Brinker International Inc (EAT) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Brinker International fourth-quarter conference call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Lynn Schweinfurth, Vice President of Brinker International. Ma'am, the floor is yours.

Thank you, Kate. Good morning and welcome to the August 11th, Brinker International fourth-quarter fiscal 2005 earnings conference call. First, let me start with the ever popular Safe Harbor statement. 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 risks and uncertainties which could cause actual results to differ from those anticipated. Such risks and uncertainties include factors more completely described in this morning's press release and the Company's filings with the SEC.

The following are key calendar dates coming up in the near-term. First, August sales will be released on September 8th after the market closes. Next, hopefully you all received our save-the-date message for the Brinker Investor and Analyst Conference that will be held in Dallas on September 14th and 15th. Please be aware that registration is required for this event. We will be sending out further information including information on how to register tomorrow. I look forward to seeing many of you at the conference. Lastly, first-quarter fiscal 2006 earnings will be released on October 25th.

With me today are Doug Brooks, Chairman and Chief Executive Officer, Todd Diener, President of Chili's Grill & Bar and Chuck Sonsteby, Chief Financial Officer. This morning, Doug will kick things off with some opening comments. Next, Chuck will provide his perspective on the past year, fourth-quarter financial results and the first quarter and full-year fiscal 2006 forecast. After which, we will open up the call for questions. With that, let me turn you over to Doug.

Thank you, Lynn. Good morning, everyone and thank you for joining us on the call today. As you saw earlier this morning, fourth-quarter earnings per share came in at the high end of our guidance or $0.71, excluding gains in charges that are detailed in our press release. As is our usual practice, Chuck will take you through our quarterly financial results in more detail as well as provide you our latest business forecast.

First, I want to highlight some of our key accomplishments over the past fiscal year and give you my perspective on why I think we are set up for a bright future. Over the past two years, we have focused on refining our brand and restaurant portfolio on assembling strong management teams at each of the brands and at Brinker and on implementing processes that will generate targeted financial results with consistency.

On the progress we made in fiscal '04, we laid considerable groundwork in fiscal 2005 and are entering fiscal year 2006 with momentum and confidence. First, in terms of refining our portfolio, during the year, we divested Big Bowl. We closed some underperforming stores and we refranchised three markets adding two high-quality partners to an already exceptional franchise community. These franchisees will develop several new stores in their respective territories over the coming years consistent with our stated strategy to increase franchise ownership in our system and to improve financial returns.

Additionally, we continued to accelerate the development of Chili's. Given the 18 month time frame it takes to open a restaurant and the training and recruitment efforts that are required to staff these restaurants, we have made considerable progress. In fact, Chili's alone opens more new company-owned restaurants than any competitor in our category. The Chili's system overall is planning to open up to 130 new restaurants during this fiscal year.

Now regarding Brinker and brand management. Last quarter, I spent time talking about members of senior management and their recent contributions. I will not repeat myself today except to reinforce that in my opinion, the management teams currently in place are the strongest we've had collectively at any one time at Brinker.

At Maggiano's, we are going through a leadership change and I would like to publicly thank brand founder, Mark Tormey, for the fantastic job he has done creating and growing this fabulous Italian restaurant concept. Mark is the most passionate restauranteur I have ever worked with and he has also been gracious enough to help us through this transition period.

In addition, I would also like to take the opportunity to publicly welcome Wyman Roberts to Brinker as the new President of Maggiano's Little Italy. Wyman's extensive experience in casual dining and hospitality, his track record driving successful business results and his obvious leadership skills make him the ideal person to make Maggiano's the billion dollar brand we know it can be in the years to come.

And finally to drive consistent predictable results we have put in place rigor, accountability and process. Our Company has embraced a consumer products mindset to ensure that innovation through consumer insights will tell us how we need to evolve as a company. To do so, we need to rely on our ability to effectively conduct consumer research to foster an environment that embraces change and innovation and to make sound decisions based on empirical data. We have done just that.

In summary, fiscal 2005 was a year of effective change and investment for our Company moving forward. It is a very exciting time to be a Brinker stakeholder. We have the people, processes and portfolio in place to build long-term value for our shareholders. I look forward to sharing my long-term strategic vision with all of your during the 2005 Investor and Analyst Conference on September 15th that Lynn mentioned earlier. So with that, let me turn the call over to Chuck Sonsteby.

Thanks, Doug and good morning, everyone. This morning we reported fourth-quarter EPS of $0.71 at the high end of our guidance. EPS grew 22% on a comparable basis as a result of operating earnings growth and share repurchases. This compares and excludes gains in charges and the estimated impact of the 53rd week last year. Our success during the year is evident by the strategies and processes put in place to ensure consistent future earnings growth.

First, we implemented a new marketing strategy and replenished the product pipeline at Chili's, which has led to good top line results the past two quarters. The predictability of consumer responses from test markets to national rollout gives us confidence in same-store sales growth in 2006. Cost challenges have been controlled by the operations teams, another major accomplishment. With each new rollout, we see steady improvement in labor and overall store level profitability. Based on the success of these initiatives at Chili's and On the Border, we have adopted them as a best practice to be utilized across the Brinker portfolio.

