達登餐飲 (DRI) 2015 Q1 法說會逐字稿

Welcome to the first-quarter earnings release conference, and thank you for standing by.

At this time, all participants are in listen-only mode until the question-and-answer portion of the conference.

(Operator Instructions)

The call is being recorded today.

If you have any objections, you may disconnect.

Now I will turn the call over to your host, Mr. Matthew Stroud.

Mr. Stroud, thank you.

You may begin.

Thank you, Ms. Heller.

Good morning.

With me today is 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 regarding our expected earnings performance and our ability to execute on our brand renaissance plan and all other statements that are not historical facts, including without limitation, statements concerning our future economic performance, plans or objectives, and expectations regarding the sale of Red Lobster.

Benefits to Darden and shareholders from such sale and related matters are made under the Safe Harbor provisions 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, except as required by law.

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 the ability to achieve Darden's strategic plan to enhance shareholder value, including realizing the expected benefits from the sale of Red Lobster; actions with activist investors and the costs and disruption of responding to those actions, including any proxy contest for the election of directors at our annual meeting; food safety and food-borne illness concerns; litigation; unfavorable publicity; risks relating to public policy changes and federal, state, and local regulation of our business, including healthcare reform; labor and insurance costs; technology failures; failure to execute a business continuity plan following a disaster; health concerns including virus outbreaks; intense competition; failure to drive sales growth; our plans to expand our smaller brands, Bahama Breeze, Seasons 52 and Eddie V's; lack of suitable new restaurant locations; higher than anticipated costs to open, close, relocate, or remodel restaurants; a failure to execute innovative marketing tactics and increase advertising and marketing costs; a failure to develop and recruit effective leaders; a failure to address cost pressures, shortages, or interruptions in the delivery of food and other products; adverse weather conditions and natural disasters; volatility in the market value of derivatives; economic factors specific to the restaurant industry; and general macroeconomic factors, including unemployment and interest rates, disruptions in the financial markets, risks of doing business with franchisees and vendors in foreign markets, failure to protect our service marks or other intellectual property; impairment in the carrying value of our goodwill or other intangible assets; a failure of our internal controls over financial reporting or changes in accounting standards; inability or failure to manage the accelerated impact of social media and other factors; and uncertainties discussed from time to time in reports filed by Darden with the Securities and Exchange Commission.

A copy of our press release announcing our earnings, the Form 8-K used to furnish for release for the Securities and Exchange Commission, and any other financial and statistical information about the period covered in the conference call, including any information required by Regulation G, is available under the heading Investor Relations on our website, www.darden.com.

We plan to release FY15 second-quarter earnings and same restaurant sales for fiscal September, October, and November 2015 on Friday, December 19, 2014, before the market opens, with a conference call shortly after.

We released first-quarter earnings this morning.

These results were available on PR NewsWire and other wire services.

Brad will review the P&L in some detail and discuss our financial outlook for FY15.

Then Gene will discuss the operating performance, a summary of the brands, and after Gene speaks, we'll take our questions.

With that, let me turn it over to Brad.

Thank you, Matthew, and good morning, everyone.

Our first-quarter financial results were slightly ahead of what we expected when we released our quarterly guidance in August, largely because of the better same restaurant sales performance at Olive Garden in the last two weeks of the fiscal month.

As we reported this morning, our diluted net loss per share from continuing operations for the first quarter was $0.14.

On an adjusted basis, our diluted net earnings per share from continuing operations for the fiscal first quarter were $0.32.

Adjusted results exclude approximately $0.02 of the Red Lobster-related shared support cost incurred in June and July that moved to Red Lobster with the sale of that business, approximately $0.03 of costs related to other aspects of the Company's strategic action plan, approximately $0.04 related to restaurant impairment charges, and approximately $0.37 of debt breakage costs related to the planned retirement of $1 billion of the Company's debt.

Darden's first-quarter sales from continuing operations increased 4.2% to $1.6 billion.

On a same-restaurant sales basis, LongHorn Steakhouse increased 2.8%, while Olive Garden declined 1.3% for the quarter, and we saw continued same-restaurant sales gains in our specialty restaurant group with a 2.1% increase in same restaurant sales on a blended basis.

Food and beverage expenses for the first quarter were approximately 180 basis points higher than last year on a percentage of sales basis.

This unfavorability, which we expect to largely subside as the fiscal year progresses, was driven by three factors: first, dairy, seafood, and beef costs were sharply higher on a year-over-year basis, and we expect some of this to continue through the end of the calendar year.

Second, year-over-year Olive Garden promotional margins were unfavorable.

However, we don't expect this to continue, given our plans for the rest of the fiscal year.

Third, while the core menu enhancement at Olive Garden that we made last February served to broaden its appeal, they do have a slightly unfavorable impact on cost of sales as a percentage of sales.

For the first quarter, restaurant labor expenses were approximately 20 basis points lower than last year on a percentage of sales basis, due to sales leveraging.

Restaurant expenses in the quarter were approximately 10 basis points lower than last year due to pre-opening and sales leveraging.

Selling, general, and administrative expenses were approximately 80 basis points lower on a percentage of sales basis due to sales leverage and the impact of our cost-savings initiatives that we have undertaken in the past year.

