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Executives

Matthew Stroud - Vice President of Investor Relations

Clarence Otis - Executive Chairman, Chief Executive Officer and Chairman of Executive Committee

C. Bradford Richmond - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Andrew H. Madsen - President, Chief Operating Officer and Director

Eugene I. Lee - President of Specialty Restaurant Group

Analysts

John S. Glass - Morgan Stanley, Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Michael Tamas - Oppenheimer & Co. Inc., Research Division

Jason West - Deutsche Bank AG, Research Division

David Palmer - UBS Investment Bank, Research Division

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Will Slabaugh - Stephens Inc., Research Division

David E. Tarantino - Robert W. Baird & Co. Incorporated, Research Division

Jeffrey D. Farmer - Wells Fargo Securities, LLC, Research Division

Darden Restaurants (DRI) Q2 2013 Earnings Call December 20, 2012 8:30 AM ET

Operator

Welcome, and thank you for standing by. [Operator Instructions] The call is being recorded. If you have any objections, you may disconnect at this time. Now I'll turn the call over to your host, Mr. Matthew Stroud. Mr. Stroud, you may begin.

Matthew Stroud

Thank you. Good morning, everyone. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and COO; Brad Richmond, Darden's CFO; and Gene Lee, President of Darden's Specialty Restaurant Group. 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 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 cost; 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 newer brands, like Bahama Breeze and Seasons 52 and Eddie V's; a lack of suitable new restaurant locations; higher-than-anticipated cost to open, close 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 the 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; a possible 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; 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 2013 third quarter earnings and same-restaurant sales for fiscal December, January and February 2013 on Friday, March 22, 2013 before the market opens with a conference call shortly after. Also, we are planning to host our annual analyst and institutional investor meeting here in Orlando on February 25 and 26, 2013, and this meeting will also be webcast for those unable to attend.

We released second quarter earnings results this morning. These results were available in PR Newswire and other wire services. And we recognize that most of you have reviewed our second quarter earnings results. So we won't take the time to go through them in detail in an effort to provide more time for your questions. We will offer a quick line-item summary of the P&L and discuss our financial outlook for fiscal 2013 and discuss our brand-by-brand operating performance summary.

To begin, Clarence will offer some opening remarks. Brad will provide detail about our financial results for the second quarter, and Drew will review the operating performance of our brands. And we'll then response your questions.

With that, let me turn it over to Clarence.

Clarence Otis

Thank you, Matthew, and good morning, everyone. I'll make a few comments up front just to provide some context for our results for the quarter. And then, as Matthew said, I'll turn it over to Brad and Drew, and they'll get into more detail.

From a big-picture perspective, the results this quarter really reflect 2 things. First, we need increased promotional innovation and increased promotional intensity around affordability at our 3 big brands, and this was made particularly clear this quarter, which has long been the most value-sensitive time of the year. Second, our results this quarter reinforce to us what we need to do beyond promotions to regain momentum at our largest brand, Olive Garden, and ensure we build on rather than lose the underlying momentum we've established over the last 2 years at Red Lobster and LongHorn.

In a moment Drew, is going to discuss our thinking about those issues. But before he does that, I want to provide a little more context around a secondary issue which we believe contributed to a loss of momentum this quarter and which is also a factor in our outlook for the full fiscal year. During the second quarter, Darden as a company, and especially our 3 large brands, was the focus of significant media coverage and online conversation relating to our testing of different labor models in advance of the implementation of healthcare reform. And while businesses across the spectrum, especially in the restaurant and retail sectors, are considering their options in this area, Darden and, most importantly, our brands were subject to a unique and sustained focus.

And as the story spread, many misinterpreted our actions as a stand against healthcare reform, and they came to believe we've made a declaration that we were committed to a policy which would avoid paying for healthcare for our full-time employees by limiting their hours. The volume of coverage and conversation about this was significant. And although it's difficult to measure, we do think it had an adverse impact on our results.

To reassure our employees and correct misunderstandings among our guests, we recently made 3 public commitments to our employees. First, none of our current full-time hourly employees will have their status changed to part-time as a result of healthcare. Second, we will continue to have both full-time and part-time hourly employees in all of our restaurants, because that's what it takes to deliver the experience our guests expect from us. And then, third, the healthcare coverage that we offer to our full-time hourly employees will be the same as the coverage we offer to all salaried and executive full-time employees.

The longer-term impact of this negative coverage on guest and on employees is difficult to predict. But because healthcare reform will remain a topic of much conversation over the next several months, it does contribute to our caution about performance for the remainder of the year.

And so what does it all mean? First, we believe that while Red Lobster and LongHorn clearly have improvement and opportunities, generally and improvement opportunities with promotions in particular, as they address those opportunities, we think they do so with reasonably solid underlying momentum. And that underlying momentum reflects the meaningful progress each brand has made over the past several years, and it also shows in the strong same-restaurant sales results that Red Lobster and LongHorn have posted when we look at their performance for the second quarter on a cumulative 2-year basis.

Second, while Olive Garden's results were at least as negatively affected by the healthcare reform controversy, even when we take that effect into account, we know that Olive Garden is well short of where it needs to be. And we see that when we look at its longer-term sales trends coming into the second quarter, and we see it when we look at Olive Garden same-restaurant sales performance for the quarter on a cumulative 2-year basis. Again, Drew is going to discuss in a moment our thinking about regaining momentum at Olive Garden.

