達登餐飲 (DRI) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the first quarter earnings release.

At this time all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

Instructions will be given at that time.

(Operator Instructions).

As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Mr.

Matthew Stroud.

Please go ahead.

Thank you, Brad.

Good morning everyone.

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.

Forward-looking statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Any forward-looking statements speak only as of the date on which such statements are made.

And we undertake no obligation to update such statements to reflect events or circumstances arising after such date.

We wish to caution investors not to place undue reliance on any such forward-looking statements.

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 food safety and food borne illness concerns, litigation, unfavorable publicity, federal, state, and local regulation of our business, including healthcare reform, labor and insurance costs, technology failures, health concerns including virus outbreaks, the intensely competitive nature of the restaurant industry, factors impacting our ability to drive sales growth, the impact of the indebtedness we incur in the rare acquisition, our plans to expand our newer brands like Bahama Breeze and Seasons 52, a lack of suitable new restaurant locations, higher than anticipated costs to open, close or remodel restaurants, increased advertising and marketing costs, a failure to develop and recruit effective leaders, the price and availability of key food products and utilities, shortages or interruptions in the delivery of food or other products, volatility in the market value of derivatives, general macroeconomic factors, including unemployment and interest rates, severe weather conditions, disruptions in the financial markets, a possible impairment in the carrying value of our goodwill, or other intangible assets, a failure of our internal controls of our 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 and 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 release fiscal 2011 second quarter earnings and same restaurant sales for fiscal September, October and November 2010 on Monday, December 20th, 2010, after the market close.

We released first quarter earnings yesterday afternoon.

These results were available on PR NewsWire and other wire services.

We recognize that most of you have reviewed our first quarter results, so we won't take the time to go through them in detail once again, nor will we spend time on a brand by brand operating summary, in an effort to provide more time for your questions.

Rather, Brad will provide some additional line item detail about the financial results for the quarter.

Drew will briefly review our operating performance for the first quarter, followed by Clarence, who will have some additional remarks.

After that, Clarence, Drew, Brad and Gene will then respond to your questions.

Brad?

Thank you, Matthew and good morning.

Darden's total sales from continuing operations increased 4.2% in the first quarter to $1.81 billion.

This strong top line performance compares to 0.8% total industry sales growth for the industry as measured by Knapp-Track and excluding Darden, indicating meaningful share growth for Darden.

Darden's blended same restaurant sales for the first quarter were up 1.1%.

For context, industry same restaurant sales, as measured by Knapp-Track, and excluding Darden, are estimated to be flat for the quarter.

Olive Garden, first quarter same restaurant sales increased 2.7%.

Red Lobster, first quarter US same restaurant sales decreased 1.7%.

Red Lobster did have a promotional mismatch in the quarter.

Last year, Endless Shrimp started in the first quarter.

This year, the promotion started in the second week of the second quarter.

The change adversely affected Red Lobster's first quarter same restaurant sales results by approximately 100 basis points.

The adverse effect for the month of August was approximately 300 basis points.

LongHorn Steakhouse first quarter US same restaurant sales increased 2.2%.

The Capital Grille's first quarter same restaurant sales increased 2.7%.

Bahama Breeze, first quarter same restaurant sales decreased 0.1%.

And Seasons 52, first quarter same restaurant sales increased 5.8%.

Now, let's review the margin analysis for the first quarter.

Food and beverage expenses were 77 basis points lower than last year on a percentage of sales basis, as a result of reduced food costs.

We have continued to benefit from lower commodity prices in the first quarter of this fiscal year, and we expect that will continue into the second quarter.

In the second half of the fiscal year, commodity prices are likely to be slightly higher to the prior year, with an expected increase of approximately 0.5%.

The net is, we expect food and beverage costs as a percentage of sales to be approximately 28.5% for the full fiscal year.

Or, about 30 basis points favorable to the prior year.

First quarter restaurant labor expenses were 72 basis points lower than last year on a percentage of sales basis, due to productivity gains and continued low employee turnover levels, partially offset by wage rate inflation.

Restaurant expenses in the quarter were essentially flat to last year on a percentage of sales basis because of sales leverage, offset by higher credit card fees this quarter.

Selling, general and administrative expenses were 13 basis points higher as a percentage of sales for the first quarter, due to the timing of general manager conferences and increased incentive pay, partially offset by sales leverage and reduced media expense.

Depreciation expenses in the quarter were marginally higher to last year on a percentage of sales basis as a result of the move to our new restaurant support center, which is owned versus the previous facility that was leased.

For the quarter, operating profit as a percentage of sales was a very strong 10.2%.

That's 128 basis points better than last year and came from the combination of strong new unit sales growth and blended same restaurant sales growth that, while positive, is still below the range that we continue to expect for the full fiscal year.

We're excited that we're on track to achieve a comparable operating profit return for the full year, which would see us pushing past historical peak margins.

That's a tribute to the progress we made strengthening our operating platform and business model.

The effective tax rate for the first quarter was 28.8%, higher than our expected annual effective rate of approximately 27%.

We anticipate the second quarter tax rate will approach what we experienced in the first quarter, with the annual expectation, though, remaining at 27%.

We accelerated our share repurchase in the quarter, spending over $95 million, buying back 2.4 million shares of our common stock, leaving 5.9 million shares remaining in our current authorization to repurchase shares.

We are on track to spend between $300 million and $350 million on share repurchase this fiscal year.

