達登餐飲 (DRI) 2006 Q1 法說會逐字稿

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

Later, we will conduct a question-and-answer session with instructions being given at that time. (OPERATOR INSTRUCTIONS).

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to the Vice President of Investor Relations, Matthew Stroud.

Thank you, Lea.

Good morning, everyone.

With me today are Clarence Otis, Darden's CEO and Chair elect, 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 Restaurant's officers and employees may make forward-looking statements concerning the company's expectations, goals or objectives.

These forward-looking statements could address future economic performance, restaurant openings, 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 the impact of intense competition, changing economic or business conditions, the price and availability of food, ingredients and utilities, labor and insurance costs, increased advertising and marketing costs, higher than anticipated cost to open or close restaurants, litigation, unfavorable publicity, a lack of suitable locations, government regulations, a failure to achieve growth objectives, weather conditions 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 physical information about the period covered in the conference call, including any information required by Regulation G is available under the heading Investor Relations on our website at Darden.com.

We plan to release October same restaurant sales results for fiscal -- excuse me, same restaurant sales results from fiscal September 2006 during the week beginning October 3rd.

We plan to release same restaurant sales results for fiscal October 2006 during the week beginning October 31st.

And we plan to release fiscal 2006 second-quarter earnings and same restaurant sales results for fiscal November 2006 on Thursday, December 15th after the market close.

We released first-quarter earnings yesterday afternoon.

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

Let's begin by updating you on some recent events.

First, our thoughts and best wishes are with our employees, guests and neighbors who have or are in imminent danger of being adversely affected by hurricanes Katrina and Rita.

As a company, we're doing everything we can to bring a sense of normality to the lives of those who have been impacted by these storms.

Later, Clarence will have some additional comments concerning our efforts to offer assistance.

As we disclosed in yesterday's press release, in terms of direct effect, hurricane Katrina will have a minor impact on our total sales and operating profits this fiscal year and almost no impact on our same restaurant sales in September.

And based on almost four weeks of actual results, we anticipate solid same restaurant sales growth in September for Red Lobster and Olive Garden.

Growth for the month should be within the range of our previously provided guidance for the year, which is 2% to 4% despite any negative effects the hurricanes may be having on the broader economy.

In anticipation of hurricane Rita, we've taken numerous precautions at the 30 primarily Texas-based restaurants that are in the vicinity of the storm.

Once the storm passes and it is safe to return, we will assess any damage and provide an update when we provide Red Lobster and Olive Garden's September same restaurant sales results in two weeks.

Also yesterday we reaffirmed the guidance we had given previously for sales and earnings growth this fiscal year.

We continue to expect diluted net earnings per share growth for fiscal 2006 in the low double-digit range and that is based on our continued expectations of combined U.S. same restaurant sales growth of 2% to 4% for Red Lobster and Olive Garden and new unit growth of approximately 4% to 5%.

Now some highlights from the first quarter.

First quarter net earnings were $85.5 million and diluted net EPS was $0.53.

This represents a 20% increase in diluted net earnings per share.

Olive Garden and Red Lobster had an outstanding quarter with strong operating profit growth at both companies.

Bahama Breeze and Smokey Bones had a good quarter as well with solid improvement in restaurant level return on sales which is a key metric in our evaluation of financial performance at our emerging companies.

Linda will now provide detail about our financial results for the quarter, Drew will discuss the operating companies' business performance and then Clarence will offer some final comments.

We will then respond to your questions.

Linda.

Thanks, Matthew.

Darden's total sales increased 10.2% in the first quarter as a result of the strong same restaurant sales growth at Olive Garden and Red Lobster that Matthew mentioned and our operation of 57 more restaurants than in the first quarter of the prior year.

Olive Garden's same restaurant sales growth for the quarter was 7.4% and this was its 44th consecutive quarter of increasing same restaurant sales.

This compares quite favorably to the first quarter NetTrack estimate of +1.2%, excluding Darden concept (ph).

Olive Garden's total sales increased 10.8% in the first quarter and its increased sales combined with lower food and beverage cost, restaurant expenses and depreciation expenses as a percent of sales more than offset increased direct front labor costs and selling, general and administrative expenses as a percent of sales.

Because of these factors, Olive Garden had a record quarterly operating profit representing a double-digit percentage rate increase over last year.

Red Lobster had a same restaurant sales increase of 5.7% for the quarter and total sales were increased 6.6%.

Red Lobster's increased sales, improved food and beverage cost and lower depreciation expenses as a result of sales more than offset higher restaurant labor cost, restaurant expenses and selling, general and administrative expenses as a percent of sales resulting also in a double-digit percentage rate increase in operating profits over last year.

Bahama Breeze reported a slight decrease, 0.4%, in same restaurant sales.

However, restaurant level return on sales increased due to lower food and beverage expense, restaurant expense and selling, general and administrative expenses as a percent of sales.

We still expect Bahama Breeze to be roughly breakeven to earnings in fiscal 2006 as they continue to invest in positioning the business for successful renewed growth.

Smokey Bones opened seven restaurants during the quarter and we expect to open between 25 and 30 restaurants in fiscal 2006.