Our third takeaway is that being the focus of controversy around healthcare reform implication -- implementation caused us to exit the second quarter with a lower sales and earnings base and lower cash generation potential going forward than would've been the case if we were only dealing with our operating challenges. And based on both our operating trends and our need to be cautious in the face of controversy, it's highly likely that, as Brad's going to discuss in a moment, our capital budget for next year, our fiscal 2014, will come down.

And with that, let me turn it over to Brad to walk you through the financial details for the quarter.

C. Bradford Richmond

Thank you, Clarence, and good morning to everyone. Darden's total sales from continuing operations increased 7.0% in the second quarter to $1.96 billion. Included in this amount is approximately $78 million in sales from Yard House, which we acquired on August 29, 2012. On a blended same-restaurant sales basis, results for Red Lobster, Olive Garden and LongHorn declined 2.7% in the second quarter. In contrast, we saw continued same-restaurant sales gains in our Specialty Restaurant Group and a 0.7% same-restaurant sales increase on a blended basis.

While the current quarter same-restaurant results were negative, we were lapping a strong success last year for both Red Lobster and LongHorn. Over the 2-year, same-restaurant sales were very solid, with Red Lobster up 4.1% and LongHorn up by 0.2%. We have an opportunity to rebuild momentum, as Clarence talked about, at Olive Garden to achieve the similar success that the brands' building efforts at Red Lobster and LongHorn have had. Where there's -- at Olive Garden, their sales were -- over the 2-year period are down 5.7%.

Now turning to food and beverage expense for the second quarter. They were approximately 30 basis points lower than last year on a percentage of sales basis. This favorability was driven by lower cost for seafood, partially offset by higher cost for beef. For the second quarter, restaurant labor expenses were flat to last year on a percentage of sales basis due to lower incentive pay, productivity gains and improved wage management that offset wage inflation.

Restaurant expenses in the quarter were approximately 60 basis points higher than last year on a percentage-of-sales basis due to sales deleveraging, roughly 35 basis points, and the impact of adding Yard House, which was also about 35 basis points. Yard House runs higher restaurant expenses as a percentage of sales than the other brands as all of Yard House restaurants are leased.

Selling, general and administrative expenses were approximately 80 basis points higher than last year as a percentage of sales, due primarily to the acquisition of Yard House. Absent these impacts, selling, general, and administrative expenses on a percentage-of-sales basis would have been flat to last year despite higher media cost due to inflation. Depreciation expense in the quarter was approximately 40 basis points higher on a percentage of sales basis compared to last year because of the increase in new units and the remodel programs at our larger brands.

Overall, operating profit margins for the second quarter, our seasonally low quarter, were down 145 basis points to 3.9%. Yard House accounted for 80 basis point of the decline because of acquisition-related cost and a slightly lower margin at the operating profit level. Yard House adverse impact on operating profit margins is expected to decline to approximately 20 basis points in the back half of this fiscal year.

Our tax rate this quarter is 21.8%, approximately 360 basis points lower than the prior year, driven by increases in available tax credits and our tax planning initiatives as well as lower taxable earnings. We estimate that our annual effective rate will be in the 23% to 24% range, which is about 130 to 230 basis points lower than last year's annual effective tax rate. This annual effective tax rate will vary from quarter-to-quarter.

Now turning to our financial outlook. For the full fiscal year, we expect combined same-restaurant sales for Red Lobster, Olive Garden and LongHorn Steakhouse of approximately down 1% to flat, and we expect a net new restaurant increase of approximately 100 restaurants, which is approximately 5% unit growth on our current base. With these same-restaurant sales and net new restaurant opening expectations combined with the acquisition of the Yard House, we expect total sales growth in fiscal 2013 of between 7.5% and 8.5% and that diluted net earnings per share growth from continuing operations for the year will be between $3.29 and $3.49. The expectations regarding diluted earnings per share include acquisition-related cost and purchase accounting adjustments of $0.08 to $0.10.

Turning to our commodity basket. We have approximately 60% of our total food spend contracted to the end of the fiscal year. We have not fully covered our usage through 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 forward. Food inflation in the second quarter was approximately 0.2%, with seafood deflation in the mid-single-digits and beef inflation in the low-double-digit range. For the fiscal year, we continue to expect that our commodity basket will be see -- will see inflation in the range of 0.5% to 1.5%.

Now category by category, through the balance of fiscal 2013, seafood costs are lower on a year-over-year basis with nearly 100% of our usage covered. Beef costs are higher on a year-over-year basis with 60% of our usage covered. Poultry costs are slightly higher on a year-over-year basis with 40% of our usage covered. Wheat costs are slightly higher on a year-over-year basis with 20% of our usage covered, and dairy costs are higher on a year-over-year basis with 25% of our usage covered. Our energy costs are expected to be slightly higher on a year-over-year basis as we have contracted 30% of our natural gas, electricity in the deregulated markets in which we operate through the balance of the fiscal year.

I'll close by touching briefly on cash flow. The key observation for this year is that even with our revised sales and earnings outlook for the year, we still expect to generate approximately $1 billion in cash from operations. This includes a change where working capital goes from a use last year to a source this year. Last year, as part of our work to optimize the supply chain, we took ownership of inventory further up the supply chain, and that resulted in a cash outflow. This year, approximately half of that outflow will reverse, and the balance will do so over the following 2 years, resulting in positive working capital this year and likely into next fiscal year, too.

