達登餐飲 (DRI) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Darden Restaurants third quarter earnings release conference call.

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

Later there will be a question-and-answer session and instructions will be given at that time.

If you do need assistance during the call today, please press the star followed by the zero.

As a reminder today's call is being recorded.

At this time I'd like to turn the conference over to Mr. Matthew Stroud.

Please go ahead, sir.

Thank you, Kent.

Good morning.

With me today are Clarence Otis, Darden's CEO, Drew Madsen, Darden's President and COO, and Linda Dimopoulos, Darden's CFO.

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 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.

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 Web site at Darden.com.

We released third quarter earnings yesterday.

Results were available on PR Newswire, First Call and other wire services.

By way of housekeeping we plan to release same-restaurant sales results for fiscal March during the week beginning April 4th, and we plan to release same-restaurant results for fiscal April 2005 during the week beginning May 2nd.

We plan to release fiscal 2005 fourth quarter earnings and same-restaurant sales for May 2005 on Monday, June 20, after the market close.

And we also plan to hold an investors and analyst meeting on June 22nd and 23rd in Orlando.

Details will be forthcoming soon.

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

Third quarter net earnings were 92.6 million and diluted net EPS was $0.56, a 24 percent increase from last year.

Olive Garden had an outstanding quarter reporting strong U.S. same-restaurant sales growth of 10.5 percent, and a 13.9 percent increase in total sales.

Red Lobster had an outstanding quarter as well with U.S. same-restaurant sales growth of 5.1 percent, and 5.4 percent increase in total sales.

Bahama Breeze' financial results this quarter were much improved as well even as the team there made great progress in its efforts to reposition Bahama Breeze to achieve its ultimate business potential, which we continue to believe is meaningful.

Smokey Bones also had a solid quarter continuing to expand rapidly while generating significant incremental sales and incremental restaurant level earnings that speak to its strong consumer acceptance.

They opened 15 restaurants this quarter and are expecting to open 35 restaurants this fiscal year.

As a result of the strong financial performance across the board this quarter, we announced that we now expect diluted EPS growth in the range of 19 to 21 percent for fiscal 2005, an increase from our previous guidance of 10 percent to 15 percent diluted EPS growth.

Linda will now provide detail about our financial results for the third quarter.

Drew will discuss the operating company's business results and then Clarence will offer some final comments.

We'll then respond to your questions.

Thanks, Matthew.

Third quarter operating profit increased significantly at both Red Lobster and Olive Garden.

Bahama Breeze was nearly breakeven in earnings which is a meaningful year-over-year improvement, and Smokey Bones restaurant level earnings were up more than 50 percent despite increased pork cost.

Even with the higher restaurant level earnings, Smokey Bones was more dilutive on an overall earnings basis than the same quarter last year, due to higher pre-opening expenses because of more new restaurant openings than last year, and the cost of advertising test we conducted in several markets this year.

We continue to expect Smokey Bones to be accretive to earnings in the fourth quarter.

Darden's total sales increased 10.8 percent in the third quarter as a result of the same-restaurant sales growth of 10.5 percent and 5.1 percent respectively at Olive Garden and Red Lobster, and our operation of 57 more restaurants than in the third quarter of last year.

More severe winter weather this year than last year negatively effected same-restaurant sales for the quarter by about 2 percentage points, which more than offset the 1 to 2 percentage points of favorable benefit due to holiday shifts, Thanksgiving, Christmas, New Year's and Valentine's Day.

In terms of marginal analysis in the third quarter, food and beverage expenses were flat to last year on a percentage of sales basis.

For fourth quarter and fiscal year, we continue to expect food and beverage as a percent of sales to be lower than fiscal 2004, because 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.

Third quarter labor expenses were 18 basis points higher than last year on a percentage of sales basis because of increased bonus expenses associated with stronger sales and earnings growth, as well as some new service initiatives at both Red Lobster and Olive Garden which were roughly 2.5 million or about $0.01per share.

Restaurant expenses in the third quarter were 28 basis points lower than last year on a percentage of sales basis as a result of favorable Workers' Compensation and public liability expense, sales leverage, and other cost savings initiatives.

These items were partially offset by higher utility costs, which was about 5.3 million, or $0.02 per share, new restaurant expenses, because we opened 15 more restaurants this quarter, which equates about $2.5 million or $0.01 per share at Olive Garden and Smokey Bones, and higher discretionary repairs at Red Lobster and Olive Garden, which was an additional 2.5 million or $0.01 per share.

Selling, general, and administrative expenses were 5 basis points higher than last year on a percentage of sales basis due to slightly higher G&A expenses as a result of impairment expenses associated with two restaurants, one Red Lobster and one Olive Garden.

This incremental expense adversely impacted dilutive net EPS by approximately $0.01.

The tax rate for the third quarter was lower than last year by about 160 basis points because of an increase in tax credits and the favorable resolution of prior year tax matters benefiting diluted EPS this quarter compared to prior year by about $0.01.

For fiscal 2005 we now expect the tax rate to be approximately 32 percent to 32.5 percent.

Finally, we repurchased almost 3.7 million shares of our common stock in the third quarter.

Since beginning our repurchase program in December of 1995, we have now repurchased 116.1 million shares under authorizations totaling 137.4 million shares.

As Matthew said, we now expect diluted EPS growth in the range of 19 to 21 percent for fiscal 2005.

That compares to a restated $1.47 in adjusted diluted EPS for fiscal 2004, which excludes the asset impairment and restructuring charges we incurred last year.

