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Ruby Tuesday (NYSE:RT)

Q2 2012 Earnings Call

January 05, 2012 5:00 pm ET

Executives

Marguerite N. Duffy - Chief Financial Officer, Senior Vice President and Principal Accounting Officer

Kimberly M. Grant - Chief Operations Officer and Executive Vice President

Daniel P. Dillon - Senior Vice President of Brand Development

Samuel E. Beall - Co-Founder, Executive Chairman, Chief Executive Officer and President

Greg Ashley - Vice President of Finance

Analysts

Peter Saleh - Telsey Advisory Group LLC

Keith Siegner - Crédit Suisse AG, Research Division

Howard W. Penney - Hedgeye Risk Management LLC

John Dravenstott - KeyBanc Capital Markets Inc., Research Division

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Operator

Greetings and welcome to the Ruby Tuesday, Inc. Second Quarter Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Greg Ashley, the Vice President of Finance for Ruby Tuesday. Mr. Ashley, you may begin.

Greg Ashley

Thank you, Robin, and thanks to all of you for joining us this evening. With me today are Sandy Beall, Ruby Tuesday Chairman and CEO; Margie Duffy, Chief Financial Officer; Dan Dillon, Senior Vice President, Brand Development; and Kimberly Grant, Executive Vice President.

I would like to remind you that there are likely to be forward-looking statements in our comments, and I refer you to the notes regarding forward-looking information in our press release and most recently filed Form 10-Q. We plan to release third quarter fiscal '12 earnings in early April.

Our second quarter earnings were released today after the market closed. A copy of our press release can be found on the Investor Relations section of our website at rubytuesday.com and is also available on Business Wire, FirstCall and other financial media outlets.

As usual, our format today includes the following: an overview of our second quarter financial results, our fiscal 2012 outlook and a review of our plans and strategies. At the conclusion of our prepared remarks, we will respond to your questions.

I will now turn the call over to Sandy.

Samuel E. Beall

Thanks a lot, Greg. First of all, I really would like to welcome all of you all listening in this evening, and thank you for joining us. I know it's late in the day. I hope we'll give you some good information on our conference call. I'll begin with a brief overview of our quarter and an update of our key value creation initiatives. Margie and Greg will then provide a financial overview and guidance update, and then Dan and Kimberly will provide additional detail on our marketing and operation plans.

As you may have seen in our earlier press release, we reported diluted loss of $0.03 per share for the quarter. These results were slightly ahead of our guidance range of down $0.04 to down $0.08. Our continued focus on cost savings enabled us to mitigate. We do control cost well to mitigate the operating loss in the second quarter. As you know, second quarter has generally been -- has always been, our lowest revenue quarter relative to the rest of the year.

Our same-restaurant sales results for the quarter at down 4.2% were below expectations. If there's any positive to it, they were flat on a 2-year basis, so that's an improving trend versus the first quarter. We went up against very, very strong sales of 4.2% last year, which probably our best quarter I think ever in the history of the company last year.

During the quarter, we had several positive accomplishments, which I'll summarize then we'll have a little more detail on these later in the call. First of all, we continue to make progress on several media tests promoting our value-oriented test offerings such as our free Garden Bar with over 40 entrées. We opened 3 Marlin & Ray conversion restaurants, 1 of which was opened subsequent to the quarter end. We opened our first Lime Fresh in-line restaurant, and we completed our first sale leaseback transaction subsequent to the quarter end, so some positive momentum there.

As we look out over the next several quarters and years, we continue to remain focused on really 5 key initiatives, which we believe can create good value for us and our shareholders. First of all, we continue to strengthen our upgraded and focused brand position and are leveraging our Garden Bar free with every entrée, which is a unique differentiator for us among our peer groups as part of our history, strong part of Ruby Tuesday. We think it plays well with the consumer.

As we and other industry peers have noted, the promotional environment continues to be very aggressive with heavy advertising levels within the casual dining and bar grill segment. The promotional programs we've historically utilized, coupons, don't compete as well versus the high-value heavy TV advertisements in this type of environment. So we're changing. We're testing some, and so far it's looking pretty good.

We're testing various value-oriented offerings such as our free Garden Bar promotion in several of our markets, many of which supported by TV. We're also reducing our coupon expense going forward to help fund these efforts. We believe our fresh Garden Bar is a huge point of depreciation as I said a second ago. It can't be duplicated really or not very easily, and the value that we bring to the consumer through this offering, free Garden Bar, along with our free fresh-baked bread, et cetera, is pretty powerful and we plan on increasing our TV locations from approximately 20% today to 50% of the system in the fourth quarter. So we're excited about that.

Second, we continue to focus on taking cost out of our business and we're doing an excellent job in this area, so that we can invest in television and pay for a salad bar. We need to drive awareness and trial, which has helped close -- to help close the gap of the brand versus actual experience in our test markets. People come in like Ruby Tuesday, people haven't come in, think of us as the old Ruby Tuesday and we've got to change that. We've got a plan, we're working on it, we'll do it.

