Darden Customers Full of Crab

A seemingly innocent all-you-can eat crab promotion is sending shares of Darden Restaurants (NYSE: DRI  ) 11% lower today and has contributed to the departure of Red Lobster President Edna Morris.

In the first warning we've ever heard attributed to "increased crab usage and additional plate accompaniment," Darden reported flat first-quarter earnings of $0.48 a share and lower sales, and said it would not meet next quarter's estimates. (The EPS figure actually beat Street estimates, but loyal Rick Munarriz readers know that means nothing.)

Most of the trouble stems from Red Lobster -- which Darden owns along with Olive Garden and Bahama Breeze restaurants and Smokey Bones BBQ Sports Bars. The Red Lobster crab promotion drew fewer customers than expected, and those who did participate were refilling their plates far more often than management anticipated. "It was kind of the worst of all worlds, actually, from a promotional perspective," Darden CEO Joe Lee said in a conference call, whose transcript was provided by CCBN StreetEvents' (registration required) nifty investor service.

While humorous to outsiders, the crab chaos provides a serious lesson to investors interested in the restaurant industry. As Lee points out, food cost increases on the income statement can come about in three ways. "You can either be having waste factors, or you can have higher cost of goods that are coming to you, or you can have margin opportunities that you're not taking advantage of," he said. "And it is the latter that is our biggest opportunity, as we price promotions, as we engineer our menu."

That engineering effort failed at Red Lobster, as the "refill rate... was higher than anything we have seen."

"And the refill rate is people getting second helpings," an analyst asked, "because it is all you can eat promotion?"

"Absolutely," answered Lee. "Yes. And second and third and fourth...."