Brinker International Inc (EAT) 2009 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Brinker first quarter 2009 earnings release. At this time, all participants have been placed on a listen-only mode. The floor will be open for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Marie Perry, Vice President of Investor Relations and Treasurer. Ma'am, the floor is yours.

Thank you, Mandy. Good morning, everyone. Welcome to Brinker International's first quarter fiscal '09 earnings call which is also being broadcast live over the Internet. Today with us from Management are Doug Brooks, Chairman and Chief Executive Officer, Chuck Sonsteby, Chief Financial Officer, and Guy Constant, Senior Vice President of Finance.

Before turning over the call, let me quickly remind you of our Safe Harbor regarding forward-looking statements. During our Management comments and in our responses to your questions certain items may be discussed which are not based entirely on historical fact and any such items should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such 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. In addition Brinker disclaims any intent or obligation to update these forward-looking statements.

On the call we may refer to certain non-GAAP financial measures that management uses in its review of the business and believes will provide insight to the Company's ongoing operations. Reconciliations are provided in the tables in the earnings release and on the Brinker Web site under the Financial section of the Investor tab for your review.

On today's call, Doug will begin with an update on the Company's long-term areas of focus. He will turn the call over to Chuck to provide a financial recap of the quarter's operating results. Following these comments we will open up the call to your questions. Now, I will turn the call over to Doug.

Thank you, Marie. Good morning, everyone. We are speaking to you this morning in the midst of one of the toughest operating environments in our Company history. Pressures from fiscal year 2008 continued into the first quarter of fiscal 2009 as reflected in our disappointing sales and earnings results for the quarter. The challenging economic environment including the volatile financial market, housing crisis and high energy prices continues to put significant pressure on consumer spending here in the US and overseas.

Along with the many pressures on consumers, we are also enduring the rising cost of commodities and the fixed costs of operating restaurants which are much more difficult to cover in this current environment. While we have seen some relief recently from rising fuel costs, consumers continue to be conservative in their discretionary spending which has a negative impact on Brinker Brands and the restaurant industry as a whole. Our traffic trends reflect a guest choice to dine out less often, prepare meals at home or trade down to quick service options. These choices have also affected check averages as guests scale back on meal add-ons such as specialty drinks, appetizers and desserts.

Guests outside the United States continue to respond very favorably to Brinker Brands but in many countries they're also beginning to feel the same pressures of rising fuel costs and the financial market volatility. As our international presence continues to grow, we can leverage our learnings from the pressures in the US to proactively address potential issues overseas. As we continue to weather the many challenges in our industry, we are confident, though in the long-term viability of Brinker Brands. We are bolstered by the fact our cash flow remains strong, our commitment to hospitality and guest satisfaction is solid, and we are focused on five strategic priorities that will strengthen Brinker Brands in the short-term and accelerate our profitability when the economic conditions inevitably improve.

We are closely monitoring the current business environment and are prepared to make choices in pacing the implementation of our initiatives. Chuck will discuss in more detail our revised capital expenditures for fiscal 2009. You may recall that our five areas of focus are designed to build on the long-term financial health of the Company and to grow our base business by engaging and delighting our guests, differentiating Brinker Brands from the competition, reducing costs associated with managing our restaurants and establishing a strong presence in key markets around the world.

I will touch on the highlights of these five areas of focus this morning. Our most active area is our disciplined and aggressive international expansion of Brinker Brands in key markets around the world. In a move to redefine our Company's development strategy, we are continuing to shift our focus to increased franchise development both domestically and are continuing our efforts to accelerate franchise growth internationally. Our growth will be driven by cultivating a relationship with equity investors, joint venture partners and franchisees interesting in expanding their business interests through the Brinker portfolio. Our stated goal for international growth has been 300 restaurants outside the United States by the end of calendar year 2010. As this goal originally included development of Macaroni Grill Brand, we will update and restate our goal once the sale of the Brand is completed.

While many restaurant companies have just one brand to offer to franchisees, Brinker can point to the strength of three diverse Brands. In fact, in recent years many of our well-established Chili's franchisees have signed new agreements to develop one of our other Brands. For example, in the first quarter our franchise partners opened two new On The Border Restaurants in Saudi Arabia and South Korea. We also signed a new development deal with our long-term partner in Puerto Rico for six new On The Border Restaurants.

In addition, our global development team opened the very first international Maggiano's Italian Restaurant, an international Brand extension of Maggiano's Little Italy in Belfast, North Ireland. Emerging markets such as China, Brazil and India present tremendous opportunity for Brinker. In these countries a growing middle class is highly attracted to the full service and comprehensive menus offered by our casual dining Brands.

To capitalize on this interest, and to establish a leading presence in growing markets, Brinker will continue to pursue new and expanded relationships with potential investors in these regions. In fact, in the fourth quarter of fiscal 2008, we signed two significant agreements with franchise partners which will open our first restaurants in India by the end of the fiscal year. A subsidiary of our long-time Middle East franchise partner, Jawad Business Group, has agreed to build 15 restaurants in India over the next four years. And Stellar Concepts, a new franchisee, has also agreed to build ten restaurants in North and East India over the next seven years. Our growing percentage of franchise operations, both domestically and internationally, enable Brinker to improve margins as royalty payments flow directly through the bottom line.

Additionally, returns in many markets are superior to the US due to cost advantages in terms of food, facilities, and labor. With growing economic pressures in the US, international expansion allows further diversification of our portfolio enabling Brinker to build strength in a variety of markets and economic conditions. For example, our significant presence in the Middle East continues to deliver impressive results due to a robust economy. Operations in the Middle East experienced a 14.5% increase in comparable restaurant sales, driven by the economies of our franchisee scale, to leverage Brand awareness in the region as well as a highly favorable macro economic environment.

