Darden Restaurants F4Q07 (Qtr End 5/27/07) Earnings Call Transcript

Jun.20.07 | About: Darden Restaurants, (DRI)
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Darden Restaurants, Inc. (NYSE:DRI)

F4Q07 Earnings Call

June 20, 2007 8:30 am ET

Executives

Matthew Stroud - Investor Relations

Brad Richmond - Chief Financial Officer

Andrew H. Madsen - President, Chief Operating Officer, Director

Clarence Otis - Chairman of the Board, Chief Executive Officer

Analysts

John Glass - CIBC

Steven Kron - Goldman Sachs

Jason Belcher - Wachovia Securities

Jeff Bernstein - Lehman Brothers

Glen Petraglia - Citigroup

Mark Wiltamuth - Morgan Stanley

John Ivankoe - J.P. Morgan

Joseph Buckley - Bear Stearns

Rachael Rothman - Merrill Lynch

Michael Smith - Oppenheimer

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the fourth quarter earnings release conference call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Matthew Stroud. Please go ahead.

Matthew Stroud

Thank you, Greg. Good morning, everybody. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and Chief Operating Officer; and Brad Richmond, Darden's Chief Financial Officer. 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 statements. These risks and uncertainties include the impact of intense competition, changing economic or business conditions, the price and availability of food, ingredients and utilities, labor and insurance costs, increased advertising and marketing costs, higher than anticipated costs to open or close restaurants, litigation, unfavorable publicity, a lack of suitable locations, government regulations, a failure to achieve objectives, weather conditions, risks associated with our plans to continue to improve financial performance at Bahama Breeze to support new restaurant growth, the closure and disposition of certain Smokey Bones restaurants and the anticipated sale of the remaining Smokey Bones restaurants, and other factors and uncertainties discussed in the company’s SEC filings.

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

A copy of our press release announcing our earnings, the Form 8-K used to furnish the release with 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 darden.com.

We plan to release same-restaurant sales results for fiscal June 2008 during the week beginning July 9th. We plan to release same-restaurant sales results for fiscal July 2008 during the week beginning July 30th, and we plan to release fiscal 2008 first quarter earnings and same-restaurant sales for fiscal August 2008 on Tuesday, September 18th after the market close.

We released fourth quarter and fiscal year earnings results yesterday afternoon. These results were available on PR newswire, First Call, and other wire services.

Let’s begin by updating you on our fourth quarter and fiscal year earnings. Fourth quarter net earnings from continuing operations were $98.5 million and diluted net EPS from continuing operations was $0.67. This represents an 8% increase in diluted net earnings per share from continuing operations.

In the first quarter, the company adopted SFAS-123R on a modified perspective basis, which reduced diluted net earnings per share from continuing operations by $0.02, or 3% of growth in the fourth quarter. Absent the adoption of SFAS-123R, diluted net earnings per share from continuing operations grew 11% in the fourth quarter.

On an annual basis, we reported net earnings from continuing operations of $377.1 million and diluted net EPS from continuing operations of $2.53. This represents a 13% increase in diluted net earnings per share from continuing operations.

Again, with the adoption of FAS-123R, diluted net earnings per share from continuing operations were reduced by $0.08, or 4% of growth in the fiscal year. Absent the adoption of 123R, diluted net earnings per share from continuing operations grew 17% in the fiscal year.

As you’ll recall, on May 5, 2007, we closed 54 Smokey Bones and 2 Rocky River Grillhouse restaurants and announced our intent to sell the remaining 73 Smokey Bones restaurants. Additionally, we closed nine Bahama Breeze restaurants on April 28, 2007 to strengthen the brand for future growth. The Smokey Bones results and the related impairments and costs are classified as discontinued operations, as are the results and related impairments and costs for the nine closed Bahama Breeze restaurants.

Fourth quarter net losses from discontinued operations were $153.6 million and diluted net losses per share from discontinued operations were $1.05. For the fiscal year, net losses from discontinued operations were $175.7 million and diluted net losses per share from discontinued operations were $1.18. These results include a fourth quarter pretax charge of approximately $245 million, comprised of a non-cash asset impairment charge for 129 restaurants -- that’s the 127 Smokey Bones and two Rocky River Grillhouse restaurants -- and other costs related to the closure of 65 restaurants -- that’s 54 Smokey Bones, nine Bahama Breeze, and two Rocky River Grillhouse restaurants. Previously, we estimated a pretax charge of approximately $260 million in the fourth quarter.

Including losses from discontinued operations, diluted net earnings per share for the fiscal year were $1.35 compared to $2.16 for the prior year and diluted net losses for the fourth quarter were $0.38, compared to diluted net earnings of $0.60 for the same period last year.

Fiscal 2007 results for the first, second and third quarters were adjusted to reflect diluted net losses per share from discontinued operations of $0.03, $0.04, and $0.07 respectively, including the pretax non-cash impairment charge of $12 million in the third quarter for the Bahama Breeze restaurants closed in the fourth quarter.

Fiscal 2006 results for the first, second, third and fourth quarters were adjusted to reflect diluted net losses per share from discontinued operations of $0.00, $0.02, $0.04, and $0.02 respectively.

Brad will now provide detail about our financial results for the fourth quarter and fiscal year. Drew will discuss the operating company’s business results and plans, and then Brad will return with some comments on our fiscal 2008 financial outlook, followed by Clarence with some final remarks. We’ll then respond to your questions.

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Bradford Richmond

Thank you, Matthew and good morning. As Matthew just said, we reported a 13% annual diluted EPS growth from continuing operations, with EPS of $2.53. I thought it would be helpful to reconcile this back to our May earnings guidance. In May, we gave earnings guidance of 11% to 12% annual diluted EPS growth from continuing operations. At that time, we were not including the fiscal year P&L impact of the closed Bahama Breeze restaurants in discontinued operations. That impact equates to approximately $0.05. In yesterday’s release, we included this amount in discontinued operations.

