達登餐飲 (DRI) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the third quarter earnings release conference call.

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

Later, we will conduct a question-and-answer session.

Instructions will be given at that time.

Participants should know that they are allowed one question with one follow-up.

(Operator Instructions) As a reminder, the conference is being recorded.

I would now like to turn the call over to our host, Mr.

Matthew Stroud.

Please go ahead.

Thank you.

Good morning everyone.

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.

Forward-looking statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Any forward-looking statements speak only as of the date on which such statements are made.

And we undertake no obligation to update such statements to reflect events or circumstances arising after such date.

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

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

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 food safety and food borne illness concerns; litigation; unfavorable publicity; federal, state and local regulation of our business including healthcare reform; labor and insurance costs; technology failures; health concerns, including virus outbreaks; the intensely competitive nature of the restaurant industry; factors impacting our ability to drive sales growth; the impact of the indebtedness we incurred in the RARE acquisition; our plans to extend our newer brands like Bahama Breeze and Seasons 52; a lack of suitable new restaurant locations; higher than anticipated costs to open, close or remodel restaurants; increased advertising and marketing costs; a failure to develop and recruit effective leaders, the price and availability of key food products and utilities; shortages or interruptions in the delivery of food and other products; volatility in the market value of derivatives; general macro economics factors including unemployment and interest rates; severe weather conditions; disruptions in the financial markets; a possible impairment in the carrying value of our goodwill or other intangible assets; a failure of our internal controls over financial reporting; 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, the Form 8-K used to furnish the release to the Securities and Exchange Commission, and any other financial and statistical information about the period covered in the conference call, including any information required by Regulation G, is available under the heading Investor Relations on our website at Darden.com.

We plan to release fiscal 2011 fourth quarter earnings and same restaurant sales for fiscal March, April and May 2011 on Thursday, June 30, 2011, 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 won't go through them in detail once again, in an effort to provide more time for your questions.

Rather, Brad will provide some additional line item detail about the financial results for the quarter.

Drew will review the third quarter operating performance of our larger brands.

Gene will speak about the Specialty Restaurant Group's recent performance, followed by Clarence who will have some closing remarks.

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

Brad?

Thank you, Matthew, and good morning.

Darden's total sales from continuing operations increased 5.5% in the third quarter to $1.980 billion.This strong top line performance compares to an estimated 0.9% total sales growth for the industry, as measured by Knapp-Track, indicating our meaningful market share growth.On a blended same restaurant sales basis, Darden's third quarter sales were up 0.9%, which is consistent with the estimates in our January 31 pre-release.

For context, industry same restaurant sales as measured by Knapp-Track and excluding Darden are estimated to be up 0.1% for the quarter.

Olive Garden's third quarter US same restaurant sales were flat, which is 1.5 percentage points below our prior estimate.

Red Lobster's third quarter US same-restaurant sales increased 0.1%, or 1 percentage point better than our prior estimate.

LongHorn Steakhouse third quarter US same-restaurant sales increased 6.1%, which is 1.5 percentage points better than our prior estimate.

We also saw accelerated same-restaurant growth gains in our Specialty Restaurant Group.

The Capital Grille's third quarter same-restaurant sales increased 8.4%.

Bahama Breeze third quarter same-restaurant sales increased 3.4%.

And Seasons 52's third quarter same-restaurant sales increased 4.2%.

Now let's turn to a margin analysis of the third quarter.

Food and beverage expenses were 12 basis points higher than last year on a percentage of sales basis as a result of increased food costs due to the planned negative mix changes related to our promotional offerings.

As we mentioned at our recent Analyst Day, we have many of our food costs locked in for the current fiscal year and we do not expect-- excuse me we so expect higher food and beverage expenses as a percentage of sales in the fourth quarter.

Some of which is due to the timing of Lobster Fest promotion at Red Lobster.

Since our investor and analyst conference, we've continued to opportunistically build coverage of some key commodities into next year.

So we continue to be comfortable with the food cost inflation outlook for the next year that we shared with you at that time.

Looking at third quarter restaurant labor expenses, they were 128 basis points lower than last year on a percentage of sales basis due to productivity gains and the benefits from continued low employee turnover levels.

We anticipate that this trend of increased productivity and lower turnover will continue through the fourth quarter.

Restaurant expenses in the quarter were 37 basis points lower than last year, on a percentage of sales basis, primarily because of reduced workers' compensation expense, based on our experiences there.

And this more than offset an increase in credit card fees.

In the fourth quarter, we anticipate that sales leveraging and additional cost savings will lead to lower year-over-year restaurant expenses on a percentage of sales basis.

Selling, general and administrative expenses were 82 basis points higher as a percentage of sales for the third quarter, due to increased media expenses, the impairment charge for lease cancellation, or restaurant lease cancellation, and elevated incentive compensation expense related to our stronger performance.

We anticipate that these expenses will be more in line with the prior year on a percentage of sales basis in the fourth quarter.

Depreciation expense in the quarter was 10 basis points lower than last year on a percentage of sales basis.

Now, for the quarter, operating profit as a percentage of sales was 11.3%.

That's 81 basis points better than last year, and came from a combination of our strong new unit sales growth and blended same-restaurant sales growth.

We remain on track to achieve an operating profit return on sales for the fiscal year that would see us approaching the historical highs for margins.

We expect to establish a new benchmark for margins as well as a result of the progress we made strengthening our operating platform and business models.

These margin levels also demonstrate our earnings capability as the economic improvement supports resumption of same-restaurant sales growth and continued restaurant growth.

We've also seen the kind of results on our broad sets of our cost initiatives that we shared with you at the investor conference, with some of it coming in even a little faster.

So this should also support continued margin expansion as we look into the new fiscal year.

Consistent with our guidance that we offered at the investor and analyst conference, the effective tax rate for the quarter of 23.8% reflects the cumulative benefit of the change in our annual estimate.