When you add it all up, we grew sales over 4% this quarter, and earnings per share were up over 19%.

Yesterday, we affirmed that we continue to anticipate reported diluted net earnings per share growth from continuing operations of approximately 14% to 17% in fiscal 2011.

This compares to reported diluted net earnings per share from continuing operations of $2.86 in fiscal 2010.

Our earnings expectations for the fiscal year are based on a blended US same restaurant sales in fiscal 2011 for Red Lobster, Olive Garden and LongHorn Steakhouse of approximately plus 2% to plus 3%.

The opening of approximately 70 to 75 net new restaurants in fiscal 2011, and total sales growth for the year of between 5.5% to 6.5%.

Each of these estimates is consistent with the outlook we provided at the beginning of the year.

And now, I'll turn it over to Drew for some comments.

Thanks, Brad.

And I will start by sharing a few thoughts about the industry, and then comment briefly on both the strategy and performance of our three large casual dining brands.

Industry same restaurant sales during the first quarter were equal to prior year.

This represents a 140 basis point improvement versus the fourth quarter of fiscal 2010, and the fourth consecutive quarter of improvement overall.

In addition, the underlying industry same restaurant sales dynamics driving this 140 basis point improvement also continued to strengthen.

Industry guest counts were down 2.6% versus the prior year, and this represents a 60 basis point increase versus the prior quarter, and the best absolute performance since the third quarter of our fiscal 2006.

The implied check growth during the first quarter of plus 2.6% represents a 90 basis point improvement versus the prior quarter, and the best absolute performance since the fourth quarter of our fiscal 2008.

Most of our larger casual dining competitors continue to run very aggressive discount promotions.

Consequently, our view is that industry check growth during the first quarter was partly driven by a reduction in discounting, but more by a combination of other factors, including more normalized levels of pricing and menu mix, which we view favorably and we believe there is improving same restaurant sales performance at casual dining chains that have a higher absolute check, which we think is lifting the reported industry check average.

As it relates to Darden, our strategy to drive competitively superior results during the first quarter was consistent with the approach that we've discussed with you since the economic downturn began.

We continue to be wary of utilizing deep discounts to combat difficult industry conditions, given concerns about what this might do to long-term brand integrity, long-term business model integrity, and related growth prospects.

Our approach is to build upon the broad appeal of our brands, leverage the cost advantage that comes with our scale, utilize selective value offers across our portfolio that are profitable in the near term and maintain the integrity of our brands over the long term and be consistent and reliable for our guests as it relates to pricing and check average growth.

We outperformed the industry by 110 basis points on a blended basis during the first quarter.

Industry same restaurant sales are recovering faster than we anticipated, driven primarily by check growth beyond what we expected.

Should that continue, our check growth will not increase as fast as the industry, and our GAAP to Knapp for our full year would be narrower than what we projected at the beginning of the year.

That said, as Brad mentioned, we still believe that we're on track to deliver blended same restaurant sales growth of plus 2% to plus 3% for the full fiscal year.

Now I want to briefly review the performance at each of our three larger casual dining brands.

Red Lobster's same restaurant sales declined 1.7% in the first quarter, which trailed the industry by 170 basis points.

And while it only trailed by 70 basis points after adjusting for the promotional calendar mismatch related to Endless Shrimp, it was still a disappointing.

Our promotional strategy entering fiscal 2011 at Red Lobster was to feature cravable dishes at affordable price points in more promotions this year than we did last year.

We started the quarter advertising American Seafood Adventure in June, a program we have run successfully in the past and added a new featured dish, plus a starting at $12.99 price point.

However, the new entry price dish, Seafood Jambalaya, was not a compelling enough feature to generate the special visit interest expected and may have been further hampered by concerns related to the Gulf oil spill.

We followed that with a new promotion in July, Crabfest and a starting at $14.99 price point.

However, the $14.99 price point in hindsight was probably a little too conservative, especially compared to more aggressive competitive discounts, and did not attract as many price conscious consumers as we anticipated.

As was mentioned in our press release, Endless Shrimp started two weeks later this year compared to last year, to better align with the seasonally low industry period that begins after Labor Day.

This resulted in having one less week of Endless Shrimp during August and one less week during September this year compared to last year, and one more week of Endless Shrimp in November, compared to last year.

To summarize, Red Lobster's softer than expected sales results were primarily due to promotional tactics that were not as effective as they need to be.

We are confident, however, in our action plans to strengthen the promotional tactics we will feature over the remainder of this fiscal year.

Now, importantly, Red Lobster delivered strong profit growth during the quarter, and is making significant progress on the strategic priorities that will enable consistent long-term sales growth, like their Bar Harbor remodel programs and VIP service initiative.

Red Lobster also completed an agency search during the quarter and Gray Advertising, the same agency used by Olive Garden and Longhorn, is their new agency of record, effective in December.

Olive Garden achieved same restaurant sales during the first quarter of 2.7%, exceeding the Knapp-Track industry benchmark by 270 basis points.

Olive Garden featured approachable price points and compelling food news during the first quarter.

They began the quarter with their Heart of the Village promotion, featuring two new entrees, and a starting at $10.95 price point.

This was followed by their Artesian Italian promotion, which featured two new full price entrees, and then in mid-August, they began their popular Neverending Pasta Bowl promotion, including two new sauces with an $8.95 price point.

