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DRI reported fiscal 4Q10 EPS of $0.86, or $0.87 when you exclude the $2 million pre-tax asset impairment charge, below both the street’s $0.88 per share estimate and my $0.90 per share estimate.  Relative to my estimates, the shortfall was largely due to lower same-store sales growth and higher SG&A and interest expenses. 

On a same-store sales basis, I was expecting sequential two-year average trends to hold steady to get slightly better in the fourth quarter, but instead, trends at the three major brands slowed when you adjust for all of the reported holiday and weather impacts in 3Q10.  Although Red Lobster’s trends looked the worst on a one-year basis (-4.6%), Olive Garden’s -1.5% result implies the biggest sequential falloff in two-year numbers.  On a positive note, comparable sales growth at both Capital Grill and Bahama Breeze came in better than I was expecting with 2-year average trends getting significantly better since the prior quarter.

Looking at monthly trends during the quarter for Red Lobster, Olive Garden and LongHorn, April appeared to be the roughest month on a one-year basis, but two-year trends slowed the most in May for both Red Lobster and Olive Garden (as shown in the charts below).

Even with the 2.3% decline in blended same-store sales growth, which fell short of management’s implied -1% guidance, EBIT margin continues to be strong at 10.5% (flat with last year), before the $12.7 million pre-tax reduction in sales related to gift card redemptions and the $2 million pre-tax asset impairment charge.  Margins have benefited from lower YOY food and beverage costs as a percentage of sales for the last six quarters, and with seafood costs potentially moving higher, this line item may prove to be a headwind in FY11.  As of February, the company was only locked in on 23% of its seafood costs through December 2010 or about halfway through fiscal 2011.  Seafood costs represent DRI’s largest ticket food item, accounting for 30% of total food costs.

Despite the slowdown in trends, Darden guided to 2% to 3% blended same-store growth in FY11.  Going into the quarter, I said this level of growth could be a stretch because it implies continued improvement in two-year trends.  Seeing that the company’s two-year average same-store sales growth already slowed during the fiscal fourth quarter with trends, for the most part, decelerating more in May , this full-year guidance seems aggressive. 

Although Darden’s same-store sales outperformance narrowed during the fourth quarter relative to the Knapp-Track benchmark to 0.5% from nearly 5% in the prior quarter, I continue to believe that Darden is one of the best positioned companies to navigate through this difficult economic period.  To that end, the company proved its financial strength by raising its annual dividend by 28% and buying back nearly $70 million in shares during the fourth quarter.

DRI – FIRST LOOK - RL May 2010


DRI – FIRST LOOK - OG May 2010


DRI – FIRST LOOK - LH May 2010

Howard Penney

Managing Director