And, we are also achieving higher than anticipated tax credits associated with federal incentives for new hires as a result of our increased unit growth.

As a result, we now expect the fourth quarter and annual effective tax rates to be in the mid-26% range.

During the third quarter, we repurchased 2.3 million shares of our common stock for approximately $105 million.

With our growing cash flows we are raising our estimates for share repurchases for this fiscal year to approximately $375 million.

So when you add it up, it was a very good quarter with sales growing over 5% and earnings per share up 14%.

Yesterday we announced that we now anticipate reported diluted net earnings per share growth from continuing operations of approximately 19%.

Which is an increase from our previous outlook of 17% to 18% growth in fiscal 2011.

This compares to the reported diluted net earnings per share from continuing operations of $2.86 in fiscal 2010.

Our earnings expectations for the fiscal year are based on, one, a blended US same-restaurant sales in fiscal 2011 for Red Lobster, Olive Garden and LongHorn Steakhouse of approximately plus 1.5% to plus 2%.

The opening of approximately 70 to 75 net new restaurants in fiscal 2011, and total sales growth in the fiscal year of approximately 5.5%.

Now, given the trajectories of our brands here at the start of the fourth quarter, we remain comfortable with the 1.5% to 2% range we provided for same-restaurant sales growth for the fiscal year.

However, we are still very early in the quarter, and as we noted in our press release, the environment, while improving, remains more fragile than normal and it's very much driven by promotional effectiveness.

So we built our financial estimate for the year around coming in at the lower end of the 1.5% to 2% same-restaurant sales range.

And now I'll turn it of to Drew for a few comments.

Thank you, Brad.

And I'll start by sharing a few thoughts about the industry and then comment briefly on the strategy and performance of our three large casual dining brands.

As Brad already said, casual dining same-restaurant sales excluding Darden, as measured by Knapp-Track were up 0.1% during the third quarter.

We are not able to quantify the impact of weather on industry sales results.

However, we note that industry same-restaurant sales declines in December and January when inclement weather compared to the prior year had a meaningfully negative impact on our three large brands was followed by solid industry same-restaurant sales growth during February when weather had improved.

And as our fiscal year has progressed, year-ago industry comparables have gotten progressively stronger.

Consequently, our view is that the casual dining industry continues to improve.

As Gene will discuss in a few minutes, the fine dining industry also continues to show solid growth, which is certainly important for our Specialty Restaurant Group, as the recovery in business travel and luxury consumer spending gains momentum.

Continued improvement in broader economic fundamentals, especially employment, should lead to continued recovery and slightly accelerated sales growth in full service restaurants going forward.

Now let's review the performance of our three large casual dining brands.

On a combined basis, Olive Garden, Red Lobster and LongHorn delivered same-restaurant sales growth of 0.9% versus prior.Consistent with the outlook we provided at our recent analyst conference.

And all three brands increased their operating profit and operating profit margin compared to last year.

Red Lobster's same restaurant sales increased 0.1% in the third quarter, despite the adverse effects of 120 basis points related to the timing of Lent and their signature Lobster Fest promotion, and another 50 basis points related to more severe winter weather compared to prior year.

When you consider these headwinds, we believe Red Lobster had a strong third quarter.

You might recall from our preliminary third quarter release that we had expected Red Lobster to report same-restaurant sales that were down approximately 1% during the third quarter, so we're very pleased with their improved sales momentum and operating profit performance.

Our promotional strategy at Red Lobster was to feature specific price points in our advertising, on dishes that were designed to address our guest need for affordability while also delivering a solid profit.

We began the quarter advertising our new surf and turf promotion in December.

This promotion featured three new dishes, a wood-fired grill peppercorn sirloin steak paired with either shrimp for $14.99, crab legs for $17.99 or lobster tail for $19.99.

Importantly, this was the first time Red Lobster has ever promoted steak successfully.

And it came at a time when competitors were advertising similar surf and turf offerings at lower prices, reinforcing our belief that Red Lobster does not have to discount their brand or the quality of their experience to increase same-restaurant sales.

We followed that with seafood dinner for two for $29.99 in January and February, which reprised what was a very successful promotion last year.

This year we added three new entrees and the promotion was very successful once again.

Red Lobster continues to remodel restaurants and is on track to have nearly one-third of their system complete by the end of the fiscal year.

Results have been strong with remodeled restaurants maintaining a sales increase of 4% to 5% which exceeds what's required to achieve a return on investment hurdle.

So to summarize, Red Lobster's new approach to address the need of their core guest for greater affordability and price certainty, which began in the second quarter, has led to better than expected sales results.

This improvement, along with strong controllable cost management, delivered strong operating profit growth during the third quarter.

And they're making additional progress on strategic priorities that will enable consistent long-term sales and operating profit growth.

Olive Garden same-restaurant sales in the third quarter were equal to prior year but short of the outlook we announced prior to our analyst meeting.

I was certainly pleased that Olive Garden continued to achieve profitable market share growth with a total sales increase of more than 4%, driven by the impact of 33 net new restaurants compared to last year.

However, we were disappointed with their same-restaurant sales results especially during February.

Fundamentally, we believe that dishes featured in both promotions this quarter leaned a little too far toward building the culinary credentials and culinary distinctiveness of the brand which are longer term business building opportunities.

And as a result did not have the breadth of appeal and value emphasis required in the current environment.

Olive Garden began the quarter with their Best of the Harvest promotion, featuring two new entrees, limoncello chicken scallopini and vino bianco pork scallopini, both served with asiago cheese-filled tortellini.This was followed by their Warms You Up promotion which featured two new artesian ravioli entrees, pear and gorgonzola ravioli with shrimp, and asiago ravioli with chicken for $10.95.

While these new items were distinctive, and they delivered high satisfaction for the guests who ordered them, they did not have the breadth of appeal we typically experience with our promotions.

