達登餐飲 (DRI) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the second quarter earnings release conference call.

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

Later we will conduct a question and answer session.

(Operator Instructions).

As a reminder, this conference is being recorded.

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

Matthew Stroud.

Please go ahead.

Thank you Katie.

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 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, 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 cost, higher than anticipated costs to open or close restaurant, 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 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 or financial reporting, disruptions in the financial markets, possible impairment of goodwill 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 Investor Relations on our web site 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 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.

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, it's 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 it's total sales increased 0.2%.

LongHorn Steakhouse sales, same restaurant sales decreased 5.7% for the quarter, while it's 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 integration costs 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 share 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 months 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 the 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 reflect it is 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 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 costs, and the impact, the significant impact of lower turnover costs 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 various, 60 basis points was due to the absence of RARE acquisition costs and mix changes associated with the acquisition, while the remainer is 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 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 tax 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 the market and business conditions, we may repurchase up to $2 million of shares in fiscal 2009.

And yesterday, we announced a dividend of $0.20 per share payable on February 2nd 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 US 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.

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 2 percentage point impact of a 53rd week in fiscal 2009, excluding the 53rd week, the expected total sales growth would l 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 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 2 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.

Now I will turn it over to Drew to comment on Olive Garden, Red Lobster, and LongHorn Steakhouse.

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 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 and 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.

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 6 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 restaurant 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 Caprese, and Asiago Garlic Alfredo.

This was followed by the Artisan 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 milky soup was introduced, to provide even greater choice and variety for the 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 from both restaurant team members and managers.

Olive Garden still expects to open 35 to 40 net new restaurants during 2009, and ultimately we believe the brand has the potential to operate 800 to 900 restaurants in North America.

We are 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 6 percentage points.

In September and October, they ran their endless shrimp promotion, which featured a new Cajun shrimp selection, and this promotion of one of Red Lobster's strongest traffic building offerings, and benefited this year from a significantly improved commercial and increased media weight.

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 plateware, 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 ten restaurants that is have been remodeled to date have been 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.

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 the first quarter call.

This reduction reflects our decision to slow unit group growth somewhat, and focus on our highest competent 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.

Thank, Drew.

Specialty Restaurant Group is focused on strengthening the foundation in 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 at 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 3 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 there 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 3 or 4 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 it's footprint in the Southeast.

The team also continues building it's pipeline of sites to support a disciplined growth plan.

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

Thanks, Gene.

I guess at the risk of, of stating the obvious, certainly this was a very challenging quarter given the economic environment.

And we expect that it is 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 is 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 we have done?

Well, we have put together a portfolio of proven brands that we believe collectively have a much stronger long term sales and earnings growth profile, compared to what we had just 18 months ago.

We have taken steps to strengthen each of those brands, we have added to our scale and all of 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 have made changes in how we work, so that our scale works even harder for us.

That is helping limit earnings erosion, as sales soften in today's environment.

You have heard me say it before and I will say it again, because it is that important.

All of the progress that we have made, the competitive position that we have built, all of that hinges on one thing, and that is having great people.

We have proud of the outstanding teams that we have 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 have said before, we have 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.

With that, we will take your questions.

Thank you.

(Operator Instructions).

We will go to the first question with Matthew DiFrisco from Oppenheimer & Company, please go ahead.

Thank you.

My question is with respect to that 70 store opening I heard you say ten full-year '09 for Red Lobster.

I did not catch the rest, and what the implication is, or can you give us a range for full year CapEx budget, because I think if you go back the in your script it sounded 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 am curious if you can give us an update, since you are the first to talk about the November trends, what you might be seeing 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 in maybe California, and the rest of the country?

Well, I will 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 remainer in the Specialty Restaurant Group, primarily Capital Grille.

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 to our share repurchase numbers, what I was referring to there.

Okay.

So that is taking out then the common dividend, and any buying back of debt?

Correct.

Yes, it is.

Thank you.

And then you talked about regionality, and what we might be seeing there.

Brad, I don't know if you have any specifics, in general, Matt what we are seeing is weakness across the country.