Olive Garden also achieved total sales growth of nearly 7% during the first quarter, including the impact of 32 net new restaurants compared to last year, driving continued profitable market share gain.

They also began the national roll-out of their Welcome Excellence service initiative including a new table management system that enables increased guest throughput during peak demand periods, and they remain on track to open 30 to 35 net new restaurants this fiscal year.

LongHorn Steakhouse achieved same restaurant sales growth of 2.2% during the first quarter, exceeding the Knapp-Track industry benchmark by 220 basis points.

This is the third consecutive quarter of same restaurant sales growth and the seventh consecutive quarter that LongHorn Steakhouse has exceeded the industry benchmark.

They began the first quarter with theiR More Than Great Steaks promotion, featuring new combination plates like cedar grilled shrimp and sirloin, plus bacon-wrapped scallops and filet, with a starting-at $14.99 price point.

This was followed by their grilled trio promotion, which included fresh grilled chicken, salmon and a choice of sirloin or filet mignon.

Longhorn also generated total sales growth of nearly 7% during the first quarter, including the impact of 12 net new restaurants versus prior year, driving continued profitable market share gain.

As we discussed with you in June, Longhorn will benefit from increased media support compared to prior year beginning this month, beginning in September.

And the brand is well-positioned to remodel another 90 existing restaurants and open 20 to 25 net new restaurants this year.

We are pleased with the increasing momentum at Longhorn and look forward to continued industry outperformance going forward.

As we reflect on the quarter, we're very pleased that we were able to outperform the industry by 110 basis points on same restaurant sales, and by 340 basis points on total sales.

Increase our operating margins at all three of our large brands, and deliver 19% diluted earnings per share growth.

As Brad said, we believe this is further evidence of the strength of our brand portfolio, our business model, and the appropriateness of our strategy to achieve consistent sales and operating profit growth.

Now I'll hand it back to Clarence for some final comments.

Thanks, Drew.

I'm very pleased that we were able to deliver 4% sales growth and 19% earnings per share growth this quarter and that we continue to increase our market share.

And that share gain's being driven by both stronger than industry same restaurant sales, and stronger than industry new restaurant sales growth.

From a same restaurant sales perspective, we understand that the magnitude of our positive gap to the industry is going to vary from quarter to quarter.

But we're confident we'll continue to outperform.

And we're confident because we believe we're well-positioned.

We've got great brands.

We have an increasingly effective and efficient brand support platform.

We've got exceptionally talented people who are working well together, and finally, though it's not as robust as any of us would like, we have tailwind in the form of a recovering economy and a recovering industry.

Now, with these strengths, we were able to deliver strong results this quarter and these strengths are why we believe that as the economy continues to recover for Darden, the best is yet to come.

And with that, we will take your questions.

So thank you.

Brad, can we open it up for questions?

(Operator Instructions).

Our first question will come from David Palmer with UBS.

Please go ahead.

Good morning.

Stephen Carlson here for Dave.

We've now seen two quarters where your gap to the industry has been below what we believe many would have thought, and this has largely been due to Red Lobster.

Why do you think this is and what learnings have you taken from the sales shortfall at Red Lobster?

Thank you.

Brad, I'll start and then I'll let Drew finish.

This is Clarence.

I think as we think about it, we look at our entire portfolio.

We manage to portfolio and pull different levers at different brands and we talked about that really at the start of the last fiscal year.

And so we're really working the different promotions, trying to make make them complementary across the brands.

For us, the critical numbers are, one, what the entire portfolio does compared to the industry, and two, the earnings that we get out of that.

I would say from an entire portfolio perspective on a sequential basis, the gap to the industry increased.

We think that's a good thing.

We also think that we'll continue to outperform the industry.

And a lot of the industry increase this quarter came from a higher check average than we anticipated.

We feel pretty comfortable with our pricing and our check average growth and to the extent that industry check average continues to be at elevated levels like they were in the first quarter, that probably means a little bit of a shrink in our gap to the industry, but we talked at the beginning of the year about our blended comp being 2% to 3% and we think that that's where we'll wind up.

We think we're pretty much on track to do that.

And as it relates more specifically to Red Lobster, I guess I'd have you take a step back and reflect on where the brand was, where it's come, and what our priorities are today.

If you look back several years, heading into last fiscal year, Red Lobster had outperformed the industry four consecutive years on same restaurant sales and they had done that by improving the fundamentals, the consistency of the experience and the quality of the experience, so guest satisfaction going up, the introduction of today's fresh fish, wood fire grilling, improved culinary expertise, all those things.

When the industry really slowed down last summer and competitive discounting really elevated, the strategy we had needed to be adjusted, and that's why in the second half of last year when we started with the seafood dinner for two, we began adjusting our promotional tactics to recognize that while the industry is improving, consumers remain cautious.

Red Lobster has a higher than average check and we need to focus a little bit more on providing price assurance as it relates to affordability.

Those tactics work very well for us in the third quarter last year.

They didn't work as strongly, the specific tactics we chose did not work as strongly as we would have liked in the first quarter this year.

We think we've got a good understanding of why they didn't for American Seafood Adventure and Crabfest and we're building that learning into the tactics that we're going to use going forward.

I think that's primarily the reason.

And I think just one last comment.

It is an environment, given the overall macro situation we find ourselves in, where we're much more tactical as everyone else is than we would be in a more normalized environment and so some things are going to work as expected, some not quite as well, some better.

