達登餐飲 (DRI) 2007 Q3 法說會逐字稿

Welcome to the third quarter earnings release for Darden Restaurants.

[OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded.

I would now like to turn the conference over to Matthew Stroud.

Please go ahead.

Thank you.

Good morning, everybody.

With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and Chief Operating Officer; and Brad Richmond, Darden CFO.

We welcome those of you joining us by the telephone or the Internet.

During the conference call, Darden Restaurants officers and employees may make forward looking statements concerning the Company's expectations, goals, or objectives.

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

By their nature forward looking statements involve risks and uncertainties that could cause actual results to materially differ from those anticipated in the statements.

These risks and uncertainties include the impact of intense competition, change in 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 costs to open or close restaurants, litigation, unfavorable publicity, a lack of suitable locations, government regulations, a failure to achieve growth objectives, weather conditions, risks associated with our plans to improve financial performance at Bahama Breeze and to reposition Smokey Bones and other factors and uncertainties discussed in the Company's SEC filings.

Because of these numerous variables, you're cautioned against placing undue reliance on any forward-looking statement made by or on behalf of the Company.

A copy of our press release announcing the earnings Form 8-K used to furbish 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 at our website Darden.com.

We plan to release same restaurant sales results for fiscal March 2007 during the week beginning April 2.

We plan to release same restaurant sales results for fiscal April 2007 during the week beginning April 30, and we plan to release fiscal 2007 fourth quarter and annual earnings and same restaurant sales for fiscal May 2007 on Tuesday, June 19, after the market close.

We released third quarter earnings yesterday afternoon, results were available on PR Newswire, First Call, and other wire services.

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

third quarter net earnings were $106.4 million and diluted EPS was $0.72.

This represents a 7% increase in diluted net earnings per share.

In the first quarter the Company adopted SFAS 123R on a modified perspective basis which reduced diluted net earnings per share by $0.02 or 3 percentage points of growth in the third quarter.

Absent the adoption of SFAS 123R, diluted net earnings per share grew 10% in the third quarter.

Red Lobster had a competitively superior quarter with solid sales and operating profit growth.

These results represent new third quarter records for sales and operating profit at Red Lobster.

Olive Garden also had a competitively superior quarter with solid sales and operating profit.

Bahama Breeze reported a solid quarter with total sales that were essentially flat and continued to make progress in strengthening their business model.

Smokey Bones continues to have its challenges but the team remains focused on making the brand more appealing for a broader range of dining occasions.

As we announced last quarter they are testing a new direction with Rocky River Grillhouse and they have plans to convert two test restaurants in the fourth quarter.

Brad will now provide detail about our financial results for the third quarter, Drew will discuss the operating company's business results followed by Clarence with some final remarks.

We'll then respond to your questions.

Thank you, Matthew and good morning.

Darden's total sales increased 4.7% in the third quarter to $1.54 billion driven by same restaurant sales growth at Red Lobster and Olive Garden and our operation of 38 more restaurants than in the third quarter of the prior year.

As a reference, industry, same restaurant sales as measured by NAP Track and excluding Darden were down approximately 1.6% for the quarter.

Red Lobster though had a same restaurant sales increase of 4.6% for the quarter and total sales increased 5%.

Olive Garden's same restaurant sales were up 1% for the quarter, it's 50th consecutive quarter of same restaurant sales growth and its total sales increased 4.9%.

Same restaurant sales at Bahama Breeze fell 0.4% for the quarter while total sales declined 0.6%.

Smokey Bones had a same restaurant sales decrease of 5.2% for the quarter and total sales fell 1.5%.

Now, let's turn to our margin analysis for the third quarter.

Operating profit margins were 54 basis points lower than last year on a percentage of sales basis including the impact of SFAS 123R and the asset impairment.

The asset impairment charge of $16.3 million or $0.07 per diluted share involves seven restaurants.

One Red Lobster, one Smokey Bones, and five Bahama Breeze locations as they strengthen their foundation and prepare for renewed growth.

Excluding these impacts, operating profit margins would have increased 79 basis points over the prior year.

Food and beverage expenses were 12 basis points higher than last year on a percentage of sales basis.

Primarily because of menu mix related to the promotional calendars at Red Lobster and Olive Garden.

The featured promotions in the third quarter were high dollar offerings, meaning that total margin dollars per guest are higher but at a food and beverage cost percent higher than that sold last year.

Third quarter restaurant labor expenses were 25 basis points higher than last year as a percentage of sales due to wage inflation and FICA taxes on additional tip reporting.

We received an offsetting income tax credit for the FICA taxes which represented approximately 11 basis points of the increase.

