達登餐飲 (DRI) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Darden Restaurants third quarter earnings release.

For the conference all participants are in a listen only mode.

However there will be an opportunity for your questions and instructions will be given at that time.

(Operator Instructions) As a reminder today's call is being recorded and with that being said I'll turn the conference now to Mr Matthew Stroud.

Please go ahead, sir.

Thank you, John.

Good morning.

With me today are Clarence Otis, Darden's Chairman and CEO, Drew Madsen, Darden's President and COO, Brad Richmond, Darden's CFO and Gene Lee, President of Darden's Specialty Restaurant Group.

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

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

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

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

We wish to caution investors not to place undue reliance on any such forward-looking statements.

Any forward-looking statements speak only as of the date on which the statements are made and we undertake no obligation to update such statements to reflect events or circumstances arising after such date.

The most significant of these uncertainties are described in Darden's Form 10-K, Form 10-Q and Form 8-K reports including all amendments to those reports.

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, supply interruptions, labor and insurance costs, the loss of, or difficulties in recruiting key personnel, information technology failures, increased advertising and marketing costs, higher than anticipated costs to open or close restaurants, litigation, unfavorable publicity, health concerns including virus outbreaks and food safety, a lack of suitable locations, government regulations, a failure to achieve growth objectives through the opening of new restaurants or the development or acquisition of new dining brands, weather conditions, risks associated with Darden's plans to expand Darden's newer brand Bahama Breeze and Seasons 52, our ability to achieve the full anticipated benefits of the RARE acquisition, possible impairment of carrying value or goodwill or other intangible assets, risks associated within considering substantial debt, failure of our internal controls over financial reporting, disruptions in the financial market, volatility in the market value of our derivatives and other factors and uncertainties discussed from time to time in reports filed by Darden with the Securities and Exchange Commission.

A copy of our press release announcing our earnings 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 at our website, darden.com.

We plan to release fiscal 2010 fourth quarter earnings and same restaurant sales for fiscal March, April, and May 2010 on Wednesday, June 23, 2010 after the market close.

We released third quarter earnings results yesterday afternoon.

These results were available on PR Newswire and other wire services.

We recognize that most of you reviewed our third quarter results so we want take the time to go through them in detail nor will we tend to spend time on a brand by brand operating summary in an effort to provide more time for your questions, rather, Brad will provide some additional line item detail about financial results for the quarter and discuss out our look for the fiscal year.

Drew will briefly review our operating performance and our Company perspective in the third quarter followed by Clarence who will have some additional remarks.

After that, Clarence, Drew, Brad, and Gene will then respond to your questions.

Brad?

Thank you, Matthew and good morning.

I want to start by detailing our same restaurant sales results for the third quarter given the holiday shifts and severe winter weather they impacted our sales.

Blended same restaurant sales for Olive Garden, Red Lobster and Longhorn Steakhouse increased 1.3% this quarter.

This includes a positive impact of 80 basis points due to the Thanksgiving holiday week shift which moved to the second quarter this year from the fiscal third quarter last year.

Excluding this affect, blended same restaurant sales results increased 0.5%.

In addition, we believe that more severe winter weather this year compared to last year adversely affected our blended same restaurant sales results by approximately 60 basis points.

This weather impact varied by brand according to their geographic dispersion as Longhorn Steakhouse was more impacted than Olive Garden or Red Lobster.

We also had some holiday shifts that had minor effects on the quarters results.

The bottom line though is that all three brands saw very good sales momentum this quarter.

The blended same restaurant sales results for the third quarter exceeded our previous guidance issued in mid February prior to our analyst day from the strength of Red Lobster's Lobsterfest Lenten period promotion and less severe winter weather benefiting all of our brands in the second half of February.

For context, industry same restaurant sales as measured by Knapp-Track and excluding Darden, which are not affected by the Thanksgiving holiday shift, are estimated to be down 4.3% for the quarter.

So we continued to outperform the industry by almost 500 basis points this quarter, which combined with continued new unit growth in the face of flat unit growth in the industry means we are building our total market share.

Turning to each brand.

Olive Garden same restaurant sales increased 1.5% for the quarter and adjusting for the Thanksgiving week shift, same restaurant sales would have risen 0.9%.

Red Lobster's same restaurant sales increased 0.9 of a percent for the quarter and adjusting for the Thanksgiving week shift, same restaurant sales would have climbed 0.1%.

Longhorn had a same restaurant sales increase of 1.9% for the quarter and adjusting for the Thanksgiving week shift, same restaurant sales would have risen 0.7%.

The Capital Grille had a same restaurant sales decrease of 1.9% for the quarter and adjusting for the Thanksgiving week shift, same restaurant sales would have decreased 4.7%.

More severe winter weather adversely affected The Capital Grille same restaurant sales by approximately 230 basis points in the third quarter.

Bahama Breeze had a same restaurant sales decrease of 0.6% for the quarter and adjusting for the Thanksgiving week shift, same restaurant sales would have decreased 2.2%.