And this was especially true for the pear and gorgonzola ravioli with shrimp that was one of the dishes advertised during February.

Going forward, Olive Garden will ensure that all promotional entrees are both compelling and have strong breadth of appeal.

In addition, Olive Garden will further enhance guest loyalty through their service evolution initiative focused on enhancing server attentiveness and their welcome excellence initiative which helps increase guest throughput.

We are confident that Olive Garden has made the necessary changes to achieve consistent same restaurant sales growth going forward.

LongHorn Steakhouse achieved same-restaurant sales growth of 6.1% during the third quarter.

And that's on top of a year-ago quarter that was up nearly 2% and exceeded the industry by roughly 600 basis points.

This is their fifth consecutive quarter of same-restaurant sales growth and exceeded the outlook we announced prior to our analyst meeting.

LongHorn also continued to achieve profitable market share growth with a total sales increase of nearly 13% during the third quarter, including the impact of 21 net new restaurants versus prior year.

On a two year basis, total sales at LongHorn are up more than 17%, while the industry benchmark is down approximately 2%.

They began the quarter with the final three weeks of their Stuffed Filets promotion featuring the new three cheese stuffed filet and a crab stuffed filet.

This was followed by their Values from the Grill promotion which featured a new loaded sirloin for $11.99, and a grilled chicken and stuffed portobello mushroom for $9.99.

This promotion was also supported by national cable television advertising.And this was the second promotion this fiscal year to have national cable advertising support.

Improved promotions and increased media support have been leveraged by a restaurant operations foundation that continues to get stronger.

In particular, the restaurant teams at LongHorn have moved from implementation to mastery of the new operating systems that they've implemented over the last two years which have helped further elevate the guest experience and reduce controllable costs.

LongHorn has remodeled 75 existing restaurants year-to-date and will complete 37 more remodels during the fourth quarter.

Consumer research shows that the remodels help significantly elevate perceptions of the brand, and they continue to deliver sustained sales lift of 3% to 4% which is in line with their investment hurdle.

The remaining 27 restaurants will be remodeled in the first half of fiscal 2012.

We're certainly delighted with the performance of LongHorn and anticipate continued sales momentum in the coming quarter.

I know many of you are concerned about the impact rising commodity and energy costs will have on our industry.

As we detailed in our recent analyst meeting in Orlando, we do expect to see greater inflationary pressures in these areas next year.

However, given Darden's scale, our supply chain expertise and our focus on several transformational cost savings opportunities, we remain confident that the pricing in the 2% to 3% range next year will cover the net inflation we experienced after our aggressive cost management efforts.

Thereby protecting both our operating margins and our guest value equations.

In summary, we remain confident that the industry is gaining strength and believe that our brands and our increasingly cost effective operating platform will enable us to achieve consistent profitable sales growth going forward.

Now Gene will comment on the Specialty Restaurant Group.

Thanks, Drew.

Specialty Restaurant Group had a strong third quarter and continues to build positive momentum.

We delivered significant sales growth of 25% which represents 27% of Darden's total sales growth.

This growth was a result of our solid performance at our 11 new restaurants, and blended same restaurant sales growth of 6.5%.

Which was driven by strong comparable sales at each of our brands, led by 8.4% at the Capital Grille, 4.2% at Seasons 52, and 3.4% at Bahama Breeze.

We intend to continue building on this momentum and expect the Specialty Restaurant Group's fiscal 2011 sales to exceed $500 million.

Our strong same restaurant sales growth resulted in significant margin expansion during the quarter with all three brands achieving meaningful improvement in restaurant level margins.

The Specialty Restaurant Group team remains focused on continually improving brand delivery and operational execution to keep driving same restaurant sales growth.

We're also continuing to build our new restaurant pipeline to fuel our brand's expansion, and meet our new restaurant growth targets of 14% to 16%.

As well as increase our organizational capabilities and capacity to support this accelerated growth.

In addition, we are implementing Darden enterprise cost reduction initiatives and working to identify unique Specialty Restaurant Group cost saving initiatives to mitigate inflationary pressures and further improve restaurant level margins.

While continuing to enhance our support platform, making it even more efficient, effective and scalable.

Now I'll turn it over to Clarence.

Thanks, Gene.

Let me say we're very pleased with our earnings per share and sales growth this quarter.

We're also pleased that we're on track for nearly 20% earnings per share growth for the full year.

When we think about two years ago or even a year ago, the economy is in a much better place, our industry's in a much better place, and so is our Company.

The evidence that economic conditions are gradually improving continues, in our view, to mount and that bodes well for an increase in visits to full service dining and it bodes well for us.

There are a few headwinds for sure, but they pale in comparison to what we've all faced over the past few years.

And also, during the downturn, we here at Darden took action to strengthen our brands, improve both the effectiveness and efficiency of our support platform, action that leaves us quite well prepared, we think, to handle today's headwinds.

Headwinds that, again, are modest when we consider all that we've been through.

We're confident that as conditions continue to improve, Darden is well positioned to grow market share and to deliver competitively superior earnings growth, just as we did both before and during the downturn.

We've got great brands.

We've got an increasingly effective and efficient brand support platform and we have exceptionally talented people, and those talented people are working well together.

These strengths are why we were able to deliver this quarter and they're why we believe that as the economy continues its recovery, the best is yet to come for Darden.

And with that, we will take your questions.

Thank you.

(Operator Instructions) Okay and our first question comes from David Palmer.

Please go ahead.

Thanks.

Hello, guys.

The same store sales guidance that you have in place, and forgive me if you touched on some of these questions during your prepared remarks, but I think it implies something like 2.6% is the low end of the guidance, what that implies for the fiscal fourth quarter.

You can correct me if I'm wrong on that.

Obviously, that's a different run rate than the February quarter and even more different than the February month.

So, the big question is do you feel comfortable with that estimate, as you said?And the little questions that come to mind behind that big question are, is Darden so far looking at a pretty good March, so far?

