Brinker International Inc (EAT) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Brinker International third-quarter earnings release. 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.

Good morning and welcome to the April 25th Brinker International third-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 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. Upcoming fourth-quarter calendar dates currently planned include May 10th, we will release April sales results after the market closes; June 7th, we will release May sales results including initial expectations for fiscal year 2007 after the market closes; and August 10th, we will release fourth-quarter earnings results before market opening.

Additionally, please refer to our Investor Relations website in the financial page for breakouts of continuing operations, discontinued operations and special items for both fiscal years 2005 and 2006. Within the special items category, we have provided detail related to incremental equity-based compensation expense. The good news is we will lap the implementation of 123R in the new fiscal year that starts June 29th, making results more comparable year-over-year.

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

Good morning, thanks for joining us on the call today. I am pleased to report earnings per share from continuing operations grew 20% in the third quarter to $0.71 on a comparable basis, excluding gains, restructuring charges and incremental equity-based compensation. Operating performance was driven by solid revenue growth of 13% and improvement in store level margin performance. Chuck will cover with you shortly why G&A spending last year was relatively low compared to this year.

During the quarter we concluded the sale of Corner Bakery Cafe, generating more than $70 million in gross cash proceeds, the majority of which were used to repurchase shares throughout the quarter. The Board of Directors also affirmed our second dividend payment to shareholders and increased our share authorization by $150 million. With the completion of the Corner Bakery sale, we have divested three brands since late 2003, retaining our four core brands enabling us to focus on our vision of becoming the dominant global casual dining restaurant portfolio company.

Each of our core brands has broad consumer appeal, is complementary to the rest of the portfolio, possesses significant brand equity, and contributes to growing shareholder value. While I will let Chuck step you through the quarterly sales results in detail, I would like to directly address the subject of traffic generation. To be clear, capturing capacity opportunities and generating traffic that will drive profitability and returns is a key area of focus for each of the brands. While Chili's tends to have greater overall traffic than its competitors making growth in traffic all the more challenging, there are still incremental occasions and dayparts that we are going after.

We have concerns with traffic trends at our restaurants, and we are especially disappointed with March results. Chili's Sizzle and Spice drove check, but did not improve traffic over what was a successful promotion a year ago. Regardless of prior successes, we must continue to improve trends in our restaurants, and we are focused on ideas and messages that will accomplish just that. Our marketing efforts have been more dinner and entree-focused with higher price points, resulting in traffic declines especially at lunch. While this focus on mix has helped drive intended profitability, going forward our focus is on bringing more guests into our restaurants to regain consistent momentum.

Innovation driven by consumer insights captured through ongoing surveys, data collections and very thorough analysis will also contribute to this effort in areas such as menu innovation, promotional offerings and execution, operational initiatives and technology, all of which we are actively pursuing. In fact, to further the traction we built during the holiday season when we generated record gift card sales, we are currently rolling out gift cards for other holiday occasions like Mother's Day, Father's Day and graduation, with fun, creative designs that are available in retail stores around the country in all of our restaurants and through our website.

Despite softer industry traffic trends, we retain our confidence in the long-term prospect of casual dining. Our experience in selling the convenience customers have come to rely on for multiple occasions gives us this confidence. And Brinker is especially well-positioned to capture various occasions with its current portfolio of great brands that target a broad spectrum of dining occasions and guest demographics.

Next I would like to give you an update on how we are progressing against our three key priorities to drive shareholder value, starting with our strategic focus on building profitable restaurants worldwide. In the third quarter, we continued to make progress by building 37 new system restaurants. In fact, the performance of newer company-owned restaurants continues to surpass our expectations, supporting a continuation of our development strategy and demonstrating exceptional site selection capabilities.

We also continue to make good progress on our domestic refranchising program, garnering further development commitments from franchise partners during the quarter. We also expect to announce the completion of additional refranchising transactions in the coming weeks, further advancing this key initiative in support of the Company's development strategy.

The second key priority is growing our existing business through successful brand-building and operating initiatives. Needless to say, each of our brands is working on such initiatives grounded in strong financial and process discipline to insure predictable returns. In fact, last quarter I provided you a more detailed glimpse behind the initiatives of Romano's Macaroni Grill, and we continue to make progress on store level margin at all of our brands as our third-quarter results demonstrate.

We continue to look for new and creative ways to more effectively market each of our brands consistent with their positioning and intended customer target. As an example, you may have seen at Chili's Bar & Grill integrated in the themes from the hit television show "The Office" in the recent past.

Finally, the third priority at Brinker is leveraging customers and brands across the portfolio. I've already shared with you our increased focus on gift card sales through the year. Brinker gift cards enable recipients to use cards at any of the Brinker brands, leveraging the power of the portfolio. We are also pursuing increased points of distribution for gift cards and making good progress to date.

