達登餐飲 (DRI) 2005 Q2 法說會逐字稿

Welcome to the Darden Restaurants second-quarter earnings release conference call.

At this time all participants are in a listen-only mode.

Later there will be an opportunity for questions and comments, instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Vice President of Investor Relations, Mr. Matthew Stroud.

Please go ahead.

Thank you very much.

Good morning, everybody.

With me today are Clarence Otis, Darden's CEO;

Drew Madsen, Darden's President and COO;

Linda Dimopoulos, Darden's CFO; and joining us from a remote location is Joe Lee, Darden's Chairman.

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.

These forward-looking statements could address future economic performance, restaurant openings, various financial parameters or similar matters.

By their nature forward-looking statements involve risks and uncertainties that could cause actual results to materially differ 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 taste 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 statement made by or on behalf of the Company.

A copy of our press release announcing our earnings, the Form 8-K used to file the release with 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 released second-quarter earnings yesterday evening; results were available on PRnewswire, First Call and other wire services.

For information we plan to release same restaurant sales results for fiscal December 2005, during the week beginning January 3rd.

And we plan to release same restaurant sales results for fiscal January 2005 during the week beginning January 31st.

And we plan to release fiscal 2005 third-quarter earnings and same restaurant sales for fiscal February 2005 on Wednesday, March 23rd, after the market close.

Let's begin by updating you on our second-quarter results.

Second-quarter net earnings were 43 million and diluted net EPS was 26 cents, a 44 percent increase from last year.

These and all other amounts discussed herein are being presented on a basis consistent with the restatement that the Company announced yesterday.

Olive Garden had an outstanding quarter delivering results that exceeded our expectations.

They reported solid U.S. same restaurant sales growth of 5.5 percent in the second quarter and total sales were up 8.8 percent.

Red Lobster had an outstanding quarter as well, delivering results that surpassed our expectations.

They also reported solid U.S. same restaurant sales growth of 3.4 percent in the second quarter and total sales were up 4.4 percent.

Bahama Breeze also delivered improved financial results this quarter.

These results are encouraging as the team there works to achieve Bahama Breeze's ultimate business potential, which we continue to believe is meaningful.

Smokey Bones continues to expand rapidly and to generate sales and restaurant level earnings that speak to its strong consumer acceptance.

They opened 7 restaurants this quarter, and are expecting to open 30 to 40 restaurants this fiscal year.

We announced that we now expect diluted EPS growth in the range of 10 to 15 percent for fiscal 2005, an increase from our previous guidance of 8 to 12 percent diluted EPS growth.

We remind you that there is still weather risk in the next few quarters and that we were also comparing against last year's 53 week fiscal year.

We also announced a change in our computation of straight line rent expense and the related deferred rent liability and as a result will restate our prior period financial statements.

As discussed in yesterday's 8-K filing with the SEC, this change has a modest impact on diluted net earnings per share, almost 1 cent per share this quarter, and no impact on the Company's cash flows, sales or same restaurant sales for prior periods or compliance with any covenant under our credit facility or other debt instruments.

The change is reflected in the financial results for the second quarter.

Linda will now provide detail about our financial results for the second quarter, Drew will discuss the operating company's business results, Clarence will offer some comments and then Joe will close for us.

We'll then respond to your questions.

Linda?

Thanks, Matthew.

Second-quarter operating profit increased significantly at Red Lobster and Olive Garden.

Bahama Breeze was nearly breakeven to earnings this quarter which was a meaningful year over year improvement, and Smokey Bones was more diluted in the same quarter last year due to increased pork costs and incremental marketing expense related to advertising tests we ran in several markets.

Darden's total sales increased 7.6 percent in the second quarter as a result of same restaurant sales growth at Red Lobster and Olive Garden and our operation of 40 more restaurants than in the second quarter of the prior year.

Sales were negatively impacted by approximately 1 percent due to shift of the Thanksgiving holiday from the third quarter last year to the third quarter -- to the second quarter, excuse me, this year.

In terms of margin analysis for the second quarter, food and beverage expenses were 36 basis points better than last year on a percentage of sales basis.

There are a few reasons for this -- a more favorable professional mix and reduced rates at Red Lobster and the cost savings initiative we've undertaken across our businesses.

For this fiscal year we expect Food and Beverage as a percent of sales to be lower than fiscal 2004.

We have forward contracts or hedges in place on many of our products and in some cases we purchased inventory to lock in our position.

Second-quarter labor expenses were 28 basis points lower than last year on a percentage of sales basis because a favorable sales leverage more than offset wage rate inflation.

Restaurant expenses in the second quarter were 44 basis points lower than last year on a percentage of sales basis as a result of fewer new restaurant openings this quarter, cost saving initiative at Olive Garden and Red Lobster and favorable developments in workers comp and public liability expenses.

Selling, general and administrative expenses were 11 basis points higher than last year on a percentage of sales basis due to the resolution of litigation costs related to meal and break period lawsuits in California.

These costs were a little over 1 cent or a penny for this quarter alone.