Brinker is the largest player in the casual dining segment in both the Middle East and Mexico which enables our franchisees to harness their broader resources through participation in marketing coalitions to drive sales. Capitalizing on the strength of this coalition, the franchisees collectively invest in advertising, and public relations opportunities that build guest awareness and drive traffic to the restaurants. Using an integrated media campaign combining a number of outlets, partners in both the Middle East and Mexico experienced significant lifts in sales during the first quarter. Brinker will continue to leverage its strength in growing casual dining outside the US and our franchisees are building more restaurants internationally than ever before. During the first quarter Brinker opened ten new international franchise restaurants in the thriving markets of Bahrain, Saudi Arabia, Mexico, Egypt, South Korea and Qatar. As for Company owned international development, Brinker also opened our first Chili's in Northern Ireland right next to the Maggiano's I mentioned earlier.

Just a few weeks ago we entered our 25th country with the opening of our first Chili's in Lisbon, Portugal. These new locations bring our international presence to 189 restaurants outside the United States.

While we aggressively pursue our goals for international expansion, we also grew strategically in key domestic markets with the help of our franchise partners. During the first quarter of fiscal 2009 we built 29 -- excuse me -- 21 new domestic restaurants, 14 of which are new franchise locations, seven Company owned. Another top priority remains creating a culture of hospitality that establishes emotional connections with our guests and engages our team members. We believe providing a consistently warm, welcoming and engaging experience differentiates Brinker Brands from all others in the industry. As guests limit their frequency of dining out, they become more selective in their choice of restaurants. With continued pressure on the guest wallet, Brinker Brands offer significant value in terms of food, atmosphere, and service. By investing in comprehensive team member training, recognition and guest measurement programs, Brinker Brands are well positioned to become preferred destinations for casual dining. As evidenced by the feedback gathered in our guest satisfaction surveys, we are gaining significant traction in this area and are focused on delivering consistently outstanding dining experiences for our guests.

An important component of our hospitality promise is to give back to the communities we serve. During the first quarter Chili's conducted its fifth annual Create A Pepper To Fight Childhood Cancer Campaign raising more than $6 million for St. Jude Children's Research Hospital. To date the Brand has raised more than $25 million as part of its 10-year $50 million pledge to the Hospital. We are also proud to report that in September, Chili's was honored for its partnership with St. Jude with the National Restaurants Association's Restaurant Neighbor Award. So on behalf of Chili's President, Todd Diener, and the entire Chili's leadership team, we thank our guests, our franchisees, our team members and our supplier partners for your generosity and creativity for a great cause. Now, throughout the month of October, On The Border will raise funds within its restaurants to benefit Susan G. Komen For The Cure during its second annual Fiesta For The Cure Campaign. Around the country, team members will also participate in Komen Race For The Cure and Breast Cancer three day events, effectively walking the talk in their own communities for this important cause. An ongoing area of focus for Brinker and its Brands is food and beverage excellence. We are going to continue to deliver against high standards of execution of food and beverage quality within our restaurants. Our Brands are also improving core menu execution by increasing training and recertification of managers and heart of house team members and by tightening product specs from our supplier partners. Additionally, periodic reviews of recipes, ingredients and processes for signature menu items help our restaurant teams ensure consistent execution and quality across the entire system.

In an ongoing effort to satisfy guests with delicious food we will offer menu items that align with our Brands' unique positioning. As guests limit their dining occasions and even menu item choices, Brinker Brands offer craveable foods consistently executed with excellence and attention to detail. We will also continue to build on core menu favorites by creating new flavors and value offerings that not only please the palate but also give our guests new reasons to dine with us more often. For example, Chili's introduced a highly successful extension of an existing core menu offering with its Honey Chipotle Chicken Crispers promotion during the first quarter of fiscal 2008 and is further extending that offering this quarter with the introduction of Crispy Chicken Tacos, Buffalo Chicken Crisper Bites and three new bold flavors of Chicken Crispers -- sweet chili glaze, honey barbeque and the habanero. We also recently extended our legendary Big Mouth Burger line into the successful Smokehouse Bacon Burgers promotion in the third quarter of fiscal 2008, soon followed by what is now the brand's best selling burger on the menu, the Big Mouth Bites.

On The Border serves the world's favorite Mexican food and is building on the success of core menu favorites with new innovations in tacos and enchiladas. In the first quarter, the brand successfully introduced three new grilled enchiladas featuring pepper jack chicken, avocado with red chili pesto and smoky beef brisket. And these items quickly became leading sellers on the menu. Guests clearly appreciate that innovation, and this summer On The Border was named a Platinum Winner in the Mexican Segment of 2008 Consumers Choice in Chains Award by Restaurants and Institutions magazine.

Maggiano's continues to charm guests with its made-from-scratch menu items created by our talented Executive Chefs. In September the Brand celebrated the Italian Harvest with new specials and wine pairings. Guests responded favorably to offerings such as the Prosciutto Wrapped Shrimp Appetizer as well as featured entrees such as Chianti Beef Stew and the best-selling Halibut Meurette paired with wines from Southern Italy.

Macaroni Grill offers a fresh translation of Italian with unique twists on traditional dishes. During the quarter, the Brand featured Sizzling Sensations while introducing innovative new menu items such as Chianti Steak, Tapinade Trio, and Pinot Grigio Chicken. New value options such as the Roma Lunch Combos and the Chef's Trio Dinner offered guests a generous meal at great values. The Brand's beverage innovation includes a new and improved Bellini made with peach nectar with a splash of champagne.

