Brinker International Inc (EAT) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the first quarter 2011 earnings release conference call. At this time, all participants had placed on a listen-only mode.

The floor will be open for questions and comments following the presentation. It is now my pleasure to turn the floor over to your host Marie Perry. Ma'am, the floor is yours.

Thank you, Tamara. Good morning, everyone, and welcome to Brinker International's first-quarter fiscal 2011 earnings call which is also being broadcast live over the Internet.

Before turning over the call, let me quickly remind you of our Safe Harbor regarding forward-looking statements. During our management comments and in responses to your questions, certain items may be discussed which are not based entirely on historical fact.

Any such item should be considered a forward-looking statement 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 the more completely described in this morning's press release and the Company's filings with the SEC.

On the call we may refer to certain non-GAAP financial measures that management uses in its review of the Company's business and believes will provide insight into the Company's ongoing operations. Reconciliations are provided in the tables in the press release and on Brinker's website under the financial section of the investor tab.

Consistent with prior practice, we will be silent on interperiod sales and other key operating results uet to be reported as the data may not accurately reflect the final results of the quarter reference. On the call today you will hear from Doug Brooks, Chairman and Chief Executive Officer; Guy constant, Chief Financial Officer; and Wyman Roberts, President of Chili's Grill & Bar. Following their remarks, we will open up the call for your questions. Now, I will turn the call over to Doug.

Thank you, Marie. Well, as you saw in the press release, we reported adjusted first-quarter earnings per share of $0.21, a 75% increase over prior year. The year-over-year improvement was slightly better than our internal expectations with the growth resulting from the implementation of business model enhancing initiatives that we communicated over the past year, favorable commodities and value offerings that better balance traffic and margins.

While the top line at Chili's is not as strong as we would like, it was to some extent expected given the year-over-year promotional comparisons. Over the past couple of months, key economic indicators such as total employment, consumer spending and consumer confidence have remained relatively flat. And with key elections looming in just a couple of weeks, it's difficult to say with certainty the economic outlook is much stronger.

Additionally, given the prolonged nature of this current economic slowdown, it is unlikely the consumer will soon forget the effects on their pocketbook. But given these factors, we believe it only [leads credence] to the relevance of our initiatives.

If short-term top line gains remain elusive, we need to transform our business model to provide the financial flexibility to sustain value offers when necessary while continuing to focus on enhancing our guest experience. We view the approach as a self-sustaining cycle starting with process improvements within the four walls of the restaurant resulting in significant margin savings.

These savings are then reinvested back into the guest through margin-friendly value offers and projects aimed at reducing variability in the guest experience and matching pace to our guest expectations. This in turn will result in increased traffic, increased sales and increased profits that fuel the next cycle.

And Chili's plan to win embodies these elements. So let me assure you we intend to deliver our goal of a net 400 basis points of margin improvement.

We started the progress with the successful implementation of team service delivering a superior guest experience, while also creating labor savings in the front of the house. Next the restaurants and the managers will benefit from the implementation of improved restaurant systems. Once in place, these systems will feed the margin improvement cycle by enhancing our capability around managing food costs.

The third pillar of the plan is around the kitchen retrofit. This is a large-scale holistic change to the manufacturing side of our business.

By modifying the equipment and processes used in our kitchen, we will deliver a more consistent and higher quality product to our guest at an improved pace while generating substantial labor improvements by reducing the heart of the house hours.

And last, we will look to drive traffic through our restaurant reimage program which will showcase visible exterior changes to invite the guests to see what's new at Chili's. Once inside, our guest can enjoy the enhanced interior decor and improved guest experience driven by these previous initiatives mentioned.

As expected, the first quarter has been both rewarding and challenging, with many of the same internal and external factors continuing into our second quarter. However, as we move into the back half of the year, the top line should be aided by an easier [lap] of marketing promotions and momentum gained from the initiatives as they start to roll out.

Now looking beyond this year, we had a clear long-term goal to double EPS in five years. The net 400 basis points of margin improvement from Chili's will certainly play a major role but cannot be fully achieved without additional contributions from Maggiano's and our global business.

Maggiano's continues to enjoy top line traction, turning in the third consecutive quarter of positive comparable restaurant sales, driven in part by their new menu and their new direct marketing capabilities. The new menu was launched in quarter one and included the compelling value of classic pastas.

And with guests who order dishes like spaghetti, lasagna or ravioli receive complimentary pasta to take home from our chefs. Maggiano's invested in incremental training labor and repair and maintenance in quarter one to help launch this new menu. These investments were isolated to this quarter and we believe in coming quarters that sales will continue to grow and the brand will enjoy even more significant margin gains.

Internationally we plan to extend our presence around the globe through new partnerships as we position ourselves to take advantage of demographic and eating trends which we expect to accelerate in the rest of the world over the next decade. Last quarter we announced the signing of our joint venture partnership in Brazil while this quarter we furthered our footprint with openings in key markets such as India and Egypt. The team is hard at work to become the global leader in casual dining with 420 Chili's internationally by fiscal 2014.

Now as progress is made on our initiatives today, we remain committed and focused on the longer-term goals. Regardless of our enthusiasm about the priorities, we're letting the data guide our decisions and betting the alternatives before moving forward.

