Brinker International Inc (EAT) 2004 Q2 法說會逐字稿

-- conference call. During our opening remarks and in our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are subject to risk and uncertainties which could cause actual results to differ from those anticipated. Such risks and uncertainties include business and economic conditions, the impact of competition, adverse weather conditions, future commodity prices, the seasonality of the company’s business, fuel and utility cost, governmental regulations, inflation, consumer’s perception of food safety, changes in consumer taste, changes in demographic trends, availability of employees, terrorist acts, acts of God, unfavorable publicity, the company’s ability to meet its growth plan, and other factors more completely described in the company’s filings with the SEC.

With me today are Doug Brooks, CEO and President; Todd Diener, COO; Chuck Sonsteby, EVP and CFO; Starlette Johnson, EFP and Chief Strategic Officer. And now let me turn it over to Doug Brooks.

Good morning, and thanks for joining us today. As we reported earlier this morning in our press release, second quarter earnings were $44.1m, or 45 cents per diluted share. While the restaurant and food industry have definitely been in the news a lot lately. You can’t turn on your TV, open your newspaper or get on the Internet without being bombarded with external noise and story about information related back to our business. The loudest story was about a cow in Washington State and how that has impacted both supply and demand of beef, as well as pricing of beef products.

Now this news was happening at the same time that millions of Americans are experimenting with diets that call for low carbohydrates and high beef and protein. We’ve been told a lot lately about obesity in the United States, and a fitness magazine even attempts to rank cities by fattest. Those of us here in Dallas listen to the news that we had moved up from number 9 to number 3 in the last year. There was even talk by a potential presidential candidate whose platform included menu labeling in restaurants. For those of us who enjoy an alcoholic beverage on occasion, a glass of red wine a day got replaced by a low carb beer after our workout as the new key to a long and healthy life.

So lots of news and noise for the consumer, and we can’t control or predict what might be in the press tomorrow anymore than we can predict the next record cold fronts to hit the East Coast. What we can and will do is continue to evolve our great restaurant brands to provide our guests with great dining experiences that include choices that they need to fit their current lifestyles. We won’t make wholesale changes to the positioning and menus in our concepts, because we know that even in the midst of new eating trends, a large percentage of our customers come to Brinker Restaurants for great, flavorful food, and service they can count on.

I do want to let you know of some new choices we have put in place at our two largest concepts since the first of the calendar year. Chili’s last week introduced a new feature card menu entitled, It’s Your Choice, which is a selection of 14 modified or new menu items that appeal to a more health conscious consumer, whether that guest is seeking a low carb or low fat offering. And Chili’s, of course, still has the Guiltless Grill items that have been a part of our menu since 1993. The new feature card lists the carbohydrates and fiber of each of the menu items, and the Guiltless Grill continues to provide information on fat content.

And Macaroni Grill recently rolled out a new menu with three great new low-fat items. An entrée salad, and a fish and chicken entrée, all under nine fat grams. They’ve also added some great side items including grilled tomatoes, sautéed spinach, grilled asparagus, or Tuscan green beans that can be substituted for pasta or potatoes to make many of our entrée dishes now low carb.

And both chef features this month at Macaroni Grill are grilled dishes that would be perfect for any low carbohydrate eater, and Macaroni Grill also offers whole wheat penne pasta for guests restricting their intake of refined grains.

Additionally, to help us sort through all of the news that seems to change everyday, we have formed a nutritional advisory council consisting of several third-party experts who will join a cross-functional Brinker working group to track evolving trends in nutrition and lend perspective and guidance to ongoing culinary development on all of our Brinker concept menus.

These three experts include a certified master chef and VP of education at the Culinary Institute of America; a registered dietician and director of nutrition at the world famous Cooper Clinic and Wellness Center; and a food scientist from [Conagris] Culinary Center of Excellence. Our goal is to remain relevant and current to our guest needs from our To Go offerings to new, healthy menu choices. These new menus, and the nutrition council are just a few ways that we will continue to evolve our brands along with our guest needs. We remain excited about our business, and remain committed to our goal of delivering strong, consistent growth over the long term. Let me now turn I over to Chuck Sonsteby.

Well thanks, Doug, and congratulations on your new role. We also want to take a chance to thank Ron McDougall for all of his extraordinary accomplishments in his nearly 21 years here at Brinker. So let’s review the second quarter highlights and our third quarter outlook before we take questions.

Second quarter revenues increased 11.6 percent to $886.5m. Capacity growth was 9.3 percent, driven by the addition of new restaurants. Same-store sales for Brinker increased 2.3 percent for the quarter. Second quarter same-store sales results were impacted by three separate events. First, Halloween fell on a Friday this year versus Thursday last year, and that’s a negative 20 basis point impact as folks generally stay home and try to protect their property from trick or treaters.

Second, inclement weather during two December weekends hurt us by about 30 basis points for the quarter, and third, a shift of Christmas from our December period in fiscal year 2003 to our January period in fiscal 2004, and that was an approximate 100 basis point favorable impact for the quarter.

Speaking of weather impact, in December itself we saw about 100 basis point impact on Chili’s and again, for the December period, a higher amount, about 130 basis point impact at Mac Grill and On the Border. For the quarter, Chili’s posted a 1.9 percent comp sales gain, composed of a 1.9 percent price increase; a 0.8 percent decrease in mix; and a 0.8 percent increase in traffic. This is the 27th consecutive quarter of positive same-store sales at Chili’s.

Our development team opened 20 company-owned Chili’s restaurants in the quarter, including one small town proto 12 while our franchisees opened four restaurants. The brand also refranchised the Cleveland, Ohio market, selling four company-owned locations as part of an agreement to develop Northern Ohio and parts of Pennsylvania. Our new partner, Strang Hospitality will open up to 25 new restaurants over the next few years.