Are there particularly well-tested promotions coming that give you increased confidence?

And perhaps are you reflecting back on promotion mistakes or things you would have done differently in the May quarter a year ago?Thanks.

Let me just say, Brad I think touched upon it.

He talked about we're early in the quarter and the trajectories that have ran this early in the quarter give us confidence in the outlook that we've got.

I think he also mentioned, though, that because we're early in the quarter, we don't want to get ahead of ourselves.

We still have an environment that's not normalized.

It's still more fragile than normal and it's still very, very much dependent on promotion effectiveness.

So, I would say we feel good about what we've got coming.

We also have the benefit of a calendar shift at Red Lobster in terms of their promotion for Lobster Fest, so that certainly helps the fourth quarter, just like it hurt the third quarter.

So, it sounds like you're doing at least what you thought you would do for the quarter so far in March, and you don't want to get ahead of yourself.

That's a fair summary.

Okay.

Thanks very much.

Okay.

And real quick, participants, remember, you are allowed one question with one follow-up.

And our next question comes from Joe Buckley.

Please go ahead.

Thank you.

First question, on Olive Garden, is Olive Garden becoming more dependent on the effectiveness of the promotions as opposed to being more execution-driven, do you think?

And was the relative softness in February at Olive Garden more at lunch or dinner?

I'm asking that question, given some pretty heavy competitive activity at lunch in the month of February.

Yes, the relative softness in February was more at dinner than lunch.

And I think I'd frame, Joe, yes -- and, Joe, I'd guess I'd start by framing your question a little more broadly, that we still believe Olive Garden's a very strong brand, very strong business model.

We're in an environment that continues to be very value-sensitive, very promotionally driven.

And the promotion we had in February just wasn't as effective as we anticipated it would be.

We went into February very confident that our promotional strategy was appropriate and our execution of that strategy was strong.

The promotional strategy, to go back to what I said just a minute ago, in February was the same as it was in the last few years.

There's really three things we're focused on.

Compelling new dishes that are broadly appealing and help drive special visit interest.

Periodically featuring an attractive price point that augments Olive Garden's already strong value proposition in a very value sensitive environment.

And then, third, beyond short-term traffic, we want to leverage all that investment in media and culinary development to build the brand long-term.

And we're really looking at two things there, value, which is the core point of difference for Olive Garden, and culinary distinctiveness which is a way we can make a strong brand even stronger.

And the promotion we developed for February against that we thought was strong.

Two new ravioli dishes.

Ravioli is very broadly appealing.

One with chicken, one with shrimp.

It's an approach that has worked well for us in the past.

It worked well for us in the third quarter last year.

A fairly traditional recipe for the chicken dish, with a very attractive $10.95 price point.

And a more distinctive culinary forward execution for the shrimp dish, pear and gorgonzola ravioli.

Our testing of all this gave us confidence that we were well-positioned to achieve the sales guidance that we gave.The conceptual appeal of the dishes, the guest satisfaction of the dishes in restaurant, the advertising clarity and persuasiveness, all of that tested well within the norms of what our past successful promotions have delivered, but we didn't get the results we expected.

And preference was lower on the shrimp ravioli dish than we expected, and that you can see in the negative menu mix for February that we reported.

And it's our judgment that our shrimp dish was a little too culinary forward.

It didn't drive the same level of incremental guest as did the ravioli promotion with the $10.95 price point last year in the third quarter.

So, it really comes down to not being more promotionally dependent, just being effective with the promotions that we've got consistently.This one wasn't quite as effective as we wanted.

But I would also say it's important to keep in mind that all other brand health metrics we look at, from guest satisfaction to brand perception versus key competitors, all continue to be very strong and improve incrementally.I would also note that a number of people were writing about and asking questions about Olive Garden same restaurant sales on a two year basis.

And when we look at that, and when you adjust for weather and holiday shifts on a two year basis, when you weight sales by month, you see December for Olive Garden on a two year basis was plus 4.9%, January was minus 20 basis points, minus 0.2%, February was actually plus 1.9% on a two year basis in the quarter, on a two year adjusted basis was plus 2.3%.

So, nothing's fundamentally changed for Olive Garden.

Our strategy, the health of the business, you just need consistently effective promotions in this current environment.

And then just one follow-up on Red Lobster.

How will you reconcile the higher expected seafood cost that you shared with us back at the analyst meeting with the new value or affordability message at Red Lobster?

Well, there's two things.

One is knowing what the seafood cost environment's going to look like.

We take that into account in the dishes that we design for the promotions that we're going to use in the future.

We take that into consideration on the other items that we're going to put in the promotional menus that are on the tables that impact preference.And we also take a broad look across the entire brand support platform and across the portfolio of brands that we've got at the cost reduction opportunities that we have and how we choose to invest those cost saving opportunities.

Joe, this is Brad here.

What I would add to that is we don't want to be unduly influenced by any particular one item, one line item of the P&L.

We look at the total business there.

And as we shared, Red Lobster, even with their promotional activity that they have going right now, continues to build absolute earnings as well as expand their margins.

So, when you look at the totality of that business and their ability to leverage the same-restaurant sales growth there, it still is a very value creating proposition for us.

And I would just add -- this is Clarence, Joe -- that as we look forward, we manage the entire portfolio of brands.

And so, we have the ability to really absorb some line items that might be particularly highly inflated in one brand by the action that we take in some of the others that don't have the same pressure.

And so, that's an important attribute for our Company and we've done it in the past when we've seen the market basket for Olive Garden be elevated, but not at other places, and we'll do that as we go forward with Red Lobster and seafood.

Thank you.

Our next question comes from Blat -- Brad Ludington.

Please go ahead.

Thank you.

I wanted to ask, at the Analyst Day there was a brief comment, I believe, that you guys or the Board have been discussing maybe raising the dividend payout ratio to 40% to 50%.

