達登餐飲 (DRI) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter earnings release conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session with instructions given at that time. If you should require assistance during the call, please press zero then star. As a reminder, this conference is being recorded. I will turn the conference over to your host Senior Director of Investor Relations Mr. Matthew Stroud. Go ahead

Thank you. Good morning. With me are Joe Lee, Darden’s Chairman and CEO, Clarence Otis, Darden’s CFO, Dick Rivera, Vice Chairman of Darden’s, Drew Madsen, President of Olive Garden, and Edna Morris, President of Red Lobster. We welcome those of you joining us by telephone and via the internet.

During the course of this conference call, Darden Restaurant’s officers and employees may make forward-looking statements concerning the company's expectations, goals or objectives. These forward-looking statements could address future economic performance, restaurant openings, financial parameters or similar matters. By their nature forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated in the statements. These risks and uncertainties include competition in the restaurant industry, economic and market conditions, food and labor costs, the availability of suitable sites for new restaurants. Government regulations and policies, changes in consumer tastes and demographic trends, weather conditions and acts of God and other risks and uncertainties discussed in the company's SEC filings.

Because of these numerous variables, you are cautioned against placing undue reliance on any forward-looking statements made by or on behalf of the company. By way of information we plan to release same restaurant sales results for fiscal December 2003 on Thursday, January 2, after the market close and plan to release same restaurant sales for fiscal January 2003 on Tuesday, January 28 after the market close and we plan to release fiscal 2003 third quarter earnings and same restaurant sales for fiscal February 2003 on Thursday, March 20, after the market close.

We released second quarter earnings yesterday afternoon. Results were available on First Call, [peer] news wire and other wire services. Now for an overview of the quarter, I would like to turn it over to Joe.

Thank you, Matthew. Second quarter earnings were in line with our earnings projections that we had disclosed at the end of October. We reported diluted EPS of 21 cents. That's 11% increase over last year. We certainly had more variability, though, in the second quarter than we would have liked. Red Lobster's results were softer than expected for the first two months, although they did reestablish momentum at the end of the quarter with a very strong 10% to 11% same restaurant sales increase in November. At the same time Olive Garden had a very successful quarter with record second quarter sales and operating profit.

We also continued to expand our two emerging growth companies, Bahama Breeze and Smokey Bones to lay the groundwork for the opening of the new restaurant, Seasons 52.

There will be continued support, we think, for the casual dining secretary tore because there was continuing support in the last quarter. In the second quarter there was strong performance of casual dining sector compared to other sectors, despite lingering consumer uncertainty and weaker than expected economic recovery, casual dining held up better than most industries. As now for some time as it also in the past economic slow downs.

Two things keep me confident that Darden Restaurants will take advantage of what the industry offers by delivering consistent strong growth. First, we will continue to make good progress on the underlying measures of operating excellence, things like guest satisfaction and turn over. Secondly, we have a great leadership team, including strong leadership from our restaurant management to senior Darden Restaurants management. And all of that is getting better all the time. Clarence will now provide the overview of details concerning our quarter and then we'll be back for your questions after he presents.

Thanks, Joe. As Joe mentioned we recorded that earning in the second quarter were $37.5m. That's 21 cents per diluted share, which is an 11% increase in diluted earnings per share. We accomplished this despite the fact that Red Lobster' operating profit was lower on a year-over-year basis, because of the third quarter sales softening that Joe mentioned and a particularly acute effect this had on earnings since the lower than expected sales came as we were featuring our lower margin offering.

The diluted, the double digit, rather, increase in diluted earnings per share in the face of the earnings decline at Red Lobster, one of our flag ship companies, I think really speaks to Darden Restaurants' strength. We were bolstered by strong earnings growth at Olive Garden as well as less dilution from our emerging companies as they funded more of their own expansion.

Our total sales increased 6.4% in the second quarter. That's as a result of the same restaurant sales growth at Olive Garden and Red Lobster and because we are operating 54 more new restaurants in the quarter than in the prior year. Both Olive Garden and Red Lobster had same store sales growth during the quarter that again exceeded the [nap track] casual dining industry average. Olive Garden which achieved its 33 consecutive quarter of same restaurant sales growth was up 3.5% and Red Lobster had a 2.3% increase, which is its 20th consecutive quarter of same restaurant sales growth. Both companies benefited from the shift in the Thanksgiving holiday. That moved from our fiscal second quarter last year into the fiscal third quarter this year. Both the shifts favorably affected sales by one percentage point in the second quarter. That shift will adversely affect comparable restaurant sales by about the same amount in the third quarter.

