Bloomin' Brands Inc (BLMN) 2017 Q1 法說會逐字稿

Greetings, and welcome to the Bloomin' Brands Fiscal First Quarter 2017 Earnings Conference Call. (Operator Instructions)

It is now my pleasure to introduce your host, Mark Graff, Vice President of Investor Relations. Thank you, Mr. Graff. You may begin.

Thank you, and good morning, everyone. With me on today's call are Liz Smith, our CEO; and Dave Deno, Executive Vice President and Chief Financial and Administrative Officer. By now you should have access to our fiscal first quarter 2017 earnings release. It can also be found at our website at bloominbrands.com in the Investors section. Throughout this conference call, we will be presenting results on an adjusted basis. An explanation of our use of non-GAAP financial measures and reconciliations to the most directly comparable GAAP measures appear in our earnings release on our website, as previously described.

Before we begin formal remarks, I'd like to remind everyone that part of our discussion today will include forward-looking statements, including a discussion of growth strategies and financial guidance. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from our forward-looking statements. Some of these risks are mentioned in our earnings release. Others are discussed in our SEC filings, which are available at sec.gov. During today's call, we'll provide a recap of our financial performance for the fiscal first quarter 2017, an overview of company highlights and a discussion regarding progress on key strategic objectives. Once we've completed these remarks, we'll open the call up for questions.

With that, I'd now like to turn the call over to Liz Smith.

Thanks, Mark, and welcome to everyone listening today. As noted in this morning's risks release, adjusted first quarter diluted earnings per share was $0.54, up 15% from last year. Combined U.S. comp sales were down 0.2% in Q1. This reflects a meaningful sequential improvement in sales trends, particularly at Outback, where we posted positive comp sales and were ahead of the industry. Overall, we are pleased with our Q1 results and they leave us well positioned to achieve our earnings and comp sales objectives for the year.

On the last call, we laid out our assessment of the casual dining environment. We believe our consumers are seeking more differentiated experiences that deliver the best 360-degree dining occasion. They are less motivated by peer-price promotion. In addition, we recognize that today's consumer is increasingly seeking more convenience in their dining occasions.

In recognition of this changing landscape, we are pursuing 3 key strategies: First, current and ongoing investments are prioritized towards elevating the total customer experience. This encompasses food quality and portion enhancements, service upgrades and improved ambience. Second, we have been reducing reliance on straight discounting and have been reallocating these dollars towards our investments. Third, we have been building incremental sales layers, such as the Outback remodel program, the Dine Rewards loyalty program, and the rapidly emerging off-premise business. In addition, we have a sizable international opportunity, which is coming into focus.

In the first quarter, we made significant progress against these strategies. In February, we rolled out the next layer of Outback investments and will discuss those more in a moment. We have built an incremental $25 million of new investments into the 2017 plan. The benefit of this strategy is showing up in strengthened brand health measures and the quality of our traffic. In addition, overall discounting was down in the first quarter. This was particularly true at Carrabba's, where we invested heavily last year in promotion to drive frequency and gain trial of the new menu. As it relates to our sales layers, the Dine Rewards loyalty program is performing very well and now has over 3.2 million members. Since its launch last July, it has consistently received high marks for its simplicity and value relative to peer programs. Dine Rewards is attracting a healthier consumer and is building to the 1% to 2% sales lift contribution we saw in test markets.

As I mentioned, the growing off-premise opportunity represents a sizable and incremental sales layer. We are currently testing the use of a third party as well as building our own delivery network. We had 116 restaurants offering delivery at the end of Q1. Early results have been encouraging and validate our belief that there is strong demand for our food to be consumed at home and that this is largely an incremental occasion.

Now turning to the brands. Outback's Q1 comp sales were up 1.4%. We were pleased with this result and although we did benefit from an overall improvement in this segment, we finished Q1 well ahead of the industry. We were also encouraged by the progress in our investments aimed at elevating the customer experience. These investments, such as our Center Cut Sirloin, started in earnest in the middle of 2016 and lead to a steady improvement in steak satisfaction metrics and higher social media scores. This past quarter, we rolled the next wave of initiatives that are focused on steak preparation, portion sizing and reducing complexity. In total, we will roll out an incremental $25 million of investments in 2017.