The tax rates for the second quarter were lower versus last year due to an increase in tax credits.

For fiscal 2005 we now expect the tax rate to be approximately 33 to 34 percent.

Finally, we repurchased 255 -- 256,000 shares of our common stock in the second quarter.

Since beginning our repurchase program in December of 1995 we have now repurchased 112.4 million shares under authorizations totaling 137.4 million shares.

We now expect diluted EPS growth in a range of 10 to 15 percent for fiscal 2005, this compares to the restated $1.47 in adjusted diluted EPS for fiscal 2004, excluding the asset impairment and restructuring charges we incurred.

There are still some risks to achieving this target including weather risk related to winter in the third and fourth quarters, and the fact that Red Lobster is still in transition with their promotional and marketing strategy.

As a reminder, we are comparing this year's 52 week fiscal year with last year's 53 week fiscal year.

And now I'll turn it over to Drew to comment on the operating companies.

Thank you, Linda.

Our second-order results were outstanding with excellent sales and earnings growth.

Total Company sales grew 7.6 percent and diluted EPS increased 44 percent.

Olive Garden delivered total sales growth of nearly 9 percent and record operating profit for the quarter.

They also achieved their 41st consecutive quarter of same restaurant sales growth of 5.5 percent, well above the casual dining industry average.

Olive Garden has a strong foundation for success that's built on superior in-restaurant operations and highly effective brand building.

Its strength in these areas was reflected during the quarter in record guest satisfaction and in two strong nationally advertised features, never ending pasta bowl and stuffed chicken, that drove profitable sales and guest count growth.

As Olive Garden makes its own leadership transition it's focused on continuing to improve the already strong guest experience it provides and establishing the foundation for accelerated new restaurant growth.

Red Lobster also had very solid same restaurant sales growth of over 3 percent and delivered record operating profit for the quarter.

These results reflect continued progress improving the fundamentals of their business, including stronger in-restaurant operations, more disciplined cost management and more effective advertising support.

Stronger execution on all fronts was leveraged by record guest satisfaction and a very appealing nationally advertised Endless Shrimp promotion.

We're certainly pleased with the progress Red Lobster achieved in the second quarter and will further strengthen these key business fundamentals over the coming quarters.

However, there is more work to do before they achieve their goal of being a simply great seafood restaurant and deliver a sustainable long-term business turnaround.

Clarence will comment on this further in just a moment.

Bahama Breeze also had much stronger financial performance this quarter.

These results reflect last year's closings of its most significantly underperforming restaurants, further progress reducing cost of sales and labor, the addition of lunch and menu improvements that reduced costs but also increased guest satisfaction -- all important parts of their strategy to make Bahama Breeze more accessible for everyday occasions.

Guest satisfaction continued to improve during the quarter and their new Pittsburgh prototype continues to exceed our expectations in guest satisfaction, sales and operating profit performance.

Smokey Bones continues to expand rapidly while also delivering strong guest satisfaction, demonstrating a high level of operating excellence.

Smokey Bones opened 7 more restaurants this quarter and is on target to open approximately 35 restaurants this fiscal year.

Average unit volumes are trending above $3 million per restaurant.

In an effort to determine their ultimate sales potential with national advertising support, Smokey Bones is conducting an advertising test now in several markets with early results that are very encouraging.

They're also focused on reducing the cost of new restaurants through design changes which include smaller prototypes.

Smokey Bones' year-to-date operating profit is trending slightly below earlier expectations.

We believe some of this decline is related to the recent sales strength of Red Lobster and Olive Garden as well as the impact of higher pork costs.

We now anticipate Smokey Bones will be accretive in the fourth quarter.

Seasons 52 will open two restaurants next month; the first is in Fort Lauderdale, Florida and the second is an Altamont Springs, Florida near Orlando.

We're excited about this new phase of testing for Seasons 52 and look forward to updating you on its progress.

Clarence?

Thanks, Drew.

We really are just delighted about our results this quarter -- very, very strong quarter and it really reflects good progress on a number of fronts.

Olive Garden continues to demonstrate how the 2 key pillars in our business, brilliance (ph) with the basics of in-restaurant operations and strong brand building combined to drive excellent guest satisfaction, excellent sales growth and consistent financial performance.

Red Lobster is making progress on two tracks; it's seeing steady improvement on important business basics, as Drew mentioned, and that's contributing to the improving guest satisfaction ratings and the financial results it's enjoying today.

At the same time Red Lobster is also engaged in very thorough and disciplined strategic work when it comes to thinking about the positioning of the brand and what needs to be done to translate that positioning into an enhanced guest experience.

This work is going to inform longer-term positioning changes when it comes to menu strategy, marketing strategies, people selection and training strategies and it will help them deliver even stronger guest experiences tomorrow and contribute to sustainable long-term financial success.

Bahama Breeze continues to strengthen its business and make progress on the key milestone measures of success that we've established and Smokey Bones remains a very meaningful business opportunity for Darden.

As Drew said, the guest experience there remains strong even if they continue an aggressive expansion pace.

