Darden Restaurants, Inc. (DRI) Q2 2014 Earnings Report, Transcript and Summary

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.

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: the ability to achieve the strategic plan to enhance shareholder value, including the separation of Red Lobster; the high costs in connection with the spin-off, which may not be recouped if the spin-off is not consummated; 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 health care 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; failure to successfully integrate the Yard House business, and the additional indebtedness incurred to finance the Yard House acquisition; our plans to expand our smaller brands, Bahama Breeze, Seasons 52 and Eddie V's; a 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 increased 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; an 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 the release to 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 at darden.com. We plan to release fiscal 2014 third quarter earnings and same-restaurant sales for fiscal December, January and February 2014 on Friday, March 21, 2014, before the market opens with a conference call shortly after. Additionally, we are planning to host our annual Analyst and Institutional Investor Meeting in New York City on Friday, March 28, 2014, beginning at 8:30 a.m. Eastern Time. This meeting will also be webcast for those unable to attend. More details will be forthcoming shortly. We released second quarter earnings results this morning. These results were available on PR Newswire and other wire services. Because we have much to cover this morning, we'll briefly offer a line item summary of the P&L for the second quarter, discuss our financial outlook for fiscal 2014, briefly review our progress at Olive Garden and then review in detail the strategic action we announced this morning. We have a slide show presentation that you should be able to access through the webcast link at darden.com or videonewswire.com. After the presentation, we will take your questions until approximately 9:45 a.m. Eastern Time. With that, let the turn it over to Clarence.

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?

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.

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.