This fiscal year, we expect capital expenditures to be approximately $750 million, which means there's approximately $250 million of cash from operations to support our dividends, and of course, our capital budget has a meaningful flexibility as well. In fiscal 2013, for example, we have trimmed our new unit opening plan. At the beginning of the year, if you remember, we forecasted 100 to 110 units excluding the new Yard House restaurants, and now we intend to open approximately 100 units, including 5 new Yard House restaurants. Looking ahead to fiscal 2014, our thinking at this point is that we are likely to reduce capital expenditures by as much as 10% on a year-over-year basis, and most of that is likely to come from reduction in new unit growth as we strengthen our balance sheet and ensure we maintain solid debt metrics that preserve our investment-grade credit profile. We have more to say about cash flow, capital expenditures and credit metrics at our Analyst Investor Meeting in February.

And now, I'll turn it over to Drew to comment on our brands.

Andrew H. Madsen

Thank you, Brad. As Clarence and Brad have already mentioned, we're clearly disappointed with our second quarter performance. So this morning, I'm going to spend more time discussing the broader industry and competitive dynamics we need to address to strengthen our same-restaurant sales trends going forward and less time on the second quarter brand-by-brand, promotion-by-promotion operational details.

So stepping back, our view is that industry sales growth will be modest once again next year, calendar 2013. And so what we will continue to see in casual dining is a highly competitive market share contest. This reality reflects important consumer changes over the last several years, changes that have resulted in a decline in category usage. The decline is most noticeable among more economically constrained households and, to a lesser degree, among Gen X and millennials.

And for all 3 groups, the primary issue is affordability. These consumers want to use casual dining more often than they do today but often do not feel that they can afford to do so. As a result, large chains have been increasing use of promotional price incentives, from nationally advertised promotions and couponing to increased levels of more targeted digital offers, and the promotional intensity has, if anything, been ramping up recently.

Now at the same time, what is also clear and important is that not all guests are motivated primarily by need for greater affordability. Over the past several years, we've also seen a growing desire among more economically secure guests for distinctive, higher-quality dishes that also have higher prices. In addition, many guests, millennials in particular, want more convenience in their total restaurant experience and menus that offer more freshness and greater flexibility to dine the way they want.

So the key issue for us has been how to respond tactically from month-to-month and quarter-to-quarter in a way that addresses an urgent need for affordability among some guests while ensuring that, strategically, we're doing what is required to strengthen and evolve our brands in ways that appeal to all guests and strengthen and evolve our organization so that Darden remains in the industry leader for years to come.

As we weigh how we're doing in maintaining appropriate balance, our assessment is that we're making significant progress on important priorities that evolve our brands so they are better positioned for the future across all guest segments but we have not responded aggressively enough or effectively enough to address the needs so many guests have for affordability right now.

And here are few examples of what we've already done to put the planks in place to grow our guest base over time. All 3 of our large casual dining brands have recently introduced new advertising campaigns that help them create a more distinct brand identity and communicate compelling news about the guest experience that each offer. LongHorn and Red Lobster have each introduced meaningfully improved core menus, and Olive Garden has begun a phased implementation of compelling new platforms to their menu. Now this is important because 80% to 90% of what our guests order are items off these core menus. These menus include a wider choice of affordable dishes, wider dishes as well as a wider choice of more distinctive dishes at slightly higher prices. While it will take time for this menu improvements to lead directly to increased guest counts, early results at all 3 brands are encouraging.

LongHorn has completed a remodel of their existing restaurant base, and Red Lobster will be approximately 75% complete with their remodel program by the end of this fiscal year. Both programs have significantly elevated brand perceptions among all guests and contributed to value-creating guest count growth. Olive Garden is preparing to implement their remodel program in the second half of this fiscal year.

We've also implemented organization structure changes in operations and marketing for all 3 large casual dining brands that are designed to do 2 things: first, to strengthen execution against our core fundamentals, especially as our restaurant base grows, which, again, is important for all guests; and second, to accelerate development of an array of innovative new programs that are each designed to appeal to different guest segments and help grow guest counts.

And finally, we're building an appropriately robust technology platform that can support targeted digital marketing campaigns and the digital engagement our guests increasingly expect and do so in a way that gives us competitive advantage.

When we look at the other side of the equation, providing the affordability many guests need right now, we have not been as consistently effective with our short-term tactics as we need to be. Fundamentally, we've been a little too protective of brand image, guest satisfaction and margin and as a result have not been sufficiently competitive to attract a more economically constrained guest looking for a great deal. We've also not responded quickly enough to communicate enough news across enough channels to consistently keep our brands top of mind.

Our second quarter is a good example. Because during the quarter, we took 3 calculated risks in our promotions that in hindsight did not appropriately take into account today's realities. First, we decided to raise the price of Olive Garden's Never Ending Pasta Bowl promotion $1 dollar this year to $9.95 in order to fund more price-pointed promotional weeks later in the year than we had last year. However, the traffic hit as a result of this price increase was much bigger than we planned.

Second, at Red Lobster, we began the year with a strategy to run 5 longer promotions this year instead of the 7 shorter promotions we ran last year in order to free up funds to invest in advertising behind the launch of Red Lobster's new core menu. The net result is that, beginning in the first quarter and continuing into the second quarter, guest traffic at Red Lobster during the added weeks has been lower than we planned, and this was most pronounced during October, when Endless Shrimp ran out of steam after 12 weeks on air.

