Darden Restaurants, Inc. (NYSE:DRI)
Q4 2014 Earnings Conference Call
June 20, 2014 08:30 AM ET
Matthew Stroud - VP of IR
Clarence Otis - Chairman and CEO
Bradford Richmond - SVP and CFO
Eugene Lee - President and COO
Joseph Buckley - Bank of America
Brian Bittner - Oppenheimer and Company
Sara Senatore - Sanford Bernstein
David Palmer - RBC
John Glass - Morgan Stanley
Priya Ohri-Gupta - Barclays
Welcome and thank you for standing by. At this time all participant lines are in a listen-only mode until the question and answer session. (Operator Instructions) Today's call is being recorded, if you have any objections you may disconnect at this point. Now I’ll turn the meeting over to your host Mr. Matthew Stroud. Sir, you may now begin.
With me today are Clarence Otis, Darden's Chairman and CEO; Gene Lee, Darden's President and COO; and Brad Richmond, Darden's CFO. We welcome those of you joining us by telephone or the internet.
During the course of this conference call, Darden Restaurants’ officers and employees may make forward-looking statements concerning the Company’s expectations, goals or objectives. Forward-looking statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Any forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update such statements to reflect events or circumstances arising after such date. We wish to caution investors not to place undue reliance on any such forward-looking statements.
By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to materially differ from those anticipated in the statements. The most significant of these uncertainties are described in Darden’s Form 10-K, Form 10-Q and Form 8-K reports including all amendments to those reports. These risks and uncertainties include the ability to achieve the strategic plan to enhance shareholder value including realizing the expected benefits from the sale of Red Lobster, the occurrence of any event, change or other circumstances that could give rise to the termination of the agreement to sell Red Lobster, the outcome of any legal proceeding that may be instituted against Darden relating to the Red Lobster transaction or otherwise, the failure of the Red Lobster transaction to close for any reason including non-fulfillment of any conditions to close, the timing of the completion of the transaction, actions of activist investors and the cost and disruption of responding to those actions, food safety and food-borne illness concerns, litigation, unfavorable publicity, risks relating to public policy changes and federal, state and local regulation of our business including health care reform, labor and insurance costs, technology failures, failure to execute a business continuity plan following a disaster, health concerns including virus outbreaks, intense competition, failure to drive sales growth, failure to successfully integrate the Yard House business and the additional indebtedness incurred to finance the Yard House acquisition, our plans to expand our smaller brands Bahama Breeze, Seasons 52 and Eddie V’s, a lack of suitable new restaurant locations, higher-than-anticipated costs to open, close, relocate or remodel restaurants, a failure to execute innovative marketing tactics and increased advertising and marketing costs, a failure to develop and recruit effective leaders, a failure to address cost pressures, shortages or interruptions in the delivery of food and other products, adverse weather conditions and natural disasters, volatility in the market value of derivatives, economic factors specific to the restaurant industry and general macroeconomic factors including unemployment and interest rates, disruptions in the financial markets, risks of doing business with franchisees and vendors in foreign markets, failure to protect our service marks or other intellectual property, impairment in the carrying value of our goodwill or other intangible assets, a failure of our internal controls over financial reporting, or changes in accounting standards, an inability or failure to manage the accelerated impact of social media and other factors and uncertainties discussed from time to time in reports filed by Darden with the Securities and Exchange Commission.
A copy of our press release announcing our earnings, the Form 8-K used to furnish the release to the Securities and Exchange Commission and any other financial and statistical information about the period covered in the conference call, including any information required by Regulation G, is available under the heading Investor Relations on our website at darden.com.
We plan to release fiscal 2015 first quarter earnings and same-restaurant sales for fiscal June, July and August 2015 on Friday, September 12, 2014 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. We have a slide to our presentation that you should be able to access through the webcast link at darden.com or videonewswire.com. After the presentation we will take you questions until approximately 9:30 Eastern Time.
With that, let me turn it over to Clarence.
Thank you, Matthew and good morning everyone. Fiscal 2014 was clearly obviously a year of significant transformation for us. And so we had a number of changes that complicate our financial reporting and we appreciate this opportunity to walk you through the numbers in some detail. The transformation also had many other very important dimensions and we appreciate the opportunity to discuss those with you as well.
Ultimately, all the change that took place is done to do one thing and that’s to better position us to create significant shareholder value. And so this year was one that was highlighted by a number of things, certainly the launch of a comprehensive brand renaissance plan to regain momentum at Olive Garden. It’s highlighted by continued success at LongHorn Steakhouse where same restaurant sales exceeded the industry by nearly four percentage points and at our specialty restaurant group which has grown to $1.2 billion in sales.
The year was also highlighted by the announcement of the sale of Red Lobster for $2.1 billion and our announcement in undertaking of significant cost restructuring. Cost restructuring which means that G&A as a percent of sales is expected to remain approximately 5% and that’s because the cost savings achieved with assistance of Alvarez and Marsal more than offset by roughly $40 million, potential stranded costs related to the sale of Red Lobster that cost restructuring also means that in fiscal 2015 SG&A as a percent of sales is expected to be the lowest, since we became a public company in 1995.
The year also included continued industry-leading return to capital and that return totals $1.2 billion now in the past three years. We distributed $288 million in dividends to shareholders and we recently announced an additional $500 million to $600 million of share repurchase for fiscal 2015 for a total share repurchase program for next year or this year that just started up to $700 million. In addition we strengthened our credit profile with our plans to retire approximately $1 billion of our existing debt and we made some refinements in our management compensation incentive programs to more directly emphasize same restaurant sales and free cash flow growth.
And Brad is going to discuss our sales and earnings results both with and without Red Lobster, so Brad?