To assist in measuring the success of these investments, we have also established our own customer panel to ensure we receive early and real-time feedback. Our research suggests that the traffic benefits begin to manifest in 26 to 39 weeks after the investments are implemented. We expect this healthy traffic to build over time due to the frequency of our core consumer. In addition to these investments, we will continue to provide customers with brand-appropriate value offers that surprise and delight, while we pull back on straight price promotion. This will have some impact on traffic. However, we will not revert to additional discounting to smooth out any quarter-to-quarter fluctuations.

We have also been aggressively completing the multiyear rollout of the Outback exterior remodel program. We expect to complete another 150 in 2017. This design contemporizes our restaurants with improved curb appeal and has driven approximately 4% to 5% sales growth. We also continue to relocate Outback restaurants as quickly as quality sites become available. This is a strong brand with great consumer appeal, experience upgrades and new sales layers to restore sustainable long-term growth.

Turning to Bonefish, we have made substantial progress over the past 2 years to return Bonefish to the lifestyle brand it is known for, offering fresh fish expertise with superior service. To accomplish this, we simplified execution, while reducing our reliance on promotional activity. This has translated into improved guest satisfaction scores that remain at all-time highs. These positive leading indicators suggest we will continue to see sales momentum building over the back half of 2017 and beyond.

At Carrabba's, Q1 sales were down 3.8% as we lapped our 2016 menu launch. This result was actually somewhat better than our expectations. We anticipated meaningful traffic declines driven by a 38% reduction in marketing support in Q1 as we lapped the Q1 2016 menu launch. Although the menu launch drove traffic over the first several months of 2016, it did not sustain as the year progressed. We have refocused efforts to ensure Carrabba's is the restaurant of choice for authentic Italian dining and special occasions. This means simplicity in the restaurant and fewer LTOs that complicate the simple message of a great place to entertain and dine with family and friends. We will return to less overt marketing programs and more direct marketing to our loyal core customer with a real focus on building off-premise. Carrabba's remains a strong brand and we will be patient in taking the necessary steps to drive healthy traffic at the brand.

Turning to international. Brazil posted comps of 3.6% in the first quarter, despite lapping an 8.8% comp in Q1 of 2016. Our Outback restaurants remain resilient in a tough environment and are performing in line with our high expectations. In addition to Outback, we are also seeing success with Abbraccio. We have 9 restaurants and sales have been similar to new Outbacks. This gives us conviction in the potential for Abbraccio. As a reminder, Italian is the second largest segment in Brazil and no clear market leader, providing us with a significant runway for future growth. Our brand strength, combined with the under penetration of casual dining in Brazil gives us the confidence to continue investing capital in Brazil for high levels of returns. China represents another important long-term opportunity for international. We have been patient and deliberate in our strategy and it is now beginning to pay off. There are now 6 Outback restaurants in China, and we recently expanded our footprint outside of Shanghai. We are seeing meaningful sales gains at both new and existing locations and are profitable at the restaurant level. This validates our consumer appeal and we intend to accelerate expansion.

As we move into 2017, we remain focused on continuing to improve sales trends domestically and are aggressively spending on initiatives to drive healthy, sustainable traffic over the medium and long term. We expect the benefits of these investments to build momentum throughout the year. However, the industry environment remains volatile and we expect the competitive intensity to persist. We will remain nimble and agile while showing the patience necessary to do what is right for the long term.

And with that, I'll turn the call over to Dave Deno to provide more detail on Q1. Dave?

Well, thank you, Liz, and good morning, everyone. I'll kick off the discussion around sales and profit performance for the quarter. As a reminder, when I speak to results, I'll be referring to adjusted numbers that include certain costs and benefits. Please see the earnings release for reconciliations between non-GAAP metrics and their most directly comparable U.S. GAAP measures. We also provide a discussion of the nature of each adjustment.

In addition, as mentioned on our February call, when presenting non-GAAP measures, we are no longer including adjustments for the following items: First, expenses related to our remodel program; and second, intangible amortization expenses from our 2013 purchase of Brazil. Our 2016 Q1 results have been recast to conform to this revised methodology. With that in mind, our first quarter financial results versus the prior year are as follows: GAAP diluted earnings per share for the quarter was $0.41 versus $0.29 in 2016. Adjusted diluted earnings per share were $0.54 versus $0.47 last year. The primary difference between the GAAP and adjusted numbers in the first quarter of 2017 was due to $15 million of restaurant closing expenses resulting from our decision to close 43 underperforming restaurants, as we discussed on our February call.