Brinkers also focused on offering relevant restaurant atmospheres that reflect the vibrant personalities of our brands and offer a warm and welcoming environment for our guests. The current reimage program at Chili's has demonstrated progress in driving incremental traffic and bringing guests back to the Brand. Since the start of the program we have reimaged 95 Chili's restaurants and results have maintained an average mid single-digit growth in guest counts. We will continue to analyze the success of the reimage program and follow a disciplined process to review continued investment in the reimage program as the business climate and economic conditions allow.

Our final area of focus is to transform the casual dining experience in terms of pace and convenience for the guest. Using a combination of hospitality, process improvements and cutting edge technologies, Brinker Brands are pursuing the delivery of dining experience that are tailored to our guests' individual pacing preferences. Whether they're short on time or want to linger over a celebratory meal, we want to deliver an experience like none other in the industry. Our activities around this area of focus consist of tests and analysis of several interrelated initiatives in both the front and back of the house. We are encouraged by our learnings to date and see significant potential in designing a fully integrated restaurant technology system.

Moving forward we will continue to analyze enabling technologies and process improvements, being conservative in our capital expenditures as dictated by the current business climate. Although Brinker and the entire restaurant industry remains challenged by a highly competitive environment, increased costs and an uncertain economy, we are more focused and motivated than ever to produce positive results for our shareholders. We will continue to optimize the use of capital by being disciplined about new restaurant development, closing under-performing locations, selling Company restaurants to strong franchisees, re-investing in the four walls and optimizing our capital structure. Just as important are our efforts to run the business efficiently by managing operating expenses including G&A. Our top priority as an organization remains increasing profitable traffic over time. While we are encouraged by the early progress and traction we have experienced with our strategic priorities, we also realize that the many external pressures are negatively impacting this progress. Through concentrated actions aligned with our five areas of focus, we are confident that Brinker is well positioned to deliver profitable growth over the long term. With that, I would like to turn the call over to Chuck to share the financial details of the quarter.

Thanks, Doug. We are certainly in interesting times now with several industries navigating uncharted waters. As Doug said, it continues to highlight why the strategies we've been focusing on and implementing over the last year are the right long-term answers for Brinker. We believe we will emerge from this tumultuous time stronger than when we began with an even stronger position in our industry.

While we expected the results of the first quarter to be lower than prior year given the difficult comparisons in media promotion and commodities, clearly, we did not anticipate the sequential pressure on the consumer as the quarter unfolded. Accordingly, sales were even weaker than anticipated, resulting in lower earnings per share than expected. As you recall during the first quarter, we lapped our successful Honey Chipotle Chicken Crisper promotion, that positively impacted prior year traffic trends. Additionally, the considerable rise in commodity prices which consumers in the industry have been experiencing did not begin their sharper acceleration until the second quarter of fiscal 2008. Accordingly, the year-over-year impact of commodity costs in the first quarter was 170 basis points.

As discussed last quarter, we continue to see strong inflationary pressures throughout our operating costs including wage rates, utilities, supplies, and maintenance costs. While we previously believed we would see a muting of downward economic trends in the first half of calendar 2009, we're now unsure a change in the trajectory of the economy and the casual dining industry will occur during our fiscal year. Throughout the first quarter we saw increasing pressures on the consumer as the quarter progressed. As a result we have re-examined our projections for the year and revised them accordingly as noted in our pre-release and today's press release.

Even with this slow start to the year, we believe the fundamentals of our business from a strategic, operational and financial aspect are sound. Chili's continues to out-perform the industry as measured by the Navtrac, beating the casual dining comp sales growth for the fifth consecutive quarter. The Chicken Crispers Campaign currently in place is a nice follow-up to several of our other culinary hits such as Smokehouse Burger and Burger Bites, allowing us to pepper in some flavor and give consumers a reason to spend their dining out dollars at Chili's.

We began monitoring growth of Company owned restaurants over the past couple of years. This slowing in development has allowed us to refocus on our team members as well as capital on our five area of focus. However, with our current financial results we must be even more prudent with our allocation of capital, protecting our balance sheet during this uncertain time, furthering the initiatives outlined in the five areas and remaining investment grade are priorities for Brinker. Our policy remains to have a high degree of confidence in the findings before we make investments. As always, we will read the results on various technology and reimage tests with diligence and apply learnings as business conditions permit. These actions of slow development, tightened emphasis on balance sheet health and disciplined capital allocation have collectively provided a stable financial base to weather these uncertain times.

Currently, we project to spend approximately $135 million to $145 million on capital expenditures in fiscal 2009, down $40 million from our previous guidance and we will continue to review and evaluate our planned capital spending to determine if further reductions are warranted. One of the company's key strengths is our strong cash flows. Brinker will generate over $380 million in cash from operations during fiscal 2009 even with the lower earnings guidance we released earlier this month and before the sales proceeds from Macaroni Grill. And with the lower levels of capital spending just outlined, the resulting free cash flow increases substantially to over $190 million, representing a $140 million improvement on a year-over-year basis. This cash flow will provide the necessary flexibility to address current challenges and to drive the business forward to secure our competitive strength.

Last week, Moody's placed Brinker's credit rating under review for possible downgrade. And just to be clear, at the end of the first quarter of fiscal 2009, and with our lowered forecasts, we are well within compliance on all debt covenants and believe our ongoing strong cash flows and strength of our balance sheet are sufficient to support our existing obligations, finance ongoing operations, and remain investment grade. It is our plan to use the Macaroni Grill proceeds to pay down debt.

