Darden Restaurants, Inc.
Q2 2014 Earnings Call Transcript

Published: 19 Dec 2013

[Operator:]

Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Mr. Matthew Stroud. You may begin.

[Matthew Stroud:]

Thank you, Vicky. Good morning, everyone. With me today are Clarence Otis, Darden's Chairman and CEO; Gene Lee, Darden's President and COO; and Brad Richmond, Darden's CFO. We welcome those of you joining us by telephone or the Internet. During the course of this conference call, Darden Restaurants' officers and employees may make forward-looking statements concerning the company's expectations, goals or objectives. Forward-looking statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update such statements to reflect events or circumstances arising after such date. We wish to caution investors not to place undue reliance on any such forward-looking statements. By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to materially differ from those anticipated in the statements. The most significant of these uncertainties are described in Darden's Form 10-K, Form 10-Q and Form 8-K reports, including all amendments to those reports. These risks and uncertainties include

[Clarence Otis:]

Thank you, Matthew. Industry conditions this quarter are an affirmation that our industry is in a period of significant change. And to better address that change, this morning, we announced the comprehensive strategic action plan that includes spinning off Red Lobster, reducing new unit expansion, a more intensive focus on operating cost efficiency and refining our incentive compensation plan. The actions we're taking are clearly exciting steps forward for Darden, and we believe these actions enhance our ability to create compelling value for our shareholders. Let me touch briefly upon our sales results for this quarter. Once again, LongHorn had competitively strong same-restaurant sales results, and our Specialty Restaurant Group continued to maintain good momentum. Importantly, we also had good same-restaurant sales progress at Olive Garden, which had significant improvement compared to the first quarter and closed its gap to the industry benchmark by a considerable amount this quarter. And Gene is going to discuss Olive Garden's plan and progress against that plan in a little bit more detail in a moment. In contrast to the rest of the business, Red Lobster had significant deterioration this quarter. And we'll discuss our strategic action plan, as Matthew said, further shortly. But first, let me ask Brad to discuss our second quarter financial results in more detail. Brad?

[C. Bradford Richmond:]

Thank you, Clarence, and good morning, everyone. Our second quarter financial results was short of what we expected when we spoke with you in September largely because same-restaurant sales and guest counts were below our expectations. Second quarter financial results were also adversely affected by 2 unusual items that, together, totaled approximately $0.05 EPS. First, there were certain costs associated with the support expense reduction we announced in September. These adversely affected earnings by a net of the benefit by $0.02. Second, there were advisory and other costs associated with the completion of the strategic review that is the basis for the action plan announced today, including the plan to separate Red Lobster. These adversely affected earnings by approximately $0.03. As we look forward to the full fiscal year, our outlook for total sales and earnings has changed since we spoke with you at the beginning of the second quarter. Given the continued industry sales softness and trends at our brands, we now anticipate total sales growth in the range of 4% to 5%. This reflects our expectation that same-restaurant sales for the year will decline 4% to 5% at Red Lobster and 1% to 2% at Olive Garden and increase 2% to 3% at LongHorn Steakhouse. Our outlook assumes that comparable sales for the industry will be flat to down 1% this year, which is about 50 to 100 basis points lower than we had expected before. With our lower sales expectations, we anticipate that diluted net earnings per share will be down between 15% and 20%. The primary reason for this change since we last spoke to you is a downward adjustment in our expectation for Red Lobster for the year. That downward adjustment reflects Red Lobster's first half trend and the potential for some disruption there as we complete the spinoff. The earnings expectation for the year includes the onetime items we incurred in the second quarter but excludes incremental costs incurred during the balance of the year in connection with the strategic action announced today. Now turning more specifically to the second quarter. Darden's total sales from continuing operations increased 4.6% to $2.05 billion. On a blended same-restaurant sales basis, the results for Red Lobster, Olive Garden and LongHorn Steakhouse declined 1.0% in the quarter, with strength at LongHorn Steakhouse offset primarily by weakness at Red Lobster. Olive Garden made good progress but not quite as much as we had anticipated. And we saw continued same-restaurant sales gains in each of our Specialty Restaurant brands with the group achieving a positive 4.1% same-restaurant sales growth on a blended basis. Food and beverage expenses for the quarter were approximately 35 basis points higher than last year on a percentage of sales basis. The unfavorable price increase was driven by higher shrimp and land-based protein costs. For the second quarter, restaurant labor expenses were approximately 65 basis points higher than last year on a percentage of sales basis due to wage inflation, reduced productivity and sales de-leverage at Red Lobster. Restaurant expenses in the quarter were approximately 40 basis points higher than last year on a percentage of sales basis because of higher repairs and maintenance across all brands, higher workers' comp expense and the sales de-leverage at Red Lobster. Selling, general and administrative expenses were approximately 25 basis points lower than last year on a percentage of sales basis due to decreased media expense at Red Lobster and Olive Garden. Depreciation expense in the quarter was approximately 20 basis points higher on a percentage of sales basis compared to last year because of the increase in new units and remodel programs at our larger brands. Our tax rate this quarter at a credit of 9.4% was approximately 30 percentage points lower than the prior year, driven by available tax credits and our tax planning initiatives. We now estimate that our annual effective rate will be approximately 17%, which is about 400 basis points lower than last year's annual effective tax rate. This annual effective tax rate will vary from quarter to quarter, though. In the second quarter, reported total company operating profit margins fell by approximately 140 basis points compared to the prior year. Our cash from operating activities increased -- excuse me, from operating activities increased by over $35 million through the second quarter of the fiscal year as changes in working capital declined as part of our ongoing supply chain optimization cost savings initiative. Now turning to our commodity cost outlook. We have approximately 53% of our total food spend contracted through the end of the fiscal year. That's roughly in line with the 60% we had last year at this time. We have not take -- fully covered our usage through the remainder of the fiscal year because we believe that premiums for future contracts are simply too great given where we expect prices to be in the cash markets as we look out. Food inflation in the second quarter was approximately 2.4%, with shrimp inflation in the high teens and land-based protein inflation in the mid single-digit range. Shrimp inflation is expected to increase in our third and fourth fiscal quarters, primarily related to production issues in Asia. We don't anticipate relief on shrimp until early in fiscal 2015. For the current fiscal year, our expectation is that our commodity basket will see net inflation in the range of 2.5% to 3%, which is about 50 basis points higher, primarily driven by shrimp, than we expected in June but is consistent with the expectation we talked about in September. Now category by category, through the fourth quarter of fiscal 2014, seafood costs are higher on a year-over-year basis with 75% of our usage coverage; beef costs are higher with 55% of our usage coverage; poultry costs are slightly higher with 40% of our usage covered; wheat costs are lower with 30% of our usage covered; and dairy costs are slightly higher on a year-over-year basis with 15% of our usage covered. Our energy costs are expected to be slightly unfavorable on a year-to-year basis, and we have contracted the majority of our natural gas and electricity usage in the deregulated markets in which we operate for the remainder of the fiscal year. And now let me turn it over to Gene to discuss Olive Garden's progress.

