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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

Matthew DiFrisco - Oppenheimer

Brad Luddington - Keybanc Capital Markets

Jeff Omohundro - Wachovia

John Glass - Morgan Stanley

David Palmer - UBS

John Ivankoe - J.P. Morgan

Jeff Bernstein - Barclays Capital

Steven Kron - Goldman Sachs

Joseph Buckley - Banc of America

Bryan Elliott - Raymond James

Darden Restaurants, Inc. (DRI) F2Q09 Earnings Call December 19, 2008 8:30 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the second quarter earnings release conference call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Matthew Stroud. Please go ahead.

Matthew Stroud

Thank you, Katy. Good morning, everybody. With me today are Clarence Otis, Darden's Chairman and CEO; Drew Madsen, Darden's President and Chief Operating Officer; 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. We wish to caution investors not to place undue reliance on any such forward-looking statements. 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. 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, disruptions in the financial markets, possible impairment of good will or other assets, 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 third quarter earnings and same-restaurant sales for fiscal December, January, and February 2009 on Tuesday, March 17th after the market close. Also, we will hold an analyst and institutional investor meeting in Orlando on January 22nd and 23rd, 2009, and this event will also be webcast for those unable to attend.

Yesterday we released second quarter earnings in the afternoon. These results were available on PRNewswire, First Call, and other wire services. Let’s begin by reviewing our second quarter earnings results.

Second quarter net earnings from continuing operations were $58.5 million and diluted net EPS from continuing operations was $0.42, representing a 40% increase 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 $0.02 in the second quarter. Excluding estimated integration costs and purchase accounting adjustments for this year and last year, net earnings from continuing operations were $0.44 per diluted share in the second quarter this year, compared to $0.39 per diluted share last year, or a 13% increase.

Brad will now provide additional detail about our financial results for the second 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.

Brad Richmond

Thank you, Matthew and good morning, everyone. Darden's total sales from continuing operations increased 9.6% in the second quarter to $1.669 billion, driven by the addition of Longhorn Steakhouse and The Capital Grille and meaningful new restaurant sales growth at Olive Garden. The incremental sales from Longhorn Steakhouse and The Capital Grille totaled $100 million for the quarter.

Let’s review the same-restaurant component of our total sales growth and for context, industry same-restaurant sales as measured by Knapp-Track and excluding Darden were down an estimated 5.3% for the quarter.

Olive Garden's same-restaurant sales were up 0.8% for the quarter, its 57th 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 6.2%.

Red Lobster had a same-restaurant sales increase of 0.3% for the quarter, which is 5.6 percentage points above the Knapp-Track industry benchmark and its total sales increased 0.2%.

Longhorn Steakhouse same-restaurant sales decreased 5.7% for the quarter, while its total sales increased 2.4% because of the addition of 19 net new restaurants.

On a blended basis, same-restaurant sales were down 0.2% at our three large brands, which outperformed the Knapp-Track industry average by 5.1 percentage points.

The Capital Grille had a same-restaurant sales decrease of 8.7% for the quarter, while total sales grew 3% due to the addition of four net new restaurants.

Bahama Breeze had a same-restaurant sales decrease of 8.0% for the quarter. The quarter was also favorably affected by the Thanksgiving holiday week shift. This week shifted from our second quarter in fiscal 2008 to the third quarter in fiscal 2009. As a result, same-restaurant sales results were positively impacted approximately 70 basis points. We anticipate that the Thanksgiving holiday shift will adversely affect the third quarter of fiscal 2009 by approximately 70 basis points.

Our second quarter earnings surpassed last year’s results. Diluted net EPS from continuing operations of $0.44, which excludes the integration cost and purchase accounting adjustments of $0.02, was $0.05 ahead of last year’s second quarter diluted net earnings per share of $0.39. Of this year’s amount, the Thanksgiving holiday week shift contributed approximately $0.02 to $0.03 of earnings per share.

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

Turning to food and beverage expense, they were 78 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 71 basis points of the increase. Excluding the mix changes, food and beverage expenses were approximately 7 basis points unfavorable.

Our outlook for the fiscal year is that food and beverage expenses as a percentage of sales will be approximately 50 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 of the impact in fiscal 2008. So excluding the mix changes associated with the acquisition, food and beverage expense as a percent of sales would be flat to last year, which primarily reflects the cost-savings initiatives we have undertaken and the improving cost environment we see today.

Second quarter restaurant labor expenses were 37 basis points lower than last year on a percentage of sales basis, due primarily to mix changes associated with the addition of RARE Hospitality, which lowered labor expenses by approximately 44 basis points. The changes in this mix more than offset wage rate inflation of 2% to 3%.

Our outlook for the fiscal year is that labor expenses as a percent of sales will be flat to last year on an as-reported basis but excluding the mix changes associated with the acquisition, we expect restaurant labor as a percent of sales to be approximately 20 to 30 basis points unfavorable to last year.

Restaurant expenses in the quarter were 50 basis points higher than last year on a percentage of sales basis. The mix changes associated with the impact of the RARE Hospitality acquisition and purchase accounting adjustments account for approximately 20 basis points of the increase. Excluding the mix changes, restaurant expenses are approximately 30 basis points unfavorable, due primarily to higher utilities and worker compensation public liability expenses.