In addition, we recently completed a workers’ compensation reconciliation dating back to pre-spin-off years when Darden was a part of General Mills. This reconciliation resulted in a $0.03 unanticipated diluted net EPS reduction in the fourth quarter that was not included in our May guidance.

If you adjust for these two items, subtract the $0.05 for Bahama Breeze and add back $0.03 for workers’ compensation reconciliation, the adjusted diluted EPS would be $2.51, which represents a 12% diluted EPS growth in continuing operations, in line with our May guidance.

Now, Darden's total sales from continuing operations increased 3.2% in the fourth quarter to $1.46 billion, driven by same-restaurant sales growth at Olive Garden and our operation of 23 more restaurants than in the fourth quarter of the prior year. As a reference, industry same-restaurant sales as measured by Knapp-Track and excluding Darden were down approximately 1.4% for the quarter. Olive Garden same-restaurant sales though were up 3.5% for the quarter -- its 51st consecutive quarter of same-restaurant sales growth and its total sales increased 8.2%.

Red Lobster had a same-restaurant sales decrease of 2.2% for the quarter and a total sales decline of 1.8%, as they lapped a strong quarter last year. As you may recall, Red Lobster reported a 9.4% same-restaurant sales increase in the fourth quarter of fiscal 2006.

Same-restaurant sales at Bahama Breeze fell 0.7% for the quarter, as did total sales.

Now let’s turn to margin analysis for the fourth quarter. Note that all figures are from continuing operations. Operating profit margins were 56 basis points lower than last year on a percent of sales basis, including the impact of SFAS-123R. Excluding this impact, operating profit margins would have decreased 25 basis points from the prior year.

Food and beverage expenses were flat to last year on a percentage of sales basis, primarily because of menu mix related to the promotional calendars at Red Lobster and Olive Garden.

Fourth quarter restaurant labor expenses were 50 basis points higher than last year on a percentage of sales basis due primarily to wage rate inflation, about half of which is due to increases in state mandated minimum wage rates across the country.

Restaurant expenses in the quarter were 24 basis points higher than last year on a percentage of sales basis, primarily from a $1.4 million of incremental pre-opening expenses supporting accelerated growth at Olive Garden and the workers’ compensation reconciliation I previously mentioned.

Selling, general and administrative expenses were 14 basis points lower as a percentage of sales for the fourth quarter. This was due to a decrease in marketing expense because Red Lobster’s signature Lobsterfest promotion started in the third quarter this year compared to the fourth quarter last year. This favorability was partially offset by the adoption of SFAS-123R.

Our effective tax rate for the fourth quarter of 28.2% includes the benefit of several initiatives, including our food donation program, our pursuit of WOTC tax credits, and our after-tax hedging strategies, as well as credits that fully offset higher FICA costs on tips included in restaurant labor.

We continued the repurchase of shares in the quarter, buying back 1.1 million shares of our common stock.

Turning to the full fiscal year, Darden's total sales from continuing operations increased 4% in fiscal 2007 to $5.57 billion, driven by blended same-restaurant sales growth of approximately 1.5% and a 2.5% increase in new restaurant operating weeks.

On an individual operating company basis, Red Lobster had a 0.2% same-restaurant sales increase for the year and its average unit volumes were $3.8 million. Olive Garden same-restaurant sales increased 2.7% and its average unit volumes reached $4.7 million. Bahama Breeze achieved same-restaurant sales growth of 0.9%, excluding closed restaurants and average unit volumes were $6 million, excluding closed restaurants.

In fiscal 2007, Red Lobster reported a net decrease of two restaurants. Olive Garden opened 32 net new. Bahama Breeze closed nine restaurants to finish the year at 23, and we had two openings of Season 52, bringing their total number of restaurants to seven.

Darden's solid 13% diluted earnings per share growth from continuing operations in fiscal 2007 was driven by the strong sales growth at Olive Garden, profitable growth at Red Lobster and Bahama Breeze, and the significant share repurchase undertaken with the resulting cash flows.

For the year, we repurchased $371 million of our shares. In the last five years, we repurchased over $1.56 billion of our stock, which speaks to the significant cash flow we generate on a consistent basis.

We have 20.5 million shares remaining in our current authorization and yesterday we announced an increase in our dividends, as well as a move from a semi-annual payment to a quarterly payment. We will pay a quarterly dividend of $0.18 per share on August 1, 2007 to shareholders of record on July 10, 2007. Previously, we paid semi-annual dividends of $0.23 per share, or $0.46 per share on an annual basis. Based on the $0.18 quarterly dividend declaration, our indicated annual dividend is $0.72 per share, an increase of more than 56%.

Let me take a moment to update you on our progress at Smokey Bones. This week, we completed the information book on Smokey Bones and our advisor is now contacting potential buyers. We are not prepared to offer any conjecture about a sales price, potential proceeds, or estimated timeline for the transaction. When we have something meaningful to discuss, we will inform everyone through the normal channels of public disclosure.

Now, I will turn it over to Drew to comment on the operating companies.

Andrew H. Madsen

Thank you, Brad. I’ll share a few thoughts about the casual dining industry first and then summarize the strategic focus for each of our businesses in fiscal 2008. Overall, we believe we are well-positioned to outperform the industry and deliver another solid year of performance.

From an industry perspective, we expect the casual dining environment over the near-term to be similar to what we’ve experienced most recently. In particular, sales growth will most likely continue at fiscal 2007 levels, somewhat below historical norms, and cost pressure will remain somewhat above what we experienced last year. Importantly, our fiscal 2008 plan addresses both dynamics.