And so you've seen a little bit more of that sort of period to period volatility.

For example, the fourth quarter, our tactics at Olive Garden didn't work as well as we would have hoped.

In the first quarter, they were spot on.

And we think we're pretty good at it which is why we think we've continued to take share.

On a same restaurant basis, and to amplify that share gain with the new restaurant growth that we've got.

And our next question comes from Brad Ludington with KeyBanc Capital Markets.

Thank you.

I wanted to start off with a brief house cleaning question.

If you do the breakdown in sales that you gave by brand in the release, it comes out a little higher than your total sales number on the income statement.

Is there some gift card breakage or something that's not included in those numbers you gave by brand?

No, if you're looking at same restaurant sales, there are a number of stores, restaurants, that aren't in that base yet because we wait until they're 16 months past their opening.

So that would comprise any real difference.

There's no meaningful adjustments at all to breakage rates or anything like that.

I was looking at total sales coming out higher than what the 1806.7.

Comes out to 1810.

Hard to reconcile.

I think there's probably just some rounding of these numbers.

Okay.

And then I just wanted to ask, a big concern that a lot of people have right now is commodities into 2011.

It's good to hear that you're looking at 0.5% of commodity inflation in the second half of your fiscal year.

Seems like you think you have it under control pretty well at least through then.

Is there any color you can give on contracts on commodities?

It seemed like most of them ended by the end of calendar 2010 last time we talked or maybe a few got extended a little bit.

Yes, we've extended some modestly from where we were.

If we just look at through the end of the calendar year, we're 90% or more forward contracted on those prices.

As you look to the new calendar year, we have a number of items that we contracted for.

I would say we're probably on a collective basis around 40% or so marked there.

We do look at some of what's going on with grain prices and some of that as not really being sustainable at those high levels and so we haven't taken further protection on those.

But we like the positions we have right now and we believe that time will work to our advantage on many of those commodity prices that we're looking at today in the spot market.

Okay.

I'm sorry, was that 40% through fiscal 2011 or calendar 2011?

No, that was for the last half of the year.

Okay.

Of our fiscal year.

Okay.

Thank you.

Our next question comes from Jeff Omohundro with Wells Fargo.

Please go ahead.

Yes, thanks.

Another question on Red Lobster.

I just want to dig into it a bit more.

The Crabfest promo, I would have thought there would have been some pretty good pent-up demand around that.

It's been a while since you've run crab.

I was a bit surprised to hear that that didn't apparently meet expectations, given the product lineup.

Even with that price point.

I'm just wondering, is it really the price assurance that you need to drive more or could part of it -- I suppose there's no way to quantify it, but maybe you can talk to lingering effects of the Gulf oil spill impacting Red Lobster.

Well, I can speak more specifically certainly to Crabfest promotion and just to step back one more time, when we put together our promotions, we -- particularly a new promotion like Crabfest that we haven't done for quite some time, we go through a fairly rigorous innovation funnel, if you will, in terms of evaluating everything from the conceptual appeal of the promotion, so does Crabfest as a promotion have appeal, to the dishes in that promotion, testing it in restaurant to make sure that guest satisfaction and menu mix are as expected, and then advertising it on television in multiple markets to see if it drives traffic.

We did all of that on Crabfest and on balance, we're very pleased with the results we saw in the test.

We also thought we saw some opportunities to enhance the results that we got in the test.

We adjusted the product lineup modestly and we increased the price from $12.99 in the test to $14.99, and I think -- because the test results were so strong and I think in hindsight that's why I said the $14.99 price point might have been just a little bit high.

We did a seafood dinner for two offer that had basically a $15 per person price.

That's what gave us confidence, because that promotion was very successful but it just shows you that every concept and every set of products and every price point is unique, and that's our reflection looking back on it.

And that's why I say we've got good insight we believe into what the opportunity was there.

To your question about the Gulf oil spill, certainly that was a big topic, particularly earlier in the summer, particularly June and July, and as closely as we've looked at it, it is just a very, very difficult thing analytically to separate from everything else that all the other moving pieces that are out there.

So it's just too difficult for us to separate it and quantify it, although it's on everyone's mind, particularly in the summer.

As a follow-up on Olive Garden, wonder if you could just give us an update on the service and throughput initiative progress that you're making at that brand.

Thanks.

Well, we started -- I mean, that's another program that we tested pretty comprehensively in the second half of last year and at its heart, it's about giving guests better service by giving them a more accurate wait quote time and based on that, also understanding where we have opportunities to turn tables faster and increase guest throughput.

So there's a guest satisfaction and a guest count opportunity that we demonstrated last year.

And it's enabled by a new table management system.

We've rolled that out to roughly 150 restaurants at Olive Garden at the end of the first quarter.

We hope to be in position to have it fully in place before the holidays across the Olive Garden system and then going forward, not this year but in future years, we'll look at the applicability of that system at our other brands as well.

And our next question comes from the line of Nicole Miller with Piper Jaffray.

Please go ahead.

Good morning.

I was just wondering if we could get some color on Capital Grille comp trends, just how things progressed throughout the quarter and what is the price versus traffic component.

And then also as you look to accelerate the specialty restaurant side of the portfolio, to kind of higher end position concepts, how do you see the supply and demand in that higher end space versus traditional casual dining?

Thank you.

Nicole, this is Gene.