There are an additional 50 basis points of costs associated with the shared services that transferred to Red Lobster and the strategic action plan cost included in this line item.

So excluding these items, SG&A expenses would have been 9.5% of sales in the first quarter.

Depreciation expense in the quarter was approximately 10 basis points higher on a percentage of sales basis compared to last year because of the increase in new units.

Interest expense was 480 basis points higher than last year as a result of breakage costs of approximately $80 million related to retirement of $900 million of the Company's debt.

There will be an additional $100 million of debt retirement at the beginning of our fiscal second quarter, which will also have an incremental breakage cost of approximately $10 million.

Now, there are a number of moving parts in interest expense for this quarter, but as we look forward, we expect interest expense in the low $20 million each quarter.

Our tax rate this quarter was driven by earnings loss attributable to the aforementioned breakage costs or debt breakage cost.

The Q1 tax rate was about 18% to 20% when you adjust out that cost of debt retirement.

We now estimate that our annual effective tax rate will with be approximately 10%.

This annual effective rate will vary, though, from quarter to quarter.

And as you look at our adjustments, I would mention that our marginal tax rate does remain at approximately 38% as we look forward.

Now, turning to our commodity cost outlook.

We have approximately 74% of our total food spend contracted through the second quarter of FY15 and 38% of our total spend through the end of our fiscal year, which is about normal at this point in the cycle for us.

We have not fully covered our usage through the fiscal year, because we believe the premiums for future contracts are too great given where we expect prices to be in the cash market as we look forward.

Food cost inflation in the first quarter, net of cost savings, was approximately 3.9%, driven by the dairy and seafood inflation in the high teens.

For the fiscal year, our current expectation is that our commodity basket will see net inflation in the range of 2% to 2.5%, which is at the higher end of the range we anticipated in June.

We anticipate that food cost inflation will moderate in calendar 2015; that's the second half of our fiscal year.

Category by category through the second quarter of FY15, beef costs are higher on a year-over-year basis,with 55% of our usage covered.

Seafood costs are higher on a year-over-year basis, with 92% of our usage covered.

Poultry costs are lower on a year-over-year basis, with 95% of our usage covered.

Wheat costs are lower on a year-over-year basis, with 100% of our usage covered now.

And dairy costs are higher on a year-over-year basis, with 50% of our usage covered.

Our energy costs are expected to be slightly unfavorable on a year-over-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 second quarter of FY15.

As we look ahead to the fiscal year, our outlook for total sales and earnings remains the same as it was when we spoke to you at the beginning of the first quarter.

We expect same restaurant sales growth for Olive Garden to be flat to plus 1%.

LongHorn Steakhouse of plus 1% to plus 2%, and our specialty restaurants at approximately plus 2%.

We anticipate diluted net earnings per share from continuing operations of $1.74 to $1.84 for FY15, consistent with our previous expectations but adjusted for the shared support costs included prior to the sale of Red Lobster that moved with Red Lobster for the sale, the costs we continue to incur in connection in implementation of our strategic action plan, asset impairments and the debt breakage cost incurred in the first quarter and some that occur in the second quarter.

Adjusting for these items, we continue to anticipate diluted net earnings per share from continuing operations of $2.22 to $2.30 for the year, which excludes the cost I just mentioned.

And now with that, I'll turn it over to Gene to comment on Olive Garden, LongHorn Steakhouse, and the specialty restaurants.

Thanks, Brad, and good morning.

Let's start with Olive Garden's first-quarter performance and our progress on the brand renaissance.

First-quarter total sales of $914 million were 0.5% below last year.

Sales decline was driven by same restaurant sales decrease of 1.3% for the quarter, which was 70 basis points below the industry benchmark, but an improvement of 250 basis points versus the previous quarter's industry sales gap.

Same restaurant guest counts were down 2.4%, which was 40 basis points better than the industry benchmark and an improvement of 240 basis points versus the previous-quarter's industry guest-count gap.

Same restaurant sales and guest counts remain volatile week to week as we continue to adjust the marketing calendar.

One of our objectives is to realign the marketing calendar with the seasonality of the business.

Over the past few years, for example, our Never Ending Pasta Bowl promotion, which is most appropriate for the fall, which is seasonally slow, has drifted into August, a seasonally strong month.

This year, we pushed the start of the Never Ending Pasta Bowl back into September.

Overall, we're encouraged with the progress we're making with the Olive Garden brand renaissance.

There are four key aspects of the plan: one, continue to evolve the core menu to reinforce value, expand choice and variety, and capitalize on the convenience trend; two, simplifying operations, improving food quality, and enhancing service; three, implementing a more integrated communication platform to enhance brand relevance; and four, bringing the brand to life with every touch point.

We introduced new lunch and dinner menus six months ago with the goal of reinforcing value and expanding variety.

As I've stated in the past, we believe adding the $9.99 Cucina Mia section to the menu was important for Olive Garden to maintain its value leadership position.

Preference for this section continues to grow, and it has doubled since its introduction.

More importantly, we know through our transactional data that guests are returning and repurchasing this menu item and that it appeals to millennials.

The new menu is also successfully delivering better value at the high end of the menu, with higher quality beef and seafood selections.