This is exceptional growth since fiscal 2004 was a 53-week year.

On an apples-to-apples 52-week basis the diluted EPS growth we project comes to 22 to 24 percent.

And now Drew's going to comment on the operating companies.

Thank you, Linda.

Olive Garden delivered another exceptional quarter with total sales growth of nearly 14 percent, double-digit operating profit growth that set a new record, and outstanding returns.

They also delivered their 42nd consecutive quarter of same-restaurant sales growth with an increase of 10.5 percent, which was dramatically above the casual dining industry average.

We remain very confident in the ability of Olive Garden to continue to perform at an industry leading level.

They have a unique and broadly appealing brand promise which is to make their guests feel like they are part of an idealized Italian family meal, and they deliver on that promise with superior in-restaurant operations and highly effective marketing that creates enduring guest loyalty.

More specifically, over the next several months Olive Garden is focused on ensuring an effective leadership transition, further strengthening the service-related aspects of their guest experience, and introducing innovative new advertising and dishes that build traffic in the short-term and strengthens their brand image over time.

Olive Garden is also taking the steps necessary to accelerate new restaurant growth.

This includes developing a portfolio of prototypes for different market opportunities and strengthening their site pipeline.

Given Olive Garden's outstanding performance and their strong business model, stepping up new restaurant growth is clearly an appropriate strategic priority.

Red Lobster also had a very strong quarter.

Same-restaurant sales were up 5.1 percent despite lapping a powerful endless shrimp promotion for seven of thirteen weeks in the quarter.

This was the second consecutive quarter of same-restaurant sales growth that exceeded the industry, and the fourth consecutive quarter of financial performance that met or exceeded our expectations.

Red Lobster has significantly improved their guest experience, advertising effectiveness, and cost management.

Their entire company is now focused on delighting guests with a simply great seafood experience with fresh, craveable seafood and friendly welcoming service.

On February 8th they introduced a base menu which includes three new items priced in the 10 to $15 range, grilled shrimp skewers, jumbo parrot baked coconut shrimp, and jumbo crunch fried shrimp.

The new menu also positions items with strong value ratings in the most visible locations.

And 12 items with low guest satisfaction were eliminated from the menu as part of an ongoing effort to simplify restaurant operations and consistently execute at a higher level.

Red Lobster's guest satisfaction was at record levels during the quarter, significantly improved from last year.

In addition, they have now completed the intentional promotional mismatches that caused large swings in comparable restaurant sales during the first three quarters of the fiscal year.

Given this foundation we expect Red Lobster to deliver more consistent sales and earnings growth and we're confident that they're on a solid path to competitively superior performance.

Bahama Breeze also had much stronger financial performance this quarter which approached breakeven levels.

These results reflect further progress on important parts of the strategy to make Bahama Breeze more accessible for every day occasions, as well as last year's closing of their most significantly underperforming restaurants.

Among other things, Bahama Breeze has reduced cost of sales and labor by making improvements to their core menu and as they've taken these steps also increased guest satisfaction.

Finally, Smokey Bones continues to expand rapidly while also delivering strong guest satisfaction.

In fact, it is the highest among all of our operating companies.

Smokey Bones opened 15 more restaurants this quarter and is on target to open approximately 35 restaurants this fiscal year.

Average sales volume per restaurant remains solid at above $3 million, and as Linda mentioned earlier, with its expansion, total sales and restaurant level earnings are up nicely.

We've begun testing television advertising and based on the good results to date Smokey Bones will expand their advertising test to several additional markets in the fourth quarter.

Seasons 52 also opened two restaurants in the third quarter.

The first is in Ft. Lauderdale, Florida, and the second is in Altamonte 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 in the future.

Clarence.

Clarence Otis, Jr., Jr.: Thanks, Drew.

Darden's overall results this quarter reflect just good progress on a number of fronts and puts us firmly on a path towards capturing the exciting long-term opportunity in casual dining.

This was truly an outstanding quarter for the company with excellent financial results even as we took the opportunity to make investments to strengthen our business for the long-term that had some effect on our P&L for the quarter.

All of our operating companies enjoyed good success.

Olive Garden's the leader in casual dining companies of size.

Red Lobster's made great progress on key business fundamentals, Bahama Breeze is on its way to being accretive for the fiscal year, and Smokey Bones continues to expand, growing rapidly while maintaining a very, very strong guest experience.

Our ultimate goal is to build a great company, one that creates superior shareholder value and will last for generations.

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

With two established and trusted brands, two emerging growth brands, and an exciting restaurant test underway, dominant market share in our industry, strong cash flows and financial position in general, and most importantly with the best people in the industry, we believe we have everything it takes to be the best in casual dining now and for generations.

And with that let us take your questions.

Thank you very much.

And ladies and gentlemen if you do wish to ask a question, please press the star followed by the one on your touch-tone phone.

We do ask today that you please limit yourself to one question per turn followed by one follow-up.

So again, if you have a question, please press star followed by one at this time.

Our first question in queue comes from the line of David Palmer with UBS.

Please go ahead.

Hey, guys.

Congratulations on a great quarter.

First, well, actually, I'll just keep it at one question, like the guy requested.

With sales, I guess with Olive Garden it's particularly impressive that you're generating this sort of same-store sales growth with sales per unit pushing 4 million.

This sort of transaction growth, I mean, it sort of boggles the mind.

Are you doing things on the table turn side of things?