Also, as a reminder, in our first quarter results from 2016, we had $27 million of defeasance expense that we incurred when we retired our CMBS loan. This expense was not included in our adjusted 2016 Q1 results. Total revenues decreased 1.7% to $1.1 billion in the first quarter. This decrease was driven primarily by the 2016 sale of our Outback business in South Korea. This was partially offset by a positive benefit from foreign currency translation and the net benefit of restaurant openings and closures. Combined U.S. comp sales finished Q1 down 20 basis points. This result was ahead of the industry and represented a significant improvement from the fourth quarter. At Outback, Q1 comp sales were up 1.4%. This was a 620 basis point sequential improvement from our Q4 comp, which was down 4.8%. We are seeing progress in our efforts to build healthy sales growth within the brand.

At Carrabba's, comp sales were down 3.8%. As Liz mentioned, Carrabba's Q1 comp was impacted by the lapping of our new menu rollout in the first quarter of 2016. We supported this launch with elevated levels of promotional activity to drive trial. We chose not to replicate this activity in the first quarter of 2017, and it had a significant impact on traffic. At Bonefish Grill, comp sales were down 80 basis points. This included 130 basis point unfavorable holiday impact, primarily from the timing of Easter. At Fleming's, comp sales were down 2.9%. The Q1 holiday impact at Fleming's was unfavorable by 360 basis points, driven by the timing of New Year's, Valentine's Day as well as the timing of Easter. Without the holiday shifts, the comps at Bonefish and Fleming's would have been positive in Q1. The holiday shifts at Outback and Carrabba's were relatively small.

Turning to Brazil. Q1 comp sales were up 3.6%. Our restaurants in Brazil continue to perform at a very high-level and give us confidence that we can continue to capitalize on growth opportunities in this market. Adjusted restaurant level margin was 17% this year versus 17.6% a year ago. The decline was driven primarily by wage inflation, the impacts in service and product enhancements at Outback, higher rent from sale-leaseback initiatives and operating expense inflation. These items are partially offset by the benefit of increases in average check, lower advertising expense and productivity savings.

Turning to G&A. After removing all adjustments from Q1 2017 and Q1 2016, general and administrative costs were $69.6 million and $72.4 million, respectively. Reduction in G&A is primarily related to the timing of our annual managing partners' conference. The conference took place in the first quarter of 2016 and was not held until the second quarter of 2017. This shift represents a $3 million headwind to our second quarter results.

There is one thing I would like to mention as you look at our reporting segments. International adjusted operating margin was down 120 basis points to 7.9% in Q1 versus last year. Included in this result is $3.4 million of certain legal and tax contingency within our Brazilian business. These expenses had a 310 basis point negative impact on international margins. As it relates to Bloomin' Brands, these expenses impacted Q1 EPS by about $0.02.

On the development front, we opened 11 system-wide locations in the first quarter consisting of 1 Outback location, 2 Bonefish locations and 8 international locations. As we've discussed on prior calls, we continue to monetize our own real estate. In the first quarter, we sold a total of 12 properties for $46 million. We have now less than 50 properties remaining to be sold, and we expect to largely be complete with this process by the end of 2017. We expect over $700 million in proceeds once the total program is completed. We have utilized the proceeds from these transactions for 2 primary purposes: First, we have fully paid off our $370 million bridge loan. Since our IPO, we have demonstrated a proven commitment to debt reduction. Second, we have taken the remaining sale-leaseback proceeds and used them to repurchase shares. Since the beginning of the year, we have repurchased $78 million worth of stock and given current valuation levels, we will continue to opportunistically repurchase shares. To assist in this effort, last week, the Board of Directors canceled our existing share repurchase authorization and approved a new $250 million share authorization, which will expire on October 21, 2018. Also of note, last week, the Board of Directors declared a cash dividend of $0.08 a share payable on May 19.

As it relates to our 2017 guidance, we are reconfirming all aspects of our guidance we provided in February. As Liz mentioned, we are off to a very good start and are pleased with Outback's Q1 performance. We will continue to update 2017 as the quarters progress. There are 4 things though I would like to mention about the quarterly flow of our earnings in 2017: First, as I mentioned earlier, the second quarter will have an incremental $3 million of expense due to our annual managing partners' conference. In effect, this is about $0.02 a share in the quarter. The conference took place in the first quarter last year.