More specifically, given this background, there are four key considerations that have helped shape our thinking for fiscal 2008. First, since consumers have become more discerning regarding where they decide to eat, brands with broad appeal and strong value like Olive Garden and Red Lobster will have the best chance to outperform the industry.

Second, when guests visit our restaurants, it is more important than ever that we consistently deliver a great guest experience.

Third, giving our guests a new reason to choose our restaurants, typically in the form of compelling new food promotions that represent a solid value, will continue to be important.

And finally, we will take full advantage of the cost management opportunities that our scale and strong operating infrastructure provides, especially in our supply chain. This will allow us to minimize the amount of pricing we need to take to protect our unit level margins while still maintaining broad consumer appeal.

Now let’s talk about the specific priorities at each of our operating companies.

Olive Garden has broad appeal, strong guest loyalty, industry leading value and a proven business model. They outperformed the casual dining chain benchmark for same-restaurant sales growth by more than 4 percentage points during fiscal 2007 while also achieving their 51st consecutive quarter of same-restaurant sales growth. Given these fundamentals, we expect Olive Garden to continue to deliver solid sales and earnings growth in fiscal 2008.

Our strategic focus at Olive Garden remains unchanged -- we will manage the business to accelerate new restaurant growth while maintaining same-restaurant excellence.

Two years ago, Olive Garden opened 19 net new restaurants. Last year, they increased that to 32 net new restaurants and this year in fiscal 2008, they plan to open 40 net new restaurants. Ultimately, we believe Olive Garden has the potential to operate 800 to 900 restaurants in North America.

A second priority for Olive Garden is continued improvement in their guest experience. In particular, restaurants with below average guest satisfaction will receive additional coaching and implement comprehensive plans to accelerate improvement in their guest experience.

More broadly, all Olive Garden restaurants will focus on further improvement in server attentiveness and pace of meal and this effort will be supported by completion of their meal pacing technology rollout during the second quarter of our fiscal year.

The final key priority for Olive Garden is to maintain a strong advertising and promotion pipeline. They will continue to leverage their popular “Moments” advertising campaign with new commercials that enhance the strong emotional connection Olive Garden has with their guests, and every promotion this year will feature new products that have been tested to ensure they will help drive guest visits and deliver strong guest satisfaction.

Currently, Olive Garden is advertising two new dishes -- five cheese tortellini with shrimp and five cheese tortellini with sausage. This promotion also has a starting at $9.95 price point and is off to a solid start so far in June.

Now let’s turn to Red Lobster. Red Lobster also delivered competitively superior performance in fiscal 2007, exceeding the casual dining chain benchmark by 2 percentage points in same-restaurant sales. They also continued to strengthen their business foundation, setting new records for both guest satisfaction and profit margins.

As we’ve discussed before, our plan to achieve sustainable growth at Red Lobster has three phases. The first phase was to strengthen business fundamentals. The second phase is to refresh the brand, broaden appeal and build guest counts. The third phase will be to accelerate new unit growth starting later in fiscal 2009.

Our strategic focus this year during fiscal 2008 is to broaden appeal and accelerate guest count growth by improving perceptions among lapsed users that Red Lobster offers a variety of fresh seafood prepared with culinary expertise.

As you know, last October Red Lobster introduced their “Today’s Fresh Fish” menu, which is printed twice daily in every restaurant, features five to eight fresh fish species and up to three signature chef’s creations. During fiscal 2008, Red Lobster’s restaurant teams will continue to strengthen server knowledge and server confidence describing the fresh fish species on this menu. In addition, Red Lobster will introduce new advertising for the “Today’s Fresh Fish” menu in July. A new tagline, “Come See What’s Fresh Today”, will be used in all ads to help reinforce freshness.

This fresh fish advertising will be incremental to their existing base of promotional advertising support. Importantly, the team at Red Lobster has worked hard to make the product news in their fiscal 2008 promotions both more compelling and demonstrate more culinary expertise than the promotions last year.

Their current summer grilling promotion is a good example. It features two new dishes, fire grilled lobster and shrimp plus citrus rum scallops and jumbo shrimp, and it is off to a very good start so far in June.

Red Lobster introduced a new restaurant prototype design last year inspired by the coast of Maine that is more consistent with their brand promise to deliver a refreshing seaside escape. Two restaurants have been opened with this new design and it has been very well-received by both current core guests and by lapsed users. During fiscal 2008, Red Lobster plans to test a remodel design that is consistent with this new prototype.

We will also continue to strengthen the business foundation at Red Lobster and this will include implementing our meal pacing system nationally in all of the restaurants and improving guest satisfaction in below average restaurants, similar to Olive Garden.

The team at Red Lobster is proud of their progress in fiscal 2007 and we are confident that progress will continue in fiscal 2008 and beyond.

In fiscal 2007, Bahama Breeze exceeded the casual dining chain benchmark for same-restaurant sales growth by nearly 3 percentage points. They also made great progress improving their guest experience and increasing restaurant level returns. Given this performance, our strategic focus for Bahama Breeze is to prepare the business for disciplined new restaurant growth.

In late April, we closed nine Bahama Breeze restaurants. While this was a difficult decision to make, it does allow them to focus on their most profitable restaurants going forward.

Bahama Breeze has approved one new site which should open early in fiscal 2009 and are actively pursuing a pipeline of additional sites. We continue to believe that Bahama Breeze has the potential to be a billion dollar brand for Darden.

And now, Seasons 52; we were pleased with the performance of Seasons 52 in fiscal 2007 and remain excited about its future potential. They continue to operate with excellence in every market, including their two new restaurants in Atlanta. Average unit volume is approximately $6.4 million. Guest satisfaction is strong and the unit economics are solid.