[Eugene I. Lee:]

Thank you, Brad, and good morning. Olive Garden continues to make progress towards our goal of renewed same-restaurant sales momentum. Same-restaurant sales results for the quarter trailed the industry modestly, and our same-restaurant guest count results were better than the industry. This represents an improving trend relative to the competition and reflects successful implementation of some early pieces of the brand renaissance plan that Dave George and his team put in place following Dave's appointment as President of the Olive Garden in January. The first phase of the plan involves simplifying operations, systems and processes. Dave and his team have redesigned kitchen processes to reduce complexity in food preparation and on the line. These changes have resulted in significant labor savings. And even more important, they've led to significant improvements in the food we're serving our guests. While some of the labor cost savings are flowing through to earnings, we're using some to fund other improvements in Olive Garden's guest experience with a particular emphasis on elevating the quality of our proteins. In the kitchen, we've also completed the rollout of our new Piaztra [ph] grills, which is a flattop surface grill. It's made our grilling simpler and significantly enhanced our grilling capabilities. Finally, we see a number of other opportunities to further simplify and enhance kitchen operations, and our culinary and operations teams are prioritizing these opportunities. As we work to reduce kitchen complexity, we're also simplifying the front-of-the-house operation. One example is our steps of service at lunch. We have revamped so that our guests can, if they chose to, have a much quicker lunch experience at Olive Garden. As a result of what we've already done to simplify what we do operationally, Olive Garden has seen great improvement in its overall guest satisfaction scores on both a quarterly sequential basis and compared to prior year. Beyond operational simplification, since Dave became President in January, the Olive Garden team has invested considerable time and resources in rethinking the core menu. That team includes Jim Nuetzi, who has been the Executive Chef at Olive Garden for the past year and was Executive Chef at The Capital Grille for the prior 11 years. We're addressing the need our more financially stretched guests have for everyday value by developing more innovative entry price offerings with a keen focus on making sure that these items have great quality and represent meaningful variety. In parallel, to increase our attractiveness to guests who are not financially constrained and want more differentiated Italian fare than we've been offering recently, we've been developing more culinary-forward offerings across a full range of price points but with particular focus on higher price points. From a promotional perspective, we expect to make these new compelling -- we expect to make these compelling new core menu items, both those that target financially constrained guests and that target more financially comfortable guests, the focal point of our promotions. In terms of timing, we have multiple tests of new core menu items and platforms in markets now, and we're very pleased with the initial reactions from our guests. We expect many of these items and platforms to be introduced nationally sometime this fiscal year. Remodels are important part of our future. Remodeling our approximately 400 non-Tuscan farmhouse restaurants is an important part of the brand renaissance plan for Olive Garden, and we have design options we're excited about. The design teams have been focused on expressing today's Italy in a casual dining environment. We'll complete testing over the next several months, and our goal is to remodel 50 to 70 restaurants over the next 12 months. For competitive reasons, I've intentionally been relatively high level about the various aspects of our brand renaissance plan. I can tell you, however, that I'm excited. I'm excited because we continue to make progress on the select few things that, together, will strengthen what, given Olive Garden's industry-leading restaurant level sales and returns, is already a strong brand. And we're confident that improving brand relevance will drive sustained same-restaurant guest counts and sales growth well into the future. What I will promise you is that I'll discuss these initiatives in quite a bit more detail at our Investor Conference in March. Now we'll turn it to Clarence to discuss our strategic action plan.