Key attributes on taste, food quality, and good value for the money continue to improve.

Additionally, with this new menu, and taking less price in the industry the last two years, we are seeing reduced price sensitivity from our guests, and [to-go] sales are exceeding expectations.

We've strengthened our to-go experience and completed online ordering ahead of schedule, which resulted in a 13% increase in to-go sales versus last year.

In recent weeks, to-go sales have grown at approximately 20% on a year-over-year basis.

We continue to see a 30% increase in check average when guests order online.

Our operation team is focused on delivering consistently great experiences through an intensified emphasis on service and food quality.

In the first quarter, the great food go rally cry was launched, with the initial concentration on improving execution of our soup, salad, and breadsticks.

In the second quarter, the team will focus on continuing to deliver great pasta, prepared passionately and plated perfectly.

Through the focus on Pronto Lunch, lunch dining times have improved for guests seeking a quicker experience.

In addition, with better forecasting and scheduling, we've improved wait times.

We continue to make progress implementing a more integrated communication platform.

We've broadened our reach by combining price point and promotions with new secondary television and digital equity messages that reinforce our culinary credentials.

The promotional strategy continues to evolve, as we better leverage menu items from our core menu and offer compelling buy-up opportunities for our guests.

And as I mentioned earlier, we will continue to realign the marketing calendar with the seasonality of the business.

Additionally, the new social media team is actively engaged in real-time conversations with our guests, talking with them, not at them.

Today's social-savvy consumer expects this type of interaction, and our social team is doing an outstanding job.

The first three remodels, which also included the new logo, signage, menu, and plateware are generating excitement with our guests and team members.

We're pleased with the initial guest count results, as these three restaurants are now trending greater than 10% above their prior trends.

In addition to the guest-count lift, we're also seeing an increase in alcoholic beverage sales.

Our plan is to complete 75 remodels this fiscal year.

And as a reminder, the 300 restaurants in need of a remodel lag our other restaurants by approximately 200 basis points in same-restaurant sales.

The [zee-ost] test is now in 11 restaurants, and the initial results are very positive; 80% of our guests are interacting with the device, and 60% of them are paying the check on the tablet.

In addition, we've seen an increase in add-on sales, e-club sign-up, guest survey response, and our server tip percentage has increased.

We're developing a plan to implement the tablets in the rest of the system, and plan to be completed by the end of the fiscal year.

There are real signs of positive momentum with our operational leaders and team member engagement.

We've held our first national directors of operation meeting in three years, and focused on driving sales growth through great dining experiences.

We've also just completed our general manager conference, where the leadership team did an outstanding job communicating the opportunities for improvement while energizing the group to improve overall operational execution.

While we're pleased with the progress we've made to date with the brand renaissance, there's still work to do.

This is a large and complex initiative with many components, and we're confident that the rate of progress will accelerate in the quarters ahead and to various aspects of the plan reinforce and build on one another.

LongHorn Steakhouse had a strong first quarter, with same-restaurant sales of 2.8% exceeding the industry benchmark for the sixth consecutive quarter.

Importantly, this top-line performance was matched by significantly higher operating profit and restaurant earnings versus the prior year.

This balanced sales and earnings growth was achieved through a combination of operational execution and compelling marketing initiatives.

Operationally, our restaurant teams continue to elevate the guest experience, as evidenced by higher scores on the key metrics of steaks cooked correctly and server kindness.

Industry-leading low turnover and a slowdown on new restaurant growth has enabled our restaurant teams to focus even more than before on executing every shift flawlessly and ensuring service that over delivers on our guests' expectations.

Successful marketing strategies are also a key driver of maintaining top-line momentum for LongHorn.

The first quarter was supported by two very different promotions that both delivered competitively superior results.

We began the quarter with our Grilled Taste of Summer promotion, which leveraged our Chef Showcase platform we launched last year, featuring seasonally appropriate, unique new entrees.

This promotion included grilled lobster chops, fire-grilled Hawaiian rib eye, and brown butter lemon tilapia and grilled shrimp.

Our second promotion of the quarter, Steaks Across America starting at $12.99, was a little closer to home.

And it featured a Kansas City barbecued sirloin, a Texas three-chili rib eye, and Manhattan stuffed mushroom filet.

Both of these promotions delivered same-restaurant performance significantly above the industry benchmark.

Our culinary and operations teams also partnered [to let] some exciting menu enhancements in the first quarter.

[Bold bites], LongHorn's version of small plates, and happy hour both launched in June.

Guest response had exceeded our expectations, and these menu enhancements have proven to be guest-satisfying and profit-driving platforms for LongHorn.

We're confident that LongHorn is on the right path and well positioned to continue to deliver the industry-leading same-restaurant sales performance they've consistently achieved over the last two years.

In addition to continuing the top-line momentum at LongHorn, the team is focused on leveraging the top-line growth to deliver strong earnings performance.

Specialty restaurant group had another good quarter, with same-restaurant sales growth at 2.1% and total sales growth of 14.5%.

The Capital Grille continues to deliver strong same-restaurant sales growth and earnings performance, while capitalizing on the opportunities to add new restaurants.

The team is committed to delivering a unique service experience, combined with an evolving culinary experience rooted in traditional steak-house style.

