Brinker International Inc (EAT) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Brinker International second-quarter earnings release 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 Investor Relations. Ma'am, the floor is yours.

Thank you, Kate. Good morning and welcome to the January 24th Brinker International second-quarter fiscal 2006 earnings conference call. During our opening remarks and in our responses to your questions certain items may be discussed which are not based entirely on historic facts. Any such item 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 next key calendar date is our January sales release scheduled to be published February 8th after the market closes. Also, please be aware, there is a holiday shift this quarter compared to last year. More specifically, Easter will fall in P-10 or the fourth quarter this year compared to falling in P-9 or the third quarter last year. Chuck will discuss the impact of the holiday shift as part of his comments around third-quarter guidance.

With me today are Doug Brooks, Chairman and Chief Executive Officer, and Chuck Sonsteby, Chief Financial Officer. Following comments first by Doug and then by Chuck, we will open up the call for questions. With that let me turn you over to Doug.

Thank you, Lynn. Happy New Year, everyone, thank you for joining us on the call this morning. I'm pleased to report earnings per share grew 22% in the second quarter on a comparable basis over last year to $0.56 before special items. This performance was driven by solid revenue growth of 11% and a continuation of our share repurchase program that reduced the share base year-over-year.

Despite this good performance second-quarter sales were less robust than we originally expected given overall softer sales and related sales deleverage as well as increased utility cost. However, sales performance versus our expectations did build over the quarter and we entered the new calendar year with momentum. Gift card sales in December increased 35% in the period over last year. Historically we have seen the majority of gift cards sold redeemed within two months and January sales to date seem to confirm this trend again. This year more targeted marketing versus the prior year combined with new creative gift card designs and increased points of distribution in retail outlets helped to drive the increase in our gift card sales.

Now we continue to focus on innovation as our platform for continued and sustainable growth. Consumer-based product development is just one example of this. We are exploring other opportunities to grow our business in unique ways to drive profitable and long-term growth. While there have been concerns reported in the media tying microeconomic events to a pullback in consumer spending, we're still confident in the long-term prospect of casual dining which we consider more of a staple than a discretionary occasion to our guests; a trend that is not going away, at least not in the foreseeable future.

Switching gears if I may, I thought I'd take a few minutes to describe the changes that have been going on at Romano's Macaroni Grill. Essentially the Mac Grill team has focused on three key areas to improve long-term financial performance -- one, improving the quality and consistency of operations; two, increasing store level profitability; and three, effectively resetting the direction of marketing. First let me share with you our new marketing direction.

Building sales and guest traffic is critical to the future of Macaroni Grill and our overall objective to build shareholder value. We have learned through our extensive research that what made Macaroni Grill magical once still works. So here's what we're doing differently to put the magic back into Macaroni Grill.

First we must recapture our core consumer by driving top of mind awareness and loyalty among this group to build their frequency. And who is that core customer? The fairly affluent baby boomer who is time starved and uses dining out as a source of personal reward as well as an opportunity to try new foods and to reconnect with loved ones and friends. For a while we chased what we referred to as an aware non tryer and what we gained could not compensate for the loss of our neglected core consumer.

Second, we have a clearly articulated competitive positioning and brand promise. Jean Birch and her team are aligning their entire organization and all of their efforts to deliver it with consistency, excellence and a maniacal focus. The brand promise is to let our Italian passion ignite your senses. This promise capitalizes on our culinary heritage and the vibrancy of the atmosphere, the unique traditions and service. Mac Grill's take on Italian is full of life, energy and humor. That's So Macaroni, an expression developed by Rapp Collins, our new ad agency partner, personifies this brand's character and you will continue to see and hear this expression tied to the brand moving forward. Foodservice and atmosphere must be fully integrated and work together to deliver the positioning and brand promise consistently to our guests each and every time.

Third, we have recommitted ourselves to our culinary heritage. Consumers are looking for new experiences, particularly in food, and they give Macaroni Grill credit for being able to deliver this. Mac offers unique dishes not found in other Italian restaurants and its reputations for new products is a clear strength. In addition to providing what's new and exciting in Italian food, consumers tell us they do want great Italian classic dishes as well.

So here's what we're doing, the marketing and culinary team is working on a pipeline of new products. Our newest feature, Vodka Rustica, is currently in market. This is one of three new features that will be introduced through the balance of the fiscal year. The menu strategy continues to embrace a continuum of Italian inspired offerings, great famous and favorite Italian classic dishes. We have signature recipes like Pasta Milano and Penne Rustica and more adventurous product offerings that show off Mac's great culinary excellence like Sole Parmesan and Pork Chop [Familiana].

Fourth, we must implement a new targeted media model and the brand marketing team has been working with Rapp Collins to create this new model. Marketing execution has shifted from a focus of being top-down to one starting at the store level and then going broad where appropriate. In other words, we start with the immediate trade area of each restaurant and market within it, utilizing marketing vehicles like direct-mail and freestanding inserts. Then markets with enough penetration and an acceptable return on investment we will layer on radio or possibly billboard advertising.

Lastly, we will focus on reaching our core Macaroni Grill customer over other cost-effective targeted mediums like the Internet. So this mix of media will reach our core customer during different day parts using the most appropriate vehicles to effectively communicate our positioning.

Operations and profitability initiatives started with an optimized menu that was tested last fall and will roll out to the entire Macaroni Grill system in late February. Essentially the menu contains 20 fewer products including appetizers, entrées and desserts. We also eliminated about 20 discrete ingredients to further simplify the supply chain. Also, the Macaroni team has been working with suppliers to identify ways to eliminate labor by outsourcing various preparation steps. This effort in conjunction with the optimized menu eliminated about 15 processes in the kitchen. The (indiscernible) menu and outsourcing effort will translate into improved food and service quality and lower cost of sales and labor expense.

Macaroni Grill will also roll out the kitchen display system or KDS to all restaurants by the end of the fiscal year after a very successful test in which ticket times, our guest satisfaction scores and cost of sales all improved as orders were prepared more quickly and accurately and individual products were served at intended temperatures. So we had exciting times at Macaroni Grill and we'll keep you posted on the results of these actions moving forward.

Throughout Brinker we continue to focus on our strategic plan. Our three priorities include -- one, expanding our global footprint by developing new and profitable restaurants; two, growing our base business through effective marketing and operations initiatives; and three, effectively leveraging our infrastructure and portfolio across our brands.