[Clarence Otis:]

Thanks, Gene. And as I said at the outset, we're very excited about the strategic action plan. It is a comprehensive plan to enhance shareholder value, and we appreciate this opportunity to review that plan with you. To help with that review, we've prepared a short slide presentation summarizing key elements of the plan. And I'll use that to help guide my remarks. Now Matthew has already referenced our disclosure around forward-looking statements, and so we can move right to Slide 3. Darden is a premiere full-service restaurant company with excellent brands and tremendous expertise in the areas that matter most to success in our industry. Following an extensive internal review, our board has approved a new direction forward that leverages our market position, our brands, our expertise and our other assets to better address some important changes in consumer demand and competitive dynamics in the restaurant industry. It's a plan that will help us most effectively increase long-term shareholder value. In developing this plan, we assessed a number of alternative ways to segment our portfolio of brands and leverage our other assets, including our real estate. We're excited about the path we've chosen because it enables us to continue to benefit from the complementary strengths of our brands. We'll be able to generate strong cash flows that support continuation of our current dividend on a combined basis post separation, as well as meaningful growth and return of capital at Darden post separation while funding expansion of the business at a rate that continues to build market share. The first element of the plan is the separation of Red Lobster. Although no final decision has been made on the form of separation, we do expect to execute this transaction as a tax-free spinoff to our shareholders that would close in early fiscal 2015. However, we may also consider a sale of Red Lobster as a potential alternative for maximizing shareholder value. The second element of the plan involves some changes in capital allocation. Now these include reducing capital expenditures through suspension of new unit growth at Olive Garden following completion of a few units that are well down the development and construction pipeline, more limited new unit growth at LongHorn and continuing new unit growth at the Specialty Restaurant Group at a pace that is modestly below this year's level. This will lower our ongoing capital expenditure requirement by approximately $100 million annually, freeing up cash to return to our shareholders. In addition, we're affirming our decision to forego additional acquisitions for the foreseeable future, and that will also help ensure more consistent return of capital to shareholders. The third element of the plan involves increased focus on operating support cost efficiency. The last quarter, we announced our intention to reduce operating support cost by $50 million annually. And since then, we've identified an additional $10 million in savings, bringing ongoing annual support cost savings to at least $60 million. In addition, and perhaps most importantly, we will focus much more intensively on operating support cost reduction as we complete the separation of Red Lobster and following the separation. And we'll do that in order to ensure that our cost structure is as lean and efficient as practical for the business. The fourth element of our plan involves changes in our management compensation incentive plans. Our board has decided to refine those plans, beginning with the performance plans for next fiscal year to more directly emphasize same-restaurant sales growth and free cash flow growth. This is a step that will better align management incentives with 2 performance measures that are even more important given the other changes we're making and that play a significant role in driving shareholder value creation in the restaurant business generally. Again, as we make these strategic changes, we expect that on a combined basis, the 2 companies will maintain Darden's current quarterly dividend level of $0.55 a share. The strategic action plan we're pursuing will significantly enhance shareholder value. By separating Red Lobster from the rest of the business, this plan better enables the management teams of the 2 companies to focus on what are increasingly divergent operating and strategic priorities and quite distinct value creation opportunities. Following the separation, Darden will also have a meaningfully stronger sales and earnings growth profile. And the other elements of the plan will support further return to capital to shareholders, which is going to be key strategic focus for both companies going forward. Slide 4 provides a summary of how we expect the spinoff transaction to work. Again, we anticipate that Red Lobster will be spun off as a separate publicly traded company sometime early fiscal 2015. Now this is all subject to regulatory and third-party approvals, as well as confirmation of tax-free treatment. Post spinoff, we expect the new Darden to use proceeds from new debt raised at the new Red Lobster to retire a portion of Darden's existing debt. This should result in a flat to modest overall improvement in Darden's leverage levels. We currently have an investment-grade credit rating. That rating is very important to us strategically, and we expect the new Darden to preserve it going forward. In addition, we expect new Darden to maintain an attractive, consistently growing dividend. And as earnings grow over time, we should be able to gradually reduce our dividend payout ratio even as our dividend also grows. Again, returning capital to shareholders through share repurchase will also be a priority going forward, and we expect to be able to increase our repurchase level in the near term based on the steps we're taking and then over time as cash flow grows. The new Red Lobster will have a capital structure that's optimized to leverage the strong cash flow generation profile of that business. And we anticipate that this will result in a strong non-investment-grade credit rating. Significant return of capital to shareholders through both dividends and share repurchase will also be a priority at the new Red Lobster, with a stronger bias toward dividends initially. Slide 5 provides an overview of the strategic rationale for the separation of Red Lobster. It's increasingly clear to us that Red Lobster's operating priorities are different in some very important ways from those of the rest of Darden. And these differences stem from the fact that the appropriate guest targets for the 2 parts of the business are increasingly divergent. Now all of our brands have been focused on 2 things