I'll explain that in more detail in a moment.

Absent the FICA taxes, labor expenses were approximately 14 basis points higher than last year.

Now, FICA taxes, on the additional reported tips, is recognized as restaurant labor expense, and increase that line item as a percent of sales by 11 basis points in the third quarter.

A corresponding tax credit equal to approximately 120 basis points on the effective tax rate was recorded fully offsetting the higher restaurant labor and leaving margins unchanged from the increased FICA tax.

The FICA tax effect will lessen in the next quarter as we begin to wrap on the higher tip reporting in the fourth quarter of last year.

Restaurant expenses in the quarter were 41 basis points lower than last year on a percentage of sales basis, primarily because of sales leveraging, reduced utility expense, and lower pre-opening expense due to having seven fewer new restaurant openings.

Selling, general, and administrative expenses were 22 basis points higher as a percentage of sales for the third quarter.

This increase was due to the adoption of SFAS 123R and the increase in marketing expenses associated with the start of Lobster Fest in the third quarter this year compared to the fourth quarter last year.

The effective tax rate for the third quarter of 22.8% was because of the resolution of tax matters expensed in prior years and increased FICA tips credits on the reported tips that I previously mentioned.

For fiscal 2007, we are now estimating an effective tax rate of approximately 28%.

We continued the repurchase of shares in the quarter, buying back 4.3 million shares of our common stock leaving 21.6 million shares remaining in our current authorization to repurchase shares.

For the full year, we now expect combined same restaurant sales growth for Red Lobster and Olive Garden to be between 2 and 3%.

We continued to expect to open about 40 new restaurants combining to put total sales growth for the year at approximately 5%.

We continue to anticipate that diluted net earnings per share growth will be 10 to 12% in fiscal 2007.

This includes the adoption of SFAS 123R on a modified perspective basis in the first quarter of fiscal 2007, which reduces anticipated diluted net earnings per share growth by approximately 4 percentage points.

Excluding the effect of adopting SFAS 123R, this translates into diluted net earnings per share growth of 14 to 16% in fiscal 2007 based on fiscal 2006 diluted net earnings per share of $2.16.

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

Thank you, Brad.

We are pleased with the operating performance our teams delivered in the third quarter especially given the challenging environment as well as the progress that they achieved on the strategic priorities that will drive our future success.

Now, let me share a few highlights from each of our operating companies.

Red Lobster delivered strong same restaurant sales growth in the third quarter of 4.6% which as Brad already mentioned significantly exceeded the NAP Track estimate of minus 1.6% for competitive casual dining chains.

During the third quarter Red Lobster advertised two different promotions.

Their big seafood festival ran from late November until early January and featured distinctive items like roasted rock lobster tails, steamed king crab legs and a new dish called big island seafood grill.

This was a seasonally appropriate promotion that was offered when guests were looking for something special during the holidays.

Their second promotion, jumbo shrimp, ran after the holidays and offered guests both variety and value which was important following the holiday season.

Red Lobster is currently featuring their signature Lobster Fest promotion.

This is a longstanding promotion started one week earlier than last year to better align with Lent.

Their advertising features two new dishes, Chef's Signature Lobster Fest pasta and margarita lobster, shrimp and scallops.

As we've discussed before, our plan to achieve sustainable growth at Red Lobster has three phases.

The first phase was to strengthen business fundamentals.

The second phase is to refresh the brand, broaden appeal, and build guest counts.

The third phase will be to increase new unit growth.

Phase One started approximately two years ago and has largely been completed and in particular, both guest satisfaction and restaurant level returns have improved significantly and provide a much stronger foundation to support future growth.

Phase Two has begun.

The primary objective of this phase is to accelerate guest count growth by addressing the outdated brand image Red Lobster has with some guests and the perception that it serves primarily frozen seafood.

Phase Two initiatives already taken include the successful introduction of today's fresh fish sheets that are printed twice daily in every restaurant and a redesigned core menu with more culinary forward copy.

In addition, two new Restaurants have been opened with a new design inspired by the Maine coast.

Red Lobster also plans to begin the introduction of new plateware and related tabletop items starting in May.

These actions plus continued improvement to their menu and advertising will help position Red Lobster for Phase three of their plan, accelerating new restaurant growth later in fiscal 2009.

We're certainly proud of the team at Red Lobster given their tremendous progress and we're confident the business will continue to improve in fiscal 2007 and beyond.

Now, Olive Garden had another good quarter, delivering competitively superior sales growth while maintaining strong returns.

