Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

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

Eugene I. Lee - President of Specialty Restaurant Group

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

Matthew Stroud - Former Vice President of Investor Relations

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

Analysts

Keith Siegner - Crédit Suisse AG, Research Division

David Palmer - UBS Investment Bank, Research Division

Alvin C. Concepcion - Citigroup Inc, Research Division

Phillip Juhan - BMO Capital Markets U.S.

Jonathan R. Komp - Robert W. Baird & Co. Incorporated, Research Division

Mitchell J. Speiser - Buckingham Research Group, Inc.

Brad Ludington - KeyBanc Capital Markets Inc., Research Division

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

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

Larry Miller - RBC Capital Markets, LLC, Research Division

Jason West - Deutsche Bank AG, Research Division

Darden Restaurants (DRI) Q1 2012 Earnings Call September 28, 2011 8:30 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the first quarter earnings release. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to Mr. Matthew Stroud. Please go ahead.

Matthew Stroud

Thank you. Good morning, everyone. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and COO; Brad Richmond, Darden's CFO; and Gene Lee, President of Darden's Specialty Restaurant Group. We welcome those of you joining us by telephone or the Internet.

During the course of this conference call, Darden Restaurants' officers and employees may make forward-looking statements concerning the company's expectations, goals or objectives. Forward-looking statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update such statements to reflect events or circumstances arising after such date. We wish to caution investors not to place undue reliance on any such forward-looking statements. By their nature, forward-looking statements involve risks and uncertainties that could cause actual results to materially differ from those anticipated in the statements. The most significant of these uncertainties are described in Darden's Form 10-K, Form 10-Q and Form 8-K reports, including all amendments to those reports.

These risks and uncertainties include food safety and food-borne illness concerns; litigation; unfavorable publicity; federal, state and local regulation of our businesses including healthcare reform; labor and insurance costs; technology failures; failure to execute our business continuity plan following a disaster; health concerns including virus outbreaks; the intensely competitive nature of the restaurant industry; factors impacting our ability to drive sales growth; the impact of the indebtedness we incurred in the RARE acquisition; our plans to expand our newer brands like Bahama Breeze and Seasons 52; a lack of suitable new restaurant locations; higher-than-anticipated costs to open, close or remodel restaurants; increased advertising and marketing costs; a failure to develop and recruit effective leaders; the price and availability of key food products and utilities; shortages or interruptions in the delivery of food and other products; volatility in the market value of derivatives; 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 2012 second quarter earnings and same-restaurant sales for fiscal September, October and November 2011 on Friday, December 16, 2011, before the market opens with a conference call shortly thereafter. Also, we plan to hold our fiscal 2012 Analyst and Institutional Investor Meeting on Friday, February 24, 2012, in New York City. Additional details will be available soon.

We released first quarter earnings this morning. These results were available on PR Newswire and other wire services. We recognize that most of you reviewed our first quarter earnings results, so we won't take the 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 and discuss our financial outlook for fiscal 2012, as well as discuss our brand-by-brand operating performance summary.

Brad will now provide additional detail about our financial results for the first quarter. Drew will review our operating performance of our larger brands. Gene will discuss the Specialty Restaurant Group, and he will be followed by Clarence, who will have some final remarks. We'll then respond to your questions. Brad?

C. Bradford Richmond

Thank you, Matthew, and good morning. Darden's total sales from continuing operations increased 7.5% in the first quarter to $1.94 billion. This strong top line performance compares to an estimated plus 2.2% total sales growth for the Knapp-Track benchmark, excluding Darden. So as you can see, we had meaningful share growth.

On a blended same-restaurant sales basis, the results for Olive Garden, Red Lobster and LongHorn Steakhouse were up 2.8% in the first quarter. And this compares favorably to the Knapp-Track same-restaurant sales benchmark and excluding Darden, that are estimated to be up 1.0% for the quarter. And we also saw continued strong same-restaurant sales gains in our Specialty Restaurant Group with plus 5.1% same-restaurant sales growth on a blended basis there.

In addition, there's approximately $2 million in sales attributable to our Synergy Restaurant and the royalties from our existing franchise locations in Japan and Puerto Rico, as well as our international expansion into the Middle East and Mexico. We are pleased with the early results from the Synergy Restaurant, and we're looking to open 2 more locations later this year. This is still a test however, so we're not ready to comment on financial metrics.

Internationally, the first restaurant outside Japan and Puerto Rico opened in the Mid-East. It is a Red Lobster that opened in Dubai in July, and the response has been outstanding. Our franchise -- franchisee is very pleased with the performance so far, and we expect 2 more restaurant openings both in Kuwait City later this fiscal year.

Traffic at Red Lobster, LongHorn Steakhouse this quarter was particularly strong driven by successful promotions, remodeling and other brand enhancements and investments. On a blended same-restaurant traffic basis, the results for Olive Garden, Red Lobster and LongHorn Steakhouse were up 3.3% in the first quarter. This compares to same-restaurant traffic as measured by Knapp-Track and excluding Darden that is estimated to be down 0.9% for the quarter.

Now before I get into the margin analysis, I want to provide some context by reviewing our pricing and promotional strategy for the fiscal year. As we mentioned at the beginning of the year, we historically have raised prices between 2% and 3% on average each year. In June, we said we expected our annual blended pricing for this fiscal year to be between 2% and 3% though more likely at the lower end of this range, and we still expect that to be the case. We also said we expected operating profit return on sales for the year to increase despite commodity cost inflation of 5% to 5.5%, primarily because of the positive effect of pricing, sales growth leverage and our transformational cost savings initiatives that would offset significant unfavorability in food and beverage expenses as a percentage of sales. That unfavorability was expected to come from higher commodity costs and our promotional strategy, which would emphasize maintaining affordability for our guest.

