able to grow, especially in Olive Garden, deeper than we may have thought we would be able to grow pre-pandemic. That is one of the things that I'm really excited about is we think that we can actually, over time, tick up Olive Garden growth and handle, because of the improvements we've made, we think we can handle the cannibalization a little bit better and still get a good return on our investment. The third bucket that you highlighted was really around how do we continue to add brands to the platform?

As I've said forever, we continue to look at what our options are. The filter that we use really comes down to, does it benefit us to put that brand on a platform? Does the platform benefit that brand? Do we think it can grow faster than Olive Garden to improve our growth rate? We've historically done something every three or four years. This has obviously been a different period of time, but we believe that to be an avenue of our growth and to support our long-term framework. I think we're really well-positioned in those three buckets to drive the business. The last thing that I would say is I think that in this transformation, it's moved a lot of the technology forward faster than what we originally were planning to do.

The big change for us is moving how we handle the off-premise business, which has been a big part of our growth historically the last five years as we capture the convenience trend, but really getting clarity that this is going to be a curbside business that's going to be technologically enabled versus someone coming to the restaurant and getting out of the car and coming to pick it up. I think that we've really worked hard and our team has done a great job. I think that experience today, when you come into an Olive Garden, especially Olive Garden and LongHorn, and all our brands, but really this is an Olive Garden play because the food travels so well. I think that that's going to really be a competitive advantage going forward.

Thanks for that, Gene. Nobody seems to be taking their follow-up, but I'm going to ask one, if you don't mind. The step back that's happening in the business in the third quarter, it's pretty telegraphed by what's been happening in the world. When you look back at the quarter that you just reported, when you got to that 97% of units offering in-store dining in the middle of the quarter, can you give us a peek into how the business was performing with that type of percentage of stores operating in that manner?

I think there were still geographic problems, and I would say that we were really adhering to the social distancing. The business, in some ways, I gave you that because I said in the last two weeks, cost us 200 basis points for the quarter. I think there were parts of the country that were performing really well. I think you can look at the mobility index out there and see what parts of the country were performing well. You look at Georgia and Texas. Florida hasn't been performing as well just because the tourism's down and we have a lot of restaurants based in tourism. In our non-tourist markets in Florida, we're performing well. We had some good momentum, but we knew as a management team that this wasn't done, that we were going to face this second wave.

We were prepared for it. We had good processes, and we have been able to wind down the businesses effectively to off-premise only. We will quickly be able to wind them back up and take advantage of the opportunity.

Thank you. Congratulations, guys.

Speaker 2

Our next question comes from the line of Eric Gonzalez with KeyBanc Capital Markets. Go ahead, please. Your line is open.

Hey, thanks. I'd also like to add my congrats on the promotions. My question is, as we look ahead to the vaccine rollout, can you talk about what you think you need to do differently in order to maximize the opportunity to capitalize on that pent-up demand that likely exists? As a follow-up to that, what do you think the flow-through rate is on incremental sales today? What do you think it will be post-vaccine, assuming you don't need to discount or advertise? Thanks.

Speaker 0

I'll let our new President answer that. First of all, thanks, everybody, for all the kind words. I want to congratulate Raj as well on his promotion. He's been a real partner to me over the four and a half, five years that I've been the CFO. I appreciate that. What are we going to do to capitalize? Gene's been talking a lot about what we're doing to make sure that we invest in our team members, invest in our food. As the restaurants start to ramp up, we really believe that we're seeing, and we've seen, growth when those restaurants start to open.

We're not going to talk strategically about what we're going to do to capitalize on that, but just know that our business model is so much better that even as we get our sales to grow, our margins will continue to improve. Which gets you to the second part of that question that you asked. The question is flow-through and incremental sales. As we look at what we're doing today, right, today, our variable margins are closer to 50%. Before, they were closer to 40%. We've taken a lot of costs out, but some of those costs will come back in. As we mentioned, that would imply about 150 basis points of margin improvement over the long run. Right now, incremental profitability is pretty strong. When we started to see some closures, we started to see that drop.

As we move forward, we still believe that we're going to get to 100% of our pre-COVID EBITDA at 90% of pre-COVID sales. We just don't know when we're going to get to the 90% of pre-COVID sales.

Very helpful. Thanks.

Speaker 2

Our next question comes from the line of Chris Carril with RBC Capital Markets. Go ahead, please. Your line is open.

Hi, good morning. Gene, Rick, and Raj, congratulations on your new roles and promotions announced this morning. Rick or Raj, could you please provide your thoughts on how to think about G&A now moving forward, both in the near term and longer term? At this point, how much of the savings that you've seen thus far do you think can be held on to in a more normalized environment? How does the increased focus on technology impact this?

Speaker 0

Yeah, Chris, thanks. The G&A, I'll talk about this quarter that we just ended. As you saw, we reported about $90 million in G&A, but that would have been closer to $82 million without that mark-to-market expense. As you recall, at the end of the first quarter call, we talked about the early retirement program that we had saving us about $25-$30 million a year. We're still seeing that. We still believe that we'll keep that as we move forward. We've also had some savings in G&A because of reduced travel and other things, no general manager conference and those kind of things. Those things will come back. How fast they come back is a question. We're running about 5% G&A, about 5.5% G&A right now, which is remarkable considering our sales where they are.

As we get back to our pre-COVID sales, we will start seeing G&A come up a little bit, but nowhere near where it was before because of that $25-$30 million, I'm sorry, $25-$30 million of savings that we got on early retirement.

Got it. Thank you. Just again, the increased focus on technology, is there any potential impact there?