The Yard House's same-restaurant sales have improved as the team moves past integration and focuses on operational improvement.

The culinary team is refreshing the menu with new and exciting items, and is also re-energizing the late-night happy hour, which is an important day part.

Seasons 52's plan to regain momentum is on track.

We're starting to see improved results, as August same-restaurant sales increased 2.9%.

With new restaurant growth slowing, the operations teams are focused on improving the entire guest experience.

The team also has enhanced the menu with new, unique flatbreads, appetizers, salads, and entrees, which have been well received by our guests.

Bahama Breeze continues to perform well with solid same-restaurant sales growth in the quarter.

Same-restaurant sales growth did decelerate some this quarter, as we adjusted our discounting strategy, but earnings significantly improved year over year.

Eddie V's continues to build momentum with solid same-restaurant sales growth in the quarter.

The team continues to elevate its service levels and ensure culinary excellence.

We will continue to look for the appropriate real estate to develop this brand.

A lot of the initiatives I've touched upon this morning are things we've discussed for some time, but you need to know that much of that time line is involved in the development and testing.

Now these initiatives are being experienced by our guests, and they are moving the needle on guest satisfaction scores, and I'm confident that will continue.

One reason I'm confident is that we have such skilled and committed people.

They have embraced change with enthusiasm, and I could not be more proud of them.

Matthew now has some additional information to share before Q&A.

Thanks, Gene.

Before we turn to the Q&A, I would like to briefly discuss Darden's upcoming 2014 annual meeting.

We have been speaking and will continue to speak directly with many of Darden's shareholders to hear firsthand what they think about the future direction and leadership of the Company, and about Starboard's efforts to take effective control of the Company by replacing all 12 of Darden's directors with Starboard's own preferred nominees and having them influence Starboard's plans.

We believe that while many shareholders believe in the importance of having a Board and leadership team who have a deep understanding of the Company and its strategic shifts over time, they also believe that Darden would benefit from new perspectives.

We also believe that many of Darden's shareholders have concerns about the risks and destabilization that would result from full Board turnover and giving control to a single shareholder's nominees.

We believe these risks are particularly acute, given the positive momentum we are achieving across our brands, including at Olive Garden, and given the potential adverse effects of giving Starboard control would have on our ability to recruit the best person to serve as the Company's next Chief Executive Officer.

The Darden Board is committed to looking at the Company with a fresh perspective, and recently announced a new slate that aligns with that priority.

Darden's new slate includes four new highly qualified, independent nominees, unaffiliated with the Company or Starboard, to bring relevant industry business and CEO experience; four highly qualified continuing independent director nominees who provide important and deep understanding of the Company's operations and the shifts in industry and consumer trends over time, and who have a record of taking proactive, decisive action to best position Darden for continued improvement and success; and four seats to be filled by candidates proposed by Starboard, thereby providing Starboard with a meaningful opportunity to participate in the decisions regarding Darden's strategic direction, including the selection of the Company's next Chief Executive Officer.

Onto this reconstituted Board, 8 of Darden's 12 independent directors would be new to the Board this year.

We believe this is a balanced slate that serves the best interest of all Darden shareholders, and is also designed to avoid what we believe are significant risks associated with the full Board turnover that Starboard is seeking.

We look forward to talking more about Darden's slate of directors, nominees, and the Board's recommendation for the annual meeting over the coming weeks.

The purpose of today's call, however, is to discuss our earnings results, so we ask that you please keep your questions focused on that topic.

We thank you for your cooperation in that regard.

Now we'll open it up to your questions.

Thank you.

(Operator Instructions)

We have a question from Jeff Bernstein at Barclays.

Please keep your questions to one initial question and one follow up.

Thank you.

Great.

Thank you.

Did have one question and one follow up.

First on the cost savings side of things, there's been a lot of discussion about opportunities to further reduce your cost structure on a variety of lines, but I know you guys have given guidance specific to G&A.

I think for this year you were initially talking about maybe $60 million then talking about upside to that.

Just wondering if you could give us an update where you stand in terms of expectations whether it's just in the different buckets?

I know you mentioned operating overhead and optimization of support and direct costs.

Just wondering when we should expect an update on that?

I know you have third party working on it, so just wondering if we could get any preliminary feedback or takeaways from that thus far?

Jeff, this is Brad, and I'll start with the question there.

Yes, you are correct in our focus has principally been on our support structure to the restaurants which appears on the G&A line.

I think, over time, if you look at some of the big initiatives have been fully broad-based around the whole supply chain, around direct labor optimization, so we've touched the whole P&L.

Those programs continue to move forward, but as you mentioned, we brought in outside expertise to help us look at the entire business.

That engagement is ongoing and so we do see future opportunity there to make progress.

Most importantly, to make that progress without affecting the guest experience.

It's very critical that we approach that delicately but with some swiftness and with some certainty of the costs that we can get out of that.

That work is ongoing.

We continue to narrow that down and as we completed the separation of Red Lobster, you should expect us to see moving more quickly on that front now.

I mentioned a follow up.

I know you mentioned essentially your FY15 guidance is unchanged.