And third, we decided to launch LongHorn's Stuffed Filet promotion without a price-point feature. This is a very distinctive dish with great guest satisfaction, and it certainly helps elevate LongHorn's steak expertise credentials. But it also carries a premium price, and in this environment, that likely contributed to guest count softness in October and November at LongHorn.

So given all these, we are making definitive changes to our second half plans to strengthen same-restaurant sales performance. Now we do not believe it benefits us to publicly disclose too much about our plans. In fact, we believe we need to be competitively less predictable, because we have seen some competitive preemption of our recent promotions. So I'm not going to discuss specifically the changes we're going to implement. But I will say that Red Lobster, LongHorn and Olive Garden, have replanned the second half promotionally in ways that will more aggressively attack affordability, which means more promotions that are fundamentally about communicating a great deal and less about communicating brand-building news. It also means more price-pointed promotions with shorter duration than we previously planned. In addition, each of our 3 large brands is also significantly elevating the number of targeted digital offers that they will send their guests to help keep our brands consistently top of mind.

Now ultimately, our approach is intended to grow total operating profit by broadening the appeal of our brands and growing guest counts, even if profit per guest and margin as a percent of sales is slightly lower. Until we get further down the road, it's difficult to assess in a very precise way the trade-offs in the short term between better guest count traction and somewhat lower margin per guest, and that difficulty is reflected in our earnings outlook for the year. We're also zeroing in on ways to make sure we aggressively leverage our new operation structure to further elevate execution in our restaurants today and as a result build stronger guest loyalty for the future.

And with that, we'll take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Mr. John Glass of Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

First, I wanted to ask about the commentary around the reallocation of capital going into 2014. And I appreciate there's been a change in tone there, but 10% reduction in CapEx on a budget that's as big as you have and has been inflating doesn't seem like a lot. So, one, is that just your opening bid, or is there more on the table here? Because I think investors need to see a greater certainty around your cash flow, particularly as it relates to your dividend. And secondly, can you just give us an update on terms of your priorities? Buybacks didn't come into that calculation, Brad, when you talked about it, and yet now the stock is cheap, and you probably, all else equal, probably wish you had more dry powder to use that against the slower stock price. So can you talk about how you're reallocating some of those priorities and talk about if 10% is just the opening bid? Because it seems still fairly small relative to the size of the CapEx budget.

Clarence Otis

And -- I'll start and then hand it off to Brad. So this is Clarence. And it's still pretty early in the process as we think about capital expenditure budget for next year, so starting in June. As Brad said, it's got a lot of flexibility in that budget, and we are pretty focused on what we need to do there to make sure we have the kind of operating cash flows that we think we need to maintain an investment-grade credit profile. And so that's the first thing, is really to make sure we manage our debt metrics to preserve that profile. We think that's important. And so share repurchase, even if the stock price is lower on the list, then making sure we've got the right credit profile is how we think about it. But for sure, we've got flexibility in the capital budget. As we look at the various streams, whether it's new restaurants or remodels, we'll put a finer point on it, but I think, as Brad said, we see at least a 10%.

C. Bradford Richmond

Yes. And, John, the only thing I would add is I'd step back and say, even as we look forward with this year's performance, still generating operating cash flows of $1 billion, and so that's a significant cash flow that we have to work with. We've talked some about trimming, and Clarence elaborated some on the CapEx piece. We're going to continue to invest to protect that strong cash flow. So maintenance CapEx, remodels, those continue to move forward, but there will be some movement around new unit growth. And protecting our investment credit profile is something that's very important for us as we look forward.

Clarence Otis

And I would just say from a new-unit perspective, Olive Garden is probably the first place that we look. I mean, Olive Garden is over 800 restaurants. We've talked about what we think its ultimate potential is. It's not that far from that. Or even without the operating trends that we're seeing, we were poised to scale down. But that's certainly the first place, then we'll look across the entire capital budget.

C. Bradford Richmond

And we'll share more in February. But -- and when you look at our new unit performance and their risk-adjusted cost of capital that they have to earn against, including any draw impact that they have in other restaurants, new restaurants continue to perform quite well with this. So they will remain a meaningful part of our CapEx budget.

John S. Glass - Morgan Stanley, Research Division

Okay. I, though I -- I do think you'd probably agree that capital now being scarcer than it used to be, there probably has to be some hard decision made, even if those returns are strong. The second question just is relates to the promotional stance you're taking, more aggressive. Does that not just get you further into the problem you already have around sales volatility? I mean, how do you balance that versus saying, "Listen, maybe we need permanent value on the menu. Maybe that does take a onetime margin hit to reestablish kind of lower price points on the menu and build from there?" In other words, why does getting more promotional help you in the long run?

Clarence Otis

Yes. I think Drew got into it. So for sure, as we look at the core menu, we need to make sure that we've got a wide range of affordable price points, because that's important to a lot of guests. And that is something that we'll -- that we've been doing, will continue to do. Red Lobster made a fairly significant move in that direction with its core menu rollout in October. From a promotional perspective, for sure, you have some volatility around promotions. And so if you're a little bit more promotional from a price perspective, there's a little more volatility. But over time, we really are looking for growth in promotional guests, and we're comfortable handling some of that volatility.