We identified at least $15 million to $20 million, hopefully more, through our cost savings initiatives to fund additional marketing dollars. And again, key there we hope to get more. Whatever we get, we plan on putting into advertising for fourth quarter and next year. While only a small portion of these savings will be recognized this year, it should position us very well, provide additional support as we execute our marketing strategy for fiscal '13.

Third, we are encouraged by the early results from our conversion opportunities as Marlin & Ray's is showing good potential as a stand-alone concept in addition to creating a halo effect at nearby Ruby Tuesdays where we've seen some decent sales increases, which all adds to the bottom line. We now have 6 Marlin & Ray's locations open, including the 3 new locations mentioned in our press release. Last quarter, we talked about our belief that Marlin & Ray's has good growth potential, and we continue to believe it is the most viable conversion vehicle for us going forward.

While it's still early, we're pleased with the sales results of our more recent openings. All of our locations are open for dinner only. We have one small lunch menu in test, but we'll probably stay focused on dinner. We're putting additional marketing efforts behind this brand and more effort also. Our conversion strategy with brands such as Marlin & Ray's provide good opportunity to enhance our EBITDA and create good value for the shareholders. We anticipate 3 more locations this year and 12 additional locations next year.

Fourth, we continue to believe that the fast casual segment represents attractive growth potential, which is why we're excited about the Lime Fresh Mexican Grill concept. Our first location opened mid-quarter in Huntsville, Alabama. Our second location is scheduled to open in a couple of weeks in Northern Virginia, D.C. As we ramp up, we plan to open 1 more location about every 3 or 4 weeks over the remainder of the fiscal year, primarily in Washington and Atlanta markets, ending the fiscal year '12 with 7 locations.

We've been very, very busy identifying and securing attractive in-line lease locations, and we look forward to another 15 locations next fiscal year for the Lime concept. We like the potential growth opportunity that Lime affords us as a strong brand. It fits well with our focus on fresh food, great service. We think investing in growth within the high-quality, fast casual segment is the right thing to do. We look forward to growing Lime.

Last, we believe we have a significant opportunity to strengthen our balance sheet with up to $150 million of sale leaseback proceeds in the future in order to invest in growth, opportunistic share repurchase and lower our debt levels. We remain focused on maximizing our strong free cash flow in an effort to create additional cash and financial flexibility. We're pleased with the progress we're making in monetizing some of this real estate through sale leaseback transactions with the brokerage firm that we have.

As noted in our last call, we are targeting to raise $50 million in gross proceeds in our initial sale leaseback wave. If the market demand remains high and the pricing economics are attractive as they have been thus far, we may seek to raise additional $100 million of gross proceeds.

I'll now turn the call over to Margie to discuss our financial performance.

Marguerite N. Duffy

Thank you, Sandy, and good evening, everyone. I'll review the quarter in detail, provide a high-level summary of our quarter-end balance sheet and sale leaseback progress and then Greg will give our updated guidance for fiscal 2012.

We posted better-than-guided earnings for the quarter, primarily driven by continued focus on tight cost controls and cost savings, which offset the leverage we lost on the lower same-restaurant sales during the quarter. We reported fiscal second quarter diluted loss per share of $0.03 compared to diluted earnings per share of $0.07 last year.

Total revenue increased 5.9% during the quarter, primarily due to the franchise partnership acquisitions during the previous fiscal year offset by the 4.2% decline in same-restaurant sales. We opened 2 Marlin & Ray's during the quarter and opened 1 more subsequent to our quarter end. We opened our first Lime Fresh in-line restaurant and opened a newly constructed Truffles Grill. Additionally, we permanently closed 1 restaurant and temporarily closed 3 restaurants in anticipation of conversion to Marlin & Ray.

Franchise revenue decreased 16.4%, primarily due to the elimination of royalties from our franchise partnership restaurants, which were acquired in fiscal 2011 in addition to same-restaurant sales for domestic franchise restaurants increasing by 6%. The restaurant level operating margin was 13.5% for the quarter compared to 15.1% a year earlier or a decline of 160 basis points due to our brand-enhancing investments from the previous year, which were not offset by increased sales levels.

Cost of goods sold was 29.9% of restaurant sales for the quarter versus 29.3% in the prior year. This increase was driven by our value-focused promotional activity such as offering our Endless Garden Bar with the purchase of an entrée at approximately 220 restaurants during the quarter. The increase is also attributable to our investment in items designed to enhance our guest experience and drive sales, like our complementary bread program, which rolled out at the end of the first quarter of fiscal 2011.

Labor costs as a percent of restaurant sales increased to 35.2% up from 34.5% from the prior year, primarily due to lower same-restaurant sales coupled with minimum wage increases in several states. Other restaurant operating costs were up 20 basis points, largely due to lower same-restaurant sales during the quarter. SG&A expenses were 7.6% of sales for the quarter versus 7.3% in the prior year due to higher television advertising cost in the quarter and the higher consulting fees related to our cost control projects, coupled with the loss of support service fee income from our acquired franchise partnership, which historically offsets selling, general and administrative expenses.