Thank you Clarence and good morning everybody. On this slide I’ll be brief as a lot of its covered in our press release that went out this morning, but I would point out that combined sales reached $8.758 billion, that’s up 2.4% to the prior year. I think more importantly is when you look at continuing operation sales, and that’s excluding Red Lobster and the Red Lobster’s consumer packaged goods products and international fees and royalties, sales were $6.286 billion, or up 6.2%; a significantly higher growth rate than the combined company enjoys.
Now our brands are making strong progress or maintaining high levels of performance in the new fiscal year. And so we will touch more about the activities and initiatives that are driving that, but if you look over at the far right-hand column, you see same restaurant sales for the first three weeks of our new fiscal year. The brand renaissance at Olive Garden is clearly taking hold as you see improvement in their trend. Their same restaurant sales are flat which is above the Knapp-Track industry benchmark, and you see continued strong performance from LongHorn Steakhouse and the specialty restaurants.
Now, turning to next page, and talking about our earnings performance and how that’s reported. Unfortunately, GAAP reporting is not always as intuitive as we'd like for it to be and that is the case with the separation of Red Lobster. So, on this slide I'll walk us through the geography of reported earnings to what we call performance view of our results; and if you start with reported combined fully diluted EPS, that’s $2.15 for fiscal 2014. Now, in that number, we have the strategic action plan costs, and that’s really to execute our plan that involves the real estate work, legal work, advisory fees, retention bonuses, and all of those costs, along with some related impairments to implement that plan.
You'd have to add those back for $0.27. There's also some other impairment charges that we incurred to exit our restaurant lease in the future but before the original lease term expires and there is also some charges as we move forward with the new Olive Garden new model designs and previous charges that we needed to write-off. And that’s a $0.05 charge. So, you need to add those two items back to get a performance view of Darden on a combined basis. And this is how we've been talking to you previously in terms of our guidance and expectations. So $2.47 earnings per share is that number.
Now, with the announcement of the Red Lobster sales, all presented Red Lobster results for current and prior periods are moved to discontinued operations, but not all of the cost move when you make that type of reporting adjustment. So if you start again with reported fully diluted earnings per share of $2.15, to that you would exclude Red Lobster’s results of operations which are $0.91 in fiscal 2014 you’d add back strategic action plan cost and the related impairment charges that are within discontinued operations, that’s $0.14. And so when you combine these, this results in a continuing operations reported number of $1.38.
Now, to move from that reported continuing operations number to how have we performed, you have to add back shared support cost. In Darden we use a very extensive shared service platform for a number of our support services, but in the reporting those shared cost cannot be moved to discontinued operations. Now, after the sale obviously those costs will go away and be moved to Red Lobster, but for reporting purposes currently they aren’t. And that represents $0.15 of impact that we've identified that it’s virtually all headcount related and so we have a high certainty that those costs will move once the separation is effective.
The remainder of the $0.27 in strategic action plan costs that are not included in discontinued operations, we add those back, that’s $0.13. And there is other impairment charges that I mentioned earlier for lease exit and remodel cost at Olive Garden at $0.05. So when you combine those with a reported $1.38 from continuing operations, we get $1.71 of continuing operations performance view if you will, EPS; or down 11.4% to the prior year.
I know this is a little confusing at first, but it starts -- always start with reported results first and then for total operations and then we go to discontinuing operations, continued operations, so you can get a view of our true performance.
We'll come back to this approach as we build our detail, our expectations for fiscal 2015, that we felt that was helpful to lay this out with the full detail so you can better understand our performance. Clarence?
Thank you, Brad. To frame our discussion about our strategic action plan and our outlook for fiscal 2015, we thought it made sense to provide some context, and that context in a sentence is that we’re in a more mature yet more dynamic industry. Now that said, as industry growth slows with maturity, we believe there are attractive consumer segments and we think we've created a portfolio that’s well positioned to succeed against those consumer segments going forward.
So we think about the industry’s maturation. There are a number of things that are driving that. Certainly slower growth in the (Bloomberg) [ph] population, aged 50 to 60 and that’s where dining out frequency is the highest, has always been the highest, slower growth in household income overall, increased competition, not only within full-service dining but also with the emergence of attractive new segments, new dining segments like fast-casual and elevated innovation within traditional quick service.
As all that happens, some important demographic and economic dynamics and where the share growth opportunity is, and that is a significant increase in millennials, significant increase in multicultural households across all age and household income spectrums, there’s increased spending power in generation X, and overarching dynamic, is that there is increased digital interconnectedness across all generations in all other demographics.
Now, as we look at these dynamics, in order to create value we got some very clear priorities. And those priorities are for value creation, really are to separate Red Lobster (through the) [ph] sale, because we don’t believe that Red Lobster is well-positioned as our other brands for the future that we see. And we sold Red Lobster, again for $2.1 billion to Goldengate Capital, and we're on track to close that sale in July. Execute the Olive Garden brand renaissance.
Gene is going to provide some more detail, but that’s all about improved food, improved service, a stronger communications platform, continue to develop LongHorn into America’s favorite Steakhouse. And LongHorn, as we've said; very successful, both with new restaurant expansion and with same restaurant sales growth; to grow our specialty restaurant sales by more than $1 billion is our target over the next five years and we’re on track based on the performance in ’14 and our outlook for ’15. To do that, further optimize operating support and direct operating cost.
We've done a lot. We'll talk in detail about that. We've described some of it already. And then better align our management compensation systems to reflect a new reality and the new drivers really of value creation. And I'll get into more detail about that later. And then to make sure that we’ve got appropriate capital allocation discipline. And certainly we believe that the reduced new unit growth that we've got going forward to commitment to hold acquisitions is consistent with that.