We're taking a similar prudent and balanced approach in our financial strategies. With the restaurants generating substantial free cash flow, we instituted a balanced approach in allocating our cash.

Starting with reinvesting cash into the initiatives discussed in March to drive margin expansion while improving the guest experience and completing minor debt paydown, the excess cash is then returned to shareholders through a best-in-class retail dividend and ongoing share repurchase. The distribution of cash in these various channels provided a diversified and balanced approach to deliver long-term value to our shareholders.

The financial health of our Company is solid and the balance sheet robust thanks to the work and financial prowess of Chuck Sonsteby. As announced previously, Chuck retired from Brinker moving on to this next opportunity and we wish him well.

I've worked with Chuck for over 20 years at Brinker and I will miss his keen business insight, his financial acumen, but most of all, his friendship and counsel. But true to form, Chuck has left the financial house in order.

We have excellent financial fundamentals, a solid balance sheet and an enviable cash position. And equally important and a testament to our focus on succession planning, we have a successor developed and ready for the opportunity, Guy Constant.

Guy was instrumental in developing our current strategic and financial priorities, making the transition so far incredibly smooth. He has taken an integral part of the leadership of this Company over the last several years and I look forward to our continued partnership.

Let me close with this. Our goal of doubling EPS in five years will be achieved by these value engineering strategies and reinvestment in critical elements that will shore up the long-term value and improve the overall guest experience.

The leadership team and I remain committed and confident about the ability for our Company to deliver. The margin improvement results this quarter reinforces our confidence and the reality of these goals is within reach. The groundwork is being laid and the transition to the future state has started and so we are invigorated by that success so far. Let me now turn the call over to Wyman.

Thanks, Doug. So Chili's comparable restaurant sales for the quarter are not where we want them to be but not unexpected. Looking sequentially, two-year traffic trends have improved from the fourth quarter to the first quarter and the improvement accelerated from July through September.

And if you further adjust for the calendar impact of our 53rd week, the results would demonstrate momentum even more clearly. But we are below the industry and that is something we're not satisfied with and are focused on turning around.

To summarize our quarter, first, earnings improved substantially despite topline challenges. In essence, current year marketing messages balance traffic with margins to achieve more profitable comparable restaurant sales.

Second, our Chili's guest feedback scores continue to improve with attentive service being a key component of the increase. And our external metrics and our internal metrics are validated by what we see in external research when we compare ourselves to the competition.

And while this may not translate into a significant shift in topline in the near term, we believe these metrics are leading indicators. As such, we believe traction will be gained as we move throughout the year, contributing to an improved topline in the second part of the year.

In the near term, we will continue to be challenged with sales growth as last year we ran the three course promotion for 10 weeks during second quarter versus just six weeks during the first. That said, we're continuing to focus on strengthening the business model with the implementation of our new front and back of the house information systems and the rollout of our new prep process which is an accelerated learning from our kitchen retrofit initiative.

But we're not just focused on costs. The marketing and culinary teams are finalizing work on several sales building initiatives that emphasize everyday value and speed of service with a pipeline of culinary innovation that leverages quality and freshness. We expect these initiatives to drive sales and improve our business model in the second half of our fiscal year.

So Doug took you through the broad strategies that are the pillars of our net 400 basis point improvement. Team service is in place and working well. It's driving labor improvements, enabling our tream members to make more money and improving the guest experiences as indicated by an increase in our scores from guest feedback surveys.

The next priority to be completed is the point-of-sale and back-of-house technology. Once in place, these systems will unlock value to improve the inventory control and actual versus theoretical reporting, further enhancing margins in the latter portion of the fiscal year.

And based on progress to date, the Chili's system should be live with the new restaurant system in the third quarter and within our projected capital investment. Next, our kitchen retrofit initiative continues to move forward.

To date, it's in five restaurants domestically and two internationally and yielding solid results. The tests clearly demonstrate a marked improvement in speed and consistency of food with lower labor costs. So much so, we are accelerating a large component of the transformation which focuses on modifications [to the press] process.

Changes is being made will optimize the labor component of your prep and maximize food prep yield which will contribute some noticeable reductions in labor and cost of sales once fully implemented in January. In the interim, we continue to refine the equipment package and the products cooked on it to ensure the full kitchen retrofit finishes with perfect food for the guest every time. As we finalize what the ultimate kitchen equipment package contains, we anticipate a rollout schedule which can accommodate at least 50 restaurants per month.

We believe our strategies are the right ones. Today's environment requires us to tighten our margins and the initiatives discussed thus far do just that while improving the guest experience.

So once the margin improvement is in place, the guest experience is elevated, we will layer in a re-image program as a catalyst to expedite a lift in traffic beyond those naturally stemming from the initiatives discussed thus far. Our re-image program is one strategic priority which is truly sales focused and comes slightly later in the process to allow the previous initiatives to take hold.

As restaurants are re-imaged, they will have implemented team service, point-of-sale and the kitchen transformation. And they will be ready to invite guests in with visible and enticing exterior and interior remodel and then surpass their expectations once they are in the door with team service and consistently excellent food.