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: maintaining relevance to guests who fit their core profile; and increasing relevance in pockets of consumer strength that are outside their core. As we pursue these 2 objectives to a large extent, the brands benefit from shared marketing, culinary, digital and other resources. When we talk about pockets of consumer strength, one example is more financially secure consumers. Another is younger consumers given just the sheer size of that category. With the exception of Red Lobster, all of our brands are having success increasing their relevance to these various pockets of strength. At Olive Garden, for example, we had 11% more visits last year, fiscal 2013, from guests with household income over $100,000 than we did 5 years earlier in fiscal 2008. And for that same period, visits to LongHorn from those guests with income demographic increased by more than 50%. In contrast, Red Lobster traffic from this income demographic was flat in 2013 compared to 2008. And the results are similar when it comes to other efforts to broaden the guest base. As a result, we believe Red Lobster will benefit from sharper focus on its core. A separation will enable it to do just that while the rest of the business continues working to both retain their core and expand their customer base. Because of these differences in appropriate guest targets, Red Lobster and the rest of Darden have significantly different sales and earnings growth prospects. They have significantly different sales and earnings volatility and capital requirements. And ultimately, they have quite separate and distinct opportunities to drive long-term shareholder value. The spinoff will transform Darden into 2 new independent public companies that can each focus on their different opportunities. And finally, a spinoff, when combined with the other actions we're taking, will result in stronger alignment of management incentive compensation, increased financial transparency and improve our ability to serve differing shareholder investment objectives. The Slide 6 lays out the new unit cost management and return to capital direction for new Darden. As indicated, we expect the new Darden to be able to achieve higher same-restaurant sales growth, have more moderate new unit expansion and CapEx needs, have the benefit of greater than initially forecast cost savings and a much more intensive ongoing focus on cost reduction, all of which repositions the business for further enhanced return of capital to shareholders through both consistently growing dividends and consistent, meaningful and growing share repurchase. Going forward, there will be minimal new growth -- new unit growth at Olive Garden, and LongHorn's new unit openings will be reduced dramatically, going to 15 to 20 units annually from the 30 to 35 we've been targeting previously. This represents approximately 25 fewer units annually for Olive Garden and LongHorn. And in addition, new unit growth within our Specialty Restaurant Group will be reduced modestly by about 5 units annually to 20 to 25 new restaurants a year. Together, these changes will result in approximately $100 million less in new unit capital expenditures, reducing our current annual new unit capital expenditures to $200 million, down from about $300 million today. And again, we plan to redirect the improved cash flow from reduced CapEx and cost savings toward enhanced return of capital to shareholders primarily in the beginning in the form of additional share repurchase. As shown on Slide 7, both companies will be well positioned for continued success following the transition. New Darden's core strategic focus will be on retaining core customers and expanding our customer base. And while both of these things, expanding our customer base and new unit growth, will require selective investment, both will also support cash flow growth, enable us to consistently increase the amount of capital return to shareholders. New Red Lobster's focus will largely be on retaining its core customers and on using its strong and consistent cash flow generation to support what will be a more stable rather than growing return of capital to shareholders. As a financial metrics highlight, both new businesses will have the average unit volumes and the overall earnings and EBITDA scale to continue to be leaders in the full-service restaurant segment. However, each business will have its own distinct financial strategy, one that best serves its shareholders. While New Darden, as I said earlier, will have an investment-grade credit for profile and reduced overall debt load, new Red Lobster will operate as a strong non-investment-grade credit with leverage level that's supported by its strong free cash flow profile and that will be in line with other similarly cash flow oriented restaurant peers. In addition, we expect new Red Lobster to have a dividend payout ratio of approximately 75% on an ongoing basis, while New Darden will have an initial payout ratio that's between 70% and 75%. That ratio will be reduced over time as earnings growth exceeds overall dividend growth. Slide 8 provides a snapshot of the financial performance of both businesses over time. And as you can see, Darden, excluding Red Lobster, has grown sales robustly over the past few years. And while EBITDA has flattened recently, it's still well above where it was 3 years ago. Conversely, Red Lobster has had fairly consistent rather than growing sales, and its EBITDA has been pressured recently, largely by both increased promotional activity and elevated seafood costs. Red Lobster's management team will be working to develop stronger, more targeted plans to reinvigorate sales and stabilize cash flow going forward. Slide 9 gives you an overview of New Darden. As you can see, we will hold a balanced portfolio of best-in-class brands, a portfolio that combines proven brands that have leadership positions and strong cash flow, with others that are proven but earlier stage and have significant runway for additional unit expansion. We see an attractive sales and earnings profile for New Darden with mid- to high single-digit revenue growth and low- to mid-teen operating income growth. In terms of cash flows, reduced new unit capital expenditure, increased support cost efficiency and meaningful free cash flow growth over time will also allow for greater return of capital to shareholders. And with this financial profile, as well as the strong collective experience and expertise that's buttressed by improved incentive alignment and what will continue to be a winning culture, we believe New Darden will have much improved, long-term shareholder value creation prospects. Slide 10 provides key highlights about our portfolio of compelling brands. So Olive Garden is one of the largest full-service dining brands in the United States and is the #1 Italian full-service brand in the country. As a result of very strong average sales per restaurant and a superior business model, Olive Garden also has industry-leading unit-level and brand-level returns. And as Gene outlined earlier, Dave George and the team at Olive Garden are making good progress on a number of fronts that will enable the brand to stabilize and then return to industry leadership on same-restaurant sales and further improve on its industry-leading position overall. We look forward, as Gene said, to be able to share some details about Olive Garden's plan with you certainly at our investor meeting in March but also as we get further into the separation process. LongHorn is also a leading brand. And since we acquired the brand 7 years ago, LongHorn has been transformed and is now poised to become America's favorite steakhouse. LongHorn's trends from a unit economics perspective are attractive as well. And then finally, our Specialty Restaurant Group is organized to leverage experienced leadership cadre to drive the growth and success of 5 premiere high-volume, high-return brands that each have compelling and differentiated guest propositions. Now this morning, we have emphasized return of capital to shareholders because it will continue to be a key priority for both companies moving forward. And as shown on Slide 11, Darden has a long track record of returning capital to shareholders with almost $4 billion returned through share repurchase and dividends over the last decade. Slide 12 highlights what will remain the same and what will be some of the key differences for Darden post-separation. Darden will remain a leading multi-brand operator with a balanced portfolio of brands, and our commitment to quality and menu innovation will continue, as will our commitment to returning capital to shareholders. We will continue to have a strong cash flow profile. We expect