Now, let's discuss the margin analysis for the third quarter.

Food and beverage expenses were 171 basis points lower than last year on a percentage of sales basis as a result of reduced food costs.

This reflects the fact that we benefited from declining commodity prices this quarter and we expect to continue to see additional benefits in the fourth quarter, although not to the same degree we experienced this quarter.

Third quarter restaurant labor expenses were 107 basis points higher than last year on a percentage of sales basis due to manager bonuses and increased benefit cost, wage rate inflation, and unemployment insurance taxes, partially offset by reduced employee turnover in our restaurants and lower turnover related expenses.

Looking ahead, we continue to expect some favorability as a percentage of, excuse me, some unfavorability as a percentage of sales in the first quarter, but we should see some improvement compared to this quarter.

Restaurant expenses in the quarter were 54 basis points lower than last year on a percentage of sales basis because of lower utility expense and reduced repairs and maintenance expense.

Looking ahead, we don't expect to see favorability in restaurant expense as a percentage of sales in the fourth quarter as we continue to lap the prior years reduced energy cost.

Selling, general and administrative expenses were 17 basis points higher as a percentage of sales for the third quarter because of higher bonuses, increased media expense, and increased benefit cost.

In the fourth quarter, we anticipate that selling, general and administrative expenses as a percentage of sales will be slightly lower than prior year.

As mentioned in the press release, following our view of gift card usage, we adjusted our gift card redemption assumption.

This adjustment reduced third quarter diluted net earnings per share growth by approximately $0.04.

We made this adjustment based on increased redemption of gift cards that we have been experiencing.

The effective tax rate for the third quarter was 23.2%, increasing diluted net EPS by approximately $0.02 if you compare to net earnings to what they would have been with a tax rate consistent with our annual guidance of 25%.

Our year-to-date tax rate is now approximately 25% and we each peck our annual effective tax rate to be the same.

With only one quarter left in our fiscal year, yesterday, we revised upward our annual outlook.

We expect blended same restaurant sales for the fiscal year to decline approximately 2.5%, which is better than previously anticipated and we also expect more favorable costs than previously anticipated.

So we now expect reported diluted net earnings per share growth from continuing operations to be plus 8% to plus 10% for fiscal 2010.

This compares to reported diluted net earnings per share from continuing operations of $2.65 in fiscal 2009 which included an extra fiscal week.

And now, here is Drew with some additional comments.

Thanks, Brad, and good morning, everyone.

Let me start by apologizing for my voice.

I'm obviously battling a cold, but hopefully everyone can understand me all right.

Similar to our second quarter call, I'll start by sharing a few thoughts about the industry and then comment briefly on our strategy and performance by brand.

Industry same restaurant sales results improved for the second consecutive quarter going from minus 6% during the second quarter to minus 4.3% in the third quarter.

Just as importantly, the underlying dynamics in this 170 basis point improvement versus the prior quarter also improved with guest counts improving 40 basis points and check improving 130 basis points.

Compared to last year, the implied industry check was down only 20 basis points, the best absolute performance since the third quarter of fiscal 2009 suggesting that the deep discounts so prevalent over the last four quarters at many of our competitors have eased significantly.

Now, we realize that industry same restaurant sales remain negative versus prior year and we believe that some of the sequential improvement I just discussed is due to the weak year ago industry comparison.

However, we also continue to believe that the fundamentals in full service restaurants are improving.

As it relates to Darden, our strategy to drive competitively superior results during the third quarter was consistent with the approach we have discussed with you throughout this fiscal year.

We continue to be weary of utilizing deep discounts to combat difficult industry conditions given our concerns about what this might do to long term brand integrity, long term business model integrity, and our related growth prospects.

Our approach is to build upon the broad appeal of our brands, leverage the cost advantage that comes with our scale, and utilize selective value offers across our portfolio that are profitable in the near term and maintain the strength of our business model and integrity of our brands over the long term.

Now, clearly, this approach worked well for us during the third quarter.

As Brad mentioned, our three large brands outperformed the Knapp-Track benchmark during the third quarter by almost five percentage points on a blended basis after adjusting our results for the Thanksgiving holiday shift.

I want to take a minute and review the underlying dynamics in same restaurant sales at each of our three large brands which is complicated this quarter by having significantly more year-over-year differences in holidays and weather than most quarters.

I don't want to take too much time reviewing all the details, but hopefully this brief summary helps.

Olive Garden achieved same restaurant sales growth during the third quarter of 1.5%.

If you account for holiday shifts and weather differences, their adjusted sales growth was actually a little stronger.

During the second quarter of this fiscal year, the comparable adjusted same restaurant sales results for Olive Garden was approximately minus 1%.

So clearly, momentum has improved.

Olive Garden featured approachable and distinctive food reviews during the third quarter, but had two fewer weeks of price point advertising than the prior year.