We have one re-image in place and the current results are encouraging. Some modifications have been made and we will continue to assess the feedback to ensure all investments yield the appropriate returns.

Based on our analysis of the re-image thus far, we anticipate further expansion to a small test market so we can measure the impact advertising has on the results. If results confirm our beliefs as expected, our rollout would begin in the fourth quarter of this year.

As you can tell, we are asking a lot from our restaurant managers. They're our leaders on the front line. And over the coming months, they're going to be very busy.

So we felt it essential to reward year-over-year improvement and invest some of the margin gains this year back into our restaurant leaders through merit and bonus pay as they deliver stronger earnings driven by these initiatives. These are investments we gladly make to empower our managers to be agents of change on the initiatives that really matter.

In addition to our financial performance, we are very proud of our accomplishments raising money for Saint Jude Children's Research Hospital. In our Seventh Annual Create-A-Pepper to Fight Childhood Cancer campaign, we raised $5.6 million, an increase of about 16% over prior year, and have now raised over $35 million to date for Saint Jude.

The generosity of our guests, our team members is unbelievable and their contributions are invaluable to the countless lives touched by Saint Jude Children's Hospital. Thank you to all that played a role in this tremendous accomplishment.

So where does Chili's go from here? Well it's simple.

We stay focused on the key initiatives. First we continue to improve the business model through team service, improved technology systems and better cooking platforms, strengthening our margins without taking away from our guests.

We build on the guest experience to improve menu offerings on lunch, dinner and core items which deliver everyday value, innovation and quality to the guest every visit. We strengthen the brand for our re-image program, updating the restaurants with a more contemporary and relevant look, one that differentiates us from the competition, and we continue our evolution of being a consumer insights driven company, working to deliver on what our guests' needs are.

It starts with fixing the business model and then growing the business one guest at a time. Now, I'd like to turn the call over to Guy.

Thanks, Wyman, and good morning. As you saw, our press release now contains more robust disclosure around comparable restaurant sales for Company restaurants and franchisees, a detailed breakout of restaurant labor and commentary specific to each brand, intending to provide better insight into the financial performance of the Company. My comments will incorporate discussion around these topics.

As Doug mentioned, our first-quarter earnings per share before special items were $0.21 which is a dramatic improvement over the prior year. Cost of sales declined from 28.7% in the first quarter of fiscal 2010 to 26.6% in the current quarter and was a significant driver of the year-over-year EPS growth.

In order of magnitude, the improvement was generally driven by a more profitable value offer, favorable commodities and menu price. While the degree of these items may vary in subsequent quarters, we would expect cost of sales for the full year to be relatively in line with the first quarter.

While the drivers of year-over-year improvement in second quarter will approximate those in the first, the back half of the year improvements will rely less on commodity favorability and stem more from actual versus theoretical improvements related to the new point-of-sale system and kitchen process improvements. Specifically commodities for the quarter were 70 basis points better on a year-over-year basis and should continue into second quarter where we have greater visibility with 90% of the food basket under contract.

However, as we move into the back half where currently 52% of the commodities are contracted through the end of the fiscal year, we would expect the commodity component of our cost of sales to be more pressured, primarily by unfavorability in our beef contract, predominantly steak. Revenues decreased by 6% from $697 million to $655 million.

The decrease is attributable to a decline in comparable restaurant sales of 4.2% and capacity reduction of 3.3% due to 30 fewer restaurants than a year ago. While the two-year traffic trend showed consecutive improvement from the fourth quarter into the first, momentum was gained within the quarter as well. We anticipated weaker sales in the first quarter given the reduction in our value offer and believe the second half of the year should have stronger overall comparable restaurant sales.

Additionally in terms of quarterly calendar shifts, Christmas will trade into the second quarter, having a negative impact which will be regained in the third quarter. Also, the quarterly comparisons are impacted by misalignment on a calendar basis created by the 53rd week a year ago. In total, the second and fourth quarter will be negatively impacted by 50 basis points and the third quarter will benefit by 100 basis points from these calendar shifts.

Royalty and franchise revenues increased 3.4% over the prior year, primarily due to a net 48 openings in the last 12 months. International was strong with a comparable restaurant sales increase of 0.4% while domestic franchise comparable restaurant sales decreased 5.8%.

Today's release also introduced a change to our income statement reporting as we have presented labor costs associated with our restaurant operations in a separate line. The restaurant labor line includes all direct labor costs associated with the restaurant including the managers but excluding above restaurant supervision costs. This line now includes total hourly costs, salary, bonus, payroll taxes, health insurance costs and stock-based compensation charges associated with direct restaurant labor.

Restaurant labor expense was relatively flat as a percent of revenue at 33.2%. However to truly understand labor, a distinction should be made in the trends of variable and fixed labor.

The variable component of this line was meaningfully lower, driven by the great front of the house labor win on team service that you heard Wyman speak about earlier. This was mildly offset by a change in banquet compensation at Maggiano's, the fixed or manager component separate sale de-leverage as well as headwinds related to investment into our managers through merit raises and increased payouts of bonus resulting from improved performance. We would expect a similar trend to continue throughout the year.