Let me begin the more detailed discussion of these priorities by reviewing the Red Lobster sale. The net sale was a result of a very robust process that maximized value and minimized risk; total consideration $2.1 billion in cash, that represents a purchase multiple of nine times trailing 12 months EBITDA as of April. That process involved 70 financial and strategic buyers and another 25 real estate buyers. With the sale we expect our investment grade credit profile to remain intact indeed to improve somewhat; we expect to maintain our $2.20 per share annual dividend; the sale will be accretive to Darden’s long term earnings growth rate, so we expect to have not only a higher earnings growth rate but higher sales growth rate and higher margins. With the sale we’ll have less volatility in our quarterly sales and earnings, so sale that was unanimously approved by our Board and the $2.1 billion sale price is a premium multiple compared to comparable restaurant deals and we’re able to secure that despite the fact that Red Lobster has some meaningfully declining operating trends and you can see that from a same restaurant sales perspective and an EBITDA perspective in the two charts at the bottom of this slide.
With the sale we achieved the objectives that we previously communicated, those objectives are listed here, so I won’t go through all of them in the interest of time. But as we look at Darden post sale, there are a number of things that are different. So Darden post sale is a leading multi-brand operator, again higher more consistent sales and earnings growth driven by stronger overall positioning with these consumer segments that are attractive given where the industry is and where it’s headed and given its restaurant expansion footprint.
We’re an operator with a commitment to quality and menu innovation and that also carries with it a more balanced commodity purchasing profile. We have a commitment to return the capital so stronger free cash flow again due to the reduced capital expenditures and that supports strong dividend and allows for increased share repurchase. We have stable and growing cash flow with reduced again quarterly sales and earnings volatility and as I said, a better credit profile.
And then finally we have an experienced and quality management team and that team with certain refinements in our management incentive program has an even sharper focus on same restaurant sales and free cash flow growth.
Now drilling down, this next chart shows just how much better positioned for growth Darden is post the Red Lobster sale. It shows our cumulative total sales growth from fiscal 2009 to fiscal 2014 overall at 23%. And then if you exclude Red Lobster that cumulative number is 40%, it also shows the CAGRs and the CAGR excluding Red Lobster for that period is 2.5 points higher than it is including Red Lobster. Beyond the Red Lobster sale, a key component of our strategic action plan is of course regaining momentum at Olive Garden and Gene’s going to update you on that, so Gene.
Good morning. I’ll spend the majority of my time this morning talking about Olive Garden and then quickly discuss LongHorn and our Specialty Restaurants. Olive Garden provides a strong foundation for the overall Darden business. It’s a premier brand in casual dining with average restaurant volumes of 4.4 million and industry leading returns. We are confident that the recently launched brand Renaissance plan is addressing erosion and visit frequency among our core guests. This plan also will enhance our solid position with millennial and multicultural households and is the platform for renewed same restaurant sales growth and margin expansion.
While many of the elements have been underdevelopment during the past year, we’re in the early stages of exposing guests to what we call our brand Renaissance plan. Our objective is to make certain that our guest enjoy differentiate experience of today’s Italy where Olive Garden’s warm hospitality and superior value bring people together.
In terms of food, quality, not surprisingly, is what guests want most. And freshness drives quality more than any other attribute. So we are emphasizing food prepared with the freshest ingredients presented simply with a sense of flair as very Italian. Our efforts are focused on making our service approachable and genuine, so guests can focus on sharing great food and conversation which is why they come to Olive Garden. Within our restaurants we want to make certain that our atmosphere is natural, clean and tasteful while its tone is warm, relaxed and engaging. At every turn we are looking to reinforce these aspects of the atmosphere within our restaurants.
Lastly, although Olive Garden has a national presence of more than 800 restaurants, we are most relevant to our guests when we act and are viewed as a family of local restaurants making a positive difference in each community we operate.
There are four key growth aspects of the plan; one, continuing to evolve the core menu to reinforce value, expand choice and variety and capitalize on the convenience trend; two, simplifying operations, improving food quality enhancing service; three, implementing a more integrated communications platform to enhance brand relevance; and four bringing the brand a life with every guest touch point. At the beginning of the fourth quarter we introduced new menus at lunch and dinner with significant changes designed to address the consumer needs for increased value and additional choice and variety and convenience. The dinner menu now has a $9.99 price point with the Cucina Mia section in the majority of our restaurants.
We know at this price point and the customization this offer enables is very compelling for our guests, especially millennial and value conscious consumers. We also added a Tastes of Italy section which addresses the guest desire to sample different menu items served topping (ph) style. In addition, we have added seven new specialty items including four new lighter fare entrées, buttressing areas of the menu where our guests are looking for more choice. To address convenience, we have successfully tested online ordering which will further strengthen our take-out business, which is approximately 8% of our sales but is currently growing 10%.
During the testing phase, when orders were placed online the check average for those transactions were significantly higher than the orders placed over the phone. Take-out sales in the online restaurants are growing greater than 10%. At lunch, we introduced Tuscan Trio Combinations, nine new items at $2.99, which can be coupled with our soup, salad and bread sticks. These items create many new lunch possibilities at a price point that is very competitive with many casual dining brands and fast casual lunch offerings. Initial feedback from our guests has been favorable and they tell if these items are unique.
They also help us enter into the emerging snack occasion. In terms of choice and variety at lunch, we’ve added sandwich and flatbread combinations as well as mini pasta bowls and small plates. Given that many guests are time constrained at lunch time, we introduced the Pronto Lunch Menu that provides a full Olive Garden experience during the condensed timeframe.
Looking at 2015, at dinner we’ll continue to look for ways to improve the Cucina Mia platform and increase the number of entrées under $15 to bolster our already strong appeal to younger and budget constrained guests.