Smokey Bones had meaningfully higher restaurant earnings compared to the prior year even with essentially flat 0.1% same restaurant sales.

At the restaurant level, now this is excluding SG&A and depreciation and amortization, earnings increased 73%.

This fiscal year, we continue to anticipate approximately 4 to 6% improvement in Darden's overall earnings due to improvement in Smokey Bones' operating results.

In terms of margin analysis in the first quarter, food and beverage expenses were 86 basis points better than last year on a percent of sales basis.

Cost savings on various products and lower dairy costs contributed to savings.

In fiscal 2006, we expect food and beverage costs as a percent of sales to be slightly favorable to fiscal 2005.

The first quarter labor expenses were 14 basis points higher than last year on a percent of sales basis with sales leverage at Olive Garden and Red Lobster offset by wage inflation, about 2.7%, and higher restaurant level bonuses.

Restaurant expenses in the first quarter were flat to last year on a percentage of sales basis.

Sales leverage and favorable worker's comp costs were offset by higher utilities, about 4.5 million, and higher repairs and maintenance expenses at Red Lobster.

Selling, general and administrative expenses were higher as a percent of sales by 48 basis points due to increased media spending.

Olive Garden had one additional week of media versus last year and both Red Lobster and Olive Garden slightly increased media weight this quarter to more normalized levels compared to last year when there was a hiatus in August because of the Olympics.

The effective tax rate for the first quarter was in line with our fiscal 2006 target of approximately 33%.

During the quarter, we repurchased 4.1 million shares of our common stock and one important development was that in the quarter, we authorized and executed several 10b5-1 plans so that we could be in the market buying our shares during what had previously been blackout periods around sales and earnings releases.

Yesterday, we also announced that the Board has approved a 400% increase in our SMI (ph) annual dividend to $0.20 per share.

Despite the increased dividend, we're still estimating our share repurchases this year to be roughly the same in dollar amounts as last year, which again speaks to our tremendous cash flow position and cash flow generation.

As Matthew mentioned for fiscal 2006, we still expect combined same restaurant sales growth for Red Lobster and Olive Garden of between 2 and 4% and September is tracking to be at least within this range.

Also we are still targeting net new restaurant increase of between 55 and 65 restaurants in 2006.

With these same restaurant and new restaurant expectations, we continue to expect low double-digit diluted EPS for fiscal 2006.

As Matthew mentioned, in terms of direct financial effect, we anticipate that September hurricanes will have minimal financial impact.

We'd expect no supply disruption concerning seafood and particularly shrimp since we have ample inventories or contracts in place that will cover our usage through this fiscal year.

There will be some higher costs associated with utilities expense but we have purchased forward contracts for approximately half of our usage in natural gas.

And this should serve to dampen some of the impact of rising energy costs brought about by the hurricanes.

Of course we do understand that because of their effect on energy prices, the hurricanes may have some adverse effect on overall consumer sentiment and spending.

Despite that, we remain comfortable with the annual sales and earnings guidance we provide you at the beginning of our fiscal year because that guidance included an expectation that there might be some amount of headwind during the year due to unanticipated macroeconomic factors.

I'd now like to turn it over to Drew to comment on our operating companies.

Thank you, Linda.

Let me start by saying that the strategic focus in business dynamics of our operating companies during the first quarter was very consistent with the discussion we had with you at our June analyst and investors meeting.

And we're certainly delighted with the results.

Olive Garden led the way with another exceptional quarter of performance.

Their sales and operating profit results were very strong.

Linda just highlighted those for you and in addition, I would highlight that their operating returns put them in the top decile of casual dining and the top quartile compared to the S&P 500.

The key drivers of this performance have been in place for some time.

A powerful combination of brand management excellence, restaurant operations excellence and a superior business model.

Their focus going forward continues to be maintaining a high level of same restaurant excellence while laying the foundation for accelerated new restaurant growth.

Red Lobster also had another quarter of strong performance.

Same restaurant sales were up nearly 6%.

Total sales were up almost 7% and they delivered a strong double-digit increase in operating profit.

Red Lobster's momentum over the last several quarters has really been driven by their simply great operating discipline and we've talked about this several times in the past and that's something that has really help them improve their consistency of execution while also reducing unnecessary cost.

And the benefit of this focus can really be seen in three critical areas; record guest satisfaction that continues to improve, profitable guest count growth and increased restaurant level returns.

Now looking ahead, Red Lobster has the opportunity for further growth in guest counts and restaurant level returns compared to their historic norms and to capture this opportunity, they will broaden their appeal and increase frequency by excelling at what consumers want most from a seafood restaurant; fresh, delicious seafood, friendly welcoming service and an exceptionally clean restaurant.

Smokey Bones opened 7 new restaurants this quarter while continuing to deliver a great guest experience and they improved and they delivered improved financial performance in a stronger restaurant level of return primarily by lowering cost of sales while maintaining a great guest experience.

Smokey Bones is working to broaden appeal and increase frequency by strengthening the non-barbecue portion of their menu.

