達登餐飲 (DRI) 2006 Q4 法說會逐字稿

Welcome to the fourth-quarter earnings release conference call.

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

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

As a reminder, this conference is being recorded.

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

Please go ahead.

Good morning, everyone.

With me today are Clarence Otis, Darden's Chairman and 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 its 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 cost, 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 furnish the release to the Securities and Exchange Commission and any other financial and statistical information about the period covered in the conference call, including any information required by Regulation G, is available under the heading Investor Relations on our website at Darden.com.

We plan to release same restaurant sales results for fiscal June 2007 on Monday, July 10th after the market close.

We plan to release same restaurant sales results for fiscal July 2007 during the week beginning July 31st.

And we plan to release fiscal 2007 first-quarter earnings and same restaurant sales for fiscal -- August 2007 on Tuesday, September 19th after the market close.

We released fourth-quarter and annual earnings yesterday afternoon.

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

Let's begin by updating you on our fourth-quarter and fiscal year earnings.

Fourth-quarter net earnings were $92.3 million and diluted net EPS was $0.60.

This represents a 15% increase in diluted net earnings per share.

On an annual basis we reported net earnings of $338.2 million and diluted net EPS of $2.16.

This represents a 21% increase in diluted net earnings per share.

Red Lobster had an outstanding quarter and year with strong operating profit growth.

Olive Garden also had an outstanding quarter and year with strong operating profit growth.

Bahama Breeze's financial results this quarter were solid with their continued progress in broadening appeal resulting in a net positive contribution to overall corporate earnings.

Smoky Bones remains focused on making the brand more appealing for a broader range of dining occasions.

Linda will now provide detail about our financial results for the fourth-quarter and year;

Drew will discuss the operating company's business results and plans, and Linda will return with some comments on our fiscal 2007 financial outlook followed by Clarence with some final remarks.

We'll then respond to your questions.

Linda?

Thanks, Matthew.

Darden's total sales increased 8.5% in the fourth quarter to $1.51 billion driven by same restaurant sales growth at Red Lobster and Olive Garden and our operation of 46 more restaurant than in the fourth quarter of the prior year.

Red Lobster had a same restaurant sales increase of 9.4% for the quarter and total sales increased 10.7%.

Red Lobster estimates that the shift in the timing of lent positively affected same restaurant sales results by 2 to 3% in the fourth quarter.

Olive Garden same restaurant sales were up 2.5% for the quarter, its 47th consecutive quarter of same restaurant sales growth and its total sales increased 6.1%.

Bahama Breeze had a same restaurant sales increase of 3.6% for the quarter and total sales also increased 3.6%.

Smoky Bones had a same restaurant sales decrease of 7.7% for the quarter while total sales increased 8.7% because of 22 net new restaurants.

In terms of margin analysis in the fourth quarter, food and beverage expenses were 33 basis points better than last year on a percentage of sales basis primarily because of savings on seafood and other commodities.

Fourth-quarter restaurant labor expenses were 30 basis points better than last year on a percentage of sales basis with sales leverage at both Olive Garden and Red Lobster offsetting wage inflation and higher indirect labor expenses.

Restaurant expenses in the quarter were 69 basis points higher than last year on a percentage of sales basis primarily because of higher utilities expense and the timing of workers comp and public liability insurance credits taken in last year's fourth quarter.

On a fiscal year-over-year basis, workers comp and public liability costs were favorable.

Finally, selling, general and administrative expenses were essentially flat as a percentage of sales for the fourth quarter due to higher media expense related to the launch of Lobster Fest in March.

Our tax rate was slightly higher than the fourth quarter of last year due to an increase in the state income tax rate and we continue to have significant share repurchase in the quarter, buying back 2.4 million shares of our common stock.

Turning to the full fiscal year, Darden's total sales increased 8.4% in fiscal 2006 to $5.72 billion driven by blended same restaurant sales growth of 4.6% and a 3.8% increase in new restaurant operating weeks.

On an individual operating company basis, Red Lobster had a 4.9% same restaurant sales increase for the year and its average unit volumes were 3.8 million.

Olive Garden same restaurant sales increased 5.5% and its average unit volumes reached 4.6 million.

Bahama Breeze achieved same restaurant sales growth of 1.7% and average unit volumes were 5.2 million for the year.

And Smoky Bones same restaurant sales decreased 3.7% and its average unit volumes were 2.9 million.

In fiscal 2006 Red Lobster opened three net new restaurants;

Olive Garden opened 19 net new restaurants;

Smoky Bones finished the year with 22 net new restaurants; and we had two openings at Seasons 52 and there was no restaurant development activity at Bahama Breeze this year.

Bahama Breeze delivered solid same restaurant sales growth and was breakeven for the year on an operating profit basis.

Bahama Breeze would have achieved moderately positive earnings except for its investment in G&A expense as they position the business for successful renewed growth.

As a result of its same restaurant erosion, Smoky Bones' overall operating loss in 2006 was similar to fiscal 2005 when you exclude the asset impairment charges taken in the third quarter of '06.

Darden's strong 21% diluted earnings per share in fiscal 2006 was driven by the double-digit operating profit growth achieved at Red Lobster and Olive Garden and the significant share repurchase undertaking with the resulting cash flows.