In terms of margin analysis, food and beverage expenses were 100 basis points lower than last year on a percentage of sales basis. Two things occurred here. First, the favorable seafood cost trend that started last year continued. Seafood as a percentage of total food and beverage and expense continues to decline. That's because the combination of Olive Garden, Bahama Breeze and Smoky Bones is becoming a bigger portion of our business. You should also note that as we said before, we bought a significant amount of seafood in this fiscal year and we expect the seafood costs to be slightly favorable for the full year. Our current expectations were modest low single digit percentage decrease.

Selling, general and administrative expenses were also lower as a percentage of sales basis by about 45 basis points. This was mostly because of lower marketing spending as a percent of sales, primarily at Olive Garden, as well as some very good leverage on the G&A line. The favorability in food and beverage and selling and administrative expenses was offset by higher labor expenses and restaurant expenses as a percent of sale. The increase in restaurant labor reflects a wage rate and benefit inflation. In addition to that, we had less sales leverage than anticipated on this line because of Red Lobster's early quarter softness.

The increase in restaurant expenses as a percent of sales was attributable to two factors. First, pre-opening expense was higher in the second quarter this year because we opened nine more restaurants this year than last year. And the second factor has to do with workers' compensation. There are two parts to workers' compensation. There's the current period cost for new claims as well as our cost for open claims from prior year. Beginning in the third quarter last year, rising medical costs and a trend towards greater awards for lost time put pressure on both those components to handle the open claims from prior years.

In the third and fourth quarters of last year we raised our reserve by a total of roughly $13m. That is something that will not recur this year. But this quarter, like the first quarter of this year, we did have a year-over-year increase in the current period expenses. That's what contributed to the increase in restaurant expenses in the second quarter. In the last half of the year, we expect significant favorability in workers' compensation expense compared to last year because we’ll be lapping on the last year's increase in the current period component and because of last year's increase for prior years, as I said, is one time in nature.

Turning to the emerging companies, Bahama Breeze opened two new restaurants during the quarter, one in St. Louis, Missouri, and one in Miami. It plans to open six restaurants in total in fiscal year 2003. As we discussed at our analyst and institutional investor meeting last month in Orlando, sales at Bahama Breeze are annualizing several hundred thousand dollars lower than we projected coming into the year. While as I mentioned earlier Bahama Breeze was less dilutive to earnings in the second quarter than last year, it was not quite as much improvement as we hoped for.

Turning to Smokey Bones, it opened six new restaurants in the quarter in Erie, Pennsylvania, Tampa, Orlando, Dayton, Ohio, Fort Meyers, Florida and Brandon Florida. Since the end of the second quarter they opened two more restaurants, both of those in the Atlanta area. Smokey Bones plans to open at least 20 restaurants in total in fiscal year 2003. That would once again would double it in size.

The tax rate for the second quarter was down again versus last year. As it was in the first quarter. And this reflects tax strategies that were put in place some time ago. We expect our tax rate to be down again in the third quarter.

Finally, we repurchased almost 1.2m shares of common stock this second quarter. Since beginning our repurchase program in December 1995 we now repurchased 91m shares.

In dollars that amounts to over $1b of share repurchase. We believe that's a powerful testament really to the significant cash flow that Darden has been able to generate. We are authorized to purchase up to 115.4m shares. So that leaves 24.4m shares remaining in our authorization.

As Joe mentioned, we continue to see strength on underlying measures of operating excellence at both Red Lobster and Olive Garden. So we continue to believe we can achieve same restaurant sales growth for fiscal 2003. That's within our target range of 3% to 5%.

We also continue to expect to increase our restaurant base by over 60 restaurants this year. That would put us at the top of the 3% to 5% new restaurant sales growth range that we target for long-term. Achieving this kind of sales growth would enable us to get within our long-term annual earnings per share growth range of 15% to 20% this year, which we recognize as a challenging objective, given our sales and earnings strength last year and the difficult macroeconomic environment this year. But that certainly remains our goal.

With that I'll turn it back to Joe for final comments

Thank you, Clarence. As you can see we are excited about our business and the opportunity we have to build a great company. That opportunity drives our focus, which is certainly on achieving strong results today, but also delivering strong consistent growth over the long-term.

This month Olive Garden celebrates its 20th anniversary. In January, Red Lobster will celebrate its 35th. These two proven growth companies are leaders in their category and continue to deliver guest satisfaction at higher and higher levels than before. Our commitment to strong, consistent long-term growth is also reflected in our expansion of Smokey Bones and Bahama Breeze. As we expand them we are taking the time to make necessary refinements to ensure that they remain exciting and broadly appealing.

I’m pleased with our direction which includes a balance between proofnld emerging brands and focus on operating excellence and a focus on effective brand building. I believe we are on track to achieve success now and for generations.