The sale of company-owned restaurants to a franchise partner is part of a long-term strategy we outlined at our investor conference in September. The acquisitions during the past few years have changed our mix of restaurant ownership. Currently, we are approximately 83 percent company owned, and we would like to gradually move that mix more towards 75 percent company owned, 25 percent franchise over the next few years.

That mix is a healthy balance. A primarily company-owned system allows for continuous innovation, but a slightly higher level of franchising provides protection against a rising cost environment, and better returns on invested capital. The refranchising of company restaurants to qualified, well-capitalized organizations like Strang Hospitality will also help us increase the pace of franchise development. We will continue to search for qualified franchise partners, the first step to move this initiative forward.

On the marketing side, Chili’s featured the Fajita Trio and To Go versus the same a year ago in October. They have Citrus Fired Chicken and Shrimp versus the Rib Eye and Triple Play a year ago in November, and the Rib Eye Steak and Triple Play versus the same items a year ago in December. In January, Chili’s is again featuring our famous Baby Back Ribs and Shanghai Wing versus Baby Back Ribs and a spot featuring Ribs to Go last year.

The team at Chili’s has built a brand that stands for innovation, food quality and high service levels. Chili’s has the highest average annual sales volumes in the bar and grill sector, and in fact this quarter they broke the $3m level per restaurant, proof that Chili’s is a brand consumers enjoy and trust.

Macaroni Grill same-store sales increased 1.2 percent, driven by a 1.8 percent increase in pricing, 0.2 percent increase in mix, and a 0.8 percent decline in traffic. For the quarter, Mac featured Create Your Own Pasta and Penne Rustica versus Mama’s Trio and Create Your Own Pasta in October, and Penne Rustica in November and they had some local ads in December versus no marketing in November and December a year ago.

Second quarter media utilized five weeks of national cable, versus three weeks of national a year ago, as we continue to adjust the marketing budget between national and local to achieve maximum effectiveness. Mac Grill opened seven new restaurants during the quarter, and remodeled 14 restaurants, and that brings the remodeled total to 25. We have 12 more restaurants on schedule to be given the updated, more comfortable look during the third quarter. The remodels continue to exceed the guests and our expectations, so we anticipate completing an additional 10 or 12 restaurants in the fourth quarter. John Miller and his team remain focused on providing a great guest experience as they work to increase brand awareness.

Maggiano’s posted a same-store sales gain of 5 percent, resulting from a price increase of 1.3 percent, a 0.8 percent increase in mix and a 2.9 percent increase in traffic. Mark Tormey and his team delivered holiday cheer to our guests as they took a break from shopping, or enjoyed a holiday party in one of Maggiano’s banquet rooms. Maggiano’s broke a number of weekly sales records during the second quarter. The most impressive week was the week before Christmas, when over 60 percent of the system set sales records.

Also, Maggiano’s had tremendous success with its feature card item, Roast Tenderloin. Guest feedback and satisfaction was tremendous on this product, so congratulations on a great quarter, Maggiano’s.

OTB posted same-store sales gains of 4.5 percent, driven by a 1.1 percent increase in pricing, a decline of 1.7 percent in mix, and an impressive 5.1 percent increase in traffic. This marks the third consecutive strong quarter of traffic gains for OTB.

OTB featured a guest favorite in October, the border sampler, versus their original fajitas a year ago. The strong performance in November and December was achieved without any advertising this year or last. The introduction of unique products like our Monterey Ranch Fajitas and Guacamole Live, which is Guacamole prepared tableside with fresh ingredients, continues to differentiate between OTB and competitors. OTB continues to build upon its success, and the team remains focused on driving increased guest satisfaction.

At Corner Bakery, the successful recent openings and higher sales in the remodeled restaurants has improved unit-level financial returns. Currently, 49 percent of the Corner Bakery’s featured a menu board and delivery of food to the guests. The team opened one restaurant during the quarter in their Chicago market. Jean Birch and her team continue to identify opportunities to both build sales and improve margins, with an eye on a more rapid development plan, as we outlined in the September’s investor conference.

Big Bowl opened one restaurant during the quarter, and plans are to open one more restaurant this year. [JJ Beckman] and his team are looking at the brands to identify the right markets for expansion and some menu position. Also, our Rock this Joint venture opened one new unit during the quarter in [Rally], North Carolina.

Well there’s the latest on the brands. Now let’s talk a little bit about Q2 expenses. Cost of sales as a percentage of revenues was 27.7 percent versus 27.4 percent a year ago, so as expected we saw a 30 basis point increase on a year-over-year basis. This increase was driven primarily by higher commodity prices for dairy, and some unfavorable menu mix shifts. These higher costs were offset by a favorable chicken contract.

Now there were a couple of events that impacted restaurant expense. We recognized $1.6m in after-tax gains associated with the sale of the previously mentioned Cleveland market, and the sale of a piece of real estate. As a result of the disposition of [Cose Mel’s] we recorded an additional $1.4m after-tax loss. Therefore, included in second quarter restaurant expense is a pre-tax gain of $400,000, or approximately $200,000 after-tax. For ease of comparability, my discussion excludes those one-time gains and losses reported in this year, and also the $9.5m pre-tax impairment charges recorded last year.

Restaurant expenses as a percentage of revenues were 55.6 percent versus 55.1 percent a year ago, beating our forecasted 50 basis point increase over last year. This was an improvement versus our first quarter, despite the impact of tougher winter weather. The higher cost factors remain payroll taxes from increased cashed in reporting, though partially lapsed this in the third quarter and then fully lapse it in the fiscal fourth quarter; utilities and insurance costs. Currently wage rate pressures have been modest at only 1 percent to 2 percent. Chili’s management expense improved as new restaurant openings and attrition reduced the number of excess managers and moved us closer to our normal staffing level.