Yeah. No, we've been investing in technology for years. As we continue to work on our technology investments, that'll impact our depreciation line, amortization line going forward. We also have some projects that we worked on five and six years ago that would fall off. We're going to continue to invest in technology. Will that help make us more efficient here in the support center? Yes. A lot of our G&A is out in the field and our directors of operations and our senior vice presidents of operations. Technology will help them be more effective and more efficient, but it won't get us a whole lot of G&A save. Absolutely, the technology investments we're making are more about in restaurants. That's not a G&A. That's kind of restaurant margin.

Got it. Thank you.

Speaker 2

Our next question comes from the line of Jeffrey Bernstein with Barclays. Go ahead, please. Your line is open.

Thank you. Good morning. And congratulations, Gene, Rick, and Raj. One question and then a follow-up. The question just in terms of the labor outlook. Obviously, lots of moving pieces. And I think we'd agree Darden's an employer of choice. And with unemployment up, inflation in theory should ease, and you experienced significant leverage in the second quarter. I'm just wondering how you think about that in the context of potential for national minimum wage increase. Just wondering your bigger picture industry thoughts, maybe using Florida as a guide, or how you think about how you can offset that, whether with cost savings or menu pricing or just broad outlook on the labor line going forward. And then I had one follow-up.

Speaker 0

Yeah, good morning, Jeff. Labor is definitely a little bit of a question mark for us and for the industry. As we think about labor, we've dealt with the structural increases over time very effectively. We're better positioned than anybody else in the industry to be able to deal with that because of where our margins are today. Now, at the bottom, if you're asking me, do I think there'll be a federal minimum wage increase that's similar to Florida? I think over time that we will see the federal minimum wage increase, but not at the same rate as Florida.

I think the key for us and the way we're thinking about it is how do we get to the right tip wage and to keep that relationship between the two constituents, the guest and the server, that do not want that relationship to change, albeit the people in public office and some advocacy groups believe that that relationship should change, where our team members and servers really do not want that to change. So how do we protect that, get that to the right level? If the industry's all faced with it, then we're going to have to figure out how, from a pricing standpoint, we are able to pass that through. I think long term, when I look at a P&L and think about it, I think California is an example of it today.

You're going to end up with a little bit lower cost of goods sold and a little bit higher labor cost, but you're going to end up at the same place. As long as you're thinking about it that way, I'm confident in our ability to manage that over the long term. Could it have some short-term impacts and volatility to cost structure? Yes. Long term, I like where we're positioned and our ability to be able to deal with it.

Understood. Just the follow-up, you mentioned earlier, Gene, that maybe there's an opportunity to increase penetration of your brands. Obviously, Olive Garden is the furthest along, so maybe that's the best example. I'm just wondering whether there's any quantification on that or how you would think of an alternative about maybe using ghost kitchens. I mean, with your portfolio being as large as it is, I would think you can create your own ghost kitchen just of your own portfolio since the brands are already pretty well known and not necessarily need to open up as many new boxes. Just trying to get a sense for that. Thank you.

Now, we believe we're an on-premise restaurant company, and we strongly believe that demand for in-restaurant dining is going to come back really strong. There'll be some falloff on the off-premise occasion. I think people have a lot of fatigue with that right now. Long-term, convenience is going to, when you think about long-term, convenience is still going to be important. I think that, right, and off-premise will come back and be stronger at some point than it was pre-COVID. I believe that these brands need to be developed to be on-premise locations, that it's your primary business, that drives an auxiliary business, which is your off-premise location, off-premise business. You develop the brand in a box, and we create a great in-restaurant experience.

The logistics of moving that the last mile are just so, so expensive and something that we know really cuts into the profitability and something that we do not want to be involved in.

Thank you.

Speaker 2

Our next question comes from the line of Peter Saleh with BTIG. Go ahead, please. Your line is open.

Great. Thank you. Congratulations to the team on the promotions. Gene, I wanted to ask if you'd give us an update on the Cheddar's brand and what, if any, changes you guys have made throughout the pandemic. How should we think about the unit growth of that concept when we come out of this pandemic?

Speaker 0

Yeah. I think we talked about in the last call that the biggest transformation we've made in the cost structure has been at Cheddar's. As we simplified the menu, we really were able to get in there and look at all the processes and procedures from the back door to the dining room table. The team has made great progress there, which has resulted in a significant reduction in labor cost. We've had a significant reduction in the waste in that business around cost of goods sold, which has really changed the business model. Prior to the pandemic, we had just rolled out croissants to every single guest, which has been received very well. We were able to absorb the pricing that we implemented when we did that. Our value ratings have actually increased.

I think the other thing that going through this crisis has accelerated their off-premise capabilities. Prior to the pandemic, we did not have a ton of capabilities there. We only had a couple of phone lines. It was just a mess. We have increased the number of phone lines. We have got online ordering in place. We have now got the curbside and the here and there. The takeout business is growing fairly rapidly through the pandemic, and we are very pleased with that. We have got to get better at it because it is not a core competency in Cheddar's, but I think the team's working really hard on it. I know they have got a big initiative, and I am really proud of what they are doing. As far as unit growth goes, I always talk about human resources when we talk about unit growth. We have stabilized the human resources in Cheddar's.

The human resource metrics are getting closer to Darden metrics. I think actually management turnover is actually in the middle now after being such an outlier for so long. I'm excited about that. We still need to bring, we still need to build management strength to handle growth. We have been opening restaurants all the way through the transition, through the pandemic, and really through the integration. I would expect unit growth to be somewhere in that 5-8% range, which I think we can handle from a human resource standpoint. It is additive to our growth rate. We're excited about the business. We're excited to see what the P&L will really look like in a post-pandemic environment. We have always loved the business, and we love the business today. We're excited about it. We got teams done a great job.

I'm really proud of them.

Do you anticipate having to spend more as a percentage of sales for Cheddar's on the marketing side to accelerate that growth in the coming quarters or year?