When you look at Olive Garden’s price points, we have to keep in mind as our guests certainly do, at every meal we serve comes with unlimited salad or soup and bread sticks, thereby dramatically increasing the delivered value versus the competition. New better for you options will also be added to the menu as well as an upgrade of our classic Italian offerings which continue to represent a significant portion of our sales from our dinner menu.
During the midst of rolling-out order to go online ordering system nationally, we expect to have this completed by the end of August. And as I mentioned earlier, we’re encouraged by the initial test results and believe this effort will accelerate the strong growth we’re experiencing to go sales today. Olive Garden’s absolute lunch business is very strong. However, lunch guest counts are declining approximately 80 basis points more than dinner. In order to reverse this trend, we will continue to focus on improving our competitiveness at lunch by expanding our Tuscan Trio Combinations as well as introducing new flatbreads, pizzas and Piadinas, which are Italian style sandwiches.
Also in the works is a test of a lunch time guarantee to ensure our guest with a time constraint can turn to Olive Garden to provide a quick lunch experience. Olive Garden is a high volume, relatively complicated operation that overtime has become increasingly complex. In order to improve execution the team recognized the need to simplify. In fiscal 2014, we focused on simplifying recipes and reducing production pars. These steps led to an annualized savings of $20 million.
We also simplified our take out procedures to improve our ability to deliver a better to bill experience. In terms of improving food and beverage quality, we have installed Piastra grills which improved the quality and consistency of our grilled items. We also improved the quality of our proteins, chicken, steak and salmon. Using higher quality proteins in our specialty dishes, it’s key to ensuring we continue to deliver strong value in entrée that appeal to all consumers but especially those consumer segments that provide attractive opportunities for growth.
Additionally, we’ve implemented enhanced service training to reemphasize and reinforce our traditional hospitality and our service culture. This year, we will continue to pursue our culinary simplification program on several fronts, including sauce consolidation and pasta preparation. As I stated earlier, we are aggressively rolling out our online to go ordering platform with the expectation of being completed in August. In terms of improving food and beverage quality, we will elevate and intensify our focus on alcohol beverage sales. We will narrow our focus to one and a few unique specialty cocktails. This is an effort underway to reenergize the wine sampling service step and to increase several wine training and knowledge through mobile apps which will help serve as recommend lines and be comfortable pairing wine with food.
While there is opportunity to elevate the guest experience throughout the entire system, we have some restaurants that underperformed the system on many performance metrics and these restaurants are significant drag on same restaurant sales. Senior operational leaders have been assigned to these underperforming restaurants and will be accountable to improve their performance. In addition, we are placing increased emphasis on ongoing training and development of all our team members through a recertification process. The objective of this is to ensure the training initiatives we started last year, are gaining traction. Lastly, we are partnering with Ziosk to introduce tabletop tablets to enhance the guest experience. This test is expected to begin in August.
One of the key drivers of the Olive Garden renaissance plan is to develop a truly integrated communication platform to enhance brand relevance. During the past several years, nearly the entire casual dining segment of the restaurant industry has reverted to a nearly 100% reliance on price driven promotional advertising and while promotions are always an important piece of the marketing communications mix, they do not tell the whole story. Importantly, it is impossible to build and maintain a strong brand with only promotional messaging. In fiscal 2014, we begin to place greater emphasis on the brand building portion of our messaging. We developed new creative content to showcase new core menu items and reinforce our culinary credentials. We launched a new interactive Web site, implemented a social media engagement and service recovery program and launched a social media road show to introduce many of our new menu items.
In terms of our promotional efforts, we place greater emphasis on a core menu items with a promotional messaging in order to minimize complexity and maximize appeal. The result has been increased guest preference of the promoted items with less strain upon the operating system to deliver them. We also began to use radio as part of the media mix to support promotions in select markets and we introduce more weekday promotions in order to drive traffic when the guest greatest capacity rather than offering discounts during a highest traffic periods which are on the weekends.
During fiscal 2015, a new Olive Garden advertising campaign will be unveiled, emphasizing our culinary credentials and the emotional connection that our guests seek when they come to Olive Garden. Creating an emotional connection with our guests help make Olive Garden a leader that it is today and we need to retune using this strategy with greater emphasis. We are increasing our investment in digital and social media tools to drive greater guest engagement and with these tools we will provide much more in the way of regional and personal messaging through customer relationships. In terms of our promotional messaging, we will continue inject new news in our existing promotions and look for innovative, new promotional constructs including the use of more seasonal and regional products as we will offer more targeted, relevant promotional incentives not always about low price to the use of CRM. All that said, while we intend to be much more effective and efficient in our promotional messaging, as stated above we will have a much better balance between our limited time offerings and our equity messaging.
Finally, we are redesigning all of our in restaurant merchandising materials to reinforce Olive Garden’s culinary expertise to elevate menu news and to enhance the ease of menu navigation so that our guest can quickly find their all favorites but also learn about exciting new offerings. The fourth and final driver of our brand renaissance plan is what we call the Olive Garden reimaging program which is intended to bring the renaissance plan to life at every guest touch point. In fiscal 2014, we reimage both the interior and exterior one of our RevItalia restaurants. The new design is natural, up-to date, comfortable and engaging. We also introduced new plateware to enhance the presentation of our food, contemporize the music and work with Lippincott a consulting firm specializing in logo evolution to develop a new logo and visual identity system.
This is an extremely important opportunity because same restaurants sales of a 300 plus restaurants in need of a remodel, lag resulted our other restaurants by more than 2 percentage points. Initial sales results of the remodeled restaurant are very, very encouraging. The sales trends have improved mid-single digit since the completion of the remodel and the new signs were installed. When the RevItalia restaurants in the market have been updated, the Tuscan farmhouse restaurants in the market will also convert to the new logo signage and new plateware package. The Olive Garden brand renaissance is a large and complex initiative with many components. We have already made significant progress in many areas building a strong foundation in fiscal 2014 but most of the changes will to life for our guests in fiscal 2015 and beyond.