Our outlook for the fiscal year is that restaurant expenses as a percent of sales will be approximately 60 basis points unfavorable to last year on an as-reported basis. Excluding the mix changes associated with the acquisition, we expect restaurant expenses as a percent of sales to be approximately 40 to 50 basis points unfavorable to last year from the impact of higher energy costs in the first half of our year and sales deleveraging.

Selling, general and administrative expenses were 243 basis points lower as a percentage of sales for the second quarter. The acquisition and integration costs associated with the impact of the RARE Hospitality acquisition account for approximately 130 basis points of the decrease. The remaining favorability is due to favorable year-over-year litigation expense comparisons, meaningful acquisition synergies, leveraging of our total sales growth, lower incentive and benefit related cost, and the impact, the significant impact of lower turnover cost on manager recruiting, training, and deployment.

Our outlook for the fiscal year is that selling, general, and administrative expenses as a percent of sales will be approximately 70 to 80 basis points favorable to last year on an as-reported basis.

Excluding mix changes and integration costs associated with the acquisition, we expect selling, general and administrative expenses as a percent of sales to be approximately 30 basis points favorable to last year.

To summarize, operating profit, or EBIT, was 124 basis points higher as a percentage of sales for the second quarter. Of this variance, 60 basis points was due to the absence of RARE acquisition costs and mix changes associated with the acquisition, while the remainder was due to positive total sales leverage and cost savings initiatives. Our outlook for the fiscal year is that operating profit as a percent of sales will be approximately 70 to 80 basis points unfavorable to last year on an as-reported basis.

Excluding the mix changes and integration costs associated with the acquisition, we expect operating profit as a percentage of sales to be approximately 40 to 50 basis points unfavorable to last year.

The effective tax rate for the second quarter of 29.1% was higher than our previous guidance and higher than last year’s rate. Last year we received some tax credits associated with the RARE acquisition that lowered our effective tax rate. We anticipate an annual effective rate of 27% to 28% for fiscal 2009.

For the quarter, we repurchased 2.3 million shares for approximately $58 million. Year-to-date, we have repurchased 4.4 million shares, spending $127 million. We have 11 million shares remaining in our current authorization and depending on market and business conditions, we may repurchase up to $200 million of shares in fiscal 2009.

And yesterday, we announced a dividend of $0.20 per share payable on February 2, 2009, to shareholders of record on January 9, 2009. Based on the $0.20 quarterly dividend declaration, our indicated annual dividend is $0.80 per share.

Our revised outlook anticipates blended U.S. same-restaurant sales for Red Lobster, Olive Garden, and Longhorn Steakhouse of minus 1.5% to minus 3.5% for the second half of the year, and when combined with the minus 1% for the first half of the year, results in fiscal 2009 same-restaurant sales decline of approximately 1.25% to 2.25%, as stated in our press release yesterday. And we now expect to open approximately 70 net new restaurants in fiscal 2009.

As a result, we anticipate total sales growth of between 8% and 9% in fiscal 2009, compared to the reported sales from continuing operations of $6.63 billion in fiscal 2008. This total sales growth includes the approximate two percentage point impact of a 53rd week in fiscal 2009. Excluding the 53rd week, the expected total sales growth would be approximately 6% to 7%.

Even in this difficult economic environment, our cash flow remains strong. We anticipate generating free cash flow of $10 million to $35 million before share repurchase and any additional CapEx spending adjustments for this fiscal year.

We anticipate reported diluted net earnings per share declines from continuing operations of minus 1% to minus 6% in fiscal 2009, which includes an 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 $0.06 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 $0.08 per diluted share. Excluding the impact of these costs and adjustments for both fiscal 2008 and fiscal 2009, the company expects diluted net earnings per share declines of minus 5% to minus 10% on a 53-week basis.

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

Andrew H. Madsen

Thanks, Brad. As has been mentioned, we were pleased to deliver solid financial performance in a very difficult environment during the second quarter and overall, we believe this performance was driven by three key factors. First, we benefit from brands that have earned competitively superior breadth of appeal and guest loyalty over many years. When consumers reduce their restaurant visits, brands like Olive Garden and Red Lobster are less likely to be dropped from the consideration set.

Second, we were able to successfully strengthen our advertising and promotion plans to address the growing consumer need for increased value and affordability. And finally, our teams have identified and aggressively pursued significant new cost management opportunities across the business, in our restaurants and at the restaurant support center, without adversely affecting either the guest experience or the employee experience.

Now let’s talk about the performance in specific priorities for each brand, starting with Olive Garden. Olive Garden’s key strategic priority this fiscal year is to sustain strong new restaurant growth while maintaining same-restaurant excellence and they continued to deliver against that priority during the second quarter. More specifically, Olive Garden delivered their 57th consecutive quarter of same-restaurant sales growth, achieving a 0.8% increase that exceeded the Knapp-Track competitive benchmark by more than six percentage points. They also opened eight new restaurants during the second quarter.

This strong performance was driven in part by Olive Garden's value leadership in casual dining. In addition, advertising during the second 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 never-ending pasta bowl promotion ran in September and October featuring a compelling price point of $8.95 and two new sauces, Tomato Basil Caprasi and Asiago Garlic Alfredo. This was followed by their artesian Italian promotion, which will run through the holidays and features two new dishes, Shrimp Carbonara and Chicken Carbonara.