Additionally, we have several shared services under the Brinker umbrella that allow the Company to leverage its size and scale to optimize the financial performance of each of the brands, either through lower input cost or more effective support than stand-alone concepts can afford.

So to summarize the quarter, we are pleased with the absolute results we reported this morning that exceeded our expectations, driven by solid revenue growth and earnings flowthrough. We have made considerable progress on our three key priorities -- restaurant development, brand building and operations initiatives and portfolio leverage. However, we are displeased with recent traffic declines, and our brand teams are greatly focused on driving profitable sales and traffic going forward.

Lastly, despite some softness in consumer spending, we still have confidence in the longevity of the industry and our ability to compete effectively within the casual dining space and build long-term shareholder value. Now, let me turn the call over to Chuck.

Thanks, Doug and good morning, everyone. Before we go through brand-level results, let's discuss recent performance against a few of the financial objectives targeted earlier in the year. As Doug mentioned, the sale of the Corner Bakery Cafe concluded this quarter as did our relationship with Rockfish, generating gross proceeds and tax benefits in excess of $76 million which was used to repurchase shares during the quarter. Our second quarterly dividend of $0.10 per share was also paid during the quarter, and these actions are consistent with our commitment to complement the growth of our business by returning capital directly to shareholders.

Our goal of balancing systemwide ownership from an 80% company and 20% franchise to a targeted 70/30 system continues through an active refranchising program and with accelerated development commitments from our worldwide franchise partners. We completed two refranchising transactions in the third quarter representing 8 restaurants, 6 Chili's and to On the Borders, and it generated proceeds of approximately $20 million. And these franchise partners committed to build 24 restaurants under their development agreements.

Given the nature of liquor laws, these deals have been in progress for some time, but generally closing takes anywhere from three to four months to complete. Additional refranchising transactions are in progress and will close in the fourth quarter. The restaurants have all been notified and due diligence is nearing completion, and as always, the final details will be announced by press release at closing.

Complementing our domestic efforts is our international expansion. Due to strong results, our franchise partners continue to accelerate the growth of restaurants in international markets. During the third quarter our partners opened a third Chili's restaurant in Juffair, Bahrain, the 15th Chili's in Barceloneta, Puerto Rico; a second Chili's at an Osan Air Force Base in South Korea, and the 30th Chili's in Mexico at the Las Americanas Mall in Mexico City.

In addition, very recently we signed an agreement that will bring the first Romano's Macaroni Grill to the Middle East with openings planned in Jordan, Kuwait, the UAE, Oman and Egypt. Next year looks incredibly bright with our international partners scheduled to open over 35 new Brinker branded restaurants. The three-phase international strategy outlined last September remains intact and is validated by both the current results and the long-term growth prospects.

Now turning to the quarterly results, overall, operating results exceeded our expectations. Solid revenue growth driven by both new restaurant development and sales leverage from a robust January improved commodity costs and effective food and cost labor and management resulted in greater than projected earnings for the quarter. Revenues for the third quarter of fiscal 2006 increased to over $1 billion, 13% greater than the same quarter in fiscal 2005. The increase was attributable to capacity growth of 7.4%, solid sales growth for newer restaurants, and comparable same-store sales growth of 2.7%.

The Easter holiday also benefited the quarter by 50 basis points and March by 1.5%. Our franchise partners enjoyed similar results as franchise revenues increased over 22% to more than $9 million. Reported capacity was slightly lower than our long-term target of 8 to 10%, primarily as a result of Big Bowl being in the revenue base last year and the refranchised transactions. Excluding the impact of those transactions, capacity growth was about 8%, which is within our target range.

Cost of sales continues to improve. For the quarter, cost of sales improved by 30 basis points as a percent of revenue from 28.4 to 28.1. Our Sizzle and Spice promotion carried a higher year-over-year cost of sales, but this mix influence was more than onset by good operational controls, higher menu prices, and favorable pork and beef costs. Negative year-over-year raw material costs were slightly higher, tomato and salmon.

One of the major reasons our controllable food cost has improved was due to new back-office systems which helped the managers control waste by computing an actual versus theoretical food cost system. To make restaurant expenses more comparable for the quarter, a few adjustments need to be made. In the prior year, the 54.6% should be adjusted to reflect the gain of $2 million for the sale of 5 Chili's restaurants, resulting in a normalized 54.8%. In the current year, 53.8% should be adjusted to remove the refranchising gain of approximately $7 million and $2.2 million for equity-based compensation, resulting in a level of 54.2%.

So, on a comparable basis, restaurant expenses during the quarter improved 60 basis points from 54.8% in Q3 of 2005 to 54.2% in 2006. Improved restaurant and management labor productivity and sales leverage drove the bulk of the year-over-year improvement. Utility pressures remain and negatively impacted results by about 40 basis points.