Now we are happy to take your questions

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Thank you. Ladies and gentlemen if you wish to ask a question, please press one on your touchtone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself at any time by pressing the pound key. We ask that you ask one question. For additional questions, please re-queue.

Our first question will go to the line of Matthew DiFrisco from G K M.

Quick question on a little bit of a near term outlook. You have been focusing on the long-term prospects of earnings and sales. I'm curious on your most recent guidance, given what you have seen now in November for the third quarter at Olive Garden and Red Lobster, what you think are reasonable expectations should we be looking for positive comp growth or expecting slight contraction given the [tough] lapse? On the expense line you are looking for significant benefit year-over-year due to the reduction or having the lap in workers' compensation. Should we read into that an aggregate that number? You will be on a relative level par to last year where it was 14%? Or should we still expect a modest increase given the expenses and other costs?

Let me take that question. In terms of outlook, at the analyst meeting in November we talked about the fact that we expected to be within the 3% to 5% same restaurant sales growth number for the fiscal year. And in order to do that, we were looking at the balance of the year. At that time we were talking about November 4 coming in on a blended basis at Olive Garden, at Red Lobster between 2% and 4%.

And we still feel good about that outlook on the same restaurant sales side.

We did acknowledge, too, that because of some of the one-time expenses that we had in the second half last year, we felt that certainly the earnings comparison is not as challenging as the sales comparison. We still feel that way.

In terms of restaurant expenses, even with the favorability in workers' compensation, because of the significant increase in the number of new restaurants that we’re opening, almost 20 on a full year basis, and the pre-opening expense associated with that, we probably are looking at a very modest increase in restaurant expenses on a percent of sales basis.

We will have a question from John Glass from CIBC World Markets.

Could you elaborate on the promotional strategies you used at Red Lobster in November? Were you couponing and how extensively? How much did that cost you? As an adjunct to that question, what was Red Lobster, did margins go up in November in Red Lobster? Or did you sacrifice margins to get those sales? Thanks.

In terms of the marketing calendar, Red Lobster did have a coupon in November. Which it did not have in November last year. Olive Garden had a coupon in November as well, although it had one in November last year also.

And in terms of margin for Red Lobster in November, we did see margin improvement in November.

We have a question from the line of Allan Hickok, from Piper Jaffray. Please go ahead.

Clarence, you mentioned you bought a significant amount of seafood so you expected a low single digit decrease in fiscal '03. Could you carry that along to the rest of the commodities and what your outlook is for the fiscal year on a blended basis? And secondly, tax rate, you said you expected to go down again in Q3. Could you give us an order of magnitude on that?

In terms of the commodity outlook, we feel pretty good about the entire array. We are not seeing a lot of cost pressure in any particular line item. Certainly seafood is one of our biggest, but even in the other large ones, chicken and some of the other categories, not seeing a whole lot there in terms of the balance of the fiscal year.

In terms of the -- the other question was on the tax rate, I'm sorry. On the tax rate, we did -- really, if you look back on the last several years, we were running roughly 35% and we, this year, have been lower than that, expect to continue to be lower than that. Really more in the 34-ish kind of range. There is quarter to quarter [inaudible], there may be a quarter where we pop up higher or lower, but on a going forward basis, the 34 looks more reasonable.

We have a question from the line of Joe Buckley with Bear Stearns. Please go ahead.

Thank you. Two questions. Your cash balances came down quite a bit during the quarter. Inventories went up but the cash seems to come down more than that. I wonder if you can comment on that. And then going back to the November Red Lobster question. Did the margins improve year-over-year in November or was that a sequential improvement as the quarter progressed?

Joe, this is Clarence again. In terms of cash balance, basically what happened is in the spring, I think it was actually April we actually did $150m borrowing, which was earlier than our need. We did that really to take advantage of what looked like pretty favorable interest rates. Although they have come down even more since then. We spent that down in the normal course. Inventory is part of it, but restaurant expenses, all those sorts of things.

You'll notice, for example, we don't have any current debt on the balance sheet. That's because -- we normally do. That's because we have been spending down that pre-borrowing. Our cash balance generally is in the $20m to $30m range. If you exclude things like that. That primarily represents cash in the system over the weekend because we closed our books on a Sunday.

We have a question from Jeff Omohundro from Wachovia.

Last quarter your third quarter benefited from one week of Lobster Fest. I was wondering what the Lobster Fest timing looks looks like this year, will we see a similar type of timing benefit and how your marketing spending looks in Q3 on a year-over-year basis.

Jeff, I'm going to ask Ed to answer. I believe Lobster Fest starts on a similar calendar this year. I don't think there are a whole lot of changes. I guess beyond that we are a little bit nervous about making a whole lot of comment because of proprietary reasons.