Red Lobster achieved same restaurant sales growth during the third quarter of 0.9% and if you account for holiday shifts and weather differences, their adjusted sales results were slightly lower, but still positive versus the prior year.

During the second quarter of this fiscal year, the comparable adjusted same restaurant sales result for Red Lobster was roughly minus 7%.

So momentum at Red Lobster has improved substantially.

These strong results were driven by two very successful promotions, the $29.99 seafood dinner for two promotion started in early January and ran through mid February.

This promotion offered guests an attractive price point that directly addressed their need for affordability, but was not a deep discount that eroded profitability or brand image.

Red Lobster followed this price fix offer with the introduction of their signature Lobsterfest promotion during the last two weeks of February.

This promotion started two weeks earlier than last year and has exceeded our expectations so far.

Longhorn Steakhouse achieved same restaurant sales growth of 1.9% during the third quarter.

Their adjusted third quarter same restaurant sales performance is essentially the same.

During the second quarter of this fiscal year, the comparable adjusted same restaurant sales for Longhorn was roughly minus 5%.

So Longhorn also had a significant improvement in momentum.

They featured their signature stuffed filets during the holidays and they followed that promotion with a value offering featuring several signature grill offerings with a starting at $9.99 price point.

Now, while both these promotions were similar to what they ran last year, we believe they featured more compelling dishes and more compelling advertising resulting in stronger sales performance.

Longhorn also benefited from increased gift card distribution and sales as part of the Darden network this year.

In addition to these successful promotions, favorable commodity cost trends and proactive internal cost management helped operating margins increase at all three of our large brands, which enabled Darden to deliver a strong increase in earnings.

We believe this is further evidence of the strength of our brand portfolio, our business model, and the appropriateness of our strategy to achieve consistent profitable market share growth across these brands.

Finally, we continue to make significant progress transforming the way we run our business and the way we support our restaurants that will make our brand support platform even more cost effective in the future.

In particular, three core projects targeting high expenditure areas, the automation of our supply chain, the centralization of facilities maintenance support, and transformation of our in restaurant operating practices to significantly lower usage of energy, water, and cleaning supplies are all on track to meet or exceed the cost reduction targets we've discussed with you in the past.

And I'll hand it back to Clarence for a few final comments.

Thanks Drew.

We are of course very pleased with our financial performance this quarter.

It reflects some encouraging industry trends for sure, but it also is strong evidence that Darden's well positioned.

We've got great brands and we have what we think is an increasingly effective and efficient brand support platform, and all of that's the case because of one thing, and that's because we have exceptionally talented people and those people are working well together.

These talented teams in our restaurants and in our restaurant support center are why we've successfully navigated what we all know has been just an incredibly challenging environment.

More importantly, they're why we believe that as the economy recovers and beyond that gets back to normalized growth, the best is yet to come for this Company.

We have tremendous confidence in our business, we feel great about how we're performing today and about our strategic and tactical decisions and we're excited about the future and with that we'll take your questions.

Thank you.

(Operator Instructions) We'll first go to the line of David Palmer with UBS.

Please go ahead.

Hi.

First of all congratulations on the quarter and in particular the improvement in Longhorn this year.

Wanted to ask you about your sales versus the industry.

Do you see any reasons why, just in this next quarter and thinking beyond that, any reasons why your gap to the industry would narrow significantly if indeed the industry is improving?

Do you think your head room versus the industry will be maintained or aside from things like Lobsterfest timing that should be roughly similar to what we've seen in the recent past?

Thanks.

Hi, David, this is Clarence.

I'll start.

We've talked throughout the fiscal year really about what we thought would happen in the industry and we did think that we would see the industry improve through the fiscal year and that's happened.

Third quarter, as Drew said, much better than the second.

We expect the industry to be better in the fourth than it was in the third quarter.

We said all along that our goal is to outperform the industry and we haven't really put -- we haven't framed that I guess through this period, but we've maintained a very strong gap.

There is volatility from quarter to quarter, month to month, based upon what competitors are doing and what we're doing.

We talked about a 200 basis points gap I think as we entered the year because we did feel we would see a fair amount of discounting that might narrow the gap, obviously that's abated and the gap has widened.

So we would expect that in a more normalized environment from a discounting perspective that we would have a wider gap than that.

Thank you.

Next we'll go to the line of Jeff Omohundro with Wells Fargo.

Please go ahead.

Thank you.

My question relates to Red Lobster and the improvements that you're seeing there.

I wonder if you could talk a little bit more about your thinking around the three course dinner for two, how pleased you were with that effort, and whether that's sort of value offering, do you see that continuing through the year or further efforts along those lines?

Thanks.

Well, we were very pleased with the performance of the sea food dinner for two promotion.

We thought it did a great job of balancing the two things that we really are striving to do in this environment.

One is on a brand like Red Lobster, periodically give guests the affordability that they're looking for, but do it in a way that doesn't negatively impact brand image or business model and we thought that this price fix dinner for two at $29.99 did that very well based on the preference that that promotion got in restaurant, the guest satisfaction that it got in restaurant, the impact on the sales trend improvement and operating margins improved, we think it did everything we were looking for it to do.