No, we just don't have the density in that business to be cost-effective from a marketing standpoint. I think we'll continue to use our digital capabilities there. It was always a high-volume concept that didn't have the cost structure set up right. Now that we have the cost structure set up, we think set up right. Doing 5,000 guests a week, I think that the growth from that business really comes from new units, not really comp growth. There's not many restaurant companies out there doing 5,000 guests a week.

Thank you. Very helpful.

Speaker 2

Our next question comes from the line of John Glass with Morgan Stanley. Go ahead, please. Your line is open.

Thanks very much. Happy holidays to everyone, and congratulations for me as well. Rick or Raj, just maybe two maybe more boring finance questions. One is just on your current quarter guidance. Even at the high end, it would assume revenues might be a little lower than they are total revenues this quarter, but the operating margins might be actually higher, I should say, EBITDA margins. Is that just a function of the G&A, which was a little bit off this quarter because of mark-to-market? Is there something else going on that would actually allow you to even have higher profitability versus the second quarter on lower sales?

Speaker 0

Hi, John. No, I think you got it a little bit on the G&A front. As we continue to reopen restaurants, we're getting more efficient at that, right? If restaurants come back and reopen, we're just getting better at doing that. As restaurants close, we're more efficient doing that as well. We just believe that we've got a business model that's wired pretty well right now, and that should show up in our margins in Q3.

This is probably the last quarter we'll be talking about negative same-restaurant sales, and then you start to lap the May period, etc., where how should investors sort of think about how to model the business or think about the recovery? Should we just focus on averaging volumes and then just sort of back into this implied same-restaurant sales because that's what really drives things? Year over year does not matter. It is really just the volume capacities are limited to a point until those capacity restrictions end. Is that the best way to think about your business over the next couple of quarters after we start lapping the pandemic?

Yeah, John. I think what investors have to do is make assumptions for when the pandemic starts to ease and when dining room restrictions kind of when dining rooms reopen, and then look at our averaging volumes, what we're doing today, and kind of put some kind of a factor on that. You can kind of see some of the things that we've shown in our releases and pretty transparent on our weekly sales and restaurants that have dining rooms open versus the total company and just kind of make your best guesses on when you think the pandemic is going to wane and when dining rooms are going to reopen. We can't tell you when that is, but we feel really confident that when that does happen, we're going to be there to capitalize on it.

Great. Thank you.

Speaker 2

Our next question comes from the line of Dennis Geiger with UBS. Go ahead, please. Your line is open.

Thank you. And congrats to all on well-deserved promotions. Gene, wondering if you could talk a bit more about technology and the digital platforms. You talked a bunch about the initiatives that recently rolled out and those that are coming. But can you size up the opportunity a bit more on the role that tech plays and digital plays and can play for the brand, perhaps a bit more maybe on some of the top-line benefits and thinking about guest satisfaction speed ultimately and sales? And then, Rick, I think you talked some about the benefits from a cost and margin perspective a little bit, but if there's anything more to kind of frame up that opportunity as well. Thank you.

Speaker 0

I think, first of all, I think technology really helps you on the off-premise side. As we talk to our guests, they continue to tell us they don't want a technologically advanced or enabled in-restaurant experience. They don't want to look at digital menus. I mean, as we put the QR codes out there and had people try to look at their menus on their phone, they really push back. They don't like that. That trend, I don't think, is going to take place in restaurant. We're playing with some handheld devices to see if we can get orders quicker. I think that Ziosk has played a major role in a lot of our brands. It's enabled our servers to, in a non-pandemic time, be able to use that device to get orders in. It really does a great job on payment.

The adoption rate on payment is extremely high with that device as the consumer becomes used to using it. In restaurant, I don't see a ton of technological advances there over time. I think the things that we're working on, waitlist is important. The big one that we're working on right now is how do you accelerate the checkout process on an online order, and how can that be as friendly as the big retailers? Those types of things on the margin, I think technology is there. We're fairly technologically advanced with our dining room system, our KDS system. I'm not sure how much more is there that we see right now. We are working on a technology roadmap over the next five years to figure out where do we want to invest and how do we get the highest return on that.

There is still work to be done. I think the majority of it still is in off-premise to accelerate that. On the other side, we do not talk much about it, but when you think about the size of our email database today and how we interact with our guests digitally, we will continue to evolve that and get better at that and more efficient with that, trying to figure out how to communicate more effectively with our consumers and let them know about the things that might drive a visit. I am excited about that. There is a lot of engagement digitally with our brand, both from an email database and from social. Just think about what happened last week when Taylor Swift dropped the song with Olive Garden in it and how we were able to capture that socially and create buzz around that.

All of a sudden, when Taylor Swift drops our name in the song, our brand becomes very, very relevant. It is a 40-plus-year-old brand that is all of a sudden relevant with her audience. Our team is working around the clock to capitalize on that activity. To those that are listening that were on that team, they did a fantastic job to be able to make that relevant. Thank you to them, and thank you to Taylor Swift for dropping Olive Garden in her song.

Thank you.

Speaker 2

Our next question comes from the line of Jeff Farmer with Gordon Haskett. Go ahead, please. Your line is open.

Great. Thank you. Congratulations to all three of you. Well-deserved across the board. Another labor question for you. If memory serves, you saw 350 basis points of hourly labor favorability in the fiscal first quarter. Sounds like you guys just talked about 310 basis points in the second quarter. How should we be thinking about favorability moving forward, especially with the emergency pay coming back?

Speaker 0

Hey, Jeff. This is Rick. On the labor front, the hourly labor of 310 basis points favorability this quarter, it was really driven by the fact compared to 350 in Q1. It was really driven by the fact that in Q1, we had a much, much more simplified menu in some of these restaurants because some of them were still to-go only. Some of those restaurants were running with very few hourly employees. As we started ramping up dining rooms, yes, we added some labor, but 40 basis point difference isn't very big when you consider the sales that we added from Q1 to Q2. The emergency pay, we don't necessarily put that into our direct labor cost. It's more in the kind of fixed labor we talk about.