Building new restaurants will provide a significant component of our revenue growth going forward and we continue to meet our disciplined development targets. Overall we have over 80 new system restaurants through the first half of the fiscal year, well on our way to meeting our new restaurant target for the fiscal year. Our growing network of franchise partners continues to commit to build new restaurants. Just a couple of weeks ago we announced the sale of six company stores in South Carolina and Georgia to an existing Chili's franchisee, the Bonnaroo Restaurant Group. And as part of the agreement, Bonnaroo has committed to build more than 14 new restaurants in these same states over the next several years.

Additionally we continue to achieve steady progress on our three-phase international development strategy. In early September we reached an agreement with Alsea and Grupo ALDI to build 14 new Chili's in Mexico City and the surrounding areas. Alsea is a large seasoned restaurant operating company currently operating more than 660 Domino's Pizzas, Burger King's, Starbuck's and Popeye's Chicken Stores in Mexico and Brazil. We are thrilled to welcome such a strong partner south of the border. And our current 12 store international franchise partner in the Middle East recently opened one of ten new restaurants planned in the United Arab Emirates and Oman.

Turning to our portfolio, when the sale of Corner Bakery Cafe is finalized this will leave us with four strong core brands that meet our portfolio criteria. More specifically, we want to own casual dining concepts with geographic reach that can be meaningful earnings growth contributors. Additionally, we will continue to manage our restaurant portfolio by continually reviewing our company restaurant base, identifying refranchising opportunities, and exploring acquisitions that maximize geographic presence and management layers, growth potential and of course resulting Company returns. We have also demonstrated the ability to leverage the power of our portfolio with our Brinker gift card. Brinker gift cards are a great way to introduce consumers to our entire portfolio and at the same time grow earnings.

I am confident in the Company's ability to meet its financial goals through the balance of the fiscal year and beyond. Exercising discipline and accountability to maximize financial returns, leveraging our expertise in infrastructure to drive innovation and profitable execution, and focusing our resources and talent against well-defined strategic goals and performance metrics will ensure Brinker grows shareholder value consistently over the long-term. Let me now turn the call over to Chuck.

Thanks, Doug, and good morning, everyone. Before we go through brand level results let's discuss recent performance and trends. Good news on the top line, same-store sales built momentum month by month and ended at 2.2% for the second quarter. In addition, our January sales and traffic trends have also been good. Our focus on building gift card sales during the holiday season is a contributing factor to December's success and offers a great start to the new calendar year.

Our positive mix trends have been a result of our strategic efforts to design and introduce items that appeal to our guests and allow us to leverage our reputation for flavor and quality. Our brands have utilized new techniques such as in-store marketing efforts and pictures within menus to present guests the opportunities to trade up to premium products at a great value and they've willingly responded. As a result, we continue to see year-over-year increases in mix.

Now we anticipate mix to improve for the near-term based on our current Chili's offering, grilled Southwestern combinations. While still a value promotion with a starting price point of $8.99, this promotion has had higher price point versus our promotion last year, the build your own Bigmouth Burger, yet it should stimulate traffic in January. As we move through the fiscal year we will begin lapping mix increases from the introduction of our pictured menu and limited time promotions. The mixed increases we have been experiencing the past few quarters will subside.

At the Brinker level we're carrying about a 2.6% price at the end of the quarter driven by pricing we took at Chili's in November. Chili's will be lapping about 1.5 points of price during the third quarter. Same-store sales growth comes from three levers -- mix, traffic and price -- and we will continue to emphasize different sales components at various times throughout the year.

We did experience soft traffic trends during the second quarter and recognize that long-term a business cannot sustain negative traffic. From time to time traffic will be a focus during upcoming marketing windows. In addition, we are excited about the changes at Macaroni Grill and believe continued innovation, flawless execution and successful marketing will contribute to our ability to grow traffic in the future.

Our current development strategy is an example of the focus on ensuring our capital is deployed to the highest return investments and creating value for our shareholders. Last year we slowed the development for Mac Grill and increased restaurant growth at Chili's due to a disciplined process of capital allocation and the belief that our brands must earn the right to grow. Our development model takes into account competition and demographics coupled with other market planning assessments. In 2003 Chili's opened 68 restaurants, 70 in 2004 and 80 in 2005. Each class of these new restaurants continues to perform 10 to 20% above our required hurdle rates. Our development capability is both proven and disciplined and we believe it is a competitive advantage for Brinker.

Increasing construction costs may cause some sites to fall out of the development schedule. But unless there are significant additional shifts in raw material costs, we expect to achieve both our long-term development and financial return objectives. We will continue to allocate capital only to new restaurant sites that meet or exceed those financial hurdles. It appears the industry is also modifying its expansion rates. A few competitors have reduced their growth rates and the industry seems to be demonstrating a more prudent approach to capital.

Moving on to second-quarter results, revenues for the second quarter increased to over $1 billion, almost 11% greater than the same quarter in fiscal 2005. The increase was primarily attributable to new openings which drove capacity growth of 7.1% and comparable store sales growth of 2.2%. Reported capacity was slightly lower than our longer-term target of 8 to 10% primarily as a result of Big Bowl being in the revenue base last year. Excluding the impact of Big Bowl, capacity growth was within our targeted long-term range.

Cost of sales improved 10 basis points as a percent of revenue from 28.6% to 28.5%. The improvement was primarily due to higher menu prices and favorable cost comparisons for tomatoes. And this was partially offset by product mix shifts primarily due to the Steak Festival promotion in November. On a comparable basis restaurant expense during the quarter increased 90 basis points from 53.9% in Q2 of 2005, and that's adjusted for the $17.3 million IRS settlement; the 54.8% in 2006 and then also excludes 2.8 million of equity-based compensation expense; higher utilities, in fact utilities are about 30% higher than last year; and increased advertising were the primary contributors to the year-over-year increase.

General and administrative expense was 4.3% of revenue, excluding 8.5 million of equity-based compensation this fiscal year, (indiscernible) also 30 basis points lower than last year's 4.6%. The team responded to other cost pressures by controlling overhead expenses. The effective income tax rate for continuing operations excluding special items for the quarter was 32.2% compared to 32.1% last year. During the second quarter of fiscal 2006 the Company acquired 735,000 shares of its common stock for approximately $28 million, bringing the total amount of shares repurchased by the Company for the fiscal year to $167 million.