It seems like it's been traditionally more of a 30% to 35% range.Is that still on the table and being discussed or has there been any progress on that?

And then also, what does that mean?

Would that impact share repurchases at all?

Yes, and I'll start.

This is Clarence.

And I would say, yes, we're pretty comfortable with what we talked about back at the analyst meeting.

And so, as we think about returning cash to shareholders, our cash flows continue to grow at a very meaningful clip which reflects basically the fundamental strength of the entire business.

We will talk more about dividends in June, but that outlook that we provided continues to be our sense of things.

And I think we have the ability to get there and still have share repurchase go up from here, given where our cash flows are.

Thank you.

And then just a brief follow-up.

Are you guys no longer going to break out sales by brand in the Specialty Restaurant Group?

Yes, Brad, that's correct.

There's enough data there, you can back into it, I think, and get pretty close, but we're not going to disclose the absolute numbers at this point.

They're still too small for us really.

I think the other factor is, as they start to accelerate growth, the period to period movement gets to be less meaningful, because it really depends on operating weeks at new restaurants and at brands that small we're not sure it provides a lot of value on an individual basis.

And so, the collective number's more important, and we also think about that business as a collection, as a business unit in its totality.

That's where it makes a meaningful difference for Darden.

Thank you.

All right.

And next question comes from David Tarantino of Robert Bailey.

Please go ahead.

Good morning.

Just a question, Clarence.

I think your comments were still pretty positive on the outlook for the industry and I just wanted to maybe ask your thoughts on rising gasoline prices and what you think that might do to the outlook for the industry here, maybe balancing that versus some of the other macro economic factors we're seeing.

I would say I think they'll have a dampening effect.

They definitely serve as a tax on consumers, gasoline prices.

That said, we saw that dampening effect I think in February and so, the industry results were stronger than they were in prior months.

Would they have been stronger if gasoline was below $3?

We think so.

So, it's an improving trend.

The rate of improvement will be less at these gasoline levels than it would have been without them, but it's still an improving trend.

And so, that's essentially how we see it.

We have no reason to believe otherwise and I think February is a pretty good indicator of that, and I suspect March will be as well, because we're living with these elevated levels.

I think our experience is that consumers adapt and they adjust their budgets.

That's helpful.

And then maybe a quick follow-up for Brad.

I think, Brad, you mentioned some thoughts on getting margin expansion in fiscal '12, I think was your comment.

And just wondering whether that was -- that comment applies to the enterprise level margins or the restaurant level margins.

Yes, I mean, restaurant -- or enterprise level restaurant margins should be positively impacted from the broad cost initiatives that we shared at investor conference.

Those, as I mentioned, those are pretty meaningful as we look forward, but we're also achieving those results a little bit faster than what we had originally anticipated and see some of that benefit already coming through.

Okay.

Thank you.

All right.

And the next question comes from Mr.

Matt DiFrisco of Oppenheimer.

Please go ahead.

I think it was said earlier about that the environment right now is very sensitive to promotions and promotions working.

I was curious in the context of industry how you guys set up.

Is that an advantage for you given that you do have a large advertising voice, especially against your casual dining peers?

Or is this a harbinger of the environment returning back to a more promotional environment and maybe what we've seen in the industry as far as price and check might be a little bit harder to get through in the next six months if the consumer is looking for promotions and responding to promotions?Thank you.

Yes, well I think that Darden has a demonstrated capability in advertising, promotion, limited time offers, that over time have proven to help build the brand and move the business forward in the near term.

So, I would say that that's a competitive strength for us.

I would also say that it's a very value sensitive environment.

It's not materially different in terms of the amount of promotional emphasis that we see right now versus a year ago.

It's pretty steady and it's still significant.

So, we would anticipate that to continue going forward.

I would also say, Matt, that when we say promotional, it's not just about price.

It's about how compelling is the offer.

And so, it needs to be a compelling offer on many dimensions.

And so, when you look at Red Lobster this past quarter, for example, its surf and turf promotion started I think at $15 and ended at $20.

And so, it certainly wasn't a price -- a deep price discounted promotion.

And then its other promotion was a seafood dinner for two, $29.99, so $15 a person.

And then it ended the month with just that first week of Lobster Fest, but Lobster Fest is a premium price promotion.

And yet all of those were effective.

And so, it's because they were compelling.

Compelling dishes in a compelling, creative envelope.

And so, that is part of the equation too.

Value's got to be part of that promotional mix as you think about your promotions throughout the year, but it's not a continuous siren song around price points and value promotion, as we think about how we approach it.

I'd say the other thing, just to reiterate what Drew said, we've always run our business feeling like news was important, and so, seven promotional windows, six promotional windows.

One of the things that was quite attractive about RARE was that that's how they ran their business, as well.

So, it's not a new approach for LongHorn.

We think the effectiveness of the promotions at LongHorn is better, but it's how they've run their business historically and so that rhythm works for them operationally.

Thank you very much.

All right.

And the next question comes from Jason West of Deutsche Bank.

Please go ahead.

Yes.

Thanks, guys.

Just wondered if you can give us an update.

You mentioned that you've continued to extend your contracts on the commodity side.

If you could give us an update on some of the bigger items, like seafood, I think, was about 30% covered through December of '11.

If you have an update there, and beef and pasta, as well.

Jason, Brad here.

I would say the coverage that we've been, as I said, has been more opportunistic.

I can't say that we've pursued any one particular commodity in particular, but there have been modest opportunities here to further extend those as we move into the next year.

What I would say from where we traditionally are at this point in the fiscal year is to have even more coverage, but we aren't to the levels that we have historically been.

But we're expanding that a little bit further as there's some breaks in some of these prices.

Continuing I think the reason why we've approached the way Brad has indicated, I think we mentioned this a little bit at our meeting here in Orlando, is there's a significant premium to pay to get out very far compared to the closer in market, and so it's much more attractive shorter and so we've got to weigh those two things.

