Darden Restaurants Management Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: Darden Restaurants, Inc. (DRI)
by: SA Transcripts

Operator

Welcome, and thank you for standing by. Welcome to the Fourth Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I'd like to turn today's meeting to Matthew Stroud. You may begin.

Matthew Stroud

Thank you, Rebecca. 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 related 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 newer brands like Bahama Breeze, Seasons 52 and Eddie V's; a lack of suitable new restaurant locations; higher-than-anticipated costs 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 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 2014 first quarter earnings and same-restaurant sales for fiscal June, July and August 2014 on Friday September 20, 2013, before the market opens with a conference call shortly after.

We released fourth quarter earnings results this morning. These results were available on PR Newswire and other wire services. Now we recognize that most of you have reviewed the fourth quarter earnings results, so we won't take time to go through them in detail once again in an effort to provide more time for your questions. We will offer a line item summary of the P&L, discuss our financial outlook for fiscal 2014 and discuss our brand-by-brand operating performance summary.

With that, let me turn it over to Clarence.

Clarence Otis

Thanks, Matthew. And I'll start by briefly sharing at a very high level our assessment of our business, including our performance last year, fiscal 2013, and what we expect this year, fiscal 2014. Then Brad, Drew and Gene are going to provide more detail on both years and on the fourth quarter last year.

Now as fiscal 2013 unfolded, I think many of you know that we moved with added urgency to address the same-restaurant traffic erosion we've been experiencing since the recession started. And during that time, our traffic erosion had been much more muted than the erosion in the industry, about half as much of a decline as the industry on a cumulative basis. But in the fourth quarter of fiscal 2013, our same-restaurant traffic decline exceeded the industry's. And when that continued into first quarter this year, we took action on 3 fronts. First, we began to match the competitive promotional intensity around affordability, and that included being more aggressive with our offers and our advertising messages and with our use of tactical support like daily and weekly digital specials. Second, we began to more aggressively address affordability in our core menus, and that included launching with some heavy media support, a new Red Lobster core menu that has a significant affordability component and then also accelerating introduction of new, more affordable core menu offerings at both Olive Garden and LongHorn Steakhouse. And then third, we increased the resources dedicated to reshaping our guest experiences to respond to what guests want beyond affordability, and that meant reorganizing our marketing and operations group and ramping up investment in better digital and other capabilities.

Now reorganizing these functions, key functions, marketing operations involved shifting many tenured leaders into new positions. And because the intent of the reorganization, reshaping the guest experiences we provide, require some new skill sets and new professional experiences, we also added new people.

Now as we look back, the cost of the leadership changes we made was much higher than we expected, and the most significant but difficult to measure cost was that associated with reduced executional effectiveness. As we look back, we also know that many of our promotional core menu affordability efforts involve more margin pressure than initially anticipated. Although as we got better in-market reads of guests' reaction, we consistently made what we think were appropriate adjustments. And these leadership, churn-related and affordability costs were partially offset by some of the initiatives that we launched in prior year and continued in fiscal 2013. And those initiatives are initiatives that we talked about before, and they include continued automation of our supply chain, continued reduction in our water and energy usage and continued implementation of more efficient in-restaurant labor processes and procedures.

In fiscal 2013, costs in these areas were reduced by $13 million, bringing the annualized cost savings from these efforts to more than $125 million since we started down this path 5 years ago. Fiscal 2013 is also a year in which our strong pay-for-performance orientation drove through because with performance that was well below our pre-established sales and earnings goals, incentive payouts from the restaurant manager level on up were well below normal. The overall annual incentive payout for fiscal 2013 was 56% of normal, and payouts ranged from 65% of normal for our in-restaurant management teams to 31% for all the others in our plan to less than 15% for the most senior leadership team, and for several individual leaders, there is no payout. Of course, the below normal overall payout prevented the EPS decline for the year from being even greater than it was.

Now when we look at our same-restaurant traffic results in the third and fourth quarters, we see encouraging signs that we're on the right track. In the third quarter, we matched the industry, although absolute results, for sure, for us and for the industry were not strong. But in the fourth quarter, we were well above the industry, and we had solid growth in same-restaurant traffic.

Looking forward, our sales and earnings goals for 2014 are to drive same-restaurant traffic growth and deliver same-restaurant sales growth that's above what we forecast for the industry, although it is likely that quarter-to-quarter traffic in sales will be volatile given our view that fiscal '14 will mirror fiscal 2013 on a macroeconomic basis. So we expect to see a continuation of the slow and uneven recovery that we've been experiencing for some time now.

From an annual incentive accrual perspective, we will accrue for our fiscal 2014 based on the assumption that we achieve our sales and earnings goals for the year and that as a result, the overall payout will be at a normal level. And the move from a well below normal payout in 2013 to a normal payout in 2014 is a headwind for fiscal 2014 earnings growth that amounts to $0.35 a share. Of course, if we don't achieve our sales and earnings goals for fiscal 2014, the overall payout for the year will again be below normal.

What's most important, in our view, is that we are confident that in fiscal 2014, we will return to same-restaurant traffic growth and to industry leading same-restaurant sales growth. And that confidence is based on the steps we've already taken, the momentum we're seeing and what we're doing to build on that momentum. And renewed same-restaurant traffic and sales growth coupled with solid new restaurant sales growth that going forward is going to be driven largely by a continued expansion of Longhorn in our Specialty Restaurant Group brands is the key to resuming competitively superior shareholder value creation.