At the end of the second quarter we had approximately $108 million remaining under our board authorizations. We are committed to our capital allocation priorities and shareholder distributions remain a key tenet of that program. December marked our first quarterly dividend, representing a 16% payout ratio and a 1% yield.

Next, I'd like to discuss brand specific performance. Chili's posted a 2.7% comp sales increase in the second quarter. This increase was composed of a 3% price increase, a 1.7% increase in mix and negative traffic of 2%. Sales results versus our expectations improved throughout the quarter. During the first half of the fiscal year we've experienced more variability at Chili's than we expect going forward due to non comparable advertising windows year-over-year. The good news is for the remainder of the fiscal year media windows will be more comparable with the prior year period and should smooth the peak and valley effect.

Chili's promoted the Steak Festival in November driving solid sales, but at a level below forecast. We believe this is primarily the result of other competitors promoting steak products, making the Chili's offering less unique or distinctive. December sales performed at the higher end of our range by using targeted media promoting gift cards. Romano's Macaroni Grill -- for the quarter Mac Grill reported an increase in same-store sales of 1.1% driven by a 1.9% increase in pricing, 1.6% increase in mix and a 2.4% decline in traffic.

During the quarter Macaroni Grill introduced lobster lasagna, a new product that was offered as a menu feature in November and December. As Doug described, there are many good things happening at Mac Grill. Jean and her team have been hard at work and we expect to see improved sales momentum given the marketing and operations initiatives that are being put in place.

On The Border, for the quarter same-store sales were slightly positive, 0.4%, made up of a 2.2% increase in price, 0.8% mix, and a decline in traffic of 2.6%. The team has been focusing on more creative new product offerings at the brand to generate the same type of positive sales and traffic performance experienced over the last two fiscal years. As with Mac Grill, we are excited about the possibilities at OTB and the partnership with Rapp Collins. It will produce a more targeted marketing plan during the back half of 2006.

Maggiano's comparable store sales were 2.6% for the second quarter driven by a price increase of 2.2%, a 0.2% increase in mix and traffic. December produced record-setting sales for the brand driven by a very successful banquet business. In fact, about two-thirds of our Maggiano's restaurants had record sales weeks during December. This quarter represents the 17th consecutive quarter of positive comparable store sales at Maggiano's. I might also note that approximately 30% of Maggiano's sales occur in December, pointing to banquet opportunities the team is intent on exploiting the rest of the year.

Our international business continues to flourish and is a key growth vehicle for the Company. Fiscal year-to-date international restaurants generated systems sales growth of over 15%. Same-store sales performance in our top five markets ranged from up 10 to 20% growth measured in local currency. This outstanding performance was driven by local consumer acceptance, quality operations and strong franchise partners. Fiscal year-to-date we have developed seven new restaurants in Latin America, Southeast Asia and the Middle East and are on target to exceed our planned openings for the fiscal year by 50%. We'll have 19 openings this year on a plan of 11.

Bill Simon and his team have been recruiting new partners and increasing development rates with our existing partners. And the demand for our brand is incredibly strong worldwide. Our EPS of $0.56 versus $0.46 last year represents a growth rate of 22% demonstrating the right focus and determination to carry us forward. For the third quarter outlook we expect revenue growth of approximately 11% and same-store sales to be in the 3 to 4% range.

As Lynn indicated, Easter will fall in the fourth quarter or period 10 this year versus the third quarter or period 9 last year, and this should positively affect EPS by $0.01 or $0.02 in the current third quarter to an offsetting negative effect in the fourth quarter. Cost of sales is expected to improve about 20 basis points to 28.2% from 28.4% last year as we begin to benefit from favorable commodity costs. Specifically menu prices and those beneficial commodity costs for beef, pork and dairy will be partially offset by anticipated increases in produce, chicken and seafood costs. We recently signed a new rib contract that will be favorable year-over-year.

Restaurant expense will improve about 30 basis points to 54.5% this quarter versus 54.8% last quarter on a comparable basis excluding incremental equity-based compensation and refranchising gains. The expected improvement will be driven by continued leverage from solid top-line sales and focus on store level profitability, especially labor productivity by our operations teams and partially offset by those increased utility costs and advertising accruals year-over-year.

Depreciation and amortization will increase to about $48 million or 4.5% of revenues as a result of new restaurant development. General and administrative expenses, excluding that incremental equity-based compensation expense, will be about 4.4% compared to 3.4% last year. If you recall, last year's G&A expense was artificially low primarily due to dramatically reduced incentive-based compensation. Overall incremental equity-based compensation for the quarter is expected to be about $6.6 million pretax and about $5.1 million after-tax or about $0.06 per diluted share. This expense has been isolated in my outlook in order to provide year-over-year comparability. The majority, or about two-thirds, of the compensation expense will fall in G&A with the balance included in restaurant expense.

Interest expense in dollar terms should approximate about $5.8 million for the quarter, slightly better than last year. Continued strong cash flows have funded capital expenditures, share repurchases and dividends. The tax rate from continuing operations should approximate 32.2% excluding equity-based compensation expense. Including this expense the tax rate should be about 33%.

Our average weighted outstanding shares for computing fully diluted earnings per share should be approximately 88 million for the quarter. Therefore, our initial estimate for the third-quarter EPS from continuing operations, including special items, is $0.57 to $0.59. Excluding incremental equity-based compensation expense of $0.06, the EPS forecast for the third quarter is $0.63 to $0.65 versus $0.59 last year, a double-digit growth rate. The range for the full year forecast from continuing operations including special items is $2.09 to $2.14. Excluding incremental equity-based compensation of $0.27 to $0.29 per share, we expect full year EPS from continuing operations excluding certain gains and charges to be $2.36 to $2.41 for growth of 12 to 14% on a comparable basis.

And recall that we will incur about $0.02 to $0.03 of expense this year related to the lease accounting change described in our first-quarter earnings release. And we also lost the earnings from continuing operations of Corner Bakery. And without those two impacts EPS growth is estimated to be up 13 to 16% this fiscal year over last.