Next, our incremental investment spending in the second quarter will be significantly higher than either quarter in the back half of the year. Many of our new investments began in February of 2017. In addition, we will not fully lap our 2016 investments, such as the Center Cut Sirloin, until later this year. Also, we see higher commodity cost in the second quarter driven by some unfavorable weather conditions impacting produce. Our supply chain team does a great job of minimizing the impact of these issues over the course of the year and these developments will not change our full year commodity guidance of flat to down 1.

And finally, in 2017, is when we have our 53rd week. The benefit from the week will come in the fourth quarter. As a result, the fourth quarter is expected to be our highest earnings growth quarter of the year. We ask that you take these 4 items into account as you develop your quarterly estimates.

Having said that, I would like to mention again, we are off to a very good start and feel very good about achieving all of our financial objectives for the year. We are confident that we are making the right and necessary investments, both domestically and internationally, to support long-term growth. We remain disciplined stewards of capital and our improving capital structure provides increased flexibility to return cash to shareholders.

And with that, we will now open the call for questions.

(Operator Instructions) Our first question comes from Michael Gallo of CL King.

My question, Liz, is -- just on the discounting, reduction of discounting. You've been doing this for a little while. You're making these investments, which again, is going to continue through this year. How are you measuring the success of those and the return off of those? And how are you ensuring that you have the right mix in an environment that's certainly continued to be pretty promotional here in Q1? And how do you plan, as the year unfolds, to kind of adjust in the event that we do see softness or we do see improvement? Might you pull those further back? How are you measuring whether these investments are driving the desired return?

Yes, great -- Michael, great question. So one of the things we've been talking about is, we certainly are going to remain nimble and agile as we go through the year because this is a very volatile environment. But we are committed to continuing the march towards reducing discounting across our portfolio, and we like what we're seeing. We are -- we had another kind of low double-digit decline in discounting across the portfolio as we march through and take out those strict price promotions. We are investing them back into the customer experience. Part of your question was, how do we know that's working? How do we measure that? We have a pretty rigorous analytics team that -- and we use a number of different customer experience measures. I also indicated that we put in place our proprietary panels and do mobile intercept. So we have a very good read on exactly what we're getting for our investments as they rollout. Now as you know, this category has a purchase frequency of 2x to 3x a year, right? So you've got to read those longer term investments over time and continue to see them build and that gives you the confidence to know that you are on the right path. We will always have brand appropriate surprise and delights in terms of promotions, but we are not going to revert to additional discounting in an environment where somebody might choose to go aggressively to try to restore their trends. We know that that is not the right solution for us. We like how the brand metrics are building. We're going to stay the course and we've given ourselves kind of the bandwidth to be able to continue with that strategy, which is very successful for us.

Our next question comes from Sharon Zackfia of William Blair.

My apologies. Our next question comes from Andrew Strelzik of BMO Capital Markets.

Just first, I had a clarification. You made the comment at the end of the quarter that you were significantly outperforming the industry at Outback. Was that a March comment? Or was that just broadly for the quarter?

No, we always, Andrew, we don't give the monthly cadence, so it's for the quarter.

Okay, great. And then, my other question. How much is price mix at Outback being impacted by the discounting? I'm just trying to get a sense for what actual pricing is? And then secondarily, I guess I would have thought that the food cost would have been more favorable given some of the dynamics and the healthier traffic that you're talking about. Was there anything specific to the quarter that maybe gave less favorability on that line item this quarter?

Yes, sure. Couple of things. When you look at our pricing, the discounting piece is a pretty big part of that. So -- and we do have some pricing, but we don't break it out between pricing and discounting. But our strategy to not use much discounting is paying off on the profitability side because of that. But that's -- we still break out -- we don't break out pricing and discounting. But part of that PPA change is due to, obviously, to our discounting. On the margin side, couple of things. One, our investments at Outback had an impact on food cost margins, because we did -- we liked what we saw and we ticked that up. And secondly, we had a little unfavorability in seafood during the quarter. Nothing to hurt our guidance for the year, but overall, it was a little higher than we had planned. But overall, we're in very good shape on the commodity side.

Our next question comes from Sharon Zackfia of William Blair.

I don't know what happened. I was bumped. So on Outback, a good start to the year. Just curious if those trends are pretty consistent in the first quarter? And you have some easier comparisons coming up, how do you feel about the potential for Outback to maybe inflect on the positive traffic this year? And then just a quick question on commodities. David, are you expecting commodities to actually tick up then sequentially as well as year-over-year in the second quarter? It would be helpful to get some clarification.