During the third quarter, we adopted FSP 13-1, which requires the Company to expense rental costs associated with ground or operating leases incurred during a construction period. This recognition of an expense during the holiday rent periods had been capitalized in previous years, and the negative impact of this accounting change was approximately $1.4 million this quarter.

Our operations teams are doing a great job controlling labor cost as well. Wage inflation remains in check and gives us confidence that labor cost will be in check in the short-term. The benefits of a continued focus on labor productivity helped to offset higher preopening costs and the 40 basis points of higher utilities during the quarter.

General and administrative expense for the quarter was 4.5% of revenue, excluding $4.4 million of equity-based compensation compared to 3.4% in the prior year. However, that comparison is misleading. As you will recall, we did not earn most of our performance-based bonuses last year, which helped last year's G&A by about 90 basis points. The majority of this year's increase, about $11.5 million, relates to the anticipated achievement of performance-based compensation for the current year.

The effective income tax rate from continuing operations was 30.9% compared to 32.2% last year. The decrease in the rate was primarily due to the income tax benefit associated with the final Rockfish settlement and partially offset by the impact of stock-based compensation expense related to incentive stock options that are deductible only when exercised.

During the third quarter of fiscal 2006, the Company acquired 2.1 million shares of its common stock for approximately $85.4 million, bringing the total amount of shares repurchased by the Company for the fiscal year to 6.4 million shares for approximately $252.5 million.

At the end of the third quarter, we had approximately $173 million remaining under our Board authorizations, and as we announced in early February, the Board of Directors approved an additional $150 million in incremental share authorization.

Turning to brand-specific performance, Chili's posted a 3.4% comp sales increase in the third quarter, bringing year-to-date comp sales to 4% at the brand. Comps sales of over 7% in January driven by gift card redemptions, positive weather, and the Southwest combination promotion helped drive these results. Soft traffic trends impacted us during the back half of the quarter, and as Doug said we recognize long-term our business cannot sustain negative traffic. At the highest average annual volumes of $3.2 million per year, Chili's has one of the highest [AAVs] in the segment combined with the lowest PPA of its peers.

The team is working on ways to grow traffic by reinforcing value and convenience across consumer touch points, including our core menu, promotions and operational execution, while continuing to be relevant to consumers' lifestyles.

Romano's Macaroni Grill, for the quarter Mac Grill reported a decrease in same-store sales of 3/10 of a percent, driven by a 2.2% increase in price and a decline in mix of a 1/2 percent and traffic decline of 2%. Towards the end of the quarter, Mac Grill rolled out its newly designated and optimized menu. The new menu removes items not often ordered and eliminates unique preps and ingredients. The result is overall cost savings and process improvements in the restaurants.

Since the new optimized menu was implemented across the system at the end of February, cost of sales and labor improved even more than we expected. And the new menu features two new pizzas -- pesto chicken and Sicilian, which are fast becoming favorites with our guests. In addition, we are still on track to have KDS rolled out to the entire Macaroni Grill system by the end of June to further improve overall food and service quality.

On the Border, for the quarter same-store sales were 1.8%, made up of 2.8% increase in price, 2% mix, and a decline in traffic of 3%. On the Border is preparing for the Cinco de Mayo celebration. May 5th is traditionally the best sale day of the year for OTB. Last year, in fact, sales for the day were $2.1 million, and that is one big day. We're working hard to keep that tradition going and growing.

Maggiano's comparable store sales were 5% for the third quarter, driven by a price increase of 2.9%, flat mix, and traffic -- positive traffic of 2.1%. This quarter represents the 18th consecutive quarter of positive comparable store sales at Maggiano's. I want to take a minute to congratulate Wyman Roberts and the entire Maggiano's team on the great job they are doing. Since Wyman joined us in early September, we're seeing continued strong sales performance as well as continued margin improvement. The team has been working hard to accelerate the growth in order to realize the vision of a $1 billion brand. The growth rate will increase in 2007 and '8, as the team has earned the right to grow more rapidly. Thanks, Wyman; we are glad you're part of the Brinker family.

For the fourth-quarter outlook, we expect revenue growth of approximately 9 to 10%, excluding the impact of store closures last year and refranchising transactions. In fact, the growth rate would have been approximately 1% higher. As pointed out earlier, Easter benefited March comp sales by about 1.5% and is expected to have a similar negative impact during April in the area of 1 to 1.5%.

Cost of sales continues to improve on both a sequential and year-over-year basis. Specifically, we expect improvement of about 20 basis points to 28% from 28.2% last year, primarily driven by favorable commodity costs, particularly pork. More broadly, commodities are favorable for pork, beef and poultry but offset by slight pressures in seafood, primarily salmon, and produce. Restaurant expense will increase about 80 to 100 basis points this quarter versus 53.4% last year on a comparable basis, excluding incremental equity-based compensation and refranchising gains. The expected increase relates primarily to higher advertising of about 60 basis points, 30 basis points of utility cost increases, 20 basis points related to holiday rent, and to offset by improved labor costs.