I'm sitting over here jumping up and down on the same thing. We don't want to be specific on our future promotional plans, but within that context –

It will be a similar time frame, but was your question specifically about third quarter and how much of Lobster Fest would be in the third quarter? It will be similar to historical trend, a couple of weeks in the third quarter. We are very pleased with what we have lined up for Lobster Fest.

Jeff, I'm sorry, the other part of that question was? I didn't write it down. If you could re-ask it, I would appreciate it.

We will move on to Howard Penney with SunTrust. Please go ahead.

I'm sorry, I don't remember what his other question was either. But if you could answer Joe's question actually about the Red Lobster margins year-over-year, that's great. My question would be, on Smokey Bones, how much money and number of stores will you have invested in Smokey Bones before it turns profitable and what year will that be?

On the year-over-year question on Red Lobster margins in November, they improved on a year-over-year basis. Red Lobster actually ran a higher margin promotion this November compared to last November.

Now we caught up with Jeff.

We caught up with Joe. In terms of Smokey Bones, really it depends on the pace of expansion. The faster we move, the slower the path to breakeven on an operating profit basis. So we haven't completely settled on really how fast we expect to open it. Although probably we would expect it to be breakeven to accretive of certainly in 05.

And we have a question from the line of Janice Meyer with Credit Suisse First Boston.

My question is to for Edna. In the beginning of the quarter you ran the thirty shrimp for $9.99. A value promotion that worked very well the year before. And then in November you did the shrimp and lobster. You did have a coupon. Could you contrast the two? They both seem to be value promotions. Why did one work well and why did one not? Clarence did say you had a coupon in November and you didn't last year. During this fiscal year, will there be a month where the reverse happens, where you had a coupon and this year not? Can you give us a sense for when that might be, if it's happening?

On the first one, Janice, the reason we believe the lobster and shrimp work very well for us, that combination with the lobster it makes it a very distinctive offer, something that has a lot of appeal to our guests. That's one difference. It stood out in terms of distinctiveness of offers out there in casual dining.

On the second one, I believe I'll refrain from answering that.

Yeah, for competitive reasons, Janice, we don't really want to talk about it. All I say, as you know, Olive Garden really does, historically has used coupons. Red Lobster has used them less frequently. That will likely continue.

We have a question from the line of Mitch Speiser with Lehman Brothers.

Thanks very much. A few questions. On Olive Garden, I believe in November traffic was down 1%. But if you exclude the holiday shift, I would think that the traffic was down more in the 3% to 4% range, or 4%. I was wondering if that's a way to look at it. If that was in line with your projections.

Second, seafood costs, a big buy in, does that flow through any to fiscal ‘04? I'm wondering if it's just for fiscal '03 or whether it will be favorable at this point for fiscal ‘04.

On the updated expense line, if the increase was due to increased credit card usage. Thanks very much.

Mitch, I would say on the Olive Garden, we talked about the sales benefit being about three points from the holiday shift. About two thirds of that would, you can attribute to guests [ph] is what I would say.

On the other questions,

The seafood.

On the seafood costs, we are pretty aggressive in taking [price views] and doing opportunistic buys and getting out as far as we can, although we do have price [inaudible] and sometimes we are out longer than at other times. As I said, we are certainly locked in through the end of the fiscal year. And a little bit past that. I don't want to speak to how far past that. And sort of when we lock that in. Again we think that's important information competitively.

We have a question from the line of Bryan Elliott with Raymond James. Please go ahead.

Good morning. A couple cash flow related questions. You usually have the negative operating cash flow during this quarter as you build inventory. I also calculated sort of the adjusted debt to the cap and came up with something close to 45 which is higher than we have seen for sometime. Wondered what your thoughts were on managing to that line, the free cash flow that comes from the inventory liquidation now? What kind of split from that free cash flow would be a reasonable expectation on debt versus share repurchase? And also if you could just review CAPEX for this quarter and your outlook for fiscal, this and next year, thanks.

On the cash flow, Bryan, you're absolutely right. This was a seasonally low period in terms of operating cash. We tend to run negative here. Although this year we did not. And that's because basically capital spending in the quarter was lower than it has been for a lot of reasons having to do with how the commitments flow. Even though the overall number for the year is going to be higher.

This year we think capital spending, roughly $400m. And next year is probably about the same. It could be a little higher, but not in any significant way.

In terms of the debt to capital ratio, actually 45% is the level that we have been at for awhile now. I think we ended the first quarter at 44 and we ended the May quarter at 46. So it's pretty consistent with where we have been. And where we expect to be. I mean, 45 is our target. We bounced around it by a point, one way or the other.

You have a question from the line of Andy Barish with Banc of America Securities. Go ahead.