As far as trends for Capital Grille, as the environment showed some improvement in the first part of the calendar year, we reduced some of the incentives we used last year, and that's why our sequential trend was down a little bit.

Also, we saw some weakness around Memorial and July 4th holiday.

Overall, we continue to experience growth during the week as business travel and entertainment continues to grow.

As far as traffic and average check, we're still seeing pressure on average check, primarily being driven by a reduction in add-on sales and some reduction in alcoholic beverage.

The third question was around supply and demand for upscale restaurants.

Obviously, we see and are experiencing less on the demand side compared to where we were two or three years ago, not a lot of new high end restaurants being built out there, which is providing us an opportunity from a development standpoint.

We're well along the way with adding additional Seasons 52s and Capital Grilles, and we believe the environment right now, it's a good time for us to grow both of these brands.

Thank you.

And our next question comes from the line of Joe Buckley with Bank of America Merrill Lynch.

Mr.

Buckley, your line is open.

Is your mute on, by chance?

And we can move on to the next line.

The next question will come from John Glass, Morgan Stanley.

Please go ahead.

Hi.

Thanks very much.

I wanted to go back to your suggestion that you've seen greater sustained level of discountings in the industry and yet the check is rising faster than you had expected in the industry.

And that, therefore, you may not keep up with that check increase.

That seemingly is a disconnect.

I guess you suggested some high end restaurants are the ones that are driving the check up but on a weighted basis those don't seem to be that important in the overall Knapp-Track, so if you could just clarify that.

If the check is rising and consumers are willing to pay more for whatever reason, why won't you participate in that benefit.

I have one follow-up after that.

In terms of the dynamics we see on check, there's some art and there's some science in terms of trying to separate what's driving that.

The check increase of 2.6% was meaningfully higher than the prior quarter and conceptually that could be driven by discounting, as you said, pricing, menu mix, or within the Knapp-Track grouping by brand mix as well.

And when we look at the levels of discounting at the biggest chains out there, first quarter this year versus the first quarter last year, for the most part it's pretty comparable.

And that's looking at Applebee's, Chili's, Friday's, Outback, our brands.

Chili's started their promotion this year, their Two for $20 a little later than they did last year, but on balance the aggressive discounting is pretty similar and as a result, what we think is driving the increase isn't a dramatic change in the level of price point and deeper discounting, but it's a core menu pricing and menu mix which I said we view favorably and we think it's important to take consistent levels of pricing, so that you can over the long period maintain your business model integrity and not shock your guests with big price increases that maybe have been artificially delayed for a year or two.

So we view any check increase related to modest and appropriate pricing as positive, and we will continue to do that.

Now, on the other hand, we know it's a very value sensitive environment still, and we are not going to be overly aggressive as it relates to the items we feature in restaurant promotionally on our collateral material, to more aggressively increase check beyond that.

As it relates to your question on the brands, we're not really -- the brands that have a higher check and maybe are doing -- have improving trend in same restaurant sales and as a result lifting the Knapp-Track average, we're really not there referring to brands like Capital Grille, we're more referring to systems like Outback Steakhouse, Ruby Tuesday, that sort of thing.

Got you.

Just a follow-up.

So your comps year-to-date or first quarter, 1.1%, you're sticking with the two to three, but you're lapping easiest comparisons of the year right now.

What's the justification for not lowering that range or at least tightening it to say, two instead of two to three?

Well, we think a couple of things.

One is we do think the industry environment will continue to improve through our fiscal year.

And so we talked about that actually at the beginning of the fiscal year, that we thought that that would be the case.

We met a lot of skepticism, but in fact it has.

And so the industry was down I think about a point, if I remember, in the fourth quarter, flat this quarter.

We think it will continue to improve through the year.

We expect our business to continue to improve through the year as the economy recovers.

The slope of that recovery is not going to be as steep as any of us would like, but as we plan the year we expected it to be a slow slog but nevertheless an improvement and we expect to participate in that improvement.

Our next question comes from the line of Jeffrey Bernstein.

Please go ahead.

Great.

Thank you.

Actually, just a follow-up on the comps and then a separate question on labor.

Just first on the comp side, the sequential comp trends it looks like August decelerated on a one and two year basis, I think even after adjusting for the Red Lobster promotional shift.

Obviously seems to be a little contrary to people getting excited about the Knapp-Track trends improving.

Wondering if you could talk specifically about the sequential deceleration and whether you could give any color on how September has begun obviously with Red Lobster seeing the benefit but more broadly the very current sequential trends and then I had a follow-up on labor.

Thanks.

Well, I have to go back and look at our promotional calendar for August.

I mean, months are not things that we pay a lot of attention to because there's a lot of noise.

In our promotional calendar, in the actual calendar, Labor Day came pretty late this year.

It may have come earlier last year.

The start of back-to-school effects.

We think that the quarter last year, if I recall, got better from June to August and, you know, that's about what we saw this year, if I recall.

And the biggest change for us was Endless Shrimp being delayed in August which had a material impact on Red Lobster and would have a material impact on the blended comp for Darden as well.

Does that bode well for September?

Is there any thoughts on the first 21 days of September?

Well, as I said, there's also one less week of Endless Shrimp advertising in September this year compared to last year as we because we delayed the whole promotion two weeks.

We'll be picking up a week in the end, in November.

And then just separately in terms of the labor side of things, it looks like it turned favorable in each brand in 1Q based on your qualitative commentary in the press release and.