For the year we repurchased $434 million worth of our shares.

With that in the last five years we've repurchased over $1.4 billion worth of our stock, which speaks to the significant cash flows we generate on a consistent basis.

And yesterday we announced that the Board authorized the repurchase of an additional 25 million shares, bringing our total open authorization to 29.9 million shares.

I'll now turn it over to Drew to comment on operating companies and be back to comment then on the financial outlook for '07.

We were certainly very pleased with our fiscal 2006 fourth-quarter results, but, more importantly, as we look at the key operating fundamentals in each of our businesses, their strategic focus and the plans they have in place going forward, we believe Darden is well-positioned to deliver another year of competitively superior performance in fiscal 2007.

Let's start with Red Lobster.

Red Lobster had a terrific year, as Linda just mentioned, and has built a strong foundation for future growth.

As we've discussed in the past, Red Lobster has significantly improved all business fundamentals through their 'Simply Great' operating discipline and by focusing on what guests want most from a seafood restaurant, which is fresh, delicious seafood, exceptionally clean restaurants and friendly welcoming service.

Guest satisfaction and restaurant level profit margins are the strongest they've ever been and the brand delivered very strong double-digit earnings growth in fiscal 2006.

Red Lobster's biggest near-term opportunity is to drive continued guest count growth by further strengthening their brand's appeal.

Over the past year they've created a new brand promise that maintains what current guests love about Red Lobster while also broadening appeal for new user groups.

And importantly, the team has also developed and tested a number of initiatives for fiscal 2007 that will better deliver this new brand promise and related guest experience in their restaurants.

Without giving away details prematurely, I will say the brand promise builds on the work they've already done -- been doing to excel at being fresh, clean and friendly.

I'll also say that the initiatives being tested include a new core menu with more innovative entrées and a new fresh fish program with signature preparation styles and daily chef specials.

Red Lobster is also preparing to test a new ad campaign.

It's a campaign that's intended to drive traffic while also doing an even better job of building lasting equity in their brand by more effectively balancing the unique functional and emotional benefits of Red Lobster.

We plan to test the revised campaign in selected markets over the next few quarters and if results are superior to the campaign that they're already using, and it's already working well, we'll introduce it nationally late in the fiscal year.

In addition, Red Lobster's promotions this year will feature more creative new seafood dishes than in the past.

Red Lobster has greatly strengthened their culinary department over the past several months and they introduced the first dishes from those new chefs during the recent Lobster Fest and 30 Shrimp promotions, both of which were very successful.

So ongoing menu news will be a key component of Red Lobster's future marketing strategies.

The team at Red Lobster is certainly proud of their tremendous progress and we're confident that progress will continue in fiscal 2007 and beyond.

Olive Garden also had another outstanding year, achieving strong total sales and operating profit growth while delivering excellent returns.

Their primary focus this year in fiscal 2007 is maintaining same restaurant excellence while they also accelerate new restaurant growth.

During fiscal 2006 Olive Garden developed and opened two new prototypes to help accelerate new restaurant growth.

They also established a strong pipeline of new restaurant sites and, as a result, they are well-positioned now to open 30 to 35 net new restaurants during fiscal 2007 which is nearly double what they achieved last year.

Continued improvement in their guest experience and further marketing innovation will also be priorities in fiscal 2007 to help maintain profitable same restaurant sales growth.

More specifically, Olive Garden will focus on improving all aspects of guest services, especially server attentiveness and pace of meal.

A new point-of-sale system with expanded capabilities and a new automated meal pacing system will also be implemented in all Olive Garden restaurants by the end of the year to help improve the guest experience and the team member experience and increase guest throughput.

On the marketing side, Olive Garden plans to offer compelling new reasons to visit their restaurants in all advertising and strengthen the distinctiveness of their core menu with several dishes inspired by their culinary Institute of Tuscany.

An important priority in these efforts will be maintaining Olive Garden's position as the value leader in casual dining.

Olive Garden's key business fundamentals, especially its brand relevance, guest satisfaction and unit economics, are very strong, giving us great confidence in their ability to maintain solid sales and earnings growth in 2007.

Bahama Breeze made great progress in fiscal 2006 as they evolved their menu to make it more approachable yet still distinctive and took other steps to improve their guest experience.

Bahama Breeze is now more relevant for a wider variety of occasions and their same restaurant sales growth in fiscal 2006 is strong evidence of that important progress.

Going forward Bahama Breeze will continue to focus on strengthening their restaurant level returns by eliminating cost and complexity that do not add value for their guests.

This involves a number of significant changes in how they run their restaurants.

They're testing those changes now in several restaurants and early results are encouraging.

With more progress Bahama Breeze will be positioned to restart modest new unit growth in fiscal 2008.

And we expect continued earnings improvement at Bahama Breeze this year in fiscal 2007.

Smokey Bones had a difficult year with the industry's challenging consumer environment having a more negative effect for them than with our other brands.

And we believe a big part of the reason is that Smoky Bones' positioning is too narrow, making it relevant for too few occasions.

So when guests scale back their casual dining visits to core occasions Smoky Bones is too often not in the consideration set.

As we've discussed in the past, these dynamics are different in different regions of the country.

