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Executives

Matthew Stroud - Vice President of Investor Relations

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

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

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

Analysts

David Palmer - UBS Investment Bank, Research Division

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

John S. Glass - Morgan Stanley, Research Division

Michael Kelter - Goldman Sachs Group Inc., Research Division

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

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

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

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

Alvin C. Concepcion - Citigroup Inc, Research Division

Priya Ohri-Gupta - Barclays Capital, Research Division

Jason West - Deutsche Bank AG, Research Division

Darden Restaurants (DRI) Q1 2013 Earnings Call September 21, 2012 8:30 AM ET

Operator

Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. After the presentation, we will begin the question-and-answer session.

I would now like to turn the meeting over to your host, Matthew Stroud.

Matthew Stroud

Thank you, Sherry. 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 make -- 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 on Darden's Form 10-K, Form 10-Q and Form 8-K reports, including all amendments to those reports.

These risks and uncertainties include food safety and food-borne illness concerns; litigation; unfavorable publicity; risks relating to public policy changes and federal, state and local regulation of our business, including health care reform, labor and insurance costs; technology failures; failure to execute a business continuity plan following a disaster; health concerns including virus outbreaks; intense competition; failure to drive sales growth; failure to successfully integrate the Yard House business and the additional indebtedness incurred to finance the Yard House acquisition; our plans to expand our newer brands like Bahama Breeze, Seasons 52 and Eddie V's; a lack of suitable new locations -- restaurant locations; higher-than-anticipated costs to open, close or remodel restaurants; a failure to execute innovative marketing tactics and increased advertising and marketing costs; a failure to develop and recruit effective leaders; a failure to address cost pressures, shortages or interruptions in the delivery of food and other products; adverse weather conditions and natural disasters; volatility in the market value of derivatives; economic factors specific to the restaurant industry and general macroeconomic factors, including unemployment and interest rates, disruptions in the financial markets, risks of doing business with franchisees and vendors in foreign markets; failure to protect our service marks or other intellectual property; a possible impairment in the carrying value of our goodwill or other intangible assets; a failure of our internal controls over financial reporting or changes in accounting standards; and other factors and uncertainties discussed from time to time in the reports filed by Darden with the Securities and Exchange Commission.

A copy of our press release announcing our earnings, the Form 8-K used to furnish the release to the Securities and Exchange Commission and any other financial and statistical information about the period covered in the conference call, including any information required by Regulation G, is available under the heading Investor Relations on our website at darden.com.

We plan to release fiscal 2013 second quarter earnings and same-restaurant sales for fiscal September, October and November 2013 on Thursday, December 20, 2012, before the market opens, with a conference call shortly after. Also, we are planning to host our annual analyst and investor meeting here in Orlando on February 25 and 26, 2013. More details would be available soon.

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

To begin, Brad will provide detail about the financial results for the first quarter. Drew will review the operating performance of the brands, and Clarence will offer some closing comments. We will then respond to your questions.

With that, let me turn it over to Brad.

C. Bradford Richmond

Thank you, Matthew, and good morning. Darden's total sales from continuing operations increased 4.8% in the first quarter to $2.03 billion. Our blended same-restaurant sales base -- on a blended same-restaurant sales basis, results for Red Lobster, Olive Garden and LongHorn Steakhouse declined 0.3% in the first quarter. We saw continued strong same-restaurant sales gains in our Specialty Restaurant Group, with a 2.2% same-restaurant sales growth on a blended basis.

Food and beverage expenses for the first quarter were approximately 15 basis points lower than last year on a percentage of sales basis. This favorability was driven by lower cost for seafood, partially offset by higher cost for beef and a 40 to 50 basis points unfavorable impact related to the promotional pricing strategy this quarter. And as a reminder, we value our inventory on an average cost basis, so we would expect to see more favorability in seafood cost as we move into the second quarter.

For the first quarter, restaurant labor expenses were approximately 77 basis points lower than last year on a percentage of sales basis due to sales leverage, productivity gains and improved wage rate management. Restaurant expenses in the quarter were approximately 49 basis points lower than last year on a percentage of sales basis due to cost favorability in credit card fees, utilities, workers' compensation and public liability expenses.

Selling, general and administrative expenses were approximately 131 basis points higher than last year as a percentage of sales due to higher media cost, relocation cost associated with the redesign of our operations organization structure and the impact of certain of our benefit programs. Approximately 1/3 of the increase in SG&A expense this quarter was related to higher media cost, with 1/2 of that increase from media inflation and the other half from an additional flight of media at LongHorn and additional weight at Red Lobster and Olive Garden. The redesign of our operations organization structure will help support our future growth and increase day-to-day in-restaurant leadership. The one-time launch cost of this effort added approximately 15 basis points of expense this quarter.

As noted in the press release, an increase in the fair value of our benefit programs increased selling, general and administrative expenses for the quarter by approximately 60 basis points compared to the prior year. These programs are economically hedged on an after-tax basis, such that the tax and SG&A impacts related to these activities were offsetting for the quarter on a diluted net earnings per share basis. As a result of the hedging activities, the effective tax rate was reduced by approximately 100 basis points for the first quarter this year compared to the prior year.