Both second quarter promotions were supported with new commercials, as well as Olive Garden's unlimited soup, salad, and breadsticks equity building advertising. In addition, a new chicken and gnocchi soup was introduced to provide even greater choice and variety for this signature offering.

Overall guest satisfaction in the second quarter improved versus the prior year and equaled an all-time high, and controllable cost management, especially in areas of food waste, direct labor scheduling, and wage rate management all remained strong. And Olive Garden continues to benefit from lower turnover for both restaurant team members and managers.

Olive Garden still expects to open 35 to 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’re delighted with Olive Garden’s strength in this challenging consumer environment and believe they will continue to deliver industry-leading performance this fiscal year.

Turning to Red Lobster, this was a solid quarter for Red Lobster as well as they also delivered same-restaurant sales growth in a difficult operating environment. Same-restaurant sales grew by 0.3% and exceeded the Knapp-Track benchmark by nearly six percentage points. In September and October, they ran their endless shrimp promotion which featured a new Cajun shrimp selection and this promotion is one of Red Lobster’s strongest traffic-building offerings and benefited this year from a significantly improved commercial and increased [media wait].

In November, Red Lobster introduced wood fire grilling and a new menu with eight new wood fire grill items. Wood fire grilling and two of these new items have been featured in television advertising since mid-November.

Wood fire grilling is a very important component of their phased plan to refresh the brand, building on prior brand enhancements, such as the introduction of today’s fresh fish menus, new plate ware, more culinary forward menu items, and seafood expert training for their servers.

Every restaurant now has a wood fire grill operated by grill masters who are certified experts in the art of wood fire grilling. Guest response to the new menu offerings has been very positive.

Red Lobster also added eight new quick catch items on their lunch menu. These dishes are designed to be served quickly and strengthen affordability, with prices that start at $6.99. Six of these new dishes are also prepared on their wood fire grills.

Another important component of Red Lobster’s plan to refresh the brand is a restaurant remodel. During the second quarter, Red Lobster completed 30 test remodels. These restaurants have different interior and exterior packages and levels of investment but all are based on our current bar harbor prototype. We will read the results of these remodel tests for approximately six months in order to determine the optimal remodel package.

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 second quarter.

Red Lobster will open approximately 10 net new restaurants this fiscal year. We are pleased with Red Lobster’s performance in this challenging consumer environment and believe they are on the right course to achieve sustainable growth as the economy normalizes.

Now turning to Longhorn Steakhouse, total sales increased 2.4% versus last year during the second quarter, driven by new restaurant growth. Same-restaurant sales declined 5.7% and were roughly in line with the Knapp-Track benchmark, which we believe is a competitive result, considering the higher absolute check at Longhorn and advertising support for slightly less than half of their restaurants today.

The Longhorn team has strengthened their second half marketing plan in several important ways. First, they have optimized the day part mix in their media plan, allowing them to expand advertising support from 46% of their restaurants currently to 60% of their restaurants, while also increasing media weight by 25% without an increase in media spending.

Second, they have developed a new promotion to strengthen value and affordability perceptions that will start in January. This promotion features a new signature steak dish, a new commercial, and a starting at $9.99 price point. The promotion has been carefully designed to drive profitable guest traffic in a brand appropriate manner while maintaining strong guest satisfaction.

Third, a new advertising campaign is currently in test that we believe communicates in a compelling way the benefits of Longhorn while also clearly differentiating the brand from other steakhouse competitors. If successful, this campaign will begin in March.

Six restaurant remodels were completed during the second quarter, utilizing the same design as their popular ranch house prototype. While still early in the test phase, the 10 restaurants that have been remodeled to date have been very well received by consumers and have generated meaningful incremental sales. Another six remodels will be completed in the second half.

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

During the second quarter, Longhorn opened six net new restaurants and they are on target to open 15 to 17 net new restaurants in fiscal 2009. Ultimately, we believe Longhorn has the potential to operate 600 to 800 restaurants in North America.

As Brad mentioned earlier, we now expect to open 70 net new restaurants in fiscal 2009 versus the estimate of 75 to 80 that we shared with you in our first quarter call. This reduction reflects our decision to slow unit growth somewhat and focus on our highest confident sites, as well as the reality that some retail developments where we plan to open new units are proceeding a little more slowly than expected.

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

Gene Lee

Thanks, Drew. The specialty restaurant group is focused on strengthening the foundation at each of our brands and managing short-term challenges in a way that supports our long-term strategies. We continue to leverage our organizational structure to successfully manage G&A expenses, as well as efficiently share best practices and expertise across the group.

Our teams are actively controlling costs without affecting the guest experience and implementing sales building initiatives, always making sure that we are protecting the core strength of each brand.

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

In the second quarter, The Capital Grille had total sales of $60.7 million. That was 3% above prior year, driven by the addition of four restaurants. Same-restaurant sales declined 8.7%, which includes a three percentage point positive impact from the holiday shift. The sales decline reflects worsening economic headwinds, particularly for the luxury consumer, and a general decline in business travel and entertainment spending. Nevertheless, Capital Grille continues to generate competitively superior average unit volumes and a very strong return on invested capital. The team also delivered another strong performance in guest satisfaction in the second quarter, as measured by the mystery shopper program.