Restaurant expense which now primarily includes supervision, rent, advertising, restaurant supplies, utilities and repair and maintenance is up 20 basis points to 25.2%. The accounts benefited by mild favorability in restaurant supplies more than offset by sales de-leverage and an increase in our repair and maintenance expense.

This line item now is much more fixed in nature than the full restaurant expense line we had showed in previous years and as a result will be more impacted by sales leverage or de-leverage going forward, particularly in the fourth quarter where we lacked the 53rd week from a year ago.

Additionally while not significant this quarter, restaurant expense was slightly impacted by a classification change for service charges on Maggiano's banquet business. Amounts previously included with restaurant expense are now shown in the revenue line. These amounts are not significant and we believe changes made provide better clarity around the business.

Depreciation and amortization expense decreased $2.6 million to $32.6 million due to fully depreciated assets, which was partially offset by some normal asset replacement. General and administrative expenses decreased by $5 million to $30 million.

Realignment of our support infrastructure continues to adjust for the evolution of the Company for multiple brands to our current two brands. Accordingly, the compensation related expenses have declined as these changes have occurred.

Additionally, income from our transition service arrangement has increased over prior year with the addition of On the Border to the arrangement. During the second quarter, some aspects of the Macaroni Grill transition services arrangement will conclude and therefore not contribute to the reduction in general and administrative expenses at the same level seen in the first quarter.

Additionally, savings generated from stock-based compensation are disproportionately large in the first quarter relative to the remainder of the year. As such, it would be difficult to maintain a $30 million run rate for the remainder of the year but we do intend to manage our spend judiciously to ensure we maintain an infrastructure which is consistent with the current size and structure of our Company.

The tax rate before special items was approximately 27.9%, above our prior year rate of 25.8% but indicative of a normal recurring yearly rate. Cash flow used in operations was approximately $7 million, driven by an anticipated but large change in assets and liabilities.

First, working capital was negatively impacted by the divestiture of On the Border where we settled liabilities associated with the brand and related deal costs subsequent to the sale without the benefit of incoming cash from operations. Second, cash taxes paid in the current quarter were higher, primarily related to the gain recognized from the On the Border sale this year while prior year cash taxes were positively impacted by the recognition of tax losses related to the Macaroni Grill divestiture and adjustments related to the tax treatment of certain expenses, both which offset taxable income in prior year.

The first-quarter results were contemplated in our original free cash flow guidance. Capital expenditures for the quarter were approximately $16 million.

We would anticipate the quarterly capital expenditure to accelerate as the initiatives progress in the manner outlined by Wyman at levels consistent with what we discussed at our investor conference in March. During the quarter, the Company repurchased 5.3 million shares for approximately $93 million.

At the end of the quarter, the Company's balance sheet reflected $215 million in cash which included approximately $50 million in working capital need. Subsequent to the end of the quarter, the Company had systematically repurchased an additional 4.3 million shares for approximately $83 million in cash.

In closing, the quarter better balanced the elements of traffic and margin through more profitable restaurant sales. As always, these learnings will be incorporated going forward and considered as we look at future marketing strategies.

As such, we do expect to see continued improvement in the topline with particular traction coming later in the fiscal year. Cost of sales will continue to be favorable to prior year due to a combination of improved actual versus theoretical yield, reduced discounting and commodities. The benefit of team service will continue at the current pace through the remainder of the year with an offset from the investments in our managers.

The year is off to a solid start but there's still much work to be done. But each day we are progressing towards both our short-term and long-term earnings goals. With that, we can turn it over to Tamara to open the lines for questions.

(Operator Instructions) John Ivankoe.

Could you give me -- maybe just rewind on some of the initiatives that you have coming up, [A versus T] for example being one, I mean, the other of course team service which is already in place, as well as change that you're having in prep, what the specific basis point impact is of each of those initiatives and when you expect them to be fully in the system?

John, it's Guy. How are you doing? On those initiatives timing as Wyman said, team service is in place already and it was part of the 200 basis points. You may recall we said 500 basis points gross of margin improvement, 300 which came from kitchen initiatives and 200 which came from other. Team service is part of that 200 basis points of initiatives that came from other already in place and working well as Wyman said.

Did you quantify that, what that piece was, just so we know what to expect over the next three quarters?

We haven't, John. We haven't broken out what that is as part of the 200.

And the other upcoming initiatives (multiple speakers)

Yes, the other upcoming initiatives -- so we're moving up the prep portion of our kitchen retrofit program which was part of that 300 basis points of improvement. That will start -- be rolled in over the next quarter and be in place fully at the start or near the start of the third quarter.

And then the benefits we get to [A versus T] related to better visibility into where we have waste that comes from the implementation of systems, particularly the [menu link] system in our kitchen in the back of the house will be in place by the end of the third quarter. And again, we haven't broken down discreetly what each of those items are, but those two items -- prep in Q2 and kitchen systems in Q3 -- are part of the 300 basis points of gross improvement we would have in the kitchen initiatives.

And the prep was originally supposed to come as the kitchen retrofit, correct?