Depreciation expense in the quarter was approximately 22 basis points higher on a percentage of sales basis compared to the last year because of the increase in new units and the remodel programs at our larger brands. Our tax rate this quarter at 24.1% was approximately 320 basis points lower than the prior year, driven by increases in available tax credits and our tax planning initiatives, including the previously discussed employee benefit hedge. We continue to estimate that our annual effective tax rate will be approximately 26%, which is about 100 basis points higher than last year's annual effective tax rate. This annual effective tax rate will vary from quarter-to-quarter.

In the first quarter, reported total company operating profit margins fell by approximately 10 basis points compared to the prior year, but adjusting for the effects of the increase in the fair value of our benefit programs would have resulted in a 50 basis points increase. This increase despite difficult same-restaurant sales comparisons at Red Lobster and increased beef cost at LongHorn Steakhouse that we chose not to fully offset with pricing. Individually, Olive Garden, Red Lobster and the Specialty Restaurant Group saw absolute operating profit dollar and margins increase this quarter. We're confident LongHorn Steakhouse would have grown operating profit margins too if not for the inordinately high inflation in the cost of beef.

Now stepping back from all the details, our first quarter financial performance is consistent with our annual outlook that we shared with you at the beginning of the fiscal year. Now turning to our financial outlook. For the full fiscal year, we expect combined same-restaurant sales growth for Red Lobster, Olive Garden and LongHorn Steakhouse of approximately plus 1% to plus 2%, and we continue to expect net new restaurant increase of approximately 100 to 110 restaurants, not including Yard House , which is about 5% unit growth on our current base.

With these same-restaurant sales and net new unit restaurant openings expectations, plus the acquisition of Yard House, we continue to expect total sales growth in fiscal 2013 of between 9% and 10% and to anticipate that diluted net earnings per share growth from continuing operations for the full year will be between plus 5% and plus 9%. The expectations regarding diluted net earnings per share includes acquisition-related cost and purchase accounting adjustments of approximately $0.07 to $0.10.

Turning to our commodities basket. We have approximately 80% of our total food spend contracted through the end of the calendar 2012 and 27% of our total spend contracted through the end of the fiscal year. We have not fully covered our usage through the fiscal year because we believe premiums for future contracts are simply too great given what we expect prices to be in the cash markets as we look forward. Food inflation in the first quarter was approximately 0.5%, with seafood deflation in the low-single digits and beef inflation in the low-double digits. For the fiscal year, our current expectation is that our commodities basket will see inflation in the range of 0.5% to 1.5%.

Category by category. Through the calendar year 2012, seafood costs are lower on a year-over-year basis, with 80% of our usage covered. Beef costs are higher on a year-over-year basis with 65% of our usage covered. Poultry costs are slightly higher on a year-over-year basis, with 100% of our usage covered. Wheat costs are lower on a year-over-year basis, with 100% of our usage covered. And dairy costs are lower on a year-over-year basis, with 65% of our usage covered. Our energy costs are expected to be favorable on a year-over-year basis, and we have contracted 40% of our natural gas and electricity in the deregulated markets in which we operate for calendar 2012.

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

Andrew H. Madsen

Thanks, Brad. We're pleased with the first quarter results across all of our brands. Olive Garden same-restaurant sales were modestly positive this quarter, up 0.3% versus prior year. Total sales growth was slightly more than 4%, and as Brad mentioned, operating profit increased on both a percentage and an absolute basis. Olive Garden started the quarter with the final 4 weeks of their Taste of Tuscany promotion, with a starting at $10.95 price point. And as we discussed last quarter, this particular promotion fell short of our expectations.

As we've discussed in the past, we've been developing new promotional constructs for Olive Garden during the past 3 quarters. In a further refined version, 2 Italian dinners for $25 began the last week of June. This promotion focused more single-mindedly on affordability, reinforced Olive Garden's brand positioning of generosity and value, and generated a strong improvement in same-restaurant sales and guest counts.

During the final 2 weeks of the quarter, Olive Garden featured our signature Never Ending Pasta Bowl promotion. Now after holding the price at $8.95 for the last 5 years, cumulative food and labor cost inflation over that period made the price increase to $9.95 appropriate, and we chose to take it this year. We believe $9.95 for unlimited soup or salad, plus endless combinations of pasta and sauce, is still a compelling offer and a great value. Just as importantly, however, taking a price increase now helps enable our broader strategy for the year, which is to feature compelling new promotion constructs with attractive price points more often this year, while also holding total pricing for the full year below 2%.

It's also worth noting that with the recent introduction of some generously portioned new appetizers, there was an increase in the number of guests at Olive Garden ordering appetizers instead of an entrée for their meal. Given how we calculate check, that means that the first quarter menu mix reported for Olive Garden is overstated and guest counts are understated by roughly 100 basis points.

Now what we've seen at Olive Garden is consistent with guest behavior at some of our other brands as well and across the industry. We believe it reflects a combination of factors, including the growing guest need for greater affordability, guest interest in safe experimentation and guests' increasing interest in smaller portions, which some brands, including Bahama Breeze, are responding to with small plates or individual-sized versus shareable-sized appetizers. Now we see the increased guest interest in both of these options, generous appetizers that can substitute for entrées and small plates, as opportunities for Olive Garden that we will address with upcoming menu enhancements over the next several quarters.