Their same restaurant sales growth of 1% during the third quarter was almost 3 points stronger than the NAP Track estimate for casual dining chains excluding Darden concepts and we're especially proud of their 50th consecutive quarter of same restaurant sales growth.

We think this is truly a remarkable accomplishment for a casual dining chain of their size.

The competitively superior sales performance of Olive Garden has been driven by a combination of strong guest loyalty, industry leading value and compelling news.

The ability of their restaurant teams to consistently deliver a competitively superior guest experience over time has helped make Olive Garden a trusted brand with strong guest loyalty, and guest satisfaction remained strong during the third quarter.

On the advertising side, Olive Garden continued to feature distinctive new dishes that reinforce their strong value positioning and provided guests with compelling reasons to visit their restaurants.

In December, they featured two new entrees, Chicken Roma and Asiago Chicken that were well received by their guests.

This was followed in January by two additional new entrees, five cheese stuffed rigatoni with either chicken or sausage, starting at $9.95.

Currently, Olive Garden's featuring their Alfredos promotion which offers guests two new dishes to choose from.

Steak and Portabello Mushroom Alfredo or Crab Alfredo Venizia.

As we've discussed previously, Olive Garden is focused on accelerating new restaurant growth while maintaining same restaurant excellence.

To help do that, they've successfully developed three new Tuscan Farmhouse prototypes and they've established a strong pipeline of new restaurant sites and as a result, Olive Garden is well positioned to open approximately 35 net new restaurants during fiscal 2007 and are planning to open approximately 40 net new restaurants in fiscal 2008.

Importantly, their new restaurants on average are exceeding hurdle rate guest counts, sales, and returns.

Olive Garden's strong business fundamentals combined with accelerated new unit openings give us great confidence in their ability to maintain solid sales and earnings growth for the remainder of 2007 and beyond.

Bahama Breeze continued to make significant progress on their two most important strategic priorities, improving the guest experience and increasing restaurant level returns.

Guest satisfaction has improved enough over the last two years that Bahama Breeze now ranks near the top of casual dining in our research, and it will continue to get better as their restaurant teams focus on further improving their biggest opportunity areas, attentive service, and hot food.

At the same time, Bahama Breeze has been working to eliminate cost and complexity from the business model that does not add value to the guest experience.

These structural business model changes have significantly increased restaurant level profitability.

Based on this progress, Bahama Breeze is now ready to restart new unit growth.

They've approved one new site which should open early in fiscal 2009 and are actively pursuing a pipeline of additional sites.

Smokey Bones had another difficult quarter with overall business dynamics similar to what we have discussed with you in the past.

Their same restaurant sales decline of 5.2% was well below the NAP Track chain average in total.

Our strategy for Smokey Bones remains the same.

We need to stabilize the existing base business, especially in regions of relative strength while we work to transform the brand in a way that will broaden appeal and make it more relevant for more dining occasions.

We told you last quarter about our test of a new direction for the business that builds upon our existing assets, and that includes good locations, a strong operations team, and a lodge setting that guests find extremely attractive.

Yet, replaces the barbecue centric parts of the brand that are a barrier to greater occasion breadth and increased frequency.

Rocky River Grillhouse opened in Cuyahoga Falls, Ohio, in November.

Thus far, sales have been strong and we are in the process of converting two existing Smokey Bones Restaurants into Rocky River Grillhouse Restaurants.

The first of these full conversions opened Monday in a suburb of Indianapolis and the second will open in April in a suburb of St.

Louis.

We anticipate converting several more Smokey Bones into Rocky River in fiscal 2008.

We're pleased that their sales have been strong in the first test location but we also realize we still have much to learn and much more work to do.

We'll update you on the progress of this test as appropriate going forward.

And in a separate press release yesterday, we announced that Seasons 52 would begin the next phase of its development which includes continuing to operate its seven existing restaurants with excellence and developing the real estate and talent pipelines for another three or so openings over the next two years.

We also announced the retirement of Blaine Sweatt, President of Darden's new business division and creator of many concepts here at Darden, including Olive Garden, Bahama Breeze, Smokey Bones, and Season 52.

In addition, we announced that Stephen Judge has joined Darden as President of Seasons 52.

Blaine has been an outstanding business and community leader for many years and we will certainly miss his insight and expertise at Darden.

Stephen has earned a reputation as a very successful operator at high end, innovative dining concepts in both luxury and high growth hospitality venues.

He comes to us most recently from MGM Grand Hotel where he led all food and beverage operations and we look forward to his leadership at Seasons 52 as they begin their next stage of development.

Clarence?

Thank you, Drew.