And as we have a more meaningful base of restaurants with a reasonable amount of operating history, we continue to see average restaurant sales levels that are the foundation for very solid financial results.

Our ultimate goal, we've talked about it before, is to build a great company, one that create superior shareholder value and will last for generations.

And we believe the key is to combine brand building excellence, in-restaurant operating excellence and an outstanding operating support.

Our immediate priorities are very clear -- we're focused on achieving a sustainable Red Lobster turnaround, building a strong operating support platform and rebuilding our broader leadership pipeline following the recent moves that we've made.

We'll take the time to put this foundation for success in place and then, once we do so, we'll increasingly turn our attention to accelerating our growth with increased unit growth at our existing businesses and the introduction of new businesses whether those are internally developed or acquired.

As you've heard us say before, there is a tremendous growth opportunity in casual dining and we're committed to capturing that opportunity.

We have two established, trusted brands; two emerging growth brands; an exciting restaurant test underway; dominant market share in our industry; strong cash flows; a strong financial position; and then, most importantly, we've got the best people in the industry.

And that includes the best restaurant operators, the best marketing professionals, and the best leaders in a range of other key functions that are critical for success in casual dining.

Now I'll turn it over to Joe for some final remarks.

Thanks, Clarence.

I just wanted to say a couple things here as we get started with questions.

One is what Clarence and everyone else has stated, I'm extremely proud and feel very good about the quarter.

But in addition to that, I wanted to point out how well the transition is working.

Clarence and Drew are working as a partnership, and that partnership is being accepted throughout the Company and they're getting great support -- in part because of the way they're going about it.

They're not only taking care of business, as is evident, but they're also meeting with large numbers of people.

They've gone out into the field and met with our field officers and field employees, management in particular, they've been to general management meetings in all companies, they've had communication meetings with our support center, and all of this is being accepted extremely well.

They're garnering support and enthusiasm.

And so I think we really are on that path that Clarence talked about of being the best now and for generations.

And they're taking care of improving the functional relationships throughout the Company whether that be in marketing or operations or in accounting or finance or taxes.

All of these basic functions are getting better and are enthused -- their leaders are enthusiastic about the transition.

So with that, I will turn it back over to Matthew with the closing comment that it really has been a great quarter, but what's really most important is we're really setting up for the generations.

Matthew?

Thank you, Joe.

We'd like to take your questions right now.

Operator?

(OPERATOR INSTRUCTIONS) Robert Derrington representing Morgan Keegan.

Good morning.

Question, if you could help us understand guidance a little bit better.

I think you're talking now about earnings per share growth that's up 10 to 15 percent.

What is the base of that earnings against which that growth is compared?

Is it the $1.47 restated number or is it the $1.50?

That would be the $1.47 restated number.

Okay.

Well, the 10 to 15 percent growth on top of that basically implies $1.62 to $1.69, and your prior guidance of 8 to 12 on $1.50 implied a $1.62 to $1.68.

So given the lower tax rate, is there anything operationally that's running better than expected to give us guidance that operating returns are actually improving above expectations?

Or is it just the tax rate?

No, we are stating margin improvements, I talked about improvements in cost of sales and restaurant expenses.

And we are -- part of the impact of the restatement is an additional 3 cent in the current year as well.

So it's comparable to the prior year, but it does affect the current year approximately 3 cents also.

Great, thank you.

John Glass, CIBC.

I wanted to go back your comments about Smokey Bones and potentially being cannibalized by your other two brands.

I guess the questions are how do you know that and specifically is it your brands?

And I guess the general comment is -- it would suggest that casual dining is more a zero sum -- some brands don't do as well and others are doing better.

That's certainly not been the industry's viewpoint; maybe you could comment on that.

I'll take that one, this is Clarence.

What we see is when you have the kind of combined power that we saw in the second quarter from Red Lobster and Olive Garden is that the entire industry is affected.

And we closely follow the sales releases of our major competitors that we compete across the country against and we think we see some of that effect.

When you add to the fact that our strategy purposefully has been to locate Smokey Bones very near both Red Lobster and Olive Garden when we can and certainly one of them, and proximity definitely is a factor in a trade area when you look at competition.

So that's sort of the basis for that.

And we're certainly not suggesting that it had an outsized affect on Smokey Bones versus how it affects the industry, but the combined strength of those two operating at the levels they operated at certainly has an industrywide effect.

I think we see that when the look at the NAP track excluding Red Lobster and Olive Garden and in the second quarter that was about 1 percent against the numbers that we released.

Mark Kalinowski, Smith Barney.

I just wanted to ask Clarence -- any surprises from your perspective as you're transferring into the new role?

And then just quickly, any update on the Company's thoughts about when it might start releasing same-store sales for Smokey Bones and Bahama Breeze?

Thanks.

Well, I would tell you that -- not a lot of surprises, and I'll ask Drew to comment as well.

Both of us have been here for a long time.