And some of the regions that had been strong, I am thinking Texas in particular, did soften up in the second quarter.

Okay.

Thank you very much.

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

Okay.

Our next question comes from the line of Brad Ludington with Keybanc Capital Markets.

Please go ahead.

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 the follow-up, just see if you can comment on LongHorns, if you can quantify the same-store sales lift you may have seen from those remodels?

Regarding the commodities environment out there, we have been able to take advantage of that.

We had been actively involved in contracting as well as hedging our positions, and our guidance on food and beverage cost reflects our ability there.

Some of those costs we already had hedged previously or contracted.

So that will continue to work it's 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.

And I would say that just in general, I mean it is 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 [Pearson] Group has done a nice job of striking the right balance there.

Regarding the LongHorn remodel, it is a little early to put a fine point on the guest lift that we are seeing, but I would l say what encouraging us is as we analyze the ten restaurant 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 is why we are continuing, and look to combine it with some other items that we are doing, to broaden the appeal of the brand.

Okay.

Thank you very much.

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

Please go ahead.

Thanks.

Just wonder if we can get a little bit more color on the monthly sales trends?

The pick-up in November in particular.

Specifically coming off of the all-you-can-eat promos at Olive Garden and Red Lobster, which I would think would index pretty well from affordability and value.

Maybe you can talk about what you think is driving that reversal in November, where there some day parts to that, or any other color?

Thanks.

Beyond the Thanksgiving shift which we talked about, the biggest impact at Red Lobster, and 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 number of new items.

I think that is part of at least what we can look to to say what caused the change, and at Olive Garden I think just the continued 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 it's introduction.

So it is obviously resonating very well with people looking for value.

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

We really don't comment too much on our gift card sales, but what I would say 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.

So we are pleased with the continued growth in that component, that we know those sales will be coming back to us in the new part of the calendar year.

Thanks.

We will go to the next question from John Glass with Morgan Stanley.

Please go ahead.

Thanks.

The first question is if you can maybe talk a little 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 is on the labor line but if it is, how much have you been able to eliminate, 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 particularly is fairly strong?

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

There are 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 has been ratcheted up, and that is why I have talked about direct labor scheduling, wage management, and 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.

That is one area of controllable costs.

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

So we have been appropriately reducing the managers per restaurant back to target, and third, we are beginning an effort to better control energy usage in our restaurants, that is beginning to have an impact as well.

Okay.

Great.

As a follow up can you talk about the impairment testing you are doing?

Are you going to touch the $500 million of goodwill potentially, that you have got on your books, and this is in anticipation of potential store closures, or could you maybe frame that, please?

Well, the impairment that we talked to should not be confused with the regularly performed restaurant level impairment assessments.

Those reviews that we completed this quarter resulted in no impairment charges, and would not result in any restaurant closings from that.

However, the steep decline in company stock price will cause companies with acquisition-related goodwill 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 are conducting our assessment, and will determine the amount if any, of noncash impairment charges to be recognized, and should be completed in time for the filing of our second quarter 10-Q in early January.

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

Please go ahead.

Good morning, guys.

Congratulations on the quarter.

Clarence, Brad, or Drew, fiscal '10, I guess that is about six months away, and obviously it is tough to talk about sales or earnings for that year, but I am 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, 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.

Yes, 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 will continue to be pretty focused on cost management, and also on our deployment of capital.

And so, we will be looking as Drew said, to really understand which are the highest confidence of sites that we have, the highest confidence operating companies that we are delivering those sites in.

And so, a tougher look at capital expending likely to mean that it will go down rather than up.

That is for sure.

And then on the cost side, the volatility has been challenging over the last 2.5 years really.

But if we assume that the top line continues to be under pressure because of difficult macro economic conditions, I think it is safe to assume that costs are probably going to be pretty well contained.

And if I had a follow-up, you had on Olive Garden and Red Lobster, an outperformance of Knapp-Track by 6 points.