With that, let me turn it over to Brad to provide some financial detail about the fourth quarter and about the full year fiscal 2013. Brad?

C. Bradford Richmond

Thank you, Clarence. In the fourth quarter, Darden's total sales from continuing operations increased 11.3% to $2.3 billion, and blended same-restaurant sales for Olive Garden, Red Lobster and LongHorn Steakhouse increased 2.2% from strong same-restaurant traffic gains of 3.2%. For the fourth quarter, U.S. same-restaurant sales increased 3.5% at LongHorn Steakhouse, 3.2% at Red Lobster and 1.1% at Olive Garden. And we also saw continued same-restaurant sales gains in our Specialty Restaurant Group with 2.3% same-restaurant sales growth on a blended basis. Fourth quarter same-restaurant sales increased 4.5% at Capital Grille, 1.0% at Seasons 52, 4.3% at Eddie V's but declined 1.7% at Bahama Breeze.

Now let's turn to the margin analysis for the fourth quarter. Food and beverage expenses were 16 basis points higher than last year on a percentage of sales basis. The increase in food and beverage expense is attributable to menu mix changes and promotional offerings. Fourth quarter restaurant labor expense were 74 basis points higher than last year on a percentage of sales basis due to lower year-over-year check average and wage inflation. In addition, I should note that restaurant labor expenses were $8 million or $0.04 of EPS, higher than we expected coming into the quarter. That was largely because of less-than-expected productivity as we reversed out some of the early year model changes at Red Lobster that did not work as planned and because the Lobsterfest menu had some additional complexity. We believe that we are past these issues and labor at Red Lobster is coming back into standard this quarter.

Restaurant expenses in the quarter were approximately 100 basis points higher than last year on a percentage of sales basis because of the impact of adding Yard House, about 38 basis points there. Since with a restaurant base that's 100% leased, it runs higher restaurant expenses as a percentage of sales than our other brands. And for all of our brands, higher workers' comp, public liability costs added about 24 basis points.

Selling, general and administrative expenses were 65 basis points higher than last year as a percentage of sales, primarily due to increased media and media inflation and mark-to-market of our securities-based employee benefit plans. As discussed in our press release, these plans are hedged economically on an after-tax basis, and we receive a benefit from the hedging that favorably affected our tax rate by over 300 basis points in the fourth quarter. These effects offset one another on a diluted net earnings per share from continuing operation basis, so there is no net impact on EPS.

Depreciation expense in the quarter was 7 basis points higher as a percentage of sales basis compared to last year due to increases in new units and remodels. For the quarter, operating profit as a percentage of sales was 8.4%, and all of this netted to a 12.2% decline in diluted net earnings per share in the fourth quarter.

Now for the full fiscal year, Darden's total sales increased 6.9% in fiscal 2013 to $8.55 billion. This increase was driven by 144 net new restaurants, including the purchase of 40 Yard House restaurants plus 4 new units opened since the acquisition closed, combined with a blended same-restaurant sales increase of 2.1% at the Specialty Restaurant Group, offset by blended same-restaurant sales decrease of 1.3% at our 3 large brands.

On an annual basis, we reported net earnings from continuing operations of $412.6 million and diluted net earnings per share from continuing operations of $3.14, representing a 12.3% decrease in diluted net earnings per share from continuing operations. This includes the integration cost and purchase accounting adjustments related to the Yard House acquisition, which reduced diluted net earnings per share by approximately $0.09 in fiscal 2013.

Despite the earnings decline, we once again generated strong cash flows, and given our ability to consistently do so, today we announced an increase in our dividends to $0.55 per share payable on August 1, 2013, to shareholders of record on July 10, 2013. Previously, we paid a quarterly dividend of $0.50 per share or $2 per share on an annual basis. Based on the $0.55 quarterly dividend declaration, our indicated annual dividend is $2.20 per share, an increase of 10%. Given the diluted net EPS, we expect in fiscal 2014, which I'll talk more about later, this equates to a payout ratio on a forward basis of approximately 70%. While this is above the 40% to 50% payout range we discussed before, we're in the process of reviewing our target range and are likely to take it higher sometime later this year.

Over the last 5 years, we have increased our dividends at a rate of 22% on a compounded average annual basis, which speaks to the consistent cash flows we generate and our intent as we think about the balance between dividends and share repurchase to return more capital to shareholders through dividends.

And now I'll turn it over to Drew to comment on Olive Garden, Red Lobster and LongHorn Steakhouse.

Andrew H. Madsen

Thank you, Brad. And this morning, I'll briefly comment on the fiscal 2013 fourth quarter performance at each of our 3 large casual dining brands, as well as their fiscal 2014 strategic priorities. But for competitive reasons, I'm not going to discuss any of our specific fiscal 2014 tactics in detail.

Olive Garden same-restaurant guest counts increased 2.3% during the fourth quarter, and this performance exceeded our estimate for the industry, excluding our brands, by approximately 340 basis points and represents a significant improvement competitively compared to the third quarter, when Olive Garden trailed the industry on traffic by 20 basis points. Same-restaurant sales grew 1.1% and exceeded our industry estimate by approximately 20 basis points, which also represents a significant trend improvement competitively compared to the third quarter when Olive Garden trailed the industry by 260 basis points.

Red Lobster same-restaurant guest counts increased 4.2% during the fourth quarter, and this performance exceeded our industry estimate by approximately 530 basis points and represents a significant improvement competitively compared to the third quarter, when Red Lobster trailed industry on traffic by 70 basis points. Same-restaurant sales grew 3.2% and exceeded our industry estimate by approximately 230 basis points, which also represents a significant trend improvement competitively compared to the third quarter when Red Lobster trailed the industry by 510 basis points.