Joe mentioned that one of the things that we've been doing is really getting out and trying to get to know better the general managers, the directors of operations and the restaurant companies that we weren't as familiar with.

And what I would tell you is a couple observations.

One is a just real enthusiasm in the Red Lobster operation for Kim Lopdrup and the new management team there and the direction that they're setting.

And so I see that -- just organizational confidence there is solid and I'm very happy about that, I don't know that I'm surprised but I'm certainly happy about it.

Drew, any --?

No, I would just broaden that comment to say the biggest headline for me is just very strong organization, confidence and momentum, not does with the second quarter, but as we talk about the legacy we inherit and the tremendous opportunity we've got going forward and very strong belief that we're going to capture that on a more consistent basis.

And then, Mark -- this is Matthew -- on your final question were looking to offer further results at Bahama Breeze, Smokey Bones -- particularly around same restaurant sales results -- probably as we get into the fourth quarter of this fiscal year.

Next question, please.

Jeff Omohundro, Wachovia Securities.

My question, I guess, relates to Smokey Bones and the timing of accretion which I guess has been pushed back a little bit.

Am I right in understanding that it's primarily a sales issue that you're attributing to cannibalization for that earlier question or is there something operationally as well that's going on that has moved that timing out a bit?

And then, as a follow-up -- or another question.

With what sounds like some stabilization of Bahama Breeze and some encouraging new prototype results, what's your thoughts regarding resumption of a faster growth rate at that concept?

This is Clarence again and I would say on Smokey Bones, certainly part of it is sales and we talked about that a little bit.

Pork costs are also a big part of it.

We've seen pork costs, especially on the rib product, at levels that were beyond what we had expected and that certainly affects it somewhat.

In terms of our Bahama Breeze, as Drew said, a lot of the steps that they are taking that we believe that they need to take to really make it a much more approachable everyday experience.

We're encouraged by the early results but they are still early results.

And so we want to step back and continue to look at it and see the kind of progress that we're seeing.

So it's a little premature at this point to really talk about resumption of growth.

But we hope to get there.

We hope that these improving trends in terms of some of these measures that we've got continue.

Thank you.

Larry Miller, Prudential.

I just wondered if you could provide a little more detail around that strategic you were talking about or you highlighted at Red Lobster.

I guess specifically where do you guys think you are with the new marketing and the new menu and ops improvement -- just your assessment of the business today?

This is Drew.

I would say, as was in our press release, that what we're seeing at Red Lobster is continued improvement in several key fundamentals of their business, particularly guest satisfaction, which three quarters in a row now has set a new record, improved operating efficiency and cost management and then improved advertising effectiveness.

And that really reflects their simply great discipline that Kim has talked about in the past.

On the operational side they're focused on being brilliant with the basics and things like being fully staffed and, in particular, focusing more on clean restaurants and friendly service going forward and setting higher standards, particularly for some of the lower performing restaurants.

They're also focused here at the restaurant support center on providing support that really allows restaurants to focus on the guest and the guest experience more consistently, getting it right the first time and less changes than they've experienced sometimes in the past.

Developing more effective advertising -- the Richards Group has really been a very strong partner for Red Lobster, helping them think about the brand and create commercials that are more effective; more disciplined testing that's being used by Kim and the group here, a number of things.

Designing promotions, they're a little better balanced to deliver a balanced scorecard, not just guest count growth but profitable guest count growth and high levels of guess satisfaction like their Endless Shrimp promotion.

So, all those fundamentals are strengthening and will continue to strengthen as they go forward.

And at the same time they're working on the broader strategic refinements that Clarence mentioned that will really help set them up for longer-term success.

And I would say that this parallels very much the experience that Olive Garden had, if you think about the performance and turnaround at Olive Garden where the first couple of years really were all driven by improvement in the fundamentals.

And I would just add, again, 41 consecutive quarters of same restaurant sales growth at Olive Garden over 10 years.

And Drew is absolutely right, the first 3 years or so of that really reflected just improving fundamentals.

And then when some of the strategic changes came in the growth accelerated.

And so we're certainly looking to do something very similar to that at Red Lobster.

Joe Buckley, Bear Stearns.

Thank you.

A couple of questions, first on Smokey Bones.

Everything we're hearing makes it sound like you've got potentially an emerging problem.

The date you provide in your 10-K on averaging the sales versus investment costs, some of the cautionary comments last conference call, this conference call.

Could you be a little more explicit, sort of what's going on there?

For example, do same-store sales match the NAP track 1 percent increase excluding Red Lobster and Olive Garden?

Yes, actually same restaurant sales there exceeded NAP track, and we are certainly not trying to indicate that we have any emerging problems.

When it comes to the investment levels, we made terrific progress really reducing investment levels.

We're about to open a new lower-cost prototype in the third quarter that reflects some of that progress.

And a lot of the progress we've made in reducing investment has been masked, though, just by the high construction cost environment we're in.

But we're seeing some of that start to abate already; it is at historical levels.

And so we feel good about it.

And Drew mentioned, we also feel very great about just the average sales volumes -- annual sales volumes that we're seeing at established restaurants at Smokey Bones.