The actions I outline today, with reduced capital spending in fiscal 2009, virtually no Company-owned new restaurant development for fiscal 2010, and a continued moratorium on all share repurchase activity will ensure the health of the balance sheet. These actions demonstrate the priority Brinker places on maintaining our investment grade rating and sustaining the overall health of our balance sheet while continuing to put capital in areas that transform our business.

As we turn to the quarter I would like to remind you that the results fully incorporate the impact of Macaroni Grill. Where appropriate, we will call out the results excluding the impact of Mac Grill. Additionally we remain on track to complete our majority sale of the Brand during the second quarter of fiscal 2009. Let's begin with the top line.

Revenues decreased by 6.7% over prior year or 4.9%, excluding Macaroni Grill. The decrease results from both capacity and comparable sales declines of 4.1%. The capacity decline is attributable to the sale of 76 Company-owned restaurants to franchisees and the closures of 49 restaurants, of which 27 were Macaroni Grills. Comparable sales decreases were attributable to the sequential pressures facing the consumer as the quarter progressed. As mentioned earlier, we were lapping the successful Honey Chipotle Chicken Crisper Promotion in Q1 fiscal year '08 as well as being impacted by the tightening of consumer spending and the disruption associated with Hurricane Ike. These negative drags on sales were offset by 3.2% price.

Franchise royalty revenues, however, increased over 30%, up to $16.6 million for the first quarter of fiscal 2009. The improvement was driven by growth in the number of franchise locations versus a year ago along with increased comparable restaurant sales at our international franchise locations of approximately 6%. This was partially offset by comparable restaurant sales decline of approximately 2% at domestic franchise locations. The continued strong sales performance internationally is further evidence of the value of a diversified growth strategy.

The first quarter of fiscal 2009 continued to see an increase in commodity costs, compared to the same time period in the prior year. Headwinds were seen in virtually all commodity categories and continued to out pace our price increases. Therefore, our cost of sales increased almost 70 basis points, to 28.4% for the first quarter of fiscal 2009.

As with many factors in our economy, food commodities defied historical norms in terms of reaction to market factors. Our current projection is for year-over-year variances to ease somewhat for the remainder of fiscal 2009, settling in at percentage levels that are similar to what we saw in fiscal 2008. Those commodities with contract renewals in the coming months, while at rates that are down from the peak we saw in May and June of this year, are still at rates that are somewhat higher than the rates when these items were contracted a year ago. As a result, we would not expect our cost of sales to change appreciably versus what was seen in the third and fourth quarters of fiscal 2008. But overall, the longer term cost trends are becoming favorable.

We want to respond to consumers' current needs for price value while not losing sight on moving our food and beverage excellence initiatives forward for the right long-term solutions that further solidify the differentiated position of the Brinker Brands. Restaurant expenses increased from 57.1% in the first quarter of fiscal 2008 to 58.8% in the first quarter of fiscal 2009. The 170 basis point increase is the cumulative result of many factors with sales deleverage being the biggest single driver. Increases occurred in almost every major expense category within restaurant expense, with utilities which were up 70 basis points, labor and repairs and maintenance accounting for the greatest impacts. In fact, utilities and repair and maintenance costs per restaurant were up double digits on a year-over-year basis reflecting strong inflationary pressures on utilities, but more importantly, Brinker's focus on making sure our restaurants are properly maintained and retain their relevance with the guests.

Restaurant expense was favorably impacted by lower pre-opening expenses due to opening eight fewer Company-owned restaurants in the first quarter of fiscal 2009. Depreciation and amortization for the quarter declined $3.8 million to $41.2 million for the first quarter of fiscal 2009. The decrease is primarily due to the classification of Macaroni Grill, assets held for sale and restaurant closures, and offset by higher amounts being recognized from investments in reimages and technologies.

General and administrative expenses continue to track favorably versus our guidance of flat as a percent of sales. On an absolute dollar basis, the spend declined $3.3 million for the quarter due to reduced salary and team member related expenses. Again, decisions put in place over the last year are yielding results, allowing us to generate free cash flow for investment in the business during these difficult economic times.

Interest expense declined from $12.9 million in the first quarter of fiscal 2008 to $9 million this quarter due to lower interest rates and lower average borrowings as compared to the same quarter last year. The effective income tax rate was 26.5%, down from 28.9% the prior year. The decrease in the tax rate was primarily due to the leverage from FICA tax tip credits and a decrease in tax expense related to required tax reserves.

Cash flow from operations for the fiscal year -- for the fiscal quarter, excuse, me was $53.4 million, a $39.5 million decrease from prior year due to lower income, adjusted for cash, noncash items, but also really driven by a reduction in revenues and incremental margin pressures as well as the timing of operational payments and the sale of 76 Company-owned restaurants.

As we look forward to the second quarter, and the remainder of the year there are two important calendar shifts to consider. First, Christmas Day will trade from the second quarter of fiscal 2009 into the third quarter which benefits the second quarter. Also, Easter will trade from the third quarter into the fourth quarter of fiscal 2009 which benefits the third quarter. As our revised guidance reflects, we expect fiscal 2009 to be a challenging year on many fronts. However, we remain optimistic about the long-term prospect of the company and the casual dining industry.

We believe this tumultuous time only further underscores the decisions we have been making are setting us up for success in the long-run, and are providing us financial stability today to stay the course on our strategies. While the dark clouds are known by all, the silver linings, lower oil, lower interest rates and the declining number of restaurants in the industry offer reasons for long term optimism. While it's a time for uncertainty for some, our path forward is clear. We remain confident in our strategies and actions are taking place to drive those initiatives forward. However, the present is not to be ignored. We look for ways to provide dining solutions to today's guest needs and look for ways to capitalize on short-term opportunities and trends. This balance of a long-term perspective on decisions, complimented with opportunistic short-term actions allow us not just to endure this volatile time but move forward and further drive our long-term value. And now, I'd like to turn the call over to Mandy to facilitate the question and answer period.