A couple of years ago we made plans for a controlled and well-executed restaurant opening schedule and it took shape during the year. The Company built a record number of new restaurants in both the fourth quarter and the full year. The increased openings were driven by our strategy to accelerate growth at Chili's. The result this team has given us provides the confidence to forecast opening up to 100 new company restaurants and up to 30 new franchise restaurants in fiscal 2006.

All of the brands continue to focus on opportunities to expand their margins going forward. Menu optimization, more frequent in restaurant visits, P&L coaching and enhanced reporting tools designed to provide greater operational visibility are just some of the initiatives focused on improving bottom-line performance. Additionally, we build shareholder value by repurchasing shares and redeemed our convertible debentures with minimal dilution all with an eye on improving return on equity.

Brinker also resolved a long-standing IRS dispute and completed the multiple required restatements forced upon our industry due to different accounting interpretations. Overall, while we weren't satisfied with the quality of financial performance we delivered over the past year; we accomplished a great deal.

Now turning to our fourth-quarter financial results. Chili's posted a 4.2% comp sales increase in the fourth quarter, the highest comps at Chili's in 15 quarters. This increase was composed of a 3.5% price increase, a 2.2% increase in mix and a 1.4% decrease in traffic. The increase in mix for the fourth quarter was driven by the success of featured menu items and our fire-grilled skewers promotion that ran for four weeks during the quarter. Demonstrating customers are willing to trade up for higher quality products. Our menu offers a wide range of great products, including offerings at lower price points to accommodate those guests interested in managing their check. Chili's has one of the lowest per person average checks in the casual dining arena according to NPD CREST and coupled with having the highest average annual volumes in the grill and bar segment means Chili's serves the highest number of guests in the category. This amount of traffic is evidence that the Chili's menu is well positioned from a value perspective versus its competition.

Advertising in the fourth quarter was non-comparable year-over-year, only five weeks this year versus nine week last year. We experienced some softness in traffic when we were off air versus when we were on the air last year. However, the strength of brand is evident by the modest amount of change. July was strong with a sequential improvement of four percentage points due to our Baby Back Rib Road Trip and the promotion also performed well versus the reported results of our competitive set.

Romano's Macaroni Grill for the quarter reported an increase in same-store sales of 9/10 of 1% driven by a 2% increase in pricing, a 0.7% increase in mix and a 1.8% decline in traffic. Mac Grill promoted its $11.99 Trio Milano, three course offering and the Boursin Fillet. During May and June but did not advertise on television or radio. Mac had no media in July this year versus television advertising last year. Of note, Mac Grill also opened its first franchise location in Taipei, Taiwan during this quarter and additionally, we entered into a franchise agreement with a veteran restauranteur, Randy Schoch, to build five Mac Grills in Hawaii. Jean and her team are in the process of analyzing data and market testing the positioning communication points and a marketing execution plan which will be rolled out during the second half of the fiscal year. We will further update you on their progress as we move through 2006.

Maggiano's comparable store sales were 2.8% for the fourth quarter driven by a price increase of 1.7%, a 1.8% increase in mix and a 0.7% (ph) decrease in traffic. This quarter represents the 15th consecutive quarter of positive comp store sales at Maggiano's. The team is gearing up to open four new restaurants through early November in new markets including St. Louis; Beechwood, Ohio; Nashville and Bellevue, Washington. And we are very excited to have found a new president. Although he won't be leaving until October, I too want to recognize Mark Tormey for his leadership, partnership, passion and vision in creating an incredible restaurant brand. Thanks, Mark.

The On the Border team continues to deliver strong top-line performance. June results marked the 27th consecutive month of positive same-store sales and traffic gain. For the quarter, same-store sales increased 4.4% driven by a 1.6% increase in price, flat mix and a 2.8% increase in traffic. The team will complete the rollout of the kitchen display system for the entire company system by the end of September. KDS pilot test demonstrated a reduction in waste, fewer mistakes and improved guest satisfaction scores, the results of delivering hot food hot and cold food cold. On the Border advertised the popular Tour of Mexico priced at $9.99 throughout the month of May and the first three weeks of June. It has been a bear of a summer in many parts of the country hurting patio sales which impact overall sales results. In fact, OTB's patio sales were down over 10% in July.

Next let's review the fourth quarter in more detail. As a reminder, the fourth quarter last year included a 53rd week which increased EPS last year by about $0.08. In the fourth quarter of fiscal 2005, revenues grew to $1,042,000,000, a 10.4% increase excluding the 53rd week. Comparable sales grew 3.7% above our original expectation for the quarter driven by a 3% increase in price, a 1.7% increase in mix and a 1.1% decrease in traffic. Cost of sales as a percentage of revenues increased to 28% for the current quarter as compared to 27.9% a year ago. Unfavorable commodity prices and product mix shifts were partially offset by price increases. Fourth-quarter restaurant expenses for 53.7% of revenues this year and 53.4% last year excluding the impact of the accounting correction for utility and vacation accrual and also the gain on the sale of commissaries. The comparison was unfavorably impacted by last year's 53rd week but benefited from labor efficiencies and more efficient advertising expenses in the current year.