Depreciation and amortization will remain about $48 million. General and administrative expenses excluding incremental equity-based compensation expense will be about 4.4% compared to 4.1% last year. And as I mentioned, last year we did not pay out performance-based profit-sharing which reduced last year's expense by about 60 basis points. Overall, incremental equity-based compensation for the quarter mirrors the third quarter and is expected to be about $6.6 million pretax and $5.1 million after-tax or about $0.06 per diluted share. This expense has been isolated by line item outlook in order to provide year-over-year comparability.

Interest expense in dollar terms should approximate 5.5 million for the quarter, slightly higher than last year due to higher debt balances from share repurchases and higher interest rates. The tax rate from continuing operations should approximate 32%, excluding equity-based compensation expense, and including this expense, the tax rate should be about 32.7%. Therefore, our initial estimate for fourth-quarter EPS from continuing operations, excluding special items, is $0.71 to $0.74 versus $0.69 in the prior year. Including incremental equity-based compensation of $0.06, EPS forecast is $0.65 to $0.68.

The modest EPS growth rate for the fourth quarter over the prior year is driven by the lack of accrual for profit-sharing last year, an increase in advertising and energy costs, as well as the impact of FSP 13-1, holiday rent. Consequently, the range for the full-year forecast from continuing operations excluding special items is $2.45 to $2.48, representing 16 to 18% EPS growth versus last year on a comparable basis. Including equity-based compensation of about $0.28 per share, full-year EPS from continuing operations excluding certain gains and charges is anticipated to be $2.17 to $2.20.

Brinker has always had a policy committed to providing ongoing robust information that will assist the investment community and particularly long-term investors in understanding key drivers on our performance in reporting important financial metrics. We're in the process of reviewing our guidance and disclosure policies, and if it is determined that any changes or refinements to our current practice are in the best interest of long-term investors, it will be announced in early June and implemented in the upcoming fiscal year.

We remain bullish on the global prospects of the industry and of our ability to be a worldwide dominant casual dining restaurant portfolio company. Double-digit revenue growth will be driven by new restaurant development, comparable store sales, and franchise revenue growth. We will reinvigorate traffic trends by focusing on value and convenience and ensuring a great guest experience every time with a continued assurance of financial and processed discipline.

We will continue to manage our bottom line with strong store level margins, increased franchise revenue, and an efficient overhead structure. Strong cash flow generation, active balance sheet management and prudent capital allocation will allow us not only to generate incremental returns by investing back into the business, but to also return capital directly to shareholders in the form of dividends and share repurchase, resulting in consistent annual EPS growth of 15% per year.

With that, I would like to turn the call back over to Kate to facilitate the question-and-answer period.

(OPERATOR INSTRUCTIONS) Andrew Barish.

Bank of America Securities. Can you give a little clarity on the current promotion at Chili's? I think the main promotion on TV is a $9.99 price point. Is this kind of signaling the start to shifting towards some more value-oriented traffic driving promotions? But then I think you have some add-on items that are higher priced as well. Can you just kind of put that within the context of where you are heading over the next six months in trying to balance the Chili's comps a little more?

Thank you. Do you want to talk a little bit about Chili's promotions?

Sure, Andy. What's going on right now we call a Mexican Fiesta, and there is carne asada and some shrimp scampi and a trio of some items, but moving forward we're probably going to be even more bullish in looking at even more value-oriented items that stick out of the consumer salads and burgers and sandwiches. Because as you look across what is going on in the competitive segment and with the customer, it is not just the sub $10 items that are getting people's attention. It is really the more quicker, faster and a lot easier to eat items than those entree type dishes that we have been pushing the last year or so.

Has there been an area, a dayparts? You mentioned lunch there. I guess that's probably been an area where you have seen much more traffic decline?

Yes, Andy, we have seen declines at lunch, but I think it's related to a number of factors. We're trying to improve our speed of service. We're trying to also be there for convenience, and some of the promotions that we have done over the last couple marketing campaigns have been more skewed towards dinner. So I think we have got to come back in future campaigns and remind people about lunch, remind people why we're such a great place to go to for lunch, and then also have to get our service and execution up to where speed becomes a lot more important.

But that is not going to be tomorrow. That is going to take us a little while, but I think as we get into the first part of the fiscal year, we will be looking for those kinds of items.

We've got some things in the hopper in May and June, Chili's, Mac Grill, some of the brands that are more lunch-related items that will scream value a lot louder possibly than some of the items we have been promoting the last six months or so.

Thank you.

Joe Buckley.

I am with Bear Stearns. Question, Doug, when you talked about the core brands and portfolio approach, you mentioned complementary businesses. And I know there is some complementary aspects on the gift cards and some shared services, but curious how much do you think the brands complement each other versus possibly having them as stand-alone businesses?