And so we have great confidence in the business, the guess satisfaction results that we get back for Smokey Bones are at very high levels.

And so extremely strong guest appeal and acceptance.

And Joe -- this is Matthew -- I would just remind you, in the K you're looking at average unit investment just for the last year versus average sales volumes for the entire chain.

So you're kind of doing an apples and oranges comparison there and it's really not true to what's going on with the business.

And so what you see in the investment levels really could reflect just the weights of the kinds of markets we've gone to in the last 12 months and some of those are high construction markets compared to the total chain average which is where you're seeing the sales.

David Palmer, UBS.

Just to confirm, you said that food margin should be down in the second half of '05?

That's correct, it should be lower -- that's for the full fiscal year.

For the full fiscal year?

As a percent of sales we're expecting lower food costs as a percent of sales this year versus prior fiscal year.

Bryan Elliott, Raymond James.

You had mentioned in the press release Red Lobster had a record operating profit, could you give us some feel for the magnitude of how far away we are from Red Lobster producing a record operating margin?

I mean, are we substantially below prior margin levels or are we within a small amount or just that's -- if you can speak to that a little bit and help understand kind of where we are in the margin side of the recovery.

Sure.

Bryan, this is Linda.

We clearly are approaching an historical level for Red Lobster.

So whether we'll completely get there this year it remains unsure, but we are clearly well on our way in that range.

So -- for this quarter particularly.

Mike Smith, Oppenheimer.

Linda, could you go into a little bit the accounting change that you're making and why you took it now and what you were doing before and what you're doing now?

Sure, I'd be happy to.

We became aware that our accounting practice was not correct and so we have made this change.

And what it does is basically think up the lives of the assets -- it relates just to obviously leased properties, and we are using the same definition of lease term for amortizing our leasehold assets as we are for averaging the rent over that same period.

So the intention is to think up these lives and in the past we had been averaging rent over the -- for the most part the initial base term of the lease.

And so now we are averaging over the base term plus all of the renewable option periods.

(multiple speakers) This issue we started to really take a focused look at after we saw a competitor who had announced a change that was similar.

I guess the only reason I was questioning it was it seemed like that you were more conservative before hand than you were in the change and yet the earnings per share were restated downwards.

Well, what it basically does is averaging all your planned rent increases for the entire generally 30-year period evenly over the whole period.

So it would bring some of those expenses forward.

And the affect of that would be to bring average to rent over the whole time period, but from our current -- from our previous practice it was bringing more of that expense forward.

Matthew Difrisco, Harris Nesbitt.

Regarding the guidance I guess, not to harp on this, but it looks like in the back half of the year there is significantly less margin opportunity.

I guess can you touch on that -- where we're going to see the biggest slowdown?

And from what you just recorded I guess your second quarter of margin improvement, especially almost 100 basis points over the -- over 100 basis points at the restaurant level.

And then also just a bookkeeping -- can you update us on your plans for Olive Garden full growth for '05 and how many stores you closed in this quarter for Olive Garden?

First I'll take the back half numbers.

We would love to continue the second quarter performance of +44 percent, but it was a pretty remarkable quarter.

So we do see the third and fourth quarter more normalized.

We did talk about our emerging businesses not being quite as strong as we'd like and we did -- we're wrapping (ph) in Red Lobster.

We moved the Endless Shrimp promotion, which was in the third quarter last year, as you know was in the second quarter this year.

So we're wrapping on that performance and the third quarter which creates a little bit of risk, we have our normal winter risk and we also have the 53rd week in the fourth quarter that we're wrapping against that gives us a bit of headway.

So we certainly are not intending to say it's slowing down, we're just trying to balance it out a little bit for the year and would like to continue obviously that 44 percent but don't expect that in the back half.

And I would just say again that we're seeing very strong momentum across our businesses.

And we feel good about that and we intend to try to sustain that momentum, but it is a little unrealistic to think that 44 percent year-over-year increases will be sustained.

And on the Olive Garden question, we opened two new restaurants in the quarter; we're still anticipating 15 to 20 net new restaurants for the year with no closings during the quarter.

Steven Spence, Longbow Research.

Good morning.

I had a couple of cost questions.

Actually you mentioned the resolution of your meals and breaks suit.

I wonder if you could tell me the dollar amount that was included in G&A for that?

The dollar amount that was included this quarter for G&A was around $3 million, we said it was around 1 penny.

We had accrued some amounts in the previous quarters as well.

And then back to Smokey Bones.

I'm still a little bit confused.

You talked about the same-store sales exceeding the NAP tract and yet the average volumes are down.

So I'm wondering if it's new stores that are coming in that are bringing these down or how that -- or how cannibalization fits in with that increase in same-store sales?

We're talking about against our expectations.

Because we've talked about an expectation of being accretive for the full second half and now we see that more in the fourth quarter.

And we talked a little bit about pork costs as opposed to sales driving some of that.

On the new restaurant side we are entering markets that are different than some of the markets in the base and so that's causing some of it -- in some cases some smaller markets.