Smoky Bones holds much better, for example, in Florida, the mid-Atlantic and the Northeast than in other regions.

Still, given its absolute level of sales per unit and declining sales trend, significant change is clearly necessary.

Based on an intensive effort over the last six months or so, we have identified a new direction that eliminates the barbecue centric parts of the brand that are a barrier to greater occasion breadth and increased frequency.

At the same time, it's a direction that will build on some of Smoky Bones' current strengths including good locations, a strong operations team, a lodge setting that guests find extremely attractive and, as a result of excellent progress over the last two years, a strong array of non-barbecue menu offerings.

Smoky Bones' authentic and well received ribs will remain part of the future menu, but other things that make it stand so strongly for barbecue will be removed, including many of the other current barbecue-related menu items, our barbecue-oriented server greeting and potentially a new name as well.

We plan to test this new direction in several remodeled restaurants starting in the second quarter of fiscal 2007.

New restaurant openings this year will be limited to the five units already under construction at the end of fiscal 2006.

With our experience successfully addressing similar issues at Red Lobster and Bahama Breeze, we're confident about our plan for Smoky Bones and are moving forward with a strong sense of purpose.

Now Seasons 52; the operational test of Seasons 52 continued in fiscal 2006 with the opening of two more restaurants.

In fiscal 2007 we will open another two restaurants, both in the Atlanta market.

Now we are extremely pleased with the results thus far at Seasons 52 and at this point we're waiting to ensure that their strong initial sales volumes sustain into year two at a critical mass of restaurants.

Before I turn it back to Linda to discuss our outlook for fiscal 2007, I wanted to make a comment on the macroeconomic environment.

While we expect the consumer environment for casual dining to remain challenging and somewhat volatile in the near-term, we have no plans to alter our long-term strategy to address what we believe is a short-term situation.

Given this environment we're managing our business with a few important principles in mind.

First, effective management of controllable cost is a top priority.

Delivering a competitively superior guest experience is more important than ever and brand appropriate news and value that give guests a compelling reason to visit has to be part of a balanced promotional strategy.

For instance, Olive Garden's current promotion features two new dishes and a starting at $9.95 price point.

Red Lobster's current promotion also features two new dishes but does not have an overt value message.

Going forward promotions for both brands in the future will occasionally have a clear value component as they have in the past.

Now Linda will discuss our financial outlook for fiscal 2007.

Thanks, Drew.

With the initiatives outlined by Drew in fiscal 2007 we expect combined same restaurant sales growth for Red Lobster and Olive Garden to be between 2 to 4%.

Of course we will be both above and below the strange month to month depending on promotional calendars, holiday shifts and changes in consumer sentiment which, as you know, has been volatile for much of the past six to 12 months.

The new restaurant plans that Drew outlined mean that we expect a net new restaurant increase of approximately 40 restaurants, putting total sales growth for the year in the range of 5 to 7%.

We expect capital spending to be about the same as it was in fiscal '06 or approximately $350 million.

We are dedicating additional resources, ensuring existing restaurants are in great shape and increased technology spending for POS replacement and meal placement systems, which Drew noted previously, and that will offset the reduction in new restaurant openings from the prior year.

From a margin perspective, we anticipate improvement of approximately 40 basis points on an annual basis compared to 2006.

This margin expansion will primarily come from two categories -- food and beverage expense and selling, general and administrative expense and we'll see more of it in the second half of the year.

The improvement in food and beverage expense as a percent of sales will come from cost saving initiatives and favorable cost trends on certain commodities, mostly proteins such as seafood and chicken.

There will also be margin improvement due to our sales mix at Olive Garden with its lower cost of sales as it -- with its lower cost of sales it continues to expand at a faster rate than our other brands.

We anticipate that labor costs as a percentage of sales will remain unchanged as higher wage rates and FICA expenses are offset with increased labor efficiency.

We have been diligently encouraging our servers to accurately report tips.

This increased reporting of tips leads to higher FICA expense, but that higher FICA expense is offset as a credit at the income tax line neutralizing the impact.

The improvement in selling, general and administrative expenses as a percent of sales will be the result of sales leverage and a reduction in unit growth at Smoky Bones which will eliminate some of the growth overhead there.

As a result of this and the improvements in the business that are planned, we expect Smokey Bones to have a positive effect on Darden's earnings growth over the prior year, as much as $0.03 or $0.04 per share.

In addition, we expect earnings to benefit from continued progress at Bahama Breeze which we expect to contribute modestly to earnings in fiscal 2006.

We also expect to again generate strong cash flows which we've done consistently since we became a public company in 1995 and to use these to repurchase a meaningful amount of shares which will also help drive earnings per share growth.

We repurchased $434 million worth of stock in fiscal 2006 and anticipate purchasing a comparable dollar amount in 2007.

Finally, for fiscal 2007 we expect our tax rate to be approximately 31%.

With our same restaurant sales and new restaurant growth expectations, the margin improvements we expect due to lower food and beverage expense and selling, general and administrative expense and the share repurchase plan, we expect diluted net EPS growth of 13 to 14% for fiscal 2007 excluding compensation expense for stock options.

We will adopt FAS 123R on a perspective basis in the first quarter of fiscal '07.