(OPERATOR INSTRUCTIONS) Our first question is from Jeffrey Bernstein. Please announce your affiliation and then pose your question.

Thank you. Barclays Capital. A couple of questions. I wonder if you can perhaps give us a little bit of an update on overall franchisee health perhaps broader franchisee sentiment, their desire to grow. It seems like you've slowed the range of fiscal '09 openings, not just from your company side but franchisees, it looks like the number have come down as well. So just looking for some broad base color and then I had a follow up.

Jeff, we did not reduce the amount of openings for franchisees, most of those would have been in the pipeline for the last 18 months. So they're well underway. We haven't heard anything specifically from our franchise partners about backing off on development. Remember, too, a lot of our development on franchise locations is not just domestic but also international where they're seeing very good performance and very good returns.

Our domestic franchisees are only seeing about a 2% decline in comp store sales, so they are not really seeing the same kind of pressures that we do since we are in so many subprime states. So far we haven't heard a lot of commentary around development from our franchisees. I know with the way financial markets are out there, that that remains a possibility, but as of yet we have not seen it. But we will continue to look at that as we go forward. Anything to add, Doug?

Yes, Jeff, I'll add, too. And some of this growth franchise are some nontraditional locations which are noncompetitive to the corner of Main and Main suburban locations. For instance, next couple of months we will open an airport location in Oakland, we'll open one in West Palm Beach. We also are starting to expand on college campuses. We opened one last month in the University of Florida. We are opening one in a couple of months in Virginia Commonwealth.

So some of those locations. In fact, we are going into an arena here in Dallas in a couple of weeks in the American Airlines Center. So there's still some Brand growth in some very non-traditional locations that have very different economic situations than the traditional ones Chuck was speaking of.

Great. And actually just a follow up question. I think your pricing is currently in the 3% range, I'm just wondering what your own kind of internal studies say in terms of what you think about pricing over the next few quarters or whether you're going to let most of the pricing lap without any further increases.

We will continue to take a look at it in conjunction with where the economy is. You know, what kinds of pressures we see for commodities and other costs. I think to make a statement of what we're going to do over the next three quarters right now would probably be premature.

Okay. Then just lastly, kind of a bigger picture question in terms of the overall portfolio, I know you guys have said on a number of occasions that you want to stick to a portfolio of brands, just wondering whether there would be any thoughts in terms of further pruning. Obviously, now wouldn't be the best time for it, but just wondering are these the three core brands that you think you will make a go of in coming quarters and years, or whether you could see possible further pruning as some of the smaller brands are underperforming, even the Chili's brand.

I would probably answer that similar to the way Chuck answered the pricing question that in this current environment, very tricky. We are going to continue to evaluate the success of each one of the brands and, honestly, the overall economic condition, what happens to the competition, if other casual dining restaurants go away, that may change the overall environment. We are going to be very cautious and sort of react to what's going on around us in the marketplace.

Our next question is coming from Joe Buckley, please announce your affiliation and pose your question.

I'm with Banc of America. A question just to follow up on the food cost comments. It sounds like you expect the cost of sales as a percent of sales to stay pretty much in the range we saw in the first quarter. Which I think was pretty close to where it was the second half of last year?

Yes, we do, Joe. You know, one of the things we are seeing is we contracted items before the big spike that you saw at the beginning of this year. Those prices are fairly comparable to what we are seeing in today's commodity market. So we really don't expect to see a big decline as we renew contracts. We expect it to be fairly flat. We sort of avoided the big spike.

But I do believe if you look at what wheat and corn have been over the last month or so we continue to see downward trends on those commodity costs. So while we have not put that in our forecast, we are still hopeful that might be a positive that can come through for us.

Okay. If they do continue to decline, how would that work through the numbers given how contracted you are? I think, last call, you mentioned you had about 34% of your contracts expiring this quarter, or the second quarter.

Yes, we did. So basically we are well under way in term of renegotiating those contracts that are expiring in Q2. To Chuck's point really as we're looking at those contracts, the rate that we are seeing is higher than the rate that we contracted for those that we got into about a year ago. So, really when you look at our commodity component we're looking still at about a 4% increase in our bucket of commodities.

About a 4% rate of inflation?

Yes.

Okay. Chuck, question on the cash flow, I think you mentioned free cash flow about $190 million. Does that include the tax credits from Mac Grill but not the proceeds?

That's correct.

Okay. And then lastly, Chuck, you mentioned I think in your comments the declining number of restaurants in the industry, I am curious what you're seeing out there, if there's a way you guys are able to track it, it sort of remains a slippery number for us to track although I think totally we hear about a number of closures, do you think the casual dining universe is actually starting to decline in numbers?

Well anecdotally, we hear about closures from a number of folks we have in the field. We heard about some, you know, closures of TGI Fridays in Phoenix. There was a rumor last night about some restaurants here in Dallas, and Texas and Colorado closing up which we haven't confirmed. I would say most of our information is more anecdotal than anything we see from any one service as an effective tracker of the number of casual dining restaurants. So it is more about conversation. Doug?

Yes, Joe, I think just operators driving around in the marketplaces where we have restaurants we are definitely seeing more closed than we are open. Currently that's probably more mom and pops, smaller organizations, and as Chuck said just rumors about more mid size companies or regional players that are having some real short term challenges.

Our next question is with Steven Kron. Please announce your affiliation and pose your question.