D&A as a percentage of revenues was flat at 4.9 percent. G&A was 4.1 percent versus 4 percent a year ago, an increase of 10 basis points year-over-year. Operating income was 7.8 percent versus 8.6 percent a year ago on a comparable basis. Interest expense was $2.9m, slightly higher than a year ago, due to slightly higher interest rates. Other net was a $1.1m cost, versus $760,000 a year ago. The tax rate was 32.3 percent, versus 33.3 percent a year ago, as federal tax benefits from the increased payroll taxes that reduced our rate.

And during the quarter, we repurchased 1.2m shares, for approximately $38.5m. So at the beginning of the third quarter, there was 27.5m available under our share repurchase authorization.

Net income as a percentage of revenues on a comparable basis was 5 percent, versus 5.5 percent a year ago. Actual earnings were 45 cents a share, versus 38 per share last year, but exclusive of the gains and charges this year and last, EPS were 45 cents versus 44 cents a year ago.

Now for our Q3 outlook. Our estimates for top line revenue are to increase approximately 9 percent to 10 percent, driven by sales-weighted capacity gains of 8 percent to 9 percent, and same-store sales expectations are flat to up 2 percent. As noted in the press release, there is a holiday shift that will negatively impact January, and of course third quarter comps.

Christmas Day shifted from the December reporting period to the January reporting period. This same calendar shift will have a negative impact of approximately 3 percent on January comparable same-store sales, and negative impact of approximately 1 percent on third quarter sales report. Cost of sales will be about 10 to 20 basis points higher than last year, due to the impact of higher beef and also continued higher dairy costs.

But before I move onto restaurant expenses, I want to provide an update on beef costs. We continue to review beef prices, but have not yet entered into a long-term contract. While the cattle futures market declined meaningfully after the news out of Washington State, the finished product market has not reacted the same way. Our purchasing team has been opportunistic in purchasing some of our short-term beef needs on the spot market, and as a result we have greater confidence in our third quarter cost of sales outlook, and will continue to review market conditions for a longer-term contract as we move through the quarter.

Restaurant expenses will be approximately 20 basis points lower as we begin to lapse those cost increases which began about a year ago. Depreciation and amortization sequentially will be up on a dollar basis due to continue new restaurant openings. G&A should be slightly higher as a percent of sales than last year.

Interest expense in dollar terms should be slightly lower than last year, and other net should approximate a $1m expense. The tax rate should be about 32.3 percent. So based on those assumptions, our initial forecast of third quarter earnings is in the 51 to 53 cent range, which marks our return to double-digit growth, and similarly our year guidance remains unchanged at $2.07 to $2.11 on a 52-week basis, and $2.13 to $2.17 on a 53-week basis.

So now we are ready to take Q&A. Kate, we’re ready for the first question.

Thank you ladies and gentlemen. (Operator instructions) Thank you. Your first question is coming from Coralie Witter of Goldman Sachs.

Hi.

Hi, Coralie.

Hi, how are you? Could you provide us with a little more detail behind what’s getting you to the unchanged full year guidance? Because it implies a fairly substantial increase in earnings growth in that fourth quarter relative to the first three, even taking into account the 53rd week.

Well I think for us – this is Chuck. Some of the margin cost pressures that we’ve seen really kicked up in the third quarter of last year, so we started to get a full lapsing of things like the payroll tax increase. We also start to lapse in the third quarter of this year health care and health insurance costs, we get a benefit from that. We start to also lapse some higher utility costs as we get into our fiscal third quarter.

So it’s a combination of just continuing the trend of being able to lapse these higher costs, which started to impact us in the third quarter last year.

Can I add one follow up?

Yes.

Can you also update us on the IRS tip reporting situation?

As of right now I think there has really not been any changes to what we disclosed in our 10Q last quarter.

Thank you.

Thank you. Your next question is from Matthew DiFrisco of Harris Nesbitt.

Hi, Chuck, congratulations on a strong quarter. Just had a quick question, if you could give us some clarity on the comp guidance. For fiscal 3Q you said zero to two, we should presume that that has the negative calendar effect in that? And if so, that seems to be a little bit more bullish than your long term, which is organically zero to two. Correct?

We generally say flat to three, and yes Matt, that does have a 1 percent impact because of the shift in the calendar day.

Okay, and also, can you update us on your full growth plan for Corner Bakery for calendar 04? It sounded like you were talking about some pretty positive things there. Were you potentially looking at some faster growth in 04 at Corner Bakery, or is that more of an 05 event to be assessed?

Matt, hi, this is Starlette. Actually there has not been any change in our development projects for Corner Bakery, we’re still looking at five to eight for fiscal 04 and then moving forward at 12 to 15 per year in 05, and then 25 plus in 06.

Thank you.

Thank you. Your next question is coming from John Glass of CIBC World Markets.

Thanks. Could you talk a little bit about your marketing plans as you go forward for the Chili’s brand? Are you satisfied with the overall message that you have now, is it something that you’d like to review in light of maybe competitors in the bar and grill segment seeing an acceleration in same-store sales? Have you put any recent thought into that?

John, this is Todd. Our marketing at Chili’s has obviously been at the top of the discussion over the past couple of quarters. I can assure you and everybody else on the call that we’ve taken all the steps necessary to have ads that were impactful from a creative standpoint, are true to the brand and have products featured that will bring customers to our restaurant.

The campaigns that you have seen over the years, they were very fluid in terms of their shelf life, and we’re working very hard on the next one for Chili’s currently. The current TV [flags] that are on today featuring a wall-to-wall, 15-second rib ad; the 30-second ad that we call canyons, both of which resurrect our Baby Back Rib jingle are being paired with a 15-second testimonial ad with our Shanghai Wings.