How are you effectively expanding capacity to get this sort of growth?

Well, Olive Garden's performance in the quarter was just tremendous, and there are a number of things that are behind that.

Certainly a very strong brand, as I said earlier, great in-restaurant operations and great marketing.

In terms of how we handle that increasing level of guest traffic, that's a great question.

As background to that, you should know that our busiest restaurants, in terms of absolute guest counts, are historically our highest guest satisfaction restaurants as well because it typically reflects great in-restaurant management.

In addition, we are looking at things to make sure that we provide a great experience but eliminate any unnecessary waits or any inefficiency in the experience that we can.

Everything from the way we greet people in the lobby to being more efficient with how we seat people, to pace of meal once they get to their table, and then not having to wait for a check unnecessarily once the experience is done.

A number of those things we're handling in a fairly traditional manner, in terms of restaurant training, and some of those are being abled with new technology that we're working through the system and those are the things that we're looking at.

Thank you.

Thanks.

We do have a question then from the line of Jeffrey Bernstein with Lehman Brothers.

Please go ahead.

Great.

Thanks.

Good morning.

Questions on Red Lobster.

February comps obviously very strong and the management has noted on several occasions of top near-term priority of driving sustainable success at Red Lobster.

While February was strong I know you had mentioned we've seen traffic run both double-digit positive as well as double-digit negative over the past few years.

Can you share more details on the progress surrounding initiatives to achieve the more consistent less volatile sales growth?

I know you mentioned something about promotion mismatches.

So I was looking for more details on that.

Yes.

The promotion mismatches I was talking about were this quarter and the third quarter we advertised jumbo shrimp.

Last year in the third quarter, particularly in January, we advertised endless shrimp, which was a very different type of promotion and contributed to a big swing in same-restaurant performance.

Going forward we don't see that we're going to have those sorts of promotional mismatches that would, by themselves, produce big changes in traffic that are difficult to understand, perhaps, externally but also difficult to handle in-restaurant, and that's the biggest reason that we're not doing it.

Red Lobster's made significant progress in the business fundamentals that we think are most important to running a successful restaurant company over time.

That all starts with guest experience, number one, which is at record levels, eliminating non-value-added costs that really strengths our business model without impacting the guest experience, number two.

And then improving their advertising and management of their brand across all guest touch points, number three.

And I touched on those a little bit earlier.

Given those improvements and the fact that we don't have the intentional mismatches that we've now worked our way past, on top of the strong heritage that Red Lobster has and the strong unit volumes that they have, near the top of the industry, 3.5 million to 3.6 million, we feel that Red Lobster does have the foundation to deliver more consistent sales and earnings growth going forward, but importantly we also believe that there is still a significant opportunity for Red Lobster to become even stronger.

You've heard us talk in the past about a simply great operating discipline, and that operating discipline is going to lead to further improvement in guest satisfaction, further improvement in value perception among their guests, further improvement in unit economics and Red Lobster's brand relevance and breadth of appeal will also continued to be strengthened by continued evolution in their menu and in their advertising.

I touched on a few things that they did in their menu in February and they will be doing more of that over the next several quarter as we go forward.

Thank you.

And we do have a question then from the line of John Glass with CIBC.

Please go ahead.

Thanks.

Good morning.

You commend in the commentary about service initiatives and discretionary repairs that impacted the quarter.

Could you maybe just elaborate on what those are, what brands they are at, and maybe how long we would expect them to persist?

Yes, John.

This is Linda.

There was really some initiatives across both Red Lobster and Olive Garden.

I would say in the service front it was more focused in Olive Garden.

They certainly saw the momentum coming out of the second quarter and invested in a number of specific things around the lobby and handling that increased level of guest traffic that they experienced, and on the repair side it was more heavily influenced on the Red Lobster side and really getting those, as Drew side, working across many fronts but one of them was really getting all those facilities in great looking shape.

And it persists through, is this one quarter?

Is this an ongoing effort?

It is likely, at some level we will continue to make appropriate investments.

As long as we're at this level of performance and see this kind of momentum we would expect to continue to improve the facilities and make investments to keep the level of performance going on at both Red Lobster and Olive Garden.

A follow-up on that, some of the investment at Olive Garden was a conscious investment to ensure a great experience and great service in a period that we anticipated we'd have higher volume, particularly heading into the holidays in December, and we've learned that we need to be appropriately staffed to deliver a tremendous experience when guest counts are going to pick up early in the quarter like that.

Clarence Otis, Jr., Jr.: I think that's an important point, that it really is about making sure that we're in touch with the rhythm of the business and doing things, so it's not necessarily that it's ongoing every week of the year.

Very similarly at Red Lobster there is a need to make sure that our restaurants are really at their absolute best when it comes to fit and finish and there was a little bit of catch-up that we decided to do this quarter, although obviously that's something that we want to do on an ongoing basis.

This quarter's expenditures were a little bit more extraordinary from that perspective.

Thank you very much.

And we do have a question then from the line of Larry Miller with Prudential Securities.

Please go ahead.

Thanks.

Drew, in your commentary you mentioned maybe accelerating Olive Garden unit growth.

I think you guys had targeted a potential for Olive Garden of about 700 units.

Are you now thinking it could be larger?

And can you give us some details as to why that might be?

Hey, Larry.

Well, obviously, we have been very pleased with Olive Garden's overall performance and the performance of our new restaurants, and given that, we think it's appropriate to accelerate our openings.