That's correct. So when we had originally said that the kitchen would roll out potentially one-sixth per quarter for the next six quarters, that was part of that rollout. So Wyman talked about moving that up, and so that portion of the kitchen retrofit will actually now be in place at some point in the third quarter with the remainder that's related to the equipment coming in over that same one-sixth per quarter over the next six quarters.

I'm sorry if I missed this, what do you think the labor, like the reinvestment would be in terms of -- I think you said that as some initiatives are maybe being pushed up a little bit that you actually might give back some costs, specifically to your managers. Is there a way to quantify that at this point in terms of at least what you're targeting?

If I understand your question, John, so what we saw in the first quarter is that team service was mostly offset by sales de-leverage which was a part. Now that that management component of course is fixed and having sales not be where we would like them to be caused some sales de-leverage and then we also had the impact of bonus offsetting some of that labor. So as the year goes on and we do get more traction on sales as expected, that sales de-leverage component of that will lessen and obviously then team service will have more of a visible impact on the P&L.

Okay and can I just -- just one more housekeeping question. I'm sorry for having that on the phone for so long.

Can you give us a dollar G&A number for fiscal 2011? I know you gave some good reasons as to why it won't be at first quarter levels, but just to make sure that we're all on the same page in terms of what you think that might come out for the year or as a percentage of revenue.

Yes, we didn't give a dollar G&A but you may recall, John -- and it's been pretty consistent for us for a few years. We probably tracked closer to 4.5% of revenues in more of a down year and closer to 5% in a better year simply because of the impact of incentive compensation.

Jeffrey Bernstein.

Just one clarification and then a broader question. The clarification I know you mentioned in the press release about guidance. Without any update to that, I assume then that the fiscal 2011 that you offered in August which I think culminated in comps flat to down 2 and EPS of $1.30 to $1.42, that is still unchanged at this point in time?

Consistent with our policy, Jeff, we would only provide you an update if there were a material difference.

With that said, as we look at the comp component on a broader question, one, I know, Doug, you had mentioned that Chili's is not where you want it to be and is below the broader category. One, I guess I'm just wondering if you could talk about drivers to potentially close the gap.

And more broadly speaking, do you think we're going to see an easing of the competitive discounting? Should we expect a removal of the [Two for 20]? I know you mentioned that you're lapping still the [3 for 20] for 10 weeks this quarter.

So I am wondering if you could just talk about drivers to close the gap and the broader outlook on the discounting front. Just trying to figure out why exactly Chili's is or has been the laggard. Thanks.

Sure, well, Jeff, let me turn it over to Wyman because obviously we're still up against a very difficult promotional comparison and that 3 for $20 goes away in the second half of the year, but we do have some actual initiatives and Wyman, why don't you update us on that?

Sure, so, Jeff, a couple things in terms of how are we going to turn the trend around at Chili's. It is -- a lot of it is driven by what we are going to bring to the guest in terms of better value and a more compelling offer.

So, for the 2 for $20 future, the future of 2 for $20, we see that that probably will make its way onto our menu. We are obviously happy with the guest acceptance of that offer.

We're comfortable with the margin impact that it's having on our business. You can obviously tell by the first-quarter margins that we're able to absorb that value offer on our menu and still deliver some really strong margins.

So that's going to help us as we start to now push through the back half of the year where we didn't have that kind of a base menu value proposition in the menu, that will be out there for the second half of the year when we really didn't have anything like that, and it will also free up or advertising to start to introduce some new, very compelling messages around lunch and dinner that we have in test now that we're very excited about that we will bring to the market in the second half. So that's how we're going to turn the trend around and improve our performance from a topline strategy.

We are very focused also on just the guest experience and as I mentioned in my comments earlier, our team service approach while it does benefit our P&L and help our business model by reducing labor, it's also delivering a better guest experience. Our attentive service cores are up significantly and our overall satisfaction scores are up and we know that as we deliver better guest experiences intent-to-returns go up and we'll see those guests back more frequently than we had seen them in the past.

So it's a combination of what we're going to be doing externally from a marketing standpoint as well as internally with our menu and our service model that's going to turn this sales trend around for us, all the while continuing to build this business model and deliver significant improvements in earnings.

Can I add something to that? I know you mentioned I guess the trends improved in this fiscal first quarter from the fourth quarter last year and it seems like trends improved sequentially throughout this fiscal first quarter.

One, I just want to make sure that -- I know there was kind of an apples to oranges comparison, but your read is that you saw sequential trends improve throughout this quarter on both a one and two-year basis. And if that is the case, it seemed like the September uptick even despite easier comparisons was pretty meaningful. I'm just wondering if you can give any color -- I know you don't give color on current quarter trends -- but just what might've driven that September uptick in this past quarter. Thanks.

Sure, again, the September -- the month of September without getting too granular is a good insight for us as to what can happen when we aren't rapping on that 3 for $20 promotion as it wasn't in that month as much as it was in the other months, and the sequential business trends got much better. And so very much an insight into what the future could look like for us as we start to get outside of the 3 for $20 promotional window.

Crhis O'Cull.

My question is kind of a follow-up on this last one. Wyman, it seems like every other quarter, Chili's shifts from a traffic focus to a margin percent focus by changing their level of discounting which makes it tough for investors to have confidence in Chili's brand management.