On the other hand, to put that in context, as we said on the call last quarter, we are going to use promotions like that selectively on a brand like Red Lobster and we don't really want to comment further on what's going to happen in the future, but we will periodically use things like that to give price certainty to their guests without deep discounts.

Thank you.

We'll go to the line of Jeff Farmer with Jefferies & Company.

Please go ahead.

Great, thank you and good morning.

You did touch on this, but after 18 months of what looks like mid single digit same-store sales declines at Longhorn, jump back to positive comps is pretty remarkable.

So with that, was there a material increase in the advertising spend and was there a big performance gap between restaurants with and without advertising in the quarter?

Yes, there is always a material difference in the businesses at the restaurants that are getting advertising support than not.

We did not add incremental media or incremental coupons at Longhorn.

We think the trend change that you're seeing just reflects continuous improvement in the marketing and culinary team at Longhorn in terms of developing creative, compelling new dishes and putting those in advertising in more compelling ways that really helps build the brand image as a great casual dining steak house and helps drive incremental traffic.

And that's complimenting everything else the brand has already done to improve the guest experience and so forth.

Clarence to follow-up to one of the things you mentioned, on the last call in late December you gave us some insight into where directionally December same-store sales trends were heading.

Can you provide the same commentary on March?

Well, we would not.

What we've talked about what we think we're going to do for the year so implicit in that is a fourth quarter sort of expectation and I would say as we look out, that's less about what's going on in March and more about the fact that we are in an environment that is still choppy, is how we would describe the overall economic environment.

And so again, we're seeing industry strengthen, we expect that to continue, it's fragile enough that you may get some set backs with headlines that are adverse.

We've not had those kind of headlines so far in March, but we still have two months to go in the quarter.

Thank you.

The next question is from Matthew DiFrisco with Oppenheimer.

Please go ahead.

Thank you.

I guess following on that I was curious if you could give a little bit more detail as far as your implied guidance of the sequential slowdown in comps, is that expecting a slowdown in the back half in being prudently conservative for the shift in Lent and other things and Lobsterfest, or are you already seeing that type of a slowdown now?

Well I think we're really doing our math based upon prior year comparisons, which are a little more difficult for the industry.

So even as we see industry improvement it's up against a stronger comp prior year.

Nevertheless we do expect it to improve and we haven't seen any reason that we should change that expectation and we continue to expect ourselves to out perform the industry across-the-board really.

We talked about Longhorn, Longhorn has been outperforming the industry for quite some time now after having lagged and Drew talked about they've been working on a lot of things to strengthen the brand, that work started with the acquisition two and a half years ago, but a lot of those initiatives really haven't shown up in the guest experience until quite recently.

And we think that when you put all of those together, it forms a critical mass that changes how guests view the brand in a positive way and so we expect outperformance to continue at Longhorn as well as the other two large brands.

That's great and then I guess just two bookkeeping questions.

With respect to the $0.04 that you mentioned for the gift card redemptions, I missed that.

Was that completely in G&A and then if you could give us any sort of outlook for CapEx for 2011, greater than 2010, equal to 2010 context?

Yes, this is Brad here.

On the gift card, that all represents a sales deduction, so that's how you should think of that.

It does not affect any of our same restaurant sales performance calculation, but that's where that particular adjustment occurs.

In terms of the CapEx, I think we detailed that pretty good our expectations at our mid February analyst call.

So there's been really no meaningful update from there.

It does suggest obviously a significant amount of CapEx investment as we strengthen our brands around remodels both at Longhorn Steakhouse and at Red Lobster, as well as an accelerated unit growth pace as we look to fiscal 2011.

Our next question is from the line of John Ivankoe with JPMorgan.

Please go ahead.

Great.

Hi.

Thanks, two questions please.

The first is on labor.

Your labor costs, as you said, were up 110 basis points on positive comps and a lot of companies now are show labor leverage on negative comps.

So I was hoping that you could maybe give a little bit more detail on what may have been discretionary in the period, bonuses, training, other types of initiatives you may have been doing especially in the context of lower turnover which normally would lower labor costs.

So that's the first point and secondly was hoping now that the healthcare bill is largely complete what you think that means for Darden?

Let me, the first part of that question, John, restaurant labor, really there's two key components that go into that.

The front line labor, that direct cost.

We do continue to see equal to or slightly better leveraging on that particular line, but we are experiencing some cost in the other components of that labor around unemployment taxes that we have to pay and certain benefits costs particularly around group insurance as well as the strong performance that we have.

Our restaurant managers are enjoying good bonuses out of those.

So that's probably the real driver in that number.

I would caution though that we've grown same restaurant sales, guest counts, which is the real driver of that, still aren't positive enough to get real leveraging out of that.

So we looked at the labor in the front line, serving the guest, we're happy where that is and we're managing that pretty well, equal to or better than the rate we were at last year.