I know back in August you had done something unusual for you guys in terms of giving us quarterly numbers and at that time it essentially brought down early estimates for the year and therefore led to a bump-up in the back half.

Just wondering if you could talk about that meaningful acceleration the rest of the year from here?

How much of it was predicated on the Olive Garden turn versus the incremental benefit from repo and lower interest going forward?

Or are there other unusuals that we should know about that leads to the outsize earnings growth in the back half, just give it a little bit more color on the seasonality of the trend?

There is progression throughout the year as you look at the quarterly basis.

Some of that is fairly simple and straightforward, so let me deal with those first.

The extra week, the 53rd week, that benefit all crews in the fourth quarter, so obviously a meaningful impact there.

Our debt pay down, which reduces interest, we look at interest expense now being that low $20 million range on a quarterly basis.

We don't have that impact at all in the first quarter.

We just paid that down near the end of the quarter.

Then, some of that gets paid down actually in our fiscal second quarter, so you'll see interest expense ramp down pretty significantly there.

Then additionally, use of the proceeds from the share buyback, because with all that's been going on that program is just now starting to get in place and so the benefit of a reduced share count will accrue mainly to the back half of our fiscal year.

That's the mechanical items, if you will.

I think the key thing is the progress that we're seeing on our brand work, particularly with Olive Garden.

If you look at it on a sequential basis, they continue to make improvement and so we do expect that to continue.

That's also a driver of the business, along with continued strong performance from LongHorn and our specialty restaurant group.

We expect that to continue near the levels it's currently at.

Jeff, I would just add that in the third and fourth quarter, we expect a little less pressure on inflation as we get past seafood and dairy, which were big impacts in the first quarter and will run in the second quarter a little bit.

Obviously, another key item I forgot was last year's pretty unusual winter weather that affected principally our third quarter.

That's kind of the top-line color, if you will, on the quarterly progressions and the drivers of them.

Understood.

Thank you.

Our next question will be from David Tarantino of Robert W. Baird.

Sir, your line is open.

Good morning.

Gene, a question on the Olive Garden renaissance plan and your efforts around the operation side.

Just wondering if you could elaborate on your plan to improve the execution at the unit level?

Maybe secondarily, one of the ideas that's been floated is to simplify the menu and change some of your food prep processes and I'm just wondering if you could comment on whether that's something that you would be interested in looking at or not as it relates to the unit-level operations?

As far as, let's start with OpEx execution.

It's my belief that we need to go back to basics, operationally, and ensure that we've set the standards appropriately and that we work against meeting those standards.

As I said in my comments, we've been focused in the last month just on breadsticks and improving our processes around that, including how well do we cook the breadsticks, how long do we hold it, how many do we serve?

Now we're moving to pasta this month, and we're just systematically going through and hitting the most important things in the operation and improving our execution.

We're working on staffing and scheduling to ensure that we're properly staffed to be able to deliver the experiences that we want to deliver in Olive Garden and we're making some progress there.

To me, it's about back to basics and we just need to do the basic things right every single day, and we need to energize our operations people, energize them and also enable them to have the time to spend on improving the basics.

As far as process, we are analyzing all the options in the back of the house to improve the overall process.

We're open to readjusting those processes.

We want to ensure that as we look at them, not only do we maintain the quality of the food products that we prepare today, but also the pride factor in the restaurant.

One of the biggest things that I've learned over the years in this business is that as you change processes in the back, the people that are most impacted by that sometimes are your service people.

And we have to really be careful how we work our way through that.

The answer to your question is we are, as we sit here today, looking at all those processes.

We are looking at the possibility of outsourcing some of our production work, and it's going to take some time to make sure that we make the correct decisions.

I expect that we'll have some tests going here in the next three to six months.

But that is something that we are definitely open to and we are pursuing and have been pursuing since the last six months.

Great.

Thank you very much.

Will Slabaugh of Stephens, you may ask your question.

Thanks, guys.

Wanted to ask about the guidance for the year and the margin.

After 1Q it looks like your margin's at the restaurant level need to grow at least modestly on a year-over-year basis to hit that guide number.

Just wondering if you expect to see that restaurant level margin expansion for the remainder of the year after the compression we experienced in 1Q?

I think as we look to the quarter, and Gene touched on it some there, was the commodity cost pressures, the dairy has been pretty extreme.

We're at record levels for the dairy.

So that will abate, particularly as we get towards the end of the calendar year.

That will enable restaurant margins to improve.

That principally is affecting Olive Garden.

As we look sequentially through the quarters, we see restaurant earnings at levels, on a percentage basis, above the prior year.

We would expect that to continue.

I think the progress that Gene was talking about driving at Olive Garden is the driver behind that beyond the higher commodity costs we have in the first part of the year.

One thing, I'll go back to Jeff's question as well, the progression during the year, is the share buyback from when we talked in June was delayed some, so there's had less benefit coming from the share buyback within this fiscal year, the ultimate benefit is obviously still the same.

We've been making that up with operating performance as well.

We like what we're seeing developing on the operating front.

Got you.

Just a quick follow up, if I go to the pricing in terms of those levels at Olive Garden.

Do you feel like the new core menu has established an effective, everyday-value platform that you can now utilize to drive traffic in its own right?