After adopting this accounting treatment we anticipate that diluted net EPS growth would be 9 to 10% in fiscal 2007.

Both of these estimates are based on fiscal 2006 net EPS of $2.16.

Now I'll turn it back over to Clarence for some comments.

Thanks, Linda.

This was really just an outstanding year.

We delivered over 20% net earnings per share growth for the second year in a row and we capped that with a great forth quarter where we saw net earnings per share growth of over 15% and that came despite a macro economic environment over the past several months that had its challenges.

Olive Garden and Red Lobster, which are two of the most valued brands in casual dining, had industry-leading results.

We're seeing good progress at Bahama Breeze, as Drew and Linda mentioned, and we're also very encouraged by what's taken place at Seasons 52.

We're fully focused on building on the strength of each of those brands while also stabilizing Smoky Bones and making sure that it's better positioned for the kind of success that we think Smoky Bones is capable of.

Although it was a difficult year for us there, we're confident in the leadership and the restaurant teams at Smoky Bones and we're confident in where they're headed.

From our perspective there's no question that there's an uncertain consumer environment and that uncertainty is due to a number of different dynamics.

And as a result of that there is more volatility than we've had for some time in the industry.

But Darden has a proven approach to achieving sustained success in casual dining.

We believe in that approach.

It involves combining great people, great brand management and great operations.

It's an approach that's served us well in the past and it will serve us well in any economic environment.

And that is why we have such a solid outlook, we believe, for 2007.

And it's also why we're confident we can continue to build a great company, one that continues to create competitively superior top quartile S&P 500 total shareholder return and one that will last for generations.

That said, we know we'll see months that are up and months that are down this year especially given the consumer nervousness that exists today.

But we're confident we'll deliver competitively through this period results for the year.

We've got two established and trusted brands that managed effectively, can perform well in any environment.

We've got two emerging brands that, despite the ups and downs that are inherent in any venture effort, we think have great potential.

And we've got an exciting test underway in Seasons 52.

In addition to all that we've got dominant market share for our industry, strong cash flows, a strong financial position overall and, most importantly, we have the best people in the casual dining industry.

In other words, I believe we have everything it takes to be the best in casual dining now and for generations.

We're immensely proud of the competitively strong results that we achieved in fiscal 2006, but I'm even prouder of the competitively superior people who delivered those results.

And so we look forward to 2007 and now we'll take your questions.

(OPERATOR INSTRUCTIONS).

David Palmer, UBS.

Good morning.

Linda, forgive me, but did you say what restaurant expense margins would be doing in '07, any guidance there?

I believe the question was -- I'm not sure about the question -- restaurant expense margins in '07?

Yes.

We did talk about margins improving about 40 basis points into '07.

Okay, thanks.

Drew, you mentioned -- I guess there were two separate points on Red Lobster where you were testing a new marketing message currently and then there was also other exciting changes in the works as well.

Could you perhaps clarify, maybe even elaborate on that a bit?

I guess a broader headline is first that the foundation at Red Lobster has never been stronger -- the brand, the guest experience, the unit economics.

But we think it's got the potential for continued growth in guest counts and the biggest opportunity is to broaden the appeal of the brand.

And so we're looking and have developed a new brand promise that is going to do that, that is going to build on the current strengths the brand has and bring in new users as well.

But the specific elements that you're referring to we mentioned in last quarter's call as well.

We're looking at new advertising, we're going at new menu items.

We're testing both of those things and we expect both of them to be in the market, as we discussed last quarter, in six to 12 months -- the menu probably a little sooner than advertising.

But those are the two different things.

Last quick one.

On Seasons 52, that's been a hot concept and it's opened at least in Florida locations.

They seem to be big, splashy, somewhat expensive units and I wonder if that's one of the reasons why you haven't been opening them faster.

You said something about an exciting new test.

I wonder if that's something about the size of the box, perhaps getting the economics right before you ramp up growth there.

Any comments on Seasons 52?

David, you were breaking up a little bit, so I'll try to answer what I heard.

But we're very excited about what we're seeing at Seasons 52 in terms of the sales, in terms of the unit economics.

A couple things -- one is that we are in '07 with the two openings in Atlanta moving out of Florida for the first time and we're excited to see what goes on there.

We do know already, because we're pretty near completion of the units, that the investment cost levels are down substantially from what we've averaged over the first five and so that was a goal.

We feel good about that, but a really want we're doing right now is simply waiting to see how well those very strong first year sales results at the early restaurants hold up in the second year.

And so it's more about that, more about seeing that second year, understanding the sustainable sales levels than it is anything else.

On the investment side we feel pretty good about where we are, again especially given the costs at the two Atlanta restaurants which are pretty well in line with what we saw in Altamonte Springs here in Orlando and our costs in Fort Lauderdale.

Thank you very much.

John Glass, CIBC.

If Smoky Bones is not going to be a barbecue restaurant specifically any more, what will it be?

Are you going to identify it with another existing category within casual dining or are you trying to establish a new category in this repositioning?

We're not prepared to disclose specifically how we're going to position Smoky Bones in the future, but I will say that it's based on three different types of research really.

One, some Darden research that helps us identify underserved areas of demand within the total casual dining space.