Similar to Bahama Breeze, Seasons 52 will also focus on maintaining excellence in their existing restaurants as they prepare for disciplined new restaurant growth. There are no unit openings planned for fiscal 2008 but we anticipate approving several unit openings for fiscal 2009.

Brad.

Bradford Richmond

Thank you, Drew. In fiscal 2008, we expect combined same-restaurant sales growth for Red Lobster and Olive Garden to be between 2% and 4%. As Drew mentioned, Red Lobster, which had a challenging prior year comparison in the fourth quarter, is off to a solid start in June, trending above this range. Of course, we will be both above and below this 2% to 4% range month to month, depending on promotional calendars, holiday shifts, and changes in consumer sentiment, which as you know has been volatile for much of the past 12 to 18 months.

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

We expect capital spending to be slightly higher than it was in fiscal 2007 at approximately $400 million. We are spending more on new units, relocations, and remodel testing than the prior year.

Looking at operating profit margins from continuing operations, we anticipate margin improvements of approximately 20 basis points on an annual basis compared to fiscal 2007. This expansion will primarily come from selling, general and administrative expenses as we leverage more of our fixed costs with sales growth.

We anticipate that food and beverage expense as a percent of sales will be unchanged from the prior year. Cost savings initiatives and favorable sales mix changes due to Olive Garden's expansion will be offset by increased costs of various commodities.

We anticipate an inflationary environment in fiscal 2008 due to the production of ethanol and other bio fuels and the downstream impacts on feed derived from corn and soybeans. However, we have contracted a high percentage of our fiscal 2008 usage in anticipation of these costs impacts as follows: total seafood prices for fiscal 2008 are expected to be moderately higher than fiscal 2007. Seafood accounts for approximately one-third of Darden's total cost of goods sold. Category by category, shrimp is our highest volume protein and we have approximately 40% of our fiscal 2008 shrimp usage covered at prices equal to fiscal 2007. We do not foresee any meaningful risk to shrimp cost in fiscal 2008.

Crab prices are higher on a year-over-year basis and we have most of our usage contracted or purchases. Lobster prices are also higher and we have almost half of our usage contracted or purchased.

Chicken and poultry prices are higher on a year-over-year basis but we have contracted most of our usage through fiscal 2008 at prices equal to fiscal 2007 costs.

Beef prices are higher on a year-over-year basis and we have contracted all of our usage through December 2007 at slightly higher prices than fiscal 2007.

We anticipate that labor costs as a percentage of sales will climb slightly as higher wage rates from increases in minimum rates take effect.

The improvement in selling, general and administrative expenses as a percent of sales will be the result of sales leveraging driven by new unit growth at Olive Garden and same-restaurant sales growth at both Olive Garden and Red Lobster.

We also expect to once again generate strong cash flows, which we’ve done consistently since we became a public company in 1995, and to use these to repurchase a meaningful amount of shares, which also helps drive earnings per share growth. As I mentioned earlier, we repurchased $371 million of our stock in fiscal 2007 and we anticipate purchasing even more than that in 2008 as our cash flows grow and we begin to increase our leveraging, as discussed last month.

Finally, for fiscal 2008, we expect our tax rate to be approximately 29% to 31%, and this will vary by quarter depending on the timing of certain credits.

With our same-restaurant sales and new restaurant growth expectations, the margin improvements we expect due to lower selling, general and administrative expense, and the share repurchase plans, we expect diluted EPS growth from continuing operations of 10% to 12% for fiscal 2008. This estimate is based on our diluted EPS from continuing operations of $2.53 in fiscal 2007.

And now here’s Clarence with some final comments.

Clarence Otis

Thanks, Brad. I think you can see that with the recent restaurant closings and our decision to sell Smokey Bones, our accounting does get a little complicated. But stepping back from that, I would tell you we feel good about our results for the year. We feel good about the strength of our business, which is in a very, very strong position from a competitive perspective.

I think everyone who follows casual dining knows that this was not an easy year. Many very strong companies with long track records of success had to make some tough choices, and certainly in deciding to sell Smokey Bones, we had to make a tough choice as well.

But we continue to have strong industry-leading performance. That’s certainly reflected in our fiscal year 12% diluted net earnings per share growth after the adoption of FAS-123R, and after all the adjustments that Brad detailed previously. And then that was 16% on an apples-to-apples basis really when you exclude the impact of FAS-123R.

We are just as excited though by the fact that even as we successfully navigated the challenging environment and put up those kind of financial results, we made progress building a long-term strength of each of our brands. As we’ve said before, we have a proven approach to the business. That approach is anchored in combining strong brand management with great operations and guided by that approach, we’re confident that we are working on the right things at all of our brands -- things that are going to drive continued, current period success while better positioning us to capture what we think is a very attractive long-term opportunity in casual dining.

Ultimately, what really drives our ability to create sustainable leadership level value for our shareholders is having great people, and so I’m proud of our results but I’m even prouder of the outstanding people in our restaurants, in our restaurant support center who have delivered those results. We’ve got what I believe are at every level of our organization the strongest leadership teams in casual dining and investing in their continued growth, their continued development is a big part of our 2008 plan and it’s critical really to any success that we’re going to have.

I’d conclude by just reiterating that we think we’re well-positioned entering 2008. We’re excited about our financial plan for the year. We’re excited about what we’ll accomplish strategically this year to make the company even stronger, and now we’re prepared to take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Glass from CIBC. Please go ahead.

John Glass - CIBC

Thanks. Good morning. Given your discussion of the cost environment right now, what do you think of price -- what is a reasonable pricing level you need to keep restaurant, protect restaurant margins? I presume that is the goal, is to keep the restaurant level margins flat in ’08 versus ’07?