And John, as you said, healthcare bill is largely complete although the reconciliation component of that hasn't passed the Senate yet and so there still could be some additional changes.

What we would tell you is we'll study the bill in its final form, figure out really the impact on our business and our employees and we'll analyze the cost implications for the business.

We think that it's much like a lot of the other cost challenges that we face like rising commodity cost and minimum wage increases, the cost of nutrition disclosure, we're going to take time to understand the cost implications and plan for implementation.

We do have time to plan.

Most of the provisions in the current legislation would be effective for us in 2014 which is really the second half of our fiscal 2013, and the provisions that are affected before that are provisions that aren't expected to have a significant impact on us, for example, our medical plans do not exclude pre-existing conditions today and so that prohibition which is effective next year is not going to affect us.

Again, we're working really to understand the implications, we feel pretty confident about our ability to really respond through some combination of cost management and price increases.

Thank you, great.

Next we'll go to the line of Jeffrey Bernstein with Barclays Capital.

Please go ahead.

Great, thank you.

A couple of longer term questions.

One, looking beyond fiscal 2010, or I guess if we use fiscal 2010 as a context, it looks like you're talking about 8% to 10% earnings growth, impressive considering comps down two to three, just wondering as you look out to fiscal 2011 as an example, comps really continue to track where they are now and unit growth is pretty well locked on the 3% to 4% range, is it fair to say we should expect earnings kind of in the near term above the normal you target 10% to 15% range just based on the fact the cost saving initiatives you've implemented over the past 18 months and the additional $40 million to $50 million you talked about of transformational in 2011.

Just trying to gauge the lasting benefits from the cost cuts and the benefits from an incremental comp as you look, specifically on fiscal 2011, it would seem like it would be above kind of normalized earnings target.

Yes, at this point, we're not prepared to talk about fiscal 2011.

We will of course do that on the year-end and fourth quarter call in June.

So I would just go back to the long term targets that we talked about at our February investor conference which is that 10% to 15%.

We feel good about that.

We think it requires all the things we talked about, which is the work we're doing to really drive the top line both from a same restaurant sales perspective and unit growth and all of the cost transformation initiatives that were undertaken.

As we said, those are designed to be responsive to some of the long term cost pressures that we see in the business whether those ultimately are on the food cost side as we get increasing competition for food from emerging countries or things like healthcare.

And so all of those things are designed to respond to the fact that we think some of these cost pressures are persistent, and will keep us in that 10% to 15% earnings per share growth range.

Jeffrey, Brad here.

I would just add we talked mid February about where our absolute performance was in terms of margins and all that.

Obviously with the strong quarter we have now we're probably at, or maybe even a little above, our peak margins that we've been at.

So from here, same restaurant sales growth can be -- we can take a lot of that and convert it very effectively into earnings growth.

So the ability to achieve 10% to 15% earnings growth over the longer term, we feel very well positioned to do that from our financial model, I think our brand strength shows itself again this quarter that it sets us up very well as we think about the longer term.

And that's been our growth target for a very long term, probably more of it being driven by operating profit growth going forward compared to cash flow growth and reduced share base.

And so very strong growth and we think it is one validation of the acquisition.

Brad talked about peak margins, we've got new targets for peaks at this point, and a lot of that has to do with the cost images that we saw from the acquisition with the kind of top line growth that we expect given the addition of two proven, yet growing brands in Longhorn and Capital Grille.

Okay, and I think you kind of alluded to it in your comments and I know in the press release you talked about ramping up share repurchase with this excess cash and you had only done 16 million year-to-date and you're talking about 75 million most of which is coming in the fiscal fourth quarter.

How should we think about that for fiscal 2011 with the debt pay down modest?

Is it reasonable that kind of accelerated pace could continue or is it still greater relative boost to the dividend as the focus for fiscal 2011?

Again we'll get into fiscal 2011 when we get to our June call, but what I would say is that we worked our debt metrics down to a level that we feel very comfortable with in this environment.

As we look to go forward the strong cash that our business generates will allow us to return more to our shareholders both through the form of dividends and share buyback.

I think we've been pretty light on that this year compared to our historical trend.

So I would say there's a good likelihood there will be more there, but in terms of clarifying or defining that, I think we'll wait until June when we get this year taken care of.

Great, thank you.

We'll go to Nicole Miller with Piper Jaffray.

Please go ahead.

Thanks, I was hoping you could give us some conversation around Capital Grille and what's happening on the higher end to aid the recovery and also could you comment on traffic price and mix trends as it relates to Capital Grille?

Sure, Nicole, this is Gene.

We're experiencing a broad based sales improvement across all geographies and in our central business districts and our suburban areas.

We're experiencing larger gains on Monday through Thursday night primarily being driven by business entertainment.

We are experiencing from a guest count standpoint.

Our guest counts are growing.

We are still seeing a little bit of negative check in the Capital Grille business and that's primarily being driven by lower wine expenditures.

