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Darden Restaurants, Inc. (NYSE:DRI)

F1Q08 Earnings Call

September 19, 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

Jason Whitmer – Cleveland Research

John Glass - CIBC

Steven Kron - Goldman Sachs

Rob Wilson – Tiburon Research

Mark Wiltamuth - Morgan Stanley

John Ivankoe - JP Morgan

Brad Ludington – Keybanc Capital Markets

Andy Barish – Banc of America Securities

Jason Belcher - Wachovia Securities

Jeff Bernstein - Lehman Brothers

Glen Petraglia - Citigroup

Joseph Buckley - Bear Stearns

Rachael Rothman - Merrill Lynch

Michael Smith - Oppenheimer

Presentation

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Ladies and gentlemen, thank you for standing by and welcome to the first 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, Rochelle. Good morning, everybody. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President an COO; and Brad Richmond, Darden's CFO. 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 the could cause actual results to materially differ from those anticipated in the statements. The most significant of these uncertainties are described in Darden Restaurants Inc. Form 10K, Form 10-Q and Form 8-K reports, including all amendments to those reports. These risks and uncertainties include successful completion of the proposed Rare Hospitality acquisition on a timely basis; the impact of regulatory review on the proposed acquisition; the ability to achieve synergies following the completion of the proposed acquisition; 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 growth objectives through the opening of new restaurants or the development or acquisition of new dining concepts; weather conditions; risks associated with the plans to expand our newer concepts Bahama Breeze and Seasons 52; the closure and disposition of certain Smoky Bones Restaurants and the anticipated sale of the remaining Smoky Bones Restaurants; and other factors and uncertainties discussed from time to time in reports filed by the company with the Securities and Exchange Commission.

A copy of our press release announcing our earnings, the Form 8-K used to furnish the release to 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 on our website at Darden.com.

We plan to release fiscal 2008 second quarter earnings and same restaurant sales for fiscal September/October/November 2008 on Tuesday, December 18 after the market close. As noted in yesterday's press release, we are discontinuing the monthly reporting of same-restaurant sales results. Going forward we will disclose monthly same-restaurant sales results when we disclose quarterly financial results at the end of each quarter.

We released first quarter 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 first quarter earnings. First quarter net earnings from continuing operations were $106.6 million and diluted net EPS from continuing operations was $0.73. This represents an 18% increase in diluted net earnings per share from continuing operations.

As you recall on May 5, 2007, we closed 54 Smoky Bones and two Rocky River Grill House Restaurants and announced our intent to sell the remaining 73 Smoky Bones Restaurants. Additionally, we closed nine Bahama Breeze Restaurants on April 28, 2007 to position the brand for future growth. The Smoky 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.

First quarter net losses from discontinued operations were $0.7 million and diluted net losses per share from discontinued operations were $0.01. Including losses from discontinued operations, diluted net earnings per share for the first quarter were $0.72 compared to $0.59 for the same period last year.

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

Brad Richmond

Thank you, Matthew and good morning. Darden's total sales from continuing operations increased 7. 9% in the first quarter to $1.47 billion, driven by same-restaurant sales growth at Red Lobster and Olive Garden, plus our operation of 27 more restaurants than in the first quarter of last year.

Red Lobster reported a same-restaurant sales increase of 7.0% for the quarter, and total sales increased 6.3%. Olive Garden same-restaurant sales were up 4.8% for the quarter, its 52nd consecutive quarter of same-restaurant sales growth and its total sales increased 9.6%. Bahama Breeze had same-restaurant sales decrease of 1.3% for the quarter.

For context, industry same-restaurant sales as measured by NapTrack and excluding Darden, were down approximately 0.1% for the quarter; thus, relative to the industry, you can see that Darden performed quite well.

Now, let's turn to a detailed margin analysis for the first quarter. Food and beverage expenses were 50 basis points higher than last year on a percentage of sales basis primarily because of promotional mix changes at Red Lobster and Olive Garden, and costs associated with the introduction of non-trans fat oils in our restaurants. The cost increases were anticipated based on our promotional pipeline this quarter.

While cost of sales increased as a percentage of sales, gross margin dollars increased as well. Despite the increase in cost of sales on a percentage of sales basis in the first quarter, we still anticipate food and beverage expenses as a percentage of sales to be flat on a year-over-year basis for fiscal 2008.

First quarter restaurant labor expenses were 9 basis points higher than last year on a percentage of sales basis, due to wage rate inflation and increased manager compensation costs. Sales leveraging also played a part in keeping labor expenses as a percentage of sales relatively flat compared to the prior year.