To conclude we're entering the new calendar year with momentum and optimism. We continue to see global development as a solid long-term growth vehicle coupled with a successful and growing domestic business. We are bullish on the prospects of the industry and our brands' and team's ability to succeed effectively in an extremely competitive marketplace. And finally, we remain committed to ongoing financial discipline and exploring all opportunities to grow shareholder value over the long-term.

Our management team has demonstrated this discipline over the past two years by rebalancing the portfolio through refranchising restaurants, asset sales, slowing the growth of underperforming brands and concept divestitures. We remain strongly dedicated to building long-term shareholder value through growing our business over time and directly returning capital to our shareholders in the form of dividends and share repurchase. And with that I'd like to turn the call over to Kate to facilitate the question-and-answer period.

(OPERATOR INSTRUCTIONS).

No questions? Hello? Anybody there?

Kate?

Mr. Kron, your line is now live.

Thank you. I had a couple of questions -- Steven Kron, Goldman Sachs. The first I guess is if you could just talk a little bit about your assessment of the category. And I ask that -- Chuck, you made some comments on the three largest I guess bar and grill players promoting similar things in November and maybe your steak promotion coming in slightly below expectations.

I guess the question is how does Chili's differentiate itself on a go forward basis? And in the same vein, if I think about the promotion in January, the combination promotion -- the Southwest combo, do you think that the success that that might be having could impact On The Border which promotes a similar type of cuisine?

Steven, this is Doug. If we look back -- even look back at September at the triple dippers when Chili's promoted more of a value product -- of course we had tremendous top-line sales, 8% in September, and we're optimistic looking at January so far again with a value promotion. Historically in the fall, November and December has been a great time to advertise more center-of-the-plate steak type items and, of course, we had tested the Steak Festival and it had done great in test. Difficult to predict what your competitors are going to advertise. But remember, all of our menus -- the beauty of the grill and bar segment is the number of menu items, the number of choices the consumer has to cover all different categories.

So when you look back at November and December and you look at all the pressures on consumers, in the rearview mirror we always get a lot smarter. Would a value play have performed better? Possibly. We really think, as Chuck said, that the fact that our competitors advertise the same product probably caused less differentiation. But in grill and bar you have the largest number of different items to pick from at all times. Also, as far as our comp sales moving in January so far across all of our brands we're seeing very, very nice results.

So to the On The Border question, each one of our brands in the portfolio has to certainly make decisions about their own product line and the bar and grill segment does have some items that are Mexican, On The Border is still the number one volume and largest Mexican casual dining chain and we've got a lot of things in progress that we think are going to be very effective at On The Border as well.

Okay. If I could just ask another one on the pricing at Chili's. You talked, Chuck, about lapping the 1.5% in the third quarter. When specifically are you lapping that and what's the appropriate price in the system that you think on a go forward basis we should see? Do you have plans to take further price, and I ask that in the context of the negative traffic that you've seen for kind of the better part of a year and a half with about a 3% price in the system? I'm just wondering what's the right balance at this point.

First let me talk a little about the negative traffic. As you know, really for all of our brands we have been going through an extensive analysis of our marketing and advertising strategies. And that has caused us to have some changes in advertising spend, some also changes in where we advertise and how we advertise. Some of that has added to particular volatility and same-store sales and traffic. The reduction of advertising spend, we think in the past year, had some impact on reduced traffic.

Now, as we get more into this year, as we get more into this calendar year, you're going to see a lot more comparable numbers on a year-over-year basis, and we will be much more able to discuss where our traffic trends are going over our longer-term basis once we've kind of taken all of the noise out of it. In terms of an appropriate price increase, again, we always take a look at where we are versus our costs, where we are on our value scores, and where we are versus the extended marketplace to see if there is opportunity for price.

Steve, if I can add some more dialogue on that, a macro statistic, Technomics recently released their average menu price increase across casual dining for 2005, and it was about 3.2% across all restaurant companies. Of course, we pay attention to a lot of different metrics. Of course, we saw the report that you put out recently. We also just recently got some information from NPD who we get quarterly information from for the October, November, December quarter. And it rated Chili's value for the money higher than our primary competitors that you mention in your report.

So there is lots of different data points, and we are real cautious to pay attention to all of those and try to balance the value for the consumer with the cost pressures we have. Also if you look at price increase, there is a lot of different factors that play into that. A year or so ago, you remember in the state of Florida there was a large minimum wage increase.

So sometimes there is price points in specific markets because of specific cost pressures there, and items across the country may be completely different when there is a price increase taken. Sometimes it is a geographical decision; sometimes it's a couple of items on the menu. So which consumers it impacts depends on a whole lot of factors, and it is tricky to look at that one number as sort of a catchall statistic that proves everything. But certainly at Chili's, the heritage of that brand is price value and it is something that we pay a lot of attention to.

Okay. The 1.5%, you're lapping that exactly when?

The majority of the lapping will be shared between P8 and P9 in the third quarter.

If I hear you correctly, at this point in time it doesn't seem like there are plans to necessarily take more price to kind of offset that?

We will look at it day to day.

Okay, thank you.

John Glass.

It's CIBC. It sounds like from your comments that traffic is picking up in January. Can you talk about where the pressure has been most acute in traffic? Has it been in the Midwest and you're just seeing that ease or you're seeing a general rise? And can you talk a little bit about that Midwestern region without back out lowering menu prices? Has that increased pressure on traffic or ticket in your stores there?

I think when you look at traffic for us; we've seen pretty much a lift everywhere, John. I can't specifically state to the Midwest in January; I haven't looked exclusively at that market, just looked more at a broad base view. We have seen some competitors have cut prices, but we think that that's a little bit independent and maybe brand specific to them and doesn't necessarily indicate anything we should do or pursue on our brand. When we looked at the Midwest and also the Northeast that most folks have talked about, while they've been a little bit soft for us, they've still been okay; they haven't been awful markets for us or anything like that.

Great, okay. And then just on the steak issue that you did experience this past quarter, has it changed the way you think about how you want to promote or position Chili's in the future to create items that probably can't be as readily copied by competitors? Or does it change in any way the way you think about promotions or is this just kind of the way life is in casual dining these days?

Just again, a very broad macro statement, differentiating yourself from a strategic standpoint to your competitor in any industry is always the goal. And so innovation in food items, we think some of the steaks that were in the Steak Festival were very creative products and quite innovative. The blue cheese steak was outstanding.