Olive Garden is a large business with more than 800 restaurants and 8,000 employees, so we know that it will take time for the brand renaissance to be fully implemented but we are already seeing positive measurable results such as strong preference in menu satisfaction, our new menu items and improvement in our guest satisfaction scores. We are confident that the rate of progress will increase in the quarters ahead at the various aspects of the plan reinforce and build on one another. In fact, in June as we gotten pass some of the year-over-year promotional mismatch we have in the fourth quarter, we’ve already seen significant positive trend change compare to the fourth quarter from a same restaurant sales perspective.
I’ll conclude the Olive Garden session with a couple of quick quotes from guests. This quote is from a Yelp event we hosted recently. I’m not usually the first one to say Olive Garden when someone wants the suggestion on where to eat, on Monday that all changed. This is a quick quote for some qualitative research we did after our remodel was complete. I didn’t even know you had a bar before, and now I really want to go in there.
Quickly, we’ll just look at -- we’ll talk about LongHorn. LongHorn has a clear vision as Clarence mentioned they want to be America’s favorite steak house, this multiyear effort is strengthening the brands to create a strong sales momentum to focus on continually improving the menu and enhancing service execution and providing the guests with a great atmosphere, as all of our restaurants have been remodeled and looked and feel refreshed has been the driving force in LongHorn’s out performance in the industry.
As we look at the specialty restaurant group, I think we have strong differentiated well positioned brands and the teams are focused on reviewing same restaurant sales momentum both at Seasons and Yard House. I would just quickly say, I think the Yard House is very well positioned in the market place, as strong appeal the volume in Gen X households. We continue to be pleased with the performance of the restaurants and the real-estate pipeline is strong. Seasons 52 broadly appealing and particularly strong with higher end coming Gen X to improve our sales trends and reverse the trends that we have. The team is focused on elevating operational execution evolving the seasonal regional menu strategy and increasing brand awareness in new markets.
And with that I’ll turn it back to Brad.
We’ve continued to achieve more cost effective platform, transformative changes that we’ve talked on the past in Darden’s operations have significantly reduced costs by over a $150 million annually in selected areas, operating areas around our support including supply chain, facilities management, water and energy usage.
During the past two year, these efforts have supplemented with broad based cost reduction initiatives due to more than anticipated alluded in sales growth recovery reduce of financial crisis in the economic downturn. Despite lower total revenues following the sales of Red Lobster, we expect general and administrative expenses to remain flat at 5% excluding strategic action plan cost.
Now Alvarez & Marsal has continued to assist us with the efforts to identify additional operating support and direct operating cost opportunities, as well as potential revenue enhancement opportunities. And so we expect to further reduce G&A as a percent of sales as we get further into fiscal 2015.
We will minimize the impact of continued commodity cost inflation through other select initiatives to achieve a net inflation, net cost pressures of 1.5% to 2.5% in fiscal 2015. Our $2.5 billion in product expand is now better diversified with less exposure to seafood inflation post the Red Lobster separation. The table in the left shows us in by major category, you can see the change from 2014 to what we anticipate in 2015 with the separation, particularly see a much less of our cost basket coming from seafood cost.
On the right hand side, we outline our coverage of our main products that we purchase as we look through the new fiscal year or in particular June to November of fiscal '15, our first half of the year. The overall coverage at 52% is little wider than it typically is at this point in the cycle for us, given that we believe cost there will elevate it and we expect them to come down. We look at inflation in this area for fiscal 2015 in the 2% to 3% range probably the upper half of that range in the first half of the year. And the lower half of that range in the back half of the year.
As Clarence mentioned earlier, we really increased our focus on driving higher semi front sales and stronger free cash to achieve higher shareholder returns. The annual incentive plan is now weighted 70% on achieving targeted EPS growth and the remaining 30% on targeted same restaurant sales growth. Our performance share units those are a three-year performance period is now based on 50% of achieving targeted total sales growth, 50% on free cash flow targets and a relative TSR performance to the S&P 500 total shareholder return.
On a continuing ops basis, our business generates a substantial and durable operating cash flow. In fiscal 2015, we expect cash provided by operations to be between a $670 million and $730 million. We will pay down approximately $1 billion in debt. The debt leverage that we expect is going to be at the low end of our 55% to 65% and that’s on an adjusted basis treating operating leases as debt equivalents.
Our debt coverage is unexpectedly above our targeted range of 2 times to 2.5 times, but it then improves from the year just ended at 3.7 to 3.0 at the end of fiscal 2015. We will also allocate $500 million to an accelerated share repurchase program. And up to $200 million in additional open market repurchases, funded principally from the sale of Red Lobster. We are maintaining our current annual dividend of $2.20, and an approximate total payout of $275 million, and deployed $325 million to $350 million of capital expenditures. This really reflects lower new unit growth, offset slightly by the investment in the Olive Garden remodel program; and all this with the expectation of retaining an investment grade credit profile.
Turning to some of the more specifics of our outlook for 2015; on this slide we’ve detailed our new unit growth and you can see that 37 net units, that’s down fairly significantly from this year’s 69 or a year before of over a 100 new restaurants. You can see that the growth is concentrated in LongHorn and our specialty restaurants. And there is also the concluding of Olive Garden sites that went well into the growth pipeline. From the same restaurant sales perspective, we look at Olive Garden to be flat to +1%, LongHorn of +1% to +2%, and our specialty restaurants at approximately 2%. All of these performances would be above the industry expectations.