Well, on the shared services, Andy, we're taking a much more aggressive approach probably then we ever have, the brand presidents working together, and that goes across all the functional areas that you might imagine, from customer insight to new product innovation, some of the consumer portfolio approaches that we have used. There's just a more aggressive approach here at the corporate office on IT, on labor scheduling, all sort of back-office systems, cost control and all of those leverage items.

Out in the marketplace, the gift cards have given us a great I think early look as the optics. Consumers have said that they are comfortable with the portfolio, and as you look for different types of food and different flavors throughout a week or so, obviously that is part of the complementary part of the brands. We're actually going to do some more of that Brinker gift card stuff here in the spring related to the grads and Mom's and Father's Days.

Just a question on traffic. Has the traffic in the dinner daypart been positive, given the marketing focus there?

It had been down -- it's been down a little bit lately. Prior to that, it has been relatively flat, Joe.

Okay. And any sense that maybe the check average increases at Chili's that have been running 6% type numbers are part of the problem on traffic?

Well, we have taken a look at really everything, Joe, to see what it is that is causing people to not come into the restaurants. We acknowledge that that 6% lift in check could be part of the issue, but we haven't been able to point to anything particularly.

When we have looked, Joe, across -- PPA across Chili's main competitors, Chili's still has a lower check than most of our competitors. So, obviously, you have to balance the message, the products that you are marketing and promoting, as well as the price increases. But certainly in the last few months, we've had more mix than we have had customer trial, and we think a lot of that has to do with the message and the products that we have been promoting.

Okay, thank you.

Jeffrey Bernstein.

Lehman Brothers. Just a couple of questions on comps. First, I guess in the past, the focus on most has been on weakness in the Midwest region. I think you spoke last quarter of Midwest and Northeast being a little soft but still positive. I was just hoping you could provide some just, I guess, color surrounding recent comp trends specifically at Chili's, for I guess of the regions that you look at, including the overall comp and the specific traffic trends. Then I just had a follow-up.

Well, I would say, Jeff, in particular where we have seen some softness of late has been in California. That has been the biggest change for us. California has been a very strong market for us and has outperformed the rest of the system, and we're starting to see some weakness. That's what we're trying to look into, you know, is it related to gas prices, is it related to something outside of our control. We're trying to isolate that, but other than that, we really haven't seen dramatic changes in market to market.

So other than, I guess, the California shift, it is safe to assume all the markets are seeing similar traffic declines; there's no standout?

There is no standout, that's correct.

Okay. Then just a follow-up on new versus existing stores. I know over the past number of months in terms of just strengthening your newly opened stores, I guess, is offsetting possibly lower-than-expected comps. Just wondered if you could talk about the potential disparity, kind of the drivers and whether you expect that to continue. I'm not sure if you view that as a healthy trend or something that perhaps is concerning? Thanks.

This is Chuck. We have seen better performance out of our new restaurants, and we consider that to be good news. I don't think that is particularly concerning at all. In fact, that higher performance has led us to feel very comfortable about capital allocation and where we put dollars into building new restaurants. We expect it to continue. We don't see any reason why it would not continue, so we are very confident that that is a good trend for us.

So I guess it demonstrates somewhat cannibalization to your existing stores but not enough to necessarily consider slowing down or different site selection?

No, when we do site selection, we take into account cannibalization. And honestly, we take into -- we put it into the financial model and look at what kind of sales the new restaurant will drive and then also the impact it will have on our existing restaurants. And then we try to really look at what our financial return will be from the two restaurants to see if it makes sense for us to continue to commit more capital into that market, and we can't say that anything is really outside our expectations in that equation.

Thank you.

Anything else, Jeff?

Actually, I just had one follow-up if that is all right. Just looking at the Chili's marketing message, you were talking about the on-again, off-again and the impact it's had on the monthly comps. Just wondering if you could (indiscernible) your expectations going forward for, I guess, the length of the promotions, the number of the promotions per year, and just the outlook for the price point advertising which I think was mentioned earlier, just in terms of big picture for the Chili's marketing message. Thanks.

Doug, do you want to talk a little bit about that?

Yes, Jeff, I think we don't normally talk too much about proprietary marketing strategies, but anything is up for discussion and conversation. We certainly look at the consumer right now, and there is more pressure probably going out in the environment between gas and utilities and talk this week about four-year high on 30-year mortgages, so less refinancing, interest rates. All of those things are probably making an impact on the guest, and certainly time. That issue is becoming more and more an issue.

So I think from a goal, we would love to have those windows go longer. From the operations side, it would be easier for them if the windows were able to be expanded, so somewhere between four and six weeks, and probably somewhere between four and six per year is what we look at right now. But as we look at more lunch promotions and different price points, anything could change.

Thank you.