We're seeing a little bit of trade down there.

Not a whole lot in food, but more in alcohol.

Thank you.

We'll go to the line of John Glass with Morgan Stanley.

Please go ahead.

Thanks.

First on the breakage question, I presume this is due to the fact that consumers during recession go through their desk drawers, pull out the old gift certificates or gift cards, use them at a greater frequency.

So can you just talk about has that been a benefit to comp in the last couple quarters and is it meaningful and can you also talk about this must have a detriment to margins since you're lowering revenue without taking any offsetting cost reductions?

John, Brad here.

I think you said it pretty good.

What we're seeing right now is with the consumers are going through their drawers and finding all of the old gift cards and everything they can for our businesses and probably others.

so we have seen a pattern that has changed as we do with any of our accounts where there is a fair amount of estimating to, we have a routine that we go through to assess those and we have seen that that redemption rate has gone up.

I think you're correct that it's been one of the things that's helped our sales as well.

We have strong brands.

You can use these cards in over 1800 different restaurants and so I think it's been a little bit of a plus to our same restaurant sales performance.

I would say in the magnitude of things though, it's really hard to measure that because it's not that significant of a number there.

What I would say is you do pick up on nuance there that our margins are a little bit stronger than the published reports would indicate because this is treated as a sales deduction.

And so I think that number is about 40 to 50 basis points better than the reported numbers that show and that would appear on every line item of the P&L.

So the individual line is not significant, but I do think it has helped us bring more guests into our restaurants.

Great.

That's helpful and you mentioned a goal for new peak margins and internal thoughts, and I'm sorry if you mentioned this and I've just forgotten, but have you talked to what you think those new peak margins are, what the order of magnitude you can pick up in this new cycle?

Well I think I'd go back to our business model that we talked about in mid February and we continue to strengthen that.

I think the more we can drive through same restaurant performance, building the AUVs in our restaurants is the highest returning biggest margin building sales growth that we have.

Historically, if you go back a few years ago, that's how we were driving most of our business and we didn't have high unit growth vis-a-vis the industry.

Now we have a model that's much better mix that between the same restaurant sales growth and unit growth.

So I think the art of the possible if you will is looking at those two components and seeing how you can grow your business between those measures and also we talked about the transformative cost initiatives we have out there.

Those agree we don't incur an increasing cost environment can be converted to lower pricing which can help drive unit volumes and/or some combination of improving margins and driving earnings directly that way in addition to growing average unit volumes.

Prior peak though was 10.3%.

Do you think you can exceed that?

Yes.

Thank you.

We'll go to Brad Ludington with KeyBanc Capital Markets.

Please go ahead.

Thank you, most of mine have been asked, but I did want to see one less week of Lent and the next quarter, or maybe two less actually I think, should that be some kind of significant impact on Red Lobster and alternatively maybe on Capital Grille and Longhorn as well on same-store sales?

This is Brad here.

It is a very meaningful impact for Red Lobster in the quarter and I think if you go to the press release, if you look at February we detail that a little bit.

It is a little bit of a drag on Longhorn's performance, although pretty insignificant and really we don't measure much of an impact on Capital Grille, but to your point, those impacts net-net helped the third quarter a little bit and do hurt the fourth quarter a little bit particularly with the strong results that Red Lobster had with their Lobsterfest promotion.

Thank you and then just briefly to follow-up on international development in the coming years, have you given any color on which brands will be focused on for the international development?

We've not talked about it publicly, but it's safe to say really our three large brands will be probably the bulk of the focus.

Thank you very much.

We have a question from David Tarantino with Robert W Baird.

Please go ahead.

Hi, good morning and congratulations on good results.

A question on the pricing strategy, at least here in the near term.

What are your thoughts as it relates to taking pricing in this environment and what might you take as you start to cycle some of the increases that you made Spring/Summer of last year?

Well we've talked, David, in the past about the fact that when it comes to pricing the thing that we try to do is be as consistent as we can.

And so when we see short-term spikes or declines in cost, we tend to absorb the spikes and benefit from the declines and not move the pricing around a lot so if you look over the long term, 2% to 3% is where we tend to be.

Occasionally we might get below that or slightly above it, but in that 2% to 3% range obviously more toward the bottom of that through a more affordability sensitive period like this.

Even at the bottom of that range, given what's happened in commodity cost inflation, inflation in general, it's helped build margins, but we absorbed some inflation that was above that range coming into this recession and took a little bit of a margin hit.

So it all nets out over the long term is how we think about it.

Great, thank you.

One follow-up.

While it's helped build margins, we're very conscience of value perception and usage across all demographic groups and the value ratings remain very strong.

Our next question is from Joe Buckley with Banc of America Merrill Lynch.

Please go ahead.

Thank you.

I want to ask a follow-up on the implicit fourth quarter sales guidance.