Again, as we discussed last quarter, we have adjusted Olive Garden's promotion strategy to feature more new value-oriented promotion constructs, like the 3-course meal for $12.95 during the third quarter last year and the 2 Italian dinners for $25 this quarter. And again, the price increase for Never Ending Pasta Bowl helped enable more of these value-oriented promotion constructs this year, as well as going forward.

At Olive Garden, we're also in the final stages of testing a new advertising campaign that puts a fresh face on the brand and more effectively ignites reconsideration from lapsed users. We still plan to introduce this new campaign later in the second quarter. In addition, as we have said before, at Olive Garden, we've been making changes to strengthen their core menu. Over the last few quarters, they've added several new entrées that improve affordability and broaden choice and variety.

Over the next several quarters, Olive Garden plans to undertake a phased introduction of several new menu platforms that will further strengthen affordability, expand their selection of lighter choices, broaden dinner variety beyond their core pasta equity and increase the number of lunch-appropriate choices. Lastly, we're in the final stages at Olive Garden of validating a Via Tuscany! remodel design, featuring both interior and exterior transformations. We completed 18 of these remodels during the first quarter, and our plan is to begin an aggressive rollout later in the second half this year.

In terms of unit expansion, Olive Garden restaurants opened during the last 3 years continue to perform very strongly, and collectively have exceeded their earnings hurdle by more than 50%. We opened 5 new restaurants during the first quarter and remain on track to open 35 to 40 net new restaurants this year. So in summary, we believe the actions we've already taken at Olive Garden, plus the actions we're preparing to implement in the coming quarters, will help gradually position the business to regain its historical level of value leadership and consistently deliver competitively superior sales and earnings growth.

Red Lobster's same-restaurant sales declined 2.6% during the first quarter, although operating profit increased on both a percentage and absolute dollar basis due in part to lower seafood costs. As you recall, last year during the first quarter, Red Lobster delivered same-restaurant sales growth of 10.7% behind the introduction of their Four Course Seafood Feast promotion, and we're pleased that Red Lobster was able to hold on to the large majority of last year's growth this quarter and deliver a same-restaurant sales increase of slightly more than 8% on a 2-year basis.

During the first quarter, we adjusted the promotional cadence at Red Lobster versus prior year to focus on our most proven promotions and elevate the emphasis on affordable price certainty. We began the first quarter repeating last year's successful Four Course Seafood Feast promotion, which offers guests a complete 4-course seafood experience for $14.99. Red Lobster ran this promotion 3 weeks longer than last year.

The quarter concluded with 2 weeks of the brand's signature Endless Shrimp promotion, featuring a variety of shrimp preparations, including new teriyaki shrimp and new parmesan-crusted shrimp. This timing is 3 weeks earlier than the promotion started last year. To strengthen affordability, we reduced the price of Endless Shrimp from $15.99 last year to $14.99 this year. A majority of the negative menu mix at Red Lobster during August was driven by the earlier timing and lower price of Endless Shrimp.

During the second quarter, Red Lobster will introduce the most comprehensive core menu change at the brand in the last decade. We've been working on this menu transformation for approximately 2 years to ensure that it's compelling for guests, can be executed at a high level consistently by operations and contributes to profitable guest count growth. This new menu will offer significantly more items with approachable price points below $15. The menu will also help eliminate the veto vote by substantially increasing the number of non-seafood selections. We plan to support this menu introduction with national media that will help build awareness and generate incremental visits, especially from guests who have stopped coming to Red Lobster.

At Red Lobster, we remodeled 18 restaurants during the first quarter and are on track to complete more than 165 remodels this fiscal year. Remodeled restaurants continue to exceed their guest count and earnings growth hurdles.

LongHorn same-restaurant sales increased 3.6%, and total sales grew 12.7% during the first quarter. The strong first quarter same-restaurant sales results were supported by 2 promotions and the new lunch menu introduced in the second quarter of last year. At LongHorn, we began the quarter with 9 weeks of fire-grilled steaks, featuring a bacon-wrapped sirloin for $11.99 and a new fire-grilled flatiron steak at $12.99. We ended the quarter with 3 weeks of the brand's popular Steakhouse Dinner for Two at $29.99 promotion. This represents a 2-week earlier start for this promotion compared to last year to better align with the value-sensitive back-to-school season. Both promotions delivered solid same-restaurant sales and guest count growth.

As Brad mentioned, we also invested in additional national cable advertising support during the fire-grilled steaks promotion. In addition, roughly half of the negative menu mix at LongHorn during the first quarter is related to increased traffic at lunch, driven by their new lunch menu, which we view as a positive development and an opportunity for continued growth in the future.

While sales and guest count growth was strong this quarter, operating profit and margins fell compared to prior year, primarily because of significant beef cost inflation. We chose not to fully price for this inflation in order to ensure LongHorn retains a competitively strong position in the marketplace and protects the value proposition we offer guests.