Let me answer the second question first. The commodity piece is not going to pick up year-over-year in the second quarter. It's just the matter of the timing I talked about. But sequentially, we've got those -- that little produce headwind I talked about. But overall, Sharon, we're in very good shape on commodities.

Hey, Sharon. So yes, as you said, we're quite pleased with Outback's start to the year and let me give you as much color as I can about where we are on that. Since these are brand health investments, we view them as like less episodic and more as they will continue to build throughout the year, as all of the measurements that we see that drive intent return continue to climb and continue to strengthen behind these layers of investments that we're rolling out. So we don't break out quarter-to-quarter guidance, but when you look at what's driving the Outback traffic, it's very healthy levers. Whether it's Dine Rewards, which is now at $3.2 million and is performing extremely well. You see the exterior remodels, which are 4% to 5% growth. They are at a critical mass, so they are showing up in the numbers. You see the investment in food and service that is showing up in the core experience. And you see the beginning of delivery starting to come through. We exited the quarter with 116 restaurants across Outback and Carrabba's. So what I would say is, we feel very good about the quality of what is driving our traffic, and we're going to be -- as I said, we're going to be patient and deliberate and put the investment in elevating the 360-degree experience, and we think that that will continue to build. And when we talk about traffic health, we're constantly focused on balancing between responsible in the short term, but that medium and long-term health, that's going to pay off in multi-quarters. So I feel very good about what's happening with the Outback brand, but we're going to continue to roll through those investments.

Our next question comes from Jeffrey Bernstein of Barclays.

Our next question comes from John Ivankoe of JPMorgan.

The question's on G&A. I think in the last quarter, we talked about kind of keeping core G&A flat in dollars from '16 to '17 and having an incentive comp reload, at least in our notes, I think it was $18 million or so. I mean, are we still on track for that '16 to '17? Or were there other efficiencies that you found in the organization to keep the overall level of spend lower despite a full IC accrual.

Yes, John. And we are on track. The -- we didn't make our judgments in the large part on the incentive comp -- shall we say give back, last year until second quarter and beyond. So we didn't have much in the first quarter. But overall, our G&A is in great shape.

Okay. I mean, can I ask for -- just because it's such an important part of the overall piece and especially, in this quarter, was an important piece. Could you help us guide to what would be kind of the reported G&A for fiscal '17, if you can help with that specific guide?

It's flat year-on-year. I mean, other than the reload, I mean, it's -- I don't want to go quarter-by-quarter. We haven't done that in the past. And I can assure you, John, I mean, our strategy on managing overhead, 0 overhead growth and investing ahead of growth is unchanged.

Okay. And I think you made the point on Brazil. I mean, there was something unusual, I mean, regarding a lawsuit or something else taxes, perhaps, down there. Is any of that recurring? Or was that just kind of a onetime clean up, and we should begin to expect margin expansion in the international segment for that growing business?

Yes, for the overwhelming part of it, it is one time. There is -- and obviously, on the tax side we do have to continue to watch that. The Brazil tax environment's very tricky. But we did have one or two cases we needed to address in the quarter. So much of it was one time and it was $0.02 a share in the quarter.

And just, finally, related to Brazil, obviously, the Olympics last year kind of took place over the second and third quarter. I mean, as we come in at 2017 and we have to lap that, how are you feeling from a profitability perspective in Brazil lapping the Olympics last year?

Yes, John, it's Liz. We don't give quarter-to-quarter commentary. But what I will tell you is that I feel very, very bullish about Brazil's performance for the remainder of the year. And I look forward to updating you on the Q2 trends during our next earnings call.

Our next question comes from Jeffrey Bernstein of Barclays.

Great. Two questions. And just one on the broader industry comp. I'm just wondering what your assumption is for broader casual dining comps for the year, I guess relative to your forecast for flat to down. And it seems like there's some sort of disconnect we're hearing and maybe you can offer some qualitative thoughts, but the disparity between the large public chains that are seemingly more challenged based on a look at the KNAPP-TRACK for example, relative to maybe stronger results at the smaller and private chains. I'm just wondering what your expectation is for the broader industry, and why you think we might be seeing a divergence for the better for the small guys and more challenge for the larger players? And then I had one follow-up.