Two, some research on Smoky Bones that helps us identify what their current strengths and weaknesses are -- I mentioned some of those.

And third, some more recent research that has articulated different conceptual repositionings that build on those strengths and address those weaknesses.

We're not moving it into the bar and grill space, as we've talked about before.

We are broadening it beyond barbecue.

The ribs will be an important part of the menu but it's not going to define the menu in the future.

And the direction that we've established we're moving forward with and we'll have in the market in a couple restaurants by the second quarter, but we're not ready to disclose the specific direction yet.

Okay, great.

And then they just a broader question.

Clarence, in your inaugural comments when you first became CEO you talked about the possibility of acquisitions over time.

Given your experience now with Smoky Bones, Bahama Breeze, is that still near-term realistic or do you look at the current valuation environment and say it's more opportune than ever given that good brands public and private may be cheaper now than the have been in prior periods?

As we've talked about our long-term strategy and really seen the opportunity out in casual dining where we're looking at an industry that on an overall basis continues to grow roughly 5% a year.

And then underneath that you've got chains growing at a much higher rate because chains have a lot of competitive strengths.

And so when we look at that and see that opportunity we believe that we need to be a multibrand company.

And so certainly the brands that we've got today are important; it's important to realize the potential, but we also believe we need additional brands.

And acquisitions are, we believe, going to play a fairly significant part there.

A lot of the things that we're doing to strengthen Darden today are things that will make us be more successful in integrating an acquisition.

And so we've been working pretty hard to be a more integrated company where we use expertise that's in one part of the Company across the entire Company and we've talked about that.

A lot of what has driven the success at Red Lobster is really stepping back and looking at our best practices and making sure we apply those in operations at Red Lobster and in brand building and brand management.

And so those things that we believe set us up to be more effective with acquisitions.

We are in the marketplace all the time with research, trying to understand some of the interesting concepts that are out there.

We pay close attention to valuations and we feel pretty good about our financial position, our ability to be opportunistic.

Do you feel your infrastructure is at the point now where it is able to integrate an acquisition or does it still require more time?

No, we think that we're at the point where we can do that today and we've got terrific talent management systems, we've got a great supply chain.

I think we're seeing the benefits of that this year.

Linda talked about food and beverage costs also being lower next year than this year.

And so we think we've got a lot of things to bring to the table.

But again, it really is being opportunistic and making sure that when the time is right that something really is responsive to consumer demand, evolvable over time that can last for generations that we're prepared.

Great.

Thank you.

Jeffrey Bernstein, Lehman Brothers.

Thank you very much.

A couple of questions.

First, I guess, Clarence, on the broader casual dining segment, obviously a lot of your peers have seen a slowdown in comp and traffic trends.

You've definitely shown some great resiliency.

Just wondering if you could provide some thoughts on what you believe has differentiated you in the current environment.

And just thinking that it's possible that improvements in food quality and speed of service have perhaps helped the QSR and fast casual segments in taking share from casual dining.

Just kind of wondering your thoughts on the potential consumer trade down?

And then I had a follow-up.

Thanks.

As you know, we've operated for a very long time and so we've been through a lot of cycles, a lot of economic cycles.

We've been able to study consumer behavior through those cycles including recessions which is certainly not where we are today.

But we do believe when there's uncertainty, and there is uncertainty and it's more about I believe consumer sentiment than fundamentals, but sentiment is important -- that people really hold their visits even more dear.

And so, they make cut back their consideration set to those brands that they're most loyal to that they feel best about.

And so that certainly helps the brands that have been around for awhile and executing at a high-level, and it also helps the brands where they've been recently and had a terrific experience.

And so we think a big part of it is the focus on operational excellence.

Olive Garden has really had tremendous results there for a very long time.

Red Lobster over the last couple of years has been executing at an ever increasingly high-level.

And so we think that sets us up pretty well for that environment.

And then we are pretty focused on making sure that we're nimble with our promotional strategy and that we have something in the marketplace that's appropriate.

Easier to do that at Olive Garden than at Red Lobster.

Red Lobster, given what it sells, has longer lead times for its promotions, so it's a little more difficult for it to change quickly.

But nevertheless, we're pretty focused on it.

And I guess as we look at the industry we believe the quick service industry is innovative for sure and they're capturing adult occasions that they might not have been capturing five years ago, three years ago.

A lot of that, when you look at casual dining, has more to do with lunch than dinner.

We think that Olive Garden and Red Lobster have very differentiated lunch occasions from what people are looking for in fast casual.

And so we held up pretty well there.

Great.

And actually just one follow-up on marketing.

I know it was kind of talked about in your opening remarks, kind of a change in approach in the current, more difficult environment.

I'm just wondering if you can go into greater detail in terms of considering more price point ads in order to drive traffic and if you were to view a shift like that as temporary or something that might be more permanent?

Thanks.

I guess the headline for our marketing strategy is that we don't want to change what our brands stand for.

Part of what Clarence mentioned earlier about the strengths at Olive Garden and Red Lobster is that we have distinct brands with guest loyalty that's been built over many years and we don't want to compromise that in any way through -- by deviating from our longer-term strategy.