Interest expense in the quarter increased to $4 million from $2.6 million, primarily due to the higher cost third-party debt, which was assumed as part of the franchise acquisition. Our tax rate increased compared to last year largely due to an increase in unrecognized tax benefit and a decrease in the FICA Tip and Work Opportunity Tax Credits recognized during the quarter.

Turning to the balance sheet. Our book debt, including current maturities, was $342 million up from $291 million a year earlier due to the assumption of debt in fiscal 2011 from the franchise partnership acquisitions and first quarter fiscal 2012 stock repurchases.

Also during the second quarter, we began executing on our sale leaseback strategy to raise $50 million in gross proceeds through the sale of approximately 25 locations. We have engaged a leading retail advisory and brokerage firm to market our real estate and have received a lot of interest from a number of potential buyers. Subsequent to our quarter end, we completed a sale leaseback transaction on 1 property resulting in $2.3 million in gross proceeds.

We are currently in conversation with potential buyers of another 17 to 19 restaurants, some of which may close during the third quarter and we're continuing to target cap rates in the 7% range. Proceeds raised from sale leaseback transactions in tandem with our excess free cash flow will be used primarily to opportunistic share repurchases and debt reductions.

And lastly, a comment about goodwill. Since August, our stock price has been below our book value per share. Our accounting policy requires that we perform our test for goodwill impairment annually at the end of the third quarter or more often when needed. Although we have concluded that no impairment exists as of the end of our second quarter and believe the low-stock price is temporary, we will continue to evaluate market conditions going forward.

I will now turn the call over to Greg to go over our guidance for the year.

Greg Ashley

Thanks, Margie. Our following guidance for the year is inclusive of the 53rd week impact. However, our guidance does not include any amounts for the potential write-off of goodwill should we conclude later in the year that impairment is necessary since such impairment is currently unknown and it would be a noncash charge in the event of occurrence. Now onto our guidance.

We estimate same-restaurant sales for company-owned restaurants to be in the range of down 2% to down 4% for the year. For the year, we expect to convert 8 to 10 lower performing company-owned restaurants to and other high-quality casual dining concepts, close 5 to 7 company-owned restaurants excluding the conversions, open 1 new Truffles Grill and open 6 to 8 Lime Fresh Mexican restaurants. For the year, our franchisees expect to open 7 to 9 restaurants, up to 6 of which will be international and close 15 to 17 restaurants, up to 14 of which will be international.

Nine of the international closures are related to the cancellation of our franchise agreement in India where we are currently seeking a new partner. We expect restaurant operating margins to decline slightly with the negative impact of lower same-restaurant sales offset by fixed cost leverage from the 53rd week in addition to our cost savings initiatives. Virtually all of our proteins and seafood are contracted through the end of fiscal '12, and our commodity exposure is minimal. Depreciation is estimated to be $66 million to $68 million.

Our SG&A is targeted to be up approximately 16% to 19% from the year-earlier, primarily due to incremental advertising expense, as Sandy alluded to, and the loss of fee income from acquired franchise partnerships, which historically offsets selling, general and administrative expenses. Our interest expense is estimated to be in the $16 million to $18 million range.

The effective tax rate is estimated to be 7% to 10% as we continue to benefit from FICA Tip and other employment-related tax credits. Diluted earnings per share for the quarter are estimated -- or for the year, excuse me, are estimated to be in the $0.55 to $0.65 range, with our third quarter estimated to be $0.12 to $0.16 per share, primarily due to year-over-year increases in advertising and interest expense. We are still anticipating solid profitability in our fourth quarter, historically our highest revenue quarter of the year, due to an improvement in restaurant level margins from our cost savings programs, benefits from an extra week in the quarter and additional EPS leverage from our share repurchase program.

Our fully diluted weighted average shares outstanding are estimated to be approximately $62 million to $63 million for the year. Our capital expenditures are expected to be $33 million to $37 million, and we reiterate that we will generate $90 million to $100 million of free cash flow during the year.

I will now turn the call over to Dan to go -- to give an update on our sales and brand building programs.

Daniel P. Dillon

Thank you, Greg. During the second quarter, we continued testing our value-oriented offerings through television in 11 spot markets, which resulted in positive impacts on both traffic and sales. Our ads featuring our Endless Fresh Garden Bar and fresh-baked garlic cheese biscuits, complementary with over 40 entrées at a starting price of $8.99, were tested in approximately 220 restaurants, roughly 30% of our company-owned restaurants with approximately 140 of those supported by television advertising. We also ran ads featuring our soup, bread and bowl of fresh salads for lunch starting at $5.99.

We think both of these offerings could potentially be real game changers for our brand as they leverage a huge point of difference that we have in our fresh Garden Bar and complementary bread. Both the free Garden Bar with entrée promotion and the lunch value menus give us some confidence that's slowly migrating from our marketing dollars from our couponing and promotional strategy to a more media-focused marketing effort, combined with incremental television spending funded by our cost savings initiatives represents an opportunity for us to stabilize our guest traffic and grow same-restaurant sales in the future.