Sure, Jeff. So our assumption on the industry is that it will be down 1% to 2%, probably in traffic. I mean, we've talked a lot about. It's been 11 years of traffic declines. We think that that maybe picked up a bit. It's certainly not going to be annualized off that Q4 number. But we do think Q4 was a harbinger of how things are going to change during the holiday season with the retail landscape. So we have assumed that that industry and trend will be negative 1% to negative 2%. That being said, the macros are certainly supportive of a good consumer environment, but that hasn't translated into casual dining growth. And as you pointed out, this is a highly fragmented, $80 billion category and you're going to have winners, and you're going to have share losers. And a lot of that is driven by, are you delivering what the customer wants, which is an elevated 360-degree experience in the box that has signature service and signature elements that says, why do I want to come in directly and specifically to your restaurant. You've noted that maybe the larger chains are struggling versus the independents. I think that there are a couple of things going on there as well. The first one is, you got -- even if you're large, you've got to be nimble and agile and that's certainly where we're driving ourselves so that -- we are a chain, but each box that you walk into has to feel independent. It has to have those signature elements. That's what customers want. And so I think you're seeing that play out. The second thing that has to happen in this environment is, you've got to continue to upgrade and invest and design in the assets and just have a prudent balance between the two. So we think that you're going to continue to see share gainers and share losers and it's going to be driven by who can drive the most unique customer experience in the box, while continuing transferring to that notion of just great food and service to full entertainment in the box. The other thing that I will just say is that I think that the chains will increasingly have an advantage on is the emerging off-premise category. I think it's going to be something that we can deliver at scale and that's going to swing towards large chain's advantage as it grows out. So it's about remaining nimble and agile and give them the best experience you can in the box, and really building out that incremental sales lever, which is the most exciting structural tailwind that we've had in quite some time. When you think about the fact that we're moving our brands into occasions where they can be consumed at home.

Got it. And then my one follow-up was just on the -- well, on the margin side of things. I mean, versus our model at least, you'd experienced greater than expected pressure across your restaurant-level expenses. I'm wondering whether that was true relative to your own internal. And as it relates to that, I mean, the Outback comp was a pretty solid better-than-expected result. I'm just wondering what type of comp you think you need in this cost environment to hold the restaurant margins relatively flat? Like when might we be able to see something like that?

Yes, sure, Jeff. Couple of things. First of all, it was right within our expectations. Second of all, we talked about the cost of goods sold improved. Labor, we had some pressure. Wage rate inflation, but also we're investing in the service model. And then, also in restaurant margins, please remember that we've got the rent increase from the sale-leaseback flow into that number and -- incorporate that in your model. And it pays off tremendously economically for the company. But on restaurant margins, there is a decrement there as we begin to put that into our system. So right on track. We already talked about having 1% to 2% same-store sales growth. We've got the productivity on track. We've got the margin management on track. We are making the investments though, and that will hurt margins, and a little bit on the sale leasebacks.

Our next question comes from Karen Holthouse of Goldman Sachs.

Looking at Outback, where you have seen a return to positive traffic and stronger comps. It's just -- there is a lot of noise in the numbers for trying to sort out sort of investments, what's going on with different brands. Is there anything you can talk about in terms of numbers of do have an idea of, is profit per guest actually rising either at the restaurant level or at the gross profit level? Something that sort of shows this sort of -- this broader shift towards investing in quality is starting to flow through?

Yes, we don't disclose profit per guest. But I can tell you that the quality of traffic when you don't have the discounted customer is helping in profitability. For instance, even though we don't break out Fleming's, Fleming's had its highest profit growth in the first quarter that we've ever had, right? Profit amount. So overall, our profitability is improving because we're not seeing the discounted guest flow through our restaurants.

Well, I guess another way of asking the same question, if you were to look at this quarter versus the same quarter last year, was there an increase or decrease in sort of meals on promotion or meals on coupon at Outback?

Yes, so Outback, specifically, I think I gave you that number that we were down approximately 10% on discounting for the quarter.

Our next question comes from John Glass of Morgan Stanley.

Can you talk a little bit, just about the off-premise business broadly at Outback? Was that a key contributor to comp this quarter, so I'm thinking about take out as well as what you were doing in delivery. And you mentioned considering not just using third party, but actually building your network. What's the thought process behind that just given that there are other networks already out there and at least the limited experience of the chains that have built those networks themselves, it's pretty costly early on. Or it can be costly early on. So what's your thinking about why you would choose to build it versus just use existing?