The operations teams increased focus on productivity and the benefits of balancing staff levels are beginning to take hold. In general, we expect to see labor costs as a percent of sales continue to trend down throughout the year. Wage rate increases have continued to remain in check at about a 1% to 2% increased level. Depreciation and amortization as a percent of revenues was 4.7% or 20 basis points higher primarily due to a net increase of 74 restaurants from the prior year and the 53rd week last year. G&A was 4% versus 4.3% a year ago, a decrease of 30 basis points year-over-year and this decrease was primarily due to lower performance-based compensation.

The resulting net operating income was 6.4% versus a reported 9.3% a year ago. Excluding charges and gains, operating income for the fourth quarter would have been 9.6% versus 9.9% a year ago. Interest expense was 5.2 million, about $2.6 million higher than a year ago primarily due to a bond issuance in May, 2004. The effective income tax rate decreased to 18.5% as compared to 31.3% last year. The decrease was primarily due to the tax credit associated with a correction of the deferred tax liabilities and excluding this correction, the tax rate would have approximated 32.2%.

Finally, net income as a percentage of revenues was 4.8% versus a reported 6.3% last year and excluding charges and gains, net income for the fourth quarter would have been 6.1% versus 6.6% a year ago. During the quarter, the Company generated cash from operating activities of approximately $113 million and repurchased approximately 214,000 shares. As a result, there remains approximately $125 million available under the Company's share repurchase authorization.

Now as you are aware, companies with fiscal years beginning after mid-June are required to begin expensing options in their first quarter and due to our fiscal year start date, we will be one of the first to record option expenses. However, prior to jumping into our first-quarter forecast detail, let me clarify a few things regarding this change.

First, based on recent SEC guidance, companies are required to immediately expense equity-based compensation related to employees that meet certain service and age requirements. This year, performance incentives covered by those rules will be recorded in the first and second quarters. As a result, the expense in these quarters will be greater than the second half of the year.

Additionally, there will be more volatility in tax rates going forward as companies implement FASB 123R Tax benefits will not correspond to equity-based compensation expense amounts because tax benefits for incentive stock options are realized when they are exercised, not when expensed. This will also increase our weighted average share-base as a result of fewer tax proceeds being included in the weighted average share calculation.

And finally in response to the expensing of options, the Company has recently put in place new compensation programs. While these new compensation plans are still tied to the stock and financial performance of the Company, the future number of options granted to employees has been significantly reduced. These new programs will ultimately reduce equity-based compensation expense beginning in fiscal year 2007.

Now turning to the first-quarter outlook, we are returning to double-digit revenue growth of 11% to 12%. That being said, revenue growth continued to be impacted by some of the asset redeployment transactions that Doug mentioned. On a comparable basis, first-quarter revenue growth will be about 14% and our outlook for the quarter remains upbeat as we anticipate comp sales to be in the 3% to 4% range. Cost of sales will increase about 50 to 60 basis points. We will be somewhere around 28 3 (ph) versus 27 8 last year primarily driven by mix, shifts at Chili's and commodity pressures on our larger protein purchases including ribs, steak, burger meat and poultry. The good news is that these cost pressures should start to abate throughout the year.

Excluding the impact of 123R, restaurant expenses will improve 90 to 100 basis points on a comparable basis driven primarily by labor efficiencies and sales leverage. We have made great strides in improving labor costs over the last few months, a trend we expect to continue. Including equity-based compensation expense, restaurant expenses are expected to be approximately 55 7 to 55 8 of revenues in the first quarter. Depreciation and amortization will be slightly higher at $50 million and 49, excuse me, 4.9% of revenues. Excluding 123R, general and administrative expenses will be 50 to 60 basis points higher on a comparable basis versus last year as a percent of revenue due to an increase in performance-based compensation and the implementation of a new annual merit increase process. Including equity-based compensation expense, G&A is expected to be approximately 5.3% to 5.4% in the first quarter. Interest expense in dollars terms should approximate $6 million for the quarter and other net should be about a $0.5 million expense as result of reduced interest incomes due to lower cash balances.

The tax rate should approximate 32.3% excluding equity-based compensation expense. Including this expense, the tax rate should be about 34.3%. Our average weighted outstanding shares for computing fully diluted EPS should be approximately 91 to 92 million shares. Our initial estimate for the first quarter of earnings per share is $0.45 to $0.47 excluding the impact from the sale of assets for restructuring charges and equity-based compensation expense versus 37% in the prior year. Assuming these same exclusions, the full-year forecast is estimated at $2.40 to $2.46 based on comparable sales of 3% to 4% and a share count of about 90 to 91 million.