When we talk about the 310 basis points or the 350 basis points, it does not include emergency pay.

Okay. Just as a follow-up again on labor, this is a popular investor question, but you touched on it, with indoor dining suspensions affecting roughly 25% of the system as you most recently, can you provide some color on the impact that that has on variable restaurant-level costs, specifically on the labor and restaurant expense lines? I know you've shared some color on hourly versus management labor as a percent of total labor, but anything there to sort of help analysts and investors understand the movement between fixed and variable costs for restaurants that are essentially closed to indoor dining?

Yeah. When you think about when you have no indoor dining, a big part of our restaurant is the servers. That is a little bit less, actually a little less efficient in number of hours than an off-premise business. On dollars, it is not so bad, but on an hours basis, you have a lot more servers per guest than you do on a to-go experience. Actually, it does help us a little bit when we go to off-premise only just for a little bit of time. We actually do not like to be off-premise only. We would much rather have the total sales and the total margin of being open on-premise. In relation to the fixed versus variable, as the definition says, the variable costs definitely go way down as our sales go down. Most of our costs on the fixed side will be there.

We have a few things that we can turn off when we go to off-premise only, the TVs, the music, and those kind of things, but that's not significant. The other thing that is significant is we have a little less repair and maintenance. When your restaurant isn't getting beat up in the dining room, you don't have to do as much repairs there. I would say we would much rather have a full restaurant, full dining rooms, and deal with the cost of that than have empty dining rooms and just do off-premise.

All right. Thank you.

Speaker 2

Our next question comes from the line of Lauren Silberman with Credit Suisse. Go ahead, please. Your line is open.

Thanks for the question. Congrats to all. Hopefully, at this time next year, all restaurants will be open at full capacity. When you reopen restaurants, how long does it take for restaurants to ramp up sales to their full allowable capacity? Is it immediate? It takes several weeks to build? What I'm trying to get at is how quickly do you expect to reach full pre-COVID sales levels, assuming capacity restrictions are lifted 100%?

Speaker 0

I think that that is hard for us to really define for you. I think that from our standpoint, other than maybe having to ramp up some staffing, we can get to a point where we can move back to 100% fairly quickly of where we were from a volume standpoint. I think even staffing, it would be more of a fatigue thing because we'd probably have to work our people more hours than what they were used to in the near term. I think we can get there right away. The question is going to be more on the consumer demand. Is this going to come back all at once, or is it going to come back over a period of time as more and more people get comfortable?

You think about the different demographics out there today, and is it going are people going to, as soon as they're vaccinated, say, "Okay, I can get out and move," or are they still going to be cautious? That, to us, is the unknown. What I would tell everybody on the call and our investors is that we're going to be prepared to be able to handle this situation as it unfolds. We're going to be in a situation where I think that our brands are trusted and beloved by our guests and that people, once they feel good about being able to have a little bit more mobility, they're going to come back to us quickly, and we're going to be ready to serve them a great meal and deliver on our expectation.

Great. Gene, you touched on ghost kitchens, but extending that to virtual brands operating out of existing restaurants, more restaurants are developing these virtual concepts to complement their businesses and add near-term sales. I think uncertainty regarding the staying power over the long term. Last quarter, you said this wasn't the right approach for Darden. Is that still your view? Can you just expand on your view on the concept of virtual brands and whether that's appropriate for any of the concepts in the Darden portfolio?

It's still our position. We believe that we need to stay focused on running the brands that we spent many, many years investing in and marketing and building. I believe that that's the right place to be. I believe, as I said last quarter, others have got to do what they think they need to do to run their business. I think the question that I would ask is who owns the virtual brand? Is it Kitchen or does DoorDash own the virtual brand?

Great. Thanks.

Speaker 2

Our next question comes from the line of John Tower with Wells Fargo. Go ahead, please. Your line is open.

Awesome. Thank you. I appreciate you taking the questions. Congrats to the team. Happy Friday and happy holidays to everybody. Just two follow-ups, really. First one, when thinking about the targeted 100-150 basis point margin improvement over time, does that take into account potentially a higher or a lower level of marketing spend over time or essentially returning back to, say, the 3% spend? Digging a bit deeper into the unit potential we were discussing a little bit earlier, when thinking about it, are you contemplating the idea of potentially putting more units in an existing trade area, or do you think that there's greater opportunity for your brands to move into smaller markets over time? Is this more about the portfolio or Olive Garden specific? Just one more on top of it.

How much has cannibalization weighed on same-store sales and margins historically?

Speaker 0

Hey, John. This is Rick. I'll go through those questions. Lower marketing is part of the 100-150 million, 100-150 basis points. I'm sorry. Most of that is going to be from our labor efficiencies that we've come to play. As sales go back up, depending on what the competitive environment looks like, we will market. Olive Garden is a national brand. One of the benefits of Olive Garden is their scale and their national footprint. Olive Garden will be on TV nationally because we think that's a big competitive advantage for us. Marketing will come back, not to the level it was before, but most of our 100-150 basis points is going to be on the labor front.

As it relates to unit potential, while we're not going to give a number on units, Gene did mention Olive Garden, seeing that we could potentially go into smaller markets because of the business model enhancements that we've made. Other brands are going to fill in markets. I mean, one of the things that Gene mentioned earlier about Cheddar's is they don't have scale. They really don't have a whole lot of scale in most of the markets they're in either. We really believe in relative market share. We think Cheddar's has the opportunity, LongHorn has the opportunity. All of our brands have the opportunity to build scale in some of the markets they're in while still growing into new markets. In regards to cannibalization, we haven't given that number in a long time. Most of the cannibalization would be at Olive Garden.