Okay.

Thanks.

That's helpful.

And then just one on LongHorn.

As we think about into fiscal '12 when you lap the push into national cable, what's the thinking from a media standpoint there?

Do you take that up another notch in fiscal '12?

And if it's more of a flattening out, then would you expect that to cause some moderation in the very strong comps you're seeing at that brand?

We'll talk more about our specific media strategy and promotional strategy for all the brands in June, but clearly as LongHorn expands and opens new units and adds more media weight, that's been a very positive thing for the business.

And I would just say, as we think about LongHorn over the next five to seven years, it will continue to go up.

Their media weights are a fraction of Red Lobster and Olive Garden.

So, we don't want to leave the impression that national cable means they're competitive with Olive Garden, Red Lobster, the four or five other nationally advertised casual dining brands.

They spend a fraction of what that competitive set spends and I think that makes their same restaurant sales growth relative to industry average all the more impressive, because that's a major handicap when you think about them against Knapp-Track which is dominated by the nationally advertised brands.

Yes, the only thing -- this is Brad -- that I would add to that, to Clarence's point, there's -- you also see that in our P&L.

You see their strong same restaurant sales and sales growth, but you also see it in our SG&A line, and particular this quarter, we were up pretty meaningful there.

More than half of that was driven by our investments in media, particularly at LongHorn, but across the other brands, as well.

Okay.

Thanks, guys.

That's helpful.

All right.

Next question comes from Howard Penney of Hedgeye Risk Management.

Please go ahead.

Thanks very much.

I wanted to tack down the question a different way.

Do you think you may have sacrificed traffic in the quarter for margin?

And then in the context of that question, can you talk about the next fiscal year, -- ?

No, I think that we didn't get the traffic that we wanted, but it wasn't because we were trying to build margin.

We had the same $10.95 price point that we had a year ago.

I didn't talk about it earlier but we had soup, salad and bread stick advertising at $6.95, the same as we had a year ago.

So, we weren't sacrificing margin for traffic.

We just leaned a little bit into a longer term business building opportunity, culinary distinctiveness, and as a result had a dish that wasn't quite as broadly appealing, didn't get the same preference as the ravioli promotion last year.

Didn't get quite the same special visit interest.So, it was more promotion effectiveness than margin.

And we'll talk about 2012 in a few months.

Thank you.

All right.

Next question comes from Alvin Concepcion of Citi.Please go ahead.

Hi, good morning.You mentioned the trajectory you're seeing is giving you confidence in the same store sales guidance.

And I know it's early, but are you seeing improvements in Olive Garden, as well, early in the quarter, or is that trajectory being driven more by continued strong momentum at Red Lobster and LongHorn?

It is early in the month, in the quarter, but we're pleased with where all three brands, all three of the large brands are, so far.

Okay.

Great.

And then you mentioned increased pricing.

What do you suspect the competitive response will be to that?Do you expect similar increases by competitors or perhaps less rational pricing in order to gain market share?

We have no idea.

What we do expect as an industry is that we will probably have pricing that's below supermarket.

We think the supermarkets will take more.

Food costs are a bigger share of their sales than they are ours.

We have other costs that are much higher -- labor.

So, that's an advantage, we think, for the industry.

And so, that's the silver lining, but in terms of what our restaurant competitors do, we just don't know.

All right.

Thank you.

All right.

Next question comes from Jeff Omohundro of Wells Fargo Securities.

Please go ahead.

Thanks.

Just a question on Olive Garden.

Specifically, an update on the thinking around remodeling some of the older RevItalia.

I think previously you talked about Via Tuscany, and particularly in light of the success you've had in your other remodel efforts, maybe you could give us an update on your current thinking on that.

And then I have a follow-up, as well.

Yes, remodels for Olive Garden are going to be important for those roughly 400 RivItalia restaurants that we've got.

They've got a very clear strategy.

They've got a Tuscan farm house prototype that's very distinctive, very brand appropriate, very compelling.And their remodel strategy is to take the most compelling elements from the Tuscan farm house and build those into what we call the RivItalia restaurants, to unify the brand look and to freshen and update the feeling, the atmosphere side of the experience in an Olive Garden.

They've done about 35 of those, roughly.

And we haven't had them remodeled for a long time, but so far the impact on brand perception and same restaurant sales lift has been positive.

And they're going to continue to refine that design, figure out the most impactful elements to incorporate into RevItalia restaurants at the most appropriate capital investment, and that's going to be a big part of what they do next year.

Thank you.

And then as a follow-up, just a quick question on LongHorn, given the momentum there.

Just curious, is there anything you're seeing different across day parts or is it pretty consistent, this positive direction?

Thanks.

It's been strong at both.

Probably a little stronger at dinner, but it's been strong at both.

Very good.

Thanks.

And let me go back to the competitor question, because I don't want to be too glib.

I would say, as we think about it, we think -- you certainly have the food cost pressure, but at the same time in an environment where comps are positive, that takes a lot of the pressure off.

And so we would see -- we wouldn't see an imperative for competitive pricing to be dramatic when you're talking about getting the benefit of sales leverage.

And this is Brad.

I want to go back for just a second on your question about LongHorn.

I would just point out the data here and looking at it.

They're seeing that strength on a geographical basis across all their regions.

And so, I think, to Drew's point, it just speaks to the overall breadth of the improvement in the same-restaurant sales trend that we see there.

All right.

Next question comes from Jeffrey Bernstein of Barclays Capital.

Please go ahead.

Great.

Thank you.

One question and then a follow-up.

The question, just on the cost side of things.

I think the SG&A line surprised us to the upside, but on the other side it seemed like labor favorability was pretty significant.

I know you talked about getting some early wins and that trend continuing into the fourth quarter.

I'm just looking back over the past few quarters, it seems like you've had an average of north of 100 basis points of leverage, the past three quarters.