Restaurant expenses in the quarter were 27 basis points lower than last year on a percentage of sales basis, primarily because of sales leverage and lower workers’ compensation and public liability expenses compared to the prior year, resulting from in-restaurant safety performance improvements.

Selling, general and administrative expenses were 6 basis points lower as a percentage of sales for the first quarter, primarily due to sales leveraging. Our tax rate this quarter was in line with our fiscal year guidance but lower than the first quarter of last year due to additional expense recorded in the prior year.

For the full year, we continued to expect combined same-restaurant sales growth for Red Lobster and Olive Garden to be between 2% and 4%. We still expect net new restaurant increases at our existing businesses of approximately 40 restaurants, bringing total sales growth for the year in the range of 6% to 7%. Our same-restaurant sales and new restaurant growth expectations will continue to support an anticipated diluted EPS growth for continuing operations at our existing businesses of 10% to 12%.

The diluted net EPS growth range remains at 10% to 12% when we include the impact of the previously announced Rare Hospitality acquisition. The tender offer began on August 31, 2007 and will expire on September 28, 2007 at 12:00 midnight New York City time unless the tender offer is extended. The transaction is expected to be neutral to Darden's earnings per share in Fiscal 2008, excluding one-time transaction and integration-related costs and the impact of purchase price accounting adjustments. We will offer an update on fiscal 2008 consolidated financial outlooks, including additional detail regarding the Rare transaction with our second quarter earnings release this December. This assumes the Rare transaction closing occurs in 2007, as expected.

Yesterday, we announced a dividend of $0.18 per share payable on November 1, 2007, to shareholders of record on October 10, 2007.

Let me take just a moment to update you on our progress at Smoky Bones. This month, we met with several potential buyers of Smoky Bones and because the process is still ongoing, we are not prepared to offer any conjecture about sales price, potential proceeds or closing schedule. When we have more information to report, we will do so through the normal channels of public disclosure.

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

Andrew H. Madsen

Well as Brad already said, Red Lobster delivered competitively superior performance in the first quarter with same-restaurant sales growth that was more than 7 percentage points better than the NapTrack competitive set, and Red Lobster also continued to strengthen its business foundation and delivered record guest satisfaction.

As we've discussed before, Red Lobster's plan to achieve sustainable growth has three phases: the first phase was to strengthen the brand fundamentals. The second phase is to refresh the brand, broaden its appeal and build guest count. The third phase, which we expect to start in the second half of fiscal 2009, will be to accelerate new unit growth.

Now during the current fiscal year, our primary focus will be to broaden appeal and accelerate guest count growth by improving perceptions among lapsed users that Red Lobster offers a variety of fresh seafood that's prepared with culinary expertise. Accordingly, Red Lobster began advertising its Today's Fresh Fish program during July. The Fresh Fish spots were largely incremental to Red Lobster 's promotional advertising and our research suggests that they're contributing to a measurable improvement in brand perception, especially regarding freshness.

In addition, Red Lobster ran two strong promotions during the first quarter: Summer Grilling and American Seafood Adventure. The first promotion, Summer Grilling, featured two new dishes: Fire Grilled Lobster and Shrimp and Citrus Rum Grilled Scallops and Jumbo Shrimp.

The second promotion, American Seafood Adventure, also featured two new dishes: Maple Glazed Salmon and Shrimp and the New England Lobster and Crab Bake. The latter dish was especially popular and helped drive significant growth in guest counts and absolute operating profit, although at a somewhat higher food cost percentage than last year’s promotion.

In July, Red Lobster began airing a new ad campaign as well that still features appetizing food photography but most spots now end with a shot of a Red Lobster restaurant by the sea with the tag line "Come see what's fresh today." During the first quarter, this new campaign was used for the Today's Fresh Fish ads and the American Seafood Adventure promotion.

During the first quarter, Red Lobster completed the rollout of its new POS system and began installing a new meal pacing system which will help them further improve operational efficiency and increase guest satisfaction.

Last but not least, Red Lobster opened its first Bar Harbor prototype restaurant in Sherman, Texas at the end of July. This Bar Harbor prototype is named after the main fishing village and tourist destination that inspired the design, and we expect it to be Red Lobster's growth vehicle for the foreseeable future. Now if you've been to Red Lobster's new Restaurants in North Olmsted, Ohio and Englewood, California the Bar Harbor prototype looks very similar but it has a more efficient footprint and many operational refinements. We're delighted with early sales results, early guest satisfaction scores and feedback from both our employees and guests.

Turning to the second quarter, Red Lobster is currently advertising Endless Shrimp where guests can choose from a selection of their favorite shrimp preparations. The promotion offers variety and value and has been a seasonal favorite for many years. This year, the promotion features a new preparation, Buffalo Shrimp, for guests who enjoy bolder flavors. Red Lobster will also be making several important investments during the second quarter that include continued incremental Fresh Fish advertising, replacing plateware and flatware with new table top items that are more attractive and more brand appropriate; introducing a new menu design with several new dishes; completing the rollout of trans fat-free frying oil; and installing the meal pacing system in roughly 40% of their restaurants.

Now, we're confident that Red Lobster is on the right course in refreshing its brand and that it will be ready to resume meaningful unit growth in the second half of our next fiscal year.

Olive Garden also continued to deliver competitively superior performance during the first quarter. In addition to achieving their 52nd consecutive quarter of same-restaurant sales growth, they also exceeded the NapTrack competitive set by nearly five percentage points. Olive Garden's key priority remains unchanged. They will continue to manage the business to accelerate new restaurant growth while also maintaining same-restaurant excellence.

During the first quarter, Olive Garden opened seven new restaurants which are four more than the same quarter last year. In Fiscal 2008 they expect to open 40 net new restaurants and ultimately we believe Olive Garden has the potential to operate 800 to 900 restaurants in North America.

Olive Garden advertising during the first quarter featured compelling food news that provided their guests with exciting new reasons to visit their restaurants. In June, they featured two new entrees: Five Cheese Tortellini with Shrimp and Five Cheese Tortellini with Sausage. During July and August, Olive Garden also featured a unique combination of exciting food news, Grilled Shrimp Caprese and Grilled Steak Caprese.

Importantly, guests who visited Olive Garden during the first quarter were delighted with a best-ever guest experience as guest satisfaction set a new record. Improving pace of meal has been a key contributor and these efforts are being further enabled by the implementation of our meal pacing system which will be in all Olive Garden Restaurants by the end of the second quarter. Management of controllable costs continued to be an area of strength as well, with both labor productivity and food waste well ahead of expectation and prior year levels.

A new core menu was successfully launched in July and features three exciting new entrees, all inspired by the Culinary Institute of Tuscany. Chicken and Gnocchi Veronese and Grilled Shrimp Caprese helped enhance the distinctiveness and breadth of appeal of their menu while Venetian Apricot Chicken adds a unique flavor profile to their garden fare offerings.

Currently Olive Garden is advertising its Signature promotion, Neverending Pasta Bowl, priced at $8.95. This strong message of choice and variety is a powerful statement of Italian generosity that provides their guests with an excellent value.

As you can see, we're pleased with Olive Garden's strength in this challenging consumer environment and we believe they will continue to deliver strong performance throughout the fiscal year.

Finally, Bahama Breeze has made tremendous progress over the last two years improving their guest experience, increasing restaurant level returns and broadening the appeal of their brand. Given this performance, our strategic focus for Bahama Breeze is to prepare the business for disciplined new restaurant growth. They have two new sites under contract both in New Jersey in Wayne and Woodbridge, which should open in fall of 2008. They continue to look for additional high quality sites to fill their pipeline for future growth. We continue to believe that Bahama Breeze has the potential to be a billion dollar brand for Darden.

Now, Clarence has some final comments.

Clarence Otis

Thanks, Drew. I'll be brief so that we can get to your questions. As you might imagine, we're very pleased with our performance. It does continue to be industry leading: 18% diluted earnings per share growth from continuing operations we feel good about, especially in an environment -- an economic environment -- that really has had its share of speed bumps and continues to have its share of speed bumps.

We also feel good that even as we do what's necessary to navigate through this environment successfully, we're building the long-term strength of each of our brands. With the Rare acquisition, we're also increasing our ability to deliver consistently strong, profitable, new restaurant growth and that enhances the long-term strength of the entire organization.

The foundation for all of this really is our proven approach to the business, and it's an approach that's anchored in combining strong brand management and great operations and then supporting both of those with excellence in supply chain, information technology, human resources and a number of other key business disciplines.

But we know that what ultimately drives our ability to create sustainable leadership-level value for shareholders is having great people. I'm proud of our results but I'm even prouder of the outstanding people that we have in our restaurants, in our support center, who are delivering those results. We're excited about the talented leaders who are going to be joining this organization as a result of the acquisition of Rare.

So we're delighted with the path that we're on. We think we continue to make great strides toward making this company even stronger and achieving our ultimate goal, which is really to be the best in our industry now and for generations.

With that, we will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jason Whitmer – Cleveland Research.

Jason Whitmer – Cleveland Research

Good morning, good quarter. Drew, can you talk a little further about Red Lobster specifically, with some of the feedback and research you have been doing over the last few months? Certainly the brand has relifted itself with new advertising. It has spent the last couple of years really working on the foundation, which I gather is really important to make that next step. But what is the feedback you are getting currently? Where do you think that can transition over the near to medium term and how does that ultimately stay in step with the long-term rebranding strategy for you guys?

Andrew H. Madsen

Well, you are correct that we’ve spent a good part of the last couple of years strengthening the foundation, particularly guest satisfaction and restaurant-level returns. Given that stronger foundation, the big opportunity now is to continue to build guest counts, and we think in particular not just with their current core guests, but with what we call lapsed users -- guests who have not been in the last year or so.

All of our research with that set of lapsed users says there is basically two big reasons that they haven’t been to Red Lobster recently. One is they view Red Lobster as serving frozen seafood, not fresh seafood; second, they view Red Lobster as not having the level of culinary expertise that they are looking for in terms of innovative new dishes and flavor profiles.

So as a result, Red Lobster most recently in the last year has been working to overcome those barriers, change those perceptions. Last year they introduced the Today’s Fresh Fish program, which you are aware of, and offers guests up to seven different varieties of fresh fish in their restaurants, prepared in a number of ways with menus that are printed twice daily. That has been very well received. But only people in the restaurant were seeing that. So this year, they started advertising broadly, letting people know about the Today’s Fresh Fish program.

In addition, they have been working harder on the culinary side as they’ve rebuilt their culinary team over the last year or so to add new dishes that are more interesting and show more culinary innovation, like the dishes I talked about in their first two promotions this year. By the way, those are dishes that their current guests love as well.

So as they continue to address the barriers with lapsed users in a way that continues to make their brand very approachable and satisfying for core users, they are going to expand their breadth of appeal, build guest counts; that is going to strengthen their unit economics even further and put them in the position next year, we think, to start opening more units.

Clarence Otis

Jason, I might add that when it comes to the culinary development, there really are two tracks. One is the core menu itself and to really move that where we need to have it go. The second is the promotional offerings, and we do a number of promotions through the year, and it is to move that promotional offering and get those where they need to be. So they’ve been working both of those tracks.

Drew, you just might comment on where you think they are in terms of progress on each of those, core menu versus promotional pipeline.

Andrew H. Madsen

Well, they’ve made great progress on the core menu with Today’s Fresh Fish and some new dishes. They have already introduced some new dishes that they will be introducing with their new menu later this year. The first quarter promotional dishes, the promotional pipeline was tremendous. The opportunity is to continue that level of consistency in their promotional pipeline into the future.

Clarence Otis

I would just say, that is where the opportunity is. We continue to work the pipeline and build that strength through the entire year. We are not there yet, but we are making really good progress. It is a terrific team that Sally [Sata] has built over in the culinary and beverage side of Red Lobster. We feel confident, given the success they have had, that they will continue to make progress.

Operator

Your next question comes from John Glass – CIBC.

John Glass – CIBC

Thanks. Brad, you talked about a 50 basis point increase in food costs, and some of that was promotional shifts. How much was the underlying food cost inflation this quarter, and how much is it baked into your full year guidance versus brand shift and some of the other moving pieces that we see in cost of goods that is impacting that number?

Brad Richmond

The underlying inflation, really we haven’t seen any difference from our previous guidance there. As we look forward, while there continues to be movement around on different products, really not meaningfully changing our expectations.

What I would say more, and as Drew and Clarence just touched on, a lot of that difference is driven by what items we are featuring in restaurant. This particular quarter, with the items they had there, that on a percentage basis, it did drive up the cost of sales as a percent of sales, but the absolute dollar margins that it was driving were also up.

John Glass – CIBC

What was your previous guidance on food cost inflation that you referenced?

Brad Richmond

I believe it was about 4%.

Operator

Your next question comes from Steven Kron - Goldman Sachs.

Steven Kron - Goldman Sachs

Thanks and good morning. On Olive Garden margins, in the release it says modestly lower on a percentage basis. Recognizing you went through some of these factors, can you talk about expectations going forward? How should we think about the leverage in that business off of the strong sales that you have been seeing?

Brad Richmond

The first thing I would say there is with their accelerating unit growth rate, that is a little bit of a drag for them. If you look at existing restaurants, at the restaurant-level margin basis, you don’t see the same drag that you are seeing on a company-reported basis. They continue to build their guest counts and their pricing is in such a range that with the energy they are putting around managing their costs, that we are seeing their margins staying about where they are for the existing restaurants, if not maybe up marginally. But when you look at the total company, the investment in a little bit of a higher growth rate puts a little bit of a drag on that.

Clarence Otis

I might just add that Olive Garden has very high margins. Expanding that business with those kinds of margins drives significant value creation, so we feel great about where Olive Garden is. Part of our long-term plan really is, as Drew said, to continue to drive towards 900 restaurants.

Operator

Your next question comes from Rob Wilson – Tiburon Research.

Rob Wilson – Tiburon Research

In the past consistently you have expressed that there has been wage inflation in your labor structure. Give your comps, relatively successful comps in Q1, I am wondering, what is that wage inflation in Q1? Was that wage inflation 5%, 6%? Can you give us some color there?

Brad Richmond

The wage rate inflation would be in the 4% to 5%, driven a lot by the various state initiatives; that is not necessarily what we are seeing across the entire organization.

Operator

Your next question comes from Mark Wiltamuth - Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

On the food costs, could you tell us how much each of the primary protein categories were up? Looking forward to when you close the Rare acquisition, what is your pro forma mix of proteins going to be? How much is going to be beef, chicken, seafood? Have you really thought about any cost-savings you will get from sourcing as you combine the two companies?

Brad Richmond

Good question there. First off though, we really don’t go into great detail on the component cost projections. With our positioning, we have quite a broad basket of products that we use, so there are always pieces moving in both directions, benefits in some areas offset the costs going up in others.

Regarding post-acquisition, we will be much more clear on that in December once the deal is complete, but to your point, we are in the process of our integration work right now and we do see large numbers of opportunities to realize synergies across the entire supply chain and distribution model. We will be able to articulate those more in December.

Mark Wiltamuth - Morgan Stanley

So the $40 million cost savings number you are talking about, is that a combination of SG&A and supply chain, or is that mostly SG&A?

Brad Richmond

That would be across the entire cost synergies.

Operator

Your next question comes from John Ivankoe - JP Morgan.

John Ivankoe - JP Morgan

It sounds like continuing in the second quarter meal pacing is really important for both of the businesses, Red Lobster and Olive Garden. If you could share with us some of the initial customer satisfaction scores or customer awareness of the fact that you are changing things a little bit of what you are doing operationally? And, if there is any measurable difference in table turns as you are starting to get your hands around that system for both businesses?

Clarence Otis

Meal pacing, as you know, just helps us move a meal in a more coordinated fashion, and all of the components of the meal through our kitchen in a more coordinated way, so that it all comes up in the window at the same time, hot and ready to go.

As far as I know, our guests are completely unaware that we have done something like this, except to the fact that they notice their food is a little hotter.

John Ivankoe - JP Morgan

But that was the question. Is that coming out in your research?

Clarence Otis

The things that we see are hotter food, and that drives increased food taste satisfaction. Secondly, we can see some modest improvement in throughput efficiency in terms of table turn. There is a little bit of savings in supplies in the restaurant, but not material. The two biggest opportunities are around guest satisfaction related to pace of meal, and then operational efficiency in terms of throughput.

John Ivankoe - JP Morgan

I am sorry if I missed this. When will Red Lobster be 100% done?

Clarence Otis

By the end of our fiscal year.

Operator

Your next question comes from Brad Ludington – Keybanc Capital Markets.

Brad Ludington – Keybanc Capital Markets

How many shares were outstanding at the end of the quarter?

Clarence Otis

Brad is looking that up.

Brad Richmond

The ending share count would be 141 million.

Operator

Your next question comes from Andy Barish – Banc of America Securities.

Andy Barish – Banc of America Securities

A question on the Olive Garden development. What percentage, roughly, of the 40 or so units are the smaller prototype? Can you give us an update on the last year store class in terms of opening volumes?

Clarence Otis

Well, the majority of the units we’re opening, called P75, are smaller than what we used to use, P77, and it lowers our guest count hurdle a couple of hundred guests in terms of being able to make pro forma hurdle. We don’t really track it by class but we do look at it in three-year periods, so units, new restaurants at Olive Garden that have been open for three years are on average exceeding, at a high level, are exceeding their sales and profit and guest count return requirements. We’ve been very pleased.

Operator

Thank you. The next question comes from the line of Glen Petraglia, Citigroup. Please go ahead.

Glen Petraglia - Citigroup

Thanks. Good morning. Clarence, you mentioned that there’s economic environment has certainly thrown some speed bumps at everybody. I’m curious to know if the current environment, clearly right now you are focusing on value at the endless shrimp and endless pasta bowl, but I’m wondering if going forward, the current environment has had any impact in terms of your marketing plan or your methods to consumer and how you go about thinking about that.

Clarence Otis

Well, I think that value is always important in this category and one of the things that really is a primary category benefit, we’ve talked about it before, is every day price accessibility. So we think about that all the time as we think about our menu strategy, and as a result of that, pricing strategy but also labor model.

And so protecting everyday price accessibility is important to us, and then within that, we do, as you know, think about the year because the year does have a rhythm to it in terms of where consumers are in terms of their ability or willingness to indulge versus when they are more value-conscious.

With all of that, then tactically we will change our marketing at the edges depending on the particular environment, so we might stress a price point in some periods where we wouldn’t in others. We might hurry up media at some point, so we might draw coupons.

I’d say this year, we were particularly sensitive to value because we do know the environment, and so we are doing a number of things to make sure that value comes through. It is more challenging when you have the cost environment that we’ve got, although a couple of things really helped there. One is, as Brad said, we’ve got a broad market basket, so that helps. And then Drew and the teams have been very focused on cost management and making sure that all costs that really don’t benefit the guests are being squeezed out.

Andrew H. Madsen

I’d add on that that what we advertise is certainly very visible but we are equally diligent in making sure that we have a range of price points on the menu and that the items that we picture or feature in our promotional materials in restaurants also offer a range of price points for guests to choose from, and that ultimately we’ve got new news that delivers at a high level, so that when people do come in with higher expectations in terms of where they are spending their time and money, that they leave very satisfied.

Glen Petraglia - Citigroup

Thanks.

Operator

Thank you. The next question comes from the line of Joe Buckley, Bear Stearns. Please go ahead.

Joseph Buckley - Bear Stearns

Thank you. Just a couple of follow-up questions, if I could; on the meal pacing, you talked about some of the effects in terms of delivering the food hotter and so forth. What are the physical changes in the restaurant surrounding that? What changes in the kitchen or in the kitchen/wait staff interaction?

Andrew H. Madsen

There’s no staffing changes but there are some monitors on the line that help, at different stations that help people understand when to start new items and when to make sure the entire meal is up in the window, complete and ready to go.

I think the other big change is that the kitchen gets quieter. I mean, there’s fewer shouting back and forth the orders, all of that stuff, and so for a kitchen employee, especially during peak periods, the work environment improvement is pretty dramatic.

Joseph Buckley - Bear Stearns

Okay, and then just a couple of real quick questions; some companies have talked about schools starting later in certain markets. I’ve heard Florida mentioned a few times. Did that have any impact, do you think, on the August sales numbers?

Andrew H. Madsen

We don’t have any data to support a point of view on that, I think is our first thought. But our sense is it probably did help at the market and Florida is a state, we are here, which had a legislative change to drive the school year back in some districts, almost crept to July, I guess and now it’s the third week, I think, of August.

Joseph Buckley - Bear Stearns

Okay, and then the pricing on the never-ending pasta bowl, was that the same as the pricing a year ago, the $8.95?

Andrew H. Madsen

The $8.95 is a dollar higher than a year ago, and it had been $7.95 for about seven years, up until this change.

Operator

Thank you. And the next question comes from the line of Tom Thomson of Thomson [Siegel]. Please go ahead.

Tom Thomson - Thomson Siegel

Thank you and good morning. Two quick ones; is it fair to assume, given what you say about the very high margins in Olive Garden that, putting pre-opening expenses aside, the fact that it’s your growth vehicle right now provides a general uplift to margins, all else equal? Secondly, can you explain what the meal pacing system is? Thanks.

Brad Richmond

I’ll take the first question in regard to margins and Olive Garden. Yes, it performs at an absolute, very high level and when you look at our basket of restaurants, growing those at a quicker rate definitely enhances our financial performance and adds significant shareholder value.

Andrew H. Madsen

And the meal pacing system is something that helps the culinary team prepare an order in the right sequence, so that everything comes up in the window at the same time, hot and ready to go. So after a server will enter an order in our point-of-sale system, the meal pacing system helps send different elements of that order to different stations in the kitchen at the right time and prompts people working in those stations regarding when to start them, so that they all finish at about the same time and come out at the same time.

Brad Richmond

I guess the one other thing I would add to Drew’s comments and Clarence, they talked about their work environment, but it’s paperless. As they said, it’s monitors so we have a lot less paper sheets that get lost and so that is another factor that improves the guest experience as well.

Operator

And the next question comes from the line of Jack O’Hara of Sentinel Funds. Please go ahead.

Jack O’Hara - Sentinel Funds

Thanks for taking the question. You listen to other retailers and other restaurateurs, they talk about the pockets of weakness with the consumer and specifically, your home state of Florida is mentioned, as well as California. Can you just tell us in general, of all your units out there, what percentage you have in those two states and whether you see really different results out of those two states versus other regions? Thank you.

Clarence Otis

I would say in California, I believe we have 96 restaurants and so on a percentage basis, we’ve got 1,400 restaurants. If I do my math, it’s about 7%, so a little bit under-penetrated in California, if you think about the population there is probably 11%, 12% of the national population. And then in Florida, we have 150 restaurants -- I’m sorry, 115 restaurants, and so about 8% or so, and that’s probably a little bit over-penetrated when you think about Florida’s 14 million, 15 million people as a percent of the national population.

In both states, we do see sales that are lower and so when you look at the industry, and I’m talking about the industry, when we look at the industry measures, we do see weakness, relative weakness in California and Florida. I think our restaurants in California do very well, though. We outperform the industry fairly significantly there, especially Olive Garden, and I think that speaks to Olive Garden's strength from a value perspective. If you’ve got an environment that is especially value-conscious, Olive Garden is the number one value player in casual dining.

That helps, but Red Lobster is doing well in California as well and dramatically outperforming the industry. And then with Florida, I’d say it’s the same story, that we do outperform the industry. So we have not been dragged down by either state.

Jack O’Hara - Sentinel Funds

Thank you.

Operator

Thank you. The next question comes from the line of Rachael Rothman of Merrill Lynch. Please go ahead.

Rachael Rothman - Merrill Lynch

Good morning. Just a couple of questions on your guidance, if I could. It seems as though you had raised the revenue growth guidance and yet keep the EPS growth roughly flat. Could you comment on what is offsetting the upside surprise in revenue?

And then, given as strong as your sales were, we would have looked for stronger leverage in G&A. Are you guys currently carrying incremental costs for the merger? How should we think about the level of G&A currently? Maybe opportunities for further leverage there? Thank you.

Brad Richmond

On the second question first on the leveraging, a couple of things going on there; we have some carrying costs related to the disposition of Smoky Bones. We’ve incurred some minor costs in relation to the acquisition there, nothing significant. But also you heard Drew talk about some of the investments in Red Lobster, particularly around the today’s fresh fish, and actually featuring that on air in a meaningful way in the first quarter. So that was a little bit of the drag, if you will, on the leveraging on that particular line.

Again, on the Red Lobster piece, clearly good investments to reposition that brand.

The sales guidance; yes, you are correct. We did move the guidance up. What I would say is we’ve had a very strong first quarter. We look through the rest of the year; there’s still a fair amount of uncertainty. We are one quarter into the year but our guidance on the earnings side of that, 10% to 12%, still feel that that’s a range that covers what we are seeing as we look forward today.

Andrew H. Madsen

And I would just say again, just to emphasize that point that we’re dealing with an environment that is what it is. It’s a tough environment. We’re looking at the forecast, as everyone is, and so we think it is prudent to be cautious just a quarter of the way in.

Rachael Rothman - Merrill Lynch

Perfect. Just one quick one on guidance again; for the $40 million in synergies that you are looking for from the Rare acquisition, can you just help put a timeframe on that? Is that for fiscal ’09 or fiscal 2010? Or maybe a blend of the two?

Brad Richmond

That will be two years out, so fiscal 2010. I would say though that we see some meaningful synergies, what we call quick wins, things that we would expect to be able to capture in this current fiscal year, such that our EPS, as I mentioned earlier, would be neutral to our current estimate, which implies with the lower share buy-back that we’ve set for ourselves now that there is meaningful growth at the EAT level.

Rachael Rothman - Merrill Lynch

Perfect. Thank you.

Operator

Thank you. The next question comes from the line of Michael Smith, Oppenheimer. Please go ahead.

Michael Smith - Oppenheimer

Good morning. EAT level?

Brad Richmond

The earnings after tax, Mike. We’ll be neutral at the EPS --

Michael Smith - Oppenheimer

-- PLAs, I think. I have two questions, actually. One is on the Rare deal; what are the costs that are going to be associated with that? When you say exclusive, you’ll be exclusive of the costs, how much are those?

Brad Richmond

At this particular time, we really aren’t prepared to detail those but they relate to the traditional cost of doing a deal, as well as integrating the two organizations. The purchase accounting, we’ve yet to work through all of that to the detail that we need to be specific on it, but obviously there will be some intangibles there. Some will be amortizable and some will not, but we’ll have greater clarity around those in December.

Michael Smith - Oppenheimer

My other question had to do with Seasons 52. We’ve kind of beaten or talked about Red Lobster and Olive Garden. Seasons 52, where do they stand in terms of your future expectations?

Brad Richmond

I’ll start, Mike, and what I would tell you is we’ve got the seven restaurants. They continue to do well and we feel good about how they are performing across the footprint, which as you know is five in Florida, two in Atlanta. And we are out trying to build a site pipeline. We are at a point where we feel like getting the right kind of site is critical for this business and that, as much as anything, will drive the pace of development. So as we look out, we are probably not looking at a new unit this year. Maybe a couple in our fiscal ’09, which starts June 1st, and see what kind of pace we can establish. My guess is it is probably somewhere, three, four, five a year.

Michael Smith - Oppenheimer

Thanks.

Operator

Thank you. The next question comes from the line of David Palmer, UBS. Please go ahead.

David Palmer - UBS

Thanks. My question is just a basic one on your earnings visibility in general, and obviously there is a consumer cost environment now that is perhaps more in flux than ever in many people’s view, and I know that those environments are never static but you are also embarking upon a large scale acquisition and so I am wondering, as you stand here in the first, after the first fiscal quarter, is the possible dispersion of revenue and earnings outcomes wider in your own minds than perhaps this time last year? And if not, what gives you confidence that you will be able to budget, to predict for yourselves how you will be able to navigate these costs and of course this integration?

Andrew H. Madsen

I would say just a couple of thoughts. One is Red Lobster is in a better place now than it was 12 months ago, and so that certainly helps. Olive Garden has accelerated its new restaurant growth and done that without adversely affecting its same-restaurant volumes. And that helps us as well, because the new restaurant growth has earnings attached to it.

The third thing is that we’ve been working and making significant investments in working to improve, making significant investments in our operating platform, so our infrastructure. So we feel that we are in good shape to manage the cost pressures that we faced, better shape than we were 12 months ago, even if the cost pressures are more intense. We’re in better shape when it comes to managing those. So all of that increases our confidence.

The acquisition does introduce another variable but it is an acquisition of two brands that are pretty proven, and so when you look at Longhorn, 25 years in operation, Capital Grill, 17 years, we kind of know how they perform through various cycles. We’ve got the leadership teams that have built those businesses coming over to continue to manage and run those, and so we feel great about visibility there as much as we can.

I think our view always is we try to manage what we can control. We feel that given our capabilities, we will outperform our category in any environment, and that’s really all that we can do.

David Palmer - UBS

And just a follow-up, I guess separately; the last two months, the industry has seen an acceleration in same-store sales from dismal levels albeit but nonetheless, there’s been a sequential acceleration in growth. Do you have any thoughts or theories as to why that might be and do any of those theories make you think it can continue to improve in the near-term?

Andrew H. Madsen

I think a couple of things. One of them is just arithmetic, that the prior year weakness helps when you are just really looking at comps, and so that’s part of it. I think the other part though is that gas prices stabilized, started to decline a little bit over the summer and that affects spending power for sure. Although I think it probably affects consumer psychology even more than it does spending power.

Andrew H. Madsen

And another thought would be that the improvement we’ve seen in the most recent period for the industry is more from check than it is traffic, so it just demonstrates that all of the consumer psychology and real spending issues are probably still there.

David Palmer - UBS

Thank you very much.

Operator

Thank you. The final question we have in queue is a follow-up question from the line of Steven Kron of Goldman Sachs. Please go ahead.

Steven Kron - Goldman Sachs

Thanks for taking the question. On the Rare acquisition, Brad, can you just remind us kind of the financing terms of that transaction? And is there any variable debt in there? And if so, what if any impact might we think to that rate as it relates to the fed decision yesterday and the economics of that transaction, and potential accretion?

Brad Richmond

Well, the interim bridge financing we have in place for that was through Bank of America at I would say terms that provide us the flexibility that we need to term this bid out. We would look to do that, to your point, with where interest rates are. We would look to do that in the near-term, but again we need to get the transaction closed before we get too far down the path on planning for that.

We have also renewed our revolver. We’ve upsized that a little bit to provide us the financial flexibility to accommodate what we’re doing with the acquisition, and I think the other thing that, the common question around that is getting that financing. We see deals with our credit profile still getting done in this environment. The rating agencies have commented we’re still investment grade there.

So we believe we are in a position and have the flexibility to do this at, if not maybe slightly better than the original assumptions when we made our decision to move with that acquisition.

Steven Kron - Goldman Sachs

And that was the 7% that you talked about?

Brad Richmond

Yes.

Steven Kron - Goldman Sachs

Okay. Thank you.

Operator

Thank you. There are no further questions in queue. Please continue.

Matthew Stroud

Great. Thank you, everybody, for joining us this morning. We appreciate your interest in Darden Restaurants. We look forward to speaking with you throughout the quarter. We will be attending a few conferences and we’ll be back with you in December to report our second quarter results. Have a great day.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 12:00 p.m. today through Friday, October 19th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701, entering the access code 886919. International participants dial 320-365-3844. Again, that access code is 886919. And 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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Source: Darden Restaurants F1Q08 (Qtr End 8/26/07) Earnings Call Transcript

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