The comment I was making about promotional strategy, we're really looking over the course of the year saying in an environment where there might be fewer occasions to stand out it's even more important to deliver a great experience every time to every guest.

And to make sure that you've some news -- give people a reason to come to your restaurant that reminds them of their last great experience.

So that news can be new dishes, as we talked about for Olive Garden and Red Lobster, it can occasionally be a more value oriented promotion as well which we'll do occasionally over the course of the year as we have done in the past.

But we don't fundamentally see a big shift for Olive Garden or Red Lobster to aggressive price pointing in the current environment.

And just one last -- just a clarification.

I believe you mentioned in regards to Smoky Bones a positive effect in terms of earnings contribution.

Did you say $0.03 to $0.04 accretive this year or $0.03 to $0.04 better than what you saw in fiscal '06?

Thanks.

It's the letter, $0.03 to $0.04 better than what we saw in '06.

Thank you.

Joe Buckley, Bear Stearns.

Thank you.

I'd like to follow-up and extend a little bit on Jeff's lines of question on the category on marketing.

One of the things that seems evident very recently over the last 60 days is that a lot of other casual dining companies are getting more promotional with their advertising message, trying to emphasize value a little bit more.

Darden has always been the leader in casual dining marketing -- you always seem to get the right mix of value and brands.

As others get more intense does that change your near-term outlook?

Does it concern you just about the level of promotional activity within the whole category?

Well, increased aggressiveness always concerns us for sure.

And I think what it basically says is we have to be better and we have to be more innovative so our guest experience has to get better.

We invest a lot of money already in national advertising to support our two big brands.

We have to make sure that what we invest it in is more effective than it's been in the past, is more innovative than it's been in the past.

We've typically featured new food news in our advertising.

We need to continue to do that and make sure it's going to drive that special visit in the near-term that we like.

But we're not fundamentally going to alter our promotional strategy to do something that might drive traffic in the near-term but could hurt our brand equity and brand loyalty in the long-term.

The only thing I'd add, Joe, is that we really believe that advertising needs to be effective.

Red Lobster has much more effective advertising today than it had a few years ago.

It hasn't really changed the weight -- it's more effective because it's better created and it's more effective because the offers, the news is more compelling.

And so, we see that as the key and if people boost our weights and increase the noise level without effectiveness we don't know that we have a real problem with that.

And kind of a broad question on the category.

Drew, I think you mentioned kind of if -- the current softness being a short-term phenomenon.

And I guess I'm curious what you think the underlying causes of -- and recognizing you guys aren't really experiencing it much, but the underlying causes of the softness in casual dining are?

You mentioned -- you or Clarence -- maybe it was Clarence who mentioned the QSR competitiveness picking up some.

Do you think it's a building issue, do you think it's a frequency issue, do you think it's a short-term consumer or (indiscernible) issue or is this something we're going to be talking about 12 months from now as well do you think?

Well, importantly, we don't think it's a structural change where guests are viewing and using casual dining differently in their lifelong term.

We don't think it's an over building issue in total.

I mean supply of new restaurant units and traffic in total have been pretty balanced for a while.

They may be growing in some segments of casual dining faster, but in total we don't think the current issue is because of over building.

Clarence mentioned consumer psychology which we think is probably more the root cause whether it's because of gas prices or interest rates or other things like that.

And it's hard to predict how long it's going to last, but we don't see a change in it next month or next quarter necessarily.

My only add, Joe, would be I think it's really people trying to wait and see what the new environment looks like.

And so a little bit of wait and see.

How persistent will $3 a gallon gas be?

Where will interest rates wind up?

And so I think it's a little bit of transition from where we were to a different place and people are looking to understand that environment before they get back to their normal spending and behavior patterns.

I think given what we hear out of most people who project those things, where we're landing is likely to be someplace where the fundamentals are fairly solid.

And so once we get there and people understand the environment and we're not in transition, we think they'll be pretty comfortable.

And so the question then for us is how do we manage the business in the near-term?

And that's why we're saying raise the bar on things we can control -- cost management, great guest experience, better advertising, better promotions -- but don't do something in the short-term that changes what you stand for because I think you'll regret it over time.

Okay.

And I have just two big picture questions, one very narrow question.

Matthew, last year in our same-store sales data we noted a July 4th shift affecting the June comps.

Is there anything we should be aware on where the holiday falls this year in your fiscal month?

No, Joe, it's going to fall in fiscal July as it did last year.

I think the only shift is really the day, the holiday itself moving from Monday to Tuesday this year.

So outside of that there's no real change;

I don't think that we have anything more to tell you about on a holiday shift for the quarter.

Terrific, thank you.

Jason Whitmer, Cleveland Research.

If I'm hearing you right, it sounds like your near-term priorities are to really kind of get down to the root of handling your margins internally and making sure that you don't chase anything out of the box.

I think that's actually a nice move where you can move the needle on the controllables.

But were you trying to get long-term on the capacity growth.

I know you've talked about 5 to 7%.

I really have two questions.

One, can get there with your current set of brands or do you have to really get the mode of acquisitions involved on it.

But secondly, considering that margins and returns should look good over the near-term, what are your highest return opportunities within the next 12 months and I guess more importantly over the next two to three years?