Olive Garden isn't growing that many restaurants, so the cannibalization isn't that impactful for us. As it relates to the other brands, as we do go into some markets that we already have restaurants in, especially for Cheddar's, because we're so dispersed on where our restaurants are, when we add a new restaurant, yes, we will have some cannibalization, but the business model is so much better now that we believe that it's the right thing to do. Plus, it actually leverages some of the G&A and other things in that market, even our supply chain. While our restaurant-level margins may tick down if we cannibalize, the costs outside the restaurant will get better.

Great. Thank you.

Speaker 2

Our next question comes from the line of Nicole Miller with Piper Sandler. Go ahead, please. Your line is open.

Thank you. Good morning. Congrats to everybody. Two quick questions for me. The first is on numbers. With the guidance, can you talk just a little bit more about what is underlying that? I would wonder about two things. I think you said like 75% of the dining rooms are open. I can't imagine you're contemplating all of those reopening, yet you're not contemplating everything closing. What is kind of the spectrum there? On the comp, is it holding steady for dining rooms open and the momentum they've achieved, or are they also seeing some softness? Thank you.

Speaker 0

Yeah, Nicole, this is Rick. As it relates to our guidance, and then I'll get into the comp, we aren't assuming that or contemplating any significant changes in net capacity restrictions. Where we are today is where we're going to expect to be through the quarter. Other than those that are already contemplated by officials, if there's some new ones coming that we already know about, but we don't know about any new ones coming. Now, hopefully, those things will ease as the quarter goes on. We do have a little bit of that. I want to give you a couple of data points. As of Sunday, our quarter to date on a fiscal basis, which is what you all look at, our comp sales are down about 26%.

If you look at it on a comparable calendar basis, because remember, we had a 53rd week last year, and Thanksgiving shifted, we're down 35%, as Gene mentioned, over the first two weeks. Our guidance takes all that into account. It takes into account that we think that our sales are going to maybe grow a little bit on a per-op week basis or an average unit volume basis. Because we're going up against that high seasonal sales last year, our comps will be a little bit more challenged. That leads to the second part of your question. What are we seeing in comps for restaurants that still have dining rooms open? We're now getting into our seasonal period.

We're getting into that point that we talked about after Q1 and recently mentioned on today's prepared remarks is that our comps are going to be harder. What I would focus everybody on is our average weekly sales. If you look at our press release that we shared, we still have average weekly sales growing. Unfortunately, they're not growing as fast as average weekly sales grew last year, which we knew would happen, and we highlighted that. We're focusing more on Q4 and next year. We believe we have the business to get us through that. We're really comfortable with the guidance that we gave for Q3. We're really focusing on getting our business really ready to capitalize on when sales come back.

That's super helpful. Thank you. To your point on, yeah, looking through this quarter and looking to the next, absolutely. That just leads me to my second and last question is exactly that. There's not even just a thought process anymore about the bigger chains like yourselves being able to take share. It's absolutely modeled, let's say, in the consensus estimates. That's where we're at. I want to understand what you think about that. What's the opportunity for sales transfer? If the NRA is saying 110,000 locations are closed, what's the type and the location and health? What's the probability in the interim that you pick up those sales? I mean, we all hope for an independent revival, but that's going to take time. Has consensus been too optimistic on that front, or is that what is happening is going to happen? Thank you.

Yeah, Nicole, I don't want to comment on what consensus is for Q4 or beyond. What I do want to get everybody understanding is before the pandemic, the full-service restaurant business was about a $100 billion category. We believe after the pandemic, it's going to be a $100 billion or more category. We also know that, unfortunately, there have been a lot of restaurants that have closed, and there might be more that are coming. We really are unhappy with that. We really would like to see these independents stay open, as Gene mentioned, because they do provide some novelty and flair that we can learn from as well. As we think about our business in the long run, full-service restaurants was a big category. We had about an 8% share, 9% share.

We believe it's going to be at least as big, potentially bigger because of the pent-up demand and people really understanding and realizing what they missed out of casual dining and full-service restaurants. If restaurants stay closed for a while, we're bound to pick up some of that share. How much that is, I can't comment on it. We believe we're really, really well prepared to capture that share. With the business model that we have, we believe that we're going to benefit from that.

Thanks again.

Speaker 2

Our next question comes from the line of David Palmer with Evercore ISI. Go ahead, please. Your line is open.

Thanks. Good morning and congratulations to all of your promotions. A follow-up on your comments so far about how Darden's transforming the business model for the long term. You mentioned how simplification and productivity will result in a longer-term margin step-up, and that can lead to greater unit growth opportunities down the road. That is great. I think I get that. The one thing I'm curious about is about this whole crisis and your internal actions. Has the business been transformed in a way in your major brands that is going to bolster sales per restaurant long term? Perhaps some year like fiscal 2023 might be higher than it would have been without the crisis and your internal actions. Be curious to hear about that.

Speaker 0

Yeah, David, I think this crisis has done a few things. I think it's done not just for the restaurant business, but for all businesses. When I listen to other CEOs talk, I mean, we've identified a lot of non-value-added activity inside our organizations that you were funding, but also was creating distractions at the operational level. I think that's a big upside for us. It's something that we're really focused on to ensure that there's not this gravitational pull to bring us back to do that type of work. What gives me the most confidence in our ability to get above pre-pandemic sales is the investments we've made.

From the day after April 20, when we raised the $500 million in the equity offering, and we knew liquidity was not going to be an issue, this management team focused 100% on what do we need to do to ensure our businesses are stronger than they were before we went into the crisis. What actions, what investments do you want to make? What things that you do in history that turned out to be wrong that you want to make right? Our businesses have worked hard to do that. Now, each one of our brands is in a different place on that journey. I think our bigger brands are much further along at this point. They have made the moves.