I think it's no secret to most of you listening in that it's been a challenging last 12 months for the restaurant industry generally and for casual dining in particular.

But I think what excites us is we think we entered this period in very strong shape.

We were working on the right things and that included operations excellence, really the fundamentals and also further differentiating our brands and we were doing that with very talented, very motivated people in our restaurants and here in the support center.

And I think this quarter's results to me affirm that we've been focused on the right things with the right people.

Our same restaurant sales results continue to be competitively superior.

That's been driven by continued improvement in both guest satisfaction and brand image and we continue to do an excellent job of managing costs, which helps us deliver value to our guests and all of that led to strong earnings, up 7% including stock option expense, up 10% excluding it.

And so we think we're in very strong competitive position in a tough environment and I think what that means to us, being competitively strong in a tough environment is that we've got great opportunity to really further separate ourselves and become the leader in casual dining, so we're excited about that.

We're excited about where our businesses are.

We recognize that ultimately the reason for our success is having great people.

Blaine epitomizes that.

Drew talked about the transition that Blaine is approaching.

He has been a terrific leader for Darden but more importantly, really for the entire restaurant industry, and our goal is to make sure that on a consistent basis, we can continue to develop people that have the kind of talent, the kind of leadership skills that Blaine so obviously embodies and with that, we would be happy to take your questions.

Thank you.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of David Palmer with UBS Securities.

Please go ahead.

Thanks, good morning.

At your Analyst meeting, you didn't seem all that optimistic about the near term sales environment for the industry, particularly casual dining and obviously it seems to be the correct instinct; however, has your outlook really changed since then?

I mean, have you gotten darker on the outlook for the industry in particular and is that shaping your views as to how you look out in the next one, two, or three quarters?

David, this is Clarence.

I would say, no.

Our view of where the industry is going to be has not changed.

I think we have been, we talked about industry, total casual dining sales growth, been in that 4 to 6% range, and it's been closer to the bottom of that range the last couple of years than it has been to the top.

We don't see a whole lot of change there.

We continue to think that 4 to 6% makes sense and we're hopeful that it will move up in that range, but no, I'd say no reason to have a point of view that's worse two months later.

Drew, I don't know if you have anything to add?

I would just add that the reason we think that is because the fundamentals of the industry still remain strong, what guests are looking for in the industry, physical nourishment, emotional nourishment, and the ability to capitalize on that is still the same.

And I would say just in terms of visit frequency, I think the folks who have cut back the most, I mean that's happened.

I don't see that accelerating going forward.

They are where they are.

I expect them actually to increase frequency as things get a little bit better, so we feel pretty good about that forecast that we had just a couple months ago.

Thanks very much.

Thank you.

Our next question is from the line of John Glass with CIBC.

Please go ahead.

Thanks, good morning.

Two questions.

My first is I wanted to revisit the idea of recapitalization of some sort in the business, especially given your strong cash flows.

Your balance sheet and the stock valuation, and what probably at least three of your other mature casual dining peers are doing in some form or fashion.

Is there anything in your view you could do from a capitalization standpoint that would, beyond the typical repurchase that could enhance shareholder value today?

Have you re-examined that issue recently?

Well, I think there's several things that go in our thinking as we think about capitalization.

Certainly, what does it take to make sure that we can continue to reinvest as appropriately in our current businesses?

The other thing is as we sit here in an environment which is presenting challenges to a lot of competitors, what kind of opportunities do we see out there to deploy capital, to build a business by building it fundamentally, by bringing on additional brands, for example, that have strength, that drive growth, and we also think about with all of that where would our capitalization levels sort of be appropriately put?

We've raised our leverage level, I'd say over the last 12 months by a decent amount.

Is there more room to do that?

Well, we look at all those variables and we sort of make judgments on a fairly ongoing basis, so all of those come into account.

I don't know that we're going to do anything dramatic in the near term.

I think the opportunities that are out there are fairly significant.

Just to paraphrase what I think I heard you say Clarence is that you're saving the dry powder if you will for an acquisition not a recapitalization?

Well, I'd say that weave increased our leverage level and we feel good about that because we think that we do have the strong cash flows that allow us to do that while still continuing to invest in the business and being positioned to make opportunistic investments.

Just a follow-up on Smokey Bones.

If you were to change the concept over entirely, what kind of impairment are we looking at?

How much have you impaired to date and how much remaining impairment or write off would there be?

Well, I think we have, we do an impairment test every quarter, and so we feel good about the assets that we've got at Smokey Bones and the value capture that's capable with those assets and our current balance sheet reflects that.

We look at it quarter by quarter though, and we'll continue to do that.

Okay, thank you.