In terms of the top line, Jason, given the brands that we have today and making progress on the things that we're focused on, we believe that when we get past the next year or so, reigniting growth at Smoky Bones, reigniting some unit growth at Red Lobster at levels that we don't have today combined with what we're seeing at Olive Garden, expectation that we'll start to get a little bit more out of Bahama Breeze as well, we think that we can get there with what we've got.

But to sustain that, to sustain that class of planning period that's three or four years we'll need additional things.

And so, we continue to work on internal ideas.

We continue to keep a pretty active eye on the market in terms of acquisitions because acquisitions make themselves available when they're available.

And so, if something were available in the next two to three years that's something we'd have to think about even though we might not need it until year four or so.

So that's sort of how we think about that.

And I'm sorry, the other part of your question was really on (inaudible) oh, highest return opportunities.

Highest return opportunities probably are around continued guest count growth at Red Lobster.

Red Lobster is operating at a very high-level, very strong margins, but they're accomplishing that with traffic levels that are still pretty far below where we were just four or five years ago.

And so getting that traffic through the operation that we've got now is a key.

And so Drew talked about beyond the basics, really building the brand.

And so that is important work.

We're making good progress on it.

We expect to see the results of some of that work this year.

And then the other is really getting Smoky Bones to where we need it to get.

On a delta basis, on a profit growth basis, stabilizing the business this year will help, getting the business moving in the right direction will help even more in the years after that so we're really focused on both of those things.

And certainly doubling unit growth at Olive Garden in the near-term is going to help as well.

Great, thanks.

Bryan Elliott, Raymond James.

Just a couple clarifications.

First, the margin guidance of up 40 bips, that's an EBIT number, correct?

That's correct, Bryan, it is.

And more substantively, you told us, I believe -- I just want to clarify this -- that you expect CapEx to be about equal and share repurchase to be about equal.

As I did my math that pushes the economic debt to cap number potentially north of 50%.

I wanted to ask if I'm doing my math right and what your thoughts were on capital ratio and also ask Clarence a little bit about thoughts on dividend intermediate longer-term as a component of returning cash to shareholders.

Thanks.

Okay.

Well, let me start with your first two assumptions are correct on share buyback and capital spending.

We do generally, as we've said, over time target between 40 and 50% leverage and we have been ticking up on that a bit this year.

We're closer to 47 and that does include capitalizing leases.

And in '07 we would expect to push up to the higher end of that 40 to 50% range.

But at this point I expect to go over it meaningfully, so I'm not sure the math is exactly correct, but closer to the 50% range.

As you know, we do have significant cash flows and we, on an ongoing basis, are evaluating our capital structure and assessing the best return.

And we've historically preferred share repurchase.

We did increase our dividend last year, but we're always in conversations with investors and advisors and we would expect to make our recommendation for dividends at the September meeting and announce at that point.

But I don't know if, Clarence, you have any other comments on that?

No, I think that's it.

I mean, we definitely have a preference for share repurchase, but we also recognize that dividends are important and that's why we felt we had gotten pretty far out of balance in '06 and had a fairly meaningful increase on a percentage basis and we'll take a look, as Linda said, to summer.

Our dividend generally gets announced in September for payment I think November 1st has been our pattern.

Back to the capital ratio -- given continued success and great performance, is the marketplace and rating agency component of your constituencies giving you a little more flexibility given the obvious results (multiple speakers)?

That's right.

Yes, it is, Bryan.

They're comfortable with this increase and would easily maintain our investment-grade credit rating.

Very good, thank you very much.

Mark Wiltamuth, Morgan Stanley.

I wanted to ask a few questions about Bahama Breeze.

It sounds like you were making progress there this year and I'm wondering what metrics you're watching before you really step back on the gas for unit growth.

And just some of the thoughts on how big the unit count could be nationally once that really gets up to speed?

Well, there are three metrics we look at for all our operating companies really to judge their health and readiness for unit growth.

Competitively superior guest satisfaction, profitable guest count growth and then strong unit economics that are in the mid teams, around 14, 15% of sales basis.

Bahama Breeze has made progress on all three of those metrics, as we discussed earlier.

The one we're probably watching most is to see if we can continue to improve restaurant level returns at Bahama Breeze this year as they change the way they run their business.

And assuming we do, then we'll start some modest unit growth in 2008, as we said.

Ultimately we think the scale could be in the 150 unit range or so.

Okay.

And do you think -- broadly do you think this one has better opportunity than Smoky Bones or we're just kind of waiting to see what happens with the new Smoky Bones model?

No, we're very confident that there's a meaningful opportunity adjacent to where Smoky Bones is; we just haven't positioned the brand to fully take advantage of it yet.

We've got a direction in mind and we're working on that, but we think the opportunity there is substantial.

And we would see that opportunity as several hundred restaurants I think is our position.

So bigger from a unit perspective than Bahama Breeze.

Okay, thank you.

Robert Derrington, Morgan Keegan.

A question, Linda, could you help for me for a second looking at a trend for your G&A over the last three years?

As a percent G&A has been relatively flat for each of the last three fiscal years, yet as I hear (indiscernible) speak, it sounds as though the advertising weights haven't changed much.