During the second quarter, LongHorn plans to introduce several initiatives that will further differentiate the brand and help ensure continued profitable growth. These initiatives include 2 new bold and distinctive steak offerings, a new menu design that elevates their steak credentials, a new ad campaign that gives the brand more personality and attitude, and a new service platform that transitions the focus of restaurant teams from delivering on internally defined steps of service to achieving positive guest outcomes.

New LongHorn restaurants opened during the last 3 years continue to perform strongly, and collectively have exceeded their earnings hurdle by more than 30%. We opened 5 new LongHorn restaurants during the first quarter and remain on track to open 44 to 48 net new restaurants this year.

Now let me spend a moment to comment on the Specialty Restaurant Group. At the Specialty Restaurant Group, we had another strong quarter, with total sales of $163 million, which represents a 26% increase over the same quarter last year and 37% of Darden's overall sales growth. This growth was driven by solid same-restaurant sales increases of 4% at the Capital Grille, 1.2% at Bahama Breeze and 1.3% at Seasons 52, as well as the impact of 10 new restaurants in operations at these 3 brands compared to prior year, plus the addition of 11 Eddie V's Restaurants. In addition to delivering strong sales growth, the team also maintained effective cost controls, which has allowed restaurant-level margins to continue to expand.

The Specialty Restaurant Group has 2 key priorities this fiscal year: first, effectively manage accelerated growth while continuing to improve operational delivery and ensuring their brands stay relevant; and successfully integrating Yard House into the SRG portfolio. To support these priorities, the Specialty Restaurant Group is developing a strong pipeline of new restaurant locations and improving the way we open new restaurants, making it a more efficient and effective process. And the team is working closely with Darden's project management team, which is dedicated to seamlessly integrating Yard House into the Specialty Restaurant Group and into Darden.

In the second quarter, we plan to open 2 Capital Grille restaurants, 3 Seasons 52 restaurants, 1 Bahama Breeze and 1 Yard House.

Now I'll turn it over to Clarence.

Clarence Otis

Thanks, Drew. And so this was a solid start to our fiscal year. We're solid strategic, solid operationally, solid financially. At the enterprise level, we're making organizational changes, and we're making investments that will enable us to respond even more powerfully to what we see as important economic, demographic and lifestyle changes.

Of course, one of the most significant investments is our recent acquisition of Yard House. Yard House is an exciting brand. It has 40 restaurants today and ultimate unit potential of at least 150 to 200 restaurants. And Yard House also has a strong unit opening pipeline in place, with 4 openings planned for the rest of our fiscal 2013. Beyond Yard House, we believe our brands have the right strategies. And in a softer and more volatile environment than any of us would like, each is executing its strategy well while operating at a very high level on a day-to-day basis.

We're able to do all of this because we've got a winning culture with exceptional employees, employees who are committed to our business, committed to our guests. Our employees are why we remain on track to becoming a great company, and they're why we're excited about the future.

With that, we have about half an hour to take your questions. So let's get started. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from David Palmer from UBS.

David Palmer - UBS Investment Bank, Research Division

I was just wondering if we could go over Olive Garden in terms of your plans for the fiscal year. Just simply put, you have menu, marketing and reimaging. Could you just remind us of the timing of that? And when you think about these initiatives, as you've rolled them out in your -- previously, in other brands, how did you think about the effectiveness? And effectively, I'm just trying to figure out when you anticipate that brand perhaps getting more traction, which initiative will have the biggest impact.

Clarence Otis

Well, it's -- certainly, it's difficult to generalize by initiative, but I would say we're still on track to introduce a new advertising campaign that we think, as I mentioned, is going to be attention-getting and excite reconsideration of the brand. The impact of a new advertising campaign generally isn't immediate. It builds over time as the number of exposures and media weight behind that campaign builds over time. We plan to accelerate our reimaging, the remodel in the second half. That tends to be more immediate as guests notice a difference, and so that has a bit of a quicker impact than an advertising campaign would. Promotions, our promotion strategy is going to continue to be to emphasize these new value-oriented promotion constructs more frequently than we have in the past. And when we get a promotion that resonates with guests like the 2 for $25 did and like the 3-course meal in the third quarter last year did, that's a fairly immediate impact as well. In core menu, we've identified a number of opportunities where we believe the Olive Garden business is underdeveloped relative to the growth opportunity presented by the market and where that growth opportunity is consistent with the brand and our business model. But those new menu platforms are going to be phased in over several quarters, over the next 4 or 5 quarters, a platform a quarter potentially. Some of them could have a quicker impact, and some of them are going to build over time because the guest need state that we're addressing is going to build over time. So that's how we're thinking about revitalizing the Olive Garden business.

David Palmer - UBS Investment Bank, Research Division

And then just as a quick follow-up to that, so there -- in terms of your -- those platforms you're talking about, I mean, with Red Lobster, you had the wood grilling. Are you talking that sort of a thing where you're getting sort of consistent with the brand, but a new type of direction where it's something different than what we have seen previously? Is that the sort of thing you're talking about?