Two questions on the Red Lobster side of things. I didn't quite understand, you were talking about gross margin and value earned promotions. The mark up on 30 shrimp for $9.99 was the same as a year ago and seafood costs are favorable to flattish or somewhere in that ballpark. Can you help me understand that?

Secondly, on the marketing expense, given the volatility in the sales, would you care to give a one-time increase on a basis point basis for marketing spend at Red Lobster during the quarter?

On the margin side, what we are saying is that we run a value oriented promotion, value promotion even if the price was the same. We certainly have wage rate and other inflation. We have to carry those costs.

So we are looking for traffic and sales increases really to get improving margins out of that promotion. We didn't get what we hoped for.

In terms of the marketing on a percent of sales basis on a year-over-year basis at Red Lobster, it was up slightly, but very slightly, ten basis points or so.

We have a question from the line of John Wade with McDonald Investments. Please go ahead

Good morning. I just wanted to get some flavor on the December promotion. It looks like at Red Lobster you are doing all you can eat shrimp. Is that right?

That's right.

Last year you did pound of crab, right?

Yes.

Any reason why the kind of difference there? You're not a big fan of a pound of crab or crab costs going up? And then I guess the follow-up on that, wondering what the Olive Garden promotion is and as far as couponing, kind of -- are you doing couponing this year for those promotions? What was that last year?

This is Drew Madsen, on the Olive Garden side and right now we're continuing advertising with the very popular dish chicken marsala as we did in November as well as featuring soup, salad, and breadsticks.

In terms of coupons supporting that.

We have the same coupon timing as last year. We had a coupon in November that we will continue to redeem through early January same as last year.

And this is Edna on the Red Lobster question. When we looked at our marketing calendar and revised it based on supply realities and lined up our promotion and feauture calendar with that, looking at both crab and shrimp.

In terms of the couponing, the coupon that was dropped in November will redeem through December. That's some support that we did not have last year at Red Lobster.

And we –

This is Joe. I would just like to say that when you were at the analyst meeting you were questioning us at that time about what we might do in the face of the slower volume of that one promotion. What you are seeing and hearing here is typical of the strength of Darden Restaurants. We are fast on our feet to make corrections, get volumes back and get profits back.

We have a question from the line of Amy Greene with Avondale. Go ahead.

You mentioned that Bahama Breeze had not been really tracking from the sales basis where you all had been hoping for. We haven't heard that much more about it on the call. I wanted to see if you wanted to add more color to it and see if it had been improving any as you’re headed into the end of the year or what changes you will make going into Q3 and Q4 to make sales there.

Amy, this is Clarence. I'll start. We usually talk about the fact that we have a great deal of learning certainly in periods that we have operated Bahama Breeze and really we can break it down into several categories of restaurants. You have some restaurants where the growth drivers, the things that drive Breeze's business aren't there. And we would likely not open in those places if we had to do it again.

We have others where all the growth drivers are there and the sales are annualizing at very different levels at those restaurants. And that still is the case. Nothing really has changed there.

In terms of plans going forward to really improve trends at Bahama Breeze, we have a lot of plans. Responding to a lot of consumer research that we shared with you when you were here that showed us that we really had an opportunity to improve our [inaudible] compared to direct competitors, improve our trial there and focus on some of the other places where consumers told us that there were opportunities.

That hasn't changed. We don't want to get into the specifics of what we are doing there again for competitive reasons, but you can be assured we are working pretty hard to make changes. We feel good about the coming year

This is Joe. I'll add to that. As we said, when you were down here at the meeting, we want to make sure that it is clear so we say it again that we have had a lot of learning on site characteristics and how to, how the Bahama Breeze concept works in different economic environments. After this economic environment turned south and after 9/11. We are taking advantage of those learning as we go into the future. And we are looking at ways to pick up the volume in those sites that don't have the traffic generators that we now know we need for Bahama Breeze.

All that said, again, Bahama Breeze really contributed to the earnings growth with [inaudible] this year than last year. That is something we expect to continue going forward and we actually will be looking for it to be accretive next year.

We have a question from Tom Sinkel with Meridian Asset Management.

Thank you, my questions have been answered.

We have a question from Coralie Witter with Goldman Sachs. Please go ahead.

Sorry. Can you talk a little bit more in detail about the couponing that we are facing, I know you can't talk about what you are going to do, but just in the next three months which periods did have couponing so that we can make that comparison?

And then secondly, are you seeing greater levels of couponing across the industries from your competitors, given a weaker economy? And finally if you can talk a little bit about more trends and the basis is too small to discuss comps, but can you speak about whether the average unit volumes are moving in the right direction?

In terms of Olive Garden, on the, on what we did last year, I think that there were, in the third quarter, there was one in the third quarter and in the fourth quarter there was another coupon. We did have coupons in each of the quarters in the back half of last year at Olive Garden. At Red Lobster we did not.