I just want to reiterate again that driving sales is more than just good TV commercials. It’s execution, it’s food items, but certainly you need to pair that up with a great message as well. So a great deal of focus is being spent on the Chili’s marketing, and I think we’re having some great results and some great learnings that we are working on currently.

And a follow up, on the union opening guidance of, I think it was 126 to 145, I think it was slightly lower than previous guidance. I’m not sure if that was a function of the refranchising activities, or have you slowed – if you have slowed development somewhere, where has that been?

I think for us it is just tweaking as we get a little closer to the opening schedule, John, we should get a little bit better visibility. Some of the cold weather up in the Northeast might impact a couple restaurants, particularly at Mac Grill, so we’re just continuing to take a look at that. Nothing drastic.

Thanks very much. Thank you.

Thank you. Your next question is coming from Janice Meyer of Credit Suisse First Boston.

Hi, as a follow up to the marketing question, if we could just switch to Macaroni Grill. You’ve obviously done more national cable over the last year or so. Do you think that’s been helpful, do you have any data you can share with us, any customer response, do you like the message, and are there any changes from a marketing standpoint at Macaroni Grill this year and next year?

Janice, this is Todd again. We’re still balancing what’s working best for us with regard to the mix of national cable and local spot, we’re trying to find the best efficiency with the wait levels, FSIs, that we’ve done in newspapers as well as the national and spot TV. I don’t know if you’ve seen our newest commercials, but we’re very, very excited about the brand imaging and the new ad creative, it really elevates the brand back to where we think it should be which is casual plus, and it focuses on the energy, the chef-prepared food and certainly the grilled items. And also paired up with a Chicken Scaloppini ad which we’re using the same creative with some awesome food shots.

Over the past few years we’ve broadened the menu, we’ve done a number of things in terms of design changes to the building, inside and outside, and we’re very excited about what we’re able to couple up with the menu, food introduction and then the creative. And also still trying to learn, what is the right balance between national cable and then the local spot markets.

If I’m not mistaken though, the remodels are trying to make the concepts more comfortable, more family friendly, and I thought you were moving away from some of the chef-driven ideas, but now you are saying your ads go the other way a little, and they are trying to go back to the more chef-driven, casual plus?

Well we never really wanted to get away from the chef-driven aspect of our brand, we think that’s always been a differentiation between us and our most direct competitors. However, at the same time we want to make the brand more approachable to the everyday consumer, whether it’s for a Tuesday lunch or whether it’s coming in on the weekend with your family. A more friendly atmosphere along with great food is a great combination that we think is going to be a long-term winner for us.

Okay, thanks.

Thank you. Your next question is coming from Mitch Speiser of Lehman Brothers.

Thank you, good morning. A couple questions. First, on the price increase you took in November, Chili’s traffic was, you know, excluding the shifts a little bit soft, particularly in December. I was wondering if you’d done any studies on the inelasticity or elasticity of the price increase? Then I have a couple follow ups.

Mitch, this is Chuck. One of the things you’ve got to look at in the December number is weather did have an impact, and that weather impact falls directly into customer accounts. So we had about 100 basis point hit on Chili’s traffic in December, just due to weather. You guys up in the Northeast have just gotten buried on two separate weekends back in December, so when we dial that out and look at Chili’s traffic, it’s much more in line with what we would expect. So when we look at the elasticity of price increase it looks like just about what we had bottled out.

Thanks. And on restaurant expenses for the fiscal third quarter, did you say you expected it to be down 20 basis points year-over-year?

Yes, we do expect to be down 20 basis points.

Because you still have management expenses flowing through and some other things, can you reconcile where you expect to get the leverage from? I was thinking it would be perhaps just not up as much versus the previous quarter, but now you are saying it is going to be down year-over-year.

When we look at it, go through and forecast out each of the individual cost categories, a couple things happen. We start to anniversary the increase in health insurance we had last year, and that really cost us 30 basis points each quarter during calendar year of 2003, so we’ll start to get a break on that this quarter. The payroll tax reporting cost us 15 basis points in our fiscal third year last year, and then became 30 basis points each and every quarter after that, again, so we lap about half of that as we get into the third quarter.

The same way with utilities, while utilities probably don’t give us a full 30 basis point benefit in the third quarter, but they were up about 30 basis points each and every quarter during calendar year 2003, so all those things start to turn our way, and then of course I think we just did a little bit better job of managing costs right now. There’s been more focus on each of the brands, each of the brand presence, and we expect to get restaurant expense more in line.

Great, and lastly, I know the beef cost outlook is still a bit uncertain. Before Mad Cow you were saying beef, whether for hamburger or your contractible items up 15 percent to 17 percent. Is there any just gut feel at this point as to if you think that rate will be lower, and maybe if you can provide just a little more magnitude on that, if you have any information whatsoever. Thanks.

Sure. In terms of beef costs, right now that would still be our estimate. We’ve been able to do a little bit better than that. Again, our purchasing team has done a great job of getting out where there’s been some availability and locking in some prices. Currently through April about 75 percent of our beef is now contracted, but again, those are short-term contracts, and everything else that we have outside of that 75 percent are mostly market-based contracts on things like burgers. So we’re pretty set for this quarter.

As we look out on the fourth quarter we would still keep that same outlook for beef prices, up 15 percent to 17 percent. A lot of things are going to depend on the external markets, whether they begin to import U.S. beef into Japan, Mexico, whether the Canadian border opens. We still need some visibility on really those international issues before we could give a real good, solid forecast on what beef prices might be.

So it sounds like you are being a bit conservative, that you’re maintaining the 15 to 17 percent if these things do reverse, but if they don’t it sounds like the outlook could be a bit improved from those levels?