On the next slide, we outline our operating cash flow, and you can see, as I mentioned earlier, $670 million to $730 million there, obviously driven by earnings. This does include the portion of cash flow that is generated by Red Lobster, prior to the sale. You see our expectations for depreciation and amortization. Working capital, there is an improvement there, extra Red Lobster business, and we have reflected that. And the other cash items really highlight the progress that we have been making and continue to expect in better managing our balance sheet as well as the cash flow benefits of our tax planning initiatives. So the least cash available for dividends and share repurchases is at $320 million to $405 million.
As I mentioned earlier, our capital expenditures are down, you can see the new units today as I outlined earlier, will result in about a $150 million of capital employed towards those. Remodels principally all related to Olive Garden as well there will be some CIP for that as we end the year to continue that program. And then we will continue to invest and maintain our restaurant standards and cooking equipment standards, and so maintenance CapEx will be in $125 million to $150 million. As I mentioned earlier, maintaining our dividend at $2.20 and share repurchases in total up to $700 million.
So, back to this page that I took us to, as we looked at fiscal 2014 to better understand and help you get your hands around our performance; and from an EPS perspective here, the prior year comparison is the performance EPS that I laid out earlier, of $1.71; we think it is the right benchmark. We expect to report $1.81 to $1.90 for a diluted EPS. Now, again we have to adjust the support cost for the period that Red Lobster is a part of Darden, though support cost which we know will go away are deductions to ours (ph) that’s what we anticipate it on $0.02 that we need to add those back to the reported continuing operations number.
And, as I mentioned earlier, we are paying down $1 billion of debt. There are some estimated debt breakage related to that of approximately $0.39. So that puts us at a continuing operations performance view, earning fully diluted EPS of $2.22 to $2.30. And that’s a 30% to 35% increase above the prior year. But there are some clear and distinct drivers of that. Those are highlighted in the lower right-hand portion of that. The results that we expect from our core operating performance driven by the same restaurant sales and the cost initiatives should drive 10% to 15% EPS growth. We talked about the reduced interest expense related to that debt reduction that drives about 12% of EPS growth and the share count reduction from the share buyback that we talked about drives 5% growth, and just add a little bit more confusion to the work that we have to do next year will be a 53rd week for us, and so there is a 3% earnings growth related to sales from that extra week, so netting to a 30% to 35% increase and earnings per share.
Now, I would point out that the share buyback really won’t begin after the closing of the Red Lobster deal as well as the debt breakage. So you can see the annualized impact actually adds another 6% in EPS growth that will be realized in the first quarter of following fiscal year of fiscal year ’16.
So with that let me turn it back to Clarence for a few more comments.
Thank you, Brad. And so we think that we have a very strong competitive position and that starts with a well positioned, much better positioned portfolio brand that can deliver balanced same restaurant, new restaurant sales growth which will leverage our operating support and restaurant support cost. We are committed to proactive, ongoing, cost optimization to amplify the leverage that we get from growing sales and ensure consistent margin expansion and earrings growth that will result in consistently strong cash flow growth to support meaningful ongoing return to capital shareholders again through dividends and share repurchase. And more than sufficient operating cash flow to address the emerging trends as they develop. With this competitive position, we are confident that we can return to industry leading financial performance with on a sustained basis mid-to-high single digit annual sales growth, low-to-mid teen annual operating income growth, and $350 million or more in annual return of capital to shareholders.
So with that, we will open it up for your questions. Thank you.
Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is coming from the line of Mr. Joseph Buckley from Bank of America. Sir, your line is now open.
Joseph Buckley - Bank of America
Thank you. I’d like to ask a few questions on Olive Garden, so the remodel information you shared with us, was that based on one restaurant or maybe more than that? And then you mentioned your underperformers kind of pulling down the brand performance, how many stores are in that underperformed group and what are the common characteristics of that underperformed group? And maybe just one more, in the same-store sales projections for this year while improved particularly at Olive Garden are pretty low and what happens to margins given those same-stores sale projections, I noticed the fourth quarter LongHorn’s operating profit was down per year tax, do you need strong comps than that to get restaurant level margins healthier?
The initial results I gave on the remodel were just the one restaurant we have up at Fort Walton Beach and it’s obviously very-very early, but we can isolate that restaurant to see what happened, it will be a little bit more time before we have a good what I can say statistically significant sample. As far as the underperformers, you always have a bottom quartile. What we try to do is get to the bottom quintile and then subdivide that even more, get this down to like 50 restaurants that are really having a significant impact on the system. I would say they’re between 7% and 10% below the system average. And the characteristics around them are; first, majority of them are older restaurants that haven’t been renovated, we have probably weaker management teams there, our attributes, our ratings on prudent service aren’t close to the system average. And it’s really getting back to some really restaurant basics in there and ensuring that we’re delivering the guest experience.
Yes, and on margins, we expect Olive Garden to expand at -- at Olive Garden not as much as the other businesses and to your point really driven by same restaurant sales, but they would still have margins that increase in the 20 to 25 basis point range. And even across Darden with the work that we’ve done on the G&A cost the things that we’ve talked about some in the marketing or selling area as well as what’s driven by the same restaurants sales. And the cost environments were -- the cost pressures that I mentioned are not too severe. We were able to greatly mitigate those when you look even across Darden you’re looking that operating profit margins will expand in that 20 to 50 basis points range depending on which end of the guidance that, that you look at.
Thank you, our next question is coming from the line of Mr. Brian Bittner of Oppenheimer and Company.
Brian Bittner - Oppenheimer and Company
Thank you and good morning. First is a clarification question, did that operating cash flow guidance for 2015 include or exclude Red Lobster’s earnings? Because I thought it’s still -- I thought I saw it say includes Red Lobster’s earnings?