Smokey Bones.

Smokey Bones? Trends are good. They continue to do well. Again there, we really have several categories of restaurants. We talked about the fact we have A locations, B, and C, in terms of the quality of site. The Cs reflect some early experimentation and we are not intending to go forward with C locations in the future because they do annualize at sales levels that are significantly below A and B.

The good news is, there are only four of those out of all the restaurants that are open. We are still trying to read seasonality in Smokey Bones as a different seasonality than our other restaurant companies. But basically sales trends there are good.

In terms of what competitors are doing, we are certainly seeing heavy media in every form. In network television advertising, radio, as well as coupons.

And casual dining, we have had a long-term set of experiences with all types of media and we are very prepared to keep our business.

We have a question from the line of Hil Davis with Thomas Weisel Partners go ahead.

My questions have been asked and answered, thank you.

Thank you. We have a question from Paul Westra with SG Cowen.

Thank you this is Paul Westra with SG Cowen . Could you comment more on your G&A line down 40, 50 basis points in the first half, what is the sustainability of some of the leverage on the G&A line, the administration line in particular? What is that and I guess the marketing spend, what should we expect for the second half of the fiscal year?

Secondly, maybe comment on competitive in roads on the shrimp price. Everyone is putting shrimp on the menu. Is that what you are alluding to, you might be getting away from that in the second half?

On the G&A line, Paul, we did get good leverage, a lot of the lower dilution we have seen from the emerging companies, that's where it shows up because a lot of that dilution has to do with training and other kinds of administrative support. And so we expect to continue to leverage that line because we expect Smokey Bones to continue less diluted as well as leveraging just our increasing scale, from a sales perspective, on the entire company.

In terms of the marketing spend, we also expect to continue to see marketing as a percent of sales of Olive Garden to come down. A lot of that has to do with the new restaurant growth at Olive Garden which really leverages the marketing infrastructure that they have in place very nicely.

And the final question was shrimp. And the answer is, we have seen more shrimp offers. There is more and so when Edna talks about having more distinctive offerings, that's certainly part of the equation. So it's not moving away from shrimp. It's making sure we have compelling preparations when we do do shrimp. But it's also ensuring that we feature a lot of our historical strength. Lobster is certainly one of those. Quite literally, given the name. And the success of Lobster Fest which is our feature promotion.

We have a question from William Nobler with Atlanta Cesna.

Thanks a lot. You ended up by reaffirming your short and longer term goals of 15% to 20%. I just wanted to be sure that was what you said. And also it sounded like on the comp side you continue to hope for this year that they should be up 3% to 5% or toward the 3% to 5% area. It sounds like what is happening is your costs are quite a bit down because of favorable commodities. And the absence of that $13m medical expense in the second half. And finally less dilution from emerging restaurants. Do I get all that right?

You got a lot of it right. Certainly we are looking to be in that 3% to 5% same restaurant sales growth number. We can do that if we get 2% to 4% in the back half of the year, which is our expectation.

To the extent we can do that, certainly that 15% to 20% is possible, although it would be at the low end of that range. And a lot of that is because, as you said, in addition to the leverage from the sales growth we've got the one-time items in last year's cost structure that we don't have. We do have the continuing availability for seafood and we have the lower dilution from our spending companies. You have pretty much all of that right.

We have a question from Peter Oakes with Merrill Lynch. Please go ahead.

Hi, good morning. I have a couple questions. First on gift certificates, can you give us a sense as to how they are selling versus last year? Can you remind us what kind of sales you generated from them last holiday season?

On the labor side, I was hoping we could dig into that a little bit more, particularly Red Lobster. On a blended basis, the portfolio hit or was just shy of the targeted 3% to 5% comp. And yet labor was up 40 basis points.

Clarence, I think you mentioned wage rates were up. Could you remind us what the inflation is there and also are the managers' bonuses tied more to sales growth or profitability? Thank you.

Those are a lot of questions.

We have to remember them all.

Let me make sure. So I can take all of those. In terms of gift cards, gift cards sales this year are up. They have been up every year since we introduced gift cards. The increase, first year we introduced them which was three years ago, was about 20%. It was close to that last year. We don't want to talk about competitive, for competitive reasons, what the increase is this holiday season, although I will say that based on what we are reading, we don't think the increases that we have seen are specific to Darden Restaurants, the introduction of cards across the retail environment has driven similar increases as far as we can tell.

So that's a good thing.

We are pleased with our increases.

We are pleased with our increases over the last several years and the increase we are seeing this year.

In terms of wage rate inflation, it was about between 2% and 2.5%, is what we've seen. That's a tick up from levels that we've seen, if you go back 12 months where it's probably more like 1.5.