Jason Whitmer, FTN Midwest Research.

Good morning.

A couple thoughts first on your unit growth and your potential acceleration on this, how much of a benefit was it this quarter for fewer units, when do you plan to start establishing that base weather it be at Olive Garden or other brands to really accelerate the total growth?

And then lastly, just a simple question on commodity costs, where do we stand certainly on seafood, shrimp in particular?

Okay.

Let me take the opening impact, that was roughly a penny this quarter difference with reduced openings.

And in terms of accelerating new restaurant growth for Olive Garden in particular you asked -- we need to do some foundation strengthening to make sure we're set up to do that in a highly effective manner and that's mainly expanding our -- our available pool of sites to accelerate new restaurant growth.

So it wouldn't be until next fiscal year that we started seeing some of that.

And on the final question regarding commodity cost, particularly seafood and shrimp, as we said earlier here on the call, we expect our cost of goods sold as a percent of sales to be lower this fiscal year than the prior fiscal year.

We have contracts or hedges or inventory in many cases, particularly around seafood and shrimp, at fairly decent prices on a year-over-year basis so we feel pretty good about where we're at in that given the marketplace that's out there today.

So that gives us some comfort and allows us to mention that cost of food should be lower as a percent of sales year-over-year.

John Ivankoe, J.P. Morgan.

Linda, in your prepared remarks you talked about some cost savings initiatives beyond sales that were allowing improvements at COGS and restaurant operating expense.

Could you provide some more detail on that -- how far we are in that cycle and how long we'll continues to see I guess structural or the (indiscernible) type of improvements?

Thanks.

Okay, we have really some ongoing efforts across all of our business units that have been in place for a number of years.

And so this is somewhat of an ongoing effort in heavy partnership with our purchasing area that is continuing -- continuously looking for opportunities across the menu to find either synergies or savings with alternative products or rebidding or a number of other efforts really.

At this point many of them small, relatively small, but a couple hundred thousand here, a couple hundred thousand there start to really accumulate over time.

So we work very hard to do this and we do it in the spirit of really helping to take that pressure off of pricing and -- so it's a good balance approach in how we do about it.

We characterize it as something that they started in Olive Garden with invest in a guest and so it's really done in that spirit that it helps.

One of the areas that I am proud to finally see that we're showing some progress in and some favorability is in workers' comp and so that does appear to be finally showing some improvement in savings in that category as well.

Sue Prohm (ph), Avondale Partners.

You had mentioned that the food costs were going to be down year-over-year.

As we take a look at labor are we looking at anything different given the passage of a higher minimum wage rate down in Florida and Illinois and up in New York?

We will feel some pressure from those increases that will be very minimal this fiscal year for us.

And as we start developing our plans and pricing approaches for next year we will certainly take those efforts and those initiatives into consideration as we think about that.

But it is a relatively minimal impact for this fiscal year.

Thank you.

Janice Meyer, Credit Suisse First Boston.

Sorry you have to go back to Smokey Bones here, but maybe you can talk about why you do expect it to be accretive in the fourth quarter?

Talk a little maybe about the pork prices, was this a onetime event or is this a new contract?

I know you do have a back end loaded unit expansion so you'll have a little more preopening against Smokey Bones in the back half.

And I'm also assuming you think Red Lobster and Olive Garden will continue to show sales strength.

So your thoughts on why accretive?

And looking out a little further, having been through China Coast and Bahama Breeze, what's sort on your short list here for Smokey Bones that you're monitoring and what would concern you over the next three or four quarters?

I think just to start with the last question, we focus pretty closely at Smokey Bones on sales trends at the restaurants that have been open for some time.

And certainly we're looking at those, those have been strong.

And that is a good thing.

It certainly is what we'd expect given the guest satisfaction results that we're seeing there which are also strong.

As we look at the back half, Janice, certainly pork costs are something that -- we contract for those midyear.

And so, it's difficult to know going into the year what they might look like.

Fiscal '04, that contract was at pork prices where at that point those really were historical highs, we did not expect that this year would increase off those levels, but it did.

And so, that's a big part of what we're discussing.

In terms of openings, we do have more openings loaded into the back half -- although, because we'd like to get more operating leads, those are more in the third quarter than the fourth quarter.

Any other comments you might make, Matthew, Linda?

Drew?

I was just going to say that there was also a significant expenditure on advertising tests that was started in the second quarter and will continue a bit into the third quarter which did impact our original estimate to be accretive in the second half.

Good point.

Peter Oakes, Piper Jaffray.

I actually have a few questions, if I may.

First, Linda, you did talk about the two different lives that are being used on the rent expense -- or what had been two different lives.

Can you share with us what the logic was behind the two different lives?

Secondly, is there any change to the full year opening plan?

Typically you do update that in the press release and you didn't this year.

So if you could just visit that?

Smokey Bones, which, as best we can tell, the sales to investment is actually one of the lowest of the growth formats in casual dining today.