But again, back to bar and grill, the beauty of the bar and grill segment are the number of choices consumers have and it gives us a bigger palette to pick from as our chefs are trying to talk to our customers first and create new products. But whether it be appetizers, salads, sandwiches or steaks, we're going to continue to offer different items across the entire menu so that we make sure that we push the levers at lunch and at dinner, weekends/weeknight and have opportunities and choices for consumers for all their needs.

Thank you.

Jeff Omohundro.

Thanks, Wachovia. A bit interested in some of the innovations you're pursuing on the marketing front, for example with Chili's, the Southwest promo tying in with the Southwest Airlines. Just curious about that element of it, how that's going and will we see similar efforts in the future?

As far as the Southwest products, there is a catchy tag line there with Southwest Airlines, but we're trying to let our customers know that they're going to have great food choices, but other potential add-ons to come into Chili's and dine. And the add-on trip is just an extra way to try to get their attention. But the products themselves are meant to be great values. Some new products paired up with some favorites that Chili's has had on the menu for a long, long time. And customers are reacting very positively to them.

So the airline tie in is you think much less significant than the product initiative on the promo?

We think the product initiative is by and large the largest news that we have to our guest.

Sure. Thanks.

Bart (sic) Kalinowski.

Just wanted to ask about what types of trends you're seeing in the frequency with which Americans eat Mexican and Southwestern style food and what implications that might have for your Chili's and On The Border brands over time?

As a general trend, Mark, the three types of cuisine that still continue to be growing the most across the entire country are Asian, Italian and Mexican. So we still think there's great opportunities to take traditional Mexican items or American proteins and add Mexican type flavors. And that just makes for a complementary portfolio across all the brands. But Mexican is still one of the top three flavoring or types of cuisine across the country.

Would you expect competition to pick up with these cuisines getting more popular?

Well, Italian -- and I can't imagine the competition being much more there and that has been a trend for a long period of time. And you have seen some growth in Asian, but Mexican has been out there for a long time as well.

That's one of the reasons we're bullish on On The Border. We believe that it is a segment that's not highly penetrated by chain restaurants and OTB is certainly the largest and has the ability to continue to be the number one player in the segment.

Great, thank you.

Jason Whitmer.

FTN Midwest Research. Doug, I was wondering if you might be able to identify one or two components of your businesses that you think you have greater control or visibility on versus a year or two ago and possibly what you still might need to get some more traction on that visibility going forward?

Well, Jason, I'm not sure exactly what you mean by visibility. I can speak to the focus of our management team with four brands in the portfolio. The shared services, some of the sharing of ideas really maximizing the corporate department teams because of the similar business model challenges we have in the business. There's no question we're more focused here in utilizing the talent in the organization to drive initiatives across all four of those brands because their business models are more similar.

And then certainly on the innovation side, we're talking to customers, as we've spoken about in previous calls first and making sure that we understand what's important to the customer before we decide what it is that we want to sell to them we want to find out what it is they're looking for. And as a part of that certainly is the discipline and market testing and the financial rigor with the testing. We're going out and trying things in the marketplace first. And if the customer doesn't like them or if they don't meet the hurdles then we'll go somewhere else. So lots more testing going on at Brinker International to hit our financial hurdles as well as satisfying our customers' demands.

Okay. And the new marketing and branding initiative, I think you're trying to broaden that a little bit more. And I guess you just get further creative, more innovative and it sounds like you're making a lot of changes in those strategies. How far along do you think you are in that curve in terms of being where you want to be ultimately for those type of go to market strategies?

Part of the marketing side of it really is our association with Rapp Collins and it's a totally different approach. A few years ago we had a traditional TV mass marketing, now we're looking particularly at three of our brands, the brands outside of Chili's, very targeted, very specific by market, by restaurant and by consumer so our marketing approach is much different than On The Border and Macaroni Grill and Maggiano's than it was just a few years ago.

Okay, thanks.

John Ivankoe.

With JPMorgan. Chuck, you said something in your prepared remarks that was interesting and that was about in I guess calendar 2006 running some traffic driving promotions at Chili's. And so I guess my question is should be expect to see more of the starting at price points that are apparently successful in January? Should we expect you to introduce some new products whether permanently or on a limited time only basis that are actually price pointed? Or would you in fact consider discounting existing products for a limited time to bring customers into the stores? So just give us a sense of what you meant by that.

We're not interested in discounting. We don't believe that it's good for the brand. We don't believe it's necessary either. What we've done is we've taken different times of the year the consumers say they want value -- September was a great example. January is also a very good example. And in those promotions we have given people and told people what the price points are. We told them $8.99 indicates great food at a great value and people respond to that.

So I think the fact that we did -- we had a targeted price point advertised in September and January, it's just part of the arsenal, it's not necessarily the long-term item every time and really the bigger thing for us is just trying to build innovation, not discount.

Okay, great. And secondly, could you update us on some initiatives you discussed in I guess it was your September conference with regards to international company expansion? How far along are we with that and is that still something that we might actually see some of in fiscal '07 if I remember correctly?

We've just closed a deal in the UK where we actually purchased four company-owned Chili's restaurants and one Macaroni Grill. For us it was a strategic investment. Our partner was going to exit the business. We felt there were some opportunities there. But I think the most important thing to remember is, for international expansion just as it is for domestic expansion, our brands are going to have to earn the right to grow. They're going to have to show us that they can produce returns that hit our financial hurdles or they won't get additional capital.

Okay, thanks.

Joe Buckley.

Joe Buckley with Bear Stearns. A couple of questions. Chuck, the third-quarter/fourth-quarter EPS mix is considerably different than we thought and Easter explains some of it. You gave us a lot of detail on the third quarter, maybe it will be obvious after we plug in -- some of those cost ratios and things. But is there anything else going on in that third-quarter, fourth-quarter mix we should be aware of? Just the split of EPS for the balance of the year?

I think on a comparable basis year-over-year we did have a very big decline in the G&A last year because of the unfortunate fact that we didn't pay bonuses last year. So I think as people were looking at spread in the third and fourth quarter they may have missed that fact. So G&A is noncomparable in the third and fourth quarters. Advertising spend is a little bit different. I'm not sure exactly if there's anything else that you're referring to, Joe.