Goldman Sachs. Thanks very much. A couple of questions on free cash flow. First Chuck, just to follow up on the numbers, make sure I heard them correctly, you were saying for fiscal '09 cash flow from operations you are expecting 380 CapEx in the $135 million to $145 million range, so call it $140 million, just doing the math there, wouldn't that be free cash flow of around $240 million in the traditional kind of sense?

Yes, we've also got dividend payments of about $40 million that we --.

So you are backing out the dividend payments. Got it. And Chuck, on the CapEx side of things where is that $40 million coming from, the cut? I mean you discussed a couple of different buckets but none of them in isolation seemed to be big, whether it is slowing development in '09, it seems to be only a couple of units versus prior expectations, are you slowing materially this remodel campaign? Is that where the majority of this is coming from?

No, not really. We are keeping on the remodel campaign. Some of it is the technology. We are allowing it to play itself out. We currently expect it to spend all of those dollars this year. We are currently reading the tests and making sure all of the technology works in conjunction with each other. We did reduce the number of new restaurants that we are looking at for 2010. That was a portion of it too.

And then we just had a bucket of other things that -- just tightening up some estimates, looking at some retro fits we were going to put in that also was part of the dollars, part of that $40 million.

Okay. And you talked about your financial ratios being strong and shoring up the balance sheet and maintaining free cash flow, flexibility important, paying down debt, I guess given that you guys talked about the Moody's watch, what are your discussions currently with rating agencies and what would the implications be to your interest expense line should there be a downgrade?

Well, Moody's is going to come in and talk to us. We just haven't had a face to face meeting with them in some time. So this move was, was more to facilitate that or as part of that. But they're going to come down and talk to us and we will go through what we have as an outlook for the year as well as our capital spending plan. But in terms of what would it cost us. A downgrade from Moody's doesn't have any immediate impact on us. If we got downgraded from both Moody's and Standard & Poor's that would impact our interest expense. But right now I still think when you look at where we are through 2009 and what we look like through 2010 we are still an investment grade company and we believe when we sit down with them, they will come up with that same conclusion. Okay.

That's helpful. Lastly on the Chili's sales front, if I recall, I think you guys, in September were maybe on-air moreso than you were last year, if I have that correctly, I mean, how are you guys finding kind of the use of media right now given the current environment and what is your expectations going forward on on-air versus off-air? Are you getting the response, the required -- desired response, excuse me.

Steven, we were on-air this September, and we weren't last year other than, we did some media things for the St. Jude promotion in 2008. So, we've had good success through fiscal 2008 with most of our media but September is the first time we saw it not work as effectively. So I think we are still evaluating the consumer, what's going on with the market and our options and the items that were put on the menu but September was probably the first time we didn't see the movement we normally see.

Yes. I think one of the things to remember is, you know, we put the investment against ToGo which is a small part of our business. So we were using it at a time when families are going back to school, everybody is sort of getting into a different routine to try to see if we couldn't push that part of the business. So I think, you know, that was an investment over the longer term.

If you go back in the quarter, I know we had the Create Your Own Fajitas. We found that that was maybe at a price point that was a little bit higher than what consumers were looking for. We replaced that rather quickly with Burgers and Bites coming back in with that, and that helped us recover a little from a slow July.

So all in all if you look at our spending year-over-year, we expect to have about three more weeks of advertising this year over last year. We are spending more on advertising expense this year versus last year as a percent of sales. So we haven't backed off as of yet.

Thank you. Our next question is with David Palmer. Please announce your affiliation and pose your question.

Hi. UBS. Thank you. It appears from some data that I have seen that the casual dining industry has had deteriorating trends at lunch. I was wondering are you seeing that in your business at Chili's, is this becoming a little bit of a source of increasing deleverage?

You know I hadn't noticed necessarily where we were on lunch. Let me take a look and see if I can't pull that out. You know we have put in the --

-- Bottomless Express Lunch --

-- at Chili's which was an attempt really to pick up the lunch business. But, yes in terms of year-over-year we are seeing lunch sales down. But not necessarily more at lunch than dinner. We are really seeing more weakness in weekday dinner is really where we are seeing softness, David.

It could have been helped by the Bottomless Express Lunch.

Right. I think you probably are killing your competitors on a relative basis on that day part.

I think, David some of the research we have also seen and some conversation is that some families are still going out on the weekends but during these tough economic times have backed off on their midweek dinners. I think that's part of what is showing up in the data Chuck just looked at.

That makes me wonder -- I guess that might be kind of a second follow up on that is that as you see some of these food costs roll off, some of the worsening inflation, I guess away from hamburger, that you might see some of the major chains particularly those that might be a little bit lower AUV than you and a little bit more desperate might try to do some things promotion-wise, kind of reinvest some of the savings back to shore up some of these, like the weekday dinner for instance to get people back in the door. Are you concerned that there might be kind of a wave of one last supernova of irrational behavior this next year?

I think, David when the consumer is pressed as hard as they are right now we have already seen folks come out with some price point, all you can eat sort of limited promotional things and I guess, as always, we want to kind of balance the short term and long term. And particularly at Chili's, it has been a brand known for great value and a lower in average ticket price than most of its competitors. So we believe as strongly as ever that in casual dining value is still part of the total experience.

So if you look at four of our five areas of focus, the hospitality is training, the food and beverage excellence is the quality, it's the flavor profile, the atmosphere of the building, the remodels, the pacing convenience is more of a time. So, sure. Price matters but -- and we have done some things, as we just mentioned the Bottomless Express Lunch. We have actually put a lunch panel on the back of the Chili's menu for the first time in the Brand history, to highlight lower cost items. We have added a Sweet Shot Dessert less than $2, smaller portion. So, there's a number of things we have done and the other Brands maybe even stronger.