So with the lowered new unit costs that, Clarence, I think you mentioned on the prototype, how much will that help them?

And then lastly, you did mention that Red Lobster's waste reduction did enhance the margins here in the quarter.

If you could quantify that for us it would be helpful?

Thank you.

Let me take the first one.

I think the way we had looked at it in the past was not linking these two so specifically.

We had looked at the estimated useful lives of the leasehold assets and depreciated them over what we believe that to be.

And on the lease side we were averaging rents over what we thought were the periods we were committed to in each case.

And so, we felt that that was a good matching of revenues and expenses under the old accounting concepts, but the new interpretation clearly links these two of your asset lives and your lease lives and requires that they be in sync at this point.

I would say just before we get to the Red Lobster margin question -- on the prototype, as I said, we have made good progress and we've developed a couple of lower-cost prototypes, in one case 5 percentage points lower -- 5 percent lower, rather, in cost and the other 10 percent lower than what we had been using.

Again, some of those reductions we're not seeing because, in fact, the overall construction environment is up although that's starting to abate a little bit and we should see that.

And then the last question was on Red Lobster waste reduction.

Red Lobster has been focusing all year really -- for the last several quarters on an initiative called balance our business which is similar to Olive Garden's invest in the guest, a disciplined approach to take out unnecessary cost while still improving guest satisfaction.

Waste has been a part of that, restaurant expenses has also been a part of that along with the workers' compensation gain that Linda already mentioned.

So it's an ongoing initiative.

I'm not sure what the actual waste reduction was during the quarter, but it was all part of that program.

That's right.

I don't have that exact number either.

But it's clearly supported also by their "simply great" initiative which is really trying to be very mindful of when we go into these promotions to be very ready, to be very consistent, have them designed in a way that they can be executed with a high level of success both from an operational standpoint but from a guest experience standpoint.

So all of those contribute to a much more efficient use of the product in the restaurant which allows for better waste.

And then in terms of the new restaurant growth for the year, I think we're pretty much still on our plan.

We had talked for the year, Matthew, 50 to 60 net new restaurants?

And no change there.

That's correct.

Robert Derrington, Morgan Keegan.

Along the line of looking at the balance sheet and development, your cash position clearly looks strong, roughly $60 million at the end of the quarter.

And your cash flow is very substantial, the buyback obviously was less.

Would you, Clarence, look at or give us some perspective on how the Company is looking at the possibility of reviewing its dividend policy and whether there might be an increase at some point in the future?

Well, Linda talked about the fact that we're really going into our planning season for next year.

And that means that we're going to take a pretty deep dive and look at our strategy, not just next year but also multiyear, and see what our capital needs are there.

And as we look at that and think about cash flow certainly we will be mindful of what kind of cash do we have to return to shareholders.

We have really focused, been oriented, as you know, toward doing that through share repurchase.

But given some of the recent changes we'll take a close look at dividends as another way to do that.

But it's pretty early right now to talk about any change.

Larry Miller, Prudential.

I just had two follow-ups.

You gave us some expectations for what you believe Bones will do in the back half of the year.

Any thoughts on Bahama Breeze?

It was, I guess as you said, breakeven in the second quarter.

And then secondly on to go -- some of the stores I've seen, particularly at Red Lobster, have dedicated "to go" areas.

What's your thinking about "to go" right now and can you update us on the percent "to go" by brand?

Thanks.

Yes, on the percent "to go", our percentages really haven't changed all that much quarter to quarter, we'll still seeing about 6 percent of our sales at Olive Garden is "to go" sales and around 3 percent of our sales at Red Lobster is "to go" business.

And then the other big standout in the "to go" business is Smokey Bones which really generates about 7 or 8 percent of their sales -- without much effort, by the way.

We really haven't pressed the accelerator down on take out sales at Smokey Bones.

We intend to do that once we establish the operating base and get a core group of restaurants out there as we continue to grow it rapidly.

So we think there's exceptional possibilities at Smokey Bones to generate more "to go" sales business and we're pleased with the business we're getting at Red Lobster and Olive Garden.

On the specific Bahama Breeze question about earnings, they are slightly accretive in the first half.

We remain encouraged that they will be in that direction, but they may be slightly negative for the year.

I mean, we've really got to -- they're on the margin here pretty close and so they'll want to -- flip it too much either way.

But they are close to breakeven which is a meaningful improvement over the prior year which is the most important thing for us.

It's really neutralized that negative earnings impact.

Joe Buckley, Bear Stearns.

Two questions, could you talk about Red Lobster's October and then November sales changes and just put them in perspective, sort of how you view them, how you react to them?

And then, back to Smokey Bones, would you give us the sales per investment ratios for the new units if it's anything material that not indicative of what's really going on?

On the question of Red Lobster sales, first of all, October same restaurant sales for Red Lobster I believe were in the 7 to 8 percent range.

And in November they were in about the 2 percent range which was also impacted negatively by Thanksgiving -- by the Thanksgiving shift by a couple points as well.

The Endless Shrimp promotion was going on that entire time as was their focus obviously on improving the guest experience.