David Palmer.

UBS. The question is about traffic in the long-term, and obviously you have the goal of stabilizing that and growing that. I am wondering when you think about dayparts or even initiatives where you see the traffic swing coming. Is it potential for a focus at lunch being a driver in the medium to the long-term? In the near-term is your goal perhaps to use the card in conjunction with value to drive some of this traffic?

Then with regard to your advertising message, I noticed that sometimes you will say starting at $9.99 with a promotion. How are customers -- consumers responding to that? Are they using that -- do they believe that that is helpful, or do sometimes they feel put off as the actual promotion prices are sometimes higher than the starting price point? Thanks.

Let me try to hit all of those. As far as our goal, lunch certainly is a priority right now, and we have restaurants where we have open seats at lunch. Even if we look at the to-go part of the business, there is some real interesting consumer data that we have gotten as far as the amount of our customers that have never tried to-go. In fact, Mac and On the Border, about 80% of our customers have never experienced to-go. At Chili's, it is somewhere close to 70%. So there's opportunity there for customers if we market it better and, of course, improve the process and the speed.

As far as the ad messages and the promotions, the limited time offers that we have rolled out the last couple years have all been new items in the menu, so there hasn't been a change in those price points. Those have been new items that have been priced for those promotions for the first time.

We are also, of course, going to continue to add permanent additions and changes to the menu. Both On the Border and Macaroni Grill just in the last quarter have rolled out entirely new menus. They've taken some long-term products that didn't sell off those menus, but they've also refined and added some new items. So we're going to continue to not just promote items on short-term basis, make additions to the menu that will be long-term. Did I cover everything there?

Yes, I think so. Just a separate unrelated quick question on refranchising. Do you ever discuss internally and potentially consider stepping up the pace of refranchising in the coming years? Obviously, you're doing at a steady pace, but I am wondering if you would ever think about going a more aggressive path there?

We definitely think about it, David. What we're trying to do is find a way we can move the [yield] from the current 80/20 to 70/30. So we're going to have to take on some different tactics really to get to that 70/30 range, and we've talked about a number of those internally.

Thanks very much.

John Glass.

It's CIBC. I have a couple questions. One is on the current quarter, Chuck, on the restaurant operating expense line. Even if you normalize margins, you've got a 70% -- I'm sorry, 60 basis point year-on-year benefit. Can you talk about the role of repair and maintenance that had on that line and is that a sustainable trend? I guess just more generally, can you talk about what you need today to get, in terms of same-store sales, to get leverage? It seems like you are a little below your long-term goal in terms of what you need for comps, and if you're getting better leverage than ever and if that is sustainable.

Well, we are getting better leverage, and I think some of that, John, goes back to we have got relatively new COOs in most of the brands, and they have really stepped up. They've taken a look at just best practices and where we can implement those across the different brands, and they have done a tremendous job in managing the middle of the P&L.

As to repair and maintenance, that is mostly a timing difference. Q3 we were a little bit lower in spend this year, but on a year-over-year basis on year-to-date, we are actually higher on repair and maintenance at all of the restaurants. So that is not a sustainable situation nor do we expect it to be. We still have to invest in the restaurants and make sure that they are very nice looking and a great place for guests to go to.

Then just the incremental advertising in the fourth quarter, is that just a timing shift or did you actually add some advertising recently to help lift some traffic?

We did add advertising throughout this year. Last year we reduced our accrual because we didn't have products to promote. This year we've had products to promote and we've actually increased our spend and increased our advertising as a percent of sales. So that is something that we will see about a 60 basis point headwind as we get into the fourth quarter.

What is your embedded comp assumption for your fourth-quarter guidance?

We're looking at somewhere around 1 point.

Thank you.

Bryan Elliott.

Raymond James. A couple of housekeeping items and then a question. On the balance sheet, Chuck, what was the cash and what is the short-term debt and the current liabilities?

Hang on a second. Cash for third quarter –- it's very small -- $53 million.

Just about $54 million, Bryan.

Yes, $53.9 million.

So you mean the print is small?

The print is small. I am getting old; it's bad.

And short-term debt or the debt in the current liabilities?

It is in current liabilities. Short-term debt totaled -- I'm trying to break it out here real quickly.

2.2.

Okay, that is small, de minimus. I wanted to kind of follow up on John's question about leverage. You also in the prepared remarks mention labor leverage, and again it seems a bit contrary to macrotrends that are out there where state minimum wage and other situations are creating some wage pressures. And wondered if that is part of the operational improvements you just referenced as well, that we are just doing a better job using technology and being a little smarter and better about labor scheduling and other store level efficiencies. Is that essentially the answer to the question?

It is the answer, Bryan. We have done a rollout of not only labor productivity; we have put in some new tools for our managers. We've also had some increased focus really with the COOs talking about both front of the house and back of the house, how we can better utilize our folks to take care of our guests.