The state of the consumer has been a very recent topic of consideration in the restaurant industry. Strong auto sales, high gas prices and hot weather may have created a short-term industry pullback. But over time, consumers return to their lifestyle patterns. Our industry offers one of the few ways people can put more time back in their life and that's a unique ability we enjoy. Demographic and lifestyle trends support the thesis that casual dining chains are the best position to enjoy superior growth compared to other segments of the industry.

Brinker commands a premium set of brands that effectively compete in each of their respective categories. This, in combination with a business foundation we have laid at our Company, will drive superior shareholder value over the long-term. Now before we take questions and answers, we also would like to wish Howard Penney a very speedy recovery from his recent auto accident. Howard, we hope you get better soon. And with that, I would like to turn the call over to Kate to facilitate the question-and-answer period.

(OPERATOR INSTRUCTIONS). John Glass, CIBC.

My question has to do with your earnings guidance for the full year of '06. You talked about operating earnings growing at 18% to 20% before G&A translating into a 13% to 15% earnings growth rate. In fact, you mentioned a little bit about the higher G&A in the first quarter. First of all, is that entire difference just due to higher G&A spending or is there something else at work there?

Then secondly, it sounds like historically, G&A has run 4% of sales for a number of years, good and bad times, and it is going to be higher in the future. So are you changing permanently compensation structure in the company or is it just a function of catching up after a year when people didn't get paid?

John, it's a little bit of both. Some of it is because we'll reinstitute profit-sharing this year. We hope to hit our financial goals and be able to pay out those bonuses. Then also, we really redid some of our compensation plans with the way that option expensing has been awarded. There will be some changes in terms of option grants versus the way that we would be paying out some of those plans. So we would expect, even on a normalized basis, to be a little bit over 4% and then with the inclusion of the equity-based compensation being somewhere in the mid 5s.

On the options dilution, it looks like it's coming in around $0.30 a share for this year. The run rate in prior years has been more like $0.20. What is the Delta and is that a share price issue? Is that a --how is that increasing?

Some of it is the change in accounting rules. It used to be when we have some measures of our plan when people meet certain age and service requirements in combination, their options would become fully vested. And under the new FASB 123R, we need to recognize the prior year impact of those option grants all in the first quarter. So we are seeing a little bit of an acceleration in the first quarter as we catch up on those. Then, as we go forward through both the second half of the year and in future years, we would not see as much of an option expense being recorded.

And just to further clarify, John, we are going to see a little bit higher in the equity-based compensation expense in the first and second quarter this year.

The second half is a better run rate to look at going forward?

That's correct.

Ashley Woodruff, Bear Stearns.

My question is on Chili's. With the changes in your promotional marketing strategy, you have seen very nice improvements in same-store sales. Traffic is still generally remaining flat or slightly negative and so going forward, could you talk about how you view the components of same-store sales? Are you happy with flattish traffic if you're getting price in mix or will you change your marketing strategy a bit going forward to try to get some traffic growth?

Hi, Ashley. This is Todd. Actually our strategy remains the same if you look over the past six to nine months and if you look forward, we will have a blend of our advertising strategy going toward mix at certain times of the year from a seasonality perspective and other times, in terms of a value method. We are real pleased with how that is working for us right now. We have had some great success going back to Build Your Own Bigmouth Burger in January with a value message and driving traffic. We have had some great success. At the other end of the spectrum driving mix most recently with the Baby Back Road Trip.

To some degree you're indifferent whether it comes from mix or traffic?

Somewhat, yes. If you look at our PPA versus the competitive set, we are still at the low end of that even with the aggressive pricing that we had in place with over 3.1 million AAB.

One other question on pricing. At Chili's, you have about 2.9% price right now. Can you remind us how long you'll have that price factor and when you start lapping those price increases that you've have taken?

Yes, at Chili's, we are going to roll off price in the first period but then we have also added some price very recently. So we will be in about the middle of 3.5 about in price at the end of the first quarter.

Jeffrey Bernstein of Lehman Brothers.

A question on Corner Bakery, it wasn't really mentioned much in the commentary. You noted in the release the sale of all three Corner Bakery commissaries. I'm questioning whether or not that means there are certain strategic actions being taken with the sole remaining emerging concept. I know we have heard talk about the potential sale of the concept. Just wondering if we can get an update on the Corner Bakery outlook for the near portfolio.

Sure, Jeffrey. Well as far as the commissary business, that just fits into the way we have looked at our entire business, trying to plan our strategy for the future and running commissaries has never really been Brinker's core competency. So we sold those commissaries to simplify our business and to focus basically on running restaurants which is what we have been doing for 30 years.

As far as the Corner Bakery performance, we're still seeing improvements in our top-line sales, in our flow-through and our guest satisfaction scores but we're still not at a point where we're ready to make a commitment to faster growth. As you saw in the release, we're going to open probably seven to ten locations in fiscal '06. But certainly for Brinker shareholders, it currently makes more sense to allocate investment dollars behind more Chili's than behind more Corner Bakeries. Having said that, the Corner Bakery team has done an outstanding job continuing to evolve the brand and we will keep moving forward.