C. Bradford Richmond

And, John, Brad here. The volatility is, as you can predict it and know it's coming, which would -- we know our promotions, we know what we're running, we know the expected impact, that makes it easier to manage through from our perspective. So unexpected volatility does challenge our operators to execute at high level. But for the promotions we're planning, we have pretty good insight so we can prepare and be ready for that.

Andrew H. Madsen

And the only add I would make to the points already made is that it's really an and equation and it's making our promotions more affordable as well as building menus that offer more everyday affordability with more distinctive items. The improvements we're making to our core menus are going to take time to reflect themself in sustained guest count growth. And in the interim, to get better guest count traction now, we need to be a bit more aggressive in our promotions. But you can see it in the things our brands have already done. I mean, LongHorn's a good example. They've added 7 or 8 items under $15 in the last year, and in addition to that, they've just added a Porterhouse for Two that's an indulgent and premium-priced dish. And I think Clarence mentioned the Red Lobster menu, where we've meaningfully increased the number of items under $15. At the same time, their Crabfest promotion now is featuring a premium and distinctive crab and lobster bake dish as well. So it's really an and equation.

Operator

The next question comes from Mr. Joe Buckley of Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Can you talk about what I presume is the gap between the test market results and the actual results for recent promotions? Are you concerned that your market research and testing processes are broken? Perhaps they were to a different time. And where's your confidence that the test market results and the actual results can re-converge?

Andrew H. Madsen

Well, I think there's a lot of dynamics in the market today from what our results would predict several months ago when we originally tested them to what's going on in the market today, elevated levels of competitive activity, and some things are tough to quantify, like the negative PR that we got. But I can tell you, in the case of -- I'll use Olive Garden as an example, value is the biggest opportunity, particularly affordability, but we also need to put a fresh face on the brand. And their new campaign, Go Olive Garden, has got in our copy testing the highest scores we've seen for that brand in terms of what we'd ultimately call involvement and relevance telling -- talking about the brand in a new way that makes it more relevant for more guests. Dinner Today, Dinner Tomorrow as a promotion has the highest value ratings for any promotion that we've tested other than Never Ending Pasta Bowl. It's a little bit different of a construct, Dinner Today, Dinner Tomorrow, and we may not have done as good a job at describing that difference in our new advertising campaign. But we saw a markedly different performance in our dinner day part versus our lunch day part in the second quarter, with dinner getting progressively better with that promotion, ultimately about flat, and lunch remaining pretty soft, which means that's an area in our core menu platforms that we're going to need to address in the relatively near term.

Clarence Otis

And I would also say, Joe, so we've got a much more dynamic market then we had historically, and so consumer sort of confidence moves around a lot more. The competitive dynamic is such that people are in and out with things a lot more than they used to be. And so, for sure, as we test something, we have to discount those results more than we've had to do in the past, because the environment where we launched may have some pretty important differences from the environment where we tested. And so we recognize that.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

And just a question on Olive Garden. As you try to improve Olive Garden's value standing, why are we seeing prices in check up year-over-year? And how is this the only concept with higher operating income year-over-year as you try to reposition? Don't you have to sacrifice margins going forward?

C. Bradford Richmond

Well, the biggest reason in the second quarter is that the check was up is our decision to increase Never Ending Pasta Bowl a $1. In addition to that, they introduced some new appetizers 6 months ago, a little more than that, and that's continuing to result in an increase in appetizer preference and add-ons. So those are really the 2 big drivers of it. And ultimately, as we've discussed in the past, we thought $9.95, even though it was up $1, was still a very compelling absolute price point, consistent with a strong value equation for the brand. But having said that, some of the things that we're looking at Olive Garden, as I described in my prepared comments, are going to more directly address affordability, which means there will be some slightly lower margin per guest. And as we regain guest count traction from that, ultimately, our goal is to grow total operating profit. But it's tough to predict it precisely in the short term.

Clarence Otis

And I would say, Joe, and Drew mentioned this, the reason why we thought it makes sense to raise it by a $1, the reason why we did it is because we wanted to fund more promotional weeks in the balance of the year. And so that was the thinking. And as you said, absolute dollar profit was up, but it wasn't up by nearly enough to support what we wanted to do. And so, in hindsight, it's something that we tried and that didn't work.

Operator

The next question comes from Mr. Brian Bittner of Oppenheimer and Company.

Michael Tamas - Oppenheimer & Co. Inc., Research Division

This is Mike Tamas for Brian Bittner. Just looking at Olive Garden's comps, the third quarter faces a much more difficult comparison than it did the second quarter. So I'm just wondering how confident you are the changes you're making there to be able to successfully lap this. And is it something that we're going to see that quickly, or do you think it'll take a few more quarters?

Clarence Otis

Yes. I would say couple of things. One is weather is part of the third quarter comp at Olive Garden. So we had much milder-than-normal winter weather last year, and that's reflected in the comp for Olive Garden and all the others. And I forget, I think it was worth, we thought, about 2 points. Now that 2 points was because that quarter was comparing against a quarter the prior year where weather was much more severe than normal, and so it was a big swing. And so a swing back from mild to something that looks more like normal shouldn't be worth a point, or 2 points rather, but it's impossible to predict the weather. So that's part of it. I think on the other side, our goal is to have more consistent same-restaurant sales improvement at Olive Garden than we've had. And so as we look back, we had a third quarter, even without the weather, that was a pretty solid third quarter. We had weak fourth quarter. We had a decent first quarter this year and the weakness that we've seen in the second quarter. So the goal right now is just to get more consistent quarter-to-quarter improvement as opposed to setting aggressive growth goals.