Your next question is from the line of Joe Buckley with Bear Stearns.

Please go ahead.

Thank you.

A question on the casual dining environment.

Why do you think it's so soft and it sounds like you think that it has stabilized but I'm curious if you see anything that could be an inflection point either up or down looking out over the next several months.

Joe, that's a good question.

I mean, we have a lot of different theories and we really do a lot of analysis to try to see where those are.

I think fundamentally, we do think disposable income growth is slower last couple years than it's been years prior to that.

Some of it really has to do with fuel oil, both gasoline and heating oil prices.

A lot of it has to do with mortgages.

People have traded up in many cases in terms of houses and mortgages reflect that.

I think the mortgages are also, there are more adjustable rate mortgages so there's more volatility in that mortgage rate.

We do see the housing market stabilizing in the sense that the mortgages that are out there are out there.

We do see interest rates flattening and so the resets are starting to stabilize as well, and then gasoline prices have been in a trading range.

It's been a broad range but it's still been a range that people are starting to see as the new norm.

And so those are some of the things that we've seen but we continue to investigate and explore and try to understand it.

And the one thing I would add to that is that we need to be careful not to generalize about casual dining in total.

Strong brands in strong segments of casual dining are still growing, not growing as fast, perhaps, but still growing, brands that are perhaps less distinctive or aren't consistently delivering the guest experience, aren't sufficiently differentiated are maybe having a more difficult time as the industry has slowed down.

So it's not a universal phenomenon I guess.

One follow-up?

You see a lot of price point advertising just in the last few weeks by a number of your competitors.

Do you see the competitive level intensifying as that occurs?

No, no.

We think that we've seen a fair amount of price point promotion for awhile now and it ultimately still comes down to what's the quality of that offer.

It's not just about the price.

It's about the product, and the product broadly defined, the food offering, the dining experience that you're offering, and people sort through all of that, and so price promotion alone doesn't make it happen.

We proved that to ourselves many times over our history and which is why we focus so much on the entire dining experience on brand refresh as Drew mentioned, for example, at Red Lobster.

Thank you.

Thank you.

Our next question is from the line of Jeffrey Bernstein from Lehman Brothers.

Please go ahead.

Great, thank you.

Actually I have just one follow-up question on that and then a separate question.

In terms of the follow-up, I'm just wondering what you guys are doing specifically at Darden to combat the recent pressures as in the prior question?

I wasn't sure if you guys were focusing more on value offerings or perhaps some greater couponing yourself or some promotional advertising, just in the near term to offset some of the pressures and then I had a follow-up, thanks.

Yes, I would say on that side, we continue to work hard to make sure we're balanced, and so the quarter we just completed is one where you saw that balance.

During the holiday season, we had offers that were a little bit more indulgent in terms of price point because that's the mood of that season.

Following the holiday season, a little bit more focused on value and so we try to really have a balanced calendar throughout the year.

We will tweak it around the edges with how we advertise the offerings and so if we've got a great offer that we think has a very compelling price point on it, sometimes we'll emphasize that price point during a value oriented overall environment whereas we might not otherwise, and we will strategically use couponing, but the coupon cycle, I think, this year is pretty much on top of what we did last year.

I don't think there are any changes.

No, we haven't -- specifically, we haven't increased our couponing or increased our price point at advertising.

Great.

And actually just had one other question in terms of food costs, I know you mentioned in your prepared remarks this quarter you did see some increase higher cost of both brands perhaps being driven by just mix shifts.

Just wondering if you're expecting further similar pressure going forward and if you could just talk about your outlook for your core commodities as we look through '07, didn't know if we should expect further pressure or perhaps this quarter was an anomaly?

Yes, you are correct.

Basically in this quarter what we saw was the promotional calendar that drove higher absolute margins and profits for us but as a percentage of sales basis was lower than the comparison to last year.

In terms of the outlook, really we are just talking about the fourth quarter, in June we'll update you on our fiscal 2008, but over the course of the next quarter, we really don't see any dramatic shifts from where we have been and continued to see some leveraging on that particular line item.

So I would say that what you're seeing is really exclusively mix as opposed to any cost pressure, and as Brad said, when we're selling more or higher priced items, the percentage COGS may go up, but the dollar profitability on those items is significant, and so we're pretty happy selling those.

Just based on the things you have locked in at this point you don't see any reason to believe you can't get further leverage or see further favorable food costs going forward?

No.

We'll really comment on that in June, when we talk about the next year but as we said before we have a fair amount of things locked up for varying periods of time but we'll recap that for you when we get to June for fiscal 2008.

Great.

Thank you.