Or do you think the customer is still looking for something maybe at a lower price point to get them in the door on a more frequent basis?

I think it's a combination of both.

We do believe having the everyday $9.99 price point will allow us, over time, to be less aggressive with our promotional activity and also allow us to migrate away from the price certainty that we've had for the past couple years with our promotions and more at a starting at price point, which we've utilized the last couple windows.

That's what we think that this $9.99 price point plays a big, big role.

As a consumer, if you know it's there, you can be brought in by a promotional activity, but then you can default back to it if that's the price that you want to be at.

When I mentioned the price sensitivity in my comments, we think that having that $9.99 price point is enabling us to, in the future, maybe be able to take a little bit more price and hold that $9.99 price point for the consumer that wants the trade down into that menu item.

Thank you.

Thank you.

The next question is from David Palmer, RBC Capital Markets.

Go ahead, sir.

Good morning, guys.

The high overhead, the high G&A and the low advertising spending effectiveness, that's already gotten some attention from Darden and the Street.

A more controversial point made by the activists in its presentation is that Darden and Olive Garden specifically is an under earner at the restaurant level due to both food and labor representing over $100 million in opportunity.

Do you see a similar Olive Garden efficiency upside?

Perhaps net of that, do you believe that you might have to reinvest some of those savings to really establish long-term, sustained same-store sales traction?

David, it's Gene.

I think we've been making these investments in the last couple years.

I think the $9.99 price point is an investment that we've made.

As we move forward, I don't think that we have to continue to make investments in our menu.

I think the value proposition is strong as it has been in the last three years.

I think the upside will continue to come from culinary innovation, but operational execution.

I think as we continue to operate and improve our day-to-day operations and create great dining visits that we can grow the business without making further investments into cost of sales or labor.

I would just add to Gene's comment there.

When you look at the Olive Garden's business model and its particular strengths, as Gene mentioned, we made a lot of investments already into that business to drive the top line.

It takes a while for that to get there, but we're seeing the signs of that that we like.

But we don't see the way to really drive shareholder value by taking tremendous cost from where we are today out of that business.

We think that we are today, we can grow the top line, maintaining the percentages where they are growing in some because of natural leveraging that comes with that, but really drive total, absolute cash flow, which translates into shareholder value.

So, the success from where we are in the platform that we have now is largely about driving the top line now, not highly focused on taking food off the plate from the consumers or less labor in the restaurant.

We just don't see that as the way to get there.

That being said, there are ways that we continue to explore, to be smart about our seafood purchasing, to be smarter around direct labor and optimizing that.

But just broadly taking cost out of there is something that we're very hesitant to do.

We always look at it, but we're hesitant to act on many of those type initiatives.

David, I would just add that as operators, we're always trying to figure out how to improve our margins.

When I look at the Olive Garden P&L, it's about an absolute EBITDA per restaurant that's exciting.

We're starting with $4.4 million in average unit volumes, and I think that we've got to protect that AUV and grow that AUV and obviously try to improve margins, but there's a healthy, absolute cash flow per restaurant today.

Thank you.

Next question is from Matt DiFrisco, Buckingham Research.

Thank you.

Gene, I have a little bit of a follow up on and I think one of the other things that a lot of other peers and concepts and some of the other investors have also suggested with respect to your portfolio.

There's an opportunity maybe to trim the menu a little bit.

I was wondering if you could speak to that?

I guess in your reference from being with something like a LongHorn back when it was with Rare and its evolution now, and Olive Garden also with your tenure at Darden, is there a case to be said that maybe the menu has gotten too big, too complex and some of the labor savings that might come with that?

Some of your smaller peers like BJRI, who as an activist is already trying to trim their menu a little bit.

Is that an industry trend that you think you could capitalize on as well, where maybe the labor savings are more back of the house facing and less customer facing?

Then the follow up to that is, what do you have as far as, that would refute that, that would say no, we would sacrifice the sales in that $4 million AUV that you spoke of, because people depend on the variety and that is where we score, we can't risk taking that menu down?

Matt, I think that what you're talking about is something that Dave, George and Val and Tim Harris and I talk about every single day, is how do we continue to simplify our menu offerings and maintain our high variety ratings?

We want to continue to simplify.

We don't want to add complexity to the menu.

As we rolled out the menu in Olive Garden six months ago, we knew we got too broad, but in casual dining, it's tough to take items off the menu.

Everybody has their favorite menu item and so we have to be very strategic as we do that.

One of Dave's projects right now, in Olive Garden, is saying, how do I decrease this menu by 20%, how do I maximize my SKUs, how do I ensure that when I'm in a category I don't have too many menu items doing the exact same thing?

How do I ensure I don't have too many pasta, cheese and red sauce and so on and so forth?

You are right on, there.

That's something that we'll continue to work on, but we also know that when you start pulling back the number of menu items, especially when you get away from entrees, there's a direct correlation to sales.

When you have eight appetizers on a menu versus six, you sell more appetizers with eight, even when those appetizers are still in the similar gap.

There's a real balance here that we have to watch, but the ultimate objective is as you described.

We need to continue to simplify our menus, simplify our process and how we prepare the food and then how we deliver it.

It is something that we talk about here every single day.