Should we assume that -- I know you mentioned in fiscal '12 labor optimization being another $30 million to $35 million.

Is there potential for a greater savings in fiscal '12 once we see some of that labor optimization?

Or is perhaps that being pulled forward a little earlier, so, we shouldn't expect more meaningful leverage going into '12 than what we're seeing over the past few quarters?

And then I had a follow-up.

Okay.

On the restaurant labor first, what I would say is we're achieving the results there maybe a little bit faster than we had originally anticipated, but I don't think with what we've learned at this point, that it necessarily changes the run rate.

But I would say we're pleased with the success that we have now with those initiatives.

On SG&A, when I look at those, as we mentioned earlier, the biggest portion of that was around media support, and for LongHorn when you add that in, that can be a pretty meaningful impact to that particular line item.

I think it's a great decision, but it does affect that line item.

As well as some of what Drew talked about with Olive Garden, some of the additions and changes they've made there during the quarter around digital advertising, Spanish language, and some of those initiatives there.

As well as with the stronger performance that we've had, there is an elevated expense for incentive related compensation.

So, those all converge into that line item and make it look a meaningful increase to last year on a percentage of sales basis.

Okay.

And then just a clarification.

I know, Clarence, you were just talking about pricing for the broader industry which is obviously difficult for you to forecast what your peers are going to be doing.

But just think about yourselves, I know you're comfortable in good times and bad times, sticking with that 2% and 3% range.

Just wondering if you can give a little bit of color, obviously with traffic still weak and, as you mentioned, volatile, the testing that you do, if you can give some color around that.

Perhaps what impact you see on traffic or whether, perhaps, there is an impact on traffic, but it's more than offset by the benefit you see from the pricing.

Just trying to gauge that 2% to 3% in this type of environment.

Yes, in terms of testing of pricing itself.

Testing of pricing and your confidence that perhaps pushing that 2% to 3% pricing, I know some of your peers might be talking about a little less.

You're talking about the supermarkets talking about a little more, but perhaps what you do and the confidence you get that traffic is not being pressured more than the benefit of taking the price.

Yes, let me -- this is Drew.

Let me start the answer to that question.

Our pricing strategy really seeks over time, over the long term, to balance two things.

One, we want to maintain our relative competitive position in the market and our value equation relative to key competitors.

And second, balance that with maintaining our unit level business models and balance those two things over time.

In terms of the amount that we take and the impact it has, we do test pricing before we implement it.

The biggest thing that we're looking for in the short term is shifting in menu preference.

So, do people move away from the items that got the price increase.

Do they move towards the item that got a price reduction.

Broadly speaking, we typically don't see a lot of that menu shifting.

We are longer term looking at whether we should be a little more proactive in how we structure and engineer the price points in our core menu, particularly at a Red Lobster, let's say, to address everyday affordability.

So, we would consciously be trying to do that in a way that actually led to guest count increases, because we had increased affordability.

But so far, from the things that we've advertised, the things we've put on promotional menus, the pricing that we've tested, we haven't seen significant shifting away from items we've taken pricing on.

I think it's important to reiterate one of the things that Drew said which is, so, we talk about 2% to 3% as the range that we typically are in.

It's important to keep in mind that that's not across the board pricing.

And so, we're introducing a new core menu every year, maybe twice a year.

And as we do that, there are new items and so, how we price the new items has an effect on it.

And then there are items that we move down on the pricing side, given testing, and our confidence about what that will do to mix and to traffic.

And so, it gives us a fair amount of flexibility, I guess, is the way to think about it, versus someone that doesn't have the number of products that we've got when you think about our entire menu.

And the other thing that gives us some flexibility is we don't typically take it all at one time.

So, we'll take some at the beginning of the year, we'll assess what the cost situation looks like.

We'll assess what the consumer environment looks like.

We'll see how guests have responded to what we've already done as we go through the year.

I think the final piece is that there are a lot of items where the price is not fixed on the menu.

So, it adds even more flexibility, especially on the beverage side, beverage, alcohol, and nonalcoholic beverages as well.

And next question comes from John Ivankoe of JPMorgan.

Please go ahead.

Thanks.

Just a couple of things, of pretty short ones.

First, at Olive Garden, it seems like the tone is you didn't get the promotion right in February, and at least what I can find online and what looks to be a television ad, you're advertising something called Sofatelli.That was a word, I quite frankly, have never heard before and I don't think has a lot of recognition across the US.

Without a price point, that's a very culinary focused product.It almost seems even more extreme than the previous product than you ran in February.

So, is that the right message?

And is that message working in this current environment?

Or is there still something that's yet to come that's going to bring Olive Garden back to more American Italian core?And then I have just a few follow-ups.

Yes.

And I would say we -- you need to think about the promotion strategy and what we're advertising at any one particular point in time in the context of an ongoing advertising campaign and an ongoing promotional strategy.

So, like I mentioned at the beginning, there's three basic things that we're -- that we seek to do with our promotions.

Compelling new dishes that drive special visit interest.

Second, periodic, not every promotion, not every month, but periodic price points that strengthen an already superior value proposition for Olive Garden.

We tend to do those in seasonally appropriate times, when the guest need state is one of higher value.

So, for instance, back-to-school time in September, right after the holidays.

And then the third thing is build long-term brand distinctiveness and brand equity, because the biggest part of our business on an ongoing basis doesn't relate to promotions.

It's having a core message and a core brand promise that's differentiated and compelling, and that's the other thing we're trying to do.

So, the Culinary Institute of Promotion -- the Culinary Institute of Tuscany promotion that we're doing now, and we tend to do every year at this time, leans more towards the culinary distinctiveness objective that we've got, just like it did last year at this time.

And it comes after a period where we had a more overt value and price message, the promotion that we just ended.

And I would also say, John, that in the creative, we take the time to tell people exactly what it is.

So, when you do that, it can get pretty simplified.