Unfavorable at each brand over the last four quarters.

I know you mentioned I guess productivity gains and lower turnover.

I'm just wondering obviously it helps to have positive comps, but is it sustainable at these levels or even greater if comp trends improve.

I know you didn't give much color in terms of the labor outlook for the rest of this year.

Thanks.

What we say on the restaurant labor is you're exactly on point there with the leveraging that comes with same restaurant sales growth.

That's typical with our business models and how we look at and manage labor so that is the key driver.

Fundamentally under that is the progress that we've made on improving productivity through many of our investments that we've made, close adherence to some our processes and the continued benefit of the low turnover in the industry, so less time has to go into training and attracting new employees.

And in terms of looking further out for the year, I will say it will be highly dependent on same restaurant sales progress.

As I mentioned in the beginning there, it is a big driver.

But vis-a-vis last year, we would expect to continue to see improvement with same restaurant sales progress.

Our next question will come from Larry Miller from RBC.

Go ahead.

Thank you very much.

I actually had two follow-ups.

And Clarence, I think you said that you expected industry traffic to improve and a lot of us have very limited visibility on just about any kind of sales metric.

Can you give us some help?

What are you looking at that gives you some confidence that industry traffic should continue to improve for you?

Yes, we actually work with an econometrics shop to really try to get a feel, starting with just the macro.

So we've got economists that start with same sort of variables that you start with, GDP growth, all of those things.

We've been working with this group, Market Outlook, for many, many years, and so we've got some factors that we think correlate the economy to consumer spending and then to dining out in particular.

And so we do see GDP growth as opposed to decline.

We don't think it's going to be tremendously exciting growth.

1.5%, 2%, but that does drive stronger sales than we've seen over the past 18 months, as we look at all the factors that are correlated to that.

And so that's essentially how we start.

And then we look to see, does what happens in fact validate those assumptions.

The first quarter's about what we thought it would be, maybe a little bit stronger.

Yes, because of check, as opposed to traffic.

Traffic's about where we thought.

Check's a little higher.

Okay.

And then on that comment that you're seeing improvements in higher check average concepts, Red Lobster's clearly one of those, and I was just curious, Drew, if you had any thoughts about is it actually too high or why you're not seeing that better trend.

Is it a customer issue?

Is it a more lower end customer than some of the ones you mentioned.

Maybe in context in your answer, could you talk about how the full price or higher item price menu items are selling relative to some of those promotional items.

Thanks.

Yes, well, Red Lobster has, as you indicated, higher than average check and their customer base is a little lower on income directionally than some of our other brands, and as a result we decided that we need to emphasize affordability more, not deep discounts, but affordability.

And when we've done that effectively, as we did last year with the seafood dinner for two, we drive profitable same restaurant sales growth and we drive improving guest satisfaction.

We didn't do it as effectively with the tactics in the first quarter as we would have liked or as effectively as the testing we did leading up to the quarter would have indicated it should have worked and as Clarence said, some tactics work better than others and we're building the learning from that into what we do going forward.

But it isn't a -- it's less a base business question, it's less a brand question, it's more a promotional effectiveness question during the first quarter.

Thank you.

And our next question comes from Jonathan Comp with Baird.

Please go ahead.

Thanks for taking my call.

It's Jonathan Comp calling in for David.

My question is related to the margin outlook for fiscal 2011.

I know you've touched a little bit on some of the line items, labor and a few others.

But I'm wondering a little bit more specifically, given the strong margin performance that you saw in Q1, I'm wondering if there's any specific updates.

I think previously you had expected roughly 70 to 100 basis points overall operating margin expansion for the year and I'm wondering if that view has changed at all.

Jonathan, this is Brad here.

When we look at that time margin performance in the first quarter, we look at it as being very strong.

We would at this point look at an annual number that's very similar to what we achieved in the first quarter.

Now, it's going to vary some with the seasonality of our business but we see the -- as I mentioned earlier, the improvement at the food and beverage line continuing, maybe not as at high level that we've seen right now.

We talked some about the ability to leverage same restaurant sales growth and the positive impact that can have on restaurant labor.

So we see those as the two biggest opportunities for us to continue to have healthy margin improvements over the prior year.

I think on some of the other expenses, there's different activities going on, but they'll be in the range of where they were last year, maybe some slight improvements, or maybe a little bit above, depending on the opportunities we see to invest and grow the business or to capture some of the opportunities out there.

But the business model that we have, the support platform that supports the 1800-plus restaurants out there is very strong, continues to get stronger, and enables us to really leverage the same restaurant sales growth as well as the meaningful new unit growth that we have as we move forward here.

So nothing has really changed from the beginning of the year in terms of the overall picture, little pluses and minuses, but still pretty darn solid.

I would just, this is Clarence, just add, we talked for quite a while about three of what we called transformative sort of cost initiatives that we've been pursuing, so further automating our supply chain, centralizing our facilities management, really driving sustainability, so we reduce our water and cleaning supply and energy usage in our restaurants and we've talked about the fact that each of those, fully implemented, has pretty significant annual cost savings and that we are achieving those.

And so we're moving toward that big number and we're getting incremental year-over-year improvement from each of those this year.

We got some last year.

We expect more next year, and so that certainly is helping across a lot of different line items.

Okay.

Thanks.

That's very helpful color.