Can help us understand the key challenges to getting Chili's on the path to a more consistent same-store profit dollar performance? I mean, from a guest perspective, what is the issue, the biggest issue that needs to be addressed?

I think it's the -- so we agree, right? So stability is something we all look for and it's tough on investors, it's truly tough on restaurant managers. Trying to run a business that's going through bigger swings than we would like and not as consistent, it's difficult for everybody.

So what's the key to that is really moving away from promotions driven and getting the base business back on sound fundamental footing. So what is it that's going to allow us to provide you and our restaurant leaders and ourselves with a more consistent, more reliable future is getting that fundamental experience in the restaurant solid.

And that means fixing the base menu to provide more everyday value and getting our lunch proposition to be stronger on a day-in/day-out basis, not driven so much by what the promotion of the day is, although we will use promotional marketing opportunities to enhance that, but not so much just be such a driver of it. That's what we're going through now.

And so while year-over-year comparisons on sales are more erratic from our restaurant standpoint, for the last three, four months, it's been a much more consistent environment for them. And I think what you're seeing there is in that consistent environment their ability to deliver a better guest experience which then works to the overall benefit of the business, again working to give a better guest experience, but then allows it to grow more organically based on the experience the guests have received versus some really aggressive promotional message.

I mean, as a follow-up, I mean, the messages to the consumer, they seem to be somewhat erratic in terms of just promotional activity. We've seen some new items from the Company, we've seen some core items being promoted.

Maybe talk a little bit about how the advertising is going to change in fiscal 11 versus fiscal 10. I understand you can't get into new promotional items, but do you see a new campaign coming on that will support some of these changes that you're making?

Yes, again, when we start to get more of the fundamental issues addressed on the base menu and in the core of the concept, then that frees up our advertising to be a lot more brand building and a lot less specific around an offer. And we are working towards that goal and that is exactly where we want to be.

We want to be able to take the significant competitive advantage we have being a national advertiser and leverage it more towards building of the brand and not so much about talking about an offer, but we have to set ourselves up for that. Right?

So we have to make some changes in the product, on our menu, on our service that will establish that stronger base business and we are doing that. And so when we start to get those initiatives fully implemented into the restaurants which is happening now, we will be able to take our advertising and change the messaging to be much more compelling from a branding standpoint. And that is what we're working towards. That is an absolute outcome.

Given that sales are down, I am assuming that advertising dollar spend is down as well in fiscal 2011 versus 2010?

Not significantly. I mean, small changes, but nothing dramatic.

John Glass.

I just wanted to drill down a little bit on September first. Last September, is that the month you withdrew the 3 for $20 temporarily as you adjusted the promotion and is that why the sales improved this September on a relative basis -- on a two-year basis or one-year basis?

September is where we didn't run the promotion for much of that month and we made some changes, put some different messaging out there.

Gotcha and then I think at your analyst meeting, you had shown -- and I don't have the numbers in front of me -- but some improvement or lower order incident rates as the promotion wore on, so that you were suggesting -- you were less and less reliant on the 3 for $20. Can you remind us what that progression was? I suspect that should benefit you in the second quarter sequentially as that quarter goes on this year. Is that correct?

John, I can answer that. It is Guy. We started off running almost one-third of our preference on 3 for $20 in sort of iteration one which would've been Q1 last year.

It went to 30% or almost 30% iteration two which we would be lapping right now. And then when we ran it again in January, iteration three, we were down in the low 20s for preference.

Okay, that's helpful. And then a broader sort of philosophical question. You seem to be building a model that's going to be a low-cost provider. Effectively you're going to be able to deliver restaurant services at a lower cost than your peers. Does that mean your model will therefore tend toward being the low-price provider for food or are those not connected in any way?

I think you raise a great point and a great opportunity for us to remind everyone that what I think continues to be seen as just cost reduction or managing of earnings, each one of these initiatives we believe strongly also improves the guest experience, the quality of the food, the taste of food.

So, yes, we want to take as many costs as we can out of our existing buildings to allow us to be more flexible what we charge, to compete better at lunch with fast casual operators. Whether we be the low cost in casual dining, I couldn't say that for sure, but what we want to be able to do is offer value as an everyday offer to the guest and have margins improve.

Where over the last year when we did promotional activities, our margins got worse. So we are really trying to evolve that business model.

Investing in new technology, investing in new processes, investing in new service platforms, so the guest experience goes up, at the same time our costs go down, that gives us lots of flexibility with what we can charge for items and still be a more profitable earnings machine for our shareholders.

Joe Buckley.

I've got to start off exactly the opposite way, of course. Hey, a couple of questions. On the kitchen prep process that you are accelerating, is there equipment associated with that or is that more of a process change?

It's mostly a process change, Joe, but there is some equipment associated with that. But it will be consistent with the CapEx that we guided. It doesn't result now in any additional CapEx versus what we guided at the start of the year.

And can that be smoothly implemented without the entire system? I mean, is there any risk of making the kitchen even more complicated as you make modifications that are only partial in nature?