During the quarter, we made significant progress in our new product development by identifying a number of new innovative menu items. We currently have approximately 7 new menu items approved based on consumer taste test. We continue to focus on keeping our menu up-to-date and contemporary to our consumer-focused product development process.

We continue to experience growth in our social media platforms. Our So Connected email club now has approximately 2.5 million members, and we currently have approximately 750,000 fans on Facebook. Growth in these subscriber bases provides a great incentive distribution platform for us as it is a low-cost option with better-than-average redemption rates in relation to our other incentive distribution programs.

On the marketing analytics front, we completed an analysis of our TV placements during the quarter, which measures the impact of advertising investment supporting our test in various markets and the potential return on investments from multiple weight levels in these test markets. So since we are testing various combinations of offers at various weight levels, this research is critical for us to evaluate the effectiveness of our TV placements and to identify the key factors that are affecting our sales results prior to rolling out the value promotion to additional restaurants over the next several quarters.

We also continue to gain additional insights into the incremental impact in return on our coupon spend, which will help our future strategies for our overall marketing budget going forward. Now Kimberly will provide you with more information on our operational initiatives, teams and guest satisfaction.

Kimberly M. Grant

Thank you, Dan. From an operation standpoint, we remain focused on consistently operating at a high-quality, casual dining level, building and retaining best-in-class teams and constantly looking for and acting upon opportunities to maximize sales and lower our cost of doing business.

Over the last 2 years, our operations team has worked diligently on significantly enhancing the overall guest experience through our initiative of $25 dinner experience for $15. From 2009 to 2011, our external brand tracker research shows that the guest experience at Ruby Tuesday now exceeds that of our other competitors in the bar and grill category and is within reach of the casual dining competitive set. Our operating plans for the balance of this fiscal year and fiscal 2013 are aimed at closing this final gap and consistently executing at high-quality casual dining levels.

We believe the foundation of consistently operating at a high-quality casual dining level starts with the quality of our team. During the second quarter, we hired almost 3 out of every 4 managers externally with a continued focus on hiring talent from high-quality casual dining competitors. We have also improved our staffing levels overall by successfully reducing the number of open management positions to only 10 across all of our company-owned locations, our lowest level of open positions ever.

Now our efforts to aggressively hire high-caliber external talent while at the same time maintaining low levels of turnover is important as this allows us to operate much more consistently and greatly reduces our risk in conversions in new growth as we are able to use 80% of our own talent. And with regard to our hourly team, we are once again on track to achieve approximately 100% team turnover for the year. However, we are aggressively testing and developing programs focused on achieving our aspirational goal of reducing our team turnover to less than 80%.

As we mentioned on our previous earnings call, we are investing in a number of new benefit and process enhancements that we believe can dramatically increase our short-term retention rate, which in turn will positively impact the guest experience over time. As Dan mentioned earlier, we have been engaged in numerous sales driving marketing tests across the country. In order to ensure we maximize our returns on these current and future investments, we have been testing and beginning to implement new service enhancements to the guest experience.

Toward the end of the second quarter, we rolled out a new surprise and delight service initiative in approximately 10% of our company-owned restaurants and are already seeing improvements in our guest experience scores. We plan to roll this program systemwide during the third quarter. Now without giving away a lot of the details, we've upgraded our uniforms to a more polished casual look. We have added a number of service enhancements such as fresh grated parmesan cheese on pastas and shaking Martinis tableside, just to name a few of the enhancements. We believe this new service initiative will further improve our record high internal and external guest satisfaction scores, where nearly 93% of our guests rate their experience a 4 or a 5 on a 1-to-5 scale and 73% of our guests rate their experience a 5.

In closing, our marketing and operating teams are determined to improve our same-restaurant sales and performance. We believe the combination of effective, traffic-driving, media-focused marketing efforts and restaurant teams that consistently deliver a high-quality guest experience is the key to achieving improved restaurant same-restaurant sales in this incredibly competitive environment.

I'll now turn things back over to Sandy for a quick wrap up.

Samuel E. Beall

Thanks a lot, Kimberly. We're excited about our brand and operational enhancements as well as our marketing strategies, all of which we believe will have a positive impact on traffic and sales. We believe that we can rebuild sales going forward but do expect it to take a few quarters to see the results we expect as we continue to ramp up our media coverage, reduce coupons and roll out our Garden Bar promotion program to more restaurants.

As we look into the back of fiscal '12, we remain focused on our key initiatives to create value. First one, again, leveraging our upgraded brand position in tandem with our free Garden Bar offering in order to provide more value to our guests and drive top line growth. Number two, continuing to take cost out of the business and reinvesting the majority of those savings into television marketing programs. Number three, continuing to invest in our leading conversion brand option, Marlin & Ray's, with another 12 locations next fiscal year.