What I'm really impressed with is the stuff that they're working on today at the level of detail of trying to improve guest satisfaction, to me, is absolutely amazing. It's down to, we're spending a lot of time working on how do we improve the off-premise experience and how do we ensure that the food at 15 minutes, if it's not going to go back into a microwave, is in its optimal eating point? What's it look like at 30 minutes when it goes back into the microwave? There is just a tremendous amount of work and investment being made at what I would call the second level that I think is going to pay big dividends. We've invested a lot back into quality and value in our brands. I'm really excited about that. The guests are telling us that they're noticing these changes.

Is kitchen capacity an issue at Olive Garden? I mean, can these step changes happen without you running into bottlenecks and thresholds where the experience is compromised on either off-premise or on-premise?

No, actually the opposite, David, because we've removed a lot of the extraneous products that we were trying to serve that we were getting a half a percent of sales out of. We've really, through our menu and our menu engineering, we are moving the high value, high satisfaction, more of those items through to our guests. The more we make them, the better we get. Actually, everything we're working on today, speed is taken into account at the simplification of that process. You guys have heard me talk about this. You're probably tired of me talking about it. A great kitchen starts with how the product comes in the back door, and you got to streamline all those processes until it gets to the table. During this crisis, we've been able to reevaluate all that activity and all those processes.

We're so far along on that journey today. That's what gives me confidence about the future.

Thank you.

Speaker 2

Our next question comes from the line of Nick Setyan with Wedbush Securities. Go ahead, please. Your line is open.

Speaker 1

Thank you. Congratulations on all the promotions. As the recent months progressed, the strength of the consumer in the context of the dining room capacities was a positive surprise. Is there a way to tease out how strong the consumer now is as the reversals happen and the dining room closures accelerate? Is there a way to tease out whether part of it is also the customer just spending less?

Speaker 0

Yeah. Nick, we haven't really seen a whole lot of difference in our check average. That's one way to think about the consumer and how strong they are. As you look at our week-to-week sales in dining rooms that are open, they're still growing. Now, it's really hard to tease out consumer strength versus people going out for holidays or people actually curbing their spending because maybe they were self-quarantining before Thanksgiving and those kind of things. It's really tough to see that other than the fact that our check really hasn't had a big dip.

Speaker 1

Thank you very much.

Speaker 2

Our next question comes from the line of Andrew Strelzik with BMO. Go ahead, please. Your line is open.

Speaker 0

Great. Thank you. Good morning. Two things for me. The first, just in thinking through what off-premise sales could look like in a normal operating environment, whenever that may be, can you share where sales were on the off-premise side in markets where the dine-in recovery maybe was farthest along or anything you've gleaned from your customer data that's informing your thinking around post-pandemic off-premise sales? The second question is you mentioned adding brands to the portfolio. Has the COVID environment either created more or fewer attractive opportunities for acquisitions or multiples less or more of an inhibitor now than they were before? Just any comments around the M&A environment would be great.

Yeah. First, on the off-premise capacity, what I would say is it's hard to get your arms around it because you still have capacity restrictions in your restaurant if you're living with the six feet. There are still a lot of people that pull up to our doors that realize that we've got an hour of wait, and they transition to an off-premise experience. We really don't have a feel for where that's going to level out. I think I said last quarter, we actually see a scenario where that could actually fall down to below pre-pandemic levels once you open up the dining rooms because there will be less demand for it. We believe it will come back at a higher level than it was pre-pandemic.

We don't have a feel for where that's going to settle in right now because I think everybody's behavior is so modified in this environment. I'm really not going to comment on the M&A environment any further than what I've already said.

Okay. Great. Thank you very much.

Speaker 2

Our next question comes from the line of Andy Barish with Jefferies. Go ahead, please. Your line is open.

Hey, guys. A lot of kind of medium and long-term questions. I just wanted to kind of think about the fourth quarter, given, obviously, there's an impossible number of variables to try to project at this time. If the environment kind of stays the same as it is, I mean, historically, your 4Q has looked a lot like your 3Q. Is that how we should kind of be thinking about things on a high level?

Speaker 0

Yeah, Andy. Our fourth quarter is not that different than the third quarter. We have Mother's Day in Q4. That is a really big day for us. While it is not as seasonally high as Q3, it is not that different.

Okay. Thanks, sir.

Speaker 2

Our next question comes from the line of Brett Levy with MKM Partners. Go ahead, please. Your line is open.

Great. Thanks for taking the time sharing all this information. Congratulations to all of the team members who were elevated and all the people who actually helped them get there. I guess just one data question if you'd be willing to share, and then just a second question on that. The first is on market share. Would you care to share what Olive Garden and LongHorn were X? And if you had any thoughts on positive units just across those two systems. Then just a second question. We've talked a lot about technology and the people. How are you thinking about the physical boxes, the existing ones, the new ones, with all of these transformative issues that you're dealing with, whether it's tech or people or just how consumers are looking and some of the structural issues you dealt with at Olive Garden?

How are you thinking about what you need to do to your current and your future boxes? Thank you and good luck.

Speaker 0

Yeah, Brett. We get the share information pretty lagging. We are usually a quarter behind to see what kind of share we have gained in Olive Garden and LongHorn. I really cannot really comment on that. I would assume that we have gained share based on the industry data. I mean, because we are looking at a total industry, a lot of restaurants are shut down. As far as our boxes, I think the biggest thing that we are looking at right now, and I mentioned this earlier, is that we believe the off-premise experience will be driven by curbside, enabled by technology. We were on a pathway in our big brands to really develop space that is consumer-facing to deal with an off-premise experience where the consumer came into the building to get it.

Now we're really looking at that, and we're trying to develop ways to adapt the current facilities to make that space non-consumer-facing and closer to the kitchen. It should actually cost less longer term as we make these adjustments. We had just built a new prototype in Orlando for Olive Garden with a dedicated consumer-facing off-premise experience more like what I would call a fast casual type restaurant. Now we've determined that's not necessary. That's good news on that. Our team's working real hard to figure out what these adjustments will look like. They'll target those investments in the high-volume off-premise locations, and they'll react and get that done over the next couple of years.