We’re pretty comfortable with the number we gave out on cost of sales for third quarter, if you look at fourth quarter we are looking at 15 percent to 17 percent, and you know, everything else is up in the air.

Thank you.

Thank you. Your next question is coming from Dennis Forst of McDonald Investments.

Good morning. At the beginning of the call there was a reference to all these low carb meals and the ads and the stories. Have you actually seen any anecdotal evidence that people are eating less potatoes and more shrimp and more beef, et cetera? At Chili’s has there been any change at all in the menu mix by the customer?

This is Todd again. We just rolled this, It’s Your Choice menu out to the restaurants late last week, so it’s a little bit early to go on record with too many results. And talking through December with the holidays we didn’t see a huge shift in terms of menu mix changes.

So you haven’t really seen anything yet.

No, not yet.

Why have you decided not to lock in beef? Can I imply that you think that the beef prices might become more attractive in the next few months?

I think there will be more visibility on where they are. Really, finished product prices haven’t changed at all, despite the Mad Cow scare and there being some additional product, additional supply available because of the change in the export rules. We really think we’ll kind of hang on right now, we might be able to get some better pricing later in the year.

Okay, and then lastly, again on the restaurant expenses for the third and fourth quarter I think, given your guidance, that implies that restaurant expenses in the third quarter will be like, 90 basis points lower than the second quarter?

Yes –

Just sequentially there’s a big drop.

There is, but there is seasonality in that number also, Dennis, so –

Higher volumes.

Higher volumes come in the third quarter. While I’d love to say we’re going to get 90 basis points better, really on a year-over-year basis we expect it to be down 20 basis points, and that 70 basis points is sort of the seasonality that’s in that quarter.

And when you say down, you mean better by 20 basis points.

We will be better by 20 basis points.

And in the fourth quarter you should be better by more than 20 basis points? You’re going to have the 14th week, you are going to have the full impact of some of those year-over-year anniversaries?

The fourth quarter is going to be basically not comparable with that week in there. We’ll get huge leverage off that, and where we finally come out on restaurant expense will be – is it the 5 cents or the 7 cents additional that we get from having that fourth quarter, and then if we decide to do any investment spend or any brand building in that quarter also.

What was the capex in the quarter?

In the quarter we spent $85m.

Great. And January comes, will come out what date? When will you release those?

February 4th.

2/4, after the close?

Yes.

Terrific, thanks a lot.

Sure, Dennis.

Thank you. Your next call is coming from Joe Buckley of Bear Stearns.

Hi, Joe.

I’m curious how you did on gift card sales over the holiday period?

Gift cards were up 15 percent on a year-over-year basis. We don’t record any income off the gift card until the customer comes in and uses the gift card.

Right.

Just for purposes of –

Go back to beef costs for a moment, you said you were about 75 percent locked in through April. The prices you are locked in for, are they up 15 percent to 17 percent year-over-year?

No, not necessarily.

Okay, is it up? They are up though, can we presume that much, anyway?

They are up.

Okay. Can you quantify it at all?

You know, to be honest with you, I don’t have the detail.

Okay. Okay, and then just a couple more questions on the marketing, both for Chili’s and Macaroni Grill. Is there a new ad campaign for Chili’s in the works? Did you just start replacing the testimonial campaign? Seems like you might be easing out of it here in January with like a partial testimonial.

There is a new campaign in the works.

And sense of timeframe on that?

Not that I want to talk about on the phone today, Joe.

Okay. And lastly on Macaroni Grill marketing, is the casual plus, is that a shift back to a little bit more upward positioning of the brand? Just talk a little bit about that, that sounded like it would be a shift back up in terms of brand positioning.

We don’t think that’s a shift at all, we think the casual plus piece of Macaroni Grill has always been the chef-prepared food, that’s always been the real distinguishing difference between us again, as I said earlier, our primary competitors. As we all know, the brand has gone through a little bit of an evolution over the past few years in that we wanted to make it more approachable without alienating our core customer who utilizes Macaroni Grill for the feature items and the high culinary execution that they are so well-known for. If we can get more people in our restaurants, again for a Tuesday lunch or coming in with their family and get exposed to the awesome preparation of that chef-prepared food, we think that’s a great positioning for the Macaroni Grill brand.

We think we have done some great things with the interior and exterior piece of it, and I think with the advertising that we have on today, really highlights what the Macaroni Grill brand stands for, and that is the high energy, the chefs, the grill. We do have grill in the name, we want people to understand that we do have other items beyond pasta, and you can get low carb, if you will, or grilled meats, grilled fish and things of that nature. So we don’t think it’s a big departure.

And Joe, if I could just add to Todd’s comments there, if you look at Macaroni Grill it is positioned for an improving economy which we are certainly seeing today with our consumers, so it’s not a departure from a long-term strategy for the brand, it’s just giving us a little flexibility within that brand.

Okay, thank you.

Thank you. Your next question is coming from Andy Barish of Banc of America Securities.

A couple of Chili’s questions, please. I was just wondering why mix was down in December, even though you promoted a steak item at a dollar more, what do you see going on there? And secondly, on To Go, it sounds like you are evolving to do a little bit more curbside at Chili’s. Can you kind of give us the thought process there? Is there an ability to drive more sales, or is it more of a maintenance of the current To Go levels?

Andy, this is Chuck. I think one of the reasons why mix might have been down, last year we were able to advertise Rib Eye for two consecutive months, and this year we had a little problem with the amount, the supply of Rib Eyes, so we did chicken and shrimp in November and really only had the Rib Eye on for just December, so I don’t think we had a chance to really break through and get some message into the Rib Eye. So I think that’s one reason why mix was down a little bit.

And then again, just in general we continue to see people using Chili’s for convenience, and so our To Go percentage continues to increase, and of course when that occurs, we do see a little bit of decline in mix.