Michael Tamas - Oppenheimer & Co. Inc., Research Division

And if I could just ask one follow-up. Specifically, on Olive Garden, you talked about pulling back on the unit growth a little bit. And I'm just wondering how do you think that impacts your ability to kind of drive comp sales. And I was looking at some other concepts, it seems like Olive Garden over the last few years had been growing units faster that some of the competition. So how -- what does that dynamic look like going forward?

Clarence Otis

Yes. We've talked about what new restaurant growth pace at Olive Garden has been on the past few years does to same restaurants, and so it's been roughly a 70 basis points negative impact on same-restaurant sales growth, the pace that we've been on. As Brad said, we take that cannibalization into account as we look at our new restaurants and forecast cash flows, and it's got to cover that in order to achieve its hurdle rate when it comes to return on invested capital. But a slowdown means that, that erosion caused by the current pace will narrow some. That's what I think it means, so...

Operator

The next question comes from Mr. Jason West of Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just another one back on the cash flow. Brad, can you just talk about your confidence level in that $1 billion of operating cash? Because you've got a long ways to go to get there for the balance of the year. And maybe if you could quantify how much of that's coming from the working capital. And I'm assuming you just assumed sort of normalized net income and D&A in line with the guidance, but I don't know if there's any other moving parts we need to be aware of there.

C. Bradford Richmond

Basically, that reflects earnings guidance that we have. It's right at $1 billion. What I would say is that a 1% movement in same-restaurant sales on an annual basis is about $30 million to $35 million of cash flow to help put that in terms of a sensitivity point of view. Like -- so we have a lot of things that go into the cash flow, obviously, driven by our earnings, but we've talked about working capital. And I think last year, that was a pretty significant usage. This year, we've talked about that is reversing out, as we had expected to. And so that when you even look at the first half of our fiscal year, our operating cash flows were up almost $200 million in spite of some of the top line weakness that we have. So as we look to the back half of the year versus the first half, to your point, long ways to get there, is the seasonal nature. This second quarter is very seasonally low quarter for us, so any variances or variability in the second quarter has a outsized percentage impact when you look at things. But if you look at last year's performance, particularly in the second half, the guidance that we have for this year, that puts you on track to have about $1 billion in operating cash flow. The biggest unusual mover would be this working capital change that last year was a usage, this year is a provider of cash flow to us. That's -- other than that, there's not any big secrets or big movements in the cash flows.

Jason West - Deutsche Bank AG, Research Division

Okay. And then just one other on the guidance for the back half. Can you talk a bit about the margin assumptions in there around things like COGS? And any other color you can offer us? Sometimes you do give some color on the current quarter for the line items.

C. Bradford Richmond

Well, obviously, with where we are year-to-date, margins are going to be down a little bit. I would say we're looking at a range, at the EBIT level, of about 70 to maybe 110 basis points for the year of a decline. I wouldn't want to go into particular line items, because we try to manage to the total. But we have had strong success on managing our restaurant labor, and there's obviously a lot of leverage in our restaurant expenses. So if we have more aggressive price points, that could raise our food and beverage cost as a percentage of sales. But to the degree it's driving some incremental traffic, we would leverage those on, I said, restaurant labor and restaurant expenses. So that, as Drew said, it's not so much about managing the percent as growing the absolute total operating profit that we generate from these activities.

Operator

The next question comes from David Palmer of UBS.

David Palmer - UBS Investment Bank, Research Division

Other than the sales malaise, with regard to the consumer backlash, with regard to Darden's tested or presumed response to Obamacare, I mean, clearly, you were taking steps that made you -- made it look like you're getting into damage-control mode. So it looks like you believed it. But what were you seeing that made you believe it, other than the sales?

Clarence Otis

Yes. Well, I would say we've got a lot of channels for listening to our guests. And so those include social media we track pretty heavily, we look at conventional media, all of those things. We've got a guest relations operation here, so we get guest feedback directly. And we saw significant spikes in all of those areas, and we see spikes on other issues. This dwarfed those. And it dwarfed them, even though on a lot of those other issues, it's -- the buzz is orchestrated. And so it's a lot of form letters and form calls. This was not orchestrated. This was organic, and so we think the intensity level was much higher. And then, as you said, we -- it's -- when you look at sales, there are a lot of moving parts, we're changing promotions, we're changing meal plans. So it's difficult to discern there. Probably the cleanest read would've been at Red Lobster, because they were relatively early in a promotion that in September was really quite strong and then dropped off immediately around the beginning of the conversation about this issue.

C. Bradford Richmond

And I'd add on that another dimension that what made us think that this had a negative impact on our business is the way we listen to what our employees were saying as well, and there was a particular spike in comments from employees across the country in our restaurants as well as here. And that reflects, obviously, what they're hearing, what their guests are saying and the way they feel, and we think it ultimately makes a difference.

David Palmer - UBS Investment Bank, Research Division

And then one -- the second and last question. Olive Garden profit was up slightly, and that makes the deleverage of the remaining brands that much more striking. I would guess that you're not shooting for that sort of profit sensitivity per same-store sales point of decline. What comment could you have about that, please?

Clarence Otis

Yes. Back to Brad's point about the quarter. So this is a seasonally low quarter. And so -- and it's -- the fall is a relatively value-sensitive time across all of retail, but certainly, across restaurants, and that really is what drives a lot of the seasonality. And so you get a lot more movement on these lines from these changes in top line than you would in other quarters.