Next, opening additional Lime restaurants and creating a development pipeline for up to 15 additional openings next fiscal year. And last, closing on additional sale-leaseback transactions and utilizing this extra cash to reduce our debt levels, fund our growth and opportunistically buying back stock.

We feel good about our plans. Our board supports our plans, and majority of the shareholders that we've met with over the last several quarters believe our plans are focused on the right initiatives to create value. We realize it's up to us to successfully execute on these plans in order to create value for all of our shareholders, and we're working hard at it and we're up for the challenge.

With that I'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Joe Buckley with Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

A couple of questions on the -- something you didn't talk about, but gift card sales.

Samuel E. Beall

Sure.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Do you hear me okay?

Kimberly M. Grant

Yes, Joe. This is Kimberly. Our gift card sales were up about 17% for the holiday season.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. And Kimberly, give us an idea, were you in more third-party retail outlets this year than last year or...

Kimberly M. Grant

We did add some additional third-party outlets, but we had equal improvement in restaurant as we did on line and in third-party.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. And then the $15 million to $20 million of cost savings, what part of the business do you anticipate that coming from?

Samuel E. Beall

Well, the 2 largest areas will be R&M, repair and maintenance, which a lot of the QSR chains and some of the other casual dining chains have gone to just a centralized system for that. That's a large area, procurement, purchasing. Alix is probably one of the best in the business in that area. They've helped us a great deal, AlixPartners. But those will be the 2 largest areas really.

Operator

Our next question comes from the line of Chris O'Cull with SunTrust Bank.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Just as a follow-up to that question, Sandy, can you expand on repair and maintenance? Exactly are you talking about centralizing what services?

Samuel E. Beall

Kimberly, why don't you talk about that?

Kimberly M. Grant

Sure. This is the ongoing repair and maintenance within the restaurants. It's approximately $40 million spend a year annually, and we believe that through using a consolidated group that we can better monitor our rates and our costs on the actual parts and what have you.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

But the timing of repair and maintenance isn't going to change or...

Kimberly M. Grant

No, no, no. It's 100% just better pricing on parts, better control of labor hours, better control of extra cost that different firms all over the country charge. Today, we manage it 900 different ways, and we'll be managing it one way.

Samuel E. Beall

It's basically bulk buying power for the services we're participating with. It's like a huge co-op, so better pricing.

Kimberly M. Grant

Exactly.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Okay. Thanks for the clarification. And then is that going to start showing up you said in the fourth quarter or fiscal '13?

Kimberly M. Grant

In fourth quarter you'll see small impact of a pilot, but mostly in the fiscal '13.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

And why were controllable expenses still low during this quarter? It looks like other operating expense is quite -- was pretty low this quarter.

Marguerite N. Duffy

In terms of absolute dollars?

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Yes.

Marguerite N. Duffy

As a percent of sales, I think it's historically comparable in terms of absolute dollars. We did have better, for instance, general liability experience this year versus last year. So some things like that helped.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then just one last one. Margie or Greg, what are the credit agreement restrictions for selling assets? And are the sale leaseback transactions intended to be tax efficient? Should we see the gross net be pretty close?

Marguerite N. Duffy

Our bank covenants allow for a $150 million sale leaseback transaction. We currently have some tax credit carryover that we're able to utilize to offset the taxable gains that we will see with these transactions. So it does help mitigate that so that we do get pretty close to the proceeds.

Christopher T. O'Cull - SunTrust Robinson Humphrey, Inc., Research Division

Is there a requirement to use the selling proceed -- a certain amount of the proceeds to pay down funded debt?

Marguerite N. Duffy

No.

Operator

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

John Dravenstott - KeyBanc Capital Markets Inc., Research Division

I had 2 -- sorry, this is John Dravenstott on for Brad. I had 2 questions, I guess, just on timing. Did you offer a time frame on when we should expect to see that $15 million to $20 million in cost savings first of all? And then secondly, on the -- I guess the messaging shift in the marketing. I think you initially -- this is a quarter ago I think, you initially suggested that we could have these ready by spring. Is that still the case? I know you said the next couple of quarters.

Samuel E. Beall

I think we're just saying, the messaging shift to TV, we should be at 50% of our system on television starting with fourth quarter. I think that answers your question, right?

John Dravenstott - KeyBanc Capital Markets Inc., Research Division

So 50% by the start of the quarter?

Samuel E. Beall

Yes. And then your other question was on the savings and we get some savings, actually in third quarter, we're paying for the consultants without getting the savings really. So we bear the bulk of that. In fourth quarter we do have some net gain $2 million to $5 million, somewhere in that range, and then we get the bulk of it really next year. It will all be in place then.

John Dravenstott - KeyBanc Capital Markets Inc., Research Division

Okay. And then when do you think you'll settle on the kind of nationwide promos as far as the -- whether it's the $8.99 or the $5.99 or the...