We're laying the foundation for that now in terms of developing a portfolio of prototypes that can help us penetrate different types of markets and different kinds of site opportunities to develop that sort of pipeline.

We've been opening, this year we said we'd open in the 15 to 20 range.

We've been a little bit above that in the last year or two, and I think we'll be getting into more detail and what we think the absolute potential is going to be going forward.

And we do think it's more than 700 at this point, considerably over 700.

Larry, we're going to give you more clarity on this and some other issues [inaudible] growth certainly at the end of the quarter when we look forward to next year as well as at the analyst day we're going to hold in June.

So we'll be able to dimensionalize that a little more for you.

Okay.

Thank you guys.

Thanks.

And we have a question then from the line of Jeff Omohundro with Wachovia.

Please go ahead.

More detail on Smokey Bones and flipping over to accretion expected in Q4.

Should we expect it to grow from Q4 into next year and do you think the level of infrastructure supporting the brand is adequate to support the unit growth rate as we move into next year?

Thanks.

I'll take it from the financial perspective.

We do expect that to continue to grow into next year and continue strengthening their performance particularly against this current year and we do believe we have, for the most part, the infrastructure in place to do the kind of growth we anticipate.

Drew, you want to elaborate?

I would just give a little more, I guess, insight onto the things that we're looking at, at Smokey Bones, because we do believe Smokey Bones represents a significant growth opportunity for us and because of that we're going to make sure that we have the appropriate infrastructure to do what we need to do.

Smokey Bones delivers a unique experience that guests love.

They love the award winning barbecue, they love the friendly service, they love the energetic atmosphere.

And as we said earlier in our comments, the team at Smokey Bones has done a great job delivering a very strong experience even while they've rapidly expanded the business.

But going forward to really capture the full potential of that business we're focused on doing two things.

One is making further improvement to the non-barbecue items on the menu to ensure that we maximize our breadth of appeal in terms of guest base and potential occasions that that business can satisfy, and then second by developing a lower cost prototype that does provide the environment for a fantastic experience, but also does that at a more appropriate investment level and there's a couple of prototypes that have been developed to do just that so we do think we have the appropriate infrastructure to do those two things and really capture the potential of the business.

Clarence Otis, Jr., Jr.: And if I might add, Larry, as you know, I mean, really, our philosophy has been to have an infrastructure that we can grow into, if you will.

So, really, experienced leaders beyond what might be needed if we were just looking at 40 or 50 restaurants, and leaders that are capable of running a restaurant company of scale, having training systems that we could grow into, and the rest.

So when you talk about infrastructure from that perspective that's where we are, and so we certainly believe that we have the infrastructure that we need going forward.

It won't need to increase, and so we'll see the advantages now financially of growing into that infrastructure.

From a guest experience perspective, we've always seen those advantages.

Again, as Drew mentioned, very strong guest satisfaction results at Smokey Bones, the best among our operating companies, and that's a significant accomplishment given just how strong Olive Garden is.

Great.

Thank you.

Thanks.

And we have a question then from Mike Smith with Oppenheimer.

Please go ahead.

Well, good morning.

Bahama Breeze, the tone of your comments would indicate that it might get out of the penalty box after you've lived with the Pittsburgh store for a year.

Can you tell me how fast you might expand that if that is in fact ---

Mike, I'll let Drew answer that question.

We were just laughing a little bit at the penalty box characterization but now that we've gathered ourselves we'll answer your question.

Bahama Breeze has made considerable improvement over the course of the year, primarily in reducing complexity in their business model that has strengthened their financial performance and has not interfered at all with the guest experience that they've provided.

In fact, their guest experience has actually improved during the course of the year.

So we continue to reduce the business complexity they have as an ongoing priority but we also want to make the business more appropriate and more accessible for everyday usage, and that's why we added lunch over the course of the last year.

We're making some menu refinements to deliver the brand promise but do it in a more approachable way.

And in the near term, at least, we're not planning on any significant increase in units there until we make further progress on that second priority.

Thank you.

Thanks.

We have a question then from the line of Jason Whitmer with FTN Research.

Please go ahead.

Good morning.

I wanted to follow-up again on Smokey Bones, considering you're now quite a sizable brand at over 100 units and the profitability I guess within the unit economics, if you take out the overhead and the expansion, do you feel like you're at the right pace here, do you see the light at the end of the tunnel considering what you experienced with Bahama Breeze some eight years ago, relative to starting off strong and then having to tweak things here and there with the investment costs relative to the store operations?

Clarence Otis, Jr.: Jason, let me just start and I would say we feel very good.

You're absolutely focused on the level that we focus on, which is restaurant level earnings.

And the restaurant level earnings at Smokey Bones are very solid, and moving in the right direction from our perspective.

For this year, there has been a penalty there because of pork costs, which are at very, very high levels, but net-net when you take away the things like pork costs that fluctuate up and down and you look more structurally we see very solid, solid results at the restaurant level earnings.

I don't know that would add anything more to the previous conversation.

We do think we have the structure in place, we're going to continue with our expansion pace and there are obviously new learnings that we continue to reinvest those as we move forward and so we think we've got a good business model in terms of progressing.

Drew, you want to make any other comments?

Okay.

Thank you.

Thank you.

And we do have a question then from the line of Stephen Spence with Longbow Research.

Please go ahead.

Good morning and congratulations, folks, on a good quarter.

I also had a question on Smokey Bones.

You had mentioned in your remarks that you saw the average unit volumes above $3 million based on this quarter.