Longhorn same-restaurant guest counts increased 3.9% during the fourth quarter, and this performance exceeded our industry estimate by approximately 500 basis points and represents a significant improvement competitively compared to the third quarter when Longhorn exceeded the industry on traffic by 120 basis points. Same-restaurant sales grew 3.5% at Longhorn and exceeded our industry estimate by approximately 260 basis points, which also represents a significant trend improvement competitively compared to the third quarter, when Longhorn trailed the industry by 10 basis points.

On a combined basis, our 3 large brands increased same-restaurant guest counts by 3.2% and same-restaurant sales by 2.2% during the fourth quarter. These results are slightly better than our expectations heading into the quarter. And as Clarence said, they reflect the increased urgency we brought to addressing the competitively weak same-restaurant guest count results we saw starting at the end of fiscal 2012, which has involved responding more aggressively to the increasing need that many of our guests have for more affordable casual dining experiences and to the related increase in competitive promotional intensity.

During fiscal 2014, all 3 of our large brands are focused on 3 broad strategic priorities: affordability, delivering our current guest experiences at a competitively superior level more consistently across all our restaurants and evolving the experiences that each of our brands offer in ways that make them more attractive to new guests and for new occasions.

The first 2 strategic priorities are intended to strengthen near-term sales momentum, while the third priority is intended to take advantage of changing consumer realities to ensure our brands remain broadly appealing and relevant in the future. And when it comes to affordability, we are refining our pricing and promotion tactics to reflect what we learned during fiscal 2013. Now this learning will help us more effectively balance guest count growth and check growth during fiscal 2014.

Olive Garden will further strengthen guest satisfaction this year through in-restaurant process simplification. And this work is all about making it easier for our restaurant teams to execute to our standards more consistently across all restaurants. In addition, to regain value leadership in casual dining and broaden appeal at Olive Garden, we plan to add more affordable Italian classics for price-conscious guests, compelling and craveable protein-centric dishes for guests that are willing to pay a little more, new offerings in our popular Lighter Italian Fare platform for health-conscious guests and more daypart-appropriate menu selections and service options at lunch. We also plan to begin the expansion of our remodel program at Olive Garden for all non-Tuscan farmhouse restaurants during the second half of fiscal 2014. Finally, we will significantly slow new unit growth at Olive Garden from 36 in fiscal 2013 to 15 in fiscal 2014 and 5 to 10 new units a year beyond fiscal 2014, allowing our restaurant and leadership teams greater time to delight current guests and build a stronger foundation for pursuing new guests and new occasions.

Red Lobster will address the labor productivity opportunity we experienced during the fourth quarter with incremental training for our restaurant management teams on how to more effectively use our labor management systems and by providing increased operations focused on labor hour and wage rate management. To further strengthen the base business and broaden appeal, Red Lobster will continue to contemporize their experience with a focus on more powerfully presenting several core equities to guests. This will include more up-to-date presentations for several premium-priced and highly craveable signature shellfish plates, the introduction of 2 new craveable seafood platforms, reinvigorating our fresh fish and wood-fire grill platforms for guests interested in fresh good for you choices, as well as optimizing the selections in the popular 4-course feast platform for price-conscious guests in ways that make them more compelling while also improving their margin dynamics. And we will introduce more daypart-appropriate menu selections at lunch. Red Lobster will substantially complete our Bar Harbor remodel program and open one new restaurant during fiscal 2014.

Longhorn has made significant progress over the last several years, transitioning the brand and guest experience from a casual dining roadhouse to a great casual dining steakhouse. We will further strengthen guest satisfaction during fiscal 2014 with a continued focus on improving what guests want most from a steakhouse, steaks grilled at a proper temperature and friendly and attentive service. To broaden appeal going forward, we're working to further differentiate the Longhorn brand and guest experience from other steak alternatives and casual dining. We plan, for example, to elevate culinary innovation with approachable new dishes inspired by fine dining and polished casual restaurants and strengthen freshness and quality perceptions by introducing seasonally relevant appetizers, side dishes and add-ons while also adding more non-steak choices and redesigning the steak panel in our core menu to help strengthen affordability. Longhorn will continue significant new unit growth but at a rate that is a slight reduction versus last year, going from 44 new units in fiscal 2013 to a range of 37 to 40 new units in fiscal 2014.

Now Gene will share a few comments on our Specialty Restaurant Group.

Eugene I. Lee

Thanks, Drew. The Specialty Restaurant Group delivered solid performance in the fourth quarter, growing sales 65%. This growth was a result of our 59 net new restaurants across the group, which includes 44 Yard House restaurants, and blended same-restaurant sales growth of 2.3%. Our sales growth resulted in significant operating profit growth during the quarter.

Total annual sales for the group exceeded $980 million, that's an increase of more than 58% over the prior year and contributed to 66% of Darden's total annual sales growth for the year. This sales growth was driven by annual blended same-restaurant sales growth of 2.1% and our additional 59 net new restaurants. With the acquisition of Yard House and strong same-restaurant sales growth at Capital Grille of 3.3%, the group's average unit volumes have grown 5% to $6.7 million.