Clarence Otis

Well, it's -- again, it's areas where we see that the Olive Garden business has opportunities to grow relative either to what we see in the industry today in terms of guest behavior and guest need states or things -- opportunities that we expect will take time, but will grow going forward. So I mentioned affordability. We think we can build more everyday affordability into the Olive Garden menu a couple of different ways, and we're going to be doing that. Lighter choices is another example. There is growing guest need for that now, but we think that's something that's going to build further as time goes on. Lunch is another opportunity where we can bring news at Olive Garden. It's a big strength for the business now, but we think we've got an opportunity to do better there. So those are the sorts of things specifically that we're focused on: affordability, lighter choices, expanding beyond pasta, adding some news at lunch. I mean, those are specifically the areas we're looking at.

Operator

Our next question comes from Jeff Omohundro from Davenport & Company.

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

First question is on Yard House. Just wondering if there's any update to the dilution target this year and accretion in the out years and just anything further on your confidence on merger integration.

C. Bradford Richmond

Yes. Jeff, this is Brad. And no, there's really no update to that. We're in the early phases of the integration right now, and we're really pleased with what we have and the strength of the business there. But there's no really new update to our expectations at this point.

Clarence Otis

And this is Clarence. And I would say, as Brad said, early stages, but we've done a lot of work. The integration process really started before the acquisition was completed and continues. And it begins, most importantly, with the team and making sure that we keep the talent that they've got, which has built such a great brand. We do continue to see the kind of sales and cost synergy opportunities that we identified when we laid out the original sort of guidance.

Operator

Our next question comes from John Glass of Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

If I could go back to Olive Garden and the traffic weakness in August. I appreciate there was, I guess, a mix change. We have to look at both mix as well as traffic, but you also mentioned that you're raising the price on the Never Ending Pasta Bowl. But did that happen in August? Was there a relationship between the weaker traffic and the higher pricing? If it wasn't, then if you think -- at least, qualitatively looking into September, do you worry or do you have confidence that the higher price won't disrupt traffic in the brand?

C. Bradford Richmond

Yes, there's a few dynamics going on in August. First, industry slowed down overall. Second, the menu mix that we saw at Olive Garden in terms of guests ordering more appetizers instead of entrées started at the end of last fiscal year, but really accelerated in August, particularly due to some new appetizers that we introduced in July. And then third, Never Ending Pasta Bowl at the higher price point did start at the end of August, and it's possible, with the higher price point, that some of the more value-sensitive guests were impacted by that price. But it's going to enable us to do some important things over the rest of the year in terms of offering value and affordability more broadly throughout the year.

John S. Glass - Morgan Stanley, Research Division

Do you have a sense -- at this point, is that mix shift or -- downward or the traffic shift down because the higher prices stabilized? Or is it the kind of thing that could -- you're worried about negatively surprising you in the current quarter, given that you haven't moved that price, what, in 5 years and it is a value-oriented promotion, and you've got regular customers and maybe they don't come back again? How confident are you that you got that right, I guess, was my question.

Clarence Otis

Yes, we think we're pretty confident that we got it right. We think it's important to not -- to make sure that a single offer doesn't become an anchor that precludes us from offering the kind of affordability across the entire year and on a go-forward basis that we need to offer.

Operator

Our next question comes from Michael Kelter from Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc., Research Division

Just to continue on that line of questions, can you talk about your comment about Olive Garden profitability being up meaningfully? Are you back to where you were before the fall-off you experienced in 2012? And can you talk about the sustainability of the meaningful improvement, especially in light of your intent to promote more and recent renewed wheat inflation?

C. Bradford Richmond

Well, the way we think about Olive Garden, in the quarter, operating profit and margins were up, which we feel very good about. And as we think about the business more holistically, we think it's in a very strong financial position. So restaurant margins for the business are very strong, and that's one of the key drivers that's enabling new restaurant growth to continue to perform at a very high level, like I said, on average exceeding their sales and earnings targets by more than 50% over the last 3 years. Now we haven't gotten back, obviously, all of the traffic over the last 3 years, but we are building back.

Michael Kelter - Goldman Sachs Group Inc., Research Division

Okay. And shifting to Red Lobster, a quick question there. You talked about the menu overhaul being the biggest change in, I think, 10 years, which sounds like a risky proposition. So maybe you could talk a bit about the extent of testing you did in market or behind the scenes to ensure that nothing you've changed will alienate some of your existing loyal customer base.

Andrew H. Madsen

Well, it is a big change. And you're absolutely right that we need to be careful with it to make sure that it's broadly satisfying to guests and that operationally that we can execute it, and that's why we've been working on it for 2 years. More specifically, we've been testing it in somewhere between 40 and 50 restaurants spread geographically across the country for almost a year. And based on that learning, we've been refining recipes, we've been refining the amount of change to the menu and how we sequence that change into our restaurants. And what we've seen -- and I guess, to dimensionalize it a little bit more, we talk about items under $15 addressing the need for more everyday affordability, and so the menu is going to go from having about 40% of the entrées being under $15 to about 60% of the entrées being under $15. We talk about the veto vote, whereas we have seafood expertise, but if not everyone in the party wants seafood at Red Lobster, historically that could have been a challenge. So the menu is now going from roughly 8% of items being non-seafood to about 25% of the items being non-seafood. And what we've seen in test market is good guest satisfaction and guest count growth over that time period, and so we're very encouraged by what we see. But it is a big change, and that's why we've been evaluating it very carefully over a pretty extended time period.