And I wonder, that's still lower, isn't it, than last year?

I wonder if you could address that and also the performance of the newer units that have been opening, whether those are opening at volumes similar to those that you've seen in the past and what you're thinking is about those volumes in relation to the new prototypes, then.

Let me start off, and what I would say is we talked actually last year we mentioned that average unit volumes were roughly $3.2 million, and we haven't talked specifically about where those are for this year, we want to see the fourth quarter.

We don't expect a significant variation from that on a year-over-year basis.

In terms of restaurant openings, we're seeing new restaurants, when you look at comparable regions, and there are regional disparities, but when you look at comparable region, an older restaurant in a certain region, new restaurants in that region, our regions of strength, we're seeing actually higher openings in terms of sales.

In the regions that are not as strong, we're seeing them about the same, and so we're feeling pretty good about what we're seeing on the sales side with Smokey Bones.

Okay.

Terrific.

Thank you.

That's helpful.

Thank you.

And we have a question then from the line of Joe Buckley with Bear Stearns.

Please go ahead.

Thank you.

Just question on Red Lobster just trying to put Red Lobster in perspective in terms of where it is in terms of your turnaround efforts.

Can you talk about margins?

I know you talked about near record profit levels but talk about margins at Red Lobster, where they are versus maybe where they were at peak levels and whether you think you can get to those levels or surpass those levels again.

This is Linda.

Hi, Joe.

Yes, we are approaching levels that we have certainly seen since we've been a public company and so we would expect to reach or exceed absolute levels and so we are continuing to make meaningful progress.

I mean, we're clearly happy with the progress we're making.

We've seen higher margins back 15 to 20 years ago but in its recent history they are approaching those levels of margin and performance and we certainly have expectations of moving beyond that.

Clarence Otis, Jr.: I would just say, again, Linda's answer is, what do you mean by peak?

If you go back over the 37-year history, certainly they're not there yet.

If you go back over our history as a public company they're close.

It seems a year ago that there's a lot of cost reduction at Red Lobster and if I'm not mistaken, profits got better before sales got better at Red Lobster.

That's correct.

Now it sounds like you're putting more costs back into the business.

Can you explain what's going on at the costs level?

We're not, I mean, we're doing the repairs and those sort of things, that's the one area and we are strengthening some of our labor areas minimally there, but there is not a heavy cost investments it's really focused on efficiency and getting the complexity out of there.

Yeah, and, in fact, I would just say that the focus is on really creating a very strong foundation that will support continued future growth, and it is not at all dissimilar to, in terms of thinking about the turnaround at Olive Garden going back several years starting more in the mid-90s where profitability started to improve before sales started to improve and Red Lobster has passed that as you've seen the last two quarters with same-restaurant sales growth over the last six months.

The costs that we're taking out of the business is costs that we don't believe contributes meaningfully to the guest experience or to the employee experience, and by taking that out we can strengthen the unit economics and we can look to reinvest it elsewhere in a way that's going to produce much more sustainable performance going forward.

What would be some examples of those costs?

There's a very long list.

There's no single thing that accounts for a lot of it, it's doing all the little things.

It's making sure that you staff appropriately, it's making sure that you get people on the clock at the right time and off the clock at the right time, that you estimate food par levels right, that your waste is controlled, all the little things in small wares that can add up.

There's no one single thing, but it's taking out all the non-value-added costs that can creep into a business over time and not contribute meaningfully to what your brand stands for or what your team needs to be set up for success in delivering that experience.

So it's just a lot of things, a lot of little things that add up to a substantial improvement.

Thanks.

And we do have a question then from the line of Steven Kron with Goldman Sachs.

Please go ahead.

Thank you.

Good morning.

I had a question on Red Lobster and kind of a bigger picture question as we look as to the refined strategy you guys have in place, kind of less specials going forward and new menu items at different price points, can you talk to us a little bit about what you've learned about your customer during this turnaround period and particularly with regards to their price sensitivity?

And do you feel as though you may be appealing to a different customer profile today than maybe what you add couple years back?

Well, I guess the first point would be we've learned that our guests love Red Lobster.

It's been around more than 36 years, it dominates the seafood segment, it's got very high average unit sales at $3.6 million.

And when we think about price sensitivity, of that guest base, I guess I'd say two things.

Number one, we think about value first, and delivering great value to our guests is really going to be driven more by continuing to deliver a much better and much more consistent guest experience than we have in the past.

It's been much better the last six or nine months and we need to continue to do that to make sure we're delivering superior value.

The second point on value is not so much lower pricing as it is making sure we have a menu that offers a range of price points that can support a range of occasions and can support a broad range of guests.

That's why three dishes were added in February that were more middle of the menu sort of price points and three dishes that are high satisfaction as well, and that's the sort of thing that we'll continue to do going forward.

The menu changes in the future are not going to be revolutionary changes.

They're going to be more evolutionary changes that continue to broaden the appeal of the menu, offer a range of price points, and can be delivered at a very high level in terms of guest satisfaction consistently.

Okay.

If I could just ask another quick one on Smokey Bones.

You've obviously in the prepared remarks talked quite a bit about rapid expansion, and a couple of the questions here have related to AUVs, but just, if I think back to last call and the comments that Clarence made as to the successes of Red Lobster and Olive Garden, perhaps eating a little bit into the success at Smokey Bones, are you still seeing that kind of give and take amongst your three brands?