Matt DiFrisco. Please announce your affiliation and pose your question.

Thomas Weisel Partners. The question is regarding just first a little bookkeeping on here. I'm having a little bit of a hard time figuring out your $0.71 and these charges as well. On the $0.71, if you add back in your charges and the 6 million and get close to that net income for $0.71, it would imply that you had about a mid 20s tax rate. Is that correct?

That is correct. The tax rate would be effectively lowered by the deferred tax liability that we recognized.

So the $0.71 was with a lower tax rate. Okay. The expenses that you are incurring in the fourth quarter, 24.3?

That's not right. I'm sorry. I'm a little confused. You said that you applied a 20% tax rate?

25, 24ish percent.

No. It's the 32.2% tax rate once you dial out the extraordinary items to get to the $0.71 result.

Okay. So you're adding back in $3 million and 24.3? You are reversing out your $3 million gain. You're adding back in 24.3 and then you're adding back in 1.1 million to G&A?

If you look at the chart that is attached to the earnings release, the adjustments are -- if you exclude the refranchising, excuse me, in the current year, you would be, excluding the restructuring impairment charges of 10.6 million, if you exclude the gain on sale of commissaries 2.9 million, if you'd exclude the utility and vacation correction for 25.4 million, so you'd have an adjusted TBT of about 94 million. There would be an exclusion of a deferred tax benefit of 6.6 million giving you an adjusted net income of 63,835,000 and that would turn out to be $0.71 per share.

Okay. I'll go through that again later on. But can you explain though the 24 --?

There is an attachment to the press release that shows those adjustments.

It dials everything out, Matt. You can give me a call later and I can go through the line items with you.

Right. The 24.3, you said it's accounting policies associated with accruals of vacation and utilities. Is that 24.3 all associated though with accruals and expenses incurred in fiscal 2005 or is that back years? I'm wondering why that's --

That would be prior years. We talked a little bit about that in our May sales release. It really relates to prior.

And for clarity, that hits the restaurant expense line item. It's the 24.3 utility and vacation accrual amounts and then netted against about a 3 million gain on the commissaries.

Perfect.

Jason Whitmer, FTN Midwest.

Maybe we can get a little bit of a sneak preview before the analyst meeting but I wanted just to readdress some of your long-term unit targets by brand and certainly I guess just shaping up Chili's versus the emerging portfolio. Obviously there is some more importance pointed toward Chili's but do you have any updated thoughts on the long-term plans for these brands beyond Chili's either for the current brands in that mix or maybe future brands that could be added to the mix? Thanks.

Well for us, we're trying to grow capacity on a long-term basis between somewhere around 10 to 11%. Chili's is certainly going to be able to hit that as we go forward. Maggiano's will be slightly above that rate, more in the 13 to 15% range as we look in 2006. We're very excited with the possibility of Wyman Roberts coming on that we might be able to pick that number of openings out maybe by a couple over the next few years. On the Border and Macaroni Grill have been growing more in the single digit rate. Both of them are trying to improve their financial model to get a flow-through and get us returns that really meet our hurdle requirements. And we're very optimistic that both Dave and Jean can get that done and start getting back to the 10% to 11% growth rate.

And do you have unit targets by brand still and/or profitability contribution by brand or should I wait for September?

We do have unit targets in terms of -- for 2006?

It's just gonna --

Long-term. Sorry. Long-term.

And actually maybe what I can suggest is we are certainly going to cover that in our investor conference coming up in the next month. But what we have talked about is Chili's potential universe being 1750 on a global basis, Mac Grill being around 500, On the Border, 300 and Maggiano's about 100.

Mark Wiltamuth, Morgan Stanley.

My question is on food costs. We have seen change in the cattle cycle for the first time in nine years. It looks like pork may even follow beef's lead. I'm just curious where you stand on your contracts and when some of those will roll off so you can start realizing some cost savings, and just how much cost savings you have got built into your 2006 guidance?

Well, on a full-year basis, we have a little bit of savings factored into our forecast. We do see the year-over-year comparison improving for beef, pork, and poultry through the fiscal year. And as I think we've said on a number of occasions, we have multiple contracts depending on the type of commodity we are speaking about, with multiple suppliers. So certainly as we roll off contracts in a favorable period, we hope to take advantage of the favorable pricing trends.

In addition, we can sometimes get in front of contracts and try to renegotiate in advance if we think it would be optimal to do so. So that is kind of our outlook for the coming -- or for the current fiscal year.

And for the prices you're watching, have you seen any movement so far or are you just anticipating that things will get better, given that we have seen improvements in the supply indicators?

We do see improvement.

Andy Barish, Banc of America.

Promotionally, I just want to get kind of big picture stuff on Chili's as you look out into the new fiscal year here. I mean is it shaping up to be a year where you do kind of five or six of these six-to-eight-week kind of promotions that you have been doing recently with some success obviously? And then how does advertising expense kind of match up, given some of the changes you had last year?