From a quarterly perspective, we expected the decision to price below food cost inflation to result in a lower operating profit return on sales in the first quarter compared to the first quarter of last year. This was because the food and beverage unfavorability would be particularly acute in the first quarter given that this year's higher-than-normal commodity cost were up against lower-than-normal commodity costs in the first quarter last year. So for the quarter, pricing, sales leverage and transformational cost reductions were not expected to fully offset food and beverage expense unfavorability.

Now food and beverage expenses for the quarter were approximately 250 basis points higher than last year on a percentage of sales basis. About 2/3 of the unfavorability was expected based on the dynamics I just mentioned. The balance or about 80 basis points was due to more check management by our guest than anticipated. This occurred at Olive Garden, Red Lobster and LongHorn Steakhouse. More specifically, fewer appetizers, drinks and desserts were purchased. Consumers still want the dining experience as evidenced by our strong blended traffic results in the first quarter, but they are choosing to reduce their check average. What this tells us is that our decision to focus on our promotional offerings on value price points at Olive Garden, Red Lobster and LongHorn Steakhouse was the right one.

In terms of our purchasing strategy, we continue to lock-in forward contracts we believe are favorable and to avoid those where there are large premiums to the current market price. For the past year, this strategy has been successful because we've purchased products in the cash market at levels that provide meaningful savings compared to what we would have contracted for in the futures market.

For the first quarter, restaurant labor expenses were approximately 50 basis points lower than last year on a percentage of sales basis due to the sales leverage and improved wage rate management. The favorability for the quarter was pretty consistent with our initial expectations. Restaurant expenses in the quarter on a percentage of sales basis were essentially flat to last year because of sales leveraging, though we had expected some favorability here.

Looking at selling, general and administrative expenses, they were approximately 60 points -- 60 basis points lower than last year as a percentage of sales due to sales leverage that more than offset higher media expense, and in this case, as well, favorably exceeded our initial expectations.

Depreciation expense in the quarter was essentially flat on a percentage of sales basis compared to last year. For the quarter, operating profit as a percentage of sales was 8.7%. That's about 150 basis points below last year. And again, that's due primarily to a higher commodity cost on a year-over-year basis and the increased check management, although about 15 basis points reflects the impact of Hurricane Irene. As we mentioned in the press release, Hurricane Irene adversely affected diluted net earnings per share this quarter by approximately $0.02. Adjusting for the hurricane impact, diluted net earnings per share would have been flat on a year-over-year basis.

Now turning to the full fiscal year, we expect combined same-restaurant sales growth for Red Lobster, Olive Garden and LongHorn Steakhouse of approximately plus 3%. And we continue to expect a net new restaurant increase of approximately 80 to 90 restaurants, which is about a 4.5% unit growth on our current base and approximately 4% growth in operating weeks or capacity for fiscal 2012, given the timing of unit openings. With these same-restaurant assumptions and new restaurant plans, we now anticipate that total sales increase for the year of between 6.5% and 7.5%.

For the full fiscal year, we continue to expect a modest increase in our operating profit margin or operating profit return on sales. That's a reversal from the first and second quarters, primarily because while the first half has elevated food cost inflation that is lapping what was pretty modest food cost inflation last year, in the second half, we expect commodity costs will be relatively unchanged year-over-year since food cost inflation really started in earnest in the second half of last fiscal year. Again, for the current fiscal year, we still anticipate food cost inflation to be between 5% and 5.5%.

I should note that our annual outlook does anticipate that the check management we saw in the first quarter will continue for the balance of the fiscal year, but at a slightly more moderate level. We have approximately 80% of our total food spend contracted to the end of the calendar year, calendar 2011 and 25% of our total spend contracted to the end of our fiscal year. We believe some commodities will experience cost declines from the current elevated levels, and we want to be in a position to benefit from that decline. In addition, we believe the premiums for forward contracts are simply too great given where we expect prices to be in the cash markets as we look to the out periods.

Now looking category-by-category, shrimp is our highest volume protein, and we have coverage through the third quarter of fiscal 2012 at prices that are higher than fiscal 2011. Crab is contracted or purchased at prices higher than fiscal 2011 with coverage through the end of our fiscal 2012. And we currently have lobster usage contracted or purchased through the third quarter at prices that are slightly higher than the prior year.

Beef prices are higher on a year-over-year basis, and we have approximately 2/3 of our usage covered through the calendar year or calendar 2011. Chicken poultry market prices are slightly higher on a year-over-year basis, but we have contracted our usage through January of 2012 at prices equal to our fiscal 2011 costs.

Wheat prices are higher on a year-over-year basis. We have contracts taking us through the second quarter for our bread and pasta products at prices higher than the prior year. Dairy prices are higher on a year-over-year basis driven by a strong export market. We have most of our dairy products contracted through calendar 2011 at prices higher than our fiscal 2011 cost. And energy costs are expected to be unchanged on a year-over-year basis at least through the calendar year. We have contracted nearly 100% of our natural gas and electricity in the deregulated markets in which we operate for fiscal year 2012 at prices that are slightly higher than fiscal 2011.

In our announcement 2 weeks ago, we reported our intentions to repurchase approximately $450 million to $500 million of our stock in fiscal 2012, which is an increase from our previously announced share repurchase targets of $350 million to $400 million. Because of this increase, we will see our debt to capital ratios move to the middle of our 55% to 65% targeted range. We continue to be committed to maintaining an investment grade credit profile and believe these leverage levels are consistent with that.