Clarence Otis

This is Clarence, and I would say the bigger risk -- given the kind of dynamic change that we're seeing in the consumer set, when you look at economic condition, when you look at demographics, the biggest risk would be to not change. So we must change, and we have to do that in a smart way, as Drew said, with appropriate testing. And Red Lobster, we think, has done that. It's done it over 2 years. It's why, as Drew said, when we look at Olive Garden, we're introducing platforms in a staged way because testing on some of those platforms is much farther ahead than it is on others. But again, we think that the risk in a changing environment is to not change.

Operator

Our next question comes from Brian Bittner from Oppenheimer.

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

So when I look at the operating model of this system, as far as the quarter goes, I think it was pretty impressive, the amount of leverage that you're able to get on the labor line and the other expense line within the 4 walls of your restaurant base and really, on a slightly negative overall comp. And the analysis I do says that basically per store, your labor costs were down 3% and per store, your other restaurant expenses were down 4%. So I'm just trying to figure out what exactly you're doing to manage the costs this effectively. And really how sustainable are these cost trends and this margin leverage? Is this a one quarter thing? Or are we going to continue to see this?

Clarence Otis

Well, I would say just a couple of things. We've talked over the last several years about the fact that we've been undertaking some fairly significant transformation in terms of how we do business in some important high-spend areas. And so we're certainly benefiting from the steps that we've taken on that side, and there's continued benefit as we go forward. The other thing that matters is inflation, and sometimes there are headwinds like there was last year with seafood. Seafood is a little bit more of a tailwind this year, although some of that is mitigated by beef headwinds. And so all of that is part of it, but we think that the transformative changes that we've made are permanent, steady-state changes that we'll continue to benefit from.

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

And you talked about, based on the way that your accounting works, that your seafood -- the lower seafood costs are going to be more beneficial in the second quarter. So should we expect cost of sales margins to be down 10, 20, 30, 40 basis points from the first quarter in the second quarter?

C. Bradford Richmond

This is Brad, and what I would say is the average cost system means that we're blending in newer purchases with the inventory that we have, so there's somewhat of a lag effect to, in this case, the downward prices on many of these items. And so if that continues as we would expect, you should see costs of sales that are slightly more favorable in the second quarter vis-à-vis last year than they were in the first quarter just because of the accounting dynamics going on there.

Operator

Our next question comes from Jeff Bernstein from Barclays.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Just 2 questions. One, I guess, broadly I'm just wondering whether you can talk about the casual dining environment, which has obviously been choppy. I'm wondering how you would describe it relative to both sentiment and -- well, consumer sentiment as well as the competitive landscape. I think you mentioned there was a slowing in August. Just wondering whether you're seeing anything on either front that gives what you -- what seems to be greater confidence on the fiscal '13 outlook. And then just as a follow-up on the commodity cost side, in the first quarter, it looks like food costs as a percentage of sales are relatively flat. You mentioned something about promotional pricing strategy. I'm just wondering whether you attribute that relatively flat cost of sales to the more aggressive discounting, perhaps. And I think you're now saying the basket for fiscal '13 is back to kind of the 0.5% to 1.5% inflation. I think you previously talked about the low end. So just how you think about that overall food basket would be helpful.

Clarence Otis

And I'll start. Just on the consumer side, as we talked about fiscal '13 back in June, I think what we said was we thought it would look a lot, from a macroeconomic environment, like our fiscal 2012. And to the extent that there was -- as you looked at the balance of risk, '13 versus '12, it was probably to the downside, and so that's how we established our plans. Nothing has really changed from that perspective. When you get to the end result for the entire year of fiscal 2012, what you saw is it bounced around from quarter-to-quarter and month-to-month to get there, and we think that, that will be the case in 2013. The year has certainly started that way, and so no new news there. And we think the bounciness -- the overall result for the year reflects fundamentals. The bouncing around reflects sentiment.

C. Bradford Richmond

Yes, and this is Brad. Just a little bit on the food cost basket side, from where we started the fiscal year to where we are now, we've got 80% coverage on our food costs to the remainder of the calendar year, so we feel pretty good about that. If you look at what we were wrapping on last year, in the first quarter, we had about 8% year-over-year cost inflation and about the same in the second quarter, and that moderated as we got into the back half of the year. And so we feel pretty good where that is, being in that 0.5% to 1.5% range. I think early in the year, we said that we're probably at the lower end of that. I'd say now we're probably in the middle half of that range, given our cost basket and how we see the outlook and what we've got contracted. We don't see a dramatic change from the start of the fiscal year.