The network of sales and marketing managers Capital Grille has deployed in every market is a competitive advantage and the company fully utilized this structure to implement sales building initiatives in the second quarter with a focus on building group and private dining sales. The brand also leveraged Darden's purchasing capabilities to launch a series of limited time unique premium culinary offerings.

Capital Grille successfully opened one restaurant in the quarter, bringing the total number of restaurants to 34, and they are on pace to open three or four more restaurants this fiscal year.

The team also continued making good progress on integration efforts, completing the implementation of Darden's purchasing and distribution systems, and making significant headway on deploying key technology platforms.

Bahama Breeze had total sales of $27.9 million in the second quarter, and same-restaurant sales performance was slightly below the Knapp-Track competitive set on a regional basis. The Bahama Breeze team continued to aggressively manage controllable costs and made good progress in optimizing their support structure to deliver significant G&A savings. At the same time, they also significantly improved their guest experience, achieving best ever guest satisfaction ratings in the second quarter, as measured by their Internet guest satisfaction survey.

The Bahama Breeze team has a new restaurant under construction in Wayne, New Jersey, which is on track to open in the second half of the fiscal year.

Seasons 52 continues to prepare for growth by building an effective operational foundation, while focusing on executing their casually sophisticated, seasonally inspired dining experience at a high level. During the second quarter, they successfully developed and implemented group and private dining capabilities, adding private dining rooms in some locations, hiring sales managers for key markets, and generally leveraging private dining best practices from within the specialty restaurant group.

By the end of fiscal 2009, Seasons 52 expects to open a restaurant in Cherry Hill, New Jersey, the company’s first location outside of its footprint in the Southeast. The team also continues building its pipeline of sites to support a disciplined growth plan.

Now I will turn it over to Clarence for some final comments.

Clarence Otis

Thanks, Gene. I guess at the risk of stating the obvious, certainly this was a very challenging quarter, given the economic environment and we expect that it’s going to be a challenging year and I think our revised sales and earnings outlook reflects that.

That said though, we do feel very good about our competitive position and that’s due in large part to the steps that we have taken over the last four years to transform the company. We think that we are better able to weather the current storm than most of our competitors and we also believe that we are better positioned to emerge from the turbulence with even wider positive competitive gaps in both sales and earnings.

And so what are the things that we’ve done? Well, we put together a portfolio of proven brands that we believe collectively have a much stronger long-term sales and earnings profile compared to what we had just 18 months ago. We’ve taken steps to strengthen each of those brands. We’ve added to our scale 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 then finally we’ve made changes in how we work, so that our scale works even harder for us. And that’s helping limit earnings erosion as sales soften in today’s environment.

You’ve heard me say it before and I’ll say it again because it’s that important -- all of the progress that we’ve made, the competitive position that we’ve built, all of that hinges on one thing and that’s having great people. We are proud of the outstanding teams that we’ve got, both in our restaurants and in our restaurant support center. They are working to successfully navigate through this environment and beyond that, create a great company, longer term. And as I’ve said before, we’ve got what I think are at every level of the organization the strongest leadership teams in full service dining.

Together we are all focused on creating in good times and bad times a company that truly is a leader in the full-service restaurant industry now and for generations. And with that, we will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will go to the first question with Matthew DiFrisco from Oppenheimer and Company.

Matthew DiFrisco - Oppenheimer

Thank you. My question is with respect to that 70-store opening. I heard you say 10 full-year ’09 for Red Lobsters. I did not catch the rest and what the implication is to -- or can you give us a range for full-year CapEx budget? Because I think if you go back in your script, it sounds a little low, the free cash flow number I believe that you mentioned. I don’t know if that was accurate or not.

And then just also as a follow-up, I’m curious if you can give us an update since you are the first to talk about the November trends, what you might be seeing on a regional basis. Can you give us some color as far as has the knife stopped falling in Florida, and then also what you are seeing maybe in California and the rest of the country? Thank you.

Clarence Otis

Well, I’ll address the new unit opening question first and Brad can address the cash flow question but in round terms, we are looking at roughly 40 net new Olive Gardens, roughly 15 net new Longhorns, 10 Red Lobsters, and then the remainder in the specialty restaurant group, primarily Capital Grille.

Bradbury H. Anderson

And on the annual CapEx number, probably $580 million to $600 million. The cash flow numbers that I was referring to is an all-in cash flow, just prior though to our share repurchase numbers, is what I was referring to there.

Matthew DiFrisco - Oppenheimer

Okay, so that’s taking out then the common dividend and any buying back of debt?

Clarence Otis

Correct, yes it is, yes. And then you talked about regionality and what we might be seeing there, and Brad, I don’t know if you have any specifics. I think in general, Matt, what we are seeing is weakness across the country and some of the regions that had been strong, I’m thinking Texas in particular, did soften up in the second quarter.

Matthew DiFrisco - Oppenheimer

Okay. Thank you very much, Clarence.

Clarence Otis

And finally, it got a little worse in Florida and a little worse in California, so --

Operator

Our next question comes from the line of Brad Luddington with Keybanc Capital Markets. Please go ahead.

Brad Luddington - Keybanc Capital Markets

Good morning. Thank you. Great quarter, first off. I wanted to ask, for the first question if you can comment on any success you may have had in hedging commodities at these lower rates, looking maybe into the third quarter and definitely beyond the third quarter. And then to follow-up, just see if you can comment on Longhorn’s, if you could quantify the same-store sales lift you may have seen from those remodels.