Thank you.

Our next question is from the line of Jeff Omohundro from Wachovia.

Please go ahead.

Thanks.

I wonder if you could elaborate a little bit on the impact of the Fresh Fish list at Red Lobster.

How is the mix there a tracking relative to your expectations and what impact is that having on check average and on this profit contribution versus margin issue?

Well, the primary impact of today's Fresh Fish program or the primary objective is to let guests know that Red Lobster features a variety of fresh fish species, up to six or seven in every restaurant across the country and if they're interested in fresh fish, then they can get it at Red Lobster.

That's not something that's widely known.

Preference on fresh fish has increased modestly since it was introduced but it hasn't had a material impact on check or on margin.

We think the big opportunity is to change how people think about Red Lobster and use the brand and over time to see that expressed in the form of higher guest counts.

My other question relates to Smokey Bones and how we should think about the strategy there.

You mentioned that your converting I think you said two more to Rocky River Grill.

Do you see a conversion strategy as the way to go or the tweaks or learnings you can take from Rocky River and just bring that over to Smokey Bones?

Well, we have been exploring both of those things.

Our strategy to date to stabilize Smokey Bones has really focused on broadening menu variety to try and address the barbecue centric nature of the menu.

On the one hand, the team which has worked very hard to do that, has successfully added more non-barbecue variety.

There's more non-barbecue items.

The percentage of guests ordering non-barbecue items has increased and the guest satisfaction on those non-barbecue items is higher, but that has not yet translated into a change in perception about Smokey Bones or a change in how they use the brand and you can see that in the guest count trend.

As a result, we are going to be looking at different ways of eliminating the same barrier to the frequency and that of occasion relevance.

Exactly what form that's going to take will be part of our strategy going forward and we'll talk more about that in the future but there could be some learnings from Rocky River Grillhouse that would apply to Smokey Bones unrelated to the menu.

Very good, thanks.

Thank you.

Our next question is from the line of Howard Penney from Prudential.

Please go ahead.

Thanks very much.

Two questions.

First, what are some of the metrics that you're looking at to know that the consumers perception about Red Lobster is changing in the Fresh Fish menu as having impact and second, Clarence, on the thought of the acquisitions, your comments about the slowing of the demand for casual dining and we've had questions already this morning about price point promotions and some of the more bigger competitors that are feeling the pinch and slower traffic trends might get more aggressive in terms of sales and promotions and what not, putting pressure on some of the smaller players.

Is there today, this environment the right time to be considering acquisitions or maybe should you wait to see where profitability ends up for some of these smaller chains?

Well on the first question about today's Fresh Fish, we'll look at qualitative measures and quantitative measures.

We know that the Red Lobster guest base, guest counts is still 5 to 10% below recent highs, and the guests that have left tell us that the biggest reason they don't use Red Lobster as much as they have in the past is their perception of the menu, particularly around having frozen seafood.

So the way we're going to evaluate the impact of today's fresh fish sheets ultimately or qualitatively we'll talk to guests and see if their perception is changing over time in terms of how they think about Red Lobster, but more importantly quantitatively, we're going to look at the mix of our guest base, light users and heavy users, the demographics of the guest base and we would expect to be seeing more of the light users or non-users that have left the brand coming back into the Red Lobster business as we go forward, keeping the current guests that we have and having the combination of that drive the total up.

And I think as we think about concepts, our own, the others that we see out there, what we really are focused on is how durable and sustainable is the proposition, the consumer proposition and the business model.

I mean, what the would it look like over time?

And so the current environment is really actually a pretty good environment to get a good read on that.

How well is the top line holding up relative to others in this environment is something that we can get a pretty good read on.

How durable is the business model at the restaurant level in this environment?

It's something we can get a pretty good read on.

Cost pressures, they are a little bit more enterprise driven, a little bit more supply chain, are those that we discount but how good does the fundamental business model at the restaurant level work is something you get a pretty good read on in a stress test environment.

So we actually feel like this is an environment where we really can see who the winners are.

Thanks very much.

Thank you.

Our next question is from the line of Tom Thomson from Thompson Siegel.

Please go ahead.

Thanks very much.

A couple of questions.

Your restaurant expenses have been down 40 to 45 basis points for the last couple of quarters and I wonder if that sort of improvement is sustainable for the next several and I understand the reasons for them.

Secondly, can you give us any sense of the tenor of sales so far in March, and then finally, a disclosure question.

You point out in the press release the impact of the tax resolutions and the impairments on your '07 quarterly EPS, but you don't mention that you have similar sorts of items in the same quarter last year and if you adjust for those as well, your EPS were really up about 17% year-over-year.