Just Brad, to dig in a little bit further on the cost of sales ratio, I think you said 28.5% might be a good target for the full year on that ratio.

I'm wondering, does that still include expectations for roughly 2% pricing for the year, and then if it does, how that might look throughout the year as we go on in the coming quarters, given that Q1 was slightly below that level?

I'd say the pricing will be probably right at 2%, maybe slightly below that, we can look at the different brands there.

But pretty close to that.

As we're seeing, there could be some mix change as promotions develop and all that.

But no, I think the pricing obviously is impactful, all the line item analysis, and we look at the pricing that we have in there, just below 2%, and the cost pressures that we're looking at, inflationary pressures on commodities, as well as the items that Clarence mentioned that helped mitigate some of those costs, we're making good progress on capturing some of those gains this year that 28.5 seems to be a pretty good number for us to be expecting.

Okay.

Thank you.

And our next question comes from Mitch Speiser with Buckingham Research.

Please go ahead.

Thanks very much.

Regarding the food cost outlook, 0.5% is the guidance for the second half of the fiscal year, and I believe what you said is that that reflects commodities coming down from current levels.

Could you give us a sense of what percent would your non-contracted food basket have to come down from current levels, to meet that 0.5% back half forecast?

Mitch, Brad here.

No, we're saying in the back half of the year that there will actually be inflation in our commodity basket of about 0.5%.

Right.

Right.

I think I got that.

And it does reflect, though, commodities coming off recent levels, I believe.

So you're making I guess a forecast that the current levels of some of your non-contracted food costs are not sustainable and coming off.

So I just want to get a sense of how much do you think off of these levels, on a year-over-year basis these non-contracted foods have to come down in order for your 0.5% inflation forecast to be met?

I think what we're saying is the non-contracted items would be coming up from where we are today, of about 0.5% or so.

Not coming down.

And I think if you're trying to tag it to spot market, that's not really relevant to us.

And we would have to go through every cost item, because some of these we don't expect to come down from current market levels.

Some of them we expect to go up.

And some in the wholesale market that we play in are going to be flat and some others will come down slightly.

But we would have to walk through item by item.

Okay.

And maybe just to get it right, you are expecting, though, some of the items that you look at today, you're not contracting them today because you think they are going to come down and then you probably will be aggressive in locking in items.

Yes.

We will opportunistically lock in some of those prices.

We're not doing that at the levels they're at today.

We do think that they will mitigate some as we move through our fiscal year.

Some of them do that.

That's just the annual rhythm of the market.

I mean, so there are seasons where you don't -- you shouldn't lock in and other seasons where you should.

So beef is one of those seasons where we're starting to get closer to where you probably should lock in, but we've never done that in the summer months.

Great.

Thanks.

If I could slip in a second question on traffic.

Industry traffic is still running negative, I believe Knapp-Track is for your fiscal first quarter was down about 2%, 2.5%.

Is it your call that traffic will swing positive in fiscal 2011 at some point or are the comps improvement primarily driven by this average ticket trend that you're seeing?

Yes, I think our assumption for the industry for the year is that traffic will be negative.

I mean, we think sales will be negative.

We thought minus 1% for the year.

We thought for sure traffic would be negative which is why, again, we don't think we're forecasting a real robust recovery but it will improve.

I mean, it will be better than it was prior year.

Thank you.

And our next question will come from Howard Penney with Hedgeye Risk Management.

Thanks.

Clarence,following on what you just said, I'm a little confused as to sort of how you view the industry improving.

If you've got GDP growth going from 5 to 3 to 1, round numbers, the ABC comfort index was down 3 points last night, and the University of Michigan confidence number's now down 10 points at the end of July.

So how again do you get to an acceleration in sales when you have all the economic metrics decelerating?

These numbers, the numbers that we really care about are the GDP numbers and the growth in discretionary and personal income and those numbers are better than they were.

I mean, if you look a year ago, our industry was a negative I think on sales a minus 8%, roughly.

To go from that to flat reflects an environment that simply is better.

It's been getting better sequentially for the last several quarters.

We expect that to continue.

We think a lot of it has to do with the job market, while not adding jobs, it's not shedding jobs which is what we were doing a year ago.

And so we think the sequential improvement that we've seen will continue.

If I could just follow up on Red Lobster, everything you've spoken to today on the call sort of -- what you've done the last couple years, improvement in the concepts, in the execution within the store, yet it is not participating in what you've clarified today as sort of a higher end change to a better, higher check change doing better but the change that you suggested would put Red Lobster in that category as well.

So is there something about maybe the asset base hasn't improved enough or maybe your core consumer that goes there, you haven't broadened out the consumer that you're bringing in?

Is there something else?

I'm confused.

As we think about it, again, and look back over the last couple of years, you had an environment where despite its much higher than industry average check, Red Lobster was gaining share.

Most of the people that had check that was comparable to Red Lobster were seeing some fairly significant declines and share declines and now they've stabilized.

I guess that's how we think about it.

And that stabilization is good for them, but Red Lobster has been a share winner and so there are not as many guests to recover, I guess, as some of the other chains.

And I would add that what it's taken for them to stabilize from a promotional strategy standpoint is far more aggressive than what we're doing at Red Lobster and while it may be leading to same restaurant sales stabilization, it's less clear what it's doing to operating margins and profit.

And then just to go back to the prior question, because I dug out the numbers, but first quarter last year industry down 7.8%, down 6% in the second quarter, 4.2 in the third, 1.4 in the fourth, flat now.