Hi, Andy; this is Todd. Advertising expense is probably going to be a little bit lower year-over-year, but we are going to look at -- I'm sorry, it's going to be up a little bit year-over-year. We have our pipeline full for fiscal '06, and as we mentioned I think on one of the last calls, by December we will have our full fiscal '07 pipeline of promotional products intact at that time as well. From a competitive standpoint, I don't really want to say publicly here what we are going to do in terms of how many promotions and how long they are going to be, but we have a very keen eye on our marketing returns and want to be sure we're not just driving hollow top-line sales.

Hil Davis, SunTrust.

I had to change names. I had a question. When you kind of look at a June same-store sales and kind of the traffic and everything else, and then you look at July and you were dark in June, and you had advertising in July and you were on there. How does that -- how do you kind of look at the industry now in terms of the need to be on national network and how that affects the way you look at not only the promotional cycle but the advertising expense cycle, and kind of just the way you test these products and will it continue to have to get more sophisticated and will the new news continue to have to be at a faster pace?

Hil, I think when we look at June versus July, if you look out at the industry, June was certainly a tough month for a lot of folks. We are pretty pleased by how Chili's responded in terms of a sales perspective given the fact that they really didn't have television. I think as we look out at and go forward, as Todd said, we have taken a keen eye to marketing return on investment and making sure that we're getting benefit in sales and profitability from the dollars that we spend on media. Customers respond to new news and that is the one thing that has been apparent as we have gone over the last year is that new news is what drives people in the door. It is what causes people to order something different and we have really had an eye on that. And it has really been part of really the platform that we have used to develop new products. As we go forward, you'll certainly see us continue to try to drive new news. That's really going to be the foundation of marketing support and new products at Chili's.

And when you look at the new news platform, do you think it will continue to be like an On the Border where you kind of took twist on old favorites like the fajitas or like what you did with the ribs at Chili's or is it going to be a combination of that as well as maybe just kind of new menu areas for you and then finally the way you might look at a lower price promotion versus a higher price promotion? Is that necessary or is that something you all look at as well in terms of what you put on the air, what time of year and the price point around it?

Hil, this is Doug. Back to your question about will the new products be twists on old favorites. If you remember, this whole process we have got of adding new menu items, it starts with the consumer. The consumer of that brand tells us what are the new items that would drive them to come to the restaurant. So obviously, it has got to have some connection to the concept, to the appropriateness, to the type of food that the concept sells and the customers that go to that restaurant tell us that is something that they would deem as appropriate in that brand as well as different enough that would drive -- as a call to action. There's no question it is going to be appropriate and On the Border is probably the best example, as you already said, of similar spices but proteins that everybody recognizes; chicken, shrimp and beef.

And then across the portfolio, as far as advertising, in Macaroni Grill and On the Border, we are looking at different ways to reach the consumer, marrying that with new news. As Chuck mentioned in his prepared comments, this new process of talking to the consumer first in terms of getting menu items and testing it, rigorous testing out across the marketplace, we haven't put those process new in all the brands now. Chili's and On the Border are ahead of the other concepts but they are in the process of implementing those same processes.

Steven Kron, Goldman Sachs.

I have two quick ones if I might. The first is on real estate and as it relates to your long-term development goals. I was wondering if you could just comment on what you're seeing out there in the current environment and whether it's anymore challenging today to not only find sites but to get them developed and opened in a timely manner?

And then secondly on Chili's, labor and increased staffing was a popular topic in last quarter's call and I just wanted to revisit it and perhaps get a bit of an update on the return on that investment and whether or not you're seeing improvements in guest satisfaction scores and Todd, you mentioned on last quarter's call that the bottom 100 stores were not necessarily responding to increased labor but rather needed more operational or behavioral type improvements. Can you kind of share with us how that is developing and what you're kind of doing there to improve results?

Steven, this is Chuck. On the development aspect, we have seen some cost inflation as we have gone over the last three years on-site. When you look at the increased rates that we're paying for the dirt, it certainly has been somewhere at the high single digits to maybe double-digit numbers on a year-over-year basis. When you look at construction costs, last year, it was driven primarily by raw material goods, inflation in raw material. And this year, we're seeing somewhere around 6% to 7% driven really by demand more than you are seeing actual raw material cost increases. Todd, do you want to --?

As far as the whole Chili's labor thing, if I did a deep dive back into the brand back in February along with our new Chief Operating Officer, Mike Dzura, we just really tried to peel the onion back and see what the cause and effect was around the increased labor investment that we put into the brand and what we were trying to achieve in terms of guest satisfaction and while there certainly is some correlation to the staffing and guest service satisfaction in the restaurant, I wouldn't say it is completely parallel. We have gone back and taken a real hard look with our operating teams around improving productivity in and out times. We are not going in and just cutting labor just to cut labor. We want to be sure that we have fine-tuned when we have staff on duty whether it is at the front door, whether it is in the back of the house or anywhere else inside the restaurant. We have made a very, very strong emphasis on coaching and development within the restaurant to be sure that we are getting again the productivity that we want to get out of it and we have some new labor tools that have helped our managers staff better for different dayparts and during different volume periods throughout the week. We are very pleased with how we have been able to impact our guest satisfaction scores while at the same time lowering our labor cost.