Bahama Breeze also improved their financial performance this quarter and they are focused on providing a distinctive Caribbean escape in their restaurants that is more approachable for a wider variety of occasions while also eliminating cost and complexity from their business model that their guests don't value.

Clarence.

Thanks, Drew.

As you have heard, we really had a competitively strong quarter.

We had industry-leading same restaurant sales results.

We also had industry-leading earnings growth.

And those financial results, those excellent financial results, really in my mind reflect a couple of things.

One is that our two established brands are just intrinsically strong.

They have high levels of consumer trust and consumer loyalty and that has been earned over decades.

And the second thing is that both of them are operating today at a very high level.

That has been true at Olive Garden for some time now.

It is the leader in casual dining companies of scale and as most of you know, Red Lobster has been making excellent progress for over a year now.

And this combination; strong brands and strong operations, served us well in the quarter.

It is serving us well so far in September in the aftermath of hurricane Katrina and it is going to serve us well in any environment.

And I would say the other thing is our first-quarter success not only reflects Red Lobster and Olive Garden's continued strong performance.

It also reflects the improvement we're seeing at Bahama Breeze and Smokey Bones.

And we are also pleased about the first quarter for a couple of other reasons.

We made great progress in our efforts to position the company for accelerated growth so we can fully capture the opportunity that we see in casual dining.

And this quarter also once again showed just how big a heart this organization has as the people here responded to hurricane Katrina.

As soon as roads and airports opened, our restaurant support and operations teams traveled to the Gulf Coast, went to our locations, went to the places where our people had relocated to provide employees with immediate financial assistance and that included cash payroll.

It included payroll on personalized fee free debit cards.

We also made grants to nearly 400 employees that totaled over $300,000 through an internal employee funded emergency assistance fund that we have for front-line employees, which we called Darden Dimes.

We also provided up to four weeks of pay to employees who could no longer work at the five severely damaged restaurants that remain closed.

In addition to that, we are offering those employees employment at a Darden restaurant in the places that they have relocated to.

And we're going to respond to hurricane Rita with this same kind of assistance.

And each of you can help as well.

The restaurant industry has once again stepped up.

The industry has designated October 5th as Dine Out for Hurricane Relief Day and participating restaurant companies, and that certainly includes Darden, are going to donate all the profits from that day's sales to the hurricane relief efforts of the American Red Cross and other agencies.

And we expect Darden's contribution to be at least $1 million.

So we look forward to seeing each of you at a participating restaurant on August 5th -- I'm sorry, October 5th.

And with that, we will open it up for questions.

We would be happy to talk to you about the issues you are interested in.

(OPERATOR INSTRUCTIONS).

John Glass, CIBC.

My question has to do with the tropic at Red Lobster, particularly an August where you faced a very easy comparison and in that context, comp store sales gains were somewhat modest.

How do we read that?

Is the absolute tropic trend sequentially from say July to August and through September, are the showing some stabilization as you predicted?

John, this is Clarence and I will let Drew answer that but I just wanted to comment that we hear you guys say that all the time but we don't see any comps as easy comps.

We are out there fighting for customers every day.

And I would add to that that it is difficult to interpret August for Red Lobster because of the tremendous variability in their promotion strategy over the last several years.

As you know, back in '04 there was a very aggressive all-you-can-eat crab promotion that really spiked same restaurant sales and traffic.

And in'05 there was a --.

You mean in '03.

Excuse me.

And we have adjusted that strategy going forward.

So year-to-year, it is really difficult to compare August.

I think the bigger point would be to look at the last four quarters of profitable same restaurant sales growth and guest count growth that has been exceeding the industry chain average each of those quarters and as Linda said, we would expect on a combined basis our September traffic to still be in that at least in that 2 to 4% range.

I guess the question is are you seeing the same absolute number of customers coming to the restaurant each and every month consistently for the last several months?

No, there is seasonality month-to-month in the industry and at Red Lobster in general and the promotion strategy has an impact on that as well.

So it does vary.

Then just quickly on food cost.

In June, you talked about flattish food costs but it being beneficial in the second half.

You have gotten a better benefit I think than that at least in the first quarter.

Are you still expecting food cost, greater food cost benefits in the second half now?

This is Linda, John.

We have seen some of that come a little bit earlier but we do see it pretty consistently across the year and it will be down slightly now we believe for the year as I mentioned.

Jeff Omohundro, Wachovia.

Two questions.

First on Olive Garden, in advance of the ramp up and expansion, I wonder if there's an update on the smaller prototype effort.

And secondly on Smokey Bones, any more thoughts on the advertising testing behind that and maybe a little bit more detail on the non-barbecue offerings.

Well starting with Olive Garden, we have discussed in the past ramping up growth from roughly 20 to 25 this year to something in the range of 40 a couple years from now and a portfolio of prototypes to help us do that is going to be a key part of this strategy.

A smaller prototype, as you mentioned, can help us penetrate smaller markets or build out existing markets more profitably and we expect to open several of those units towards the end of this year at Olive Garden.