Operator

Our next question comes from Joe Buckley of Bank of America.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Just wanted to go back to the comments about media weights and maybe the impact of the final 2 weeks in August at both Olive Garden and Red Lobster from kind of opposite pricing moves in your key promotions. So the fact that you have heavier weights in the first quarter and I guess an extra flight at LongHorn, what happens for the balance of the year on a year-over-year basis? And again, if you could talk a little bit about that last 2-week impact at both Olive Garden and Red Lobster, yes, I guess, particularly the traffic number at Olive Garden, if that was affected. You commented briefly, but again, a little bit more detail on the pricing of Never Ending Pasta Bowl.

Andrew H. Madsen

So starting with the media weight, the biggest drivers -- the 2 biggest drivers of the media weight increase in the first quarter was media inflation and then the addition of another flight of network cable advertising at LongHorn under their first promotion. For the rest of it, there was not a meaningful change. There was a modest change at Olive Garden and Red Lobster, driven largely by when the promotion started, but not as significant a change as at LongHorn. And as we look over the balance of the year, all the brands have strong media weight equal to or slightly above prior year. So we think we've got substantial media weight to deliver the news and the messaging that we need to going forward. But then back to Olive Garden, in August, there was -- as I said, when you look at the traffic and the same-restaurant sales number, there were a few things going on. So the industry did drop, our estimate, by probably about 1 point. Second thing, for the quarter, we think there was about a 100 basis point impact on traffic versus check related to ordering appetizers instead of an entrée. And that was, for the quarter, much higher in August than it was for the quarter because we introduced some new appetizers in July and you could see the menu mix change much more in August as a result. And then third, it's difficult to precisely determine the impact of a dollar increase in price of a promotion on traffic. We do know that higher prices by themselves are probably, over time, going to have a downward impact on traffic for some guests on some occasions. We might have seen some of that at Olive Garden in the month. But as we also said, we think that it was an appropriate move to make because we'd held that price for 5 years and the higher price is now going to put us in a position to do the things that we need to do more broadly over the next 3 quarters this year and into next year in terms of offering new promotional constructs that communicate everyday value more consistently.

C. Bradford Richmond

Brad here. Just one thing I would add is in the first quarter, SG&A were up about 130 basis points. About 1/3 of that was the media and inflation was half of that. So if you look out through the year, I mean, we're going to see about a similar number for the whole year. So it's not like we pulled media forward that's going to be sacrificed in a later quarter.

Operator

Our next question comes from Andy Barish of Jefferies.

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

Wondering if you guys can opine on the strength in the casual steak category. Obviously, your own LongHorn business, performing well, but competitors doing well also. Is it maybe something to do with high beef prices in the -- at the retail grocery market level? Or what do you think is going on category-wise that continues to drive customers?

Andrew H. Madsen

Well, I mean, we have some beliefs, so you have to take them as a point of view on this, as opposed to factual. Well, there are some facts. So one of the facts is that chains are taking share from independents at a much more rapid rate in the steak category than in casual dining overall. And a lot of that has to do with the advantages that chains have when it comes to being able to offer the kind of cuts that they offer at prices really that independents find it difficult to match. We believe another part of it is that consumers are less inclined to have their steak occasions at home and put those occasions at risk, given how much steak costs. And so they're probably having more away-from-home steak occasions. So there's some shift going on there as well. So we think those are 2 big factors. And then yes, the final piece would be that the growing steak chains are all doing a very good job of delivering the experience, we think, led by LongHorn. But we think you've seen significant improvement operationally at Outback, and Texas Roadhouse and Logan's Roadhouse both do a good job as well.

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

Great. And then just one quick numbers question on interest expense for this fiscal year maybe versus fiscal '12. Just give us a sense of where that's heading with the Yard House deal, but then the debt pay down focus going forward.

C. Bradford Richmond

Interest expense, obviously, we're taking on more debt with the Yard House acquisition and you just mentioned paying down the debt. So it is going to be up to last year, but probably in that, say, 8% to 12% higher than the prior year.

Operator

Our next question comes from John Ivankoe from JPMorgan.

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

First, a follow-up and then a separate question. I think it was Brian that asked about labor costs. That obviously did very well in the first quarter, especially given the comp. And wherever costs have been -- I mean, with the numbers that I'm looking at, I mean, we're down every quarter in 2012 as well relative to 2011. So just a follow-up to that question is, will we continue to see year-on-year declines in labor costs for the rest of 2013? Or was that just a one-quarter event? I don't know if I caught the answer. And then a separate question, if I may, as well.

Clarence Otis

It's paging through, there's no typical [ph]...

C. Bradford Richmond

Yes. As we look through labor costs, and again, Clarence touched some on this, just the more longer-term nature that of initiatives we had against that plus our tools around guest count, forward testing, labor management. We would expect to continue to see year-over-year improvement on the restaurant labor line, maybe not as great as it was in the first quarter. But obviously, a key thing for us is growing same-restaurant sales. It's -- that line is pretty heavily leveraged. So to the degree we have more success there, we could have even more success from the restaurant labor line. But what we see in the first quarter is success that we expect to achieve in the remaining quarters of the year, but maybe not as at high a level.