Matt, the thing that I would add to Gene's comments and having been there and seen a lot of these from the financial perspective is you need to maximize each section of the menu.

You have to optimize the total menu because, particularly in Olive Garden's case, when you have a brand that's $3.6 billion, $3.7 billion driving AUVs of $4.4 million, you have to be very broadly appealing.

You have to have that array to do that.

I think Gene said, that he said getting the right items in each section, clearly, there's opportunity to work on that and guest taste, guest preference change and evolve over time, so you need to move with that pace to do that.

For us, from a financial perspective, it's about maximizing, getting the total dollars versus trying to scale it down, maybe get better percentages, but you've got a smaller business.

And I think that's been the hallmark of Olive Garden for so long, is the absolute breadth of that -- appeal of that and the absolute total dollars on a per unit or for the total brand that that business can drive, provides a lot of earnings power, a lot of cash flow.

Matt, I would finish this comment with when we look at LongHorn against its major competitor, even though we may have more menu items today, our variety scores are lower.

Strategically we, in LongHorn, continue to try to increase our variety scores to make ourselves available for more occasions.

Excellent.

Thank you.

Thank you.

Joe Buckley, Bank of America-Merrill Lynch, you may ask your question.

Thank you.

Couple of technical questions first.

You mentioned, Brad, a 10% effective tax rate for the adjusted earnings.

Is that what you're thinking for the full year?

Could you elaborate again or maybe give us more detail on what the first quarter was?

Sure.

In the first quarter, if you were to take out all the adjustments, it's about an 18% effective tax rate.

Obviously, you've got the debt breakage and the different accounting treatment for that, but 18%.

If you look out to the full year, our expectation is around 10% when you consider these type of entries in there.

I think the key thing as you look forward and one is the margin rate, so what's the additional earnings or some of the adjustments?

That continues to be at 38%.

If you're trying to build your models, different scenarios, those would be the rates that you'd want to use.

Is that what you're looking for?

Yes.

So lowering that from 12% to 10% implies the operating income is lower than your original expectations.

Is that correct?

No, as I mentioned, operating earnings are actually higher than what we thought at the beginning of the year, but we had the delayed impact of the share repurchase.

On a GAAP reported basis, we actually had more debt breakage cost.

Now, it's more economic and feasible because we could optimize who we wanted to surrender their bonds, so the cash cost was less and we got a better going-forward interest expense out of it.

But no, operating performance from where we began the year is better.

It's these other items that are providing less lift to our guidance.

Okay.

Just one more.

Gene, I think you mentioned matching the marketing cost with the seasonality of the business.

So is that why the second quarter, the November quarter EPS numbers look high relative to historical standards, because the marketing spend will be down significantly year over year?

No, the marketing spend will not be down significantly in Q2.

I've got some people checking numbers here, but I believe we're pretty flat year over year.

That's correct.

I think the second quarter has more brand mix, right?

If you're looking at year-over-year basis, pulling out the Red Lobster piece, it's a key driver.

It had a seasonality with a much greater dip in the second quarter, a stronger third quarter, and so if you're looking at previous numbers that drives part of it.

I think when you look at the guidance, we'll have the full impact of the debt reduction while beginning to see the impact of the share buybacks that are there.

It's really more continued margin improvements, largely, from the G&A reductions on a year-over-year basis, or SG&A reductions on a year-over-year basis.

Then as we talked about a little bit earlier, the litigation on a year-over-year basis of the commodity costs getting more back to that 2% range versus nearly 4% in the current quarter.

Okay.

Thank you.

We have a question from Jeff Farmer of Wells Fargo.

Thanks.

Can you guys share your thoughts on the health, or state of the new product pipeline at Olive Garden?

I'm only asking because it looks like, I think it was the new alfredo three-course promotion contributed to roughly a 4% traffic decline in July lapping a pretty favorable 8% decline in the year-ago month.

The product pipeline is robust right now.

We actually have a lot of products sitting on the shelf that we can pull out.

We went back in July to alfredo because it's the item that guests like the most.

We went three course against two for $25, which wasn't as strong.

So, there's a promotional mismatch in July.

We also moved some media around and on top of what was a really tough three weeks for the industry, we did not -- ended the last week in June and the first two weeks in July, we did not perform well.

I don't believe that had a whole lot to do with the strength in that three course.

The three course performed fairly well compared against a three course in the past and using Alfredo really, really helped us.

It hurt us from a profitability standpoint because the dairy spike.

If we had known that dairy was going to be at the levels it was at, we wouldn't have done it at that time.

But very, very popular promotion, high preference, high guest satisfaction.

I do feel as though our pipeline is in really good shape and that the promotional activity I think's been pretty effective.

Right and then just a follow up on that.

Again, you've highlighted this a couple times on the call, but Olive Garden's results clearly volatile intra quarter and do to there's still significant month-to-month, again, volatility.

Looks to me like driven by that promotional calendar based on what you just said.

What is the latest thinking or strategy around reducing some of that volatility?

You mentioned Cucina Mia section of the menu, stable everyday value might be something that can help.

What's the longer term game plan here in terms of really getting or meaningfully reducing that volatility month to month?