Samuel E. Beall

I think we've already settled on it. I mean, our tests -- we've done extensive tests over the last 6 months. We're continuing that into this quarter, and we think we know what we're doing, rolling out this for fourth quarter.

Operator

Our next question comes from the line of Howard Penney with Hedgeye Risk Management.

Howard W. Penney - Hedgeye Risk Management LLC

For fiscal '13, do you have any idea what your capital spending might look like?

Samuel E. Beall

What our capital needs?

Howard W. Penney - Hedgeye Risk Management LLC

Yes.

Samuel E. Beall

Budget what, Margie. $40 million?

Marguerite N. Duffy

Yes, about $40 million, $40 million to $45 million.

Samuel E. Beall

$40 million, give or take, yes.

Howard W. Penney - Hedgeye Risk Management LLC

So you're -- and I would assume you're probably going to still generate the same level of cash flow, so you're generating probably 2x your capital needs next fiscal year. So can you maybe explain why you need to do the sale leaseback program and why you need to generate the cash today when your cash flow or your free cash flow is in excess of what you need to spend on your capital needs? And then also, just a little confusing, I thought you said it strengthens your balance sheet. So if you're selling an asset and taking on a lease, how does the strengthens...

Samuel E. Beall

Well, I think it's strengthening your balance sheet. It gives you much more financial flexibility because you presumably could have less covenant-related debt versus long-term lease debt. I think the advantage of it, Howard, at least for consideration up to the $150 million is, one, it's allowed under our revolver. Number two, it is pretty inexpensive long-term 15-plus year debt, which is kind of unique as compared to the last 10 years. Number three, we would like to -- we think we have a platform for growth. We think we have some solid core competencies in our company for ability to operate from being able to leverage purchasing technology things that we're very, very good at. We're trying to build more of a marketing skill, and we would like to invest more in growth over time and we want to have a balance sheet that allows for that. I guess as a fallback, we also would like to have a balance sheet that allows for more repurchase if we -- if it deemed to be just a great value. So it's kind of -- it's one of the things we may not do though $150 million, but we can see where it could be in hindsight a great -- a smart thing to do as we look down the road. And we will -- I think the first thing is let's get the first $50 million done and then let's start working on the next $50 million.

Howard W. Penney - Hedgeye Risk Management LLC

So just going back to kind of Chris's question, I mean, the intention use of this cash is to pay down debt?

Samuel E. Beall

To pay down, I think no. It's repurchase, its debt and it's more aggressive growth than what we have planned. Understand your question, you've got excess capital. You don't really need it for growth because you could use it for other, so that would say to pay down some debt temporarily anyway and to repurchase shares, unless another [ph] acquisition which isn't on top of mind but at least you'd have a strong balance sheet that gives you more flexibility.

Operator

Our next question comes from line of Bryan Elliott with Raymond James.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Just a couple of questions, a little nitpick first. Did I hear correctly, Margie, I think going through the quarter that the employment-related tax credits were below your expectations originally?

Marguerite N. Duffy

So Work Opportunity Tax Credit and FICA Tip Credit, right, are below.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

And is that because of profitability or is there something going on with the expiration or anything like that? Is there something fundamentally changed with that, or was it just based on the pretax profit coming in?

Marguerite N. Duffy

It's based on the pretax profit and the low second quarter.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Okay. Did everything that you have been able to utilize get renewed or continues in place for 2012 here with all the political nonsense going on these days?

Marguerite N. Duffy

No. Work Opportunity Tax Credit has been suspended starting with January. We do hope it will be renewed. But at this point, because it's not renewed, we do not project that, do not have that on projections. [indiscernible] come back into play and timely so that we can actually get the credits. That will be an enhancement.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

All right. Okay. That's helpful. And bigger picture question. The surprise and delight service enhancements that you all talked about, clarifying, I heard that was in 10% of the units now, is that right?

Kimberly M. Grant

Correct. We went into test in November in about 60 locations, and we're rolling out -- in the process of rolling out the rest of the system in January and February.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Okay. And any help you can give us in thinking about the -- you told us a bit though, I think, about the Guest Satisfaction Scores. But I mean, did it actually seem to increase maybe time between -- decreased time between visits or do anything on...

Samuel E. Beall

We don't know that yet.

Kimberly M. Grant

We don't know that yet, but the best indication we can have of Guest Satisfaction beyond the survey is how they're tipping the servers in the restaurant, and the tip percent is up in excess of what the concept is up. So that's a good indication the guests are happier in the restaurant, and that will always work out to be better for sales.

Operator

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

Keith Siegner - Crédit Suisse AG, Research Division

So I have 2 questions, and the one I want to start with really relates to like -- you've been pretty open about talking how -- you're very focused on maintaining or kind of managing the company to some extent at least to free cash flow. In other words, you're not going to just chase sales for the sake of traffic or sake of comp if it doesn't really generate -- or if that means lower profits right? So when you think about the incremental advertising spends and you have tested some, but as you roll this out across the system, like what type of lift do you need in your plans to justify sustaining that higher spend? In other words, like if there is still some focus on free cash flow, like where is the threshold for lift or benefit that you need before you might turn off some of that spend?