Clarence Otis

Regarding the commodities environment out there, we have been able to take advantage of that. We have been actively involved in contracting as well as hedging our positions and our guidance on the food and beverage costs reflects our ability there. Some of those costs we already had hedged previously or contracted and so that will continue to work its way into our P&L through the course of the year. But on a number of our key proteins and commodities, we have extended those hedges and at these more favorable prices.

Bradbury H. Anderson

And I would say though just in general, it’s a balance between trying to get as much price or cost certainty as we can but also recognizing that the trends are down and so wanting to take advantage of those trends, and I think the purchasing group has done a nice job in striking the right balance there.

Clarence Otis

And regarding the Longhorn remodel, it’s a little early to put a fine point on the guest lift that we are seeing, but I would say that what encourages us is as we analyze the 10 restaurants that have been remodeled in our standard pre-post analysis against a benchmark group, we are able to quantifiably identify a lift that we are getting from this and that’s why we are continuing and look to combine it with some other items that we are doing to broaden appeal of the brand.

Brad Luddington - Keybanc Capital Markets

Okay. Thank you very much.

Operator

And your next question comes from the line of Jeff Omohundro from Wachovia.

Jeff Omohundro - Wachovia

Thanks. I just wonder if we could get a little bit more color on the monthly sales trends, the pick-up in November in particular. And specifically coming off the all-you-can-eat promos that Red Lobster and Olive Garden, which I would think would index pretty well from affordability and value, and maybe you could talk about what you think is driving that reversal in November. Were there some day parts to that or any other color? Thanks.

Clarence Otis

Beyond the Thanksgiving shift, which we talked about, I think the biggest impact at Red Lobster in the increase in November is the introduction of wood fire grills, which is a meaningful message, both to current users as well as lapsed users in terms of building culinary expertise at the brand. A very powerful commercial, one of the strongest they have developed -- a major new menu introduction, a number of new items. I think that’s part of what at least we can look to to say what caused the change, and at Olive Garden, I think just the continuing value leadership, two new items, and a new soup dish in their soup, salad, and breadstick advertising, which doesn’t sound like much but it dramatically moved the preference, the percent of guests that are trying our soup, salad, and breadstick offering, since its introduction. So it’s obviously resonating very well with people looking for value.

Jeff Omohundro - Wachovia

And as a follow-up, what are you seeing in gift card sales trends, given what I perceive is some greater competitive discounting away from you around gift card sales?

Clarence Otis

We really don’t comment too much on our gift card sales but what I would say is they have been strong for a number of consecutive years and this year continues to be a strong year as well in terms of growing the sales of those. We have over time added a significant number of new channels where those can be purchased outside of the restaurant and so we are pleased with the continued growth in that component, and we know those sales will be coming back to us in the early part of the new calendar year.

Operator

And your next question comes from the line of John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks. The first question is if you could maybe talk a little bit more specifically about some of the cost savings you have been able to implement really at the restaurant level. I think last quarter you talked about getting after some of those. I presume it’s on the labor line but if it is, how much have you been able to eliminate and such that you can maybe decouple the relationship between same-store sales and the deleveraging or leveraging in earnings, which I think in your model in particular is fairly strong.

Clarence Otis

I don’t think we can decouple it but we certainly hope to try to limit the downside deleverage, but Drew.

Andrew H. Madsen

Well, there’s a number of areas that our restaurants as well as our restaurant support center teams have really gotten after very effectively. In restaurants, just adherence to existing standards and controllable cost management have been ratcheted up and that’s why I talked about direct labor schedule, wage management, little things in wage management like doing more annual performance reviews on time, which allows us to give more merit increases that are in guideline across our scale has a meaningful impact in wage management. So that’s one area of controllable costs.

The second area is we’ve noticed with turnover reducing in our restaurants, which is a very positive thing because it saves us hiring costs and training costs, we’ve noticed our staffing par is going a little higher than we need to effectively run our restaurants, particularly in managers per restaurant. So we’ve been appropriately reducing the managers per restaurant back to target.

And third, we’re beginning an effort to better control energy usage in our restaurants. That’s beginning to have an impact as well.

John Glass - Morgan Stanley

Great, and then as a follow-up, can you -- when you talk about the impairment testing you are doing, are you going to touch the $500 million on goodwill potentially that you’ve got on your books? And is this in anticipation of potential store closures or could you maybe frame that, please?

Andrew H. Madsen

Well, the impairment that we talked to should not be confused with our regularly performed restaurant level impairment assessments. Those reviews that we completed this quarter resulted in no impairment charges and will not result in any restaurant closings from that.

However, the steep decline in company stock price will cause companies with acquisition related good will to perform impairment testing in accordance with SFAS-142, and in our second quarter we saw an unprecedented decline in our stock price, thus triggering the need for impairment testing. We’re conducting our assessment and we’ll determine the amount, if any, of non-cash impairment charges to be recognized and should be completed in time for the following of our second quarter 10-Q in early January.

Operator

And your next question comes from the line of David Palmer with UBS.