So we were very pleased with the overall quarter in terms of sales growth and profit growth.

We were very pleased with the guest satisfaction with the Endless Shrimp promotion -- even though it was a dollar higher than it was last year.

And so, we were very pleased.

And on the Smokey Bones, the sales to investment ratio, Joe, on the newer restaurants is roughly 1 to 1 or slightly better in some cases.

We certainly would like to see that go up and have 1.1, 1.2 to 1 and we're working towards that effort with obviously assessing marketing, advertising and as we build more restaurants and get a core again in several of these markets that makes it a little more efficient for us to do something like that.

David Palmer.

Could you give us an update on the marketing repositioning at Red Lobster?

Aren't we going to see something more dramatic in the terms of the repositioning of advertising soon?

And when it comes to menu value, do you think that you are where you need to be in providing kind of that medium priced type option anywhere from $8 to $13 entrees?

Well, first of all, I think as we've said before, the fundamentals of the business are improving substantially.

That is going to really help any brand positioning refinement we make in the future.

And, yes, you're right to say there will be some refinement in how we position the brand and the promise we make to our guests in terms of the type of experience they can expect to have at a Red Lobster.

That refinement will include an evolution in the advertising, some adjustments to their menu that will help strengthen value.

I suspect it will also lead to some refinements to staffing, training, the type of service we provide as well as some building design changes.

All those things will play out in a disciplined manner over time and build on this base that is continuing to improve.

I don't think any of those changes would lead to a -- such a dramatic repositioning of Red Lobster that it wouldn't be familiar or comfortable to its current guest, we are very mindful of that.

We are really more talking about broadening its appeal than anything else.

And that will take us a little time to make sure we do it in a thoughtful and effective manner.

Bryan Elliott, Raymond James.

I just wanted to follow up on Joe's question about Red Lobster.

I'm hearing obviously you're portraying a strong sense of confidence in the intermediate term outlook and the improvements have been made there.

I think the Red Lobster camp would still have some camp with a camp fire going in it suggest that the Endless Shrimp promotion drove sales in October, petered out some in November and how is there some visibility for Red Lobster continuing to show progress?

So if you could give I think people some insight -- the basis for your sales confidence over and above what we've seen from this first promotion in some time, I think that would be helpful.

Thank you.

Before we get to the near-term or the month to month, I just would remind you, Red Lobster is over 35 years old and Red Lobster has some of the highest average unit volumes in our business and total sales that are among the highest in our business.

So we've had people in and out of that camp.

The reason why it's 35 years old is we tend not to focus month-to-month, we really are focused on making sure that Red Lobster is able to deliver a compelling, differentiated brand promise and experience to consumers and we think about that over the long-term.

And because of that approach we are proceeding in a very thoughtful and very disciplined way, we do see the results of that progress on a month-to-month basis.

And now I'll turn it over to Drew to comment a little further.

All I would add to that is you are absolutely right to read our optimism and confidence about strengthening fundamentals at Red Lobster in the near-term and our disciplined approach to evolving the brand and refining the experience guests have in the longer-term.

But in addition, there will be some variability, as Linda said, month-to-month or quarter-to-quarter as promotion timing changes or holiday timing changes.

Like the Endless Shrimp promotion was done later last year than this year; it was done in the third quarter last year compared to the second quarter this year.

So we're not saying there won't be any movement in month-to-month results, but we will say the trend is clearly strengthening going forward.

And again, I might add just to build on that, the month-to-month is affected by things like holiday shifts, Thanksgiving, a day that we're closed, occurring in November, fiscal, this year and not last year.

It's affected by the fact that Christmas may fall on a Friday or a Saturday one year versus a Monday or a Tuesday a prior year.

So we don't really focus as much attention on marginal differences year-over-year in a month.

Operator, we have time for more question, please.

Howard Penney, Friedman Billings.

Howard?

Are you there?

Mike Smith, Oppenheimer.

I guess we'll go beat the Smokey Bones horse one more time.

You've got a number of units that you sited early in life and some old locations and I know that's one of the reasons why you're reluctant to release comps now.

But it would appear that you probably got enough of the new units with your new site selection process out there that you've watched for a couple of years now.

Is the return on investment at Smokey Bones and the operating margins at the store level if you adjust for the extra labor because you're in a growth?

Is that going to be similar to Olive Garden and Red Lobster when you get out of the growth mode?

Yes, it will.

And it will probably be -- there's a difference between Olive Garden and Red Lobster.

We hope to see it in between those two at the restaurant level, trends are good, though, at that level and so we feel pretty good about it.

The other thing I would say is Matthew talked about really looking at disclosing same restaurant sales in the fourth quarter and that's because we are beginning to build up a big enough base there that they're not distorted by the locations that don't reflect our current location strategy.

Thank you very much for listening to our call today.

As you all know, we are available for further follow-up on questions.

If you'd like to give us a call here we'll be happy to see if we can answer your questions.

Thanks again for your participation and we'll talk to you next quarter.

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