Just want to confirm that basically you're looking for comps to be down about 2% in the fourth quarter and just curious if there's any nuances around that in terms of when pricing might be running off or even the year-over-year comparison with the 14 week quarter from a year ago.

If there's any wrinkles beyond the obvious Easter Lent shift we should be thinking about?

This is Clarence.

I would say the 2% sounds a little heavy.

I think we're lighter than that probably more like 1% and then there are a few wrinkles having to do with that extra week that technically put pressure on the comp and I guess I'll let Brad try to walk you through that wrinkle.

Basically, the 53rd week last year, that -- traditionally the last week of the fiscal year is a weaker lower volume week.

So it's excluded last year but we're comparing the same 13 weeks, so last years results are reflective.

This year we moved that 13th week or week back into our quarterly computation.

So it is some of an impact.

It's really not too dramatic though, but it does put more downward pressure.

I think more when I look at it and look at the fourth quarter is we're on much stronger comparisons last year in the fourth quarter than we were in the second quarter.

We've had the Red Lobster's Lobsterfest Lenten promotion that has moved two weeks out of the fourth quarter and into the third and that will go back to Clarence's earlier comments about just looking at where the industry is and where the consumers are.

We do expect it to improve modestly and we expect it will outperform the industries performance, but we also look at a consumer that's in a fairly fragile state right now.

So we need to continue to see their household economics strengthen.

We need to see more employment as well to really drive the industry and our business.

And then I would just -- the last comment just reiterate one of the things I said earlier which is that's a look at the entire quarter.

It's not a comment on quarter to date.

Right, and so we're forecasting what we think the quarter might be based upon the two unknown months as opposed to the known month, and so it really reflects our perspective that the environment remains fragile as opposed to anything we're seeing in the business currently.

Okay, and then just a question on gift cards as well, just another follow-up.

So the change in redemptions, was it more based around gift cards you sold this year during the holiday period or was it more people finding the old gift card in the drawer and maybe if you would just give the year-over-year comparison for gift card sales in the February quarter.

Joe, Brad here.

Gift cards, I would say a lot of those get redeemed fairly quickly like in the first 90 days, maybe 70% or so of those, but you'd be surprised they have a very long development period that we have a lot of activity in these cards into the second year and even past the second year.

So you do have to look at a fairly long development period.

So it does reflect what's been happening recently, but you have to look at a long period to do that.

So I think consumers are digging pretty deep in that.

I think the other thing we see is our sales of these through third parties, those sales channels.

We've had meaningful increases over the past couple of years in those sales channels, those cards typically have a slightly higher redemption rate if you would than what we sell in our restaurants.

And in terms of our overall performance on gift card sales we really don't get into the details of that, but we've been very pleased with the program we've had for a number of years, we've had meaningful increases in that.

It helps drive sales right after particularly the Christmas holiday season period there that we find beneficial and we see that also helps expose more consumers to our brand, they give it as a gift and they've come in, I think we've seen a lot of that in this particular quarter with Longhorn.

They now were able to use the Darden network.

So they get a lot more of their cards out there for consumers to see and I think that's just one of the advantages to the acquisition that beyond the cost synergies we've talked about to help them gross their total sales base as well.

So we're pretty pleased with all of that.

Okay, thank you.

Our next question is from Larry Miller with RBC Capital.

Thank you very much.

Just two quick follow-ups on that peak margin discussion.

Do you need to see G&A and labor leverage to run at that peak and then also what kind of comp would you need to see to run that north of 10.3% margin?

Thanks.

Yes, I would just say on the G&A line, we actually invest in trying to get more cost efficient and so a lot of investments show up on the G&A line, the benefit of those investments may show up on other lines being labor, food, marketing, all of those things.

And so the G&A line is probably not the appropriate way to look at leverage because, again, those investments take place there, the benefits come in all of the other places.

So I don't know if that's one I would focus as much attention on.

Yes, I would agree with Clarence there because we do make, at different times, meaningful investments to help drive the high average unit volumes that our brands enjoy and help avoid some of the costs that come along, but when you look at new unit growth, that leverages our support structure that we have here.

So we do get leverage on that part of our G&A, like Clarence said we invest at different times for different initiatives.

And same restaurant sales in our existing restaurants meaningfully leverage all of the lines on our P&L that we have there.

So to your point you would expect to see a little bit of leveraging on virtually all of the lines, very little though on cost of sales and year to year, quarter to quarter it may vary on what we're doing in G&A.

You see most of the leverage coming in the restaurant expense, depreciation and restaurant labor.

I think that the last part of your question is about same restaurant sales and what does it take to grow our margins.

Obviously you can look at the recent history or this year and see that we're growing those margins pretty significantly on a down traffic, down sale.

I don't think that's the longer term norm, but we have made really meaningful progress on our business model here.

I think historically, we said we need it close to 2% same restaurant sales to maintain our margins.

I would say, if I look at where we are today, somewhere in the low 1% range is all it would take in a normalized environment to maintain our margins.

So anything above that would add to our margins and accelerated earnings growth.