I guess LongHorn would have done simply like the industry, that might average out to 4 or 5 points outperformance of the industry, I guess what is striking is that you have the negative 2 to negative 4, and you expect the outperformance to continue or even increase, it does speak to some pretty dire Knapp-Track assumptions during the remainder of the year.

I would say I mean, we really think it is prudent to be pretty cautions about the macro economic outlook, because visibility is so limited.

And Jeff talked about the trend through the quarter, and the improvement from October, and part of November is that October was so bad.

And we have to assume that things could get there again.

So we have been fairly prudent we think in our planning assumption for the second half of the year.

Thanks, guys.

Our next question comes from the line of John Ivankoe from JPMorgan.

Please go ahead.

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 2009, and obviously the trend has gone down, 40 Olive Gardens, 15 LongHorns, 10 Red Lobsters, call it 3 or 4 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.

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 are going to continue to develop into it?

No, again we will continue our planning, but we should expect to 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 discounted cash flow 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 will 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 will have to take a hard look, but even at Olive Garden and Capital Grille, as Drew mentioned, there are things outside our control.

So a lot of things in the pipeline are subject to where developers are, and in many of those cases, the pace of the developments has been slow.

That color is very helpful.

Thank you.

Also in terms of things that may be discretionary in 2010, Red Lobster remodels and also the new corporate headquarters, is this the kind of environment, where big expenditures like that could get pushed out into the outyear, or do you still think that we should at least from our perspective be planning that enters the budget in fiscal 2010?

Yes, again, because we haven't read the results of the remodel at Red Lobster, it is pretty early.

We will have a better feel six months from now as the new year starts.

On corporate we are pretty much completed, I mean we are pretty far along, and from a cash flow perfective, there are tax benefits that really make it relatively neutral from here.

Do you remember what the spend on the corporate headquarters was in '09 versus 2010?

'09 it is about $80 million.

Okay.

And it will obviously be meaningfully less than that in 2010?

I believe it drops to about 45 to 50 million.

Okay.

Just one final quick question, 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?

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 those were all in the right spot.

I could see us buying up to $200 million but it is a challenging environment out there.

So we will keep reassessing it as we go through the rest of this fiscal year.

All right.

Thank you.

And our next question comes from the line of Jeffrey Bernstein with Barclays Capital.

Please go ahead.

Thank you.

[inaudible].

Jeff, you are breaking up on us.

Is that better?

Yes.

I wanted to follow-up on the last question, can you 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 is any debt due before 150 million in August 2010.

Just wondering if you can give your thoughts on pay down versus building a cash position?

Yes.

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 obligation, so interest payments comes before that.

But taxes and maintenance CapEx and dividend, all of those things are the highest priorities.

The other parts of the capital budget, remodel and expansion would be further down the priority list.

I would just add to that 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.

So we will 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.

Okay.

And then just one other follow-up, on comps, I know the question has come up about November improving, it does look like if you adjust for the 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 to slow down from September.

Just wondering how you would characterize your second half comp guidance, and if you said down 1.5 to 3.5, does that reflect a further slow down, it seems it is just more like stabilization from here?

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 have provided a range, and the bottom of that range does reflect a slowdown from here.

Great.

Thank you.

And our next question comes from the line of Steven Kron from Goldman Sachs, please go ahead.

Hi.

Good morning.

Thanks.

A couple of questions back on the margin front if you can.

I am trying to parse through the aggressive cost management programs that you have said help protect the margins a little better with the merger related synergies, I know you have a target 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 coming in better and higher, than what you had originally planned for, and then on the second bucket, the aggressive cost management, is there a level, 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?

First starting with the acquisition related cost synergies, we are feeling very good about the progress there.

They are coming in very strong this year, we have included 40 million of acquisition synergies, that is 30 million above last year, and as you have heard I us say, the pieces of getting the systems in place to be able to achieve those we are feeling good with.

So they are coming in strong I wouldn't say we are at a point we would be raising that, but we are feeling good where those are.

We also have been undertaking additional what we call business strengthening opportunities.

There are opportunity costs for a business of doing those.