We're on track with our three-phase integration -- we're on track with our three-phased integration of Yard House. First, people. We've retained all key operational leaders, which ensures continuity, and these leaders will continue to run the brand. Second, we anticipate full supply chain integration by the end of first quarter fiscal 2014. Lastly, we're in the process of migrating all transactional activity to Darden systems and expect this to be finished in late fiscal '14. This approach enables us to capture meaningful synergies. The Eddie V's integration is complete, and we exceeded our synergy targets. Additionally, we've opened our first restaurant since acquiring the brand in Tampa, Florida, and we're very pleased with its initial performance.

As we enter fiscal 2014, our key priorities remain effectively managing accelerated new restaurant growth while maintaining operational excellence in existing restaurants and ensuring our brand and business models continue to improve and remain vibrant. We will also continue to focus on taking advantage of our strong culinary and beverage expertise to remain nimble and dynamic and drive sales, which involves responding to favorable costs and supply developments that we see on various products from time to time to provide compelling special offers to our guests. We will also continue to add new on-trend menu items and seek ways to improve our current offerings. Finally, of course, we'll remain as focused as ever on improving restaurant-level execution, further elevating the guest experience appropriately in each of our brands.

In fiscal 2014, we plan to open 25 to 27 net new restaurants, including 7 to 8 Season 52s, 7 to 8 Yard Houses, 4 to 5 Capital Grilles, 3 to 4 Bahama Breeze restaurants and 1 to 2 Eddie V's restaurants. We're confident that the Specialty Restaurant Group is working on the right things to achieve our long-range growth targets, and we're well positioned to take full advantage of all that Darden has to offer, including robust supply chain, information technology, consumer insights, finance and other capabilities, and make significant contributions to Darden's sales and earnings growth.

Now I'll hand it back to Brad for the fiscal 2014 financial outlook.

C. Bradford Richmond

Thank you, Gene. For -- our outlook for fiscal 2014 reflects the resilience of our business model in the face of what we believe will be a continuation of what has already been an extended period of well below normal economic growth. In this environment, in fiscal 2013, we generated $950 million in cash flow from operations. In fiscal 2014, we anticipate even stronger cash flows from operations driven by a combination of same-restaurant sales growth, new unit growth and improving underlying operating margins. And after investing appropriately in both regaining momentum and expanding our businesses, we plan to return additional capital to shareholders through an increase in our dividends, which we announced today.

In fiscal 2014, our outlook is based on a combined same-restaurant sales growth for Red Lobster, Olive Garden and LongHorn Steakhouse of between 0 and plus 2% and combined same-restaurant traffic growth of between 0 and 1%. This includes pricing that is estimated to be approximately 1%. Of course, we will be both above and below these ranges from month-to-month and quarter-to-quarter, depending on promotional calendars, holiday shifts and changes in consumer sentiment.

Looking at unit growth, new restaurant plans we outlined means that we expect a net new restaurant increase of 80 restaurants, which is 3.7% unit growth on our current base. And with the timing and mix of our fiscal 2013 openings, this will translate into 4.5% sales growth from new restaurants. Given our same-restaurant sales assumptions, new restaurant expectations and an incremental quarter of Yard House's sales, we anticipate that total sales increase for the year will range from between plus 6% to plus 8%. Excluding the incremental quarter of Yard House sales, the total increase would between plus 5% and plus 7%. With lower new unit expansion, we expect capital spending for fiscal 2014 to be lower than in fiscal 2013. We expect it to be between $600 million and $650 million, which compares to $686 million in fiscal 2013. Included in this capital spending estimate is approximately $15 million in capital dedicated to information technology initiatives that we have previously discussed, which largely involves building the kind of guest-facing capabilities that are crucial given our guests' increasing digital lifestyles.

Looking at operating profit margins from continuing operations, we expect margin contraction of approximately 60 to 80 basis points on a full year basis compared to fiscal 2013. On a percentage of sales basis, we expect to see unfavorability from food and beverage expenses in the first half of the fiscal year as we experience elevated inflation on shrimp due to production issues at some farms in Asia, but this will begin to level out in the second half of the fiscal year as farmers implement solutions they have already identified.

We also expect restaurant labor expenses as a percentage of sales to be higher this fiscal year primarily because we are accruing for normal annual incentive payout following a year where the payout was well below normal. The remaining line items, restaurant expenses, selling, general and administrative expenses and depreciation expense are expected to be relatively unchanged on a percentage of sales basis.

Looking at food costs more specifically, we expect food and beverage expenses to be higher as a percentage of sales. This is based on our expectation that net food cost inflation will be between 2% and 2.5%, which is slightly higher than what we discussed at our Analyst Meeting in February, primarily because of the shrimp production issues. We have many of our products, approximately 60% of our total spend, contracted through the end of the second quarter of fiscal 2014, so we have about 6 months of full visibility on our costs. There's limited coverage beyond the second quarter in part because we believe some of the commodities will experience cost declines from the current levels and we want to be in a position to benefit from that decline and in part because we feel the premiums for future contracts are simply too great compared to what we expect prices will be in the cash market several months from now.