At Macaroni Grill we've got the Chef Trio Dinner, the Duo Combos at lunch -- great value at lower prices. On The Border, we ran the Endless Enchiladas during part of last year. So the single supernova one-time low price is a little bit probably more in the category of limited time promotions that did not leave such a great taste in our mouth. We'd rather work on all of the basics of casual dining and offer good value price as well as the experience.

Thank you. Our next question is with Brad Ludington. Please announce your affiliation and pose your question.

Thank you. With KeyBanc Capital Markets. I wanted to get a little clarification on the franchise royalties this quarter of $16.6 million. Can you break that down as to what was royalties and what was fees and what it would have been excluding Macaroni Grill as well?

Do you want to take that one?

All right. Well, in terms of one-time fees, very small because as you know we haven't been doing a lot of franchise transactions in the past few months sometimes driven by -- somewhat driven by what's been going on in the credit market. So the vast majority of that was just simply the royalties we're seeing from the ongoing sales from franchisees domestically. Mac Grill is not significantly franchised.

So, there's really not a lot of revenue in there from Mac Grill franchise transactions. That's almost purely Chili's and OTB franchise royalty dollars.

Okay. Would Macaroni Grill be below $1 million then?

I don't have the number off hand, but my estimate would be yes, likely it would be below $1 million.

Okay. And then I wanted to ask you about the, you said the reimages are providing a mid single digit boost in traffic. I wanted to confirm that's traffic and not same-store sales?

Sorry. Could you repeat that?

The boost in traffic from the reimages at Chili's, I think I heard you say you are getting a mid single digit boost in traffic. I just wanted to confirm that was accurate and not an -- which implies kind of an upper single digit boost in same-store sales.

The numbers that we are seeing, the lift is in traffic, but we, you know, we are not seeing the same sort of spread, I don't have the reason why that isn't in front of me between traffic and sales that we're seeing in other locations but yes you could -- to clarify the phraseology, it would be a mid single digit boost in traffic.

Okay. All right. And then, just one last question, on franchise openings that you are expecting this year, I mean we feel those are safe since the pipeline is so far out, correct?

Yes.

All right, thank you very much.

Thank you. Our next question is with Chris O'Cull. Please announce your affiliation and then pose your question.

Yes, I'm with SunTrust Robinson Humphrey. My first question relates to the labor line -- the labor costs, do you think the deleverage that occurred during the quarter related to an abrupt change in the guest count trends or is this something that we are seeing back of the house labor becoming just more fixed as you kind of lap multiple years of declining guest counts?

Chris, we're seeing a little bit of both. Our productivity was off, you know just because we couldn't respond or didn't respond quickly enough to being below our sales expectations. Having said that, I think we have done a really nice job, operationally keeping what we call some labor scheduling we have done a pretty good job against productivity but we were down year-over-year on productivity related to just not being able to adapt quick enough. We are seeing back of house labor up on a year-over-year basis. That is something that will be hard to tamp down. So I think that is something that becomes more an element of a fixed cost that's put into the equation, Chris.

Okay. Can you help quantify in terms of just the abrupt change we saw in guest counts during the quarter, maybe what kind of implications that could have had to the margin during the quarter.

I think we fell below what our expectation was. When we were looking at the quarter, I think street estimates were always a little high on, on what we expected to do for the quarter. We were pretty much on track until September, and then September was really weaker. But, you know, there's so many things happened in September related to the two hurricanes that hit, definitely the credit market impact started in earnest in September. So, I think there were a number of items that really did affect the sales fall off.

Okay. And then I know historically the industry or casual dining at least has not utilized value as a primary offering during the Holidays but in light of the environment, do you think we will see more value oriented offerings as a primary promotion from casual diners during the Holiday season?

I think it is possible, Doug.

Yes, I think so. We are already seeing some of the casual dining operators as well as all parts of the restaurant industry, everybody is trying to get the guests' attention with a low price, I guess in the grocery stores they might call it a loss leader to get people to show up and hopefully sell them something different but I don't think there's any question.

That's where you get into brand loyalty and how many people really do -- are out there chasing $0.50 or $1 difference on a check. That's going to end up being the real question for the industry.

Okay. Last question, Chuck, does the company have any debt commitments that need to be renewed in fiscal '09?

We do have a bank line revolver, that we are going to renew here within the next few months.

Great. That's helpful. Thanks.

Our next question is with Tom Forte. Please announce your affiliation and pose your question.

Great, thanks. Tesley Advisory Group. The first question I had was you had talked about for fiscal 2010, at this point in time, stopping the Company-owned new unit growth. I wanted to know from a long term perspective when you think about your ownership mix, Company-owned versus franchise, how you look at Chili's today and On The Border.

Well, we said that we would have virtually no, but we still may have a couple of openings, relocations, et cetera, that we feel very good about where they're located. I think as we look at it over the longer term, what percentage mix between company and franchise, certainly today, there's not the ability to go out and sell restaurants to franchise partners just, in any big sense or doing any kind of significant deal because of the unavailability of credit. But I think as we look at it today, Tom, it might be a little bit different than the way we might look at it in a year from now or six months from now.

Okay. And then, for the next question, you talked a little in your opening comments about starting to see some benefit from lower gas prices, could you provide a little more detail on that.

No, what I think is, hopefully there are some things that will affect the consumer. People who have a job today and start to feel a little bit more secure about where their job is, start to see lower gasoline prices, lower home heating oil, that those things might end up being positives for the consumer over a little bit of time. What we have normally seen in our industry and again, I don't want to typify this as anything that has been just totally normal, but after 9/11 when the Iraq war started you see people immediately pull back from what their normal routines are. And it's taken folks about 60 to 90 days to get back into a routine.