When we look at that long term target, we talk about 2% to 4% and that 2% to 4% would build margin and push us to new levels which we would expect.

So when we look at margin growth annually, on a normalized basis depending on where we're investing at 20 to 50 basis points a year is what we tend to be in.

Thanks a lot.

Great job.

We'll go to Robert Derrington with Morgan Keegan.

Please go ahead.

Yes, hi.

Quick follow-up on the gift card piece for a second.

I assume this adjustment in this past quarter for the gift card redemption I think you said it was worth 40 to 50 basis points if you X that out.

Is it reasonable that we should the expect to see another adjustment in that redemption as we go forward?

Robert, Brad here.

I would say first off, we always review this, but I think we've seen a meaningful change in the consumer behavior, we've seen our sales channel mix grow more in certain areas.

So barring major changes in those, I think we've got everything adjusted that we need to and wouldn't expect any future adjustments, but I would say we're always looking at this and should consumer patterns or behaviors change it might be there, but it's not anything I would anticipate.

We believe that the entire gift cards we have outstanding we've adjusted for those.

Got it, on follow-up if I could, Brad, if we look at the depreciation line, it was up at about 9.7%, considerably higher than revenue and a higher increase year-over-year than some of the prior quarters.

Can you kind of walk us through what's going on with that depreciation line and how that's affected?

Is it the remodel program and are we getting a benefit from the remodel program in other lines and increased sales?

I think that's more reflective of a years worth of same restaurant sales challenge, average unit volumes were down a little bit.

When we look at the programs, remodels or new restaurants we're very pleased with where they are.

I think it's more just a result of the sales leveraging impact that's going on there.

Nothing else particular that's driving that.

You have to remember that many of the units that are coming online recently were units that were in the works a year and a half, two years ago.

So they do have a little bit higher investment base there than what we have with new units going forward and so that does put a little bit of pressure on that line, but there's nothing else significant or meaningful that's going on there.

Okay, all right, very good.

Thank you.

We'll go to the line of Keith Siegner with Credit Suisse.

Please go ahead.

Thanks.

Two quick questions.

The first one on Longhorn.

Obviously, traffic improved a lot this quarter, but so did mix and I was wondering given that you still had somewhat of a value promotion in place for part of the quarter, where did the mix improvement come from?

Was it just an easier competitive environment with less promotions?

Was it lapping initial value offers from last year, did the gift card push at Longhorn actually help to drive a little bit higher mix?

If you could help us on that that would be helpful and then the second question is you mentioned that marketing was up in the quarter, but that it wasn't up in Longhorn.

So I was wondering if you could tell us maybe where the increase in the spending and the quarter was located?

Thanks.

On the first part of the Longhorn question, we think the mix change is really being driven primarily by higher interest in their new signature dishes.

So the stuffed filets in particular, crab stuffed filet over the holidays were more popular than the new dishes they had last year and that's what I meant by the culinary team and the marketing team gaining traction on developing popular new dishes that are compelling and there's just a higher percentage of people buying that and on the -- what was your second question?

I forget now.

It was about the marketing spend being up, but not up at Longhorn, so wondering where the increase was located.

So we didn't increase our advertising dollars at Longhorn, but the marketing as a percent of sales was up and I think they had one extra week of TV during the quarter.

They had more points.

Okay, thank you.

We'll go to Steve Anderson with MKM Partners.

Please go ahead.

Maybe this was on the initial call, but do you have any guidance on full year interest expenses?

Steven, no, we really haven't detailed that particular line item out.

It's more Incorporated in our overall guidance, but we are enjoying very strong cash flow.

We ended the quarter with no draw against our revolver.

So all we have out there is our bonds and that's definitely helping our interest expense and our year-over-year basis.

That's probably about all I can detail in that particular line item.

Okay, thank you.

We got time for one more question, John.

That will be from the line of Tom Forte with Telsey Advisory Group.

Please go ahead.

Great.

Thank you very much for taking my call.

Congratulations on the quarter.

With the improving environment for casual dining and having a large number of brands that you're adding units on, I just wondered if you could take a minute to talk about the real estate environment if you're seeing any change to rents or tenant improvement allowances, things of that nature?

We have seen a shift in the real estate environment in a couple areas, maybe the most important is that our brands are able to secure higher quality sites than they might have been able to in the past for a variety of reasons.

One our brands are broadly appealing, they attract a lot of traffic, they're very differentiated and second the financial strength of Darden is obviously appealing in this environment.

So one meaningful trend is that we're getting access to higher quality sites which is a great thing long term.

Second, we have seen across the country building costs come down about 10% and even though there's very few new developments being constructed now, because of all of the challenges with existing tenants we are seeing rents come down also probably more in the 5% range.

Great.

Thank you very much.

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

We appreciate your interest in the story here at Darden Restaurants and we look forward to speaking with you again in June and if you have any further questions please get a hold of us here in Orlando.

Thank you and have a great day.

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