In terms of specific food categories and items, total seafood prices for fiscal 2014 is expected to be higher than in fiscal 2013 because of the shrimp supply disruptions. Seafood accounts for approximately 25% of Darden's total cost of goods sold. Category by category, shrimp is our highest volume protein, and we have coverage of 60% through the second quarter at prices higher than in fiscal 2013. Crab is contracted or purchased at prices slightly higher than in fiscal 2013 with coverage of 100% through the second quarter. And we currently have 40% of our lobster usage contracted or purchased through the second quarter at prices that are lower than the prior year. Beef prices are higher on a year-over-year basis, and we have approximately 60% of our usage covered through the second quarter. Poultry market prices are higher on a year-over-year basis, but we have contracted approximately 100% of our usage through the second quarter. Wheat prices are lower on a year-over-year basis, and we have contracted approximately 40% of our usage through the second quarter. Dairy prices are higher on a year-over-year basis, and we have contracted approximately 40% of our usage through the second quarter. And energy costs are expected to be slightly higher on a year-over-year basis due primarily to increases in the price of natural gas. We have contracted nearly 50% of our natural gas and electricity through the fall in the de-regulated markets in which we operate, and we will be opportunistic about adding additional coverage.

Now turning to labor. As I mentioned, we anticipate that restaurant labor costs as a percentage of sales will be higher due primarily to return to normalized incentive compensation accruals for our restaurant managers and field supervision teams following a below normal payout last year and the cost associated with implementing the next phase of the Affordable Care Act.

We believe that restaurant expenses as a percentage of sales will be slightly favorable to the prior year because of sales leverage and our transformational cost savings initiatives. We anticipate that selling, general and administrative expenses as a percentage of sales will be relatively unchanged compared to prior year. This is despite media inflation in the upper single-digit range and a return to normalized incentive compensation accruals for our non-restaurant teams because these are expected to be offset by sales leveraging from same restaurant and new unit sales growth. But in the aggregate, the annual incentive accruals for 2014 which are in both the restaurant labor and in SG&A lines of the P&L, are a significant factor. As Clarence mentioned earlier, the payout in fiscal 2013 was below normal based on performance. In fiscal 2014, we are accruing for a normal annual incentive payout, and the difference between this accrual and the actual payout in fiscal 2013 adversely affects year-over-year diluted net EPS growth by approximately $0.35. I should note that we have broad-based annual incentives with approximately 75% of the payout at normalized level goes to restaurant managers and field supervisory leaders and the remaining 25% going to approximately 800 Restaurant Support Center employees.

Finally, for fiscal 2014, we expect our tax rate to be approximately 20%, although this will vary by quarter, depending on the timing of certain events. Again, we expect to generate solid cash flows in 2014, which we've done consistently since we became a public company in 1995 and to use this to pay our increased dividend, fund capital expenditures and pay down debt. We expect to pay out approximately $290 million in dividends to shareholders, an increase of approximately $30 million from fiscal 2013.

For the same-restaurant sales assumptions, new restaurant growth plans, costs expectations and headwinds from moving from a well below normal to normal annual incentive payout, we anticipate that reported diluted net earnings per share from continuing operations for fiscal 2014 will be down between minus 3% and minus 5% compared to our reported diluted net earnings per share from continuing operations of $3.14 in fiscal 2013. Importantly, absent the incentive and Affordable Care Act headwinds and adding back the $0.08 of lower acquisition and purchase accounting costs for the Yard House acquisition in 2013, this would translate into diluted net earnings per share growth from continuing operations of between plus 4% and plus 6%.

And now Clarence has some final comments.

Clarence Otis

Thanks, Brad. As I said at the outset, we're confident that we'll return to same-restaurant traffic growth and to industry-leading same-restaurant sales growth in fiscal 2014. And again, our confidence is based on the steps we've already taken, the momentum we're seeing, what we're doing to build on that momentum. And again, we know that renewed same-restaurant traffic and sales growth, coupled with solid new restaurant growth going forward, is the key to returning to competitively superior shareholder value creation.

So with that, we will turn to your questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question on the phones comes from Michael Kelter with Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc., Research Division

Clarence, you said that growing same-restaurant traffic was Darden's top priority. And I guess I'm wondering, in what length are you willing to go to achieve that goal? Would you actually be willing to sacrifice and potentially rebase your restaurant-level margins lower at any or all of the concepts to achieve traffic growth, if it came to that?

Clarence Otis

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

Michael Kelter - Goldman Sachs Group Inc., Research Division

And then maybe as a follow-up specific to Olive Garden and in the quarter. Sales were up 5% with positive same-store sales and then unit growth, but operating profit dollars were actually down as per the release, and profit percentage was down. How much was Olive Garden profit percentage down? And in terms of the operating profit dollars being in decline, I mean, what kind of same-store sales do you need given the investments you're making for that to be a positive number? Or should we just expect that dynamic to continue for a while?

Clarence Otis

Yes. I will let Brad follow up. But the -- we don't get into specifics. But the dollars were down single digit on a percentage decline basis. So we're not talking about dramatic differences. And the operating profit as a percent of sales reflects that. Again, Olive Garden's margins are pretty high. And so we have some room there.

C. Bradford Richmond

Yes, and I think as you look at our business model what's capable of going forward, I think 2014 is a good example that when you set aside the incentive and ACA-related costs, we're talking about on a check growth of around 1%, pricing of 1%, that we're able to very modestly grow margins. And so yes, we're some around that 1% or maybe even slightly less that we need in pricing given the improvements that we made over time in our cost model, somewhat aided by the transformational cost initiatives that we talked about that allow us to price at a little bit lower level and maintain the margins that we have today.

Clarence Otis

And I would say that, that number that Brad just gave you, excluding those big adjustments, also is a year where we're seeing pretty significant beef inflation that we're not pricing for at Longhorn. And so that has put some downward pressure as well.

Operator

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

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

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

Clarence Otis

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

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Now was that in the labor line? Or was that within the 4-wall line? Or was that in G&A?