Let me start just by maybe clarifying a little bit, because I don't know that I fully expanded the thought on the last call but really, we work very hard to make sure that when we develop a new concept, it's differentiated from our existing concepts and really speaks to a different set of dining occasions.

We certainly see evidence that that's the case with Bahama Breeze, with Smokey Bones, with Seasons 52 when you compare them to Red Lobster and Olive Garden and when you compare them to each other.

That said, our strategy with Smokey Bones has been largely to locate them more recently pretty close to Red Lobster and Olive Garden, and proximity matters in our business.

And so when you're approximate to another restaurant concept in casual dining, even if the occasions are somewhat different, or significantly different, there will be some overlap of customers, and we've seen that.

And so it's primarily driven by proximity.

We've had very solid results at Smokey Bones for the third quarter.

Could those have been even stronger if Red Lobster and Olive Garden weren't at 10.5 percent comps and 5.1 percent comps?

Probably.

But that's a trade we'll take.

Thanks.

And we do have a question then from the line of Hil Davis with SunTrust.

Please go ahead.

Hi.

When you look at Red Lobster traffic trends on a two-year basis, this is the first time since August of 2004 that Red Lobster has basically had positive traffic on a two-year basis and looking forward Red Lobster is lapping negative two-year traffic trends until February of '06.

I guess my question is, the first question is, how much of the two-year traffic deterioration was from your core user versus your medium user and your light user?

And given this, and given the overall increase in the guest experience that's probably more in line with the average check, how much of the core customer have kind of reduced their frequency and what is the implied traffic, or potential traffic gains if you recapture that lost core guest frequency and also if you recapture maybe a medium and heavy guest frequency?

Well, I'm not sure where to begin there, but you're asking a question that's very important for everyone to understand because we do believe there is potential for Red Lobster to continue to deliver consistent growth in sales and earnings.

One of the reasons for that is we think we can broaden the appeal of Red Lobster by attracting new users over time.

In terms of specifically how the heavy users versus medium users versus light users compare and the frequency within each of those three groups, that's a difficult question to answer quickly.

I would say that over time, the people who are not coming to Red Lobster as frequently now as they might have three or four years ago, chances are were lighter users that just found what they were looking for elsewhere and Red Lobster needs to do a better job offering a range of flavors, interesting flavors, a range of price points at a higher level of execution to attract a broader audience like that, and that really is a big part of their thinking going forward but I'm not sure that I could characterize the frequency by group, meaningfully, for you now.

I guess how much of the deterioration of traffic has been that core customer maybe that instead of coming every three or four times a year has reduced it to two times because it was either too expensive, the guest experience wasn't in line with the check or above the check, and is there a lot of recapture potential there where you don't even to have go after that light user right now, you just have to solidify your core base, and then how much of that also might be needed in terms of maintenance Cap Ex and or increasing the manager level?

Well, I think a substantial part of decline over time was from our biggest user group, and so a big part of our growth going forward will be from recapturing our biggest user group and their frequency.

So I do think that is an opportunity.

Great.

Thank you very much.

Thanks.

And we do have a question then from the line of Peter Oakes with Piper Jaffray.

Please go ahead.

Hi.

Good morning.

Actually I have a clarification query on a prior question, then I have another one.

The clarification is, of the one-timers that Linda mentioned that were there in the third quarter, one of which was the stepped up service initiatives which basically sounds like increased staffing, why wouldn't that have some residual components on a go-forward basis?

And then the other question is, as you're laying the groundwork for stepped up expansion at Olive Garden, how much of your thought process includes working on lowering the cost of the prototype similar to the success you've seen with Smokey Bones?

Thanks.

On the first part of the question, on one-time service investments, the service investment that was made during the third quarter, at least at Olive Garden, was more a seasonal investment, those related to an expected increase in guest counts and traffic, and we needed to make sure that we were staffed appropriately to handle that level of volume.

That's not something that necessarily will maintain itself every week, every month.

We adjust our staffing based on expected volume patterns, so that's not necessarily something that we'll sustain.

And then the second question was --

Prototype.

Oh, prototype, yeah.

We do think that we're going to have to develop a range of prototype options for Olive Garden similar to what Smokey Bones has done to make sure we can match the appropriate investment level with the size of the market opportunity or site opportunity that we're looking at, particularly for smaller markets, medium size and smaller markets.

So there will be some lower cost work being done to facilitate Olive Garden's expansion.

Okay.

Thank you.

Thanks.

And we do have a question then from the line of Mark Wiltamuth with Morgan Stanley.

Please go ahead.

Hi.

Good morning.

Could you tell us if there's been any response back yet on those new menu items at Red Lobster and also if you could give us more color on what was driving the traffic lift of about 7 percent for February for Red Lobster?

I think it's too soon to characterize reaction on those three items although we've been pleased with the sales of the three items.

We haven't collected the guest satisfaction information yet and the sales strength was really being driven by an improved guest experience and improved fundamentals in the business as we've talked about.

Okay.

Thank you.

Thanks.

And we have a question then, a follow-up question from the line of David Palmer with UBS.

Please go ahead.

Hey, Drew, I guess it's really a follow-up on what you just said there with regard to you've made a couple comments, one was the evolutionary nature of the changes with regard to menu, and then you said the guest experience is improving.

Is there any way that you can maybe provide a little bit more detail on what changes in particular are driving that customer satisfaction improvement?

Maybe just, maybe dig out a couple more details for us on the Red Lobster brand.