Any further questions on that, Andy?

No, just I guess playing into curbside, it sounds like you are going to do a few more of those. Can To Go go higher, or is it just more of a maintaining of these To Go levels?

Well I think it’s hard to say, although we did see To Go creep up a little bit in Q2, for Chili’s it was 10.4 percent of sales, up about 150 basis points. We do continue to add curbside to the restaurant. I think it’s a little bit of both, you want to have as many convenient aspects to the To Go side of your business, along with again, trying to promote that part of it as well.

Thank you.

Thank you. Your next question is coming from John Ivankoe of JP Morgan.

Actually I had a follow up on that mix question that was just asked. I think it was mentioned earlier that Macaroni Grill was being positioned for an improving economy, a stabilized and improving consumer. Can you make a point whether the same thing could happen at Chili’s when it comes to new items that may be introduced in the future, and if we should expect or even look for some of that negative mix that we’ve seen recently for a number of reasons, to turn around things?

Well we wouldn’t expect negative mix to continue at Chili’s, John, and while we would like to sit down and talk about things to come on the menu, again this is a pretty competitive segment, we know our competitors are listening now, so we’ll kind of keep this close to the vest, the things we’ve got planned on future menu rollouts.

Fair enough, thanks.

Thank you. Your next question is coming from Mark Kalinowski of Smith Barney.

Hi, two things I wanted to ask about. First just regarding advertising and advertising rates, how far have you bought out into calendar 04, what are the rates that you are getting, compared year-over-year, given that we have the summer Olympics and elections this year?

Second question, I am just wondering if you’ve been able to quantify to any degree if On the Border is receiving any sales benefit from some of the issues that rival chain Chi Chi’s has faced recently?

Okay, well let me start with the advertising question first, in terms of kind of where we are and our media buys. All of our national buys have been bought upfront, and we’re locked in for this year from a national perspective. Then we are buying, and our local tier 1 and tier 2 markets, the spot markets, and buying up where we can now, but we are not really seeing, as we mentioned before, a close to double-digit increases in terms of media costs on a year-over-year basis. So that is, I think we feel pretty good about our advertising as a percent of sales, because year-over-year it’s flat for the company.

And in terms of On the Border and any pick up they may be seeing from Chi Chi’s, there’s not any real market overlap there between those two, not significant, so again we’re real pleased with what On the Border and their team has done right now in improving traffic for execution, their limited time only offers, and kind of continued success there.

Thank you.

Thank you. Your next question is coming from Mike Smith of Oppenheimer.

Good morning. I noticed that in the most recent quarter you had an up tick in the rate of increase in your G&A expenses. Was there something unusual behind the increase this year, or in this quarter as opposed to the prior couple of quarters?

No, I think Mike what we’re doing is we’re just feeling a little bit better about the balance of the year, and profit sharing is a little bit of an accrual there in the quarter, nothing drastic.

And in terms of your gift card sales, could you remind me what your gift card sales were as a percentage of total in 2003 for the year?

I believe last year they were about the same, I think on a year-over-year basis they were pretty close. Todd do you –

I don’t know the exact number, Chuck.

I think they were pretty close to 15 percent up.

No, I meant as a percentage of your total revenues.

Oh total revenues. I don’t know, maybe 3 percent to 5 percent.

And could you remind me of what the redemption experience is?

We generally see most of the redemption in January and February.

Okay. And capex for the year?

Capex should be around $335m to $340m.

Thank you very much.

Thank you. Your next question is coming from Jason Whitmer of FTN Midwest Research.

Okay, before we go farther, it’s 2.4 percent of total sales for – 2.5 percent of total sales was the answer to Mike’s question. Sorry, Jason.

That’s fine, that’s fine. Good morning to you. If we were to step back a little bit on Chili’s, a lot of activity going on right now. What would you say is your number one focus over the next six to 12 months?

I think for Chili’s right now the big focus is on a couple of things. They can’t be singly singled out, but I would say execution, marketing and food introductions. I can assure you there is a great deal of effort and focus on all those things right now.

Very good. On the traffic side of things then, are you happy with your repeat business or your core business at this point with some of your pricing adjustments?

Absolutely. As Chuck mentioned earlier, from a pricing standpoint we haven’t had any real anecdotal feedback from a negative perspective from our customers at the restaurant level over the past couple of months at all.

With marketing, when you say marketing, does that mean you are going to be more promotional or do more features within the current environment?

We haven’t really decided that yet. As I mentioned, we’re working on some new campaign ideas, and I really haven’t gotten that filled in yet.

And lastly for Chuck, if I were to just understand this beef thing one last time, you seem to have a little more favorable year-over-year cost outlook here just relative to this quarter. And even the percentage is roughly flatter or the same versus this quarter. I am trying to understand that, with buying in the spot market I would presume that would be a little bit more costly, just on beef, let’s say.

Well spot market prices are actually lower than contracted prices right now, because contracted prices take into account the expectation of events that are going to occur over the next year. So spot market price today is lower because Japan is not importing beef from the U.S., whereas if you look at a long-term contract, they may expect the border to open, let’s say hypothetically, in June. So you’d only see a benefit of that lower price for one half of the contract period. So you see a much different volatility in spot market prices then you would see from a longer term, over a longer-term contract.

Are you saying the spot market is less than forward-looking contracted prices, or contracted prices you’ve already had for the past 12 months.

Spot market prices are lower than forward-looking, or longer-term contract prices.

Very good, thanks.

Sure.

Thank you. Your next question is coming from Glenn Guard of Legg Mason.

Hi, thanks a lot. Chuck, just a quick question on the convertible. I think on the analyst day the magic number was $40, correct me if I’m wrong, $40 for the first 20 days of the quarter or something, that you would have to show 7.8m shares on the income statement. But I remember that this was a moving target. Can you give us any updates in terms of, has that target moved?

