DRI’S JAMIE QUESTION

We still like the stock but, in light of recent events at JPM, DRI shareholders should ask some questions of the leadership team in Orlando.

Darden’s Chief Executive Officer and Chairman of the Board, Clarence Otis, has been keeping a low profile of late. The industry-lagging operational performance of Darden’s brands has led others to join us in expressing doubt about the effectiveness of his strategy for the company. Despite JP Morgan shareholders affirming their confidence in Jamie Dimon’s ability to execute both roles, we believe the broader conversation of single persons holding the dual role of CEO and Chairman will have an impact on the leadership structure of many companies going forward. Within our space, Darden is the first that comes to mind in this respect.

Where is the New Plan?

Darden’s plan, outlined in its 2012 Annual Report, has been badly discredited virtually since the quarter it was released as many of the doubts we expressed in our reaction to that report came to the surface in the company’s results. We were bearish on the stock from July to February before turning bullish in early March.

Since turning positive, we have been arguing that substandard operational performance could potentially be ameliorated by structural changes to the multi-brand portfolio company. While the stock has recovered well since late-February, the operating strategy of the company remains - we assume - unchanged. Perhaps, in the event that a separate Chairman of the Board was in place, there would be added impetus for the current management team to devise a new, more effective, strategy for the company.

Leadership

We’ve been surprised by Clarence Otis not taking a more active role - or any role - in recent presentations by the management team. It’s almost an American tradition in corporate America, that the same person occupies the role of Chief Executive Officer and Chairman of the Board. Although it should be noted, according to some corporate governance experts, that a separation of these roles is starting to become more common. According to Spencer Stuart’s 2011 board index, only 41% of S&P 500 companies separate the job of chairman and CEO, up from 26% in 2001. We think Darden continues to be vulnerable to changes in the corporate structure.

Over the past three years DRI has underperformed the S&P 500 by 25% and the average casual dining stock by 59%. At the same time the company has spent nearly $2.0 billion in capital spending, and showed no growth in EBITDA. Despite these metrics, management has not been held accountable for mismanaging the company. One key reason for the underperformance was that management was late to recognize the secular changes in the casual dining industry, leading to misuse of shareholder capital. By separating the CEO and Chairman of the Board roles, thereby making the CEO more accountable, shareholders could benefit significantly if the change were to bring about better governance of the company, and higher returns to investors.

Combining the roles might have its advantages in certain instances but, in Darden‘s case, there appears to be little evidence that such an arrangement is benefiting shareholders. Corporate governance advocates submit that the CEO acts as his own boss because he reports to himself in his chairman role. Some corporate governance experts submit that a CEO serving as Chairman of the Board acts as his own boss, leading to a lack of accountability and a tendency for unchecked risks to be taken, which can end up harming the company’s financial health. We think this line of reasoning applies directly to DRI as the many decisions by the current CEO have led to suboptimal results for the company and its shareholders.

If Darden is going to keep the current operating structure of a complex multi-branded company then it is even more imperative to separate the two roles. Splitting the roles at DRI will allow the CEO and Chairman to focus on different, equally vital aspects of the company’s performance. DRI is in need of a CEO that is focused on the operations of the individual brands. We have heard from more than one shareholder suggesting that the current CEO is detached from the operating side of the business and does not know the numbers. Perhaps some overview from a separate Chairman of the Board could rectify that alleged detachment.

DRI is getting ready to close the books on a dismal FY13, with EPS expected to decline 11% and the outlook for FY14 also uninspiring. In 4Q13, DRI is estimated to report $1.04 in EPS, down 10% from last year. The 4Q13 results will see a sequential improvement in top line trends, but there is still no cohesive strategy to fix the longer-term issues that plague the company. Some creative thinking may be in order!

Howard Penney

Managing Director

Rory Green

Senior Analyst