We are working on some of the other things, but those have been significant, and those are the incorporated into our guidance, when I talk about those, but those continue to increase from where we were in the second quarter, and so we are those are baked into our estimate at this point.

Related I guess, as we think about 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 maybe a little bit more flattish, based on the language you had in these.

The question, you talked about one of the soups being added to the unlimited soup, salad, and breadstick promotion, did you see a big mix shift on a year-over-year bases, as people sought value as opposed to maybe Red Lobster with the new wood fire grill, is that a higher mix level of sales?

First off, in the release we talked about as 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.

The margin was a little less.

The impacts of the new soup and all of that, I think there is some there.

They probably aren't that significant though, and also we are talking a period where that was introduced, and that has a lot of fanfare.

So over the course of the year we have incorporated that probably not being as strong of a sales mix.

And I think you had question Red Lobster I missed that though.

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

We did see an increase in soup, salad and breadsticks preference at Olive Garden, we think that probably does reflect a desire for value.

So 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.

That is helpful.

The one on the Red Lobster side was really just the wood fire grill introduction, what percentage of your sales, it seems like it has gotten some descent traction.

What percentage of sales is that?

Is it positive margin mix to your business, is that priced at a higher point?

I am not sure.

There are 14 wood fire grill items, and there is 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.

All right.

Thanks.

Our next question comes from the line of Joe Buckley from Banc of America.

Please go ahead.

Thank you.

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

Maintenance CapEx would be around 150 to $175 million, depending on some of the remodel activity that we are testing to be included in that.

It is around $150 million is what we would be looking at for this current year.

Okay.

And then, Brad, your free cash flow range for '09 I think you said 10 to 35 million.

But that is after the dividend payment which in rough terms, might be about 110 million or so, does that sound about right?

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

Okay.

And then, a question on food costs, shellfish prices seem have come down pretty hard from what I can see, at what point do we start to see the benefit of that?

How far ahead are you covered by 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 in the back half of '09?

Well, we have seen some of that come into play, but based on the inventory levels, I think we look at the 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.

Okay.

But I would say the spot market, what you are seeing there will start to show up in FY '10 more than this year, and more in the back half of this year than you are seeing today.

Okay.

And then one last question.

And we will go to the next line of Bryan Elliott with Raymond James.

I would like to drill down a bit on the labor costs, you mentioned a number of things, 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 what is happening with hourlies?

It would from our perspective hard to separate the management and hourly, worker's comp, et cetera, you mentioned wage inflation is 2 to 3%, you are giving merit increases, have labor hours for hourly, sort of hours per operating week, or hours per store been reduced?

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 scaled, a scale that moves with volume.

As volumes move up or down, those are adjusted pretty quickly.

It is true it is a little bit harder to adjust those when it is 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.

I think the short answer is yes, they are very variable to our guest count volumes.

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

And experience?

Well, we know the steps of service and it is fairly formulaic of the guests that we anticipate to be serving at a particular shift.

That we match those expectations up and staff accordingly.

And I build on that by saying there is some art to go with the science, as well.

And 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 a guest experience is going up, and what our labor productivity is in those restaurants, we put together the model that Brad referenced, but there is some art to it as well as science.

Thanks.

Joe Buckley just e-mailed me his question, and it relates to SG&A.

Phone a friend.

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.

I would say it is a collection of many items that drove that.

First starting back with just the meaningful synergies we had talked about giving, those are 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 in adjusting our manager restaurant level manager par for that has resulted in much less hiring, and therefore all of the training and deployment costs related to those, as well as you mentioned the benefit piece.

So we are not really getting into detailing those in general, but there is 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 next year, once you take out all of the acquisition related costs as well.

Was there an advertising shift in Q2?

Let me double check.

Not really.

Olive Garden started the never-ending pasta bowl a week earlier, but there is not a substantial change.

All right.

Thanks.

Katie, we are going to have to cut it off right here.

And we would like to thank everybody for joining us this morning on the call.

If you have some further questions, of course, we are here to answer those down in Orlando.

Please give us a call.

We wish everybody a Happy Holiday and 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.

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