C. Bradford Richmond

That's -- it's in both places.

Clarence Otis

Depends on which employees. So there's -- some of that -- some of those benefit plans are for restaurant managers and multilevel supervisors, and some of them are for others, and so it winds up in both places.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Okay. And then the last question is just the guidance. So it's a little below what the initial outlook was at the Analyst Day. I'm just wondering, what's really changed in your thinking since? Because I assume comp sales outlook has not gotten worse, maybe, in fact, gotten a little bit better since then. So what is it that's really surprising you that caused you to, on a year-over-year basis, slightly bring down that outlook?

Clarence Otis

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

Operator

Our next question comes from Alvin Concepcion with Citigroup.

Alvin C. Concepcion - Citigroup Inc, Research Division

In terms of the new core menus at Red Lobster and Olive Garden, you previously talked about that it would take some time for those to gain traction with consumers. Did you begin to see that happen this quarter? Or have we yet to see that happen?

Andrew H. Madsen

No, we are beginning to see it have a positive impact on how our guests think in terms of their perception of the brand, particularly around value, and how they're beginning to behave, which we're seeing in traffic. And 2 of the best examples would be the way core menu at Red Lobster has helped address the need for affordability, particularly with their 4-course offering. And a big barrier for Olive Garden to broaden appeal is the need that many guests have for lighter, fresher dishes there. And they've introduced Lighter Italian Fare section that didn't exist and now is getting close to 10% preference. So both of those are having meaningful impact. We're going to build on those things, make them better next year and also address, as I mentioned earlier, the need some other guests have that we think are broad and important for us to get after.

Alvin C. Concepcion - Citigroup Inc, Research Division

Great. And it's encouraging to see that you're back on track for traffic growth. I mean, can you give us any color as to the type of customers you're seeing coming into the stores? I mean, are they coming in from the lower income groups that you wanted? Are they customers you lost that are now coming back? Or are they just existing customers that are coming back more often because of the changes?

Clarence Otis

Yes, our sense is that given our emphasis on affordability, particularly in promotions and core menu, that we're probably getting a little more impact from the guests that are the most financially constrained and may have cut frequency in the past. But increasingly, we're doing more to let our guests know about other important changes we've made to the experiences that they can get. So I mentioned Lighter Fare at Olive Garden. We've advertised that a couple of times. We'll do that again going forward. So I think increasingly, we're going to see more balance in the guest count growth that we get not just from those guests who are really under financial pressure and need affordability.

Operator

Our next question comes from Jeff Bernstein from Barclays.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Two questions as well. First, kind of talking about the discounting side of things and you've talked about matching your competitive promotional intensity of -- just from a peer group perspective. I was wondering if you can do that profitably. And perhaps it would help with a little bit of history because I know -- perhaps close to a decade ago, you guys were very aggressive on the promotional front at Red Lobster and Olive Garden and then really tried to shy away from that because you felt the consumer really end up just coming because of the deal. And I know you held with that kind of more recent thought of less discounting was better. Now that you're being more aggressive again, is it because your hand is being forced or do you think there's maybe a better dynamic versus the prior go around, whether it cost or line item leverage or whatnot? Kind of how do you think about the driver of that need to be more promotional?

Clarence Otis

Yes. I would say and we talked about it a little bit at our Analyst Meeting. I mean, we've got to remember that we've got a highly segmented guest space. And so broadly appealing brands, Red Lobster, Olive Garden, LongHorn Steakhouse, they bring in a lot of different kinds of guests. They're in the segment of the guest space that has a fairly significant need for affordability, and so we are responding to that. And that is a heightened need compared to where they've been historically given the financial pressures. Those financial pressures include underemployment, stagnant wages. They include other spending priorities from cell phones to some other things. And so for sure, we're being more aggressive promotionally from an affordability perspective because of those guests. And that's really primarily what the promotions are designed for. We're also responding to the needs of those guests on our core menu, trying to add more affordable items. But then we've got a lot of other guests where affordability really isn't the issue. They certainly want value. And they are looking for fair prices, but they are looking for an even stronger experience on a lot of different levels, from quality of ingredients to sophistication of offerings, and we're responding to those as well. But promotionally, I'd say, yes, we tilted promotionally to really talking mostly to that group of guests that are looking for affordability. And when you compare that to history, that's a switch. Our features, our promotions across the year probably had a little bit more balance between price promotions and non-price promotions, but that reflects sort of the state of the economy and where the consumer is.

C. Bradford Richmond

And I'd say going forward, we've got an opportunity to do it more effectively, to do it smarter. So we implemented some new tactics, promotionally that we hadn't used before, largely starting in the second half of fiscal 2013. And we've got a lot of great learning on how to do that in ways that visibly provide guests the affordability assurance they're looking for but also put us in a better position to do that profitably. So that learning is going to be reflected in how we construct and how we communicate and how we present those offers during fiscal 2014.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Understood. And then just, Brad, perhaps as a follow-up or, Clarence, you talked about the dividend payout increase, one obviously yield being industry-leading. But it sounds like you're reconsidering the payout ratio, pushing it above kind of your 40 to 50 historical. But you kind of alluded to share repurchase, which I believe in the past, you've told us we shouldn’t have expected any in '14 anyway because of the Yard House acquisition. But kind of over the next few years, should we now be assuming less and less if any share repurchase? Or how do we think about that? And then how do you balance the payout or dividend with the kind of [ph] reduction or leverage?