Joe, this is Wyman. No, these are actually changes that simplify the kitchen process and just allow us to rethink how we do our manufacturing in the back of the house, both in the way we handle the products and the goods that come in and in who we have working those procedures and processes. So, it actually simplifies the world for our restaurant managers versus adding complexity.

Okay and then a question on the GM compensation changes. Had you seen GM turnover starting to pick up in fiscal 2010, last fiscal year? Is that partly what prompted it?

No, we hadn't seen that. Now again, tough economy, so people not as quick to jump jobs. But it really is just -- you know, you've seen the improvement in our earnings and our bonus plans at the restaurant level tie back to performance.

And so when we get this kind of performance, we share it with our restaurant managers. So again when you see these kind of earning improvements, we're going to be paying out higher bonuses. And when we don't -- we didn't last year we didn't have as much, and so managers got better bonuses based on the first quarter's delivery of strong earnings and that I would hope would make sense.

Is there a component of their bonus tied to sales?

Absolutely.

So, Joe, when we talk about better bonuses, you always have to think about how it is relative to last year. So bonuses certainly could get better with much better sales performance, but they are better than bonuses where last year when performance -- as you can see in our earnings results were really quite a bit poorer than they were this year. So I don't know that I would classify them as significantly or as high bonuses, I would just say better bonuses than the low bonuses we paid last year.

Okay, last question, Guy. What is the health of the US franchise system, especially some of the new entrants into the system via some of the deals over the last two years?

Joe, we review that on a regular basis and we're very comfortable with the health of our system. Have we had a couple issues?

Certainly with some smaller players in our system, but just reminding everyone again that 80 to 85% of our system is made up of six or seven very large franchisees, all of which are very strong financially. So we're very comfortable with the health of the system.

Destin Tompkins.

Just a couple of quick follow-ups. One, I think, Wyman, you were talking about the transitioning advertising message to more of a -- maybe a brand building message ultimately and less deal focused. But then I think you also referenced later in the year plans for compelling messages around lunch and dinner.

And I'm just trying to -- are those more value focused or would that be more of the I guess offer focus that you mentioned previously? And if you could just kind of explain those dynamics.

And then, Guy, I think you mentioned cost of sales would be similar on a percent of sales basis as they were in the first quarter. And can you just give us how much menu pricing would be assumed in that?

Well let me -- Destin, let me first take the advertising and marketing question. So, you're right, we are going to be introducing some new news around lunch and dinner. And when we do that, obviously those messages are a little more difficult to wrap branding advertising around as deeply as you would like.

There's always got to be solid branding components in your advertising and in your marketing. But we will have a component of new news. We're focused on bringing news though that is more long term, less promotional and fleeting if you will.

And so that allows us to establish that message and then move on to a more branded approach and a more balanced approach to our marketing and our advertising. So we will have a balance I guess is the best way to say it as we look forward into the next -- especially into the back half.

We'll have some messaging that will be introducing new news whether it be at lunch or dinner that will have a branding element to it but will also have a very solid new news component, focusing on changes that we are making within the brand (inaudible) to the offering. And then we'll also layer that with some more branded messages which will talk more about food and food offering and the quality of the experience at Chili's.

And, Destin, you had a question on price?

Yes, that's right.

Right now, Chili's is running about 1% price versus 2% at this time last year. Maggiano's is essentially carrying little if any price as compared to about 1% last year.

I think our expectation might be that Maggiano's would start to creep up a little bit on price. But as we said, we would expect Chili's to stay in that 1% to 2% range versus what it's historically been, a 2 to 3% range.

Can you just explain kind of the thinking around -- given the traffic trends at Chili's, would you consider limiting that price? Why continue to add 1 to 2% there relative to Maggiano's where you're actually seeing healthy traffic, yet you don't seem to have much price in those numbers?

Yes, I think, Destin, I don't know that you can completely attribute what's going on at Maggiano's just to what's happening with price versus what's happening at Chili's. Again the differences are 1% at Chili's and basically nothing at Maggiano's.

I don't think those are dramatic differences. I think what you see happening at Maggiano's is a little bit of return of some more of the corporate traffic.

So we see strong weekday lunch trends at Maggiano's which on balance is more expense account driven than you would see out of Chili's. And then on the banquet side, we have seen a return to more corporate bookings.

As you know, the banquet business at Maggiano's is both corporate and social and we have seen some strength in corporate bookings. So that's really what's driving what's going on at Maggiano's.

I don't think it's necessarily attributed to the price. But to get back to your point, we obviously want to be very careful when we think about taking price which is why we're kind of at the low end of that 1 to 2% range right now at Chili's.

Brad Ludington.

You know, I think on the last call, you said that you were seeing some benefit from the add-on of beverages to the 2 for $20 deal. Is that still -- are you still seeing that right now or up through the deal this past quarter?

I mean, we did -- obviously the big difference year over year with 2 for $20 and 3 for $20 is the fact that we don't have a desert as part of the offering this year. So on balance, even one desert getting added is good from a PPA point of view.

We do see higher PPA this year than we did last year simply because of the incidence of desserts. In terms of beverages being added at a higher rate than last year, I don't know that we would say that we have seen any significant increase in that versus what we have seen in prior years.