[Operator:]

[Operator Instructions] Our first question comes from Jeff Farmer of Wells Fargo.

[Jeffrey D. Farmer:]

So prior to an activist investor getting involved, I'm curious how many of the business model strategy shifts that you guys outlined this morning have you been considering, and that's specifically the idea of a standalone Red Lobster.

[Clarence Otis:]

Yes, we've actually -- we've been really reviewing the business pretty comprehensively for some time now. And it reflects what we've been seeing in the industry. And so last year was disappointingly -- our last fiscal year, from an industry perspective, disappointingly weak. So the same-restaurant results less than 1% coming after a year that was not particularly strong. We had anticipated something stronger than that. And we also, as we put our plan together for this year, assumed that this year would look like last year. So we did not assume improvement. We thought that was a relatively conservative assumption. And as the year unfolded, it's been even weaker than last year. And in the face of all of that, we've been looking pretty comprehensively at our plan. We've been talking to a lot of our long-term shareholders, and we've been thinking about various alternatives that might make sense in terms of adjustments to our plan. And Red Lobster's been part of that thinking. The separation Red Lobster has been part of it. Our new unit expansion pace has been part of that thinking, and support cost reduction has been part of that thinking. We got further along faster on the support cost reduction part, and so we announced that a little bit in advance of the rest of it. But we've been looking at it for a while.

[Jeffrey D. Farmer:]

Okay. Just one other quick follow-up. Just looking at the numbers, it looks like the majority or at least the lion's share of that combined $60 million in cost management efforts will be at the corporate level. So I'm just curious why you have not been more aggressive or what theoretically is preventing you from being more aggressive at the restaurant level in terms of pursuing cost efforts across management within the restaurants themselves?

[Clarence Otis:]

Yes, and I think a couple of thoughts. One is Gene talked about some of the things that Olive Garden has done as it tries to simplify operations. And the goal is twofold. I mean, one is to improve execution. And we believe we're doing that based upon the consumer satisfaction feedback that we're getting. And the second is to be more cost efficient in the restaurant. And some of those cost efficiencies are flowing through. Some of them we're reinvesting in the guest experience. But Olive Garden, for example, had an operating profit increase this quarter despite same-restaurant sales are a little bit below what we had anticipated. And some of those in-restaurant cost savings are part of that. We are further along at Olive Garden on that score than we are at LongHorn, but that's certainly a focus at LongHorn as well. And it will be more of a focus at Red Lobster.

[Operator:]

Our next question comes from Brian Bittner of Oppenheimer & Co.

[Brian J. Bittner:]

On the business separation, you're separating a business in Red Lobster that has been a major headwind on your performance. But the decision to keep Olive Garden in this new DRI is a big decision because its performance was such a large sensitivity factor on the earnings profile of the new DRI, and it doesn't necessarily completely separate or allow the growth brands that are performing well to be in their own dynamic. It will likely still be a company that as Olive Garden goes, so goes the company. So the first question, I think, number one, and I'll have a follow-up after this, is why exactly do you want to keep Olive Garden in that portfolio and not separate it as well? Same-store sales were still negative this quarter against what were pretty easy comparisons. And I know traffic outperformed the industry, but we're still dealing with the negative comps there.