Today, we also affirm that we anticipate that reported diluted net earnings per share growth from continuing operations for fiscal 2012 will be between 12% and 15% growth, and that at this point in the fiscal year, we're more comfortable with the lower end of this range. Again, this is an outlook based on flat earnings in the second quarter given the cost dynamics I've talked about, and we expect that to be followed by double-digit earnings growth in the third and fourth quarters.

Our outlook reflects tempered, but nevertheless, improving same-restaurant sales growth at Olive Garden; continued sales momentum at the other brands: Red Lobster, LongHorn and the Specialty Restaurant Group; more neutral year-over-year commodity cost in the second half of the fiscal year; continued but moderating check management and the related menu mix impacts; and the addition of $100 million increase in our share repurchase. I won't get into any details in September since it is a relatively volatile period, but I would say that we have reason to be encouraged.

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 before I discuss the key business dynamics at our 3 large brands during the first quarter, I also want to briefly provide some additional context on the current environment and our strategy to compete successfully in the near term, while continuing to build a great company for the long term.

Now the fundamental strategic challenge we face in the near term is how to address the growing need for affordability that's demanded by our guest, while also protecting our margins given significant commodity cost inflation. And our strategy to address this challenge is really grounded in 2 important choices. First, we've chosen to maintain our annual price increases in the historical range of roughly 2% to 3%, and we believe this will allow us to protect the guest value equations we believe are fundamental to long-term brand vibrancy. At the same time, we will leverage the impact of 4 transformational cost savings initiatives to protect our profit margins. Essentially, we're pricing to cover the net inflation in our business after accounting for the impact of our cost savings initiatives. Second, we have chosen to elevate the emphasis on affordability in our promotions. Now importantly, these are not deep discount offers that erode profit margins or brand equity. These are new dishes designed to offer our guests compelling brand-appropriate price points, with a food cost that is consistent with sustainable value creation. Growth in total sales and growth in total earnings is driven by more guests paying a little less. And we're on track to capture pricing that covers our net inflation for the full year. Pricing was below net inflation during the first quarter, primarily because the core menu introductions and related pricing at Olive Garden and Red Lobster occurred a little later this year compared to last year, combined with the elevated year-over-year increase in commodity cost.

Now we are also pleased with the results of our refined promotion strategy during the first quarter, especially at Red Lobster and LongHorn. Our earnings shortfall compared to our internal expectations during the quarter was primarily driven by soft guest counts at Olive Garden and a search for affordability by our guests across all brands, generating a negative menu mix that was due in part to more check management than normal.

Olive Garden same-restaurant sales were down 2.9% during the first quarter, roughly 390 basis points below the full service restaurant industry benchmark. Now while the vast majority of business fundamentals at Olive Garden remain competitively strong, from guest satisfaction and brand perception to average unit volumes and restaurant-level profit margins, same-restaurant sales have clearly softened since the third quarter of last fiscal year. As we discussed during our call in June, we thought the primary opportunity to improve same-restaurant sales at Olive Garden was to improve the impact of their promotions. Specifically, we felt the need to feature dishes that were more broadly appealing, while also emphasizing brand-appropriate affordability more often during the year.

As a result, Olive Garden launched their twist on classics promotion in late June, featuring carbonara ravioli with pan-seared chicken for $10.95 and carbonara ravioli with sautéed shrimp for $12.95. This was followed in mid-August by Never Ending Pasta Bowl priced at $8.95. Now we believe this new promotional strategy is a step in the right direction. For instance, the percent of guests who bought one of the new dishes during the carbonara ravioli promotion was higher than any other promotion, except Never Ending Pasta Bowl, during the last 3 years. And same-restaurant sales improved sequentially during the quarter from minus 3.1% in June to a hurricane-adjusted minus 1.3% in August. However, sales were still below expectations. We now recognize that to regain same-restaurant sales growth, Olive Garden needs to go beyond improved promotional effectiveness and make more significant business-building changes to address both a challenging external environment and an improving competitive set led by Red Lobster and LongHorn.

Now these changes will include a new advertising campaign featuring a broader range of emotional attributes to reinvigorate the idealized Italian family meal promised by Olive Garden, a new core menu featuring even more everyday affordability to ensure the brand remains accessible to as many families as possible and a remodel that updates and refreshes the dining atmosphere in their 430 non-Tuscan farmhouse restaurants.

Now we anticipate introducing improved bridge advertising and some additional core menu news during the balance of our current fiscal year which, combined with improved promotional effectiveness will, we believe, drive improving same-restaurant sales trends going forward. We are working on even more meaningful changes, and their introduction and full impact will take longer given the lead times associated with each initiative.

Olive Garden opened 3 new units during the first quarter and is on track to open 35 to 40 net new restaurants this year. And these new Tuscan farmhouse units continue to significantly exceed their sales and earnings hurdles.

Red Lobster same-restaurant sales increased 10.7% during the first quarter, 970 basis points above the full-service restaurant industry benchmark. Now Red Lobster has delivered competitively superior same-restaurant sales since last October when they began emphasizing craveable new seafood dishes and price certainty in their promotions, and that momentum continued during the first quarter.

They began the quarter advertising a new 4-course seafood feast for $15. This was followed by a significantly reengineered Crabfest promotion that started the last fiscal week in July and featured 3 new crab entrées priced under $20. The most popular dish actually had the highest price point, demonstrating that craveable seafood dishes, combined with price certainty, are more important to Red Lobster's guest than just a low price on undifferentiated seafood.

Red Lobster also introduced a new advertising campaign during the first quarter that leverages the authenticity of real Red Lobster employees to communicate everything that has been improved at the brand over the last several years, including the introduction of an expanded variety of fresh fish and wood-fire grilling, and demonstrates that Red Lobster goes the extra mile to provide every guest a great seafood experience. The new tagline of this campaign is, "Sea Food Differently," and we believe this campaign goes beyond craveable seafood to help humanize the brand in a way that strengthens the emotional connection with our guests and builds long-term brand equity.