I'm just curious as to why you don't show apples-to-apples in that comparison?

Thanks.

Well, thank you, Tom.

Let me start with your question on restaurant expenses.

Our organization, we find plenty of opportunities and they vary from quarter to quarter to address our restaurant expenses and we have a multitude of efforts under way to address some of those costs and so our success varies a little bit from quarter to quarter and the item that they maybe heard us talk about in the past about success in the workers comp, public liability area, in this quarter, we talked some about the impact of lower utilities, and so when you look forward for those, we still see a fair amount of opportunities to keep addressing that cost line and don't really see a huge change in that.

I would say we'll update it again in June for fiscal 2008 but continue to see opportunities to leverage that line.

As to your comment about comparability of numbers, of course we are getting some disclosure requirements there but I would agree with your assessment when you look at the true performance, the true strength of our brands and how they're performing in a difficult environment, we're very pleased, very happy with the results there.

Oh, and your other question about looking forward into March, again, we typically don't lean into the month that we're in right now, but we'll have our same restaurant sales release out in a few weeks here.

Thank you.

Tom, I would just say that your comment about year-over-year comparability, I mean, we do lay out, last year in last year's releases, those moving parts and we lay them out this year so they're there for people to do the math.

We don't do it ourselves quite candidly because we are sensitive to being accused of whining about the quarter, and so we lay out what this quarter is.

We've laid out last year's same quarter, and encouraged people to do the math.

Great.

Thank you.

Thank you.

Our next question is from the line of Rachael Rothman from Merrill Lynch.

Please go ahead.

Hi.

Good morning, guys.

Can you take a little bit about how much of your $350 million in CapEx we should think about as maintenance or defensive and what portion you see as actual growth CapEx?

And then on the prototypes, what kind of return hurdles would you look for in how many stores or in how many varied markets before you would be comfortable moving forward with a larger scale rollout of any of the particular prototypes?

Thanks.

Let me address the CapEx first and when you look at our number out there, there's roughly $100 million of that that we would look at as just replacement or ongoing CapEx to keep our restaurants at the level of appearance and standards that we would expect, so that's what I would look roughly in that range for that.

And I would just say inside the balance of that, you've got new restaurants.

You've got -- and those new restaurants take several forms and when we talk to this audience mostly about net new restaurant growth but in addition to those 35, 40 restaurants , we are relocating restaurants and so they don't add to the incremental number, but in fact we've closed an old restaurant and built a new one, and we are rebuilding restaurants where the building isn't worth reinvesting in.

It's still the right location and we'll scrape and build a new restaurant on the same spot, so all of those are in there as well beyond the incremental net new, and the other thing that's in there that we consider growth capital is we're making some fairly meaningful technology investments, to make sure that we could continue to handle with excellence the volumes that we have that are starting to approach $5 million a year, for example, at Olive Garden, and so we can continue to grow same restaurant sales there.

We're doing those same investments at Red Lobster which also had a very significant annual volumes approaching $4 million a unit per year.

I'm not sure I followed the second question.

Which prototype were you referring

Just generally speaking, would you think maybe three, if you tested three prototypes either at Rocky River or the new prototypes that you're doing at Red Lobster, would you feel more comfortable moving ahead with the wider scale rollout of the prototype, at what percentage of units would you feel comfortable in how many different markets that you're achieving the hurdle rates that you would need to move forward with the wider scale rollouts?

Clearly you wouldn't rollout if if you just had three units in test and were pleased with those.

Yes, it's actually a restaurant by restaurant return on invested capital calculation so a prototype is certainly part of that, but the other part is just the guest count projection that we've got which really depends on a lot of other factors, how good is the site that we picked, some are A plus, some are B plus, we'll go with B plus sites as well so all of those things go into calculating.

The way we think about the prototype is we've got a guest count hurdle, given the total investment and does that hurdle go up or I'm sorry, come down with the new prototype and so that's a little bit of how we think about it.

And in addition on Rocky River which is new compared to, say Red Lobster or Olive Garden, existing business, in the case of Rocky River, we're going to be looking to make sure that the prototype in addition to being the right investment level also offers the right environment for the guest experience, and then we want to make sure that all the pieces of the business model fit together before we would start to aggressively roll something out.

So we've got a lot to learn still there.

Perfect.

Thank you.

Our next question is from the line of Glen Petraglia from Citigroup Investments.

Please go ahead.

Good morning.

I did have a follow-up question regarding Red Lobster and then another one of my own, but Drew, you made the comment about trying to get lapsed users back at Red Lobster by changing their perception of their opportunity to get fresh fish and I'm curious to know how you're communicating that to lapsed users.