[Clarence Otis:]

Yes, I touched upon a little bit of it earlier. So I mean, the priorities really at Olive Garden away from unit growth are very similar to the priorities at the other brands. So we're trying to make sure we maintain relevance to our core consumers and that we broaden our reach to some other consumers that are in some pockets of strength. And we're seeing Olive Garden be able to do that. And so all the support that we have, the integrated support structure that works operationally for our other brands works operationally for Olive Garden. The other thing I would say is that Olive Garden has always been, and is today, a significant piece of the Darden story. So that doesn't change. Olive Garden's sales and earnings results, though, are much less volatile than Red Lobster's. And so we don't see the same volatility going forward. And the other thing is that Olive Garden's cash flow growth as we stabilize same-restaurant sales, even without unit sales, is significant. And it really benefits the rest of the brands to have not just that absolute cash flow generation but that growth in cash flow. And it benefits shareholders because it drives growth, meaningful growth, along with the new unit growth at the balance of the business and free cash flow.

[Brian J. Bittner:]

Okay. And what was impressive is under a slightly negative comp, not only was the operating profit margin was up at Olive Garden and the absolute profits were up. Is there any way you can comment on the magnitude that operating profits were up at Olive Garden in the quarter?

[Clarence Otis:]

Brad?

[C. Bradford Richmond:]

Yes. I think first off, that speaks to the part of the earlier question. There's cost savings occurring in the restaurant. A lot of that is being reinvested beyond the $60 million that we talked about. But I would say from a margin perspective, it was pretty significant both in terms of the basis points. We don't get to brand specifics, but it was meaningful for us. And obviously, with the new unit growth, which those [ph] new unit growth, they're profitable sales growth, the magnitude of the absolute profit was something that we're pleased with the progress. As Gene said, we're excited with where we are and where we can go forward from here. So I'm feeling much better about where the brand is. And as Clarence mentioned earlier, they're further along than LongHorn in making some of these moves that we've talked about. So we're pleased.

[Brian J. Bittner:]

Great. And just lastly, do you know when we might get a full Red Lobster P&L?

[C. Bradford Richmond:]

No, that's something we're in the process of right now. So we need to get to the audited process to really share those given the nature of what we're talking about. So it will be probably a couple of months out, but as soon as we have those available, we will start the share those with the investment community.

[Operator:]

Our next question comes from David Palmer of RBC.

[David Palmer:]

I have 3 super short questions, which I'll just rattle off to you guys. Darden owns, I believe, about 50% of the land, 85% of the buildings across the business. How is that different at Red Lobster? My sense is it might be higher than that. That's first. And second, can you spin off this Red Lobster business without overhead de-leverage to the remaining co.? And third, can you give a little bit more detail about the executive incentive structure and how that's changing?

[Clarence Otis:]

I'll start with the second and third and let Brad answer the first on real estate. And so there are -- there is some additional support cost that we would incur as a consequence of the separation. We are working to minimize those. So Red Lobster is going to be a lean organization as a standalone company. And Darden, excluding Red Lobster, would be a leaner organization beyond the cost savings that we've already announced. We're not in a position at this early stage really to give a sense of the magnitude of that. That is something that we will get into, though, as we get further along. But we feel confident that we can minimize those incremental support costs that come with having 2 companies. The third question was on incentives. So from an incentive perspective, right now, our incentives are driven by sales growth and earnings growth. So both our annual incentives and our multiyear performance stock units. And we would expect that same-restaurant sales would be part of the annual incentive as opposed to total sales. And then we are looking to have a measure of free cash flow growth for the multiyear, where we think that, that's appropriate as opposed to earnings per share. But there's still some work to do there from the board's perspective to settle on the specifics, and we'll update you on those as the board reaches some final conclusions.

[C. Bradford Richmond:]

Now on your first part of the question, we detailed some of that on Slide 7 of the presentation. So you can see, with where we are today of the 705 Red Lobsters, 473 of those would be where we own the real estate. So that's just a little under half of Darden today's owned property. So a lot of it will move to Red Lobster. The remainder of the Red Lobster units are virtually all land leased and that we own the building on those.

[Operator:]

Our next question comes from Todd Duvick of Wells Fargo Securities.

[Todd Duvick:]

First of all, I appreciate your comments about the plans to pay down debt and maintain your investment-grade credit rating. And I guess just one question I have related to that, can you tell us if you've vetted this with the rating agencies? And if not, when do you plan to talk to them about your plan?

[Clarence Otis:]

Yes, we've been in dialogue with them. And so we've received some feedback. We're continuing to share information with them. Obviously, they're going to make their own determination. But we have a good track record from the past of working to take the actions that we think are necessary to preserve investment credit profile. We know it's very important from a strategic perspective. And so on the new Darden side, we will continue to work aggressively to ensure we retain that type of profile.

[Todd Duvick:]

Okay. And then just with respect to with respect to the Barrington proposal. They talked about the formation of a REIT for the real estate. Is that something that is in consideration of -- with Darden management currently?

[Clarence Otis:]

Well, as we conducted this review, one of the things we did was evaluate the potential for a REIT. And as we went through that evaluation, we believe that the value creation opportunity is limited. And we believe that, that's the case because the Darden REIT may trade at a lower multiple than others so the net lease REIT and the substantial debt breakage cost that are involved. And so that is not something that we think makes sense going forward. And we think the plan that we've outlined is a plan that best creates shareholder value.