Your second question was Smokey Bones non-barbecue variety, which is an important part of building on what is a true competitive strength at Smokey Bones, which is their award-winning barbecue but also making that restaurant more appropriate for a broader variety of occasions and that is something J.J. and the team are certainly working hard on.

They introduced some menu changes in August that have had a positive affect from a guest satisfaction standpoint and from a restaurant return standpoint.

They introduced a new New York strip, a honey glazed salmon, shrimp and chicken dish, a tomato, cucumber and onion salad.

I can only remember the ones that -- there were a few more than that.

They also introduced a new create-your-own combination barbecue section that offered guests some flexibility, ability to personalize their combination plates, which was well received and also lowered a little bit the protein per plate, which has helped cost of sales.

So those efforts will continue during year.

We're not going to talk about upcoming menu changes but that strategy will continue and there's a third question.

I can't remember.

The advertising test.

The results on that were positive in Atlanta and Indianapolis a little more than a year ago but we don't have any immediate plans for local television advertising in the near term.

Jason Whitmer, FTN Midwest Research.

Clearly Red Lobster has been making a lot of progress on your operation side of things.

What is really the next step towards revitalizing the brand?

I know you talked a lot about marketing, a lot about changing some things for branded visibility.

What still needs to be done here to kind of get to that next level and to get more traffic flowing on a regular basis?

Well our approach so far has really focused on two things and we will continue to focus on these two things so we don't want to lose sight of them.

Basically how we run our business, number one and number two, the type of guest experience that we offer and Kim and his team in terms of how we run the business -- Kim and his team have really been focused on this simply great operating discipline, which is illuminated complexity and variability in the business that make it tough to execute at a high level consistently.

We have talked about things like simplifying recipes, reducing the number of items on the menu, doing more testing of initiatives so they are restaurant ready before they get to the restaurants, having fewer longer promotions so that we can execute at a high level.

All those sorts of things are going to continue into the future and on the guest experience side, we are really focused on being the best in casual dining at what guests want most from a seafood restaurant and it is the three dimensions I mentioned before; fresh, distinctive delicious craveable seafood.

That's the first thing.

They introduced a new menu back in February that had some new dishes on it that has been well received and we are going to continue to introduce menu -- continue to evolve the menu I should say in a way that maintains the current core business we have and broadens appeal.

We don't want to talk too much about our future plans but that will be an important part of what Red Lobster is all about in the future.

We'll also evolve our advertising to let people know that there is an even better experience they can have at Red Lobster.

And again that is coming in the future and we don't want to tip our hand too much on that.

Same thing on fresh or on friendly service.

They are continuing to improve that and continue to do a tremendous job just in the way they run their restaurants and how clean they are.

So all those fundamentals will continue and that is the base that we're going to build on going forward.

And then just a second question, you're building a pretty good foundation here to accelerate growth but do you think you're ready to accelerate growth either as a company through your multiple brands or generally just with the environment, is the environment right now -- is the timing right to start accelerating the growth?

Well as we think about accelerating growth, Jason, we are really looking out our planning horizon over the next five years or so.

And as we look at the industry over that period, we have seen through the last five years really industry growth around that 5% range.

And that is through the challenges that we have had over the last twelve months but also through early in the decade a recessionary environment and so we expect as we mentioned that that growth rate for the industry will continue going forward fueled by a lot of factors.

Below that, we also expect multiunit operators to continue to take share and so we're looking at multiunit operators seeing sales growth we think in the high single digits.

That's the opportunity as we define it.

As we attack that opportunity, we think certainly the foundation is continued same restaurant sales growth at Red Lobster and Olive Garden.

That is the foundation.

That is the mark of brand vitality.

On top of that, as Drew just mentioned, we think we can benefit from more Olive Gardens and so accelerating the number of new units there.

We also, as Drew mentioned, are doing things really to strengthen the same restaurant performance at Smokey Bones and the restaurant level earnings.

And as we do that, there may be an opportunity to accelerate their growth.

Right now we think in 25 to 30 new restaurants this year, probably be there for the next year or two.

Beyond that though we think there is opportunity to go up.

And so those are some of the things that would be driving our thinking about growth and we think the industry on the demand side is there as we look out over a multiyear period.

David Palmer, UBS.

Congratulations on the quarter.

Two questions.

At your analyst meeting, you stated that 2 to 4% same-store sales guidance for the year and you also said something I remember finding interesting at the time, you said Olive Garden would likely be at the low end of that 2 to 4 range and Red Lobster would be towards the high end.

That guidance would now imply flat or even down same-store sales in the back half of the fiscal year for Olive Garden and continued strength out of Red Lobster.

And I'm not sure that folks would expect either of those outcomes.

Perhaps you could comment on that.

Secondly, energy contracts I think last year during the heating season in particular were unfavorable for you, Linda.

Maybe you could comment on that in light of the fact that you're saying that your half hedge this year maybe come out higher than the norm on that.

Thanks.

This is Drew.

I'll answer the first part of your question about same restaurant sales expectations and we never really want anyone to be at the low end of a range to be sure and we are working hard to meet or exceed any expectation or guidance that we give.