On March 24th of 04 that number will be $41.10.

Okay, and the dilution is still 7.8m shares?

Yes.

Okay. And just a point of clarification on Chili’s, I think you guys mentioned 10.4 percent of sales was To Go. Is that overall or is that for the units that have To Go?

That’s overall. Virtually every restaurant does To Go.

Okay, great. Thanks a lot.

Thanks.

Thank you. Your next question is coming from Peter Oakes of Piper Jaffray.

Hi, good morning. Actually, a couple of questions starting with Mac Grill. With the step up in remodels, I think you are a little bit north of 10 percent of the system now. Can you share with us the financial parameters you are looking for from the remodel activity?

Peter, this is Todd. We look for about a single, mid-single digit comp lift to pay for the remodel, and we’ve been achieving that and I feel real good about where we’re at so far.

Todd or Chuck, has the remodeling activity had any impact, I guess you can kind of back into that maybe a 50 or 60 basis point impact on comps, and I guess more importantly, what’s your sense as to the contribution that might provide going forward?

Well as we get the remodeled restaurant to be a bigger piece of the system we’ll see that, but since we’re rolling it out relatively slowing, you know, 10 or so a quarter, you are really not going to see any major up tick in the comps, because we’ll start to lapse them as we get through the full system? Does that make sense? That we’re doing 10 or so a quarter, we’ll see a little bit of lift – it’s really different than you might have seen in an On the Border, because when you drive by a Macaroni Grill you probably don’t realize that there has been a remodel, so you don’t see the sudden increase like we saw at OTB, it’s much more gradual, but we’ve been able to hang onto it. So as a result, you’re not going to see one big lift in any one quarter as we start to get these remodels through the system.

Thank you. Your next question is coming from Paul Westra of SG Cowen.

Hey gang, maybe one more question left, but can you give us a little more detail on the new diet conscious menu items? Did you get an early read on reception so far, and if not, if you can’t provide us with that how about the design of the price point margins, penny profits, et cetera, versus I guess maybe, you know, the comparable items that people may trade down from?

Hey Paul, this is Todd. What we’ve done, I think the thing that we’re most excited about in particular is the Chili’s It’s Your Choice menu insert. Ninety percent of the items that we have on this menu are current menu items that have been modified just very slightly, whether it’s a side item or in the case of a burger, served without a bun.

So in terms of a penny profit margin from these items, there should be very, the menu is going to be very comparable to what we have here. We don’t really have any mix info at this point, it’s too soon to really say. And our burgers, as I mentioned, our burgers are being served bunless, they are being served with real vegetables instead of French fries. We have our buffalo wings, we have a fajita Caesar, our fajitas, a grilled rib eye with vegetables instead of a load of mash potatoes.

Again, it’s too early to tell because it just got into the restaurants last week, but we are excited about the potential of it.

Great, thank you.

Thank you. Your next question is coming from Jeff Omohundro of Wachovia Securities.

Good morning. Just a quick question on [Cose Mel’s] and is this $1.4m charge the end of the exit costs there? And is the aggregate exit cost around $16.5m? I think that’s what I am calculating.

What we have right now is we do have a deal that’s been finalized with an individual. Really it was the second person that we – we had two parties that were interested, we ended up going with the second deal which was for a little less than the original purchase price we had anticipated. This individual is currently out getting permanent financing now, so we’re hopeful he can get the financing, as best we know he will, but if there are any other issues we’ll address those in the third quarter.

Okay, so it’s not really completed then, the sale. There’s more to come.

It’s been documented, but we don’t have full cash receipt yet, no.

Okay, great. Thanks.

Sure, Jeff.

Thank you. Your next question is coming from Brian Elliot of Raymond James.

Good morning. A couple of follow ups and then a conceptual question. The gift card redemptions which you talked about, you said most of them come in January and February. Is that, in magnitude, is that 80 percent or 60 percent or give us some feel of, you know, kind of what comes in January and February. You are seeing a difference this year, maybe weather impacted? Do you have data on that or not?

Brian, historically the redemptions have been over 90 percent in total, and we usually see somewhere between 70 percent and 80 percent in the first two months. Too early this year to put that data together, consumers seem to be buying more and more gift cards, not just in restaurants but in retail, and we would assume it would be similar to last year.

Fair enough. You mentioned execution, Doug, as one of your Chili’s priorities right now. What have you done sort of initiative-wise or otherwise that’s creating improved execution, or is that ahead of us? Flush that comment out a little bit.

Well I think it boils – this is Todd. It just boils down to a lot of things, whether it is an execution in the back of the house with food items, training in the front of the house for our servers, our hostesses, host or busser, our bartenders. Just trying to make sure that the experience that our customers are experiencing is at as high a level as we possibly can.

Well I mean, you kind of wake up and do that every day though. What’s new? Is there anything new or different that has occurred in the last three to six months, maybe associated with some of the management changes or anything like that, that you can be more specific on that point to driving that?

No, it’s just a constant evolution of what we are trying to do inside the four walls of the restaurant. You know, it’s not rocket science but at the same time it takes a great deal of feedback, whether it’s feedback we’re getting from our customers, from our GSS survey or what we just hear anecdotally from customers calling into our customer hotline.

Fair enough. Last question, address the franchising which nobody has asked about yet, but seems like a pretty strategic alteration. You talk about sort of a 75 percent goal, flush out generally sort of timing. Are you looking at maybe doing some small town, single unit operators, or are we looking more at the by a major market like Cleveland and get a development contract to fill it out? A little more color on that issue?