Okay. A question also just on the 3 to 4% comp guidance. You indicated the mix benefits will start to diminish. Should we expect to see more consistent traffic growth as some of the year-over-year comparability issues on advertising smooth out as well?

We're feeling pretty good in the near-term about traffic. Again, we think that we'll get through January with some pretty nice traffic numbers. The Easter flip is going to help traffic as we get into the March period too. Other than that I think some of the promotions that we will do as we go through the fiscal and calendar yield year will be focused on trying to build traffic. We have that on our radar screen; we're trying to address that. But I can't sit here and guarantee where traffic will be.

It sounds like, though, in your forecast traffic is playing a bigger role in that 3 to 4 than it did previously if mix is leveling off.

Yes, I think that we know that mix is going to be leveling off, and so traffic is going to have to pick up the pace.

Okay. And a question on Macaroni Grill. As you move to the optimized or streamlined menu, rollout KDS, talk about just risks -- is there some earnings risk as you make this transition or do you feel pretty comfortable from the test market that there's more potential upside because of some of the margin implications that you spoke about?

We've been conservative in our estimates of Macaroni Grill and we think that -- while we believe very much that everything we're doing is the right thing, we also believe that that would provide upside to our current forecast.

Okay, thank you.

Joe, one last question before you go. I still misunderstood the third- and fourth-quarter question.

It just seemed like the EPS is very skewed. Obviously the back half of the year you raised the guidance by a little bit, but it seems a lot more skewed to the third quarter than we expected it to be -- and I think that the consensus expected it to be as well. So maybe something in the model that will be evidenced when we spend more time with it. But that was my question. The fourth-quarter EPS number looks like the implied number is down.

The implied number -- Well, I think some of that has to do with just where people may not have taken into account the Easter flip. So if you take a penny or two out of fourth quarter and put it into the third quarter, that certainly starts to get it more in line.

Okay. I'll talk to you off-line after we crunch some numbers.

We're not trying to take down fourth-quarter numbers; we're just trying to get people to adjust for the Easter flip. I don't think anybody did that in their models.

That's probably fair.

But we're also off to a very nice start for Q3.

Sounds good.

Mike Smith.

This is Mike Smith with Oppenheimer. Maybe part of Joe's answer might be that the model and the implied number is including an option expense would seem to me to be a big part of that (indiscernible) -- that was not my question. Gift cards, sounds like you did a pretty good job on those. How much of your total sales do gift cards now account for?

Mike, I don't have that number off the top of my head.

Okay.

Excuse me. Redemptions were 28% of total sales in fiscal year '06 which is up from 2.5% in '05.

[So your fixed]. Chuck, when you were talking I guess what I heard you say was that you still have some Chili's promotions in the prior year that you're going to try and smooth out going forward. What periods did those occur in?

I think it's just -- for instance, if you look at our last quarter, a year ago we advertised on television in October, this year we did not, so that showed low sales performance on a year-over-year basis. In November quite the opposite. We advertised in November, didn't advertise a year ago so same-store sales improved. Some of that variability has caused people to look at our same-store sales performance and say it's very volatile.

If you go back to September we advertised this year and we're up 8.9% or there about versus a year ago we didn't do any advertising. So he had three months in a row -- September, October, November -- that were totally noncomparable from a marketing perspective. As we start going through the calendar year they'll be much more closely aligned and we'll get rid of that peak and valley that we experienced at least by example those three months.

So most of those are behind you then?

Yes, they are.

And did I hear you say that you bought some stores in the UK and those are going to be company operations?

That's correct.

That would seem to be somewhat contradictory to your refranchising of some of the smaller franchise markets.

We are actively refranchising here in the United States. We think that there are some markets that are much better operated by franchise partners either because of scale or size. One of the things as we looked at the UK, there was a unique opportunity there in that our partner wanted to exit the business. We also had been in contact with a great gentleman who is in the UK, had built casual dining brands in the past. He had done some incredibly successful work at some brand names that you would know there, Bella Pasta, also Cafe Rouge, and his name is Gavin Williams. And Gavin is a very experienced casual dining operator.

We felt like he could operate those restaurants and give us a pretty good look at whether there even is a possibility for us to expand a Chili's into the UK and then also into Europe. For us it's an R&D project. Again, it's four restaurants, one Macaroni Grill -- four Chiles, one Macaroni Grill. A relatively small endeavor at the start and we have to understand it.

Thank you.

Will Hamilton.

Sanders, Morris Harris. I was wondering if we could touch on utilities. Obviously natural gas prices the last month or so have really fallen. I was wondering at what point do you expect to see a benefit potentially from that or whether there's a real lag effect in terms of when it comes down to your P&L at the restaurants.

There still is a lag effect. We still have a number of markets that are regulated by public utility commissions. As we look into the third quarter we're expecting utility to be up anywhere between 30 and 35%. In the second quarter by comparison they were up about 30%. So we're very hopeful that declining natural gas costs may actually give us some benefit as we go forward, but we still are taking a look at it on the negative side.

And then secondly, I seem to get some mixed signals in terms of your domestic restaurant development. You said that you're still on target for this year in terms of unit development, but it seemed to also imply that there might be some delays or slippage. Can you maybe clarify that a little bit more?

No, there really isn't any slippage. We're right on target for this year's openings. As you're aware, it takes us about 18 months from the time we approve a site until it actually opens. So what I was saying is we have seen increases in construction costs of around anywhere from 8 to 10% due to some of the hurricanes that came in. And so there may be sites that were on the bubble that may not make it. Which again, for us is just part of our capital discipline. I think that was the more important point I was trying to get across versus (multiple speakers).

So that's a more long-term perspective such as '07 or '08?

It is, it's out to '07, '08 and beyond. We'll continue to take a look at it and we think that capital discipline is the primary driver of our decision-making.

Okay, thank you.

Andy Barish.

On Macaroni Grill can you maybe point to one or two areas in the consumer research, other than obviously all the things you laid out? What are you kind of hearing back from the consumers or have you done it in those test stores that kind of give you a little bit more confidence in seeing those programs start to work? And then just secondly, on the gift card redemptions in January and February, do you typically see those across brand in terms of the same percentage that you do system wide, or does Chili's get even more than its fair share of gift card redemptions?