Speaker 2

Our next question comes from the line of John Ivanko with J.P. Morgan. Go ahead, please. Your line is open.

Hi. Thank you. I don't think this was touched on in any of the questions. You did mention technology making, and I think it was field-level management more effective and more efficient. I wanted to explore whether that has been fully implemented in the field and the regional manager ranks and exactly, I guess, how big that could be. Secondly, as you do think about repopulating the restaurants, is there a possibility of changing the mix between manager and hourly employees? Do you think you actually may have an opportunity to run more efficient restaurants from a managerial perspective as we return back to normal?

Speaker 0

Yeah, John, good questions. I think from a technology standpoint, there's nothing we're adding to help our supervision. We've got management information systems that we've been well developed over the years. We continue to evolve those, streamline those, try to get them the most important information that they need to run their businesses. I think the biggest challenge there is how to not give them too much information and paralyze them. I think that'll be one thing that I think Rick will look at in his new role, especially with his technology background, is how to fine-tune that platform to ensure that they're getting the information they need, but not too much information. As far as the team member management mix, I don't see any gain there. We've always been efficient, maybe more efficient than I think a lot of our competitors are at that level.

We use key employees to supplement as a supplement to management, but also as a development program, as a gateway into our management program. I think we're pretty lean there. I don't see how technology is going to change that at all. I mean, I'm always going to want a management person in the business, in the facility, leading these large groups of people. I think the difference in casual dining, and I think it's one of the reasons why it doesn't franchise all that well, is that these are complex businesses with lots of team members. It's not you're not doing this business over a counter. The one thing that off-premise has added is added more complexity as you're dealing with 10 or 12 guests at a time in your parking lot as you're bringing the food out.

The business is, in some ways, getting more complex as you're trying to deliver food through different channels. I don't see a whole lot of cost savings there.

Thanks.

Speaker 2

Our next question comes from the line of Gregory Francfort with Bank of America. Go ahead, please. Your line is open.

Hey, thanks. I'll keep it brief. I just had a follow-up to Palmer's question about the menu. Can you maybe talk about from two quarters ago to today how your thoughts might have changed on re-expanding the menu? You shrunk it quite a bit, and I think customers were okay with that. Are they still okay with it? Have your thoughts on re-expanding it changed at all? Thanks.

Speaker 0

Yeah. Good question, Greg. I think that, obviously, we shrunk it for many reasons, primarily supply chain and just from a labor productivity standpoint. We've been very judicious as we brought the products back. We think through our TURF studies, we think that we've satisfied everybody on any consumer and offer them places that they would want to go eat and eat specific menu. What we've really focused on is eliminating duplicity in the menu where you have a menu item that does the same thing. I took it someone else that I think that has a very broadly appealing menu, but yet limited number of items. You have to go to a Hillstone or a Houston's environment where they touch everything in each category that you might want as a consumer, but they do it with 15 menu items.

I think that's what we're trying to do is to ensure that we don't have duplicative. I think the example I would use is in LongHorn as an appetizer, you don't need both Wild West Shrimp and calamari. It's the same consumer that's going to buy the product. What we're working on is how do we end up with the unique product and a product that you can only get in our restaurant that's very craveable and that differentiates you? Having two products that do the same thing and one's ubiquitous and one's differentiated makes no sense to me. That's how we're thinking about it. Over time, yeah, will it be a product here and a product there? Yes. What you have to have is you have to have discipline. The discipline is you have to take stuff off.

We have not demonstrated that as an industry over the last 15 years. We need to demonstrate that moving forward.

Speaker 2

Thanks, Jim. Our next question comes from the line of Jared Garber with Goldman Sachs. Go ahead, please. Your line is open.

Good morning. Thanks. Congratulations to the team on the respected promotions as well. Just a quick one for me. Wanted to get an understanding of the potential opportunity in the sort of the family ordering or catering business. Is that something that over the long term, when things normalize and consumers tend to come back to the restaurants, is that another business that can be maybe bigger than it was in the past as we think about consumers maybe adopting more of an at-home occasion and in restaurant dining occasion?

Speaker 0

Yeah. We are very strong in that in Olive Garden already. Obviously, we sell pans of lasagna, pans of fettuccine. That's a big part of our business. Where we're seeing some growth right now is in Cheddar's with that business with family packs. We've also had some success in our upscale brands being able to sell family packs or steaks and sides where steaks aren't prepared, but the sides are prepared, and we give you instructions to reheat. We are calling family meals or family packs that are working very well. I think it's something that we had some penetration in in Olive Garden. I think it'll be bigger as we move forward. It's provided us an opportunity in some of our other businesses to get in that business.

Speaker 2

Our next question comes from the line of James Rutherford with Stephens Inc. Go ahead, please. Your line is open.

Hey, thanks for taking the question. Just one quick one for me. Gene, with the technology investments that you all have made around online ordering and curbside, has your view changed at all in terms of the long-term mix of off-premise where perhaps it does end up being a material higher mix longer term compared to where it was pre-pandemic? Or is the view still this is maybe a slight bump, but not huge kind of pre and post-pandemic? Thank you.

Speaker 0

Yeah. I think it's a slight bump. From pre-pandemic levels, I think that, I mean, listen, this was a growing piece of everyone's business as convenience became more and more important. Maybe there's an opportunity for us to take more share in Olive Garden than I think because the experience is going to be so frictionless. We'll get to see what the consumer demand is. What I'm confident in, and especially on the Olive Garden side and somewhat to Cheddar's, is that we will get our share in this business. We will get our share of the off-premise pie. I think we'll do a really good job with it, and it will continue to grow over time.

Speaker 2

Our next question comes from the line of Brian Vaccaro with Raymond James. Go ahead, please. Your line is open.