I think the answer is yes, Brian. Actually we’re not looking for single market operators, but what we’ve done is we’re trying to find good, quality franchise partners that are well capitalized and can really build out a market. Cleveland for us was sort of the poster child event. Cleveland we hadn’t built a restaurant there in a while, our system averages for Chili’s there – excuse me, the market average for Chili’s in Cleveland was less than the system average. We were able to find a partner who had built that market out for one of our competitors and he wanted to right the Chili’s. For us it’s a real positive because we sold that market at a gain, but more importantly he’s going to build 25 restaurants in that territory over the next couple of years.

This is really a change for us. You know, if you go back to fiscal 1999 we were 70 percent company-owned, 30 percent franchised. The acquisitions of the New England territory and then [Sidrin] really are what moved that percentage up. So for us it is kind of getting back to our routes, we’ve already got systems in place to support franchising for Chili’s, and we’ll go through the markets and see what we can find. Again, well qualified partners who can take on a major market, and then also build out those small towns that surround that territory.

Would you expect, as we kind of sort of pencil out the next three years or so of company store growth, would this be the sort of supplemental to that, the number of stores that you all have talked about opening on the Chili’s side, company stores in the next few years? Should we be bringing that down some? Because the stores that were penciled in for Cleveland down the road aren’t going to happen, or would those stores open up in other markets now?

Well, Brian, to use Cleveland as an example we actually didn’t have anything in our three-year plan to build to Cleveland because of the way our capital allocations work. So on that sense this would just be additive to the number of restaurants to be built out for Chili’s. But again, something like this isn’t going to happen overnight, it’s going to take us a few years, as we said, to get that. But it’s a longer term target and we just wanted to set that out there.

And would you expect the deal to close in fiscal Q3?

The Cleveland deal has already been signed and closed.

It is closed, reflected in Q2 balance sheet?

Yes, sir.

Okay. Given that it’s closed, could you share proceeds, or cash flow models?

No.

Okay.

We recorded a gain of about $1.6m pre-tax.

Fair enough. Thank you.

Sure, Brian.

Thank you. Your next question is a follow up question from Matthew DiFrisco of Harris Nesbitt.

I’ll make it quick. I just wanted to know, the Corner Bakery remodels, you said half of them are done of the base. What are you seeing in the incremental gain? Is it just pure reduction of operating costs or is it a better leverage relating to higher sales volumes from these new stores?

Matt, hi. It’s kind of a combination of both, with the remodel program we didn’t go into it expecting a sales lift, we went into it generating returns based on food, cost savings and labor savings, which we are seeing with the remodel. In addition to that though, we are experiencing some positive sales lift which is nice to see, it wasn’t what was in our initial model, but it’s great to have that on the top line.

Thanks.

One last question.

Thank you. Your next question is a follow-up question from Janice Meyer.

Thanks, this one is quick too, so you may even have another. Just a follow up on the beef, as long as spot prices are below forward contract prices, how long do you feel comfortable just continuing to buy spot, and are there any supply trade offs with staying on the spot market versus contracting?

I think for us we’re just trying to figure out where the market is going. The biggest issue for us, Janice, is really the people who are making long-term contracts, they are reluctant to go out and set a price over a longer period of time. I think nobody knows or has much visibility, so they are going to be a little bit more conservative when they give us a price, rather than being aggressive.

We feel like as things start to get a little bit better now prices may come down a little bit. So we don’t think really all the volatility or uncertainty has been priced at the lower beef prices.

Right, but is there a timeframe where you say to yourself, we just need to contract, or as that situation continues, can you just stay on the spot market all year, and can you get enough supply doing that, is there no issue?

We can get supply, and I think, Janice, we look at it every day. You know, the folks at purchasing are in contact with their suppliers all the time to see what’s the right deal that we can sign and feel good about for the year. So we can stay on spot markets for the whole year if we want to, if we need to.

Okay, thanks.

Sure. One more.

Thank you. Your next question is coming from Mitch Speiser as a follow up.

Thanks, Chuck. Just on G&A, can you, with earnings below long-term targets I would think that the performance accruals would be lower or zero, just trying to understand why relative G&A would be up if performance-based bonuses are down year-over-year. And then I think Starlette said that you are seeing an improvement in the economy or you are seeing it, just in particular, what are you seeing that leads you to believe that the economy is improving? We all know the macros, but just in the store what you are seeing to lead us to believe that the economy is having an effect on restaurant sales? Thanks.

We are seeing the same macros that you see, so what we want to do is be prepared and capture the guest’s experience, where they feel a little bit more flush, feel like they have more money. In terms of performance bonuses, you’re right. Year-to-date we’ve not hit our targets of where we’re at, and we’ve got a pretty aggressive second half year plan. So we have accrued based on hitting those plans.

If indeed we do stumble or we don’t deliver the numbers that we fully expect to deliver, there might be some bite back on those bonuses. But again, for us we believe we can hit that second half of the year, and so part of our accrual for bonuses in Q2 is based on our expectations for Q3 and Q4 performance.

Great, thanks.

Thank you. Your final question is a follow-up question from Joe Buckley.

Hi, thank you. Curious on the To Go, you gave the overall Chili’s mix of 10.4. Was that mix higher for the units where you have curbside, and where do you stand now with the curbside rollout, do you have it every place you can do it?

That number, again it’s a blended number across the entire system, Joe, and honestly I don’t have that information in front of me as far as if any curbside restaurants are actually doing more. I don’t have that information right here, but I’ll try to find that out. If you want to have a follow-up call with Hill or Chuck later on today or the next couple of days. As far as curbside, our rollout right now, we’re continuing to do more and more curbside. I can’t tell you that number either, but our goal is to do probably about another 100 in the back half of this fiscal year.

Okay. Thank you.

Well thanks for joining us today. We’ll release our January sales, as we said, on February 4th. If you have any questions or comments, please feel free to call Hill or myself. Thank you.

Thank you ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.