Sure, John. So what I'll -- we ended the quarter with 116 stores across Carrabba's and Outback. So while we're really pleased with what we're seeing, it certainly wasn't any meaningful contributor to the comp for the quarter, right? This is just -- the great news is this is all in front of us as we deliberately and slowly build and roll it out. Pivoting to your second question, which is, why we have elected to take a hybrid approach. We are certainly testing with all those third party delivery systems that you mentioned that are out there. But about 2 years ago, we started to build our own internal capability to manage, structure and staff having our own delivery network. And there're a couple of reasons. That's a group that reports in to Dave, so I'm going to let him enumerate the reasons why. But the one thing I'll say before I turn it over to him is, we're going to let the customer decide, right? So of the -- that's why we're testing both. If the customer decides they want to do third party just because it makes more economic sense to you personally, you got to go with what the customer wants. I will tell you though, and I don't want to tip my hat and give Dave's thing, is that our customer service metrics in do-it-yourself and our profitability in doing it yourself really increases the attractiveness of our chosen strategy. So I'll just let Dave kind of enumerate some of the benefits and where we are.

Yes, thanks a lot, Liz. First of all, from a people capability standpoint, we have a fair number of people in our company that have significant delivery experience, including myself. So we know how to do this, first of all. Second of all, if you look at the third party pieces, yes, the network is there. And yes, you do get the benefit of the marketing on the site, but you pay a price for that. So the flow through on a delivery of third party is not as favorable as flow through on do-it-yourself. But more reportedly, do-it-yourself, we control the experience. We know the customers. We can do some surprise and delights very directly with the customers. And we think that these things offer some pretty nice potential for the company going forward. So we're being very deliberate in how we roll this out. We want to make sure the experience is top-notch from when we start in the marketplace. But those 3 or 4 things from a do-it-yourself standpoint really are attractive as we look at rolling this out.

The other thing, John, is that with our average check, right, some of the other groups that are building out delivery, I think they have more of a challenge with that than our average check, and I think we've talked about how on delivery our actual average check is actually greater than our off-premise pick up at the restaurant level. So the economics are proving to be quite attractive. By going direct, you also -- that's your customer. You get that database. You have the ability to communicate with them. You have the ability to give them Dine Rewards credit. You have the ability to give them a cheaper service because you're not adding on that third party intermediary. So we'll let the customer decide, but they're pleased and we're pleased with what we're seeing by going direct.

Thanks for all that. And just to clarify, my first question really didn't have to do with the delivery business contribution to the first quarter, but just generally, off-premise, which has, I think, been growing in a lot of brands. Did that meaningfully, the pick up business itself, meaningfully grow in the first quarter?

Got it. No, it wasn't a meaningful contributor to comp in the quarter. I think, you saw a lot more of the exterior remodels, the Dine Rewards. It had some positive engrafting. It grew modestly, but a lot of it was investments and the core experience that we talked about that elevated all those dining metrics that drive intent to return.

Our next question comes from Jason West of Crédit Suisse.

Just a quick clarification, Liz. That 116 stores you just mentioned, I missed, what was that? Was that for the stores you're doing your own delivery? Or was that your total delivery offering in the system?

That was our own. That's our own. And I think it does include how many of third party.

It's a small number of third party, but that's the total third party and our own at the end of the first quarter.

But the majority of that is direct.

Correct.

Okay, got it. And then just a bigger picture question. I know we're a ways off from the holidays, but given what happened in 4Q in the industry last year. Just curious, how you guys are thinking about that going into this year, given the potential volatility now around that time of year with people shopping at home. I mean, how do you think you want to approach that, especially with this new focus on removing some of the sort of call to action promotions and things like that?