In fact, their new grill master commercial was the second-highest scoring restaurant ad ever tested in our vendor's database. Red Lobster remodeled 18 restaurants during the first quarter and is on track to complete more than 100 remodels this fiscal year. And remodeled restaurants continue to exceed their guest count and earnings growth hurdles.

LongHorn same-restaurant sales increased 4.8% during the first quarter, 380 basis points above the full-service restaurant industry benchmark. These competitively strong results were supported by 3 successful promotions and increased advertising weight. The quarter began with the 3 final weeks of their steak and seafood promotion featuring new shrimp and lobster top filet, plus new sirloin and cedar grilled shrimp. This was followed in late June by their Steakhouse Grilled Trio promotion that combined a 6-ounce top sirloin, grilled shrimp wrapped in hickory smoked bacon and grilled chicken with garlic lemon sauce on one plate for $16.99. The ad for this promotion also featured their 6-ounce top sirloin for $11.99. And finally, their Steakhouse Dinner for Two for $29.99 began the final week of the quarter.

During the second quarter, their operations team will begin rollout of the table management system currently in place at Olive Garden. This technology, which enables more accurate wait time quotes and better guest count throughput during peak demand periods, will be in place in every LongHorn restaurant for the busy holiday season.

LongHorn completed 26 remodels during the first quarter and plans to remodel the remaining 3 restaurants during the second quarter, at which time all restaurants in their system will be in the ranch house image. New units at LongHorn continue to significantly exceed their sales and earnings hurdles. LongHorn opened 3 new units during the first quarter and is on track to open 30 to 35 net new units this fiscal year. LongHorn same-restaurant sales have now exceeded the industry benchmark for 11 consecutive quarters, and we're obviously thrilled with the consistent momentum at this business.

Now stepping back, we draw several important learnings from our first quarter results. First, guest behavior reinforces our belief that moderating our price increases and focusing on affordability in our promotions was the correct strategy. Second, we need to take full advantage of the transformational cost savings opportunity available to us, given our scale and expertise. And third, we need to continue to design promotions that appropriately balance affordability, food cost and guest count growth.

Now Gene will discuss our Specialty Restaurant Group.

Eugene I. Lee

Thanks, Drew. The Specialty Restaurant Group had another strong quarter with total sales of $129 million. That's a 20.7% increase over the same quarter last year and represents 16% of Darden's overall sales growth. This growth was driven by solid sales performance at our 12 new restaurants, as well as same-restaurant sales increases of 7% at The Capital Grille, 2.9% at Bahama Breeze and 2.5% at Seasons 52.

With 6 consecutive quarters of blended same-restaurant sales growth, our trailing 12-month average unit volumes are 6.6 million at Capital Grille, 5.5 million at Bahama Breeze and 6.4 million at Seasons 52. In addition to delivering strong sales growth, our teams also maintain effective cost controls, which allow the group's restaurant-level margins to continue to expand.

The Specialty Restaurant Group remains focused on our key priority, which is to effectively manage accelerated growth, while continuing to improve operational delivery and ensuring our brands stay relevant. To support this priority, we are developing a strong pipeline of new restaurant locations and improving the way we open new restaurants, making it a more efficient and effective process. In addition, each of our brands continue working on initiatives designed to further improve the service cultures to drive guest loyalty, and our marketing team continues to develop and communicate affordable, unique new product offerings for our guests.

At The Capital Grille, for example, we are expanding the rollout of our brand-appropriate lunch menu, offering guests their choice of a soup or salad, gourmet sandwich and a side for $18, along with a faster-paced 45-minute service option for those guests on a time constraint. We also recently introduced a snack and small plates menu at Bahama Breeze, which has a very approachable starting price point of $2.95.

In the second quarter, we plan to open 3 Seasons 52 restaurants, which continue to be well-received in all geographies and 1 Bahama Breeze. And we're on track to achieve our target openings for the year, which is 10 to 12 net new restaurants.

Now I'll turn it over to Clarence.

Clarence Otis

Thanks, Gene. This was a more complicated and more challenging quarter financially, given this year's cost dynamics and the sales slowdown at Olive Garden. As we think about the balance of the year though, we're encouraged, very encouraged because, one, we have a sound strategy in place to strengthen our business at Olive Garden; two, we continue to see good momentum as a result of the many changes we've made at Red Lobster, LongHorn Steakhouse and within our Specialty Restaurant Group over past several years; and three, we fully expect current cost dynamics to change meaningfully in the second half of the year. So we continue to expect to deliver solid financial performance this fiscal year, and just as importantly, well into the future.

As Drew just outlined, we're making changes at Olive Garden with appropriate urgency. Some of the changes will be implemented soon, while others will take more time. But we're confident in the Olive Garden team, and we believe we're on track to deliver good performance this fiscal year.

Fortunately, we have a strong portfolio of brands that, in aggregate, can produce solid results even when a single brand has its challenges. Our outlook for the year, which is for strong sales and earnings growth against a backdrop where we have an economic recovery that continues to be uneven and relatively anemic is a testament to that. And the reason we have a strong and resilient portfolio is that we have exceptional employees across all our brands who are committed to our business. Their commitment and capabilities are why we continue to make progress toward our ultimate objective, which is to take full advantage of the opportunity we have given the strong brands, the strong support platform, the strong cash flows to create a great company.

And with that, we'll take your questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of David Palmer with UBS.