So a little bit higher wage inflation, although well below, go back a couple of years, when we had a run where wage inflation was closer to 5%.

And on the other comment about managers' bonuses, it's a formula that ties both to both sales profitability and consumer satisfaction.

We have a question from the line of John Ivankoe with JP Morgan. Please go ahead.

Actually my question is related to Peter’s labor question. When we look at sales volatility at Red Lobster in September and October specifically, and I think you were surprised at the fact that customer traffic wasn't what we expected, have you encouraged the managers and perhaps the staff to react more quickly to adjusting staffing hours from what we learned on the profitability side from the sales volatility in those two months? In other words will you react more quickly to a shortfall on the labor side in the future?

That's a continuing focus for us on balancing the need to reduce the labor quickly when the guest flow is not as great as we expected but also making sure that you are staffed appropriately to serev guests that do come in. It's a continual focus for us and will remain so. There have been some changes to that. We see some improvements to that. We have very clear goals set. That remains a continual focus for us.

John, you make a valid point on the Red Lobster labor line but in addition to the inflation, the fact that we got caught short of expectations on the September/October feature meant that we had more labor hours than we would have if we had come in where we expected to be.

If you look at the balance sheet, you can see that the Olive Garden did a good job of managing the labor and they had less of a volatility issue than on expectations. We have good controls in place and [inaudible] has said that Red Lobster working on new techniques to be faster on the adjustment of labor either way.

And we have a question from the line of Mark Kalinowski with Smith Barney.

I want to make sure I have a handle on the company’s expectations for same sales restaurant sales for the back half of fiscal ‘03. 2% to 4% is what you are saying. Does that imply you expect to be at or somewhat below that in fiscal Q3 and make up for that in fiscal Q4? I'll ask my second question after that one is answered.

All we have said really is on a total second half basis, we expect to be on a blended basis, Olive Garden and Red Lobster two to four, we don't want to get into parsing the quarter. Okay?

And then the second question I have is, any early read on how seafood costs trends might be in fiscal ‘04?

No. It is still a little bit early really, given the fact that seafood, you know, costs vary quite a bit. As you know, there's a great amount of volatility. To talk about ‘04 is tough. We know how the continuing year is going to behave because we bought into the beginning of the year. Beyond that would be speculation. It doesn't have enough support.

This is Joe. I remind everybody, Red Lobster is reaching the 35th anniversary this year. We have dealt with some very large swings in seafood costs. The menu management model and the marketing teams, we adjust Those menus, there's over 100 Red Lobster menus today. We adjust those offerings in order to balance the demand side with, against the supply side, taking into account the supply availability and cost along with consumer preference. I just remind you we have, unlike any other company you are dealing with, we have a long record of dealing with seafood price changes. We are not expecting anything as major as we saw just two or three years ago.

We have a follow-up question from the line of Matthew DiFrisco with G K M.

Just two questions. On the average check given the strong success in November, are you doing anything different with the wait staff in terms of incentivizing them or giving them bonuses to the promotional dishes? Can you give us an update on the remodel programs on Olive Garden and Red Lobster, how much of it is complete, how much of it was in the comp base as a percent? Thank you.

At Red Lobster, we haven't gone to incentives. What we continue to work on is really educating servers to be proud of all our offerings and be able to help the consumer navigate the menu. You know, the incentive comes through their tips as being of service to the guest and helping the guest make good choices. We have not done that. The other question was about remodels? We have a very aggressive remodel plan at Red Lobster this year with 134 remodels. We are on schedule to complete all those.

At Olive Garden we completed the remodel program at the end of the last fiscal year. I would say in terms of incremental traffic or sales due to the remodels, we talked about the fact that at Red Lobster remodeled restaurants do about four points higher in same restaurant sales than restaurants that aren't remodeled. At Olive Garden because it is entirely remodeled it's difficult to break it out analytically at this point. At this point we do know that Olive Garden has industry-leading same restaurant sales growth and has had that consistently. The remodels are part of that. Everything that you are doing works together to make that happen. We don't believe they could be at the levels they do have without the remodels.

And we have a question from the line of Karen LeMark with Merrill Lynch Investment Management.

Could you comment on the sales trends by day part for each of the concepts and in particular talk about traffic or any indication of trading down due to fast food. Thanks.

At Olive Garden we looked at traffic and sales changes by day part by region, by time of week. We haven't noticed any significant variation from what we were seeing last year. It has been very consistent. That would suggest that there isn't any measurable dramatic trading.

At Red Lobster we look at it in a similar way. One thing we have seen is softening in our lunch business and we have initiatives going on to really increase our traffic at lunch and making sure we have offerings that meet the needs of people at lunch in terms of great offerings also served very quickly to respond to the needs at lunch.