Sure. So as we -- the good news is, this year we have a year right to get in front of it and we know that that shift really happened and hit seemed like the tipping point in terms of the number of feet on the street shopping retail. So the way that we're approaching it is kind of twofold. The first thing is, if you want to get people in the restaurant and out of their house, it has to be more about just great product and service. It's got to be those eatertainment queues. So what during the holidays gets me specifically into your restaurant, because I can get an experience that I can't get just by sitting at home. And for competitive reasons, I'm going to leave it at that. But I think during the holidays, one thing doesn't change. People are looking to be entertained. And so I think the burden on having that 360-degree experience, be unique in the box in Q4 is something that all casual diners will be focused on, ourselves included. The second thing is, is that this is tailor made for the growing off-premise occasion. People are very house proud. If you look at the spending on housing and investments in their ambience of their house, they are very house proud and they want the quality of casual dining. But sometimes, they want it in the privacy of their own home. We think that has a huge opportunity during the holidays when you're gathering with friends and family and you have a desire to have that occasion, but maybe you don't want to go out, specifically per se. So we do think that off-premise has a real opportunity in Q4 as well as delivery. But again, we're going to be paced. And so I think, one, it's about getting the entertainment to make me want to come out for the holidays, specifically; and two, about really helping them when they do want to eat at home, have our brands present in their home.

Our next question comes from Jeff Farmer of Wells Fargo.

Dave, just wanted to follow-up on the cost of goods sold line. So a lot of moving pieces out there, but I think you said flat to plus -- minus 1 on commodity basket, modest menu pricing. And then I think the majority of this year's productivity savings are expected to benefit the food cost line. So with all those drivers in play, can we assume that the year-over-year COG favorability in '17 can approach I think, it was 50 or 60 basis points of favorability that we saw in ‘16? Is that a realistic assumption? Or will something else prevent us from potentially not getting to that same level of favorability?

Yes, Jeff. We're not going to guide by line item. But I think if you build up the various pieces of our cost of goods sold, we will make progress this year. Productivity, yes. We're going through that particular line item, but don't forget the investments, right, at Outback and other places. We will make progress in food cost margins this year. We're not going to get into that level of granularity and providing that kind of guidance by a particular line item.

(Operator Instructions) Our next question comes from Gregory Francfort of Bank of America.

Maybe not on the guidance, but during the quarter, in the cost of sales line. How much of that is from deflation being offset by investments you've made? Can you quantify, I guess the investments and how much that is, I guess offsetting deflation in the quarter?

Yes. No, we have -- we've made -- we're going to make $25 million in incremental investments this year. A bunch of that will be in food cost. Productivity helps and the commodity deflation helps. But we improved cost of goods sold this quarter by 30 basis points, which is a good result. So that is -- excuse me, 40 basis points. So that's a good -- it's a good result for us. And we'll continue to make the investments in the product that we need to make and we'll have a very good year on commodities. So we expect continued food cost -- good food cost management during the year.

Got it. And maybe going back to delivery. Anything on incrementality you've seen so far? Or the necessary incrementality to see it as a profitable addition to your business?

Sure. So the great thing that we're seeing is, is that it's primarily incremental. And we're seeing it as 85% incremental. And that's consistent with the market structure. When people decide that -- they either decide they're eat in or go out versus saying, "Gee, I want Outback tonight. Do I want it in or do I want to go out?" So the exciting thing is, it's moving our brands into an occasion eating at home, that's 4x the size of the dinner business that they have eating outside. So that's just been holding pretty consistent at that 85% level. And we're going to monitor that and look at that, but that has been what it's been coming in at across the brands.

Got it. And maybe I'll sneak one last one in. You talked about China and expanding outside of Shanghai, I guess. What's the strategy going to be going forward? Are you going to continue to target major cities, potentially expanding into lower jurisdictions? I know this is probably a ways off, but just what's the early thinking there?

Well, first of all, much like delivery, we have the people capability in China to make this happen. We've got Pat Murtha and [ Joseph Hsu ], [ Joseph Hsu ] in [ Country Patlin's ], our international business. So it's really terrific. We will be expanding -- we expanded in the first Tier 2 city. And a reminder for everybody, a Tier 2 city in China is 5 to 10 million people. We expanded in Hangzhou and so we're looking at higher margins in Tier 2 cities, great volume and a better economic model for us. We started in Shanghai. We've gone to Hangzhou. We will accelerate expansion in China because we have the sales and the profits now at the restaurant level that has the ability to expand. So we are very, very excited about this opportunity. And China is the biggest restaurant market in the world. So you look at our people capability, our economics, our expansion plan and everything else, we think there is a huge runway coming for China.

There are no further questions. I'd like to turn the call back over to Ms. Liz Smith for closing remarks.

Thank you. We appreciate everyone for joining us today, and we look forward to updating you on the portfolio during the Q2 call. Thanks a lot.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.