Clarence Otis

What I would say, we don’t talk specifically about pricing just due really to competition and not wanting to disclose that. When we talk about that 2% to 4% same-restaurant sales level and we said before that really -- and that’s a normalized level and we expect that again in ’08. In general, what we’re looking there for is about a point of traffic and the balance would be some combination of pricing and mix change. So that’s generally about as far as we’d go for competitive reasons. More specifically about this year, we’re not prepared really to get into our pricing strategy.

John Glass - CIBC

That’s helpful. And then, Brad, if you could just clarify something when you talked about the difference in how you looked at the annual earnings versus the prior period, can you talk about what actually hit in the fourth quarter? In other words, was the $0.05 a benefit from Bahama Breeze and the $0.03 both in the fourth quarter, or was one stretched across the whole year and one just hit in the fourth quarter?

Bradford Richmond

Both of those occurred in the fourth quarter, and that’s relative to the guidance that we set out before.

John Glass - CIBC

So just to clarify, did you feel like this quarter was in line with what you previously expected or was it better, worse? I think there was a difference between what you reported versus what street expectations were, but I’m not sure street expectations had all the facts.

Bradford Richmond

There were a lot of moving pieces and that’s why I tried to take a moment there and detail that out. We believe it was right smack in the middle of our range or just slightly above it.

John Glass - CIBC

Okay, that’s helpful. Thanks.

Operator

Your next question comes from the line of Steven Kron from Goldman Sachs. Please go ahead.

Steven Kron - Goldman Sachs

Thanks. Good morning, guys. A couple of questions, if I might. First, Clarence, I was wondering if you could just give us a little bit of an update on your current thinking as it relates to strategic acquisitions in light of some continued pressure in the category and the continued inflationary cost environment. Is there anything that we should be thinking about as far as any change in timeline or thought process?

Clarence Otis

I don’t think much has changed in our thinking. We want to be in a position to be able to be opportunistic if something that really is attractive and can drive value for our shareholders becomes available. So we do manage our capital structure with that point of view and we’ve talked in the past about the fact that we do feel there’s room to take our leverage level up and still maintain the ability to be opportunistic and so we’re going to be doing some of that through this year.

But that’s about as much as we have control over, is really being prepared in case something develops that makes some sense.

Steven Kron - Goldman Sachs

Secondly, you guys talk about strong cost management and in your prepared remarks, there was a couple of points that were made as far as whether supply chain efficiencies or just other ways to try to control costs. I was wondering if you could just, in light of the current cost environment, in light of your expectation of continued margin gains, some of which will come from sales leverage, but are there specific things that you could point to to help us understand a little bit better what types of cost efficiency programs are currently in place here?

Clarence Otis

Sure and I will start it and then ask Drew and Brad to weigh in but we’ve had a pretty strong focus on cost management for several years now, just to make sure that we’re able to have a pricing strategy that make sense, that protects our top line. So we’ve had significant upward pressure the last several years coming from a number of different lines -- utilities, food costs, labor, all of those things have been there.

One of the things that’s helped the last couple of years has been a real strong focus on running restaurants that are even safer and cleaner, and so loss prevention has been important. We’ve seen our workers’ comp incidents, our public liability, our guest incidents when it comes to accidents go down. We’ve also, when we do have accidents, we focus on managing the claims process in an effective way and so the costs of each of those claims has also come down.

So significant dollars saved in the workers’ compensation area the last couple of years offsetting some of the pressure, and there are a host of other things. Drew, Brad, you may highlight some of the bigger ones.

Andrew H. Madsen

Sure. There’s three broad buckets that we think about when we are thinking about this disciplined cost management. One is our supply chain that we’ve already mentioned. We think it’s competitively superior and we think our ability to understand the markets and place our contracts accordingly put us in a favorable position and Brad went through where we stand with shrimp and a lot of the other higher priced proteins, and we feel very good about that.

The second big bucket is investments we make in information technology. I talked about meal pacing system, rolling that out, iKitchen is another initiative that we are in the process of rolling out that really helps us automate ordering inside our restaurants A, to make it easier for our restaurant managers and B, to make sure we’re capturing the accurate and negotiated price more consistently and we see cost savings there.

Third is more an organizational discipline, if you will, for us each year to step back from our business, look at how we’re running it and what costs have gotten into the business that may not be adding value today that we can take out without in any way impacting the guest experience or the employee experience for people who work in our restaurants. So beyond food and the supply chain, beyond technology initiatives, we continuously have a focus to reduce waste in restaurants, to have labor productivity that continuously improves each year. Clarence mentioned workers compensation already, so it’s more an ongoing discipline with very aggressive targets in each area that cascade throughout the organization.

Bradford Richmond

I think the only thing that I would touch on that Clarence and Drew haven’t touched on is our past investments in direct labor and the management of that, particularly as the wage rates increase there. The more sharing of those programs and additional investments in that of our scale make those very worthwhile to do, very good returns without effecting the guest experience but also helping protect our margins as well.

Steven Kron - Goldman Sachs

Thanks a lot.

Operator

Your next question comes from the line of Jeff Omohundro from Wachovia. Please go ahead.

Jason Belcher - Wachovia Securities

This is actually Jason Belcher for Jeff. Wondering first if you could give us an idea of what the ongoing earnings dilution would have been for just the Smokey Bones brand at Q4 if it were not all moved to discontinued operations?

Clarence Otis

Just one second here. We’re looking for that answer.

Jason Belcher - Wachovia Securities

While you’re looking, I’ll go on with my follow-up; I was wondering too if you could provide a little more detail on the timing of the ’08 store development plans throughout the four quarters.

Clarence Otis

Olive Garden is obviously where we are opening the bulk of our restaurants and it’s pretty balanced quarter by quarter. It may be slightly more in the second-half than the first-half, but not dramatically.