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

Okay. And that, I think, is a good follow-up to the next question. I would assume that the new -- bet the new menus at Red Lobster, the new menus at Olive Garden bear negative mix. I mean, correct me if I'm wrong in that way, in that you're giving consumers an opportunity to spend less. I mean there might be some other factors there that it's not the case, but you can explain that. And so what I just basically wanted to get a sense is, if there is that negative mix, are the new items designed to be gross profit dollar neutral to the higher-priced items? And if it is gross profit dollar negative, how much traffic do you need, from a profit perspective, to offset the potential for negative mix, if you're prepared to talk about that?

Clarence Otis

Yes. So those are dynamics we are looking at very carefully, obviously, over the last year when we were testing this new menu in market at Red Lobster. And what we've seen is a pretty modest check decline related to the new entrées that we're adding that are more affordable. That modest decline is partly offset by an increase in appetizers because there's a broader range of appetizers on this new menu, and we've talked about the dynamic earlier about some guests ordering appetizers instead of an entrée. And then the rest of the check impact is offset by guest count growth and some labor optimization that we've put in place. So what we would expect to see isn't a big decline in check, probably a slower growing check, improving guest count growth that's driving growth in total sales and total earnings. And that's kind of the dynamic overall that we're seeing in the test.

Operator

Our next question comes from Alvin Concepcion from Citi.

Alvin C. Concepcion - Citigroup Inc, Research Division

Just wanted to ask, historically, what have you seen in terms of sales lift from major new core menu changes at Olive Garden and Red Lobster?

Andrew H. Madsen

Most of the new menus that we've done in the last several years have been 3 or 4 new items to replace just to add news and variety, and we don't typically track a guest count lift directly with those new menu introductions. This core menu at Red Lobster is different. It's much more comprehensive, and it is having a bigger impact on the business. I don't think we want to talk about, specifically, the traffic lift that we saw in the test market at this stage, other than to say we did see traffic improvement and we did see improvement in sales and earnings overall.

Alvin C. Concepcion - Citigroup Inc, Research Division

That's great to hear. And with the early launch of Endless Shrimp, I mean, how should we think about that in terms of its impact to next quarter's same-store sales? I mean, do you believe that the new menu will more than offset that early launch?

Andrew H. Madsen

That's a big question. But what I would say is obviously, the launch weeks are a little bit stronger. But Endless is a great promotion for Red Lobster, great guest appeal, and so there shouldn't be a dramatic impact from there. But as you touched on, the menu introduction and how quickly that resonates with guests and that they come in and enjoy, that's probably going to be a bigger driving factor for second quarter same-restaurant sales performance at Red Lobster.

Operator

Our next question comes from Priya Ohri-Gupta from Barclays.

Priya Ohri-Gupta - Barclays Capital, Research Division

I was just wondering if you could please update us on your funding plans for Yard House in your October debt maturity at this point. It looks like you put a term loan in place last month.

C. Bradford Richmond

Yes, in terms of our funding expectations and plans that we've done is, over the past 3 months, we have put in place a private offering that we did that took down our CP balance pretty much to 0. And then -- so we paid for the purchase of the Yard House out of our revolver amount that we had available to us there, and then just recently, we have initiated a term loan with a number of our banks that has a delayed funding feature to that. So that's available to us as we move into the future here. And then to your point, we do have debt maturity coming this October, and so we're evaluating that right now, but would anticipate most likely going back to the public markets to refinance that debt around the time that it matures.

Operator

Our next question is from Jason West at Deutsche Bank.

Jason West - Deutsche Bank AG, Research Division

Just going back to some of the menu changes that are upcoming. You mentioned at Red Lobster, it's sort of a more holistic menu change, but at Olive Garden, it's more phasing in some new platforms and promotions. And just wondering, is that sort of the permanent step you're taking at Olive Garden to address some of the traffic issues there? Or is there plans for a bigger, more comprehensive menu relaunch later this year, similar to what you're doing at Red Lobster?

Clarence Otis

It's Clarence, and I'll start. And so when Drew talks about introducing new platforms at Olive Garden and phasing those in over the next 3 to 4 quarters, at the end of that period, the cumulative effect of that menu change will equal Red Lobster. Perhaps it will even be a little bit bigger. And so we're talking about a fairly significant change to the Olive Garden menu, which we think is appropriate. And the reason why it's happening in those stages is so we can make sure that we test each stage appropriately, but the net effect is a very significant change. Beyond that, we've talked about some of the other things that we're doing around changing promotional constructs; advertising, which will hit this year; and then the reimaging, which will really accelerate in the second half of this year and will reach a critical mass pretty quickly into next fiscal year, yes.

C. Bradford Richmond

And, Andy, Brad Richmond here. I wanted to come back on your question about interest rate. Still integrating, so working off a number of pieces of documents here, but interest for us on a year-over-year basis, with the Yard House acquisition, is probably going to be in that 18% to 22%. The number I gave you earlier was on a pre-acquisition basis. So let me clarify that for you.

Matthew Stroud

Thanks, Brad. That's all the time we have for this morning. I know there are still several of you that are in queue. We apologize that we couldn't get to your questions. Of course, we'll be here in Orlando throughout the day to take your calls. We hope everybody has a great weekend. We look forward to talking to you in 3 months. Thanks again.

Operator

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