Just one quick follow-up to Chuck's comments on the development plan and obviously you have been facing some cost inflations. As far as once you find the sites, are you finding that length of time it takes to develop the site and actually get the store open is more challenging in the current environment where there is a lot more building and construction going on?

I think it's tough but I think our team has done a great job of hitting deadlines. We really have been able to hit our projected openings at Chili's for the last three or four years in a row. While I think it is definitely a more challenging environment with zoning committees and trying to liquor licenses, there are a lot of obstacles that are thrown up. Our team has really pushed through a lot of those based on having the experience and then also the fact that Chili's has got such great unit economics allows us the ability to really cast a wide net, have a number of properties that are available. Doug, do you want to add anything else?

I'm just going to add that we do have the -- part of the thing that helps us is the number of restaurants we build and the similarities of the Chili's prototypes. We have relationships in regional areas with real estate companies and preferred vendors and so that helps us lineup those people because they know we have an ongoing number of restaurants that are going to continue to build. So those long-term partnerships I think also help not just in availability but also in the time it takes from the dirt turning over to when the customers walk in the front door.

Mike Smith, Oppenheimer.

Just a couple of quick questions. One, what is the regionality, you're one of the largest in terms of the regionality of your comp store sales? Is it true that the Midwest is the weakest area and that you're getting most of those from the Southeast Southwest type of areas?

What I will say -- is your question trends in the various regions of the U.S. or in terms of the way they impact the overall sales results?

I guess it's trends in the different regions.

We actually did see a bit of an unfavorable trend in the Midwest versus what we have been seeing. The last couple of quarters we actually had been seeing sales improve. But in terms of our Northeast and our Southeast performance, our performance has held up.

And we have been positive in the Midwest. It's just lower than other parts of the country.

The other question I had, you've (indiscernible) your portfolio of the number of concepts that you've tried to develop in the last couple of years. Are you down to what you consider a core or could we expect you to perhaps divest yourself of some of the concepts that you currently operate?

Well, Mike, that's a moving target and ongoing question. We always want to evaluate the right number of brands for management focus. As Chuck said earlier, we want to make sure each brand is a meaningful contributor of portfolio and earns the right to grow as it builds returns, the same hurdles. We want to make sure the brands are complementary in the portfolio, not competitive, and that they have broad consumer appeal. It's relevant to today's consumer. Right now we're comfortable with the portfolio we have but it's something we're continually watching and we will always evaluate versus the marketplace.

John Ivankoe, J.P. Morgan.

Two questions if may, the first is on development, specifically at Chili's. Where do you see the brand currently under penetrated and I guess ideally under penetrated where bar and grill was under penetrated in general. The question is if you can help us understand whether it is rural or urban or geographically where you see most of the units going over the next two years?

And a totally unrelated question is on Macaroni Grill. As you've done your studies and you've spent time with customers, what were the major reasons cited why visitation of the brand wasn't higher? Thanks.

Hey, John, this is Todd. As far as Chili's goes, we are having great success, honestly, coast-to-coast, north and south. We have had some good success obviously building out the metro areas where we are already very penetrated. We have had some good success urban. We have had good success in some of the outlying markets as well and that is the beauty of being a national brand and being able to be on network television. It doesn't matter where you build. Whenever those people turn on the TV they're going to be able to see our message when in fact we have one. So we are very bullish about the ability to continue to grow both our full-size prototypes as well as our small town prototype twelve which will be around eight looking out into fiscal '06. Primarily our big unit growth is going to continue to be again from California up through New England.

So geographically, it's just completely broad, no real concentration in any specific area?

Absolutely.

Strategically though, we have picked markets that we really do want to develop into because we either want to maintain the market or we want to try to create presence there. We're not just looking for 100 restaurants anywhere. We do have targeted markets that we are trying to take on a strategy and take that 100 restaurants and execute against that strategy.

And I would just add that the additional overlay is our franchise partners that are developing stores out there as well in the markets that we haven't necessarily prioritized Company dollars.

And on that Mac Grill question.

Yes, John, this is Doug. On the Mac Grill question, as we've said in our prepared comments, we have talked to consumers. We have some new positioning information but we are still kind of analyzing all the data testing, market testing, not just positioning communication points but also media execution plans, menu items and all those things aren't going to roll out until the second half of the fiscal year. We're also still trying to build up a culinary pipeline at Macaroni Grill like we have at Chili's and On the Border. At this point, we're not ready to publicly I guess talk about all the things that we've discovered because we want to make sure out in the marketplace we get the results in the test restaurant and we will put in this part of a strategy in the first half of the calendar year.

Larry Miller, Prudential.

Maybe I can ask a question that I think Mike asked in a different way. I was just curious -- with respect to portfolio, what has to happen for On the Border and Corner Bakery to either come out of the emerging portfolio or to be divested? Any specific metrics you can share with us? And then I wanted to follow up on Chili's growth plans. What about the potential for global growth? It's a real small part of the equation right now and your thoughts just about the mix between company and franchise globally. Thanks.