For Red Lobster as well as Olive Garden and the other businesses here at Darden we measure guest satisfaction in restaurant weekly on a range of attributes, eight or nine attributes, everything from temperature of food, taste of food, server attentiveness, pace of meal, a number of dimensions, and every single one of those dimensions has improved measurably for Red Lobster and is well above prior year levels and at or very near record levels.

So it's really been a comprehensive improvement in the guest experience at Red Lobster that's leading to a bit, what we would call a base business improvement, which is much more sustainable as opposed to a promotionally driven increase in sales and traffic for a month or two.

And just one quick follow-up.

With regard to the margins at Red Lobster, is at fair characterization to say that your sales increased over time at Red Lobster but a lot of that was with these limited-time offers and that caused perhaps kind of a tough-to-measure type of drag on food costs and labor, food and labor waste and that sort of more efficient scheduling, and from a food and labor side is perhaps where you're seeing the most margin upside in addition to sales going forward?

Well there's no question that part of the simply great operating discipline at Red Lobster is to try and have more consistent, predictable growth in sales so that we can deliver a better experience and so that we can manage costs better relative to big increases and big decreases month-to-month that are promotionally driven, so I think you're right in terms of how you're characterizing the source of growth and what the implications of that growth are for the way we run our restaurants and the margin that they're able to produce.

I would agree and add to that.

I mean that churn and that range of promotional tactics from the more deep discounting creates a certain amount of churn and that's a great deal of how we've been able to remove much of that cost from their structure and improve their business model meaningfully.

Clarence Otis, Jr.: And I would just, responding to your first question, really as you talk about a little bit more color in terms of the guest satisfaction attributes that are really where we're seeing the most progress at Red Lobster, Drew said it all.

I mean we're really seeing it across the board on all attributes, but as we bucket attributes in broad categories, food, service, and then the value and atmosphere components of that, I'd say the service piece of it and the atmosphere and value pieces of it have seen even more progress than the food side, and those are very difficult things to move.

Much tougher to move, in fact, than food, and so we really feel great about what Kim and the team at Red Lobster have been able to do.

Thanks.

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

Please go ahead.

Hi.

Two quick questions, actually.

First on the tax rate goal, just want to make sure I understood.

Does the 32 to 32.5 percent apply just to fiscal '05 as a whole or can we also take that as your goal for fiscal years going forward?

And then second, I actually just did not quite catch the data of the next earnings release.

Thanks.

I'll take that first question.

I didn't get your last question.

But in terms of the guidance for the tax rate, that is for this year.

It will be similar to the range that we, in '04, and we are working on really our information and would be more specific around next year at our June meeting, but I would not expect it to remain at this level.

And Mark, the next earnings release will be on Monday, June 20th.

Okay.

After the market close.

Just a clarification.

When you say would you not expect the tax rate to stay at this level, you're talking specifically the low tax rate in fiscal Q3 you don't expect.

That's correct.

Okay.

Great.

Thank you.

Thanks.

And we do have a question then from the line of Larry Miller with Prudential Securities.

Please go ahead.

Yeah, hi.

Thanks.

Clarence, just first, maybe a bigger picture question.

I wonder if you can kind of give us your thoughts on some of the strength we've been seeing across casual dining in general and maybe what you think the larger drivers are?

And then I have a couple of quick follow-ups on Red Lobster.

Clarence Otis, Jr.: I think we've talked generally about some of the drivers of casual dining long-term structural drivers, and it's been an industry, if you look back ten years, that has had great growth given its scale, upper single-digit kind of growth, a little bit slower if you look back over the last five years, more mid single digit, and some of that really had to do, over the last five years, with macroeconomic sort of environment, a slowdown.

And the economy is certainly strengthening and we're seeing the effect of those longer term growth drivers.

They have to do with increasing time pressure across all demographic groups.

They have to do with the aging U.S. population and people really moving into the age cohort, the 50s, where they use casual dining more, and that's just been the case historically, and it's driven by the fact that those are peak disposable income years and they're also the years where people have a lot more free time with children out of the house.

Other things that continue to matter is certainly continuing growth in the participation of women in the work force, not growing at the levels that it's grown at in the past, but still growing.

That drives increased household income, it also is one of those things that puts time pressure on people, so all of those fundamentals are certainly there.

They've been masked probably a little bit by overall macroeconomic weakness or uncertainty in the case of some of the geopolitical issues.

We're starting to see some of that clear away.

I also think the best operators in the business, the best multiunit operators continue to do a better and better job.

They continue to do a better job in terms of guest experiences they provide, continue to do a better job managing their brands, and that includes advertising but includes all consumer touch points and so people are responding to that as well.

And speaking about advertising, that was my second question.

I'm starting to see your little familiar tune on the Red Lobster brand campaign.

Is that the one you're going to settle in at?

And then two other questions on Red Lobster.

I was just curious about the earlier start to Lent this year, how much that might have helped.

And just on the guest satisfaction scores, are you still seeing an acceleration in guest satisfaction scores or are they starting to peak out at Red Lobster?

I'll take the first and the third there.

On the advertising campaign, Red Lobster has been working with the Richards Group in Dallas now for over a year.

The campaign they've got they call, "Ignite the Crave" and it really is speaking to the unique craveability of seafood in general, shellfish in particular, and that is obviously resonating well with their guests.

That is going to continue.