I think the perspective I would just have us all keep in mind in terms of the traffic at Olive Garden is that they are already operating at a very high level and in the second half of last year have some aggressive comps that they're going to have to go up against.

And so directionally, you might expect them to be at the lower end of the range.

Red Lobster on the other hand is building momentum.

Four quarters in a row as we already said and improving their guest experience and you might expect them to be directionally higher.

So I think that's mostly what we were talking about.

The only thing I would add is I know we have a lot of employees listening and our team at Olive Garden is focused on really keeping that business as strong as possible.

So Dave and the team here us but as Drew said, they are working hard to make sure they meet or exceed any expectation that we have.

David, this is Linda.

On your question about the energy contracts, last year, we did have some contracts but not nearly as aggressive as we certainly wish we had been as the year unfolded.

And so this year as we continue to see energy accelerate we have been much more aggressive about getting into the contracts throughout the summer.

So while certainly they are higher, we do expect costs to be higher.

We have a higher percentage of contracts than we did last year going into this same time period.

Jeffrey Bernstein, Lehman Brothers.

I also had two questions.

First on dividends, it looks like historically most companies competing in your casual dining space paid rather minimal dividends if any at all rather than using their excess cash for more rapid unit growth.

I was just wondering if you could talk about the thought process behind the decision to increase the dividend so significantly after the rate was flat for the past few years and how you assess the benefits between dividend and share repurchase.

And then just secondly, on a more income statement front, a question on SG&A and labor.

It seems like you saw some pressure on those line items at both mature concepts.

I'm wondering if you could talk about the drivers, the largest components behind those increases and whether you think that pressure was more one time or it might be more ongoing.

Thanks.

This is Clarence and I will start and take the dividend question.

I think as we look at our business and the kind of reinvestment that we need to fund the growth that we expect and that is growth that would maintain marketshare leadership for us, we have got capital expenditures this year for example a little bit north of $300 million.

We have kind of been there and that allows us to grow.

It allows us to reinvest in our businesses.

With that, if you go back a few years, we have been $200 million or so in share repurchase.

Last year, $300 million.

This year we expect something pretty similar to that and the dividend side of our payout in dollars was probably about $13 million.

So we thought there was some opportunity to really bring that dividend up in terms of balance between dividend and share repurchase.

So now we're looking at something that looks more like $60 million but it is still compares to, as Linda mentioned, a share repurchase amount that is about the same level and potentially a little bit higher.

That is with capital expenditures that fund our growth.

So we think ultimately what all that means is that we have just very strong cash flow strength at this business because we are able to do all of that and yet still maintain an investment-grade credit profile.

And that is something that we continue to believe that is important as well.

To your question about labor and SG&A, we did see, as you noted, a little unfavorability as a percent of sales.

So this is mostly due to wage inflation, some increases in bonuses and insurance costs offset somewhat by sales leverage.

I would say that we have been pricing for some of the minimum wage but not pricing to margins.

So you do see a little bit of headwind from that as well.

So there is a little bit of pressure on that line.

In the SG&A, I think we talk -- that is probably more onetime.

Certainly in the first quarter, we talked about the media and we would expect over time that we do see leverage with our SG&A line and so I would not expect as much headwind at that category.

Mike Smith, Oppenheimer.

Just a couple of questions.

What kind of safeguards -- Olive Garden has been so strong for so long.

You are accelerating the pace of openings plus trying a smaller unit.

Do you have any kind of safeguards in place to assure yourselves that this won't cannibalize too much on your existing stores?

I didn't quite understand the question.

What was in place?

Safeguards.

I'm sorry.

I think Mike -- yes, safeguards -- to make sure that we don't overly cannibalize ourselves.

The answer is we do.

We have some fairly robust models as we look at new restaurant sales expectations on a per unit basis at Red Lobster and Olive Garden and if we put a new unit in, what we think that unit is going to do, what the effect is going to be on restaurants that are around it.

And that is based on the fact that we have got decades of empirical data.

And so we feel pretty good about that.

Linda.

I really would just want to add we have been really working on refining our models and really have invested in actually some additional technology in this area to improve it even further.

That gets very down to the street corners so we really are building our confidence around it and we're not certainly going to go so fast that we get ahead of ourselves because we certainly are mindful of it as well.

And the final point I would add is that obviously our mindset for doing this is to maximize total sales growth and maximize total operating profit growth at returns that are competitively superior, or more than we would want.

Or more than we would need.

And making sure we maintain a strong same restaurant foundation in the process.

So we're very mindful of all of those things.

My second question has to do with the two embryonic concepts;

Bahama Breeze and Smokey Bones.

As I looked at Smokey Bones' comps in particular, you have a 10 basis point decline.

I guess I'm a little surprised that that number is that low and I know there is a little math at work with the first stores that you opened in old locations.

Could you tell me how many of the comp store sales units in the base are those old real estate?

It's probably in the 8 to 10 range out of 55, 56.

And comparing a year-ago number to a quarterly number this year maybe is -- we have to be a little careful with that and in addition, we've talked about frequency of purchase in the past.

Another thing we look at is same restaurant sales, not just on a 16 month basis but a 24 month basis.