Okay, and then looking at bar sales, has that just remained steady with the previous year? Are you seeing a move up in that or a decline in that?

At Maggiano's, we have seen a slight decline but coincidentally we just rolled out an entirely new beverage program at Maggiano's in the last 30 days to address some of that. A couple of the initiatives are where we actually made the wine list much smaller from about 90 bottles to less than 60, really to focus on training.

We also laid out the wines by flavors versus by varietals or geographical regions to simplify not just for our team member and server, but also for the guest. We also added some skinny low-fat cocktails.

So a lot of focus at Maggiano's on simplification. Also on that wine list, there's a number of bottles in the $30 range.

So what we had seen were guests ordering a single glass of wine versus wanting to spend $40 or $50 for a bottle. So back to this value component, even at Maggiano's, we've added more $30 bottles and we've seen guests order a $30 bottle over -- versus a glass previously.

Chili's we actually had slightly improving beverage sales primarily because of beer. So again, the lower-end cost item, back to the consumer looking for value during their experience. So all in all, a little bit up but Maggiano's is working on some initiatives and Chili's is slightly up already with beer sales.

Okay, thanks, Doug.

We are focusing at Chili's on happy hour daypart and programs are rolling out on a local basis to eb appropriate. So we've got new happy hour programs rolling out across the Chili's system as we really start to become more competitive at that daypart.

Sara Senatore.

Just two quick follow-up questions. One is on testing the new kitchens. I think you said it was in sort of a handful of domestic and international.

I am wondering, is that that number -- I can't remember, I think you said five -- is that like a critical mass? Because to go from that number to now rolling it out kind of 50 a month seems like a big leap forward.

And so I'm just trying to figure out, are these like very representative kitchens? And again, kind of what gives you confidence? Because the test number sounds relatively small versus the whole system. So that's the first question.

All right, Sarah, good question. It's Guy. Two things.

So on the equipment side, I think you remembered that number correctly. It was five restaurants where we have the new equipment package.

And really what we would describe it as is we are finishing up the developmental phase which is trying to identify what equipment we want in the kitchen, how does it cook the various products, get familiar with the time and motion that you're dealing with the new equipment. In restaurants sort of within those five, we have a high-volume restaurants that runs high labor, we have an average volume restaurant, we have good labor restaurants in there. So I wouldn't say completely representative of the system, but they're not all one kind of restaurant either.

The prep component that we are advancing is actually in about 30 or more restaurants around our system. So we feel much more comfortable aggressively rolling out the prep component that Wyman talked about because we do have it in a broader set of restaurants and as a result have a lot of confidence in the results of what we'll see as we roll those numbers out.

So, that piece we feel very comfortable with. The equipment component, really the next phase will be to go to a set of restaurants that is much more representative of the entire system and is much broader than simply a five-restaurant test.

But we wanted to make sure we had the equipment package nailed down and some of those other aspects before you then go into a full test mode. We believe we are in that test mode already with the prep component and as a result, feel much more ready to roll that out more broadly.

Got it. Thank you. And then the other question is I guess more for Wyman in the sense that we have talked a lot about the kind of changes you're making.

It sounds like the idea is to again give you some flexibility and to allow you to focus more on Chili's brand positioning. I think I'm interpreting it to mean a lot of things like the compensation for managers and the back-of-the-house kind of changes you're making would bring you more towards industry standard or maybe best in class, but bring you more flexibility.

What will be -- I think the issue we all struggle with a little bit in bar and grill is that there seems to be a lot of similarities and across the chain. So can you -- I know I'm asking a lot, but can you just kind of talk about ultimately what it will be that will be the -- how the brand will be more positioned from a brand standpoint versus your competitors?

Sarah, I'm not exactly sure how to answer that. It's a big question. I think the point of differentiation for Chili's, it is a unique brand.

We offer -- while bar and grill -- people like to kind of package bar and grill up into a big category and focus on kind of the homogeneity of the whole category, there are unique brands within the category and Chili's has the benefit of being one of those very unique and differentiated brands. And I think what we are focused on the Chili's now is just bringing that brand to life more aggressively.

And so when we talk about how are we going to break ourselves out from the pack, the consumer already has done some of that for us, has told us what this brand -- how it separates itself in their mind. And now we have to just deliver on that more aggressively.

So, what some of the structural things we talked about do, it just allows us the flexibility to then invest in those things. So by becoming more efficient with our labor model and -- that allows us to take some of that earnings that we free up there to reinvest back into the things that guests are really looking for out of a casual dining bar and grill concept that has got the unique attributes that Chili's does which is a fun, everyday place to go and have a great meal with my family and friends.

And that's what we are doing. And we've got -- so reinvesting in the re-image is probably the most tangible way to see that when you see where we are taking the brand from a re-image. Standpoint that's probably the easiest way for you to kind of see, oh, okay, this is how a Chili's will differentiate from some of the other competitors in the space.

Thank you all for joining us today. This actually concludes our earnings call. We look forward to following up with some of you on the phone later this afternoon and everyone in our second-quarter call which will be on January 25. Thank you.

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