So again we are, we saw a lot of this contraction, a lot of consumer confidence declines start in September, continue through October and we are hopeful that we will sort of see the same kind of cycle play itself out. We do have some things that may help that, may help that play out, gas prices, interest rates, home heating oil, those are the kinds of things we are hoping the consumer might see and then gain a little more confidence that those who have a job still will have a job and so again do we have that forecast baked in our forecast? No. But I think those are some of the things people aren't talking about. Right now everyone seems to be talking about all the negatives and we are hopeful some positives might start to take root.

Great. The last question was I hoping you could give a little more detail on the regional trends for example, the California and Florida restaurants.

California and Florida remain difficult as well as Arizona and Nevada. Those are markets that have been hit by subprime. We saw basically sales were doing pretty well through June and then we saw them fall down by about 9% difference as we started getting into July. About a 9% difference between June and July and Florida and California still remain soft.

Great. Thank you very much for your answers.

Thank you. Our next question is with John Glass, please announce your affiliation and pose your question.

Thanks. Morgan Stanley. First of all, on the Mac Grill sale what are the remaining conditions for closing? Is there a potential that the buyer can renegotiate or is there an out based on the market conditions, for example?

The customary conditions that we face are landlord consents, getting liquor licenses transferred, and they're also doing a sale lease-back. So they've been going through, doing title searches and environmentals. Those are all of the things that are currently being done and we feel like we are making very good progress on that and feel like we can still get to the end date.

There's nothing explicitly that says they can -- Have you had conversations with them, I guess, more directly about renegotiating the price given the market conditions?

No, we haven't and, John, I don't want you bringing that up. I don't want you giving anybody ideas.

Hopefully they are smart enough to have thought about it.

They are smart enough. But I think, again, Macaroni Grill has remained on plan. So Macaroni Grill is performing as we had expected and they had expected them to perform. So we don't feel like there's any opportunity to use anything like that as a lever.

Got you. Just going back to this question about cost cutting. In 2007, you experienced negative, you know, 2% to 3% comps but you actually grew net income that year despite the adversity. I understand food costs are more this time around but what else is different that you are now experiencing so much more deleveraging in your business on effectively the same range or at least a lower end of the range of the comps? If you just walk through, have you already cut the G&A that you were going to cut in that process and there's not a lot more or maybe if there's another opportunity, what is it, same thing with store level labor, is there just no more variable labor left in the store?

Well, I think that's a little of it, too. But also John we have restaurants that you know we invested more heavily in and were more expensive generating the same kind of volumes. If you looked at a few years ago the restaurants we had open cost significantly less. The ones we've opened the last couple of years were $3 million investments or $2.8 million investments, and with those doing lower sales, we get to a deleverage because of fixed costs on those newer restaurants. Anybody have anything else they want to add?

Utilities, I think. That's a new line item that has really impacted us related back to the price of oil. And so, again, long-term maybe that will get more in line but if you look back over the last six months or so, it has been an issue.

Yes, year-over-year utility costs are up 70 basis points, which, that's huge. We would hope that we start to get a little bit of a benefit from that on our own P&L as we go back through the next year.

In any color commentary in October it would seem that this, the market, the news flow, the election all of those things got amplified substantially in October and anecdotally I've heard that therefore sales at least in other companies have been materially worse in September. Without me maybe putting even a fine point on it, is that a fair statement?

I hesitate to paint the industry any way, and really don't want to get into a lot of guidance but I think, again, there hasn't been a reason for the consumer to come out of their hole. And until people kind of settle down a little bit, I think as we have said we normally see these last 60 to 90 days. We are not in a period where we would have expected things to really get turned around yet.

Got you.

I'd say, John, too, the Presidential election, just the beat down of bad news, this morning I heard some newscasters talking about the price of gas being under $3 a gallon and they actually had a smile on their face.

I would just think the consumer -- the consumer's plight is a lot real but part of it also is just environmentally you can't turn on the TV or open the paper or listen to the radio or turn your computer on without just getting reminded about how bad it is. So with the election behind us in November at least there will be less talk about it and with some of the short term trends we have seen with price of oil we will see some improvements real and imagined.

Amen to that.

Yes, amen.

Amen, brother John.

Our last question for today is coming from Joe Buckley. Please pose your question.

Thank you. Doug, in your opening remarks you talked about the international business softening, it sounded like things are still pretty strong, could you talk about what parts of the world you are seeing softness and you know, relative to the size of that business the size of that business to Brinker -- I was surprised you focused so much on it.

Yes, Joe, I really wasn't talking about sales, just talking about the economic environment starting to make news in those marketplaces. In Mexico you are hearing about the peso, the cost of food products in other countries where we have restaurants. It is a pretty global marketplace now. So some of the things that have been going on here for the past six months they are starting to enter into more of the cost environment and just economic landscape of those countries.

Top line is still great and overall if you look at cost of land, cost of people, cost of food, it's much better and much less competitive. Just things we are watching, the top line sales are still great in most of the markets around the world.

Then maybe just one more item going back to John's questions on the sales numbers, was the September comp materially worse than July and August?

No, but we had expected it to be better.

Okay, so It was more versus expectations than seeing a substantial fall off in terms of the rate of comp decline?

Yes, it was down about 100 to 150 basis points sequentially. But we had expected it to be better than July, better than August.

Thank you. That was our last question. Do you have any closing comments you would like to finish with?

Yes, I just wanted to thank everyone for joining us today. This concludes the earnings call and the Q&A session. We look forward to talking to everyone again to go over the second quarter fiscal 2009 in a few months. Thank you so much.

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