Samuel E. Beall

That's not an easy question to answer because at same time you're doing it -- and then Dan, while I'm talking, see if there's something you want to add, but same time you're doing it you're also pulling back on coupons. So you're looking at net effect of it. But I think if we can get from the TV, that 5% to 10% lift...

Daniel P. Dillon

Yes. I mean, Sandy's right. It's really a movement of spending out of coupons into advertising, and coupons are a one-time visit and advertising has a repeat effect that we're hoping to see. So I don't know this as easy a question answer as you might have hoped it would be but...

Keith Siegner - Crédit Suisse AG, Research Division

Okay. Then what I'll do is I'll tie it into guidance, right? So if you look at your guidance, how it was and how it's changed, the top line comp comes down a little bit, margin's actually unchanged. SG&A goes up funded by cost cuts. But if we look like, the deltas in the guidance, there is more marketing spend was the biggest piece of the change and that actually means just looking at that little lower free cash flow from like the 4 walls. So kind of the flip side to this end was, what's the sensitivity to the $90 million to $100 million in free cash flow now? Like, how confident are you still in that number? Where is the push and takes on the $90 million to $100 million now?

Samuel E. Beall

Well, I think -- I'm not sure we can answer that right now. I think the advertising expense is up, so that's going to have -- that could happen next year. For this year, we've given the guidance on the free cash flow. For next year, depending on what your sales, you could have a moderate impact to your free cash flow based on expense being up, marketing expense being up. It just depends on the sales results we get from it. But you could have a small impact there, you could. But we think that investing in dollars that help change brand perceptions and change the impression of the brand is a much better long-term investment for 6 and 9 and 12 months later than it is spending that same dollar on coupons. Coupons are good for short-term, but they're not going to help build the business long term. So what you're saying is right, there could be some exposure there, but all depends on the sales results we get versus expectation. Does that help any?

Keith Siegner - Crédit Suisse AG, Research Division

No, it does. Thank you.

Samuel E. Beall

It just says I don't disagree with you, but our goal would be keep that to a minimum because we are very free cash flow-driven.

Daniel P. Dillon

And key there [ph] to keep in mind is we didn't pair back our CapEx guidance for the year, so that should go a long ways towards where we think the free cash flow number should come in for the year.

Operator

Our next question comes from line of Peter Saleh with Telsey Advisory Group.

Peter Saleh - Telsey Advisory Group LLC

Just wondering if you could remind us how much weather had impacted your results in the second quarter last year and in the third quarter of last year. I know that we had some pretty nasty weather on the East Coast here.

Kimberly M. Grant

I don't remember an event in the second quarter. In the third quarter, I believe -- we'll have to go back and check, but didn't we say it was like 1.3%, 1.4%. Because you had weather in the 2 years ago as well, so last year's net effect was about 1.5% if I remember right.

Peter Saleh - Telsey Advisory Group LLC

Great. And then anything on the regional variances that you're seeing? Are there any pockets of strength versus any places that are actually significantly lower than what your average is coming in at?

Kimberly M. Grant

Sure. During the second quarter, New Jersey and the Pennsylvania-New Jersey area was particularly strong. Florida held up rather well. The Washington, D.C. market, Baltimore market and parts of the South Atlantic were the weakest.

Operator

Our next question comes from line of Robert Derrington with Morgan Keegan.

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

Sandy, I'm trying to understand directionally, there's a lot of things that are kind of in the hopper here in the stew, which will affect your sales. Your guidance -- your same-store sales guidance of down 2% to 4%. Simplistically, sales were down roughly 4% in the first half of the year. If we assume that they're flat in the second half of the year, that essentially gets to the minus 2%, which is the, I guess, the less negative comp within your guidance. Yet your sales comparisons are materially easier in the second half. So I'm trying to understand given that you have a surprise and delight program, you have more TV spend in the plan, you've got a lot of things that seem to be positive sales drivers but why is it that...

Samuel E. Beall

Because one, having surprise and delight is not going to get your guest any faster until you start communicating it and get a new guest in I think. But we're pulling back on coupons at the same time we're spending more on television. And I mean I don't know what sales are going to be, but I think that's the prudent way to look at it.

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

Was there a material amount of couponing that was done in this past quarter?

Samuel E. Beall

In the past quarter, in the second quarter?

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

Yes, in the second quarter.

Daniel P. Dillon

Well, material as compared to the prior year? It wasn't material compared to the prior year. In third quarter, we're couponing less. In the fourth quarter, we're couponing significantly less. That's what we anticipate. I mean we review that darn near every week. But we just think as we go through this change, it could be something act [ph] as the balance between pulling back on coupons, which has an immediate effect on sales and adding advertising, which lag -- has a lagging effect and being able to call that right now is the difficult part. But that's the approach that we're taking is trying to balance the reduction in the short-term effect of coupon withdrawal while we add in advertising that we know has a positive effect in traffic over the long term.