Part of that question has to do with potential shift in dining to quick serve. I remind everybody that the casual dining experience is quite a different experience than a quick serve experience. There might be occasionally some lunch shifting going on, but if you look out over time and all kinds of economic conditions, the strong lifestyle and demographic support for the expansion of a casual dining sector is strong. It has been strong and is strong now in this situation, out performing any increases you might see in quick serve. So the notion that casual dining has to lose in an economic stress period to quick serve has not been proven out in previous economic recessions or our boom times. You can see the two operate differently and the winning companies in each of those sectors can do better, can continue to grow.

And Darden Restaurants, Olive Garden, Red Lobster are winners in the casual dining sector

We have a follow-up question from the line of Joe Buckley with Bear Stearns.

Two questions, the Red Lobster all you can eat shrimp commercial don’t seem to feature a price point. I was wondering if there's different price points around the country and what those price points might be.

Secondly, I'm curious if the coupon terms which were offering in terms of dollars off or the length of, the duration of the coupon is different this year than last.

Joe, on the first question on all you can eat, you don't see a price point. We have different price points. They are in the range of $12.99 to $14.99, depending on parts of the country, obviously. Your question on coupons, you know, we will have two this year. We will do two coupons this year. We have done the one and we have not made any changes to redemption timing or when it expires.

Let me -- and the offers.

Four dollars off in the offer, the redemption and the timing is the same.

The same thing is true at Olive Garden. The value and the terms are unchanged versus prior coupons.

You have a follow-up question from Howard Penney from SunTrust.

I want to follow up on the Smokey Bones. From your comments about the growth and when it turns profitable in 2005. It looks like call it 100 stores depending on when 2005 it opens up . Probably close to $250m in capital invested in Smokey Bones for four terms of profit. Can you put it in context, the return you are expecting to get from Smokey Bones to maybe Bahama Breeze? It seems like it's a lot of money that you invest in the concept before it actually turns –

It is a large amount of money. The reason we do that is because we have a compelling idea and it's important to be out there quickly. And it costs a fair amount to be out there quickly. But the return equation is driven by the strong unit economics. So when we do get the units built and operating and you are away from the expansion overhead to get there, you start to see some pretty impressive acceleration in terms of the P&L effect.

When we look at returns, we are looking to get returns on invested capital at Bahama Breeze and Smokey Bones that are about a point higher at minimum than what we would get from Red Lobster and Olive Garden.

Ultimately, that is driven by the unit economics of the two as much as anything

Yes, you've got to remember that we operate with a conservative accounting system in the way we look at our businesses. I'll probably say the same thing Clarence said, but please understand we are not saying it is going to be ‘05 before individual restaurants start making -- those individual restaurants come up and become profitable within a year and in many cases shorter than that. So the individual restaurants are contributing and meeting the hurdle rates as we go along. And because of the rate of growth, like Clarence said, the administrative costs associated with finding those sites and building them and developing them and then the pre-opening costs and the opening costs, all of that is what drives down the enterprise.

If you slow down the expansion, you actually speed up the profitability of the enterprise. If you slow down the expansion, then you wind up not having the full capacity, the potential of the enterprise

And our philosophy, in order to really help assure the success of the new business is, we should put in very strong, very experienced leadership and some key functions early on. And so you are seeing costs there that are much higher than you ordinarily see for restaurants of a similar size. We believe those investments are well worth it.

We have time for one more question and then we'll end the call.

We'll go to the line of Mitch Speiser with Lehman Brothers. Go ahead.

Two quick questions. First on Seasons 52, it does have, I guess, a healthy skew to it. I was wondering if you are going to have calories on the menu or if that will be something supplemental. And second, your distribution agreement or your supplier, I believe, was shifted to [Cisco] some parts of the country. I wonder if you expect any benefits or interruptions from the distribution supplier change. Thanks.

Let me answer the second part of that question first. Our distribution, we are shifting some to different firms. That shift is going extremely well. And even in light of all the snowy and weather conditions we have here, the new distribution team and the distribution companies are operating essentially well.

As far as Seasons 52, we won't talk a whole lot about what we will do there, but we wanted to have you know the fact that we are doing it. It is a sophisticated restaurant. It's a little up market casual. It has a big wine bar and our, I mention there our position is to have great tasting food that is nutritionally balanced. So every entrée that comes out will have a nutritional balance to it. It will be somewhat lower in calories than you would find in other competing restaurants.

So that is as far as we want to go on that. The taste and experience will be great and that's what we are setting out to do. It is not until February that it opens. Really it's premature to talk about it now, especially with competitors on the line.

We would like to thank you all for joining us today. If you have any further questions, you are certainly free to give us a call at Darden Restaurants. We appreciate your interest in the company. We look forward to speaking with you next quarter.

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