David Palmer - UBS

Good morning, guys. Congrats on the quarter. Clarence, Brad, or Drew -- fiscal ’10, I guess that’s about six months away and obviously it’s tough to talk about sales or earnings for that year but I’m wondering if two items might be coming together, and those are capital expenditures and food costs. I don’t know if I missed it on the call but -- and you might want to save some of this for your January analyst day, but is it safe to assume that both will be down and perhaps any details on that would be helpful. Thanks.

Clarence Otis

Yeah, we will get into more detail in January. I think we are in the very early stages of kicking off planning for 2010. It will be difficult to try to get a handle on the top line, and so one of our planning assumptions is that the top line will continue to be challenging. As a consequence of that, we’ll continue to be pretty focused on cost management and also on our deployment of capital. And so we’ll be looking, as Drew said, to really understand which are the highest confidence sites that we have, the highest confidence operating companies that we are delivering those sites in, and so a tougher look at capital spending likely to mean that it will go down rather than up, that’s for sure. And then on the cost side, you know, the volatility has been challenging over the last two-and-a-half years, really, but if we assume that the top line continues to be under pressure because of difficult macroeconomic conditions, I think it’s safe to assume that costs are probably going to be pretty well-contained.

David Palmer - UBS

And as a follow-up, you had on Olive Garden and Red Lobster an out performance of Knapp-Track by six points. I guess Longhorn was done simply like the industry and that might average out to four or five points out performance of the industry. I guess what’s striking is that you have the negative 2 to negative 4 and you expect the out performance to continue or even increase. It does speak to some pretty dire Knapp-Track assumptions for the remainder of the year.

Clarence Otis

I would say we really think it’s prudent to be pretty cautious about the macroeconomic outlook because the visibility is so limited. And Jeff talked about the trend through the quarter and the improvement from October and part of that -- part of November is October was so bad, and we have to assume though that things could get there again and so we’ve been fairly prudent we think in our planning assumption for the second half of the year.

David Palmer - UBS

Thanks, guys.

Operator

And your next question comes from the line of John Ivankoe from J.P. Morgan.

John Ivankoe - J.P. Morgan

Thank you. Actually, somewhat of a follow-up on the previous question -- when I think about the new unit openings that you laid out for us in ’09 and obviously the trend has gone down -- 40 Olive Gardens, 15 Longhorns, 10 Red Lobsters, call it three or four Capital Grilles, I guess Longhorn, Red Lobster, Capital Grille all had traffic worse than what you originally modeled when you contemplated those sites in ’09, so should we expect a meaningful deceleration in unit development in fiscal 2010 or do you still have the attitude that hey, this is a 20-year cycle and we’re going to continue to develop into it?

Clarence Otis

No, I think what we -- again, we’ll continue our planning but we should expect that likely it will be down rather than at current levels -- how much is hard to say at this point. The way we approach things though is through a [inaudible] model, restaurant by restaurant. And so we will be looking at restaurant commitments based upon a starting point that reflects today’s volumes and applying a hurdle rate to those. I would tell you that at Olive Garden, the return on invested capital is sufficiently above the hurdle rate that lower volumes is not likely to limit the pipeline a lot.

And that is actually also true of Capital Grille. That calculus doesn’t work the same way at Longhorn and Red Lobster, so we’ll have to take a hard look but even at Olive Garden and Capital Grille, as Drew mentioned, there are things outside our control. And so a lot of things in the pipeline are subject to where developers are and in many of those cases, the pace of developments has been slow.

John Ivankoe - J.P. Morgan

That color is very helpful. Thank you. And also in terms of things that may be discretionary in 2010, Red Lobster remodels and also the new corporate headquarters, I mean, is it -- I mean, is this the kind of environment where big expenditures like that could get pushed out into the out year, or do you still think that we should be at least from our perspective be planning that it enters the budget in fiscal 2010?

Clarence Otis

Again, because we haven’t read the results of the remodel at Red Lobster, it’s pretty early. We’ll have a better feel six months from now as the new year starts. On the corporate headquarters, we’re pretty much completed. I mean, we’re pretty far along and from a cash flow perspective, there are tax benefits that really make it relatively neutral from here.

John Ivankoe - J.P. Morgan

Do you remember what the swing, what the spend on the corporate headquarters is in ’09 versus 2010?

Clarence Otis

Brad.

Bradbury H. Anderson

In ’09, it’s about $80 million.

John Ivankoe - J.P. Morgan

Okay, and it will obviously be meaningfully less than that in 2010?

Bradbury H. Anderson

I believe it drops about 40, to about $45 million, $50 million.

John Ivankoe - J.P. Morgan

Okay, and just one final quick question -- you know, we saw in this quarter that you continued to buy back stock. Many companies did not. Should we assume that free cash flow kind of in the future continues to go to buying back stock or is conserving cash or debt pay-down more of a priority at any point in the future?

Clarence Otis

I think in the environment right now, as I said in my prepared remarks, we need to evaluate that as we move from here based on business conditions and the market conditions, so if those were all in the right spot, I can see us buying up to $200 million but it’s a challenging environment out there, so we’ll keep reassessing it as we go through the rest of this fiscal year.

John Ivankoe - J.P. Morgan

Thank you.

Operator

And your next question comes from the line of Jeff Bernstein with Barclays Capital.

Jeff Bernstein - Barclays Capital

Actually, just to follow-up on that last question, if you could talk a little bit about --

Clarence Otis

Jeff, you’re breaking up on us.