Samuel E. Beall

And I think also what you've seen in the last couple of months during the Darden release, et cetera, is that restaurant sales aren't necessarily better. They're a little bit worse. I mean, I guess our outlook for the back half is probably a little more conservative than it would have been in October -- September, October.

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

Can you give us any color, Sandy, on how the 200 plus stores, which have the free Garden Bar, how they've performed relative to the reported results?

Samuel E. Beall

I think what you have to keep in mind is within those 200 Dan talked about, you've got many different tests.

Daniel P. Dillon

Yes. So we've got a variety of different sales within the 220 restaurants around that free Garden Bar promotion, 140 of them have television. And even within the 140, we have various weight levels that we're trying to optimize. But generally speaking, we're seeing in the high single digits in terms of sales and traffic increases where we're putting the advertising efforts in place.

Robert M. Derrington - Morgan Keegan & Company, Inc., Research Division

So directionally, you combine all those things together and potentially maybe things won't be as bad as down 2% to 4%.

Samuel E. Beall

Well, it may not be. But it could be worse I guess, but I hope better. But it's hard -- of the stores that we have on the weight levels and the message that we think we're rolling out with, if we can reproduce that, it could be better. Our new creative that Dan just viewed today with the new agency he says the most impressive ad he's ever seen, period. And so maybe it could be. But I think the main point here is that we have been underperforming on sales. Disappointing, yes. This back half, it's an easier overlap, yes. Doesn't always add up to results. We're trying not to be overly optimist, but even with that, we can make -- we believe we can make the numbers we're talking about which won't be terrible -- it's not good, but won't be terrible based on the amount of investments we're making and the changes we're making to better position the brand and to be -- add more effective advertising and some growth vehicles. So we will see.

Operator

Our next question is a follow-up question from the line of Joe Buckley with Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Just a follow-up on the high single-digit comment...

Samuel E. Beall

On the what?

Joseph T. Buckley - BofA Merrill Lynch, Research Division

On the high single-digit sales increase comment for the stores or TV support. So would that have been in place for the whole quarter?

Samuel E. Beall

No, no, no. That's just a couple of test sales but it's what we're trying to replicate, Joe. And so that's based on the weight levels that we want to do.

Daniel P. Dillon

It's a very small percent of the marketplace.

Samuel E. Beall

But that is what we hope to replicate. That's why we're still testing. I mean, we're -- but we think we have the right package. That's what we're rolling out within fourth quarter.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. And then just a question on the free cash flow guidance, the $90 million to $100 million. Your EPS guidance is lower. Depreciation and amortization is basically the same. CapEx is basically the same.

Samuel E. Beall

We don't have much tax at all this year, Joe.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay. So is tax the difference?

Samuel E. Beall

It's really tax. Did I get that right, Margie?

Marguerite N. Duffy

Yes.

Samuel E. Beall

Okay. So it's a one-year windfall in other words. So if you pull that out, next year on an apples to apples it will be a little bit less without that unless you improved.

Operator

Our last question is a follow-up question from Bryan Elliott with Raymond James.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

I just would like to hear some of your thoughts I guess, Sandy, really this is directed to. So just thinking back 2 years ago, you were a pretty significant TV player.

Samuel E. Beall

Us? Ruby's? Never significant TV player, no. No, we weren't. For about 4 or 5 quarters, we tried it.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Yes, you went from -- at the time it was a pretty significant -- You were moving away from TV and going to go back or going to the couponing and direct mail and all of that. But I guess what has -- what's going to be different this time? Or what has changed between then and now or what -- why will it be different this time?

Samuel E. Beall

I think one of the biggest reasons why TV is having the effect that we're seeing in our test markets now is that we've got a brand where the experience scores of what guest experience is when they come into our restaurant relative to the changes that we've made over the last 2 years that Kimberly and her team have been able to execute, their experience scores are 20 points better than the perception scores are in the marketplace. So by using advertising, you change perceptions and drive traffic. What the consumer is getting when they walk into the restaurant is a very good experience that brings them back. And I don't know that we had that balanced right the previous times we were doing advertising, and maybe that's why we didn't get the results that we had achieved, that we were achieving now is that the experience scores and the perception scores are just so much different now that we're getting this wow impact when somebody comes into our restaurant and has the experience of today. Their perceptions are so much different and they haven't changed those perceptions because we haven't told them anything new about the brand.

Bryan C. Elliott - Raymond James & Associates, Inc., Research Division

Okay. That's very fair. A quick follow-up on Joe's question. Could you quickly help me make sure I heard correctly? The 140 stores and the up strong sales, were you talking about the strong like high single-digit sales or whatever the number was, that's a small subset of those stores that we're talking about?

Kimberly M. Grant

Correct.

Daniel P. Dillon

Three markets out of 11.

Samuel E. Beall

Right. Thank you all very much for joining us today. Please give us a call if you have any questions. We appreciate your support and any ideas you have. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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