I think the key is to get the promotions that we've historically run, which are still very popular, like Never Ending Pasta Bowl, back into periods where they make sense.

Never Ending Pasta Bowl makes sense in September.

Our volumes are a little bit lower than our average.

It's capacity for us to handle the extra volume that the promotion drives.

It didn't make sense to be doing it the last two weeks in August when our restaurants are fairly -- are really busy, and that really worked out well for us this year, both from a sales and profitability standpoint.

Once we get the calendar back to where we want to, and we believe by this time next year we'll have the calendar aligned and matched up year to year and we won't be moving it back and forth.

Thank you for that.

Jeff, I would just add.

That's why we had the quarterly guidance that's out there, because some of this variability is driven by the changes that Gene has talked about.

In Olive Garden's case, moving Never Ending Pasta Bowl.

It's clearly the right decision to do.

It did create some variability around the menu mix and traffic, but net-net, we think it's a better place to be.

As we said, the last two weeks of August we were lapping on the Never Ending Pasta Bowl last year, we're actually provided some upside to our expectations.

Some of it's what's going on in the industry, but some of it is volatility that we are introducing because it's the right thing to do.

Thank you.

Thank you.

Next we'll have Keith Seigner of UBS.

Gene, if I could just follow up a little on some of that week-to-week volatility at Olive Garden?

The delta from July's numbers to the back half of August is pretty meaningful.

Was this really just the cadence of promos against promos?

The back half of August this year had the return of the buy one, take one with the red box.

It had some discounts for online orders.

Is that really what was just going on there, more so than say a macro?

Then second to follow that up, on the to-go orders, it seems like there was a fairly meaningful promotional push in the back half of August to help highlight this during a busy period, get people focused on it.

Do you think that helped to contribute to the success of the to-go?

Thanks.

I'll take the second question first and say absolutely, we were promoting it so that definitely has increased the activity with to-go.

As I said in the comments, we're now over 20%.

But we don't feel like the activity is overdone.

We think we're just introducing people to something that they want.

The consumer feedback is fabulous on the to-go.

People are thrilled with the process.

Again, I think the answer to your question is, yes, we promoted it, but we've gone from 10% growth to over 20% growth with that.

I believe this is going to stick.

I believe to-go is going to stick and it's going to continue to grow.

As far as volatility goes, a lot of the volatility really comes down to TRPs per week.

We know that when we back off our TRPs in Olive Garden, which we did, the two weeks that were really negative in the month of July, especially around the 4th of July week, we saw the sales decline.

We know pretty much when we increase TRPs what we're going to get and when we decrease TRPs what we're going to get.

That was where the volatility really came from.

It was also the industry the week of the 4th of July was down mid-single digits and we were down a little bit worse than that.

The industry dropped significantly while we were backing off TRPs and switching promotions.

I'm really not that concerned about it.

When I looked at the quarter, I believe that we had a lot more better weeks than we had bad weeks.

I'd just add a little bit.

If you look quarter to quarter for the industry, there wasn't any macro improvement in the industry.

Clearly, there was from July to August, but in all those cases Olive Garden outperformed the industry on those measures in terms of its improvements from quarter to quarter or months during the quarter, so we're pleased.

I think there are some promotional activities that are helping forcing that.

I think more fundamentally what we see is the progress that Dave, George and Team are making there, are changing the base trends in the business.

Thanks.

Thanks, Operator.

We have time for one more question.

Thank you.

That will come from Brian Bittner of Oppenheimer.

Your line is open.

Thank you.

Good morning.

Olive Garden's traffic, it has performed better relative to industry than it has in the recent past, which I definitely appreciate, but it did remain negative through the quarter.

What I'm really focused here, is what you guys are assuming traffic will be for the balance of the fiscal year in order to you achieve this earnings guidance?

I know your same-store sales for Olive Garden need to be up about a 0.5% to 2% for the balance of the year to hit the sales numbers.

But what is the traffic assumptions within that given what you're assuming for average check?

Just a quick follow up would be under this new model without Red Lobster, what is the sensitivity with Olive Garden sales?

What is 100 basis points of same-store sales worth to EPS going forward?

We've talked about our general guidance for the year and some pricing in that.

What I would say is we get to the year on an annual basis, we are looking at traffic that will decline at Olive Garden.

If we look at the back half of the year, the expectation it's going to be roughly flat to maybe slightly positive.

The second quarter will likely be negative.

Though we're pleased with how we came out of August, particularly not having the Never Ending Pasta Bowl, so on a broad basis there, it's improvement from the trends it's been on.

It is clearly better than where we see the industry going from a traffic perspective as well.

I didn't write down, what was your second question?

100 basis points.

Oh, 100 basis.

So 100 basis of same-restaurant sales across Darden on an annual basis is still in that $0.11 to $0.14 range.

If we look at quarters, remember second quarter's still seasonally lower than the others, not to the magnitude it used to be on a post Red Lobster basis, though.

Okay, and that number that you gave for EPS, that was on the whole chain or was that just on Olive Garden same-store sales?

That's the whole business.

So are you able to boil it down just with the sensitivity on the Olive Garden comps would be?

It would be roughly 55%, 60% of that, as just a broad measure.

I don't have a specific number handy, though.

Okay.

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