I'm not sure if I have the quick answer to the gift card redemption question. We've got some numbers across the whole Brinker portfolio. If you want a quick assumption it's the same as yours that because people go to Chili's more often the redemption would happen a little quicker. We do have some different dates on those and to drive interest quickly a couple of the brands, they actually expire in January. So you have 31 days to get your you know what into the restaurant to eat. So we're trying to drive that traffic to get acceptance as quickly as possible.

As far as Macaroni Grill, I think, Andy, we always get smarter when we look in the rearview mirror. I think what I can probably talk about the easiest is focus by the Macaroni Grill team. And as I said in my prepared comments -- if we're guilty of anything at Macaroni Grill a few years ago it was by trying to continue to take care of our core customer but also trying to attract that aunt, that aware non tryer, the person that may have already had another Italian restaurant they were going to. We were focusing the initiatives, both marketing as well as internal menu, on a customer that wasn't currently the core user.

We are now focusing back on that core customer, the chef driven menu items not necessarily all traditional Italian dishes. The other good news is that part of the consumer feedback and the testing is no really major remodeling on these take place in the restaurants. There is a new menu design and again some new products, but a lot of it is focused. And Jean Birch, as she did at Corner Bakery, Jean has got her team focused on less things. We understand who our core customer is, we have a great new partner in Rapp Collins who's helping us take our focus and apply it to those specific customers who do make up the core consumer at Mac Grill and we're very bullish on that turning into positive results moving forward.

And Andy, if I could just clarify one point. The date that Doug alluded to in terms of January for Chili's does relate to a certificate that was part of the gift card program. Gift cards are offered and certainly accepted for a long period of time. We typically see over 70% of gift cards come back within the first 90 days.

Okay, thank you.

Jeffrey Bernstein.

Lehman Brothers. I just had a follow-on to an earlier question regarding just the overall portfolio ownership. I guess I'm looking specifically at Chili's. It seems that you're comfortable operating most of the stores. I think ownership has been consistent in the 70 to 75% range in recent years. Just wondering if you can broadly compare the performance of your company operated stores maybe versus franchise. And I know you had mentioned refranchising opportunistically. I'm just wondering if you would make a conscious effort to increase the percentage of franchised units given more of the stable royalty stream? And then just as a follow-on, just wondering other than Chili's if you would consider greater refranchising efforts at some of your other brands? Thanks.

We have stated that we want to increase our franchise ownership and that is part of our strategy going forward. And that would include at all brands. We're currently looking at franchise opportunities and refranchise opportunities throughout our portfolio. So I would say that that's definitely on the table, definitely under consideration and also in progress.

Might we see a meaningful shift from the 70 to 75% or is it more just kind of buying some, selling others or is there a conscious shift to really move that percentage significantly?

There is a conscious shift to move it significantly. Doug, I don't know if you --.

I just would add though, as we spoke a moment ago, there's an 18-month lead-time on existing locations. So there's already 80 or 100 Chili's that are currently company-owned that deals have been struck and those are on the plate. So in the short-term it's difficult to change that percentage in a meaningful manner, but we're going to look at every opportunity, not just in the U.S. but internationally as well because we are building a lot more franchise locations there at the same time.

So if you're interested just contact us.

Can you just talk broadly about the performance of company versus franchise stores? I know some competitors have talked about franchisees tend to be better operators because they're really kind of more of their hands in the game. Just wondering if you can give a broad brush look at the company versus franchise performance?

I think some of the reasons that we have expanded our franchise ownership is their knowledge of that individual market. They live in a particular metropolitan area, they understand much better than we do in Dallas, Texas all the business levers -- real estate, location, cost of real estate. So obviously we've had examples in the last couple years where we had markets we had not been successful. We have refranchised those and those local operators are now building new restaurants and they are performing in those markets at a higher level.

At the same time, we have some great company operations as well so we've tended to look at each market individually and determined based on the current profitability and the current consumer scores does it make sense in the future to continue to have it be a company operation or is there a chance to increase our success with a great franchise partner in that market?

Long term from a financial standpoint of course there's less capital involvement on the corporate wide with franchisees and we also have historically found out some of the great innovative ideas come from franchise partners. They tend to put their money where their mouth is because they're investing dollars out of their own checking account. And so we get great operational input, initiatives and insight from franchise partners. So it's a great blending and, as Chuck already said, our hope is that that franchise percentage will increase over the years.

And Jeffrey, what I want to point out to you too is we actually go through, as Doug said, market by market and do an analysis of what our profitability is currently and also what the expected return would be as a franchise market. And we look to see where we can maximize the net present value of the cash be it company or franchise, and that's how we make the decision to operate that market.

Thanks.

Matt DiFrisco.

Matt DiFrisco, Thomas Weisel Partners. Chuck, can you talk about the economics or the difference in economics at the franchises internationally and domestically looking at the royalty stream and also the upfront payment for those new stores as they go up? Is there a difference there?

There are some differences. In some markets internationally our brands are so demanded that we actually have a slightly higher royalty rate than we do here in the U.S. Other than that it's relatively comparable.

And the royalty rate in the U.S., can you update us on where that stands now. Also post the taking in of the 15 stores?

Well, the royalty rate we charge per restaurant is generally 4%. In terms of what the mix is on total royalty in revenues received, taking in those 15 restaurants really doesn't make that big of a change.

Okay. And then also, Doug, on the labor improvement that you've made, is there something behind where your -- can you give us some tangible things that have gone on in the restaurant? Is it back of the house efficiencies that you're gaining on or is it maybe since traffic has been down you're spreading out the tables a little bit more or is it just the systems are getting better where you can schedule? Can you give us some tangible things? And how long do you think this improvement in labor is going to exist to offset some of the other things like utilities?

Well, there is some new technology and some new labor analysis that we have created here that has caused some great focus on the operating side and some great follow-up. But it's primarily the operating team focusing on it and our IT technology department creating some great new tools that they can use that help them look at goals on a shift by shift basis for customers as well as labor dollars and labor hours. We slice it and dice it a bunch of different ways so that you can forecast again by shift, by section what you should pay to staff that restaurant and it can adjust with the model as customer traffic goes up and down. So I think we're getting a lot smarter about how we operate the restaurants and making sure that we are fully staffed when it's busy but are able to make quick moves as volumes levels change by day part.