Are you actually taking labor hours out of the restaurant, or are we doing a better job of controlling initial hire wages or bumps in existing employees? Can you flesh out a little bit?

We are. We are getting leverage off of the mix changes that we have seen in price increase. So we are seeing some productivity benefit from just the fact we have been able to take some pricing. But we are also seeing better efficiency in the number of people that we have in the restaurant serving guests.

All right. Doug, on the labor issue, could you address just conceptually your views about the potential longer-term impact on the business should there be a significant change in the amount of newly arrived workers, for lack of a better term; if there is a significant political change in the offing here, what you see potentially as an impact on the organization looking out a number of years?

Bryan, that would be a question probably to go across the entire restaurant industry, because a large percentage of the population of the entire industry, both casual dining and QSR, is made up of folks that have probably entered our country from somewhere else. We, of course, support the temporary worker provisions and did a great job on April 10th, working with our employee population, did not close any restaurants, and worked between sort of the social and cultural challenges they have and the pressures they feel and their loyalty to our restaurant concept.

So I can't imagine the country taking as hard a stand that is being mentioned right now, simply because there aren't Americans to pick up all of the jobs that particularly the Hispanic workforce is doing in restaurants. So I think there will be some temporary worker provision. As I think President Bush said yesterday, I don't think we are going to deport 12 million workers out of the country. I mean, the entire restaurant industry as well as a number of other manufacturing industries, other industries, would fall apart because there are not Americans to replace those workers.

The May 1st plan demonstration will be quite interesting. We have had great dialogue with our employees about balancing their responsibility to their culture and their families and their heritages with their responsibilities and loyalties to our restaurants, and anticipate that being a day no different for our customers. And we'll just have to kind of wait and see whether political and social issues all fall apart, but there a lot of workers in our industry as well as others that will be impacted by whatever happens.

Thank you.

Jason Whitmer.

Midwest Research. Good morning. Doug, I remember a couple of years ago to kind of revisit your pricing philosophy, you were very hesitant at the time to pass on pricing. You were much more focused on value at the time, and then followed through with some more subsequent price increases and actually looks pretty aggressive over the last 12 months on pricing. Now that you're looking at your traffic trends relative to pricing, maybe even traffic in the entire channel, can you readdress that philosophy and how you plan to manage your pricing and mix for overall check going forward? As you look at the industry overall, maybe even your subcategory, bar and grill, and how cluttered it's been getting over the last year or so.

Jason, we have always taken a position we want to have great price value, and value does seem to be the term right now, though price value is always more than just about price. Historically, Maggiano's of our four brands at a $25 check average has had the best consumer price value perception. So there is a lot of factors that go into that.

As we look across the entire casual dining industry last year according to Technomic, it was about a 3.2% price increase across all casual dining restaurant companies last year, and they are anticipating something similar this year. But we try to not make short-term pricing decisions. Obviously, we're always looking at some long-term trend before we do that. Now, as we look across our current channel checks, both our guest satisfaction scores as well as looking at sales results in markets where we have recently taken price, in markets where we haven't taken price, we haven't seen changes in guest counts.

So if I was going to hedge where we are going to stand over the next six months or so, it was going to be conservative on price increase. But what you have seen across the industry is about 2.5 to 3%, and that is where we have been. But we are paying very close attention to customer scores, market trends based on what those price points have been, and it will probably be pretty conservative with the consumers' current feeling about value.

So the traffic trends you are seeing are not necessarily a direct relation to pricing or pushback on that. You would just say then the channel itself -- I know you've talked a little bit more in the past about how you don't think this is a zero sum game and there's enough seats to go around where marketshare is not an issue. Do you still feel that way today relative to the consumer and how many choices are out there, both chains and independents?

Well, we think a lot of our traffic issue short-term are about the products and the dinner meals that we have marketed where a lot of our competitors and a lot of the fast feeders as well as the lunch type items, lunch type restaurant concepts have been pushing sandwiches. You may have seen Subway advertising their hot sandwiches, trying to move to the dinner side. Casual dining probably has the other challenge, trying to make sure there is appropriate items to compete in the lunch environment. But I think short-term, our traffic we think is more about the message, the products that we push and those price points, more so than long-term environment.

The other question then, to kind of take that thought big picture with your pace of traffic and I guess the pace of capacity coming online in the industry, do you still feel comfortable about your rate of development especially as you accelerate that for your long-term capacity goals?

We do, because as we look at it, we have got a governor on our capacity in terms of the way we go through site approvals. We look at today's sales, today's margins, and that is how we make approvals for new markets and new builds. If we see declines in margins and declines on returns, then we will start to slow up capacity gains. Right now, we are still putting out very good returns on new restaurants. We just had a great quarter. Traffic is not where we would like it to be, but our operations team is doing a great job managing costs and not influencing the guest. They have used some new tools that we've put in place to help manage cost of sales and how to manage labor, and that has given us some of the best productivity numbers we have seen in some time.