And 24 months is positive, significantly positive.

Bahama Breeze, isn't lunch a new item at a bunch of stores this year versus last year?

And if so, are you disappointed in the 40 basis point decline in the comps that you gad at Bahama Breeze?

Lunch was in all restaurants a year ago.

So it's not part of a year-to-year change.

There are other things that are going on at Bahama Breeze that we think our long-term positives that make that brand more accessible and more approachable for everyday occasions.

For instance, Laurie and her team have added dinner on the deck in a majority of restaurants, roughly 24 or 25 out of the 32 there.

And they have added some new items in May and things that are changing the dynamics a little bit at Bahama Breeze.

But lunch isn't part of it.

That has been there.

Mark Wiltamuth, Morgan Stanley.

Mark Wiltamuth, Morgan Stanley.

I wanted to ask about what you are seeing out there in the different regions.

We are still hearing some weakness in the Midwest from some of the other casual diners and I'm curious if you are experiencing that?

Our same restaurant performance in the Midwest was positive but not growing quite as much as it was in some other parts of the country.

Yes, I would say it is directionally a little lighter but it does not seem to be as dramatic as some other folks are portraying for sure in our business.

And to add onto that, maybe a little comment on the Northeast and in general how you feel you are doing with the lower-end consumers because that seems to be a group that is taking some pressure.

I think in New England, I think the same thing sort of holds true as Linda mentioned for the Midwest.

We don't have a lot of Red Lobsters in New England obviously so we're talking about the other brands.

Yes, I am looking at it now.

And it appears to be the same response really, it is holding up fairly well throughout New England.

Actually in both brands.

And then just a comment on that lower-end consumer.

We presume that is a part of why these businesses are holding up because they have broad appeal and we work hard to have that range of price points and that range of accessibility for our brands.

And so we think that is part of why they hold up well during these times.

And I would say within the casual dining industry, Red Lobster and Olive Garden tend to be sort of on top of the conventional consumer for casual dining, which tends to be not lower income, those with the greatest frequency.

So that 50 to $70,000 household income is at the heart of the industry.

It is one of the reasons why we tend to hold up pretty well even when there is some economic uncertainty given those incomes and our check averages as an industry.

So even Red Lobster is on top of that 50 to 70 average.

Oh yes, absolutely.

Red Lobster, given its check average, has a guest that is fairly well-heeled from an income perspective.

Andy Barish, Banc of America.

I guess we don't have Joe around to provide the perspective anymore so I guess Clarence you are the senior spokesman now.

I would love to hear -- you guys have been through a lot of cycles and have probably done more research than anybody in the category on what goes on.

I think it would be helpful to provide a little bit of perspective on that just in terms of the big brands versus kind of secondary brands versus kind of the independence and the non-chains.

And then maybe a little bit of your commentary in terms of pricing in the current environment.

Do you need to look at it a little more closely?

Do some of the big picture energy price concerns and stuff out there kind of keep you on the sidelines for now?

That's a lot.

Let me start by saying, as you mentioned, we really do pride ourselves on being very analytical.

The last time we looked, which was a few years ago, and commissioned an independent study to understand consumer behavior in a recessionary environment, in an environment where there was economic concern, what we saw is the same thing we have seen in prior studies, which is casual dining in particular restaurants in general hold up very well.

What consumers tend to do is forgo some of the bigger ticket items, some of the autos and vacations.

They tend to reward themselves by maintaining purchase levels with things like restaurant meals, movie tickets.

So that is what we have seen consistently over time.

I think the other thing that we see is that it is very important to be an established trusted brand in times when people are being more selective.

And so we certainly see -- we have seen it in the past where consumers really are going to those that they know well and that they trust and Olive Garden and Red Lobster benefit from that.

Our emerging brands are on the other side of that.

They are not as well-established and they don't have the share of voice to have aided awareness.

Top of mind active (ph), top of mind awareness.

And so that is another thing that we have seen during these kind of periods.

I think the thing that we've also seen is that when people are being more selective and they are holding their dollars more dear, it is very important to deliver.

And so operating at a high level is essential.

And I think as we come into this environment, that is a huge competitive advantage that we have got, that Olive Garden operates at a very high level and that Red Lobster has been improving fairly significantly and Smokey Bones operates at a high level.

We talked about the guest satisfaction levels, the fact that they are based on our internal measures even higher than Olive Garden's as high as Olive Garden's are.

And from a value perspective, just a couple of thoughts.

One is -- Olive Garden is the value leader in casual dining.

That is a tremendous brand strength.

We guard it, we protect it.

So that's important.

I think the other thing from a pricing perspective is that we benefit from an exceptionally strong supply chain.

That is a competitive advantage for us.

You have seen us whether commodity spikes better than most.

We think that we can do that again.

We think it gives us competitive advantage when we think about pricing and whether we can afford to take less pricing than some of our competitors and strengthen guest loyalty through some of those kind of tactics and so we feel good about that as well.

One insight I would add to the point that Clarence made about casual dining holding up better than other parts of the restaurant industry, the insight is that casual dining really satisfies fundamental emotional needs better than other parts of the restaurant industry where people want to slow down and relax and reconnect and be with family and friends and our restaurants offer a tremendous environment to do that in.