So if I were just to look at your way you'd set up a new store today versus how you might have done it three years ago, what type of sales assumptions are equivalent to the comparable periods? Would you be looking to staff it more efficiently and with less bodies now off a new store or are these labor improvements and efficiencies gained at the existing stores (inaudible)?

It's some of both, but you wouldn't have less bodies necessarily, it's the efficient use and scheduling of those bodies when they come in, when they leave. It's based on the business and demands at hand at that time.

And then just another question on -- I think a clarification. You said 80 to 100 are on the table for general restaurants when you were asked about the refranchising. Do you mean 80 to 100 existing stores?

No, I was speaking about corporate Chili's restaurants that we already have either negotiations or real estate deals done or under construction for the remainder of fiscal '06 and fiscal '07, and even early fiscal '08. I was speaking about corporate restaurants where we already were building and how that would make it more difficult to change that 70/30 percentage on corporate versus franchise restaurants.

Okay. And then last question. You guys historically have been seen as one of the better bar and grills at least positioned to the upper casual diner where --.

Well, thank you. We feel like we still are.

Well, I mean your advertising as well gives a little bit more attention to the food side than your peers. I'm wondering, are you still seeing -- is this a near-term effect of a trade down or is this something you think that is sustainable as far as looking at the mix, looking at the exceptions of the price increase it would suggest that you do have a more affluent customer. At least the customer is willing to spend more there while of the numbers are going down as far as transactions of late. Is this something that you think is sustainable or is it something that you think might be just in the near-term and that there is a trade down going on from the higher level brands into Chili's?

Well, I think one thing that -- and you just said it, I'm glad you did. One thing that people don't always understand is that there is trade down into our portfolio; it isn't always trade down out of our portfolio. But I think what we are sure about is that casual dining, eating out is going to be a fabric of Americans for a long time. Over the last quarter there has been a lot of economic pressure on consumers and you see the QSR group, they're working on improving their quality and having more choices and healthier items and casual dining is always working on price, value and speed and teaching consumers we had to go. It's amazing the percentage of our own consumers that had never tried to go. So we're always trying to have different options for our customers.

Mix has been going up over the past several months though, so you also see consumers at different needs ordering steak, ordering higher priced items. It's the economic conditions out there matched up with the needs of the consumer at that time. And if we looked across our portfolio, particularly in the bar and grill versus some of our main competitors, our customer is a little more affluent, their average income is higher. So that does offer Chili's the opportunity to trade up and maybe trade that customer up but maybe bring them from a dining experience where they were spending more.

I guess though you feel pretty confident the numbers are true numbers, it's not an anomaly in that you've had some greater push in store on appetizers that might be reflected in the mix rather than traffic number. The numbers are less bodies coming in and more people spending money?

Well, back in September we had an increase in guest counts, but overall we'd like to increase traffic and increase mix both. We're trying to balance that affordability and price value of casual dining with lots of options that might not have existed in grill and bar years ago.

Okay, great. Thank you.

David Palmer.

UBS. First question, you noted that value oriented promotions were working better, particularly for Chili's. And I'm wondering when you look beyond Chili's in the overall casual dining chain industry with food commodity cost down and traffic trends broadly down do you see a value oriented promotion calendar maybe being the theme of the casual dining industry here in calendar '06?

I think the time of the year has a lot to do with the customers' needs for that. But we're always going to keep in mind what are the economic pressures that are going on at point in time. And the bar and grill niche has always been about choices and options and great price value. It's always been the ability to get high-quality food at a very reasonable price. So we're going to try to do both. Again it's mix, it's traffic, it's salads, it's steaks, it's in appetizers to desserts. We're going to always try to have balance, that's the beauty of that bar and grill niche is it has opportunities for every experience at all different needs.

So you don't think that we might be in for an environment where we do see -- it seems to me that some of the things that you're experiencing and seeing might be applicable broadly and we just might see just the rule of the game switch a little bit more towards the value oriented whether it's consumer led, food cost led, whatever. It just seems like we might go there into that zone a little bit for better or for worse.

Without the crystal ball in front of us, yes, we'll follow consumer trends whatever that will be. Certainly we're going to try to give them -- as I said before, we're going to ask them what their needs are, what they're asking us for and if it's value from some short period of time, certainly, we'll try to offer those. There's no planned value strategy short-term. Let's watch utility costs, let's watch gas costs, let's watch unemployment. As always, we're economists as well as sociologists here as we try to predict the future and we're going to try to be there, whatever they need.

The gift card mix, you mentioned it was 2.5 to 2.6% for the year. In the March quarter in the fiscal third quarter, I would imagine it would have to be a lot higher than that. Do you have a sense of what it might be in that quarter in terms of redemptions as a percentage of sales?

Not yet but the consumer likes gift cards and the beauty of a portfolio is our gift card has four different dining opportunities to pick from. That's what the consumer have played back to us is they have lots of choices with that one gift card.

Obviously what I'm getting at there is that that number is two to three times that and you've got a 35% increase in your gift cards, a 3 to 4 point kicker to your sales wouldn't be so unreasonable particularly for Chili's. Does that sound outrageous?

We also had gift cards last year.

But I'm talking about incremental. You have a 35% increase in your gift cards versus last year. And if you have -- say there's a 10% mix of gift cards for the quarter --.

It was a 3/10 of a percentage point improvement in redemption, so we'll see. It's not going to be as large of a number as you're throwing out there.

It's way under a percent.

Got it. And lastly, I think you noted that building costs and real estate costs are up and then you committed to the current growth goals. And it's more or less you're saying that the development of competitors looks like that's subsiding and that you're perhaps in the medium to long-term some of the traffic pressures per unit might be eased just by your competitors changing their growth goals. Is that a simplified assessment as to where you think this industry might navigate towards as a more stable outlook -- maybe not with any help from yourselves because you're going to keep on growing at the same rate? But by some perhaps lower return chain having to pull it back a bit?

Well, I think that's one of the great things that we have in our portfolio. We've got Chili's which gives us very good returns and will give us the ability to continue to grow and deliver great shareholder returns. If we had brands that maybe don't return as much in the industry that's a good thing for us. They will have to stop growing or slow down.

Great, thanks. Good call, guys.

Gentlemen, thank you. There are no questions in the queue.

Thank you, Kate, and thank you, everyone, for joining us on the call this morning. I look forward to speaking with many of you later today.

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.