Jason Belcher - Wachovia Securities

Okay, great.

Bradford Richmond

In the fourth quarter, just from operations for Smokey Bones would have been roughly the $0.04 range.

Jason Belcher - Wachovia Securities

Okay, that’s helpful. Thanks a lot.

Operator

Your next question comes from the line of Jeff Bernstein from Lehman Brothers. Please go ahead.

Jeff Bernstein - Lehman Brothers

Thanks. Just a follow-up on the popular topic of acquisition versus I guess peers’ focus more on brand disposition. Clearly your brands have been more resilient than most but obviously not immune to the broader casual dining pressures. I’m just wondering what metrics give you comfort, I guess Clarence, that industry trends ultimately improve, making an acquisition the best option at this point?

And then as a follow-up, I’m just wondering if you guys have given from a high level perspective any thought to the alternative of perhaps focusing on your two core brands, perhaps lowering long-term growth expectations and more of a focus of returning capital to shareholders, similar to your brethren in quick service? Thanks.

Clarence Otis

I would say that the thing that we look at when we talk about the industry is really the top line, and so we have had a deceleration in growth in casual dining from what was 4%, 4.5% to the last 12 months, it’s more like 2.5%.

But that said, that’s still very solid growth given all of the pressures that consumers have been under and so I think it speaks to the category and its strength and the fact that it really is part of the fabric of people’s lives. So we think that ultimately, that’s the bottom line when it comes to the category. So growing at 2.5% in a difficult environment given all of those pressures we think is good solid evidence that this is a strong category.

I think in terms of how we think about creating value, we think that we create value by building this business, taking advantage of that industry opportunity and to the extent that we think we can’t build a business, we can’t leverage all of these restaurant support assets that we’ve got, all of the fixed and semi-fixed assets we’ve got, all of the leadership expertise that we have, then we will return cash to shareholders, which I don’t -- I think that’s how we think about it but we do think that we’ve got a tremendous amount of expertise, an incredible infrastructure and platform to leverage to grow and capture the industry growth opportunity. So that’s how we think about it.

Capturing that growth opportunity from our perspective includes not just really running our existing businesses better and continuing to get more volume across that base of restaurants. It’s an important part though, and so if you look at Olive Garden I think Drew mentioned or Brad may have mentioned it, annualized volumes on a per unit basis at Olive Garden of $4.7 million, which I think if you go back a decade no one would have predicted it was possible, drives tremendous value. We expect to continue to do that at Olive Garden and to continue to grow volumes at Red Lobster, which at $3.8 million are pretty significant.

So we are focused on that but we are also focused on new restaurants and again, we believe that Olive Garden can add a lot of new restaurants. We talked about that. But we also believe that as we grow volumes at existing restaurants, Red Lobster’s model will support new restaurant growth and Drew talked about that.

Beyond that, a way to add additional restaurants and leverage this platform and the expertise we’ve got will mean additional brands and so that’s how we think about it. Building the business ultimately drives shareholder value. The fact that we’re where we are today, just under $6 billion versus $3.2 billion when we came out of General Mills 12 years ago is what’s driven the 20%, 22% annualized total shareholder return that we’ve enjoyed. A different strategy of sort of just trying to maintain the two brands that we had, not grow them from a new restaurant perspective and not grow new restaurants overall I think would have driven a lower total shareholder return.

Jeff Bernstein - Lehman Brothers

Clarence, you mentioned leverage and I know you said returning cash to shareholders would follow obviously your primary focus on building value through new units in the platform but in the prepared remarks, I know it talked about repo in ’08 would be more than in ’07, and I know that your increased leverage got a lot of attention on your last conference call. I’m just wondering in terms of now that it seems like you are willing to increase that ratio of the leverage, the timing of potential repo or whether you would just do an open market or perhaps something more in lines of a tender or an accelerated share repurchase? I’m just wondering your thoughts with this increased leverage opportunity.

Clarence Otis

Good question and I think it really does speak to the strength of our brands that we’re able to build the business and still have free cash flow increasing to return to investors and on top of that, we are taking the leverage level up. We talked about a new range that is 55% to 65% on an adjusted debt-to-capital basis. We’ve been at roughly 50%.

We would be moving toward that range, so getting up to at least 55% through the course of this year. Our practice has been to do that with a continuous bid in the marketplace and so the dollar average our way there, we think that’s a much more effective way to do it than an accelerated share repurchase. I don’t know that we’d get a whole lot of lasting benefit from an accelerated share repurchase. I think we pay a little bit more for the shares.

So we would expect to continue to do that. As Brad said, share repurchase in ’07 I believe was nearly $400 million and so it is going to be higher than that in ’08, but it will be paced through the year.

Jeff Bernstein - Lehman Brothers

Thank you.

Operator

Your next question comes from the line of Glen Petraglia from Citigroup. Please go ahead.

Glen Petraglia - Citigroup

In terms of Red Lobster and if I read into your unit growth openings planned for fiscal 2008 of 40 units, the intimation is that there’s I guess virtually no unit growth at Red Lobster. If I go back to your January presentations, you suggested maybe four to 10 units in both ’08 and ’09. I’m curious; maybe I’m over-thinking this, but have you scaled back your thoughts in terms of how many units you should be opening in ’08 at Red Lobster. I’m curious to know if so, what’s driven that decision.

Clarence Otis

We’re opening about the same number of restaurants at Red Lobster that we thought we would but in combination with relocations and closings, the net new units --

Glen Petraglia - Citigroup

Got it. And then earlier, you mentioned that you are going to try to tightly manage the costs at the restaurant level to limit the amount of pricing that you need to take. Obviously that’s a prudent strategy but I’m curious -- do you feel that in this current environment that the pricing opportunity may be less than it may have been let’s call it 12 months ago?