[Operator:]

Our next question comes from Michael Kelter of Goldman Sachs.

[Michael Kelter:]

Yes. I guess first question, you're halting all Olive Garden unit growth at this point. Is this, in your view, a temporary move given your current situation and you expect to grow units again in the future? Or have you come to a new conclusion about the brand's unit growth opportunity from here?

[Clarence Otis:]

No, I think it's really that we think the focus at Olive Garden needs to be on regaining same-restaurant momentum. And so this is a suspension really that would last the next 3 years at a minimum. So that's what we see. In terms of the ultimate unit potential, we think the ultimate unit potential is still much higher than where we are today. And the reason we think that is as we look at the units that Olive Garden's -- the new units that Olive Garden's opened over the last 4 years, they exceed -- despite the slump at the business overall in the last couple of years, those units still exceed our return hurdles from a return on capital investment perspective by a substantial amount. But the key priority right now is to make sure that the base business is as strong as possible. And we think that suspension of new unit growth is appropriate to do that. And we also think that it's appropriate because it boosts free cash flow and enables us to return more capital to shareholders near term and improve our credit metrics, both of which are very high priorities over the next several years.

[Eugene I. Lee:]

Mike, I would just add that this is about focus in Olive Garden right now, and this allows us to take some resources that we're spending time on opening 15 to 20-plus restaurants a year and put them on the this brand renaissance project, which we're -- again, as I said, we're very excited about. And so to me, it's really about just focusing on regaining same-restaurant sales momentum. And this is an important part of that effort.

[Michael Kelter:]

The other question I had is you mentioned in your prepared remarks that SG&A was lower this quarter from reduced marketing expenses at Red Lobster and Olive Garden. Is that just the timing of initiatives or have you decided to reduce your annual budget for marketing for the brand more broadly?

[Clarence Otis:]

Yes. I would say it's 2 different answers. So for Olive Garden, that's just timing. For Red Lobster, we believe there's an opportunity to reduce marketing as a percent of sales. Over the last couple of years, it's floated up higher than is sustainable. And that's going to be a key focus area for the new Red Lobster going forward. Olive Garden marketing as a percent sales is in a place that makes sense for a national brand.

[Operator:]

Our next question comes from Joe Buckley of Bank of America.

[Joseph T. Buckley:]

You had said in the presentation that you gave us that the key to whether this could create value or not is on those operating income growth numbers, low- to mid-teens at the new Darden and mid- to high-single digits at the new Red Lobster. Why are those credible given the track record?

[Clarence Otis:]

Well, we think that the key at the New Darden really is to stabilize same-restaurant sales growth at Olive garden. And we are confident in the plan we've got to do that. We also will get past some of the onetime headwinds that we've got that have depressed earnings such as some of the incentive resets that we've talked about in the past. But we think the key really is to stabilize sales at Olive Garden. We're seeing improvement relative to competition. And so as we said, we're closing that gap. We've got other things in the pipeline that Gene talked about that give us confidence we'll continue to close it. At Red Lobster, we believe that the focus that they will get on target guests, on core guests, as a result of the separation will make a significant difference that they have been, along with the other brands, really trying to broaden the reach that works for the other brands. It's been working. They are broadening their reach. Red Lobster has not had success there. And so additional focus on core guests and away from sort of trying to broaden reach, we think, will help Red Lobster significantly.

[Joseph T. Buckley:]

So when you look at those 2 growth metrics, the ones at the New Darden and the ones at the new Red Lobster, what kind of Olive Garden same-store sales growth do you need to get to mid- to high-teens operating income growth? And what kind of Red Lobster same-store sales growth do you need to get to mid- to high single digits?

[Clarence Otis:]

I'd say in each case, 1% or 2%.

[Operator:]

Our next question comes from Jason West of Deutsche Bank.

[Jason West:]

Just a couple of modeling questions. I didn't quite see if you guys put it in the presentation. But how much of the dividend and the balance sheet debt will sort of get allocated to Red Lobster under the new structure?

[Clarence Otis:]

That is still to be determined. So until we are further along in the audit work, of course, we can't answer yet. But we will provide that information as soon as it's available.

[Jason West:]

Okay. And then I think there was $260 million EBITDA number for Red Lobster. I don't remember if that was LTM or if that was fiscal '13, but I'm assuming you guys are modeling that number quite a bit lower for fiscal '14. I mean, any sense of what that number is going to look like on a run rate basis for Red Lobster given the new guidance today?