Now all we have got to do is just get traffic back to where it was, and we'll be in great shape, and we are confident we can do that. So we are not pulling away from our development plans right now, but again that model will adjust out capacity growth as we go forward if we see any kind of change in our returns.

Jason, I know your question was more forward-looking, but as a data point at the end of February, we do see that Chili's is still lowest in terms of per-person average versus the casual dining group. So I just wanted to give you that as a point of reference.

Great, thank you.

Matt DiFrisco.

Thomas Weisel Partners. Just a couple of clarification questions here. Regarding the comp outlook for the fourth quarter associated with the earnings guidance, did you say that is a 1% for Chili's or 1% overall for the Company?

That's an overall for the Company number.

So if you were to do better than that 1%, then I presume that you'd be outside of your $0.68 range, correct?

That is just what we have used to give that range. You would hope that if we could get increased sales, we would see some flowthrough from that.

Then also just looking back on your prior years where you have seen somewhat of a -- maybe dealt with higher gas prices and the middle-class consumer might have been squeezed a little bit, have you seen in the past lunch be the first indicator of any slowdown, or where does lunch stack up as far as what you'd view as a discretionary meal versus dinner and to-go and etc., and bar business?

Well, in a very broad sense, the hardest thing is, Matt, we generally haven't seen a lot of correlation with our sales and gas prices. This is unusual for us, and that is why we're trying to go back and examine to see if there is any correlation. We do know that gas prices are at $3; we do know that lunch has been soft for us. We're trying to find out if that is a correlation or it is something else that we have done.

Then also I guess just going back to that 1% outlook for the fourth quarter (multiple speakers) -- okay, about -- do you also have factored in there then a little bit less of an average check?

Pardon me?

Do you have a little bit less of an average check factored into that as well?

No, not necessarily.

Okay. Then on a longer-term issue, looking at -- I think someone asked before about maybe accelerating the refranchising mix. It seems as though if you just look at the number of stores you have as far as company-owned versus franchise, the first nine months of this fiscal year the growth rate has been greater on the Company side versus franchise just net adds, and you're growing franchise around 5%. Should we expect that pace to pick up over the next nine months and see franchise potentially accelerate and grow faster than the company-owned units?

It will in terms of the refranchising that we will do in terms of selling off company restaurants. The hard part for us is, Matt, as we sell company-owned restaurants to a franchise partner, they have got to start development, and there's a little bit of time period there. There is an 18-month lag between the time they can first get that restaurant open. So we're still going into a little bit of that. That is why domestically we won't see a lot of growth as we get through the balance of this quarter and into next year, but internationally we are picking up the pace and it will help to offset that.

As I said earlier, we will be in the upper 30s in the number of international restaurants we will add next year. That will help move that percentage growth higher.

Then the last question, I think you mentioned something about the royalty revenues. What were royalties contributing towards revenue or what was the growth rate of that?

It was up about 22% in this quarter.

And how much did they contribute to the quarterly sales?

It was about $9 million in total.

Thank you.

Larry Miller.

Prudential. Chuck and Doug, I just want to follow up because I think what you said basically, if I summarize it correctly, is there is a lot of macro pressures out there. And I think, Chuck, you accurately described that. You know, gas isn't really a new pressure and some of these other ones aren't really a new pressure. I'm curious if there's anything you are seeing with respect to the way the guest is using some of your brands out there. And I know you just did that consumer research study. Maybe you can enlighten us on that.

Also -- or is it just the situation maybe where some of those stronger markets that had been carrying the day are started to weaken? And I just wanted to see if you could add a little color on that. Then, Chuck, I just had one easy question with respect to your disclosure. Are you considering brand level sales and profits?

We are not considering brand level sales and profit. That is the easy question. As we talked about some of those other effects on us, Larry, I think again you are right; gas is at an all-time high. We are seeing some weakness in California, which has been traditionally a very, very strong market for us. But we know that folks in California also drive a lot, so we don't know yet if there is a huge impact between the two factors.

We also know that interest rates are in there. But I think what I really want people to remember about today is we are in control of our destiny. We own sales and we control sales. We feel like we've got the brands that can compete in the marketplace, and we just have to balance which is the right daypart to be focused on and what is the right marketing mix and message that we need to do. Macroeconomic pressures will come and go, but we control our destiny in terms of top-line sales.

The team here is very committed to finding out what the underlying factors are, resolving those, and driving top line. We are in the midst of uncovering data to help us determine what is the right action to take in both the near and longer-term to address those. Until we can get that data and those facts, it is just supposition.

Thanks very much.

There are no further questions in the queue.

Okay, well great. Thank you very much, Kate, and thank you, everyone, for your interest in participating on the conference 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.