It includes it for the approximate period that we would own that business still, so you know that’ll be just part of the first quarter.
Brian Bittner - Oppenheimer and Company
Okay, so it’s a question I have is really at almost based on the EPS guidance and you are kind of close to that 100% dividend payout ratio here. And when I look at the operating cash flow guidance you are assuming working capital inflows and some other inflows from non-cash items. And I guess, the question is how confident are you that you can really maintain the $2.20 dividend going forward and how much does it rely on continued influence from working capital in certain items like that.
Obviously as we look to fiscal 2015 there is contributions in cash flows from these other items but also the reduction in CapEx that we’ve done, leaves sufficient room for us to maintain our 2.20 targeted dividend. From there I think the platform that we’ve laid out, the initiatives we have underway, earnings will grow and so the contributions from operating cash flow would grow and continue to allow us to have a $2.20 dividend and depending on the rate of those earnings growth the opportunity to modestly to start growing that dividend rate beyond 2015.
Brian Bittner - Oppenheimer and Company
The new restaurant piece obviously of the capital budget is discretionary and we demonstrated that with the scale back that we accomplished in fiscal ’14 on the new restaurant side.
Brian Bittner - Oppenheimer and Company
I see, so if, you know we saw a scenario where earnings didn’t grow as much as you expect in 2015, do you think there would be some [Indiscernible] on the CapEx to still be able to maintain that dividend.
Yes, we see sufficient room to make the adjustments that we need to make to maintain the dividend to work at our debt metrics as well to have that investment’s credit profile, so we see the ability to do both really.
Brian Bittner - Oppenheimer and Company
Okay and then jus the second and final question is on LongHorn. Revenue growth was up double digits. And as Gene said, and you say in the press release that operating profit -- dollars actually declined year-over-year. Can you just walk through that a little bit more and the dynamics there?
LongHorn profitability, I mean it continues to grow fuelled a lot by the unit growth, we do see the margins there expanding, their particular brand performance is a little bit muted by the elevated beef cost and we see those continuing but still good progress from that brand, new unit growth is profitable and when you have same restaurant sales growth as strong as they do well above industry average, we’re able to leverage those as well.
And I would say also Brian, as we look into fiscal 2015, with the slowdown in unit growth at LongHorn and there are a lot of new restaurant opening expenses not just direct from the restaurant opening expenses but manager training, all those sorts of things, in the model that will be a lot lower in ’15 than they were in ’14 with the unit growth pace cut in half.
Thank you, and once again participants may I request everyone to please to limit yourself with one question and one follow up, our next question is coming from the line of Ms. Sara Senatore from Sanford Bernstein, Ma’am your line’s now open.
Sara Senatore - Sanford Bernstein
Thank you very much. I do have one follow up and one question. The follow up was just on the Olive Garden remodeling I think you said unremodeled restaurants lag by 2 percentage points and so it sounds like the core restaurants are still comping negatively and the remodeling isn’t having as much of a lift as I would have thought, because I thought it’s sort of 3% to 4%, so, if you could just clarify that and then the first question is, the real question is, can you talk about whether Alvarez and Marsal has identified any kind of unit level cost saves, I think you mentioned G&A savings, further G&A savings but it seems like if you’re going to invest in improved food and service for the Olive Garden you probably need to fund that with maybe cost savings elsewhere, thank you.
I’ll start, on the remodel side, I think what Gene was saying is that the restaurants that have not been remodeled are the ones that are in need of a remodel are lagging by about 2 points, now we’ve had some remodels in the past that have had a lift of 3, 4 percentage points but we paused on them because we believe that they really didn’t have the kind of shelf life going forward that we needed, that they didn’t make dramatic enough change, and so we would hope that, this new remodel, and again it’s too early to tell but at least 2% to 3% to 4% and perhaps more than that. And then on Alvarez and Marsal, they’re working to identify four wall opportunities, but Dave George and the team at Olive Garden have been working on that as well. And so to some of the simplification work that they have done, they have taken out about $20 million of cost on an annualized basis and they’ve reinvested a significant amount of that in food quality and some of the other things that Gene mentioned already.
And I would add that on, from A&M’s perspective where they really were able to help us is on the marketing side, help accelerate our attack on nonworking media cost, and so that’s been a big help and we think there is big dollars there. And there is some other marketing ideas that they have that we’re planning on implementing I think those are all going to be cost saves.
Thank you. Our next question is coming from the line of David Palmer from RBC. Sir, your line is now open.
David Palmer - RBC
Thank you, good morning. You’ve mentioned the June to-date sales for Olive Garden -- you understand that goes short-term influences on the sale like the promotion timing, the media wave better than us, can you evaluate that and perhaps just comment on what do you think that this June result is indicative or the kind of sales you’ll see perhaps for the first half in fiscal ’15 and why some of the -- why this is truly is a turning, what are the factors driving the turn specifically in terms of your initiative? Thanks.
So, I will start. I would just say promotionally June lines up pretty well year-over-year and so we don’t have a lot of promotional noise in the June to-date numbers, but June we might wind up.
David, I would say that we’ve been working hard to gain guest count momentum. If you look back in the fourth quarter, guest counts in March were down 61 affected somewhat by weather April 35, May rolling down 17 and the majority of that was one week when we had some promotional transitional issues, but June’s comes back and been pretty solid. We think it’s just a result of the focused efforts that we put on this brand from an operational standpoint from food service. We think our advertises are getting a little sharper a little bit more focused again it just -- I don’t think we’re on a straight line up to 3% to 4% comps, but I do think that we’re putting in the effort and we’re making some improvement and the guests are telling us that by coming to our restaurants more often.
Thank you. Our next question is coming from the line of Mr. John Glass of Morgan Stanley. Sir, your line is now open.
