Darden Restaurants Earnings Call Insights: Same-Restaurant Traffic and Margins Outlook

Darden Restaurants (NYSE:DRI) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Same-Restaurant Traffic

Michael Kelter – Goldman Sachs: So, Clarence, you said that growing same-restaurant traffic was Darden’s top priority, and I guess I’m wondering what length you’re willing to go to achieve that goal. Would you actually be willing to sacrifice and potentially rebase your restaurant level margins lower at any or all of the concepts to achieve traffic growth if it came to that?

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Clarence Otis Jr. – Chairman and CEO: Michael, we do believe that same-restaurant traffic growth is critical. I mean, that ultimately is the best measure of brand health and I mentioned and we talked about at our Analyst meeting that we’ve seen deterioration and same-restaurant traffic in the industry and at our brands and so we talked about the period from fiscal 2008 through fiscal 2012 with industry decline cumulatively up 20% and our brands declining about half of that 10%. And that’s an issue we’ve got to address and so we need to do, what we need to do, from a guest experience perspective, both affordability and the things that we’re delivering to really reverse that trend for our brands and get back same-restaurant traffic growth. To the extent that that puts pressure on the restaurant level margins that’s the pressure we’re willing to accept. Now we’ve got restaurant margins, restaurant level margins that are very high, at our brands, from a competitive perspective. So we’ve got some room there especially at Olive Garden where the restaurant level margins even with some of the erosion we’ve experienced recently continue to be the highest in the industry as high as Capital Grille. So, we’re prepared to accept some pressure on margins at that level, to really renew same-restaurant guest count growth.

Michael Kelter – Goldman Sachs: Then maybe as a follow-up specific to Olive Garden. In the quarter sales were up 5% with positive same store sales and then unit growth, but operating profit dollars were actually down as per the release and profit percentage was down. How much was Olive Garden, profit percentage down and in terms of the operating profit dollars being in decline. I mean what kind of same-store sales you need given the investments you are making for that to be a positive number or should we just expect that dynamic to continue for a while…

Clarence Otis Jr. – Chairman and CEO: I will let Brad follow-up but the – we don’t get into the specifics but the dollars were down single-digit on a percentage decline basis. So we’re not talking about dramatic differences. And the operating profit as a percentage of sales reflects that. Again Olive Garden’s margins are pretty high and so we have some room there.

C. Bradford Richmond – SVP and CFO: I think if you look at our business model what’s capable of going forward, I think 2014 is a good example of that. When you set aside the incentives and ACA-related cost, we’re talking about on a check growth of around 1%, pricing of 1%, that we’re able to very modestly grow margins. So we’re somewhere around that 1% or maybe even slightly less that we need in pricing given the improvements that we’ve made over time in our cost model; somewhat aided by the transformational cost initiatives that we’ve talked about that allow us to price at a little bit lower-level and maintain the margins that we have today.

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Andrew H. Madsen – President and COO: And I would say that that number that Brad just gave you excluding those big adjustments. Also as you are aware, we’re seeing pretty significant beef inflation that we’re not pricing for at LongHorn and so that has put some downward pressure as well.

Margins Outlook

Brian Bittner – Oppenheimer & Company: The question here is on margins. On this type of comp growth that you had this quarter, I would have expected less deleverage, and the restaurant level margin deleverage was pretty similar on a year-over-year basis to last quarter when comps were really down almost 5%. Both labor and other costs really spiked pretty dramatically on a same-store basis in the quarter, so there was much more than a negative margin mix dynamic going on. It seems as though there’s actually a lot of new costs that are entering the model. So if you could just talk a little deeper on what those are and how you’re going to work to improve those dynamics, because I know, Clarence, you keep saying there’s a lot of room, but we want to see margins – try to see what you guys can do to get margins to go higher even despite the fact that they are still high to start?

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Clarence Otis Jr. – Chairman and CEO: Yeah, I would say, then Drew can follow-up. I think Brad dimensionalized one other things, which is compared to where our expectations were entering the quarter we have labor at Red Lobster. It was about $8 million higher than we thought. And that had to do with a couple of things that he mentioned; one was a little bit more complexity, and the menu for Lobsterfest than we anticipated. And the other factor that Brad mentioned was that we were making some adjustments to the model through the year to reverse out some changes that we’ve made. And there was reduced productivity as we went through that transition. So those, we think of it as one-time in this quarter and that was part of it. And then on one of the other line items, we talked about the fact that we do have to mark-to-market some employee benefit plans that are basically securities-based, fixed income securities and equities, and so that takes down operating margin, but those are hedged on an after-tax basis, and so we do get a benefit at the tax level, so there’s some geography there.

Brian Bittner – Oppenheimer & Company: Now, was that in the labor line or was that within the four-wall line or was that in G&A?

Clarence Otis Jr. – Chairman and CEO: It’s in both places. Depends on which employees, so there is some of that – some of those benefit plans are for restaurant managers and multilevel supervisors and some are for others, and so it winds up in both places.

Brian Bittner – Oppenheimer & Company: And then the last question is just the guidance. So, it’s a little below what the initial outlook was at the Analyst Day. I’m just wondering what’s really changed in your thinking sense, because I assume comp sales outlook has not gotten worse, maybe, in fact, gotten a little bit better since then. So, what is it that’s really surprising you that cause you to on a year-over-year basis slightly bring down that outlook?

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Clarence Otis Jr. – Chairman and CEO: I’d say two things. I mean, one is the one that Brad mentioned, which is given the production issues that cropped up in so many Asian shrimp farms, inflation – food inflation costs, about 50 basis points higher I think than we were thinking when we talked to you in February. Now, solutions have been developed for that and so we would expect that the farms will implement those solutions and this is temporary but the fact of the matter is that we will see that in the first half of the year. Then the second is we talked at the analyst meeting about blended same-restaurant sales growth for Olive Garden, Red Lobster and LongHorn Steakhouse of between 1% and 2%. Our current thinking is a broader range. So, we’re talking about between flat and 2%. And so although we had a very strong fourth quarter from a comp perspective, the industry was really pretty sluggish. And so, we think at this point in the year as we build plans we need to be conservative because we have seen a cycle over the last several years where we had some encouraging spring followed by some challenge through the summer into the fall, and we have to be prepared for that.

A Closer Look: Darden Restaurants Earnings Cheat Sheet>>