David Palmer - UBS Investment Bank, Research Division

A question on Red Lobster first. With regard to the $15 meal that you ran earlier in the quarter, is there -- are you sort of evaluating that menu? And is there any reason why you might not bring that back in an adjusted and maybe even permanent basis? And secondly, with regard to Olive Garden, is a similar type value certainty menu the appropriate long-term solution there?

Andrew H. Madsen

Well, I don't want to talk specifically about our future promotion and core menu plans. But I would say at Red Lobster that offer, the 4-course seafood feast for $15, was very carefully designed to do a few things: give consumers, give our guests a price point that they felt that was certain and clear and that they felt was compelling; design dishes that had a food cost, we think was -- thought was appropriate; and an overall offer that would drive traffic that ultimately resulted in total sales and total margin growth. And we were delighted with the way that promotion performed in June and through most of July. And certainly, given that strong performance, we will seriously consider the role that, that offer can play in future promotions and potentially on the core menu. As it relates to Olive Garden, I would say that we do have an opportunity to make -- to offer even stronger everyday affordability on our core menu to make sure that our brand remains as accessible to as wide a range of household incomes as possible. And that's something that the Olive Garden team is examining and working on now. In the near term, we're going to be emphasizing affordability more in our promotions, as I mentioned. And even next week, roughly within the next week, we'll be adding some news to the market to help with affordability. We introduced Panini sandwiches about 6 weeks ago, and we're going to start advertising a half-Panini sandwich, unlimited soup and/or salad for $6.95 to bring in some lunch news and affordability. So that's an example of something that's happening right away. But some longer-term core menu work and affordability, we'll also be examining.

Operator

The next question is from the line of Brian Bittner with Oppenheimer & Co.

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

I was just wondering if you could just dive a little bit deeper into the year-over-year food cost dynamics in the second half of fiscal 2012 and just describe exactly what gives you confidence in the potential for a neutral commodity cost comparison like your guidance assumes?

C. Bradford Richmond

Yes, Brian, this is Brad here. I think if you look at how we've laid out our forecast and what we see in the back half of the year, is really wrapping on the period last year, the back half of our fiscal year, where there's really pretty high year-over-year inflation, similar to what we're seeing in the first quarter, where it's very high single digit year-over-year inflation. And so just as we had forecast that back in January, February at our Investor/Analyst Conference there, the same tools, the same folks that are looking at that as we look forward at the marketplace and what's going on and while this involves the grains in terms of the harvest and all of that, that's going on, we don't see the costs elevating from where they currently are today. So when you get to that year-over-year comparison, they're going to be very modest, if any, increases on a year-over-year basis.

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

Okay. And then real quickly on Red Lobster, you had obviously great sales growth in the quarter and you even got some labor leverage, but it seems as though operating profit dollars actually declined. Just wondering if you could kind of go deeper into that? Obviously, I know there is some food cost headwinds, but was it the lower margins, was the promotion lower margin or what exactly was going on there? Was there some investment costs embedded in the operating profit line?

Clarence Otis

Yes. This is -- I'm sorry.

C. Bradford Richmond

Well, Brian, let me start off and I'll turn it over to Clarence. But no, first off, when you look at the features that they did, the margins on there are really no dissimilar from what we have done regularly with our Endless Shrimp promotion, done in a very different way though as Drew detailed just earlier. But what we see when you look particularly at Red Lobster is shrimp was one of the products that we had the highest year-over-year inflation, and so that's what really entered into their operating profit return metrics, if you look at those. And so if you neutralize the elevated cost, we look back and then feel very good with how that performed and the margins that, that delivered for us.

Clarence Otis

And I was just going to add, I mean we talk about food cost inflation for the year 5%, 5.5%, obviously much higher than that on the front half of the year. And then much of that increase is concentrated, as Brad said, in the products that Red Lobster uses most. And so you've got that against pricing that, as Drew said, took place a little later in the quarter this year than it did in the quarter prior year. And so if you look at the press release, you'll see average pricing across those 3 months sits well below 2%. And all of those things sort of came together to drive that. But as we look at the fiscal year, a little bit different story.

Operator

The next question is from the line of Alvin Concepcion with Citi.

Alvin C. Concepcion - Citigroup Inc, Research Division

Just in regards to the core menu changes at Olive Garden, I know there's a tough balance between menu innovation and alienating some of your core customers, so wondering if you could provide more color on your strategy there. And secondly, what kind of sales lift have you been seeing or would you expect to see from remodels at Olive Garden?

Clarence Otis

Well, as it relates to the core menu, one of the great strengths of Olive Garden is the breadth of appeal it has for different occasions and different set of customers at a range of household incomes. And as we have stepped back and looked at industry trends over the last several years, structurally we have seen a decline in business coming from households with incomes below $60,000 for the industry in total. And that's been -- the impact of that has been a little more elevated at Olive Garden because it's got broader reach into that group to begin with. So as we think about the core menu, we want to maintain price point accessibility to that full range of households. And so we will be looking to strengthen that portion of our menu, but doing it in a way that introduces dishes that will be equally relevant for other consumers at other occasions. We don't think anything we would do for that target demographic would in any way be off-putting to other people. I forget the second part of the question. Remodels. Yes, ultimately, we want to see a sustained same-restaurant sales lift at Olive Garden that's similar to what we were seeing at Red Lobster, which is in the 3% range or so. 3% to 4%.

Operator

The next question comes from the line of Keith Siegner with Crédit Suisse.

Keith Siegner - Crédit Suisse AG, Research Division

I just have a follow-up question for Drew on the Red Lobster margins, and it's probably just me, but I'm just having a little bit of a hard time following. If we just talk Red Lobster restaurant-level margins year-over-year for the quarter, what were they doing this year versus last year? And how -- let's say they were up or down, how much of that came from, say, inflation and how much came from, say, just promotions as the stand-alone factor?