And I think advertising rates have actually been relatively favorable in the last couple of years.

So what is it that keeps the G&A line from gaining any leverage given that unit develop is relatively slow as a percent of your entire base?

Well, as I said, we would expect to see some of that in '07.

We have been and there's been a number of growth initiatives that we've been investing in and Smokey Bones being a significant one and that slowdown helps to improve the leverage there.

We've also had -- there were some impairments that showed up in that line and some litigation for the last couple of years that have shown up in that line.

And we certainly hope to not repeat either one of those, but it does put pressure on that line and that's why we believe going forward we will have some improvement.

In fiscal '07 where would you expect that leverage to come?

From which piece of the G&A?

Is it from either compensation or is it from advertising or --?

I'm not sure I fully understand the question, but in general we would expect to have the increases in sales be able to more than offset the increases in G&A so that we'd be able to more leverage it.

So we wouldn't have as rapid a growth rate in our G&A in fiscal '07 because our unit growth has slowed down a bit.

I think when you back out -- there are so many moving parts, as Linda said, when you talk about litigation charges which I think we had in fiscal '06 and '05.

And then the G&A line is where a lot of the growth overhead associated with the rapid expansion of Smokey Bones is.

But away from those things, we have been investing in a couple of areas, and some of those investments continue into FY '07 and '08.

So technology is one of those things where we have made significant investments in our technology infrastructure so that we can now have some applications that really drive effectiveness of the business, and we have talked about the point-of-sale system.

We talked about meal pacing, all of those things.

So infrastructure investments last couple of years, applications going forward, the benefit of those show up in helping us contain some of the other lines; food and beverage expenses, a lot of technology things to go into inventory management; labor expenses.

Then the other thing that we have invested in is talent.

And so from an executive leadership perspective, we have got a lot of new leaders who have joined us.

They're a lot of the reason for the operating performance success that we have had, and we are also focused on being better at developing our folks internally.

So we built up a talent management unit in our human resources area headed by a very talented leader that we brought in from Hewlett-Packard, and so those sorts of things are in the line as well.

Thank you, Clarence.

Rachael Rothman, Merrill Lynch.

Hi, this is [Pushma] actually.

My question is around Smokey Bones.

You talked about a lot of changes in brand positioning.

And with weak same-store sales so far, I was just wondering what your thoughts were on any impairment charges going forward.

Pushma, this is Matthew.

We didn't quite hear that question.

I don't know, if you're on a speakerphone, if you could pick up the handset and repeat the question for us, please.

My question was around Smokey Bones' concept; you talked about a lot of changes in brand positioning.

My question was with weak same-store sales so far I was just wondering what your thoughts were on impairment charges going forward?

I believe if you've been following us you know we did take an impairment charge for a few restaurants in the third quarter of '06.

But our current evaluation assessment of the assets at Smokey Bones indicate that the new direction that we are proposing would not necessitate an impairment charge further.

It's clearly something that we will be watching very closely from quarter to quarter, but at this point we do not see a significant impairment charge associated with that.

And the changes that we're talking about going forward would have very minimal sort of capital implications so we don't anticipate significant capital associated with that.

My other question was about Red Lobster.

You talked about certain metrics that you track when you want to expand unit growth.

And I was just wondering where Red Lobster is given those metrics -- at what stage would you think about growing units there?

Clarence already mentioned that we think we're a year away from starting more modest unit growth at Red Lobster.

Their guest satisfaction is at record levels, they've had profitable guest count growth five or six quarters in a row that significantly exceeds the chain average.

And their restaurant returns are at the target that we're looking war.

So they're very close.

Okay, thank you.

Stacey, this is Matthew.

We've got time for about one more question and then we're going to have to wrap it up here, please.

Andy Barish, Banc of America.

On Smokey Bones, just wrapping that up and then a quick one on G&A.

How much sales stability are you projecting in fiscal '07?

Are you assuming comps stay significantly negative or start to move in the right direction?

And then on G&A, I know the fourth quarter has always got a few moving pieces with accruals and bonuses.

Was there anything unusual, either positive or on the negative side, in the G&A numbers here?

I'll take the first part of the question on Smokey Bones' sales trends.

We would expect early in the year the sales trends to be similar to what they've been and then we would look for them to improve versus prior year as we go forward for a couple reasons; what the team is doing proactively to improve guest satisfaction, what they're doing too broaden menu appeal that's a little more fundamental than what they've done in the past, and increasing some promotional support as well.

So we would expect same restaurant sales trends to improve as the year goes on.

Andy, as it relates to the SG&A, which is more of the marketing side of things, we did, as we've mentioned a couple times, have some movement of media spending, particularly at Red Lobster, into the fourth quarter associated with their launch of Lobster Fest.

And so -- and in addition they had some testing of some of their media.

So there was in fact some higher media offset by some favorability and in G&A, which is more just associated with some one time things from the prior year than anything that significantly happened in the current year.

Thanks.

Thank you.

Great, thanks, Andy.

And we'd like to thank everybody for listening in to our call today.

If we didn't get to your questions we apologize -- please give us a call here in Orlando and we'll see if we can answer those questions for you.

We hope you all have a safe and happy summer and we look forward to talking with you again in September.

Thank you very much.

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