Clarence Otis

Yes, we would expect to have a focus over the next year or so on paying down debt. So we've got 2 important leverage measures that we look at. One is adjusted capital, adjusted debt to adjusted capital ratio. And there, we're sort of inside the range that we target. But when we look at our coverage ratio, our EBITDAR coverage ratio, we're at -- we're above the range that we target, and so we're looking to pay down debt and get ourselves back in the range on that particular measure. We would expect to do that reasonably quickly given the cash flows that we've got. And then we have decisions to make about how to allocate the cash that we've got between dividends and share repurchase. We will have a balance between the 2. But compared to where we've been historically, that balance is going to tilt a little bit more toward dividends.

Operator

Our next question comes from Andrew Barish of Jefferies.

Andrew M. Barish - Jefferies & Company, Inc., Research Division

I guess just sticking on the promotion and affordability focus, the mix numbers in the fourth quarter were down anywhere from 2% to 4%, depending on the brand, and you're implying kind of flattish mix for '14. Maybe that could be addressed. And I think Drew mentioned that you are refining some of the promotional stuff. So did the fourth quarter reflect maybe a push a little bit too much on price? And if you can kind of just round out some of those comments for us, please.

C. Bradford Richmond

Yes. No. The fourth quarter this year is really -- second half of fiscal 2013 really saw us become more aggressive with promotional tactics that we hadn't used in the past. And what you saw in menu mix each month at Olive Garden and Red Lobster was a year-over-year comparison of very different types of promotions and very different types of offers. And that year-over-year comparison is going to abate next year because we'll be wrapping on these constructs. But in addition, we've got a clearer sense now of what compelling affordability looks like to our guests and how we can design that and communicate it in a way that is less dilutive to check and margin. And that's really -- the combination of those 2 things is what I was referring to. And for instance, we started these constructs at Olive Garden with a 2 for $25 in July a year ago, for instance.

Operator

Next, we have John Glass, Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

First, Brad, if I could ask you to maybe help us understand the cash flow for '14. You said cash from operations was going to be strong or stronger this year than last year. Maybe I heard that incorrectly, but you're guiding to lower net income. So can you walk down what do you think cash from operations is? And is there a variance from like working capital or something? And just how much cash after that less CapEx do you think you have left for that debt paydown and/or share repurchase?

C. Bradford Richmond

Yes. As you mentioned earnings -- the earnings cash flow is going to be roughly the same as this year. We talked -- actually, now we're entering the third year of the supply chain transformation. We're on the front end of that. We had to use some working capital to enable the P&L savings that we've gotten. That has reversed. You see that this year, and it continues into next year. And as we open new restaurants they provide working capital to us because we collect our sales pretty much daily and pay on terms. So those are what enables us to look at our operating cash flows, and that will continue to grow. In terms of the balance there, we've talked about the CapEx for next year being in the range of $600 million, $650 million, which is down pretty significantly from our expectations that we had for fiscal 2014 from where we were a year ago. Those are the adjustments that we've made to be more responsive to the marketplace, as well as to ensure that we maintain a strong financial position. And so you look at operating cash flows, it would be, call it, roughly in the $1 billion range, CapEx somewhere in the $600 million, $650 million and dividends that are $285 million to $290 million range. So that leaves that excess cash that would be applied towards reducing our debt and improving our ratios there.

John S. Glass - Morgan Stanley, Research Division

Okay, and just the math that I got is about $80 million to $90 million of excess. So it's not a significant portion. I mean, it's a -- that's okay.

C. Bradford Richmond

Not a large portion, but we're still growing our capital base. So we focus more on the ratios. So the leverage ratios and coverage ratios. So you do see improvement beyond just the debt reduction that you're talking about.

John S. Glass - Morgan Stanley, Research Division

And can you speak a little bit -- so conceptually, you've raised the dividend payout ratio or dividend, and therefore, dividend payout ratio to a level that's I don't think typically seen in capital-intensive businesses, 70%. I know you talked about increasing your target, but I'm not sure why that is if that's just a convenience because you've increased your dividend. Usually, when you do that, it signals a reduction to capital intensity of the business significantly. So can you maybe think about -- help us think about how you get your CapEx budget in decline now and in '15 and '16 declines versus the '14 number? Or you're just going to raise the payout ratio and keep that more level, and therefore, you just -- it's a change on how you think about how you use your cash?

Clarence Otis

I think Brad talked about the fact that we are -- the way we think about it, I guess, is that we are less capital-intensive as our base of restaurants continues to grow and generate incremental cash that comes from the new restaurants and the percentage of new restaurant growth on that base declines, we are less capital-intensive. And so we've talked about the fact that we like the portfolio we have. We don't expect to add brands. And so we would see that percentage growth declining a little bit.

C. Bradford Richmond

I think another way to dimensionalize that is our CapEx is -- as we look forward, we talked about our growth expectation is near its peak level. Unit growth is in the range we want it to be at. We have -- Red Lobster will be finishing up the remodel there this fiscal year, pretty much essentially getting it done. We will roll into Olive Garden and the remodel there. So CapEx really isn't going to be expanding, but yet the business is growing. Any improvement in same-restaurant sales. We have strong leverage of that. So that would generate additional cash flows as we look beyond the current year.

Clarence Otis

Yes. Thank you for saying that better. But that's the gist of it.

Operator

Your next question comes from Jeff Farmer with Wells Fargo.