C. Bradford Richmond

Keith, I -- this is Brad. Your question -- as these margins on the promotional items, if you look at more normalized year-over-year cost, and the fact that you can see the tremendous traffic that they drove, if you look at overall margins or operating return margins, they are a lift to the earnings. So they're a better place to be. I think Drew talked some about more guests at slightly less price, slightly less margin as well, is actually a good place for Red Lobster to be. And as you can see throughout, really from October forward of last year, when we've gotten more to the price certainty in our messages there for the consumers, that they've been able to demonstrate pretty strong top line performance in the current quarter. As Clarence mentioned earlier, the more elevated cost inflation of the particular products that they use that did, in the quarter look – or show a little less progress. But when you net that all out, we're pleased with where they are.

Keith Siegner - Crédit Suisse AG, Research Division

So when that’s reported in the year over…

C. Bradford Richmond

So I would simplify it and say that it's -- more than 100% of it is commodity cost inflation. So a more normalized cost environment, we would see op profit increase with the success of these promotions.

Keith Siegner - Crédit Suisse AG, Research Division

So to Drew's comment earlier when he said total margin growth, total margin growth works for both percent and dollars on promotions alone?

Andrew H. Madsen

Yes.

Operator

The next question is from the line of Jason West with Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just wanted to understand a little bit more on why you guys raised the comp guidance for the year. I know Olive Garden, a little disappointing this quarter, but it doesn't sound like you really have the full turnaround effort in place there and you talked about some bigger picture issues you need to address there. So just want to understand your confidence on the acceleration in that brand and also maintaining, kind of a 3-level of comp without the promotion at Red Lobster, as you move through the year, particularly in this backdrop.

Clarence Otis

Yes. I would just -- this is Clarence. I'll lead it off, but it really reflects the momentum at the other businesses. I mean, Red Lobster at 11% almost same-restaurant sales increase, LongHorn roughly 5%. These are big businesses, and when they get momentum, they have momentum. And so Olive Garden, we're trying to turn that momentum a little bit, but we expect to see the momentum continue at the other businesses, and it's hard to stay where we were given where those are even as we see that growth moderate through the year at the other 2 brands.

Jason West - Deutsche Bank AG, Research Division

So it doesn't sound like though you've seen anything very recently that's turned around at Olive Garden?

Clarence Otis

Well, no, I think we're -- I think Brad said we weren't going to comment on what we see at any of the brands in the second quarter just because we got a very volatile environment. So whatever we see in September needs to be confirmed in October. And I think the phrase he used is, he has reason to be confident or -- and that's pretty much where we are.

Operator

The next question comes from the line...

C. Bradford Richmond

This is Brad. Jason, I was going to say real quickly, I mean, if you look even in the press release, if you look at the core -- within the quarter, you are seeing the progress that Drew alluded to some with the changes there at Olive Garden, and it's going to take a while to get everything done that we think we need to do for the brand. But I think you're starting to see some of the benefits of those efforts already.

Operator

The next question is from the line of Jonathan Komp with Robert W. Baird.

Jonathan R. Komp - Robert W. Baird & Co. Incorporated, Research Division

Just want to dig in a little bit more on consumer data you have for Olive Garden. And more specifically, I'm wondering given the negative comps that you've seen for several months at the brand, do you have any broader insights on where Olive Garden might be losing share to? And is there any chance during the quarter, given the geographic overlap that some of the strength in Red Lobster may have taken some guest occasions away from Olive Garden?

Clarence Otis

Yes, I don't think there's any question that the strength at Red Lobster and LongHorn where it's located in markets that have an Olive Garden, that both of those had an impact on Olive Garden. But more broadly speaking, what we see at Olive Garden today is a very strong foundation and an opportunity to build on that foundation with some more significant business building growth initiatives that really address the need to take market share over time versus growing with the industry and to regain momentum in a target demographic, that's got directionally somewhat lower income, $60,000 plus -- or below $60,000, certainly above average. But that's the demographic where Olive Garden has seen a little more softness just as the industry has seen a little more softness. And we think the dynamic there is purely one of affordability. There's nothing that's become off-putting about the brand. It's just across the category, that demographic is stretched. They need more affordability, and Olive Garden needs to build on their already strong everyday affordability to make it even more compelling.

Jonathan R. Komp - Robert W. Baird & Co. Incorporated, Research Division

Great, that's helpful. And then one more question on the full year comps outlook. I think you mentioned expectations for some improvement in Olive Garden comp trends for the rest of the year. Can you give any more color onto how much improvement you may need? And if Olive Garden gets back towards flatter or very slightly positive comps, is that good enough to hit the full year guidance?

C. Bradford Richmond

Jonathan, Brad here. No, I think the only thing that I would say from where we are right now is that trend, from where they've been, will continue to make modest improvement.

Operator

The next question is from the line of John Ivankoe with JPMorgan.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

A couple things. I mean, I guess as we -- maybe I guess you just consider that the consumer is, I guess still wants to come into your restaurant but wants to spend less money when they get there, and it's influencing some future menu development, what have you. Could you put that in the context of you kind of running pricing consistent with your long-term 2% to 3% average, whether that menu pricing that they see might actually cause more of a negative than a positive from a consumer perspective? And I guess, as we kind of think about rolling over increases as we go throughout fiscal '12, does it make sense to consider a hiatus on pricing, given what the current environment is?