Clarence Otis

I think that’s fair and that’s why we are so focused on taking costs out of the business that doesn’t add value and why we’re so focused on providing a consistently great guest experience every time in every restaurant.

Glen Petraglia - Citigroup

Thanks.

Operator

Your next question comes from the line of Mark Wiltamuth from Morgan Stanley. Please go ahead.

Mark Wiltamuth - Morgan Stanley

Good morning. Clarence, there’s been some commentary from some of the peers out there that some of the weakness in the industry has been centered on real estate markets where housing prices have tumbled. Have you seen any of that? If you could really comment on how the Florida market looks versus the rest of the country.

Clarence Otis

I would say Florida and California are pretty weak. I don’t know that it’s the real estate prices. I think it is more about the nature of the mortgages. People took on a lot of mortgage in California and Florida. There are more -- I don’t want to say exotic mortgages but there are more floating rate mortgages. There are more lower down payment mortgages because the housing prices are so high that I think people are responding to that. But we’ve certainly seen both states weaker than the rest of the country.

Mark Wiltamuth - Morgan Stanley

Thank you.

Clarence Otis

That’s 15%, 16% of the population of the whole country in those two states.

Mark Wiltamuth - Morgan Stanley

What can you really point to that will really make you feel like the comps are going to get better in the second-half of the year? Is there anything out there you can really address?

Clarence Otis

We would expect that interest rates will stabilize and so they will not continue to increase since we won’t see the upward adjustments putting pressure on people’s discretionary income that we’ve seen over the last 12 to 18 months. I think that’s part of it.

When it comes to energy prices, that’s anyone’s guess but our expectation is that while there might be volatility, it will be around the levels that we’re at today. And so some of it is a deceleration in those cost pressures.

Mark Wiltamuth - Morgan Stanley

Thank you.

Operator

Your next question comes from the line of John Ivankoe from J.P. Morgan. Please go ahead.

John Ivankoe - J.P. Morgan

Thanks. A question on the CapEx; can you walk us through of that $400 million, how much is new units, how much is just your standard maintenance and how much is associated with Red Lobster and if there’s any kind of one-time-ish corporate spending that’s in that number?

Bradford Richmond

In the broadest sense, new units is by far and away the large portion of that as we look at ’08.

John Ivankoe - J.P. Morgan

How many gross new units are you opening?

Bradford Richmond

That’s a great question, John, because we did talk about net and on a gross basis, it’s probably about 54, 55 and 40 on a net basis.

John Ivankoe - J.P. Morgan

Okay. If you use 40, you can’t really get there but I guess if you use 55, you can.

Bradford Richmond

Because that obviously includes relocations and some rebuilds.

Clarence Otis

And back to Drew’s answer on Red Lobster, they actually have nine new openings planned for ’08, though all those are relocations so the net growth doesn’t show up.

But in rough terms, new units in terms of relocations, rebuilds is approximately half of that number. About I’d say 35%, 40% of that is what you would call just replacement maintenance CapEx, and then we have about the remainder of that is really testing of some new remodels as we look out to the future and being prepared for that.

John Ivankoe - J.P. Morgan

Two follow-ups, same question; I think we talked about Red Lobster remodels before, fairly inexpensive, just over $100,000. Am I remembering that correctly in terms of just some small types of interior touch points and what have you? Or might you be considering something larger?

Clarence Otis

I think at this point, John, it’s hard to say. We are thinking about something a little bit more substantial but Drew I think mentioned the first step was really getting a new restaurant prototype that we were comfortable with because that’s going to be the basis for the remodels. We got that in ’07. Now we’ve got to test a variety of different options when it comes to remodel and they’ll stretch across a lot of price points, so it’s pretty early now when we have none of those in the marketplace to comment on what they might cost.

John Ivankoe - J.P. Morgan

Finally on a corporate basis, I think you are moving soon. Is that correct?

Clarence Otis

We are.

John Ivankoe - J.P. Morgan

Is any part of that in the ’08 budget for CapEx?

Clarence Otis

There is some. I think what Brad didn’t pull out, there is technology in there as well and so a lot of these technology investments we’re making but there is also some for the move of the headquarters, although we’re still two years away but Brad, you may want to comment on that.

Bradford Richmond

As Clarence mentioned, the technology piece of that is going to be in the -- a little bit less than the prior year but still that $20 million to $25 million and that would be in the, when I was grouping it before, in the maintenance CapEx, if you will.

On the new RSC Campus, as Clarence mentioned that’s two years out so there’s -- I don’t have the exact number on hand but it’s probably around the same amount as the technology number.

John Ivankoe - J.P. Morgan

Okay, very good. That’s helpful. Thanks.

Operator

Your next question comes from the line of Joseph Buckley from Bear Stearns. Please go ahead.

Joseph Buckley - Bear Stearns

Thank you. Can you tell us where you are now using your definition of adjusted debt to capital?

Clarence Otis

We’re just over the 50% mark. I think about 51% is where we came out when we ended the fiscal year.

Joseph Buckley - Bear Stearns

And then a question on meal pacing, I think you mentioned it for both Olive Garden and Red Lobster. Could you go into a little bit of detail what it is, how far rolled out it is right now, and what the desired effects are?

Clarence Otis

Meal pacing for us is something that helps coordinate the flow of an order through the kitchen so that everything comes up in as sequenced a manner as possible and the food gets to the guest as hot as possible. What we’ve seen in testing at both Olive Garden and at Red Lobster is an increase in throughput, so there’s some guest count benefit, and also an increase in guest satisfaction.

So it is in the process of being introduced already at Olive Garden and we should complete that, as I said, some time in our second quarter. We’re further ahead at Olive Garden. Red Lobster has just finished their testing and is beginning implementation now but should have it finished by the end of our fiscal year.

