Financial Review 2004

Management's Discussion and Analysis
of Financial Condition and Results of Operations
This discussion and analysis below for Darden Restaurants, Inc. should be read in conjunction with our consolidated financial statements and related notes found elsewhere in this report.

For financial reporting, we operate on a 52/53 week fiscal year ending on the last Sunday in May. Our 2004 fiscal year, which ended on May 30, 2004, had 53 weeks. Our 2003 fiscal year, which ended on May 25, 2003, and our 2002 fiscal year, which ended on May 26, 2002, each had 52 weeks. We have included in this discussion certain financial information for fiscal 2004 on a 52-week basis in order to assist investors in making comparisons to our prior fiscal years.

OVERVIEW OF OPERATIONS

Our business operates in the casual dining segment of the restaurant industry, primarily in the United States. At May 30, 2004, we operated 1,325 Red Lobster, Olive Garden, Bahama Breeze, Smokey Bones Barbeque & Grill, and Seasons 52 restaurants in the United States and Canada and licensed 38 Red Lobster restaurants in Japan. We own and operate all of our restaurants in the United States and Canada, with no franchising.

Our sales were $5.00 billion in fiscal 2004 and $4.65 billion in fiscal 2003, a 7.5 percent increase. On a 52-week basis, after adjusting for the $90 million of sales contributed by the additional 53rd operating week in fiscal 2004, total sales would have been $4.91 billion for fiscal 2004, a 5.5 percent increase from 2003. Net earnings for fiscal 2004 were $231 million ($1.36 per diluted share) compared with net earnings for fiscal 2003 of $232 million ($1.31 per diluted share). Net earnings for fiscal 2004 decreased 0.3 percent and diluted net earnings per share increased 3.8 percent compared to fiscal 2003. Although Red Lobster's string of 23 consecutive quarters of U.S. same-restaurant sales gains ended during fiscal 2004, Red Lobster has made progress in some important areas. Red Lobster improved its operating efficiency during fiscal 2004 through improvements in labor management and other cost controls, as well as implementing a less-disruptive promotional strategy in the second half of fiscal 2004, which resulted in higher operating profit than in fiscal 2003. Results from guest satisfaction surveys also improved as the fiscal year progressed. Red Lobster retained a new advertising agency in fiscal 2004 and is in the process of developing a marketing plan designed to achieve more sustainable benefits than have been obtained in prior years. Red Lobster also is developing new entrée offerings in the $10-$15 price range to strengthen the value offered to its guests. Olive Garden's sales gains in fiscal 2004, combined with lower food and beverage costs, restaurant expenses, and selling, general and administrative expenses as a percent of sales, more than offset increased restaurant labor expenses as a percent of sales. This resulted in a double-digit increase in operating profit for Olive Garden during fiscal 2004 along with record annual operating profit and return on sales.

In fiscal 2005, we expect to increase our number of restaurants by approximately 50 to 60 restaurants. We expect combined same-restaurant sales growth in fiscal 2005 of between one percent and three percent for Red Lobster and Olive Garden. We believe we can achieve diluted net earnings per share growth in the range of 8 percent to 12 percent for fiscal 2005. In fiscal 2005, we also expect Bahama Breeze to be accretive to earnings, and Smokey Bones to remain dilutive to earnings. However, we expect Smokey Bones to be accretive to earnings in the second half of fiscal 2005. As with same-restaurant sales growth, there can always be some quarter-to-quarter variability in operating results, where specific factors put us above or below the expected range of diluted net earnings per share growth. We believe our strong balance sheet and cash flows will be important factors in helping us reach our goals.

Our mission is to be the best in casual dining, now and for generations. To achieve this goal, we focus on four strategic imperatives: leadership excellence, brand management excellence, service and hospitality excellence, and culinary and beverage excellence.

From a financial perspective, we seek to increase sales and profits. To evaluate our operations and assess our financial performance, we use the folowing two key factors:

  • Same-restaurant sales - a year-over-year comparison of each period's sales volumes for restaurants that are open more than 16 months; and
  • Operating margins - restaurant sales less restaurant-level cost of sales (food and beverage costs, restaurant labor, and other restaurant expenses).
Increasing same-restaurant sales can increase operating margins, since these incremental sales provide better leverage of our fixed costs. Same-restaurant sales increases can be generated by increases in guest traffic, increases in the average guest check, or a combination of the two. The average guest check can be impacted by menu price changes and by the mix of menu items sold. For each concept, we gather sales data daily and regularly analyze the guest traffic counts and the mix of menu items sold to assist in developing menu pricing, product offerings, and promotional strategies. We view guest traffic counts as an indication of the long-term health of a concept, while increases in average check and menu mix may contribute more significantly to near-term profitability. We continually focus on balancing our pricing and product offerings with other initiatives to generate sustainable growth in same-restaurant sales.