Clarence Otis

Well, I'll start, John, and I would, I guess, I'd begin by differentiating between our pricing strategy and our menu strategy. And the way we think about it is we need to price for the net inflation we see in our business year-over-year over time. And we don't want to get ahead of that inflation and have our prices rise too much, but we don't want to get too far behind that net inflation either and have to catch up with a bigger increase in 2 or 3 years. So we try and minimize the amount of pricing we have to take by identifying and leveraging big cost savings that eliminate costs from the business that our guests don't see. But we do feel like we need to have pricing that's pretty much in line with net inflation over time. Separate from that, our core menu strategy is really all about making sure that we offer a range of items that suit different taste profiles, that suit different pocketbooks with different price points and are satisfactory for different occasions. And as we look at that menu strategy, I think what we see is we haven't been perhaps as aggressive as we could have been at strengthening price point accessibility from a menu strategy standpoint at the lower end at Olive Garden, which to us is separate from the pricing strategy that we need to pursue. Now having done that or having said that, we need to do that in a way that brings in incremental traffic so that we can grow total sales and total profits. So for instance, that's one of the reasons we're advertising Panini sandwiches at $6.95 to tell people there's something new and to drive incremental traffic and have them discover a more affordable option at Olive Garden at lunch, for instance. But we would -- I would separate those 2 things.

Andrew H. Madsen

The other thing I would add, John, is that as we look at the consumer, it's a very segmented set of consumers. And so for our industry, household incomes north of $100,000 are roughly 1/3 of sales, and you're seeing discretionary income growth there. And so a moratorium on price is across the board, we don't think is appropriate. It's more about being very targeted based upon where people are, so a range of options that address how each of those income segments define affordability.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And I guess the tricky part is, is when you do take pricing on kind of your core or your more expensive items is that you don't actually force maybe your middle of those 3 consumer buckets down on the menu. I mean, that's kind of the point when you don't want to have your value items be too inexpensive relative to your core and your premium. And I guess that's just all in the execution of how you implement that to pricing on the new menu.

Andrew H. Madsen

I would agree.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Okay. I know, as I listen to myself talk, sorry about that. So can I just -- just a quick follow-up and I may have missed it. I think in Brad's prepared remarks, he said that you expected a decline in operating expense margins, but you didn't get it. Could you -- and again, apologize if you said it. I mean, could you kind of clarify as to why that didn't happen?

C. Bradford Richmond

This -- in restaurant expenses, I think, is what you're talking about?

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Restaurant expenses, yes, sorry.

C. Bradford Richmond

Yes. When we looked there's no one particular item. We just felt we'd have a little bit more progress there than we did. Now had some upward pressure on credit card fees, more repairs, things that were done, but no one item really stuck out there. We just felt it would be a little bit better and have every reason to expect that some of that could even be timing and nature of some of those like repairs and some of those items.

Operator

The next question comes from the line of Brad Ludington with KeyBanc Capital Markets.

Brad Ludington - KeyBanc Capital Markets Inc., Research Division

Just got a quick one and one follow-up. On the first for whoever who wants to address this. A couple of quarters ago, I think in the second and third quarter last year, you talked about how employee turnover remained low and that was helping you on the cost side. I don't think we've seen much of that commentary over the last couple of quarters. Has that changed? And are you seeing more turnover these days?

C. Bradford Richmond

Brad, this is Brad here. And no, we're maintaining the low -- historically low turnover that we had. So that's helping increase turnover, I would hope -- decreasing talent acquisition cost. And we do maintain a lot of training, but more of that training now is going towards the incumbents and enhancing their skills. So we do see productivity gains there. Now we still had, I think it was 50 basis points of improvement in this quarter over the first quarter of last year, which was, I think, roughly 80. So on a 2-year basis, we're making pretty good progress and still making progress this year. And our guidance encompasses that there’ll be still some improvement over the prior year in quarters 2 through 4.

Brad Ludington - KeyBanc Capital Markets Inc., Research Division

And then I guess this one's more for Gene. You'd talked about the new kind of more -- I don't want to say value, but more value-oriented price points for lunch offerings at Seasons 52 and Capital Grille. Are you seeing the traffic in those higher-end restaurants looking more for a value price point as well right now?

Eugene I. Lee

Especially -- yes, Brad, especially at lunch. But our desire to go after lunch at Capital Grille has more to do with the fact that we have 3 separate types of lunch opportunities when we look at that business. We have central business districts, we have smaller central business districts and we have our -- what I would call our mall restaurants or our mall pads. And those restaurants were really the ones we were attacking. We saw a huge opportunity with capacity available at lunchtime, and we thought we needed to develop a lunch program that would drive traffic in those malls. Now it’s we've had such success with it, we're taking it into the smaller central business districts and we're -- just like we're doing in our large brands, we're able to create menus where we're able to maintain margins and offer great value to the consumer. I would also say that on the Capital Grille side, the time piece of it was very important. We've -- through some research, we found out it was just taking way too long to eat lunch in a Capital Grille. So now we offer the guests, with this lunch option, do you want a 45-minute experience, and we've gotten great feedback on that.

Operator

The next question is from the line of Larry Miller with RBC.

Larry Miller - RBC Capital Markets, LLC, Research Division

I just want to go back toward that 3% comp plan for a second. You said part of that plan is expecting modest improvement at Olive Garden, continued momentum at the Red Lobster and LongHorn businesses. And I was just curious, are there any contingencies or, and said another way, any leverage you can pull in place here if comps really aren't what you think they are? For example, you guys accelerated your share buyback in the first quarter. Is there anything else that you guys could do?

Clarence Otis

Well, I think, Larry, there's always things that we can respond with. I think when you look at our plans laid out in front of us, we have good confidence in them and we'll continue to manage to those. There'll be opportunities with some promotional opportunities if we would choose to do so. And we can always look at our costs, but the base plan that we have out there today, we feel pretty good about and we're really focused more towards executing on the base plan.