Joseph Buckley - Bear Stearns

Last question, you mentioned Red Lobster being off to a great start with the grilled promotion. It’s a pretty high check promotion, I believe. I guess I’m curious of the game plan for fiscal ’08 in terms of value or possibly driving higher check through Red Lobster.

Clarence Otis

I’ll start just with our general thoughts, Joe, and then Drew can get more specific if he wants to. I think what we believe when it comes to a promotional calendar on an annual basis is that it needs to be balanced when you are talking about price points. So it needs to have value, it needs to have something in the middle that pretty much approximates what your core menu looks like from a price point and margin perspective and then there are times of the year, any year, almost any environment, where people are in a mood to spend somewhat more than they might be at other times in the year and you need to be responsive to that promotionally.

That’s really been the goal with Red Lobster is to get that balance. We were out of balance if you go back several years and probably had too much discounted price promotional part of our total promotional calendar.

Andrew H. Madsen

Maybe to amplify it a little bit, the current promotion that we’re seeing, the dynamics of it, fit pretty well with what Clarence outlined earlier for what we would expect to see in same-restaurant sales growth. So if you get a percent in guest count growth and 2% or 3% in check growth, that’s about what we’re seeing in combination with this current promotion. So it isn’t giving us any value concerns at this point.

Joseph Buckley - Bear Stearns

Thank you.

Operator

Your next question comes from the line of Rachael Rothman from Merrill Lynch. Please go ahead.

Rachael Rothman - Merrill Lynch

Good morning. Speaking about modeling out your G&A going forward, given the disposition of Smokey Bones and the closures at Bahama Breeze, how should we think about your opportunity to scale your G&A?

Clarence Otis

Clearly as we continue to grow and complete the sale of Smokey Bones we would expect to see some more leveraging in our G&A as we move forward. Again, that’s a highly leverage-able line for us. We’ve also invested over time and continue to invest in there to drive some of our enterprise strategic initiatives. So I’d look for more leveraging there in future years as well.

Rachael Rothman - Merrill Lynch

Do you have a sense for what portion of the G&A you attributed to Smokey Bones or Bahama Breeze, or is that not how you guys look at it?

Clarence Otis

On Smokey Bones, we really wouldn’t go into that much detail on our G&A but obviously there’s a portion of our G&A that still exists to support that operation until the time of the sale.

Bradford Richmond

And that piece is in discontinued operations, so I think we’ve moved some of that down already.

Rachael Rothman - Merrill Lynch

Okay, fair enough. Would it -- I guess the way I’m thinking about it, obviously you guys have been doing extensive work on the concept and so obviously that probably took a lot of management time, attention, et cetera. So maybe if you focus back on your stable or less growth-oriented brands, maybe that would give you an opportunity to leverage that line item a bit.

Clarence Otis

I think that’s fair. I think that’s a fair way to think about it. That’s how we think about it.

Rachael Rothman - Merrill Lynch

Okay, perfect. And then if I could just follow up on the CapEx at Red Lobster. Can you guys talk a little bit about the prototype that you unveiled at the January analyst meeting, is that similar to what you guys are going to be going with? Have you had opportunities to value engineer that prototype and maybe what some of the feedback or guest feedback and return hurtles that you are looking for are?

Clarence Otis

The design is what you saw at the analyst day. The Red Lobster team, after having opened two and operating them for a while, has had the opportunity to value engineer them a bit, reduce the investment by a few hundred thousand dollars and add more seats and maintain guest satisfaction. So going forward, the new prototypes that they will open will have the same look and feel but will be optimized.

Rachael Rothman - Merrill Lynch

Do you have a particular return hurtle that you are shooting for?

Clarence Otis

Absolutely. We really have a return hurtle for Red Lobster and Olive Garden. It’s pretty similar and it’s about a point-and-a-half of what we calculate to be our cost of capital.

Rachael Rothman - Merrill Lynch

Perfect. Thank you so much.

Operator

Your next question comes from the line of Michael Smith from Oppenheimer. Please go ahead.

Michael Smith - Oppenheimer

Good morning. Most of my questions have been asked and answered but I thought I would take advantage of this to see whether you have experienced any new trends in the construction cost of new units or remodeled units. Are they still going up at the same pace they have been for the past couple of years or have they stabilized somewhat?

Clarence Otis

Construction costs are not going up at the same pace, so they have stabilized. They have not come down as much as we’d like to see them come down but they’ve stabilized. I think the bigger challenge on the new restaurant side is really land costs or lease costs, which we’re not seeing any mortgage busts on the commercial side.

Michael Smith - Oppenheimer

The other question I had was concerning the promotion of Red Lobster. You might have covered this in your prepared remarks but you did indicate that it was going to be a price point I think commercials that you were going to be using all year long. Was that correct?

Clarence Otis

Not at all. For Red Lobster, what we talked about is making sure we have promotions that have more compelling product news in them more consistently across the year and product news that is less about quantity and more contributes to culinary expertise. So that’s really what we were getting at.

The Olive Garden commercial that’s in promotion, that’s on the air now has a price point in it but for Red Lobster, the real emphasis is making sure we consistently have more proven compelling product news that also builds a perception of culinary expertise.

Michael Smith - Oppenheimer

Thank you.

Operator

At this time, there are no further questions.

Matthew Stroud

Thank you, Greg. We’ll wrap it up right there. We appreciate you all joining us on the call this morning. If there’s any follow-up questions that you’d like to ask, please let us know. Give us a call here in Orlando. Everybody have a great summer. We look forward to talking to you again in September.

Operator

Ladies and gentlemen, this conference will be available for replay after noon Eastern Time today through July 20th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 876924. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844, with the access code 876924.

That does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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