And the more trusted your brand is, as Clarence said, the more it is going to be sought out during challenging times.

And we have seen that time and again in the past.

Thanks.

Nice work on the dividend also.

Steven Kron, Goldman Sachs.

I wanted to go back to the long-term kind of growth drivers and specifically beyond the Red Lobster and Olive Garden brands and I guess there are three parts to this question.

The first is on Smokey Bones, it seems as though the profitability improvements thus far have largely come from operations and not top line.

And at your analyst day you talked about certain parts of the country, particularly I think it was the Midwest and the Southeast, where the brand is not driving the unit volumes that you had hoped for.

So, Clarence, I was hoping you could just comment first on why you still have that level of optimism as to bringing this brand to more national presence and as large perhaps as Olive Garden and Red Lobster one day.

That's the first part.

The second part is whether you can just update as on your thoughts of either acquiring or developing a fourth brand that you might be able to bring national down the road and where you currently think on that.

And then finally a casual dining peer last week announced plans to build out its international efforts and I know that you guys have concepts in Canada.

I was just wondering what your thoughts were on international expansion and whether you think your brands have the ability to move cross-border.

Thanks.

Let me start with Smokey Bones and what I would tell you there and Drew mentioned it is that we recognize that frequency is a little bit lower around Smokey Bones and that is in part because of the barbecue/non-barbecue balance and so we're working very hard on improving our non-barbecue items and broadening the occasion appeal.

That said, Drew also mentioned that given that we look pretty hard not just at same restaurant sales as reported, which is really on a 16 month basis, we also look and see what are they doing on 24 month basis and they are -- the same restaurant sales and guest counts are positive, strongly positive, in the case of sales.

And so that gives us pretty good confidence along with our guest satisfaction data that we have got something that really works.

And that is the case across the company.

I think the other thing is that we're talking about $3.1 million today per restaurant at Smokey Bones and that is without advertising.

We have got nationally advertised, nationally penetrated brands that aren't at that level.

And so that gives us a great deal of confidence in this as well.

So we feel good about it.

I think on the acquisition, additional development front, a couple of thoughts there.

One is that we are doing a lot of work to make sure that we can effectively leverage our scale when it comes to the restaurant support that we provide.

We think that that is increasingly important if we are going to be the kind of multibrand enterprise that we need to be to capture growth opportunities in casual dining.

So there is some of that work to do before plugging in another brand.

And in addition to that, we are also, as you know, working pretty hard on Seasons 52.

We feel good about the early read there.

There is still more that we need to confirm before we move to the next phase of development.

But I would say the enterprise piece of it and making sure that we can plug these in and be more effective at running them than we are today and more cost-effective is an important part as we think about additional brands.

That work is going on.

This is a big year for that.

Next year will be a big year for that.

We would expect assuming success, which we always do, that that would position us pretty well to think about other things 18 to 24 months from now.

From an international perspective, we periodically look at international to try to understand where the opportunity is.

We think given the momentum we have at our existing businesses, given the kind of open horizon if you will that we have got still with Smokey Bones and Seasons 52 and with Bahama Breeze.

If we do the things that we need to do that the domestic opportunity will consume most of our time for the kind of planning period that we're looking at over the next five years or so.

Joe Buckley, Bear Stearns.

Clarence, I got a big picture question for you as well.

You talked about the outlook for demand that makes you feel comfortable accelerating expansion.

There seems to be a lot of concern right now about the supply side and I guess my question is what are your thoughts on the supply side in casual dining?

Do you think independents are still shrinking in numbers?

And how confident are your data sources on that?

I would say, given the data that we're looking at, what we're seeing is on a total basis kind of flattish on the unit growth side and both independents and chains being a little flat and that's a change because independents had been negative for well.

Chains had been a little bit positive.

We still see chains as we look out in the future taking more share and we think that the unit growth will be pretty well contained but that's still means a few more seats if you look at it on a seat basis because chains tend to build somewhat bigger restaurants.

I think that is the general feel that we have for it.

I guess the second part of that question -- I'm sorry.

I'm trying to recall it.

I guess --.

The site side of the equation.

I'm sorry, Joe.

I think the pressure less to do with our concern about overbuild from the number of units and the pressure really shows up on the availability of quality sites and the cost of those.

And so certainly that is something that may temper a little bit unit growth plans across the industry because as chains take more share we see more return discipline.

We're tending to talk about public companies that pay attention to returns and so the land cost or construction costs or the combination of both, I think construction is a little bit more temporal.

The land piece is a longer-term challenge.

A question on Red Lobster.

You've spoken in the past about trying to smooth out the sales cycle to try to get away from the spikes and valleys.

And I guess I'm curious where you think you are in the scheme of that?

Do you have the number of price related promotions that you like to do a year figured out at this point and the timing of them?

Just looking at the numbers over the past twelve months, it is hard for me to see if you have made progress on that or not.

I think we're much closer to that than we were a year or 18 months ago.