Operator

The next question is from the line of Mitch Speiser from Buckingham Research.

Mitchell J. Speiser - Buckingham Research Group, Inc.

My first question is on Red Lobster and on the 4-course for $15, can you give us a sense of what the incidence was on it and was it above your expectations?

Clarence Otis

Yes, the percent of guests ordering it was above the typical promotion and above our expectation. It was broadly appealing, and as we said, very successful driving the traffic, right.

Mitchell J. Speiser - Buckingham Research Group, Inc.

Got it. Okay. And if costs were flat, you're saying that the promotion in conjunction with the entire menu would have been margin accretive?

Clarence Otis

Yes, right. More guests paying less would have driven total sales, total margin improvement. The issue is really pricing relative to inflation.

Mitchell J. Speiser - Buckingham Research Group, Inc.

Okay. And on -- one question on Olive Garden. Can you give us a sense, first, how lunch comps were versus dinner comps in the quarter? More broadly, what percent of Olive Gardens and Red Lobsters are literally next to each other or in the same mall?

Andrew H. Madsen

So lunch for Olive Garden was a little bit better than dinner at Olive Garden and lunch remains a strength and a differentiator for Olive Garden, particularly the soup, salad and breadsticks, the new Panini sandwiches that were introduced. And then the question about Red Lobster and Olive Garden sharing parking, yes, there's 400, roughly, Red Lobsters and Olive Gardens that share a parking lot.

Operator

The next question comes from the line of Jeffrey Bernstein with Barclays Capital.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Just 2 questions. First, the fiscal '12 guidance now at the lower end of that 12% to 15%, obviously, we've talked a lot about assuming some sort of improvement at Olive Garden through the quarter. And it seems like you're feeling good about that. But if there was no Olive Garden uptick, just wondering kind of a deleverage that Olive Garden has relative to the other brands; I'm not sure you how to talk to that, but perhaps how much of a negative hit to EPS was there in the first quarter, because Olive Garden came in below plan? Or how you think about the flow-through of Olive Garden and the importance of that to hitting that 12% versus the other brands? And then I have a follow-up.

C. Bradford Richmond

Okay. Well, obviously, we'd love for Olive Garden to do better and had it done better, we would have had tremendous first quarter. But with the growth of our other brands and the addition of new units, we continue to expect even with the challenge that we had in the first quarter and how we’ve talked the second quarter is going to be that we're still going to be able to expand margins or operating profit returns just because of the growth in our other brands and, as I mentioned, the new units. Olive Garden is currently or is still our highest returning unit brand, but the difference between that and the -- with the success that we've had at Red Lobster and LongHorn Steakhouse and SRG, it's not a -- the mix change is not a tremendous impact. I think you have to step back and look at more at the absolute growth that the other brands are achieving and the fact that, that drives margin improvements and absolute dollar improvements over the course of the fiscal year.

Andrew H. Madsen

And so the way we think about it, Olive Garden has the highest returns, but the delta, the growth in returns at LongHorn are pretty strong.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Okay. And just as a follow-on to that. I mean, it seems like you said continue to expect margin expansion. I know last quarter, I think you had alluded to 30 basis points for the full fiscal year. Obviously, the first quarter came in below plan and it seems like food inflation basket is still in the same range, restaurant expense leverage actually fell a little short as well in the first quarter. I'm just wondering, the confidence in achieving that 30 basis points or so, is there any incremental cost saving opportunities in there? I think you said we need to take something along the lines of full advantage of the cost saving opportunities we have, whether there's upside to that $65 million to $75 million?

C. Bradford Richmond

Yes, Brad here. We still look at this year, it’s going to have margin expansion. Beginning of the year, I do believe we said it was going to be around 30 basis points. It’ll be something a little less than that, but it's still going to be expanding some. And I think when you -- you can't really look at the first quarter as indicative of the whole year because, one, on the food side, but we've discussed that pretty much detail. And when I -- we look back at our transformative cost savings initiatives, they're all pretty much on track. They do build a little bit through the course of the year. So we get a little bit more cost relief, if you will, as we approach the back half of the year. So with the tremendous growth that we're having, the addition -- and same-restaurant sales across all of our brands and the new unit growth, those all provide leverage to help us increase our returns and achieve pretty significant earnings growth.

Andrew H. Madsen

I think the only thing I'd add is if you look at Olive Garden and Red Lobster, you think about the 2% to 3% pricing that we're talking about for the year, you'll see more pricing in the second half of the year than you saw in the first quarter, where both of them were below that range. So that's a factor as well. And as Brad said, seeing that 30 basis points improvement be somewhat lower than that is what drives us toward the bottom of that 12% to 15% range.

Operator

And the final question is from the line of Phillip Juhan with P -- I'm sorry, BMO Capital Markets.

Phillip Juhan - BMO Capital Markets U.S.

I guess, given the economic backdrop, it's good to hear Brad saying that you guys are seeing reasons to be encouraged in September. And I guess in that context, are you still seeing the same degree of negative menu mix shift or check management, as you guys are calling it, in the month of September?

C. Bradford Richmond

Yes, I'd tell you it's pretty hard to look at those trends in the short-term nature, so I'd save that comment until we meet again in December.

Matthew Stroud

Thank you, everybody, for joining us on the call today. As always, if you have additional questions, please let us know here in Orlando. We look forward to hearing from you. Everybody, have a great day. Thank you.

Operator

Ladies and gentlemen, this conference will be available for playback beginning today at 10:30 a.m. Eastern running through Friday, October 28, at midnight Eastern Time. You may access the AT&T playback service by dialing 1 (800) 475-6701 and entering the access code of 216830. International participants please dial (320) 365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Darden Restaurants' CEO Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts