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Executives

Matthew Stroud - Investor Relations

Brad Richmond - Chief Financial Officer

Andrew H. Madsen - President, Chief Operating Officer, Director

Gene Lee - President, Specialty Restaurant Group

Clarence Otis - Chairman of the Board, Chief Executive Officer

Analysts

Steven Kron - Goldman Sachs

Matthew DiFrisco - Oppenheimer

John Glass - Morgan Stanley

Joseph Buckley - Banc of America

Jeff Omohundro - Wachovia

Brad Luddington - Keybanc Capital Markets

John Ivankoe - J.P. Morgan

Jeff Bernstein - Lehman Brothers

Robert Derrington - Morgan Keegan

Chris O’Cull - Suntrust Robinson Humphrey

Stephen Anderson - MKM Partners

Mitch Speiser - Buckingham Research

Darden Restaurants, Inc. (DRI) F1Q09 Earnings Call September 17, 2008 8:30 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Darden Restaurants Incorporated first quarter earnings release. (Operator Instructions) At this time then, I would like to turn the conference over to Mr. Matthew Stroud. Please go ahead, sir.

Matthew Stroud

Thank you, Ken. Good morning, everybody. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and COO; Brad Richmond, Darden's CFO; and Gene Lee, President of Darden's Specialty Restaurant Group. 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 could cause actual results to materially differ from those anticipated in the statements. The most significant of these uncertainties are described in Darden's Form 10-K, Form 10-Q, and Form 8-K reports, including all amendments to those reports.

These risks and uncertainties include the impact of intense competition, changing economic or business conditions, the price and availability of food, ingredients, and utilities, supply interruptions, labor and insurance costs, the loss of or difficulties in recruiting key personnel, information technology failures, 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 Darden's plans to expand Darden's newer concepts, Bahama Breeze and Seasons 52, our ability to combine and integrate the business of RARE Hospitality International Incorporated, achieve synergies and develop new Longhorn Steakhouse and The Capital Grille restaurants, risks associated with incurring substantial additional debt, a failure of our internal controls over financial reporting, and other factors and uncertainties discussed from time to time in reports filed by Darden 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 2009 second quarter earnings and same-restaurant sales for fiscal September, October, and November 2009 on Thursday, December 18th after the market close.

We are planning to hold an analyst and investor meeting in Orlando on January 22nd and 23rd, 2009. Additional details will soon follow.

We released first quarter earnings results yesterday afternoon. These results were available on PRNewswire, First Call, and other wire services, so let’s begin by reviewing our first quarter earnings results.

First quarter net earnings from continuing operations were $82.4 million and diluted net EPS from continuing operations was $0.58, representing a 21% decrease in diluted net earnings per share from continuing operations. This includes the integration costs and purchase accounting adjustments related to the October 2007 acquisition of RARE Hospitality International Incorporated, which reduced diluted net earnings per share by approximately $0.03 in the first quarter. Excluding the estimated integration costs and purchase accounting adjustments, net earnings from continuing operations were $0.61 per diluted share, or a 16% decrease from prior year. These results were in line with the preliminary first quarter earnings guidance we announced on August 26, 2008.

Brad will now provide additional detail about our financial results for the first quarter. Drew will discuss the business results of Olive Garden, Red Lobster, and Longhorn Steakhouse. Gene will discuss the specialty restaurant group, followed by Clarence who will have some final remarks. We will then respond to your questions.

Brad Richmond

Thank you, Matthew and good morning. Darden's total sales from continuing operations increased 20.9% in the first quarter to $1.77 billion, driven by the addition of Longhorn Steakhouse and The Capital Grille and meaningful new and same-restaurant sales growth at Olive Garden. The incremental sales from Longhorn Steakhouse and The Capital Grille totaled $270 million for the first quarter. Excluding the acquisition, sales growth for the quarter would have been 2.5%.

Let’s review same-restaurant sales component of our total sales growth. For context, industry same-restaurant sales as measured by Knapp-Track and excluding Darden are down an estimated 3.7% for the quarter.

Olive Garden's same-restaurant sales were up 2.4% for the quarter, its 56th consecutive quarter of same-restaurant sales growth and that was 6.1 percentage points above the Knapp-Track industry benchmark. Olive Garden's total sales increased 8.1% for the quarter.

Red Lobster had a same-restaurant sales decrease of 3.7% for the quarter, which was in line with the Knapp-Track industry benchmark and its total sales decreased 3.5%. As a reminder, Red Lobster reported a 7.0% same-restaurant sales increase in last year’s first quarter while the industry was flat.

Longhorn same-restaurant sales decreased 4.9% for the quarter, while its total sales increased 4.2% because of the addition of 25 net new restaurants. This compares to a same-restaurant sales decrease of 3.9% for Knapp-Track in the regions where Longhorn Steakhouse operates.

On a blended basis, same-restaurant sales were down 1.0% at our three large brands, which outperformed Knapp-Track industry average by 2.7 percentage points.

The Capital Grille had a same-restaurant sales decrease of 8.6% for the quarter, while total sales grew 6.7% due to the addition of five new restaurants.

Bahama Breeze had a same-restaurant sales decrease of 3.7% for the quarter. Their quarter was also adversely affected by the Fourth of July holiday impact. This holiday shifted from Wednesday in fiscal 2008 to a Friday in fiscal 2009, the move to what is normally a much busier day of the week and caused a negative 0.7 percentage point impact to same-restaurant sales for the quarter.

Now let’s discuss the margin analysis of the first quarter, which is complicated by the acquisition of RARE Hospitality. We are comparing year-over-year results on a reported basis and we are also comparing results from continuing operations this year and last year. Thus, results from Smokey Bones, which was sold in December 2007, are not included in the first quarter of fiscal 2008 and the acquisition of RARE Hospitality is included for the first quarter of fiscal 2009.

Our first quarter results fell short of our target and last year’s results. Diluted EPS from continuing operations of $0.61, which excludes the integration cost and purchase accounted adjustments of $0.03, was $0.12 below last year’s comparable first quarter diluted net EPS of $0.73. Of this amount, approximately $0.09 of the EPS shortfall was attributable to sales deleverage and approximately $0.03 was attributable to cost pressures that exceeded last year. I will explain each P&L line item in detail.

Food and beverage expenses were 194 basis points higher than last year on a percentage of sales basis. This is primarily the result of mix changes due to the addition of RARE Hospitality, which accounts for approximately 152 basis points of the increase. Excluding the mix change, food and beverage expenses were approximately 40 basis points unfavorable, due equal to changes in promotional mix at Olive Garden, protein cost increases across all of our brands, and higher costs for dairy, bread, and pasta.

Our outlook for the fiscal year is that food and beverage expenses as a percent of sales will be approximately 70 basis points unfavorable to last year on an as-reported basis. This would include the full year impact of the RARE acquisition in fiscal 2009 but only eight months impact in fiscal 2008. Excluding the acquisition impact, food and beverage expense as a percent of sales would be approximately 20 basis points unfavorable to last year, consistent with our previous guidance.

First quarter restaurant labor expenses were 67 basis points lower than last year on a percentage of sales basis, due primarily to the mix changes associated with the addition of RARE Hospitality, which lowered labor expenses by approximately 99 basis points. The change in mix more than offset wage rate inflation of 2% to 3% and the impact of sales deleveraging. Our outlook for the year is that labor expense as a percentage of sales will be approximately 20 basis points favorable to last year but excluding the acquisition impact, restaurant labor as a percentage of sales would be 10 to 20 basis points unfavorable to last year.

Restaurant expenses in the quarter were 145 basis points higher than last year on a percentage of sales basis. The mix changes associated with the impact of RARE Hospitality acquisition and purchase accounting adjustments accounts for approximately 50 basis points of the increase. Excluding the mix changes, restaurant expenses were approximately 95 basis points unfavorable, due primarily to higher utility costs and sales deleverage. We were also wrapping on a favorable workers’ compensation public liability credit in the prior year.

Our outlook for the fiscal year is that restaurant expenses as a percentage of sales will be approximately 40 basis points unfavorable to last year.

Selling, general and administrative expenses were 17 basis points lower as a percentage of sales for the first quarter. This favorability is primarily related to reduced performance-based incentives. There is also some unfavorability related to marketing expense at Olive Garden as the never-ending pasta bowl promotion began one week earlier than in the prior year, adding an extra week of media expense as well as the entire production cost of the commercial. The production cost is expensed when the first commercial is broadcast. These costs added an additional $4 million to the first quarter marketing expense.

Our outlook for the fiscal year is that selling, general and administrative expenses as a percentage of sales will be approximately 50 basis points favorable to last year.

To summarize, operating profit, or EBIT, was 300 basis points lower as a percentage of sales for the first quarter. Of this variance, 130 basis points was due to the RARE Hospitality acquisition and associated exchanges, while the remainder is due to sales deleveraging and increased costs. Our outlook for the fiscal year is that operating profit as a percentage of sales will be approximately 70 basis points unfavorable to last year on an as-reported basis.

The effective tax rate for the first quarter of 28% was in line with our previous guidance and lower than last year’s rate due to an increase in federal tax credits. We now anticipate an annual effective rate of approximately 27%.

For the quarter, we repurchased 2.1 million shares, or approximately $68 million, which speaks to the significant cash flows we generate on a consistent basis. We have 13.3 million shares remaining in our current authorization.

And yesterday, we announced a dividend of $0.20 per share payable on November 3, 2008, to shareholders of record October 10, 2008. Based on the $0.20 quarterly dividend declaration, our indicated annual dividend rate is $0.80 per share.

As we indicated in our press release yesterday and our pre-announcement in late August, our revised outlook for the fiscal year anticipates combined U.S. same-restaurant sales growth in fiscal 2009 of approximately 0% to 1% for Red Lobster, Olive Garden, and Longhorn Steakhouse, and we expect to open approximately 75 to 80 net new restaurants in fiscal 2009. As a result, we anticipate total sales growth of between 12% and 13% in fiscal 2009, compared to reported sales from continuing operations of $6.63 billion in fiscal 2008. This total sales growth includes the two percentage point impact of a 53rd week in our fiscal 2009. Excluding the 53rd week, the expected total sales growth would be approximately 10% to 11%.

We anticipate reported diluted net earnings per share growth from continuing operations of 5% to 10% in fiscal 2009, which includes the impact of the 53rd week. This compares to reported diluted net earnings per share from continuing operations of $2.55 in fiscal 2008. The additional week is expected to contribute approximately two percentage points or $0.05 per diluted share of growth in fiscal 2009. Excluding estimated integration costs and purchase accounting adjustments of approximately $0.19 in fiscal 2008, net earnings from continuing operations were $2.74 per diluted share. In fiscal 2009, these costs and adjustments are estimated to be approximately $0.07 per diluted share. Excluding the impact of these costs and adjustments in both fiscal 2008 and fiscal 2009, the company expects diluted net earnings per share growth of 0% to 5% on a 53-week basis.

And finally, let me take a moment to update you on our integration efforts. We are pleased with the progress we made integrating Longhorn Steakhouse and The Capital Grille brands we acquired with the purchase of RARE Hospitality. As we previously said, our integration plans and synergies are exceeding our original expectations. We are seeing greater cost savings than we estimated and we are seeing an acceleration of those savings.

For fiscal 2008, we realized cost savings of approximately $10 million. In fiscal 2009, we are estimating incremental cost savings of approximately $30 million and we anticipate additional incremental cost savings of approximately $10 million more in fiscal 2010, or approximately $50 million in annual savings. These savings are of course especially welcomed in today’s increasing cost environment and are slightly higher than our original expectations.

And now I’ll turn it over to Drew to comment on Olive Garden, Red Lobster, and Longhorn Steakhouse.

Andrew H. Madsen

Thank you, Brad. As we mentioned in our press release, economic and consumer dynamics during the first quarter were much weaker than we anticipated. As a result, we have adjusted our fiscal 2009 business planning programs and investments in a way that responds to these near-term financial pressures without materially impacting our longer term strategic priorities and growth potential. More specifically, each brand has reviewed their key sales building initiatives, including advertised promotions, coupons, and menu initiatives, and made adjustments where appropriate that we believe supports same-restaurant sales growth in the 0% to 1% range this fiscal year.

In addition, we’ve been more aggressive in the pursuit of additional cost management opportunities, including better adherence to existing operational standards and optimizing our G&A spending. As a result, we expect net cost inflation across the business, including food and beverage, labor, energy, and all other areas of cost to be approximately 2.5% after including the savings from or proactive cost management efforts. And this is an amount that can be covered with pricing that is slightly above recent years, while still maintaining the breadth of appeal and value of our brands. In addition, we remain confident that we will capture an additional $30 million in incremental RARE acquisition synergies this year to help offset the impact of guest count declines and investments in future growth.

Importantly, we are not taking any action that would erode our guest experience, reduce employee pride and engagement, or interfere with the successful integration of RARE.

Now let’s talk about the specific priorities for each brand. Olive Garden’s strategic priority this fiscal year is to accelerate new restaurant growth while maintaining same-restaurant excellence and during the first quarter, Olive Garden delivered on that priority. As Brad already mentioned, Olive Garden reported competitively strong results during the first quarter. More specifically, Olive Garden delivered their 56th consecutive quarter of same-restaurant sales growth, achieving a 2.4% increase that exceeded the Knapp-Track competitive benchmark by over six percentage points. In addition, Olive Garden opened nine net new restaurants during the first quarter.

Now this exceptional sales performance is explained by two important factors. First, Olive Garden is a trusted brand with broad appeal that has earned strong guest loyalty and a reputation for exceptional value over many years. Second, advertising during the first quarter featured exciting food news and strong value that reminded guests why they love Olive Garden and gave them a compelling new reason to visit.

Their Culinary Institute of Tuscany promotion ran in June and July. It featured a compelling new entrée, Chicken Milanese, and new advertising featuring Olive Garden's cooking school in Tuscany. This was followed by their Vibrant Italy promotion in July and August that featured two new dishes, Grill Balsamic Chicken and Grilled Garlic Shrimp. Both first quarter promotions were supported with new commercials as well as their unlimited soup, salad, and breadsticks for $5.95 equity building advertising.

Olive Garden also began national advertising on Telemundo and Univision with Spanish language commercials during July, becoming the first brand in casual dining to reach this growing market nationally. Going forward, every promotion will include advertising support on these two networks.

Operating fundamentals at Olive Garden also remained strong. Overall guest satisfaction in the first quarter set an all-time high and they are seeing reduced turnover levels for both restaurant team members and managers.

To maintain competitive superior same-restaurant sales performance in a value sensitive environment, Olive Garden decided to start their never-ending pasta bowl promotion one week earlier than last year, during the last week of August and end the promotion one week later than during fiscal 2008.

Olive Garden also experienced more food cost pressure than our other brands during the first quarter, primarily in pasta, dairy, and bread. To help offset this cost pressure going forward, they have implemented plans to take moderately more pricing this year than they did in fiscal 2008 and to further strengthen their management of wage rate and labor hours.

Olive Garden still expects to open approximately 40 net new restaurants during fiscal 2009 and ultimately we believe the brand has the potential to operate 800 to 900 restaurants in North America.

We are pleased with Olive Garden's strength in this challenging consumer environment and believe they will continue to deliver industry leading performance this year.

Turning to Red Lobster, this was a challenging quarter for Red Lobster in large part because they wrapped on same-restaurant sales growth of plus 7% last year, which was the strongest performance of any brand in the Knapp-Track database. Despite this challenge, the first quarter same-restaurant sales performance this year was in line with the Knapp-Track benchmark.

Red Lobster utilized two promotions that were successful during the same quarter last year. In June and July they ran Summer Grilling, which featured fire grilled lobster and shrimp, and a new dish, Honey Citrus Seafood Grill. In July and August, Red Lobster promoted the American Seafood Adventure, which featured New England lobster and crab bake plus two new dishes, Hawaiian Isle Shrimp and Salmon and Georgia Peach Bourbon Shrimp and Scallops. Guest traffic and sales of lobster entrees fell short of expectations and prior year results. We believe this was due to the economic environment and pressures facing many of our consumers, which were exacerbated by the higher absolute check at Red Lobster and higher price points for lobster dishes during the first quarter, compared to last year. Fortunately, lobster costs are now declining and we will be able to reduce the price of several promotional dishes going forward.

In light of the current economic environment, Red Lobster has added a coupon during the second quarter and has significantly strengthened their endless shrimp media weight and advertising to better communicate choice, variety, and value. The endless shrimp started three weeks ago.

Looking further ahead, Red Lobster’s plan to achieve sustainable growth has three phases: the first phase was to strengthen the brand’s fundamentals. The second phase is to refresh the brand, broaden its appeal, and build guest counts. The third phase will be to accelerate new unit growth.

Importantly, the operating fundamentals at Red Lobster have never been stronger. Guest satisfaction, labor productivity, and food waste in particular all showed meaningful improvement again during the first quarter.

During this fiscal year, Red Lobster will continue to focus on broadening the appeal of their brand and recapturing lapsed users. Specifically, they will introduce a significantly improved new core menu supported by compelling advertising late in the second quarter, and they plan to finalize preparations for a remodel program of their existing restaurants by the end of the year. We are confident Red Lobster is on the right course and that it will resume meaningful unit growth in the second half of fiscal 2009, with plans for approximately 10 net new restaurants this fiscal year.

Now at Longhorn Steakhouse, as Brad already mentioned, total sales increased 4.2% versus last year during the first quarter, driven by new restaurant growth. However, same-restaurant sales declined 4.9% and were below the Knapp-Track benchmark for the regions in which Longhorn competes. We believe there are two key issues driving Longhorn’s disappointing same-restaurant sales versus the industry benchmark this quarter.

First, their check average is at the higher end of casual dining, making them somewhat less affordable in an economically challenging environment, especially given the increase in competitive discounting. And they do not yet have the ability to provide advertising support for all of their restaurants that gives their guests a compelling new reason to visit.

To help offset this, Longhorn has increased their coupon pressure approximately 25% over the remainder of the fiscal year.

Longhorn has three key areas of focus during fiscal 2009. First, they will successfully complete the integration process; second, they will further elevate the guest experience by improving results at underperforming restaurants and on weekend occasions; and they will continue their efforts to strengthen brand relevance. In particular, Longhorn will sharpen their brand promise, strengthen their advertising and promotion effectiveness, and expand their ranch house remodel program.

Operating fundamentals at Longhorn also remain strong. Guest satisfaction, as measured by their mystery shop program, improved versus their prior year and set a new record for the first quarter, and employee as well as management turnover remains at industry-leading levels.

During the first quarter, Longhorn opened three net new restaurants. They are on target to open approximately 20 net new restaurants in fiscal 2009 and we believe that ultimately Longhorn has the potential to operate 600 to 800 restaurants in North America.

Two trusted business partners, Gray Advertising and Zenith Media, have been brought on board to work with the Longhorn team on this priority.

Now Gene will discuss the three brands in our specialty restaurant group.

Gene Lee

Thanks, Drew. The specialty restaurant group organizational structure, reestablished a year ago, is functioning effectively and providing an appropriate level of governance and support for our three brands. In this difficult economic environment, each of our concepts is focused on executing the strategies and tactics to deliver differentiated guest experiences, and our operations teams continue to operate at a high level, as indicate by our guest satisfaction measures. Our teams will also continue implementing sales building initiatives that we believe will increase market share and result in competitively superior performance.

Now I’ll go into a little more detail on each of the specialty restaurant group brands.

The Capital Grille's first quarter sales were $54.4 million, a 6.7% increase over prior year, driven by an additional five restaurants. Same-restaurant sales declined 8.6%, reflecting continued weakness in luxury consumer spending and a significant increase in promotional activity in the premium steak category.

The team continued providing guests with an exceptional personalized dining experience. Overall guest satisfaction, as measured by our mystery shopper program, was at an all-time high. Everyone on The Capital Grille team is committed to rapidly regaining competitively superior same-restaurant sales. The company is focusing on numerous sales building actions, including additional efforts to grow the private dining business, compelling new culinary news through chef’s suggestions, and limited promotional activity. The team is also focused on delivering an extraordinary dining experience by increasing training efforts, refreshing brand touch points, and enhancing reservations management to maximize efficiency.

The Capital Grille successfully opened one restaurant in the first quarter and will open another one next Monday, which will bring the total number of restaurants to 34. The company will open a total of five to six restaurants in this fiscal year. The Capital Grille team continues to make progress on their integration efforts. The company remains focused on balancing the demands of the integration with managing new restaurant growth and building sales momentum.

Bahama Breeze had first quarter sales of $35.8 million, 3.7% below last year. Same-restaurant sales also declined 3.7%; however, this performance outpaced the Knapp-Track competitive set on a regional basis despite a higher check average.

The company’s overall guest satisfaction continued to improve. We believe implementing fewer operational changes this fiscal year is allowing our restaurant teams to focus on being brilliant with the basics, which is helping improve the overall dining experience.

At the same time, the company is taking a number of actions to improve same-restaurant sales, including cable television advertising in select markets, targeted direct mail, and testing online advertising. Bahama Breeze is preparing to open one restaurant in the second half of the fiscal year.

Seasons 52 remains focused on building an effective operational foundation and continuing to hire and develop more talented team member who can help support the brand’s growth and ensure we continue executing at a high level. The company also continues to actively identify and secure new locations to support disciplined growth, starting with one new restaurant later this fiscal year.

Now I’ll hand it over to Clarence for some final comments.

Clarence Otis

Thanks, Gene. There’s no question that this has been a difficult quarter and given the difficult economic environment, it looks like it’s going to be a challenging year. Our current sales and earnings outlook reflects that.

But as we step back and look at where we are competitively, we feel good and we feel good because of the actions we have taken over the last four years to transform Darden, and those actions have put us in a position where we can weather the current storm better than most of our competitors and we think we can emerge with an even wider positive competitive gap. With the actions we’ve taken, we have a portfolio of proven brands that together give us a much stronger long-term sales and growth earnings -- sales and earnings growth profile than we had just 18 months ago. We have greater scale than we did and all the advantages that scale brings, and those advantages are reflected in the cost synergies that we are realizing from the RARE acquisition, and we’ve made changes in how we work so that we can be even more effective and efficient, and that enables us to let our scale work even harder for us.

The progress we made and the competitive position that we’ve built as a result of that progress really hinges on one thing, and that one thing is having great people. We are proud of the outstanding teams we have in our restaurants, in our restaurant support center. They are working to successfully navigate the current environment and beyond that, they are working to create a great company.

We have said it before -- we believe it. We have what we think at every level of the organization is the strongest leadership team and full service dining. Together, we are focused on creating our company that in good times and bad is a leader in the full service restaurant industry now and for generations, and we recognize we went a little long this morning but we did want to give you some detail on the cost dynamics that we are seeing and on the cost management and sales building initiatives that we have put in place. But with that, we’ll take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Steven Kron with Goldman Sachs.

Steven Kron - Goldman Sachs

A question on Olive Garden profitability -- I guess given the 8% increase in sales, a little surprised to see operating profit decline and if I did my math correctly, I think that implies kind of restaurant level margins down a couple hundred basis points. It seemed I guess from your prepared remarks that commodity cost pressures were at a disproportionate hit there. If wheat was the big pressure there, and maybe you can confirm that, if I look out and considering comments that you made last quarter that you were floating quite a bit, does that become a year-over-year benefit for you guys in the current quarter?

Brad Richmond

Well, Steve, you are correct in that the commodity cost, the non-protein commodity costs are disproportionately weighted to Olive Garden and so that is the big driver of their profit miss on that. And to your point with what’s happening in the commodity market and particularly as we move past the October timeframe, that comparison for them gets much easier.

Steven Kron - Goldman Sachs

And as a follow-up on the commodity discussion, you guys last quarter talked quite a bit about suppliers not really being receptive to longer term contracts. Given what we’ve seen in the moves in some of the commodities, can you update us on the current ability to contract and I guess to that point, how active were you guys in this quarter in the futures market?

Brad Richmond

The environment still exists. No one’s too excited really about contracting on any long-term basis but as you’ve seen, particularly in the case of wheat here, its price has moved down. We through our supply management chain had anticipated getting the harvest in, getting the crops planted, getting the harvest in and see how that was materialized. We believe that that would be the likely course and we have not taken [a lot of] positions that existed at the end of our first quarter, so we have been waiting for the market to move down and it is moving in that direction, so we’ll continue to evaluate that. We are getting to the point where we will be taking more positions if it continues its current path in this quarter.

Operator

Thank you. Our next question comes from the line of Matthew DiFrisco with Oppenheimer.

Matthew DiFrisco - Oppenheimer

Thank you. Can you just update us a little bit also on where you see the regional strength where Olive Garden and both Longhorn can grow, even in this environment? And how set in stone are you on especially Longhorn in this, given the current trends of it and their regional weakness seeming somewhat temporary but still out there, is it time to still grow there? And I do have a follow-up.

Andrew H. Madsen

Well, in the near-term, Longhorn is really focused on filling in existing markets so they can get to spot market media efficiency faster. And they are not now in Texas, which is the most -- which is the best-performing Knapp-Track region now. Olive Garden is also -- they are entering new markets but largely filling in existing markets as well, so while Longhorn is down a bit in same-restaurant sales compared to the Knapp-Track benchmark currently, we still see significant potential for them to continue expanding.

Brad Richmond

And I would just like to add, I think Drew is absolutely right. As we think about Longhorn near-term expansion, clearly filling in markets, getting to media efficiency is important because that gives them one more tool that they can use to help build sales, and so clearly focused on that, probably a little bit more cautious about entering new markets until we get the kind of clarity around brand positioning that Drew talked about, and so that’s the balance and I think that explains the unit growth number that we have this year, roughly 20, which is down from where they’ve been over the last couple of years.

Matthew DiFrisco - Oppenheimer

Okay, and then the ranch house remodel, what are you seeing in early tests, or can you give us some sort of characteristics on the lift that you are getting, either on sales or greater profitability potentially?

Andrew H. Madsen

Well, they’ve been working on a ranch house remodel for maybe not quite two years and they’ve continued to refine the investment level, as well as the changes that they are investing in. Qualitatively, the consumer reaction has been very strong. The ranch house remodel is moving closer to what their new prototype looks like, and quantitatively guest count increases and operating profit increases early on are encouraging but we really haven’t had a big enough group of restaurants for a long enough period of time to be conclusive about that. They have it in maybe 20 restaurants, 20 or 25 restaurants and it just hasn’t been for a long enough period of time. So we would think by the end of this year, at least another couple of quarters, that we’d have a better sense of it but very encouraged and we think that atmosphere change and what it does for the experience and the brand is going to be a major lever in terms of strengthening their brand relevance going forward.

Operator

Thank you. Our next question comes from the line of John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks. Good morning. I wanted to go back to your comments on the promotional stance and maybe how far are you willing to go to recapture some sales? It sounds like for the two main brands, you are just extending existing promotions but I’m wondering if you’ve thought about going beyond that in terms of increased couponing or absolute sort of price discounting, and how you factor that into your plan. Do you think of that as a lower margin but higher sales volume or do you think that’s just going to be an absolute negative to margin this year? Maybe how much of the plan is factoring in that, the benefits of that discounting.

Andrew H. Madsen

Well, I would characterize everything that I went through on the sales building adjustments as refinements versus radical change, and we are trying to respond appropriately to the near-term financial pressures we see, do it in a way that passes all three filters that we really run these decisions through -- number one, we have to believe that we get sufficient incremental guest count to offset whatever the discount is that we may be offering. Not everything I described was a discount but if there is, that’s our first filter. Second, we want to be confident that there is no other menu mix changes or labor changes that would adversely impact margins, and third, we want to make sure that we are not doing anything to the brand, the way guests perceive it, the way guests would use it, going forward, so we don’t want to diminish that in any way.

So we believe that everything I went through is going to help us get to the 0% to 1% same-restaurant sales growth in our guidance, it’s going to be profitable, and it’s going to be consistent with what our brands stand for. And we would be hesitant to go significantly beyond that in a way that either was very aggressive in discounting that diluted margins or diluted brand equity going forward.

John Glass - Morgan Stanley

Okay, and then just is there anything in the sequential trends you saw as you exited the quarter, maybe entered this quarter, that give you hope or despair? In other words, were August trends relatively level, did they get worse? How should we look at the current environment?

Andrew H. Madsen

I don’t think we want to talk about September, John, but the summer clearly -- the most stressed month was July, and so we certainly had a difficult June, got more difficult in July. Some of that was the holiday. Brad mentioned Fourth of July, which was a slow day, falling on a Friday, a very strong day, this year versus a Wednesday, a more average day, last year, hurt the entire industry but beyond that, we saw a weakness and so the effect I think of gas prices at the levels that they were, a lot of other things going on, we certainly saw a better consumer in August, still not anywhere near where we’d like to see them but better.

Operator

Thank you. Our next question comes from the line of Joseph Buckley with Banc of America.

Joseph Buckley - Banc of America

Thank you. Could I start with a follow-up to John’s question? As gasoline prices have come down, are you seeing any benefit from that in the last eight or 10 weeks?

Brad Richmond

I think we certainly saw August better than July, and the gas piece was certainly part of that but August was still a tough month. I mean, when you look at the absolute industry number ex Darden, 3.7% negative and so as we built our outlook, we’ve assumed that things will stay difficult and we are not looking at a whole lot of improvement because there are so many pressures beyond gas prices and those continue to emerge. And so while we did expect gas prices to come down, they have. That’s not a dramatically changed outlook for the year.

Joseph Buckley - Banc of America

Okay, and then I wanted to ask about the RARE acquisition, what the EPS effect on the quarter was and I know with the pre-announcement a large part of it seemed to be laid at the feet of Red Lobster but looking at some of these RARE numbers, I guess I’m concerned that maybe that’s the drain on earnings per share. Can you comment on that or give us some comfort that --

Clarence Otis

Yeah, I will let Brad answer that and I’ll follow-up.

Brad Richmond

Joe, in the particular quarter, obviously the RARE brands that we acquired were pressured by some of the cost pressure and more importantly the sales impact but their total part of Darden is not that significant that their impact on EPS I would say was very slightly dilutive but not meaningful in any sense. The real opportunity there is the opportunity to grow those brands and add meaningful growth to Darden.

Clarence Otis

I would say, I mean, the cost pressures that we saw at Olive Garden and operating profit decline was significant, so this is not just a -- it’s not just about Red Lobster for sure, or RARE, and so I think that’s why Drew went through the discussion of Olive Garden on the cost side, Drew and Brad.

Operator

Thank you. Our next question comes from the line of Jeff Omohundro with Wachovia.

Jeff Omohundro - Wachovia

I wonder if you could share a bit more details on the direction of the new menu initiative at Red Lobster. In particular, I am concerned about the apparent affordability issue in this environment at the brand and how you plan to meet that challenge. Certainly I understand the value offering position of endless shrimp. Do you need to do more of that or is there another solution that you are leaning towards in the new menu? Thanks.

Clarence Otis

Well, there’s a couple of different things we are doing to broaden appeal, strengthen value, and even further strengthen the brand. On the core menu, what we’ve talked about in the past is that to regain lapsed users, those people that use to come to Red Lobster and have stopped, we really need to address two fundamental things -- one is change their perception that the menu at Red Lobster is primarily comprised of frozen seafood prepared in a fried manner and not having a lot of interesting innovation, flavor profiles, culinary expertise.

The menu that is coming out late in the second quarter is really designed to maintain or increase appeal of current users, which is important, but also address those concerns about this is frozen fried seafood without any interesting flavor profiles.

Importantly, we are not addressing that in a way that introduces a lot of new higher priced items that’s going to take the check up. It’s really more about freshness and flavor profile and culinary innovation, as opposed to more higher priced items.

Beyond that, we are looking at ways to strengthen value in a more targeted fashion to a group of Red Lobster customers in particular that are more value sensitive and that will be coming in the second half. And I don’t want to get into that in more detail but we are looking at a couple of different levers to address both the issues that you brought up.

Jeff Omohundro - Wachovia

Is it when you look at those two issues, the perception of frozen versus value and affordability, how much weight do you put on each of those?

Clarence Otis

Well I don’t think it’s value versus, or frozen versus value. I think it’s frozen versus fresh, interesting, something for me and that if you offer that, then second, I’m going to view that as an experience that offers more value and a brand I’m going to be more loyal to, so it isn't directly an either/or, and I think we have to address the first -- be more relevant with the type of food items that people want today to ultimately address the second around value. We are not going to win on value just by lowering menu prices or portion sizes at Red Lobster.

Operator

Thank you. Our next question comes from the line of Brad Luddington with Keybanc.

Brad Luddington - Keybanc Capital Markets

Thank you. I wanted to start off just asking if we should expect any other variability on the G&A line with timing of -- changes in timing of marketing expenses and maybe the production costs falling in.

Clarence Otis

I’m not aware of anything now that would be moving around in a meaningful nature, although we will continue to assess the competitive and business environment out there and if there’s opportunities that we think can strength our position, we will take those but nothing I’m aware of at this moment that causes any big quarterly shifts -- beyond the holidays.

Brad Luddington - Keybanc Capital Markets

Okay. And then just on the integration charges impact, trying to do a pro forma model, is it fair to assume that you have maybe around $1.5 million in pretax on the restaurant expense line and about 5.5 on the G&A line?

Brad Richmond

One moment. Say that again? I’m sorry.

Brad Luddington - Keybanc Capital Markets

Just thinking about $7 million total pretax, 1.5 on restaurant expenses and 5.5 on G&A?

Brad Richmond

At the restaurant line, you are talking for the full year, that would be pretty close and on the G&A side, that really works out to the $0.06 to $0.07. I’d have to do the math on that one, so it would be about -- for the year about $13 million.

Operator

Thank you. Our next question comes from the line of John Ivankoe with J.P. Morgan.

John Ivankoe - J.P. Morgan

A question on Red Lobster -- I guess for the better part of a year, the concept has been performing I think beyond your expectations, or below, I should say, your expectations, below my expectations, from a traffic point of view. So I would like you to frame your continued commitment to development of new restaurants in the second half of 2009 -- in other words, why you think this is the right time to commit capital for new restaurant development? And if the decision on ’09 is because you already have those units in plan, if there is any kind of sense in direction for what new unit development might even be for the out year 2010?

Clarence Otis

I’ll take that. I would say as we look at traffic over the last couple of years, from a traffic perspective Red Lobster has outperformed the industry as measured by Knapp-Track, and for Red Lobster with its materially higher check than Knapp-Track average, that’s competitive strength because in the past, we underperformed Knapp-Track on traffic. And so I would say they performed strong competitively. We wish it was even higher but we also wish the entire industry environment was higher, the industry’s numbers were higher. And so that’s how I think about it.

I think on a new restaurant basis, Red Lobster is a restaurant by restaurant decision. I don’t know that we’ve got a pace of expansion that we think makes sense versus we scour the country, look at all the markets and decide market by market, does this restaurant make sense from a return perspective? And so it is very much a bottom-up driven expansion. Here’s a market that’s expanded, it’s a market that is strong, here’s a trade area that we think we can get X-guests out of, it makes sense to open this restaurant. Some years it might make sense to -- all that adds up to five and other years it adds up to 10. I think it’s more about that and to the extent that the guest count level that we start to make that restaurant by restaurant assumption from is lower and we scale out over 30 years, fewer trade areas will make sense. And so that’s a little bit of how we think about Red Lobster. I don’t know that there’s a master plan as opposed to a unit-by-unit investment decision.

John Ivankoe - J.P. Morgan

It does seem like maybe the sales part of the equation is lower today than we would have liked it to have been a year ago. Is there anything that is changing -- and if you can answer this question kind of very immediate term on the investment side of the equation, whether in land or in building costs?

Clarence Otis

I would say the biggest change on that side is the attractiveness of the units that are available in terms of where they are located and therefore what we can forecast for guest counts is the biggest change, so units that would have been unavailable to Red Lobster because developers felt other concepts were more attractive are now available, and so as we forecast those traffic numbers into the future, they might be half a point higher than they would have been if we didn’t have that softness in the development community. That’s the biggest piece compared to land values. Construction costs certainly have flattened out and they were scaling up.

I think the other thing as we look at these unit level investment decisions at Red Lobster that helps them is that there are secular declines in a lot of the products that they use and so the food cost product on the shrimp side, on a lot of the fin fish side, has helped and Kim and his team have done a great job in their direct efforts of really reducing the cost of the restaurant support platform. That dovetails with a lot of work that we’ve done at the Darden level to reduce the cost of our restaurant support program on a per operating week basis and certainly the acquisition helps, and it improves Red Lobster’s restaurant level earnings model with the cost synergies, because a lot of those it benefits from.

So all of those things I think help each of those restaurant by restaurant investment decisions, but that’s how it’s looked at. It’s not some global goal that we are trying to meet.

Operator

Thank you. Our next question comes from the line of Jeff Bernstein with Lehman Brothers.

Jeff Bernstein - Lehman Brothers

Thank you. A couple of questions -- first, obviously being a 100% company-operated system, you are very sensitive to the swing in comps. I’m just wondering if you could talk about your flexibility or perhaps your ability to adjust certain costs real-time based on comp trends that you are seeing, whether you have examples of the ability to pull back on certain labor lines or make adjustments as you move through the quarter, and then I have a follow-up. Thanks.

Clarence Otis

Well certainly we think our operating fundamentals on wage rate management, labor hour management are good but we think they can be even better, that we can do a better job of forecasting what the guest counts are going to be in this environment and reacting faster on the labor hours side. The same thing on something like managers per restaurant, where historically we’ve been very good at that. We’ve seen reduced turnover recently and we can respond to that a little quicker as well.

So we think we’ve got strong tools for our front line restaurant operators to do all those things and we just need to continue doing it at an even higher level.

Jeff Bernstein - Lehman Brothers

Okay, and then just in terms of this specific quarter just ended, you talked about the Red Lobster comparison being so difficult, which we definitely recognize and it seems to get a lot easier. Just wondering, I mean, the down 3.7% comp off of a plus 7, that didn’t seem so horrible when you consider the comparison, and yet it seems like internally you guys are expecting Red Lobster to actually be posting a modest positive comp in this past quarter. Just wondering why perhaps that assumption, if you are considering the year-ago comparisons -- perhaps what were the expectations of promotions for this quarter that you thought would lead to the positive comp, if that was one of the big drivers of the earnings shortfall. Thanks.

Andrew H. Madsen

Well, part of the positive 7% last year was promotions that worked exceptionally well and we were repeating those promotions this year in the first quarter and we had a little more media weight behind them in the first quarter this year than we did last year. We didn’t have the investment in fresh fish advertising media weight that we had a year ago, which was one of the big drivers of the 7% increase. But we though we had proven promotions, slightly increased media weight behind those two promotions, some new products. We thought we had some momentum behind those and obviously we didn’t get that.

Operator

Thank you. Our next question comes from the line of Robert Derrington with Morgan Keegan.

Robert Derrington - Morgan Keegan

Thank you. Clarence, could you kind of revisit for us for a minute the company’s philosophy about the plan for your operating cash flow this year? I know there’s a number of pieces there between new store development, share repurchase, dividend, et cetera. Could you kind of update us on that plan and if it’s changed any?

Clarence Otis

Well, the operating cash flows are somewhat lower, I guess, so that’s changed things a little bit. It probably means that I guess our debt levels will stay a little bit where they were a year ago, and I think that’s probably the biggest piece. We may have been looking to pay down a little bit more debt than we were likely to and so we feel comfortable at those levels because the dividend really hasn’t changed, share repurchase is about the same place I think that we talked about and the capital piece has come down slightly but not a whole lot.

I don’t know, Brad, if you have anything else to add to that.

Brad Richmond

No, I think that pretty well sums it up. The net of it is that you we are continuing our share repurchase, as we previously stated. Of course, the dividend, we are anticipating continuing that as we have talked about and a fair amount of support for capital expansion still continues, slightly moderated some but not meaningful. So it does put a little bit more pressure on our debt metrics but we still believe that that preserves investment grade debt profile.

Robert Derrington - Morgan Keegan

Okay, that’s fair enough. And then a follow-up question as it relates to the Longhorn brand, the market seems to be pretty competitive for that concept, or for the whole industry, I guess, and we are seeing a national competitor use a price point promotion to try and drive sales within its steakhouse concept. Any kind of thought there about getting a different repositioning or more aggressive on a price point, as opposed to just couponing?