Operator

The next question comes from Nicole Miller with Piper Jaffray.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

There's been some earlier questions about the promotional and testing behind the promotions. I wanted to ask, actually, about the new menu rollout you were discussing today in your prepared remarks. How did you test those, for example, in what markets? Can you distinct if you're getting a new guest or a legacy guest more frequently? And also, what was impact to mix and margins and average ticket?

C. Bradford Richmond

Well, the biggest change was the menu -- new menu introduced by Red Lobster, and we tested that for not quite a year in multiple markets across the country. And we -- probably 80. And what we saw when we tested it over several months was a pretty modest reduction in check related to entrees that people were purchasing. A little bit of an increase in check related to new appetizers and different types of items on the menu than what we had today and about a point increase in traffic. And -- but that took several months to materialize. Since we've introduced it, and it's only been about 6 weeks, not even a couple of months yet, we've seen -- and the objectives for this menu at Red Lobster are to help sustainably grow guest counts by addressing everyday affordability, first, and, second, the veto vote, had more non-seafood variety. And since we've introduced it, we've seen almost a 50% increase in preference on items under $15 and more than doubling preference on non-seafood items. So very early, but encouraging. That's the sort of guest behavior that we want to see to gain confidence that, ultimately, what we're doing is going to help grow guest count sustainably.

Clarence Otis

I think as Drew said, so the build for core menu change takes time. I mean, so that's not the same as a promotion. So that will occur over a period of time. We tried to stimulate some of that with the launch of that new menu having some media support behind it, but it does take time.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Okay. And then just one question about the Specialty Restaurant Group, which you haven't talked about so much today. Could you talk about current holiday trends? Anything you'd be willing to share, specifically perhaps on The Capital Grille, or maybe you're benefiting from banquet and private dining bookings and how that is shaping up?

Eugene I. Lee

Nicole, it's Gene. I would just say that all the drivers for luxury are in place. Business travel is still improving. Holiday parties have been strong. And I would -- not getting ahead of ourselves here, I think the holiday season has probably been pretty strong for luxury brands.

Operator

The next question comes from Will Slabaugh with Stephens.

Will Slabaugh - Stephens Inc., Research Division

I wonder if you could talk just a minute on some commentary you made earlier and what you meant by being too protective of both guest satisfaction and brand image, which sounds maybe a little counterintuitive on the surface as you think about messaging and experience going forward and maybe how you balance that with the affordability push that you're making now.

Andrew H. Madsen

Sure. Well, obviously, we want to build brands that have broad appeal and build loyalty for years and years to come, and we start with the guest in everything we do. And part of the way we're trying to build distinctiveness is reflected in our promotions. So an example at both LongHorn and at Red Lobster, so Stuffed Filets is an example of how we're trying to offer distinctive dishes that you can't get anywhere else that really contribute in a meaningful way to building steakhouse quality and steakhouse credentials at LongHorn while also helping drive near-term guest count growth. That's worked for us in the couple of years. It didn't work as well this year, and we think one of the biggest reasons is probably the perception of that is it is distinctive but it's expensive. Crabfest is another example at Red Lobster. So part of what we want to do is become -- maintain the reputation of the brand as being the best choice for seafood and casual dining. And part of the way we do that is by offering, again, distinctive dishes that you can't get anywhere else, an array of crab dishes, in this example, that some are affordably priced, some are little -- a little more indulgent to build our image about food quality, food distinctiveness in the seafood space. That's a promotion that we ran middle of July and August last year. It contributed 5% or more same-restaurant sales growth when the industry was plus 1%. In the current environment, we think it was viewed as perhaps just a little bit too indulgent, perhaps a little bit too expensive, even though we featured a $12.99 dish that was better than the $14.99 dish we featured last year, so a focus on brand-building there. And on guest satisfaction, we're not going to do anything in terms of quality of ingredients, as an example, or service to jeopardize guest satisfaction. But we do believe what guests are willing to -- what some guests are willing to accept today in terms of portion size and price is a little bit different than what they might have been willing to accept in the past. And as we become more aggressive in affordability, we think there's room to refine what we offer without in any way negatively impacting guest satisfaction.

Clarence Otis

My only add would be -- so when we talk about building the brand, much of that takes place with the guest experience in the restaurant. And so it's about every piece of that, the core menu, the service, the decor and image inside the restaurant, the look and feel of the place. And we try to support that with our advertising. And so the look and feel of the advertising consistent with the brand, promise that we're making and the brand delivery that we're endeavoring to do. And then we try to support that with a narrative inside the advertising as well. And so I think a little bit of what we're seeing is we're probably trying to make it work too hard, and the narrative needs to be more specifically about what a great deal it is. Now it still needs to be presented with creative that has a look and feel that helps build the brand. But we do think we do a lot of things in the restaurants themselves to build brand, and we can dial back, at least, on the narrative part, the brand-building piece and dial up clarity around a great deal.

Will Slabaugh - Stephens Inc., Research Division

Understood. And then a quick follow-up from me on healthcare. I appreciate the takeaways there from the test on employee morale, guest satisfaction, et cetera. But wondered if you could talk about what steps you think you will be able to take to help mitigate these costs. And I know it's early here, with a lot of the regs not having been written, but any sort of estimate around what that cost might look like?