[C. Bradford Richmond:]

Yes. What we're showing there, I should remind everyone, is unaudited financial results. So that's going to change some. But that's a good basis to work from. And as we talked about for the current year, the lower same-restaurant sales expectation of Red Lobster, there is about a flow-through that lowers sales expectations, 30% to 35%. And so to your point, it will be lower but not as dramatic lower as folks may think. And it tends to be an opinion of the impact of same-restaurant sales for Darden. 1% across all brands for an annual basis is about $32 million, $33 million in operating cash flow. So it is important to the health of the brand, but it's not as dramatic as its impact on the overall operating profit in the near term. So I'd just remind you that until we can get out and share more specific numbers on those measures.

[Jason West:]

That's helpful. And just one other quick one. Clarence, you mentioned the REIT structure and you looked at that and you said Darden, you think, would have a lower multiple than other REITs and there would be substantial debt breakage costs. Can you just talk a little bit more about those 2 factors and what that means in terms of why the REIT doesn't make sense exactly?

[Clarence Otis:]

Yes, we don't want to get into the analysis. But as we look at comparable REITs, certainly you have to discount for the fact that there's very little -- no diversification, really, in a Darden REIT, and the debt breakage costs are hundreds of millions of dollars.

[Operator:]

Our next question comes from Will Slabaugh of Stephens.

[Will Slabaugh:]

I want to go back to the cost savings initiatives you have and how we should think about that $60 million number. And should we think about that as a maximum number of cost savings that you're willing to take out of the business before being concerned you would negatively impact the guest experience, I guess, is the first part of that. And secondly, can you address the additional field personnel that you explained the need for at the most recent Analyst Day and then how you're thinking about that right now?

[Clarence Otis:]

Yes, I would say a couple of things. One is that we don't think of it as a maximum, actually. We think there's opportunity. We'll be working hard against those opportunities through the separation process and afterwards. And it really is about being more cost efficient in the support areas that are not those areas where we're making -- we have made significant investments. So we have invested in some new capabilities in order to broaden our reach, digital capabilities, marketing capabilities. But the support cost away from that is where we're taking a very hard look and we think there's more opportunity. What I'd say just as a final piece is in terms of the new capabilities, we don't think that there is incremental investment that needs to be made. We've gotten where we need to be. And so at this point, it really is about getting the benefit of those additional capabilities.

[C. Bradford Richmond:]

Yes, and your question on the field capabilities we've added, we have relooked at that and continue to modify the operations structure to become a little bit more efficient. But we are pleased with where we are operationally at this point from a structure standpoint.

[Clarence Otis:]

And I would say the last thing is as we look out, some of the new marketing and digital capabilities that we've added, really our designed to enable us to have much more robust one-on-one conversations with guests. And as those scale up, we would expect our television marketing expenses to scale down dramatically. And so it is an upfront investment in really trying to meaningfully improve the business model down the road.

[Operator:]

Our next question comes from Greg Hessler of Bank of America.

[Gregory Hessler:]

I realize not everything is set in stone at this point. I mean, are there any sort of qualitative comments that you can offer on Red Lobster's going to be a high-yield, mature brand? What do you think is the appropriate amount of debt and leverage might be at that entity? I'm just trying to figure out how that entity might be capitalized once you execute on these plans? And then I have one follow-up.

[Clarence Otis:]

There's still a lot to be determined there as we work through this, but I would start with the new Darden piece. The importance of this investment-grade credit profile there, work very hard to maintain that and be in a position to continue that going forward. On the Red Lobster piece, as you've seen, barring a bit of near-term headwinds, its annual cash flows are quite substantial. They're pretty durable. And as we look at it, it's not going to have a need to fund growth. Its CapEx will be greatly reduced. And so it will have a debt load that probably positions it below investment-grade profile. So we're looking at it right now but not dramatically below that. And so still more to come on that. But that's how we view it as we look at it today.

[Gregory Hessler:]

Okay. And then have you thought at all about how you plan to sort of monetize that spinoff? I think Red Lobster's been in the portfolios for quite a long time, maybe since the '70s or so. So I would imagine that the tax basis there is relatively low. And in that case, if you want to monetize it, would you have to do something like a debt exchange? I mean, I'm not sure how much you guys have thought through the details there or what you're willing to share today, but I think a debt exchange often allows you to monetize the asset in excess of the basis. So any comments that you would have there?

[Clarence Otis:]

Yes, you're getting quite detailed and quite technical. But yes, we have reviewed those. We've been well advised, and we are looking at exploring those options to make sure that we maximize shareholder value through this transaction. I'd say just stepping back a little bit from some of the finer points is we do expect this to be a tax-free exchange transaction for our shareholders, and we will take advantage of whatever planning opportunities are there to minimize debt cost, debt load for Red Lobster and make sure that we get the greatest shareholder value out of the opportunity as well.

[Operator:]

Our next question comes from Jeffrey Bernstein of Barclays.