Jeff Bernstein - Barclays Capital

Is that better?

Clarence Otis

Yes.

Jeff Bernstein - Barclays Capital

Great. I just wanted to follow-up on that last question actually -- if you could talk a little bit about capital allocation if comp trends were to continue to slow, perhaps prioritize your thoughts in terms of the CapEx versus repo versus dividend and debt pay-down. I don’t believe there’s any debt due before -- I think it’s $150 million in August of 2010. I’m just wondering if you can give your thoughts on pay-down versus building a cash position.

Clarence Otis

I would tell you, I mean, if the environment got appreciably worse, certainly we need to do the maintenance CapEx so the reinvestment in our business and obviously meeting our debt obligations, so interest payments comes before that but taxes and maintenance CapEx and then dividend, all of those things are the highest priorities. The other parts of the capital budget, so remodel and expansion, would be further down the priority list.

Bradbury H. Anderson

I would just add to that that we, particularly in these times, show us that our desire for and our discipline to strive for an investment grade debt profile has served us well in these times and so we’ll continue to adjust our actions to preserve that ability and that access to lower cost capital that you have with that than when you don’t have it.

Jeff Bernstein - Barclays Capital

Okay, and then just one other follow-up -- if you could -- just on comps; I know the question has come up about November improving, and it does look like if you adjust for the -- I think it’s 250 basis points of benefit in November, if you adjust for that shift, it seems like trends were probably more similar between October and November, both likely a slow-down from September. I’m just wondering whether -- how you would characterize your second half comp guidance. I think you said down 1.5 to down 3.5. I mean, does that reflect a further slow-down? It seems like it’s more just stabilization from here.

Clarence Otis

I would say even adjusted, November was a little bit better than October, obviously both worse than September. A lot of negative factors across the board in October. We provided a range and the bottom of that range does reflect the slow-down from here.

Jeff Bernstein - Barclays Capital

Great. Thank you.

Operator

And our next question comes from the line of Steven Kron from Goldman Sachs.

Steven Kron - Goldman Sachs

Thanks. Good morning, guys. A couple of questions back on the margin front, if we can. I’m trying to I guess parse through the aggressive cost management programs that you have said have helped kind of protect the margins a little bit better with the merger related synergies. I know you have a target out there of $50 million on a run-rate. Can you give us a little bit of an update on that integration and whether those costs are coming in better and higher than what you had originally planned for?

And then on the second topic, the aggressive cost management, is there a level that you can -- or can you quantify a little bit for us and maybe give some indication as to where you are at this point in that cycle of realizing some of those cost saves?

Clarence Otis

I guess first starting with the acquisition related cost synergies, we are feeling very good of the progress there. They are coming in very strong. This year we’ve included $40 million of acquisition synergies. That’s $30 million above last year. And as you’ve heard us say, the pieces of getting systems in place to be able to achieve those, we’re feeling very good with so they are coming in strong. I wouldn’t say we’re at a point that we are -- we would be raising that but we are feeling very good of where those are.

We also have undertaken additional, what we call business strengthening opportunities. There are opportunity costs for our business of doing those. We are not working with some of the other things but those have been significant and those are incorporated into our guidance when I talked about those, but those continue to increase from where we were in the second quarter. So we’re -- those are baked into our estimate at this point.

Steven Kron - Goldman Sachs

Okay. Related, I guess, as we think about kind of restaurant level margins, it seems by the language in the press release, Olive Garden if I read it correctly, the margins were down. Red Lobster it seems may be a little bit more flattish based on the language that you had in there. I guess it begs the question -- you talked about one of the new soups being added to the unlimited soup/salad/breadstick promotion. Did you see a big mix shift on a year-over-year basis as people sought value as opposed to maybe Red Lobster with the new wood fire grill? Is that a higher mix level of sales?

Clarence Otis

Well first off, in the release we talked about the margins as a percent of sales. If you look at Olive Garden, they were actually growing not only sales but they grew earnings as well, but the margin was a little less. The impacts of the new soup and all of that, I think there’s some there. They probably aren’t that significant though, and also we’re talking [inaudible] was introduced and has a lot of fanfare so over the course of the year, we’ve incorporated that probably not being as strong of a sales mix. And I think you had a question on Red Lobster as well -- I missed that though.

Steven Kron - Goldman Sachs

I guess what I’m just trying to get at is did you see people, as they sought value and Olive Garden obviously known for value, did the mix of ticket related to the unlimited salad breadstick promotion, did that pick up in the quarter? Are you seeing people gravitate to that more?

Clarence Otis

Well, we did see an increase in soup, salad and breadsticks preference at Olive Garden. We think that probably does reflect a value, a desire for value but we took some pricing on our soup, salad and breadstick offering this year and even with the preference increase, we were fine. The margin issue at Olive Garden was more about food costs than it was a change in mix related to value driven by soup, salad, and breadsticks.

Steven Kron - Goldman Sachs

That’s helpful. And the one on the Red Lobster side was really just the wood fire grill introduction -- I mean, what percentage of your sales, it seems like it’s gotten some decent traction. What percentage of your sales is that and is that a positive margin mix to your business? Is that priced at a higher point?

Clarence Otis

I’m not sure. There’s 14 wood fire grill items and there’s a range of price points on those items, so they are not all premium priced. But I wouldn’t think it would cause a negative mix implication for us.