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

Unfortunately, one more on promotions, just getting a little bit more color. So you touched on this a little bit. Over the last 18 months, it looks like Olive Garden has introduced a bunch of things. You mentioned the 2 for $25. I think that was followed by the 3-course Italian at $12.95 and the Buy One Take One at $12.95. The question really is are you set with that collection of so-called value-based promotional constructs? Or do you think we should expect to see more coming? And then as part of that, can you just sort of give us a little bit of an update in terms of your efforts to maybe theoretically reduce the duration or time periods of some of your promotional windows?

Clarence Otis

Well, we don't want to be too specific about the promotional constructs were going to use. You're correct that in the fourth quarter, those are the 3 promotions that Olive Garden ran. And they all address affordability, and they all helped us regain significantly better same-restaurant traffic. We also learned importantly how we can do those promotions in the future better for our guests, how we can do them better for our in-restaurant operations team, which is important learning we're taking into next year. And to tie back to a question that was asked earlier, those are all wrapping on promotions that were very different last year like Passion for Parmesan that didn't have any price point in it and led to a negative menu mix that was referenced. So we clearly are going to continue to focus on affordability in promotions, but it's not all we're going to focus on given the range of guests that we've got and the diverse needs that they've got.

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

And then just the duration of the promotional windows, again, thinking about maybe shaving a week or 2 off on some of them?

Clarence Otis

Yes, again, that's a level of specificity that, for competitive reasons, we don't want to get into.

Operator

Our next question comes from Matthew DiFrisco with Lazard.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

I have a question, but also, I just want to clarify. I think it was said earlier about the guidance for the comp, 1% coming from price, 1% coming from traffic. I'm curious, is that -- that's an annual outlook. But should the cadence be that the mix should continue to be slightly negative to start the year and then get to flat maybe on a positive mix in the back half to get you to that sort of net neutral on the mix front?

Andrew H. Madsen

I think directionally that, that's accurate because of the timing of the promotion constructs that we introduced in particular, which really started more in the second half.

Clarence Otis

And also, Matt, we talked about traffic being between flat and up 1%. [indiscernible] 1%, which is the top of the range we gave.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

I think the mic was just far away. I think that was Clarence talking about traffic being flat?

Clarence Otis

I'm sorry. I said we talked about the traffic range being between flat and up 1% as opposed to 1%, which is the top of that range. We'd love to get hit the top of that range. But right now, our thinking is between flat and up 1%.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

Okay. And then also, I guess at the conference back in February, there was some discussion about the dividend payout ratio and that some credit agencies also look at that as a -- it factors into their overall rating. Are you -- is there a level that you can sort of -- are you not so focused on the credit rating necessarily as you might be more so on maintaining dividend growth? Or can we do both evenhandedly? Can you expand your dividend payout ratio without sort of putting yourself closer to a point where you might be under review by one of the agencies?

C. Bradford Richmond

Well the credit rating is very important to us. But when you look at our dividend, the cash flow that it takes to fund that and compare that with the adjustments we made in the CapEx plus the fact that we'll be growing our operating cash flow from this year, we feel comfortable that we can do both.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

Okay. And just last question. Looking at your guidance, even if you were to wipe out the compensation impact or going back to sort of normal payout ratios on compensation, you're still forecasting margin contraction. Is that, all of that pretty much the commodity picture change? Or is there anything else in there as far as -- is it store opening -- is it more that you're looking for more growth from your newer stores or, I mean, your comp doesn't look to be outside of the range of what historically you've been growing at, sort of that 0 to 2% or -- I'm just curious where you're seeing that incremental deleverage, if it's anything more than just the incrementally worse commodity outlook than what you had back in February?

Andrew H. Madsen

Yes, when you give recognition to the health care transition cost, the Yard House related costs and the incentive accrual that we talked about, our math gets us margins that are flat to up about 20 basis points is what we see. And even included within there is continued investment that's -- a lot of it's hitting the P&L for our technology digital platform that we talked about. So we look at the base model and see that the margins are at least flat or modestly growing as we look to next year in a cost environment, like you said, that's got a little bit more food cost inflation that we originally anticipated.

Operator

Our question comes from Jeff Omohundro from Davenport & Company.

Jeffrey F. Omohundro - Davenport & Company, LLC, Research Division

My question relates to the ACA guidance. Just wondering if you could maybe elaborate on what is going into that number. And just given the uncertainties around the program, how do you think that might evolve or change over the next year?

Clarence Otis

Well, Jeff, there is a lot of uncertainty. And so that number is a difficult number to try to get at because we have to make a number of different assumptions, assumptions about as we offer health care to full-time employees how many are going to take, assumptions about premiums, and we still don't know what premium's going to be. That number will come out this summer. And so it's a tough one to make a guess on. But we think that's about the right guess. There are some excise taxes, surcharges that are pretty clear that are included in that number, but the rest of it is really about assumptions about what people are going to do when they're offered more options than they've been offered before. Hard to say. And a lot of it will depend on how they feel about the new institutions and structures that are going to be up this fall and what the reporting is on how well those are proceeding. So difficult to say, but that's our best guess as to what the range of cost might be this year. We'll keep you posted on it.

Matthew Stroud

All right. Thank you, everybody, for joining us today on the call. We recognize there's still a number of you that were in queue for questions. We apologize we couldn't get to you this morning. Of course, we'll be here throughout the day if you want to give us a call. We'll try to answer your questions at that time. But we wish everybody a safe and happy summer. We look forward to talking to you again in September. Thank you.

Operator

Thank you. Thank you, all, for attending today's conference. You may now disconnect.

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