And we expect that sequential progression to continue.

Actually we expect the progression to decelerate, but still continue.

And our next question will come from Bryan Elliott with Raymond James.

Actually, been answered.

Thank you.

And we move on.

Our next question is John Ivankoe with JPMorgan.

Please go ahead.

Thanks.

A couple quick ones.

It seems like there are some opportunities still with acquisition synergies and other initiatives that you've identified previously to save on costs and you're doing a better job of managing labor, but the turnaround is slower than even your projections, I mean, which don't sound like they're very robust for the industry overall.

Are you willing and do you have the opportunity to cut other costs in the business, we might be up for prolonged consumer weakness, to protect the overall economics of the business?

I would say yes, John.

We talked about the three items that have been on the table from a transformative cost perspective.

There are other things that could be placed on the table.

Obviously, there's opportunity cost to pursuing those, because in many cases it touches a lot of people throughout the organization, and gets in the way of having them deployed to build sales, but to the extent that we didn't think the sales building opportunity was there, we incur that cost.

I would add, as Clarence mentioned earlier, the three major transformational projects we're working on are progressing on or ahead of the pace that we've communicated in the past and the level of incremental savings this year compared to last year from those three projects is meaningful.

Okay.

Thank you.

And then just quickly, given current interest rates, especially for a Company like Darden being I guess at all time lows, do you have any opportunity to refinance the balance sheet or does it now make sense to even extend the balance sheet beyond or the debt on the balance sheet beyond current levels?

John, Brad here.

We continue to look at that and have made some hedging of some of our future anticipations.

When you get the Q, you can see more of those.

We see this as a very favorable interest rate environment so we're locking some of those up.

But what I would say is the strong cash flows from our business and our ability to reinvest that into the remodels and new unit growth, we're still generating excess cash so we're returning that in the form of the increased dividend and meaningful share buyback in this quarter, and anticipate that continuing throughout the fiscal year.

So yes, it's a good time to be borrowing but we also have strong cash flows.

We don't have a need to do that but we're managing it as prudently as we can in terms of our debt balances.

Okay.

Thank you.

Brad, we've got time for one more question, please.

All right.

That question can come from Joe Buckley with Banc of America, Merrill Lynch.

Please go ahead.

Thank you very much.

Sorry for the confusion before.

Just a clarification question on the food cost.

I know several have been asked already.

Sort of clarifying, you're saying inflation for the food basket in the second half will be up by half a point and not food costs as a percent of sales and maybe in the context of that answer, could you talk about seafood and beef specifically, what you have locked and for how long?

Joe, this is Clarence.

And it is half a point in our food basket as opposed to percent of sales, that's right.

Yes.

And Clarence kind of mentioned earlier about the seasonality in beef so we're entering that period where we have the least amount contracted forward, so if we look into the new calendar year we're in that 20%, give or take a little bit range there because this isn't the time that you would seasonally do that.

But we're approaching that.

I think you mentioned on seafood, particularly if you look, the shrimp, lobster, crab, the big items, we're two-thirds or more forward price protected on those items.

So a big part of it is done.

The piece that we're still waiting to move on would be the beef component, though.

Okay.

And then just one additional follow-up.

On the Olive Garden table management system that you're in the process of rolling out, just remind us sort of what's involved there.

Is there any new technology or is it scheduling, or is it just the way you're covering servicing the tables with the staff?

Yes, I would say, Joe, this is Brad, it touches a pretty broad area but it starts with the lobby experience and trying to make that better by really getting away from what today exists of a pen and paper with the greeter that is fairly pressured to give a quote time.

So the first step is to provide a more accurate quote time.

And so that makes it -- the lobby experience for the guest, you're getting a better time.

They don't potentially get an artificially long time, so that you're not faced with frustration of not meeting the expectation there.

That is a technology solution.

It's automated.

Automated.

So that is a much more fail-proof system, increases consistency and accuracy throughout the whole system.

It also gets us into managing the dining room better so we know where there's open tables and how to better manage those.

It also ensures that all the checks are rung up so there's some advantages there and it importantly gives us a new point to help project guest counts because now we can measure how many guests are waiting to get into the restaurant that you typically can't capture in our old system, so we can better anticipate demand, better staff the dining room for the guests when they're ready to come versus when we're ready to serve them.

So it really touches a broad array of items for us in terms of managing the overall guest experience to make it better, managing our P&L and the results for Olive Garden have been pretty meaningful.

So we're pleased with that and as we've talked about, we'll move that through the Olive Garden system and then opportunistically we'll move into our other brands as well.

It is a technology solution, so both hardware and software?

Okay.

Thank you very much.

We would like to thank everybody for joining us on the call today.

We recognize that there were several of you still in queue.

We're here in Orlando to answer questions.

Please give us a call.

We look forward to speaking with you in three months in December.

Thank you very much.

Ladies and gentlemen, that does conclude our conference for today.

Replay will be available after 10.30, running through October 22nd, at midnight.

You may access the AT&T executive playback service by dialing 1-800-475-6701 and entering the access code 170692.

International participants may dial 1-320-365-3844.

Those numbers again, 1-800-475-6701, and 1-320-365-3844, with an access code 170692.

That does conclude our conference today.

Thank you for your participation and for using AT&T executive teleconference service.

You may now disconnect.