We're obviously always looking to raise the bar and see if we can't improve our advertising, and I think there probably is an opportunity, not a need, but an opportunity to broad their message a little bit and provide a little bit more of an emotional overlay to what the experience at Red Lobster is like, not unlike the Italian family meal overlay to fresh, delicious Italian food at Olive Garden, if you will.

So, in the near term, we expect that campaign to continue, but we're always trying to push for more and better and more differentiating advertising for all of our businesses.

Clarence Otis, Jr.: And the, I think on the other question you asked about, the makeup of the quarter, certainly we were helped by the Lenten season and the calendar starting earlier and so two extra weeks of Lobster Fest.

At the same time on the other side last year, third quarter, as Drew mentioned, we were running a very powerful endless shrimp promotion and were up against that for quite a few weeks this year.

So net-net we think that all balanced out.

The third question was guest satisfaction, and the rate of improvement versus prior year in guest satisfaction this quarter was the same, just as strong as it was last quarter.

Obviously over time, we're not going to continue to see the same rate of improvement, but right now it's substantial.

Thanks.

And we do have a question then from the line of Dennis Milton with Standard & Poor's.

Please go ahead.

I was wondering if you had any updates on the potential refinancing of the debt that you have coming due?

And also, with the impending deadline to start expensing stock options, I was wondering if you were considering any changes to your stock compensation plans?

This is Linda, Dennis.

We do expect to refinance when our debt expires in September, and we have another issue in February of '06 as well, and so we are exploring options at this point and would expect to roll those over.

What was the other question?

Stock options.

Yes, we would expect to expense stock options next fiscal year and we disclose that at a pro forma basis in our financial statements historically and would expect the impact to be in that range.

Clarence Otis, Jr.: I think from the composition of compensation what I would tell you is we really look very closely to make sure that we're competitive from a market perspective.

And so we watch that very closely.

We have seen some changing trends.

We've seen a movement a little bit less on the stock option side, a little bit more in terms of restricted stock.

We have made changes in our plan over the past couple of years in that direction ourselves as well, but we monitor market developments and we'll be pretty consistent with the general market because we absolutely have to be competitive for talent, and that's our key objective.

Thank you.

Thanks.

And we have a question then from the line of John Ivankoe with J.P. Morgan.

Please go ahead.

Yeah, hi, thanks.

If could you go over some of the throughput initiatives again, at Olive Garden and how far along you are in dropping throughput?

It sounded like getting the check to the people that are done faster is one of those.

And secondly, if you could talk about whether there's opportunities at Red Lobster with throughput and certainly in my mind kitchen times might be an opportunity, if you could talk about that focus.

Thanks.

At Olive Garden the things broadly that we've been working on systemwide are really what I would characterize as being brilliant with the basics in service, so in particular, we've been working to eliminate gaps in the experience that can lead to guest frustration, number one, and also lead to less inefficiency and lower table turns.

The first piece of that was really focusing on the lobby welcome, first of all.

And the second piece of it was focusing on accurate wait time quotes in seating.

And the third part was around not making sure that no one waits for their check.

And there is some, there are initiatives against each of those things in Olive Garden restaurants.

Clarence Otis, Jr.: I would just say the other thing that is, that we're looking at, Smokey Bones does have an automated meal pacing system, and the goal there is really guest satisfaction and making sure that all the items on a plate come together appropriately even though they may have different cook times, and the same thing about all of the items that are ordered by a party, and we're seeing good success there with guest satisfaction and we're looking at the opportunity to expand that to our other operations.

What would be a kitchen display system?

Is that currently being tested at Olive Garden and Red Lobster?

Clarence Otis, Jr.: Yes, it is.

And in terms of Red Lobster, do you have opportunities to increase table turns structurally as you're, well, or through operational focus like you're doing at Olive Garden?

Clarence Otis, Jr.: Sure.

And as the business continues to increase there, and we experience higher levels of guest counts and higher levels of traffic, then that will be an even bigger benefit.

Thank you.

And we do have a question then from Joe Buckley with Bear Stearns.

Please go ahead.

Hi.

Just a question on the new menu you mentioned at Red Lobster.

You talked about adding three items in that 10 to $15 range.

I think you mentioned eliminating 15 items that had lower value scores.

Did you cut back on the menu or are there other product movements on and off the Red Lobster menu?

We did add three items in the 10 to $15 range, and Red Lobster eliminated 12 items that were low satisfaction items and tended just to add complexity to the overall operation, so, yes, the menu has fewer items on it now than did it before.

In addition, there were some structural changes in the menu to make sure that we were increasing attention on the items on the menu that had great guest value.

So structurally, the menu itself, the layout of it changed, and where items on the menu were shown changed to highlight guest attention to the great dishes and the great value we already have.

Thank you.

Thanks.

And we do have a question then from the line of Jason Whitmer with FTN Research.

Please go ahead.

One of my follow-up questions was already asked but if you were to look at your cost horizon relative to your menu pricing, I've noticed you certainly built up a little on inventories this quarter, it looks like you bought forward on some.

Can you just address where your cost outlook goes there?

This is Linda.

We will certainly address it much more specifically in June, but we really have just an excellent supply chain management department and they have been very, very effective over the last several years in helping us really manage this cost of sales and we expect that to continue from the visibility that we have at this point it does look to be at an appropriate level.

Kent, that's all the time we have for questions this morning.

We'd like to thank everybody for joining us on the call, and if you have any further questions feel free to call us here in Orlando, and we'll be happy to answer those questions for you on the phone.

Thanks for listening in this morning.

Great.

Thank you.

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