Andrew H. Madsen

The Outback $9.99 promotion is probably having an impact on Longhorn and others in the category. It’s the first time we can remember that Outback has advertised a price point.

We have chosen not to do a price point on Longhorn at this point for a couple of reasons -- one, we don’t have enough experience with the brand to know if it’s going to meet those filters that I just talked about a minute ago, that it’s going to drive incremental traffic at a margin that maintains our profitability. And second, what does a price point discount like that as a pretty aggressive price point do for the image of a steakhouse restaurant, so we want to get a little more comfortable with both of those things. I wouldn’t rule out a value-oriented promotion in the future, not unlike an endless shrimp promotion that Red Lobster does, which doesn’t happen to be price pointed but we are going to continue working on ideas for that versus just a straight discount.

Operator

Thank you. Our next question comes from the line of Chris O’Cull with Suntrust.

Chris O’Cull - Suntrust Robinson Humphrey

Thank you. A quick question on the contribution from RARE -- Brad, will the extra period in the second quarter this year with RARE ownership, will that have a material benefit to earnings?

Brad Richmond

Are you talking about in the second quarter, will it have an impact?

Chris O’Cull - Suntrust Robinson Humphrey

Right.

Brad Richmond

I think the biggest impact you are going to see is it’s going to be a quarter of transitions, so the P&L will still be a little bit confusing and we’ll have to look to that, to be honest. But in terms of its contribution on an as-reported basis, yes, it would be. I mean, we’d be lapping past some of those initial expenses in those items that are there but in terms of its EPS impact, I would presume at this point that it’s going to be slightly positive, once you ex out all the acquisition and integration cost-related items.

Chris O’Cull - Suntrust Robinson Humphrey

Okay, and then as a follow-up, and I may have missed this but is your guidance for SG&A expense to be flat as a percentage of sales from last year?

Brad Richmond

SG&A to last year is to be approximately 50 basis points favorable for the entire year.

Operator

Thank you. Our next question comes from the line of Stephen Anderson with MKM Partners.

Stephen Anderson - MKM Partners

I just wanted to ask about at the end of the second quarter of this year, you have the Thanksgiving holiday. I just wanted to ask, last year that fell pretty much within the second quarter. How is that going to affect this quarter, if at all?

Andrew H. Madsen

Well, we are moving out a week in our fiscal quarter which is typically a low week, in that we are not open on the Thursday and that Friday is not your typically strong Friday sales period for us. We haven’t gone into quantifying that but I would say that it is a meaningful impact for us in the quarter.

Stephen Anderson - MKM Partners

Okay, and can you give us an update on any of your restaurant closures from recent storms, hurricanes Gustav, Hannah, and Ike?

Andrew H. Madsen

Yes, we -- it’s an unfortunate situation, obviously, for the areas affected and we went in there beforehand and prepared our restaurants and we’ve gotten most of those reopened but through Monday anyway, we’d lost about 115 operating days. So on our scale, it is not a meaningful impact to our business.

There are a few restaurants, I think it’s around a dozen, that still remain closed today but those are slowly coming back online for us. No reports at this time of any meaningful property damage.

Operator

Thank you. Our next question comes from the line of Mitch Speiser with Buckingham Research.

Mitch Speiser - Buckingham Research

First on the overall pricing/average check strategies at the three core brands, it looks like you are going to take some pricing at Olive Garden incremental to the 2% to 3%. Can you give us a sense of how much more incremental pricing you might take? And then on the other brands, Red Lobster, Longhorn, it sounds like you may actually lower lobster prices at Red Lobster and I guess more generally, is the plan maybe to lower the average check at Red Lobster and Longhorn while actually taking up the average check at Olive Garden?

Andrew H. Madsen

No, we are not planning on lowering the check at Red Lobster. Our pricing for Olive Garden, Red Lobster, and Longhorn, but Olive Garden and Red Lobster in particular has typically been in the 2% to 3%, historically more to the middle of that. This year we are probably going to be towards the upper end of that range, so it’s not a dramatic increase but it is a little bit more pricing than we’ve taken in the past and directionally true for Longhorn as well.

Red Lobster, what I meant to say, and maybe I wasn’t clear, is that there are few lobster specific promotional dishes that we won’t have to take the price up as much now that lobster cost has come down on those couple of items, so we can actually reduce the price on those a little bit but in terms of total pricing and total menu and total check, it’s not going to have a material impact. We still would expect to be at the upper end of that 2% to 3% range in pricing.

Mitch Speiser - Buckingham Research

Okay, and just on labor, wage rates I think you mentioned were up 2% to 3%. With the labor market softening, is there any sense that perhaps wage rates can go down in fiscal ’09, or is it just with all the state minimum wage increases, federal minimum wage increases that it’s just not going to happen that wage rates can actually come down over the next nine to 12 months? Thanks.

Andrew H. Madsen

We don’t see them coming down but we think we can be even a little more proactive in how we manage them in this environment.

Matthew Stroud

Ken, that’s all the time we have for questions today. We appreciate those of you who joined us. If you have further questions, please contact us here in Orlando and we look forward to speaking with you in about three months.

Operator

Thank you. And ladies and gentlemen, this conference will be available for replay starting today, Wednesday, September 17th, at 10:30 a.m. Eastern Time, and it will be available through Friday, October 17th at midnight Eastern Time. You may access the AT&T executive playback service by dialing 1-800-475-6701 from within the United States or Canada, or from outside the United States or Canada, please dial 320-365-3844, and then enter the access code of 960220. Those numbers once again are 1-800-475-6701 from within the U.S. or Canada, or 320-365-3844 from outside the U.S. or Canada, and again, enter the access code of 960220.

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Source: Darden Restaurants F1Q09 (Qtr End 8/24/08) Earnings Call Transcript
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