I did see one advertisement that may have had the Fresh Fish tag on the back end of it but I'm curious to know if you've come up with a new advertising strategy or maybe I'm just not watching the right programming because I haven't seen a lot of discussion around Fresh Fish.

Well, what Red Lobster is doing initially is presenting today's Fresh Fish sheet personally to every guest as they sit down at the table and explaining that they offer six fresh fish species that can be prepared in a number of different ways so the initial focus was on letting all the guests, which is a substantial number in their current restaurants know about what they have, but second, they have been testing today's Fresh Fish advertising and early results were encouraging but they are going to be looking on how to build on that going forward to get the word out more broadly but they have not done that in a significant way yet.

Okay.

So are we still several months away do you think from--?

Yes.

And then just following up from some earlier comments about the casual dining environment, traffic has been down the last couple of months at both Red Lobster and Olive Garden while mix has been favorable and I'm just curious to know if you think that that's a function of your losing the bottom end consumer or is there something else going on there?

Well, what we look for typically is about 1% guest count growth and a couple percent and check 3% same restaurant sales, and in terms of while our brands are growing slower than they have in the past, they are still growing at a competitively superior rate.

It's difficult to say whether in the short-term in a couple months the guest base has changed materially in terms of lower income guests or not.

That is one of the things that we talk about because we know there's more pressure financially on that guest demographic, but it's difficult to tease out in a two or three-month, four month period.

Okay, thank you.

The reason why it's difficult is the visit cycle for that guest is quarterly at best to our restaurants, they are going to a handful of restaurants quarterly so probably once a week, twice a week, but it's -- in our restaurants, it's a quarterly sort of cycle at best.

Thank you.

Our next question is from the line of Mark Wiltamuth from Morgan Stanley.

Please go ahead.

Just wanted to follow-up on what was really driving the average check for Red Lobster?

The check was really strong all quarter and just wanted to get a sense of that.

And then if you could really give us a little sense on how long do you think the Phase Two for Red Lobster will last and are you working on real estate pipeline now in anticipation of entering Phase Three?

Well, the check increase for Red Lobster was partly promotional, not just Lobster Fest but some of the earlier promotions and it was partly some guests at lunch ordering more dinner entrees, just choosing to order more dinner entrees.

In terms of Phase Two, that's going to be a couple year process.

It's not going to, and these phases by the way are not things that completely stop.

They are still working on strengthening the fundamentals which was Phase One, at Red Lobster, but Phase Two is going to continue with new menu items, improved advertising, some amount of actual restaurant refreshment inside the unit, and that's going to take a couple years until all of that is done but there's going to be continuous improvement on those items step by step as we go forward.

Just like it was at Olive Garden in the late 90s.

And in terms of pipeline, yes.

We are looking at building a pipeline of sites assuming success on Phase Two and assuming success with the new prototype that we mentioned has opened already one in North Olmsted and one in Englewood.

Okay, thank you.

Our next question is from the line of Andy Barish from Banc of America Securities.

Please go ahead.

Hi, folks.

Can you give us a sense first of all on the rollout of the small wares at Red Lobster cost-wise and how long that lasts?

And then secondly, just where you are on the kind of new food and innovation pipeline also at that brand, how far out is the team there?

On the small ware side, plateware, flatware, napkins, those sorts of things we're beginning the rollout in part of Red Lobster at the end of this fiscal year in May and as we build inventory of plates, flatware, et cetera, we'll gradually expand it to the rest of the Red Lobster restaurants over the course of the year, so it's not going to be something that is finished quickly in May or June, and that's, we think the most efficient way to do it as well as the most effective way to do it.

In terms of changes to the menu, or changes to food, I would think about that in two ways.

Number one, changes to menu items on the core menu, the menu that's there every day as well as changes to the types of food items they advertise, and we think we're making substantial progress on both of those areas but don't really want to elaborate on the specifics, but that is a big part of their plan for next year.

Andy, this is Brad, and I would just add that as we -- as Drew talked about rolling these in in phases, you really won't see a dramatic impact on the P&L at all because a lot of it will be just normal replacement so its impact in terms of expenses reflect on the P&L's will be smaller amounts but throughout the year.

Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] And there are no further questions.

Please continue.

Well, great.

Thank you.

We will wrap up the conference at this point.

We appreciate everybody that joined us on the call today.

If you have further questions, of course, we're here to answer them in Orlando.

We look forward to seeing you as we're out and about this quarter at various conferences and we'll talk to you again in June.

Thank you very much.

Thank you.

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