John Glass - Morgan Stanley
Thanks. Gene, if I could first ask you to clarify last comment? Your mix was down pretty substantially in May, so your traffic was better, but the mix was worse. So you traded -- it seems like you traded one for the others. Is that correct? Is that the way you would look at it going forward that you will take a lower check for the traffic? Or was that just a monthly?
I think that was just a monthly skew where we were out there in May with our classic promotion at $10 and last year we had a different type of promotion that didn’t impact check averages as much. I was pleased with May’s results even though we did have a mix change. I thought getting our classics which represented close to 20% of the sales in the May into our guest, on the table for our guest was a really good thing to remind them about some of the reasons why they really love Olive Garden and I think that momentum is carrying on through June.
John Glass - Morgan Stanley
And then on the SG&A or the G&A savings, where were you just up the benchmark -- where were you in G&A as percentage of sales in the fourth quarter after you’ve striped out all of Red Lobster? What’s the progression of events in ’15? How quickly can you keep getting if there was -- it’s above five materially ex-advertising how fast can you get it to five?
Well, we’ll get it to five in the fiscal year and I’m looking up your question there, fourth quarter.
Yes, we may have to get back to you with this John perhaps flipping through some pages, but we’ll get back to you. I think for the full year it’s 5%, so we expect to get to that level pretty quickly.
The SAP costs that I’ve laid out there are virtually…
SAP, strategic action plans.
In the G&A line there I think maybe to the heart what you giving as we look forward. We talk about a flat G&A at 5% with the opportunity in ’15 as we get through more the A&M work and things we’re doing to take that even lower. In the year, but at a flat 5%, that’s implying an absolute reduction of well over a $100 million of G&As and granted there is about say 75 million of that, that is either allocated or directly within Red Lobster that goes away. There are some stranded G&As of about $20 million, which says we’ve already got well over $50 million of G&A reductions that stays within the Darden continuing operations and more than offsets the stranded G&A cost over there. So we were really pleased with the progress and those plans are largely all in place and delivering the expected results.
John Glass - Morgan Stanley
If I could just ask one final question. On the low to mid teen operating profit growth longer term, how do you -- in an industry that grows comps at a very low single digit rate, you’re going to square footage at least this current year at a very low single digit rate. How do you get there? Or is it presumed that you are a unit grower -- a much more materially faster unit grower in the future again?
Well let me start it out and then I will turn it over to Clarence. I think even if you look at the guidance that we have -- our expectations for fiscal 2015, on the composition of same restaurant sales growth that we have, a cost environment, where commodity costs are in that 2% to 3% range. Through all that we’re still able to generate what I call a core operating profit growth of 10% to 15%. That’s pretty significant. There is a little bit of unit growth but a much more moderated pace that we think is appropriate for our businesses and for a large chain. And then, with that there’s strong cash flows that will allow us to begin growing the dividend and repurchase shares so that those repurchased shares also aid EPS growth as well as its how you get into that low double digit mid-teen range.
And I would say the portfolio of new Darden, in an industry that’s challenged is strongly positioned against the healthiest parts of the industry. So when you look at Olive garden and LongHorn, but also the specialty restaurants strongly positioned against the healthiest parts. The brands also have very strong -- in the new Darden X Red Lobster very strong, restaurant level returns and with the support cost activities that we’ve had, we’re able to realize a lot of that restaurant level return.
Thank you. Our next question is coming from the line of Priya Ohri-Gupta from Barclays. Ma’am, your line is now open.
Priya Ohri-Gupta - Barclays
One, just a point of clarification, that around the 3.7 times leverage that you mentioned for fiscal year ’14, that includes $1 billion of notional debt reduction, correct? And then secondly, as you map to getting the three times leverage at the end of fiscal ’15, a lot of it is predicated on you hitting that cooperating profit growth target, but what other levers could you pull, if for some reason you start to fall towards the lower end or below that? Thanks.
Well, first on the 3.7 times, that’s adjusted debt-to-adjusted capital. So we’re treating those operating leases as debt equivalents, which they are. That’s the range of the end of fiscal ’14. The outlook that we’ve laid out here gets us to 3 times, 3.0 times into fiscal ’15. And so that’s our expectations there. Like so the other key thing is the cash flows and to a degree there’s shortages on the operating cash flow as Clarence outlined earlier is that we’ve clearly demonstrated our willingness and ability to work on the CapEx side, particularly around new unit growth. And so that would be obviously the first item that we would look to. Olive Garden remodeled CapEx. We know it was very important. That delivers results that we’re anticipating. We would probably keep that in there. That would be hard to touch and obviously, maintenance CapEx. There’s pretty significant operating cash flows. We want to protect that as well. So the real opportunity is around new unit CapEx and the others would be more difficult for us to change but if needed, we could.
Priya Ohri-Gupta - Barclays
And just, I think you might have misunderstood the first question. The 3.7 times number, that you have at the end of fiscal ’14, is that on a reported basis using your current debt or is that adjusting out the $1 billion of notional debt reduction you expect to occur as a result of the Red Lobster proceeds?
That includes the reduction of debt from the Red Lobster proceeds, I’m sorry.
Thank you. Our next question is coming from the line of Jonathan Compt (ph).
Wait a second let me finish that question. I misunderstood, the 3.7 is the reported number at the end of fiscal year that does not include unit reduction. That’s based on our reported numbers.
Sorry, that’s the last question. We are out of time here today. We appreciate those of you joining us and listening in and those that asked questions. Of course we’re here in Orlando if you have further questions and further follow ups. We look forward to talking to many of you in the near future. Thank you.
Thank you. That concludes today’s conference. Thank you all for participating. You may now disconnect.
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