Clarence Otis

Yes. I would say it is very early with the regs not being written, and there's also -- as we think about costs when regs are written, we've got to make a very significant number of assumptions about employee behavior and how they're going to respond to the landscape. And some of those assumptions we'll have to make without full information, because we don't know our employees' household incomes. That's going to be a big deal in the new landscape. And so it's pretty too early to talk about cost. But our sense is that it'll be of a magnitude where we'll do things across a number of different sectors to mitigate costs. And as -- we've got supply chain. We've got a lot of levers, and we'll be looking at all of those.

Operator

The next question comes from David Tarantino with Robert W. Baird.

David E. Tarantino - Robert W. Baird & Co. Incorporated, Research Division

Just, first, a clarification on the capital discussion around cutting back CapEx and leveraging that. One thing that you didn't address directly is the dividend. And could you maybe talk about how you're thinking about dividend policy currently, and whether there's a risk that the dividend might need to come down to maintain your investment-grade rating?

Clarence Otis

Yes. And I would say the answer is no. There's not a lot of risk that dividend will come down. Because as Brad said, we've got $1 billion, roughly, operating cash flow, a $250 million dividend and actual day-to-day renewal capital of $120 million. And so the flexibility in the capital budget is $600-plus million. And so the real question for us is less about dividend coming down and what about -- more about what dividend growth looks like going forward.

David E. Tarantino - Robert W. Baird & Co. Incorporated, Research Division

Great, that's helpful. And then maybe back to the question about affordability. And I'm just wondering how you arrived at your conclusion that you need to address affordability more so than focusing on the quality and differentiation of the experience. And more specifically, I guess, how do you think about the risk of training consumers that the brands are all about the price points you're offering rather than the differentiated experience that you're offering?

Andrew H. Madsen

Well, we think -- again, to reiterate a couple of points I made in my prepared remarks, we think we need to do both. There are guests where we need to strengthen affordability more directly, and there are other guests where we need to continue to focus on distinctiveness and quality. And then make sure for all of those guests, as Clarence just said, once they come into the restaurant, inside the 4 walls of our restaurant, that we're building value and loyalty by delivering a consistently great experience. But what's given us the belief that we need to emphasize affordability now, in particular, is that we have seen a drop in category usage among households that are more economically constrained, particularly under $60,000. That's more pronounced than any other demographic or generational cohort segment. Our drop in that group has been more pronounced than the industry drop, and that's -- we're still well above the industry in households under $60,000. But we've declined more than the industry, and that's a key part of the breadth of appeal of our brands and why we think we need to be particularly more aggressive there in our promotions while we continue to do other things with core menu and service that build quality and distinctiveness and value.

Clarence Otis

Yes. So again, it really is an and equation. We've got to do both, because both of these customer groups are big for us, those who are economically constrained and those who are economically secure. So we've got to do both, and we've talked about the strategies to really accomplish that.

Operator

The last question will come from Jeff Farmer of Wells Fargo.

Jeffrey D. Farmer - Wells Fargo Securities, LLC, Research Division

You touched on this earlier, but I'm just trying to get a better read on what a casual dining consumer, what the consumer's responding to in the current promotional environment. So I guess using Olive Garden as an example, you had the 2 for $25 promotion. Did that attract a different type of customer than what you saw with the Dinner Tonight, Dinner Tomorrow promotion? And again, just trying to all relate that back to the deal narrative that you related to.

Andrew H. Madsen

I don't think we yet have great insight in that shorter time period on the difference or similarity of the guests that we're attracting with those promotions. But clearly, they're designed to be more about a great deal, specifically addressing affordability. We had very solid traction with the 2 for $25 that you mentioned earlier in the first quarter, and at dinner, we had solid traction with Dinner Today, Dinner Tomorrow. And that's what they were designed to do. But it's too early, too short, in just a couple of months, to have a -- draw a conclusion about the guest base.

Clarence Otis

And I would say -- so Dinner Today, Dinner Tomorrow is a more challenging construct, right, because the 2 for $25 is one that customers are familiar with, because it's being offered in various forms with different price points across the entire category. The other took a lot more to explain, and so those are differences.

Jeffrey D. Farmer - Wells Fargo Securities, LLC, Research Division

I didn't know with one if -- for example, the 2 for $25, you're getting sort of increased frequency from a loyal customer, and with Dinner Tonight, Dinner Tomorrow, you're essentially renting some shorter-term customers. Is that even close to being fair?

Clarence Otis

No. That's not close to being fair, because we have a lot of customers. And so the question -- and they have different frequency levels. And so we need to dig in and understand better, as Drew said, over a longer period of time, which of those bases we were tapping into. But we have very few customers that are rented, very few customers -- and those are customers that we capture in our Specialty Restaurant Group. So some of those customers don't interact with our other brands, but beyond them, not a whole lot out there.

Matthew Stroud

We'd like to thank everybody for joining us this morning. And we recognize there's still several of you in queue that have some questions. Of course, we're here all day today to help answer those questions.

We wish everybody a safe and a happy holiday season. We look forward to speaking with you again in February at our Analyst Day. Thank you very much.

Operator

To listen to this call via replay, you may call one of these numbers: U.S. toll free (866) 459-3542 or U.S. toll (203) 369-1331. You will also need to enter a passcode via touchtone phone. The passcode is 12202012. The replay will be available until January 20, 2013, 11:59 p.m. Eastern Time.

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