Steven Kron - Goldman Sachs

All right, thanks.

Operator

And your next question comes from the line of Joseph Buckley from Banc of America.

Joseph Buckley - Banc of America

Thank you. Just to go back to the capital spending again for a moment, would you share with us what you view a maintenance CapEx level to be at this point, for starters?

Clarence Otis

Maintenance CapEx would be around $150 million to $175 million, depending on some of the remodel activity that we are testing would be included in that. If you take that out, it’s around $150 million is what we would be looking at for this current year.

Joseph Buckley - Banc of America

Okay, and then Brad, your free cash flow range for ’09, I think you said $10 million to $35 million, but that’s after the dividend payment, which in rough terms might be about $110 million or so -- does that sound about right?

Bradbury H. Anderson

Yes, that would be after dividends, taxes, and all of those, and the dividends would be around $110 million for the year.

Joseph Buckley - Banc of America

Okay, and then a question on food costs -- shellfish prices seem like they have come down pretty hard from what I can see. At what point do we start seeing the benefit of that? How far ahead are you covered by either contracts or inventories? Is it possible we go into fiscal 2010 with significantly lower shellfish prices based on what you are seeing right now? Or do we see some benefit here in the back half of ’09?

Bradbury H. Anderson

We have seen some of that come into play but based on the inventory levels, I think when we look at our balance sheet, we had been buying some of that up. You saw a rise in our inventory levels that were essentially 100% covered on our shrimp usage for the remainder of the fiscal year.

Joseph Buckley - Banc of America

Okay.

Clarence Otis

But I would say the spot market, what you are seeing there will start to show up in FY010 more than this year, and more in the back half of this year than you are seeing today.

Joseph Buckley - Banc of America

Okay. And then one last question --

Operator

And your next question comes from the line of Bryan Elliott with Raymond James.

Bryan Elliott - Raymond James

I would like to drill down a bit on the labor costs. You mentioned a number of things and -- including sort of reducing the par level of managers as the turnover and therefore the skill set improves, et cetera. Can you help me understand with the hourlies? It would -- from our perspective kind of hard to separate out the management and hourlies, workers’ comp, et cetera. You mentioned wage inflation is 2% to 3%. You are giving merit increases. Have labor hours for hourlies, sort of hours per operating week or hours per store, been reduced?

Clarence Otis

We have a lot of systems and expertise around labor hours and managing those to match the hours that we have in restaurants to deliver the guest experience that we expect to deliver and those are on a very scale that moves with volume, so as volumes move up or down, those are adjusted pretty quickly. It is true it’s a little bit harder to adjust those when it’s going down than when it is up but we look at it both ways. If labor can get too good that the guest experience gets shorted and that doesn’t allow us to deliver the experience that we want to have that guest return in future visits. So I think the short answer is yes, they are very variable to our guest count volumes.

Bryan Elliott - Raymond James

How do you measure where that break point is on the service and experience?

Clarence Otis

Well, we know the steps of service and [inaudible] you could guess that we anticipate to be serving at a particular shift that we match those expectations up and staff accordingly.

Andrew H. Madsen

And I would build on that by saying there’s some art to go with the science as well, in that we do look at guest per labor hour on the financial side, and then we also track a number of in-restaurant guest experience dimensions in terms of server attentiveness, server knowledge, pace of meal, and over time as we combine those two things and identify where guest experience is going up and what our labor productivity is in those restaurants, we have put together the model that Brad referenced. But there’s some art to it as well as science.

Bryan Elliott - Raymond James

All right. That’s helpful. Joe Buckley just emailed me his question and it relates to SG&A.

Clarence Otis

Phone a friend -- you got a phone a friend.

Bryan Elliott - Raymond James

And can you elaborate a bit on the $20 million drop in SG&A and how much might have been bonus reversal and how much of that is more sustainable? Thanks.

Clarence Otis

Well, I would say it was a collection of many items that drove that. First off, really starting back with just the meaningful synergies that we had talked about getting those, or coming through very meaningfully at that particular line. Our ability and the scale that we have to leverage our total sales growth is significant as well, and as Drew had mentioned earlier, the lower turnover that we are seeing and adjusting our manager, restaurant level manager pars for that has resulted in much less hiring and therefore all the training and deployment costs related to those, as well as you mentioned the benefit piece.

So we’re not really getting into detailing those in general but there’s a collection of all of those that are significant and I think you would expect most of those to continue, even with the significant deleveraging of same-restaurant sales. We still would take this year and expect it to be about 30 basis points better than last year once you take out all the acquisition related cost as well.

Bryan Elliott - Raymond James

Was there an advertising shift in Q2?

Clarence Otis

Let me double-check -- not really. Olive Garden started never-ending pasta bowl a week earlier but there’s not a substantial change.

Bryan Elliott - Raymond James

All right, thanks.

Matthew Stroud

Katy, we’re going to have to cut it off right here, I think, and we’d like to thank everybody for joining us this morning on the call. If you have some further questions, of course we’re here to answer those down in Orlando. Please give us a call. We wish everybody a happy holiday and a safe and happy new year and we look forward to seeing many of you down here in Orlando in January at our institutional investor and analyst day. Thank you.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 10:30 a.m. today through January 19th at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 975537. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, access code 975537. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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