Right.

Pear and gorgonzola, when you tell them exactly what that is, which is exactly what I just told you, it's still not necessarily broadly appealing.

Right, and --

That's part of it, as well.

And if it's working, it's working.

And so, it doesn't mean -- so, you can still have that type of direction in your brand without a price point and again, I think you just have to consider just February wasn't right.

It doesn't necessarily mean that you have to change something going forward in March, I suppose, at least as it relates to the Culinary Institute promotions.

Okay.

And then, secondly, it seems like there's been some allusions of pulling some cost savings forward from fiscal '12 maybe into fiscal '11.

Is that, for example, the labor scheduling which I think was an incremental 30 to 35 basis point positive impact, at least as we calculated, guided for fiscal '12 versus fiscal '11?And so, does that, therefore, mean there will be less incremental benefit in fiscal '12 versus fiscal '11?

Yes, it is the labor optimization and it does not mean that necessarily there will be less, because, if you recall, there's still an incremental benefit from that even in fiscal '13.

And so, it's a multi-year initiative.

Okay.

So, we should expect the same amount as you guided to in fiscal '12 year-over-year, then?

Yes.

More or less?

Okay, thank you.

And then just the final thing, and I'm sorry if you mentioned this, what was that lease cancellation charge in G&A?

Could you quantify that?

It was in the couple million dollar range and it was a restaurant where we're not going to continue the lease to its full term, and so, once we made that determination we had to take that charge in the current quarter.

Okay.

Thank you.

All right and next question comes from John Glass of Morgan Stanley.

Please go ahead.

Thank you.

This quarter you had a promotional misfire on Olive Garden.

I think last quarter we were talking about the same thing for Red Lobster.

So, is there something that's changed in the way -- typically Darden has been very driven by testing and data, and so, these things don't happen as often.

Is there something that you've changed in the way you've tested products or the speed at which that's created this?

Or should you, better asked, should you change something so that it doesn't occur in the future?

Well for Red Lobster, at the beginning of the year we knew that consumer need for affordability was elevated.

And they changed their promotion strategy for the first three or four months of this year compared to last fiscal year to add starting-at price points which have worked well for Olive Garden, worked well for LongHorn.

But given that Red Lobster has a higher check and some higher priced individual items, a starting-at price point didn't give enough price certainty for their core guest to motivate a special visit.

So, we determined that that approach, while it works for other brands in our portfolio, wasn't as effective for Red Lobster.

So, in October, in the middle of Endless Shrimp, basically, we changed the approach.

And for Endless Shrimp, for the surf and turf promotion that came after that, for the seafood dinner promotion for two that came after that, three promotions in a row, that new approach has worked for Red Lobster.

For Olive Garden, I think the approach is still sound.

We just had a dish that even though it tested well conceptually, didn't play out as well in the market as we had anticipated.

So, there is some art and there is some science to the way we test.

I would say, John, that as we think about promotions, there always is going to be some variability around our estimate.

There's probably a little bit more in this environment where the consumer is particularly cautious about spending, but there's always going to be some.

And so, one of the advantages we have is we have three major brands that really run their business that way and so, we can get some offsets, which is what we got this quarter.

And so, yes, little bit lighter at Olive Garden than we anticipated, significantly heavier on the plus side at LongHorn than we anticipated, and meaningfully heavier on the Red Lobster side, all netted out to a combined number that was pretty much what we thought we would get, at up about 1%.

Thank you.

Larry, we have time for one more question this morning.

No problem.

And the next question will come from Mitch Speiser of Buckingham Research.

Please go ahead.

Thanks very much.

On the pricing theme, it looks like pricing across the board is running at around call it 1.5%-ish.2% to 3% is your long-term view, and you did mention 2% to 3% should be adequate to offset your cost pressures going forward.

Should we imply, then, that you are going to uptick pricing over the next several months?

And how do you weigh that into the topics you've talked about in terms of the consumer being a little bit fragile at this point?

Mitch, I'll start the answer to that and then turn it over to Drew.

I would say our pricing is probably a little bit more reflective than what you'd see as you look at same restaurant sales and same restaurant guest counts, because for some time where there's some mix of the business that we have, mix within day parts of the business.

So, that's not always reflective of the pricing that we're taking.

So, the pricing is running a little bit higher than the net check average that we're most recently seeing and that's been that way for a while.

So, as we develop our estimates and think of that.

As we look forward -

I think the net of that is it's going to be roughly the same going forward as it's been looking backward.

Yes.

Yes.

That's pretty much the answer there.

I'm sorry, so, are you -- the pricing -- you do give us specific pricing data in the press release.

Are you saying it's effectively higher than that at this point, or -- ?

No, we're saying that that pricing reflects day part mix.

And so, those mix changes --

Okay.

Lunch versus dinner, will make that pricing look like less than our actual dinner pricing, and we're not changing our dinner pricing and we don't expect the mix to make the kind of changes going forward that it's made looking backward.

Okay, thanks.And one follow-up.

Can you remind us on your appetite for acquisitions and the criteria for acquisitions that you outlined at the February Analyst Day?

Yes, I would say as we think about acquisitions, we want something that is durable, has sustaining consumer appeal, something that's got a fair amount of runway ahead of it in terms of unit expansion potential, has a strong restaurant level business model, because that's ultimately what speaks to the durability from a financial perspective, and that has a valuation that enables us to create value for our shareholders.

And so, those are the most important things.

Not a long list, when you look at the restaurant industry.

More names that would be consistent with our specialty restaurant group than not and such.

Generally, what we see out there.

Thank you.

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

We apologize that we couldn't get to everybody in the queue.

Of course, we're here in Orlando for additional questions, if you didn't get your question asked this morning.

We hope everybody has a great weekend.

We look forward to talking with you again in June.

Thank you very much.

All right.

And ladies and gentlemen, that does conclude our conference for today.

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

You may now disconnect.