[Jeffrey Andrew Bernstein:]

Just a couple of questions as well. First, I'm just wondering, on the real estate side of things, you addressed the -- your concern around the REIT. I'm just wondering whether there was a sale leaseback considered at all or whether or not you can walk us through why might that not work. Separately, the second question, I was just wondering on Red Lobster -- or actually, Olive Garden as well, whether you consider holding Red Lobster and/or franchising either one of the brands. I know that's been talked about as maybe an option, especially for Red Lobster. It's such a mature brand and fundamentals have been slowing. And then lastly, I'm just wondering why maybe LongHorn unit growth is being slowed. It seems like we're only halfway their maturity and the performance is strong. Just wondering whether it's something to do with the real estate or what might keep you from -- or why slow down at LongHorn growth.

[Clarence Otis:]

Yes. And I'll start with the last 2. And so at LongHorn, it was very important for us to get to a scale where we could have national cable advertising, and we reached that scale. And to get to that scale, as you think about the balance between the pace of expansion and talent pipeline, we'll lean into expansion and take a little bit more risk on talent pipeline. Now that we're there, we feel like we don't have to take that risk on talent pipeline. So we want to be at a pace that really enables us to be pretty confident as we put the management teams in place, and we're there. In addition, as we said, we think that in the environment we're in, return of capital to shareholders is a more important value creation lever. And we like to improve our credit metrics, and slowing growth at LongHorn contributes to both of those. In terms of franchising, when we looked at the Olive Garden and the returns at Olive Garden, we like to own 100% of that return. I mean, it's the highest returning brand in our portfolio. Essentially, Olive Garden and Capital Grille, the 2 of them have the highest returns. And so we don't really see a whole lot of value creation in giving those returns to shareholders -- to franchisees. Red Lobster has a different return profile. It's got more variability in returns within its portfolio, and so franchising is something I'm sure that Brad and Kim will take a pretty hard look at.

[C. Bradford Richmond:]

Yes. And well, let me just add one comment to Clarence's on the LongHorn pace. You've heard us talk about reaching national cable media. This is the first year now that they have that through all of their promotional cycles. And so that's why the timing of this one works out where it does. Like you said, it's the balance that we need given where we are in terms of unit growth and talent pipelines. On the sale leaseback, as Clarence mentioned earlier on, we have an ongoing discipline of looking and reviewing for strategic opportunities. And we've always seen in the past that sale-leaseback opportunities, given where Darden was and our access to lower-costing public company debt given our credit profile, they just haven't made sense. As a part of this review, we went back and looked at that again. And really, it hasn't changed a lot, and so it still doesn't make sense for us at this point. Like I said, it's a new opportunity for Red Lobster. We're going to review that even more in depth down the road, but nothing I would expect immediately. And we didn't see things that made sense. So it's not something that's high on our list right now. But we're always out there looking. And if conditions were to change, we would not hesitate to look at that.

[Operator:]

Our next question comes from Priya Ohri-Gupta of Barclays.

[Priya Ohri-Gupta:]

I just wanted to go back to a comment you made around your overall leverage being flat to modestly improved at Darden. Just given sort of the shrinkage in the existing profile of new Darden, how much flexibility will you have to, let's say, actually decrease debt more if necessary, potentially flexing some of the share repurchase you're looking to do in order to maintain the rating?

[Clarence Otis:]

Yes. I would point to 2 things real quickly. And that is around the reduced CapEx. We talked about a range of $100 million, maybe even a little bit above that. And so that provides a fair amount of flexibility. And as you've seen in this year's financial results, the second quarter, the operating CapEx, even in a tough environment like this, continues to grow and improve above prior years. So we've seen a couple of big levers to continue to improve operating cash flows outside of -- or excuse me, total cash flow outside of just the straight operating performance that we have.

[Priya Ohri-Gupta:]

Okay, that's helpful. And then as we think about, I guess, just the Red Lobster piece, if we were to explore a sale, would sort of the use of proceeds, I guess, be consistent with some of your thoughts around separation?

[Clarence Otis:]

Yes. We would look at that, and you'd see that greatly go to reducing debt, as well as the balance of that as return to our shareholders. We don't know exactly what form that would take at this point in time, and there's more to be learned. But we do know we need to work on both sides of the debt profile but also maintain a strong return to equity holders as well.

[Matthew Stroud:]

That's all the time we have this morning for questions. We'd like to thank everybody for joining us. We recognize there's still some folks in queue. We'll be happy to try to answer your questions throughout the day here. We appreciate you joining us, and we look forward to speaking with you in March following our third quarter earnings release. Thank you.

[Operator:]

This concludes today's conference call. Thank you for participating. You may dial in to hear the replay of the conference today by toll-free number of [phone] or the toll number of [phone]. And again, this concludes today's conference call. You may now disconnect at this time.