to retain our investment-grade credit profile, and our business will continue to be supported by an experienced management team that's passionate about its brands. So what's different? As I said earlier, we expect higher and more consistent sales and earnings growth driven by an expanding customer base and restaurant footprint. We'll also have a more balanced commodity purchasing profile, reduced quarterly sales and earnings volatility, more meaningful growth in free cash flow, improving credit metrics and an even sharper focus throughout the company on same-restaurant sales and free cash flow growth, which again are even more important given our new strategic direction. Now let me briefly highlight what new Red Lobster will look like post separation. The key strengths and opportunity for the business lie in its heritage as an iconic American brand that helped pioneer the casual dining sector, its strong and consistent annual free cash flow generation and the dedicated and highly experienced team that will lead the business. With the improved guest targeting that the spin will enable, Red Lobster will, we believe, more quickly and more sustainably achieve same-restaurant sales stability and margin improvement. And then looking out, we think that as a standalone company, Red Lobster can generate low-single digit revenue growth and mid- to high single-digit operating income growth. Given its core guest base and the nature of seafood, there will continue to be volatility in quarterly sales and earnings results. But in contrast, annual cash flows have been strong and consistent, and that's expected to continue. And Red Lobster's cash flows, the new Red Lobster, should support substantial and stable return of capital to shareholders through dividends and share repurchase. We are truly excited about the quality of the management team we've assembled to lead Red Lobster following separation. Kim Lopdrup, who will serve as CEO, brings strong leadership capabilities, with extensive experience with Red Lobster and in the food service industry generally. Kim currently serves as President of the Specialty Restaurant Group and was President of Red Lobster from our fiscal 2005 through fiscal 2011. And during this time, he spearheaded the revitalization of the brand, a revitalization that resulted in strong sales and earnings growth. Kim is the right person to lead and deliver on the strategic objectives for the new Red Lobster. Kim will be supported by Salli Setta, who will continue in her role as President of the Red Lobster. And should, as expected, the separation take the form of a spinoff, Brad Richmond, who's been Darden's CFO for nearly 7 years, will be Chief Financial Officer of the new Red Lobster. Post separation, Red Lobster will continue to be an iconic American casual dining brand with a dominant position in the casual dining seafood special segment. The business will also continue to have a strong and steady cash flow profile aided by a leaner organizational structure, and the fact that following the Bar Harbor remodel program that's nearing completion, its repairs and maintenance CapEx requirements will be modest. So all in all, we're absolutely thrilled about the comprehensive strategic action plan that we've put in place. Now let me close by reiterating what Brad covered at the outset, which is our outlook for fiscal 2014. We now expect to open approximately 75 net new restaurants this year. That compares to our prior expectation of 80. Same-restaurant sales are expected to be down 1% to 2% for Olive Garden and up 2% to 3% for LongHorn, and that is down somewhat in each case from our earlier expectations since we now believe that for the full year, the industry will be softer than we previously anticipated. The biggest change, as Brad said, from previous expectations is in Red Lobster's same-restaurant sales, which we now expect to be down 4% to 5%. As Brad indicated, this reflects first half results at Red Lobster as well as the potential for some disruption as we work through the separation. Combined with our same-restaurant expectations for the Specialty Restaurant Group, all of this means that we now expect overall revenue growth of 4% to 5%, which is below our previous estimate of 6% to 8%. And with the sales shortfall and the second quarter costs associated with our new strategic direction, we now expect net diluted EPS for fiscal 2014, excluding any second half costs related to the strategic action plan, to decline 15% to 20%. Once again, as we look forward, we're very excited about our comprehensive action plan. This is a plan that reflects thoughtful discussions among our management team, our board, our shareholders and our advisers. And we're confident that this plan offers the most potential to enhance long-term shareholder value. As Slide 18 highlights, we have a significant amount of work to do in the coming months, but we promise to keep shareholders apprised of our progress as we make this exciting transition. That brings us to the end of our prepared remarks. And so now we'd like to open it up to questions and answers.

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

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.

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.

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?

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.

Our next question comes from Brian Bittner of Oppenheimer & Co. Brian J. Bittner - Oppenheimer & Co. Inc., Research Division: 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.

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 - Oppenheimer & Co. Inc., Research Division: 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?

Brad?

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 - Oppenheimer & Co. Inc., Research Division: Great. And just lastly, do you know when we might get a full Red Lobster P&L?

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.

Our next question comes from David Palmer of RBC.

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?

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.

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.

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

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?

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.

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?

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.

Our next question comes from Michael Kelter of Goldman Sachs.

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?

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.

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.

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?

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.

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

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?

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.

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?

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

Our next question comes from Jason West of Deutsche Bank.

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?

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.

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?

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.

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?

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.

Our next question comes from Will Slabaugh of Stephens.

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?

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.

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.

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.

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

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.

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.

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?

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.

Our next question comes from Jeffrey Bernstein of Barclays.

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.

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.

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.

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

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?

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.

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?

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.

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.

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 (888) 566-0705 or the toll number of (203) 369-3090. And again, this concludes today's conference call. You may now disconnect at this time.