Well on the On the Border Corner Bakery question, Larry, again assuming that the brand is relevant to the consumer and they are enjoying their experiences, it's about return. It's about return on investment and we are continuing to try to balance how we moved both those brands along the both of them are showing improvement. But returns have to get better to ramp up (indiscernible).

Can you give us an idea what the returns are currently and where they need to be?

We will talk about those as we get to the investor conference. We are very excited about the possibilities of international business. Chili's has certainly had a strong foothold currently but we think there is tremendous opportunities. Bill Simon joined our team early in this part of this calendar year. He has made great strides in getting some accelerated development from our franchise partners internationally and then looking at other options that might be out there. Bill is also going to be able to speak to everybody in September about some of the really, really exciting things he has been doing.

And the ideal mix or the current mix that you think between company and franchise?

I think long-term, we've talked about targeting more of 70/30.

I meant internationally. Is that internationally as well?

I think internationally we are still looking at what the options might be. We are currently franchised internationally and we are looking at whether it might make sense to be company-owned. We can't make that call right now. Of the 111 restaurants that we have got internationally, they're all franchised currently. We don't if that makes sense going forward or not.

If I could just ask you one question (indiscernible), Chuck. I think you said 34% for the first quarter is the one we should be using. Is that a good number for the year as well?

Really that is with the FASB 123R changes in there. If you were just to look at an ongoing tax rate on a comparable basis, we would be looking somewhere around 32 4, 33.4, excuse me.

For the year then because you'll have the FAS 123, that's a good number and then it goes back? Is that a way to think about it?

Let me clarify, Larry. For the full year including the equity-based compensation expense, the tax rate is projected at 33.4%

Perfect. I get it.

Bryan Elliott, Raymond James.

Just a quick clarification on the food cost discussion awhile back. You talked about later in the fiscal year expecting to get some relief as you put new contracts in place as market prices are coming down. I realize mix and promotional activity is uncertain but would you expect -- would it be unreasonable to project sort of maybe flattish type food costs in Q2 and then a down year on year second half? Is that the right way to be thinking about it?

Well Q2 does have a bit of an anomaly in it in that produce costs last year were so high. So in terms of the second quarter, we do expect a favorable comparison because of that factor primarily.

Peter Oakes, Piper Jaffray.

Basically I just had a couple if I may. First, I was curious if we go back to the regional performance, did I hear you correctly that the Northeast actually is quite strong for you folks?

No. The Northeast has been relatively weak too, Peter. We have seen weakness as most people have talked about.

No. I must have misheard you. That's why I was curious on that. Actually, also on that regional theme, is Florida a standout market for you as far as a positive contribution?

Yes. Florida has been very strong; Florida, Texas, California, we have had some very, very good markets.

Peter, can I just clarify something? While the Northeast isn't as high of a sales growth region, we did see a trend favorably more recently in the recent quarter. That was just to clarify my earlier comment.

Anything discernible daypart-wise worth mentioning?

No. Not really. We have been up in all markets. We don't have -- when we talk about the Northeast being soft there, it's still positive.

The 15 stores that either were or about to be closed, are those, collectively, are they EBIT losers?

I think collectively a couple of them are for lease expirations and some of those may have been positive net net. I really couldn't tell you if in total they would have been net positive or negative.

We shouldn't necessarily think of those as materially impacting the world kind of going forward.

Yes, in either way.

As far as manager turnover, is that holding steady for you folks?

Yes, Peter, this is Todd. Yes, management turnover has held real steady for us. We are real pleased with that.

Lastly, on the stock option expense that you've got for '06 at $0.31. How does that compare to the pro forma '05?

It is higher. I think '05 was about $0.17 on an EPS basis but it is a different methodology to a certain extent. Certain implications associated with expensing options with 123R account for things different and as a result, the expense amount is greater.

And that is $0.17 though for '05?

Correct.

Jeff Omohundro, Wachovia.

With the success of KDS at OTBM, I'm just wondering what your next step might be with the KDS program?

We're fighting over answering that question. We are trying to check the success at other branches while Macaroni Grill has been testing it is well, a little different application because of the open kitchen. So you have to change the technology a little bit but we see the same sort of kitchen management of food in/food out, hot/hot, cold/cold and moving across the portfolio.

Any time frame for a significant broadening of KDS utilization?

No. It's totally in the Chili's system, has been now for, oh gosh, two or three years.

Yes.

We put it in Corner Bakery here recently. Mac Grill has been doing some work and Maggiano's is also evaluating it. So it's really something that Chili's is on the forefront of that technology and got it out to the restaurants relatively quickly and based on that success, we've been bringing it into other brands too.

There are no further questions in the queue. Do you have any closing comments you would like to finish with?

No. I just wanted to thank everybody for their interest in Brinker International and I look forward to seeing many of you folks at the investor conference coming up in September. 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.