The biggest part of smoothing out those demand fluctuations was aligning our promotional, our strongest promotions, with the lower seasonal periods during the year.

So we were doing endless shrimp historically during a higher seasonal period that put a lot of peak pressure on our restaurant to perform at a higher level.

That's something that was changed last year and we are consistent with it again now in this time period.

I think from a promotional standpoint, we have largely adjusted the big differences year-to-year from a promotional strategy standpoint.

In terms of price promotions, I would say there is always going to be a reason to have a brand appropriate value promotion in a low seasonal period, particularly one that delivers high guest satisfaction and also delivers against a balanced scorecard that includes our financial measures.

Endless shrimp does that.

So I would assume we're going to continue in the future to do that sort of thing gradually.

As the brand strengthens and appeal broadens, I would think there is an opportunity to do less all-you-can-eat type of promotions but I think there will always be a reason to have a value-based promotion in a low seasonal period much like never-ending pasta bowl at Olive Garden.

I would say just to add to that and Olive Garden is a good template.

They demonstrate the value of really having innovative, exciting, compelling food news and to feature that and the feature may be a price discounted feature or it may not but having that kind of strong pipeline of great offerings is critically important.

And Red Lobster and Kim and the team there are working to develop that.

But we have got more work to do there.

And that is part, when we talk about the guest count upside compared to historical levels, that is part of it.

And so it is clearly something we're working on.

Lea, we have time for one more question please.

Peter Oakes, Piper Jaffray.

Actually I have a couple.

I was hoping we could start out with the prime cost behavior we saw there in the first quarter.

Linda, you had mentioned that food costs benefited from I think you said cost savings in dairy.

But if you look at the food cost line, which was the preponderance of the margin improvement, that actually was an all-time low on a quarterly basis since you came public so is there something going on also from a mix standpoint both from the portfolio of the concepts or even within the two prime concepts?

I was hoping you could explore that a little bit further.

Sure, Peter.

We really are seeing improvement across all of our brands in cost of sales and Clarence talked about our supply chain and the work we're doing there.

We do however though benefit from a mix of sales with Olive Garden's strength because they do carry a lower cost of sales.

So in the mix, that does kind of afford us the opportunity to take down as well.

We did have a very strong first quarter and we got, as I said, that dairy favorability a little more and a little sooner than we had expected.

So I'm not sure we will see that throughout the year but directionally we are seeing some good opportunity and good work in many places.

There is pressure in some items so there is plusing and minusing but our brands are also working on their menu mix and trying to get a good breadth of offerings there as well.

So that helps over time.

They target appropriate levels of cost of goods and so all those things come into play as we are working in our businesses to improve the business model and improve the guest experience.

And I would just add, Peter, that you really do hit on an important point because the portfolio and the mix of our sales drives a lot of it and as Linda mentioned on the food side, Olive Garden with lower food cost, Smokey Bones with slightly lower food cost and Red Lobster both becoming a bigger piece of the mix.

And that also shows up on the labor line because Olive Garden's labor as a percent of sales is somewhat higher and so both of those things are going on inside those two lines.

Why shouldn't we think of the first-quarter food cost as kind of the new run rate as opposed to reverting back to a higher level given the descriptives you just shared with us as far as the success there?

All of our concepts or our businesses have some different -- there is some seasonality to it depending on their promotion, depending on what they are offering and so you can't just lock it in there.

That delta is -- we directionally would like to see more of that.

We don't think it's going to be in the magnitude of 100 basis points but we are certainly looking for -- and we talked to that and guided to that for the year.

So it really is dependant on a lot of the promotional strategies that are going on and that does move around a little bit throughout the year.

Also depending on when contracts expire and new contracts come into the system; that does create some variation as well.

The other side of the prime cost.

I think Clarence kind of hit on the labor there that Olive Garden's success might have put some portfolio pressure on the number but for first quarter you had kind of a blended comp for the two core concepts of a six.

So hopefully you'll be able to outperform your target but if you were to come in at your target for second quarter and beyond of kind of half that level, do you feel you'll have the ability to get the operating leverage to make that line perform a little bit better than what we saw there say in the first quarter?

Yes, there is always opportunity and focus and there is always a balance as we're introducing change, as we're introducing new menus, as we're trying new things to get more efficient and more productive with our labor.

So we don't see, as I said, huge reductions there for the year but we believe we can stay at roughly our current levels for the year -- prior year levels for the year.

And there is leverage -- leverage is part of that.

I will turn the conference back to you for any closing comments you may have.

Thank you.

We'd like to thank everybody for joining us on the call this morning.

If you have further questions, please give us a call here in Orlando.

We look forward to speaking with you again in December and again, we encourage you to dine out for hurricane relief on October 5th.

Thank you.

Ladies and gentlemen, this conference is available for replay after 12 PM Eastern time today through October 23rd at midnight.

You may access the AT&T executive playback service at any time by telling 1-800-475-6701 and enter the access code of 796096.

That number again is 1-800-475-6701 with the access code of 796096.

That does conclude your conference for today.

Thank you for your participation and for using AT&T executive teleconference.

You may now disconnect.