Thanks. I echo the congrats on your promotions. Just two quick ones for me. I wanted to circle back on the labor discussion, and you spoke to some tech investments. I'm curious what role you think server handhelds could play in the coming years with Florida and others potentially moving towards the path to 15. Perhaps there are other adjustments in the service model that you could see maybe implementing while protecting the guest experience. Just curious to get your thoughts there.

Speaker 0

Yeah. I'm not a big believer in trying to gain too much efficiency on the service side. I mean, I think every time you say you're going to gain efficiency there, you're really saying you're going to cut service. And we're a full-service restaurant. So when I think about the handhelds and technology for the service, I'm thinking more about speed of service for our guests than saving money. I've been doing this a long time. Every time I've tried to increase the efficiency in that part of the restaurant, it doesn't end well for me. I am committed to keeping the service levels up. I think service is a big part of the value equation. That's a differentiator when you come into our restaurant versus going to a fast casual or fast food is we got to provide a service.

There is a level that you want to get to, that minimum level. You want to do it better than your competitors, and you want to earn your business that way. I see the technology solution more as a benefit to the consumer, not a benefit to us from a cost standpoint.

Understood. All right. That's helpful. Then shifting gears quickly on the store margins, Rick, could you provide a little more perspective on the other OpEx line, some more specifics on costs that are starting to normalize versus the lower spend levels in your fiscal Q2? It looks like your guidance for Q3 embed store margins that are in the ballpark of Q2. I know you mentioned emergency pay, but are there other changing cost dynamics that we should be mindful of specifically in Q3 versus Q2? Thank you.

Yeah, Brian. The one cost that will continue to go up is repairs and maintenance. As I mentioned, when we have dining rooms closed, we do not have as much beating of our dining rooms. We will have R&M start to tick up, and it already started to tick up in Q2 as dining rooms reopen. It also gives us the time to actually do some of that repair and maintenance while the dining rooms are closed. We will have some of that coming up. Utilities go up as your dining rooms open, and you have more utilities going that way. Again, that is all contemplated in everything that we have in our guidance.

All right. Thank you.

Sure.

Speaker 2

Our next question comes from the line of Jake Bartlett with Truist Securities. Go ahead, please. Your line is open.

Great. Thanks for taking the questions. Also, congratulations to all. My first one is a quick one on LTOs and marketing. You mentioned that your marketing dollars would largely recover post-COVID. Do you expect to go back to the same sort of cadence you had on LTOs, or are you rethinking kind of your promotional strategy longer term?

Speaker 0

Yeah. We're totally rethinking our promotional strategy and how to effectively use that. There was a lot of good in what we did, and we've realized there was a lot of bad in what we did. There's a lot of activity that goes into those. As we evaluate that after the fact, we believe there's a better way to do that. It doesn't mean that we're not going to do LTOs, but we've been out of them; we were out of LTOs in LongHorn for almost two years pre-pandemic. We have been able to make that adjustment. As we look at Olive Garden, we'll continue to try to figure out what's the best way to use our scale advantage and market that business effectively, but also considering do we need to do six LTOs a year, or are there other ways to do that more effectively?

Got it. My second and last question is you talked about improvements to the business and kind of coming out of COVID, I think, with a better business model. How do you think about—I do not know if you're ready yet to talk about it, but how do you think about the long-term growth algorithm that you've talked about in the past as it pertains to unit growth or maybe margin expansion opportunities? Are we still kind of thinking the 7%-10% EBIT growth, or do you think we should think about that differently longer term?

Yeah, Jake, this is Rick. I think if you think about our long-term framework, we haven't adjusted our long-term framework. As of now, we still believe we can get to those numbers over the long run. As we've always said, any one year could be above or below that. I would hope that FY22 would be above that because of where we were in FY21. In FY21, we're going to be below it. In the long run, which is what we talk about to all of our investors and to all of you, we believe we can hit our long-term framework. I will remind everybody that we've been a public company since 1995. We've never had a 10-year period where our average annual TSR has been below 10%. Even when we—a fiscal period.

Even last year when we had the worst fourth quarter, I think, of any industry and of anyone, at least for us, we still had a 10-year TSR of over 10% on average.

Great. Thanks a lot.

Speaker 2

Our next question comes from the line of Priya Ohri-Gupta with Barclays. Go ahead, please. Your line is open.

Great. Thank you so much for letting me in. Let me just add my congrats to the three of you as well. I was just curious if you could give us some thoughts around how you're broadly thinking about the dividend. I know you mentioned sort of 50% payout relative to this quarter's EPS, but just in light of the upcoming guidance and some of the continued volatility that we're seeing in the external environment, how should we anticipate the dividend sort of progressing going forward? Thank you.

Speaker 0

Yeah, Priya. As we know that dividends are important to our shareholders, we also know that the dividend policy is important to our bondholders. As you think about our dividend and what we do, we typically set it within our long-term framework of 50%-60% of our earnings. The quarter that we just ended was at the low end of that at 50%. We're going to continue to work with the board on what our dividend is going forward. Going farther than this quarter, it's kind of hard for me to say because the board is the one that decides the dividend. We did contemplate what we think our guidance was in Q3 when we set our dividend in Q2. We always look forward to see what we think our cash flows are going to be to ensure that the dividend is safe.

That's why we set the dividend at $0.37 this quarter.

That's helpful. Thank you.

Thanks, Priya.

Speaker 2

Ladies and gentlemen, that concludes today's Q&A session for the call. I would like to turn it back over to Mr. Kalicak.

Speaker 1

Thank you, everyone, for participating. That concludes our call for today. I'd like to remind you that we plan to release third-quarter results on Thursday, March 25, before the market opens with a conference call to follow. Thank you and happy holidays.

Speaker 2

Ladies and gentlemen, this concludes today's conference call. We thank you for your participation. You may now disconnect.