Brinker International Inc (EAT) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the second-quarter 2011 earnings conference call. At this time, all participants have been placed on a listen-only mode, and we will open up the floor for your questions and comments after 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, Holly. Good morning, everyone, and welcome to Brinker International's second-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 our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such 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.

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 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 (inaudible) on interperiod sales and other key operating results yet to be reported, as this data may not accurately reflect the final results of the quarter referenced.

On the call, 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. Also joining us this morning is Tony Laday, who will be taking over the investor relations role going forward as I transition to Brinker's Accounting Shared Services and Planning & Analysis.

Tony has been part of the Brinker finance team for almost four years, and has been involved in the earnings call process for the past two quarters, allowing him time to get fully up to speed, and he will be hosting the third-quarter earnings call scheduled on April 22. It has truly been my pleasure to work with each and every one of you over the past three years and I wish you all the best.

Now I will turn the call over to Doug.

Thank you, Marie, and Tony, you've got some big shoes to fill there. But good morning to everyone. Last March, we told you of our plan to double Brinker International's earnings over the ensuing five years with a plan to win, the foundation of which is our plan to rejuvenate the Chili's brand by improving service and food quality, while at the same time working to restructure Chili's P&L to drive a net 400-hundred-basis-point improvement in margins.

It also included making Maggiano's business as strong as the brand, also becoming the leading casual dining chain outside the United States, and using the cash that was generated from three challenging years of balance sheet discipline to drive a significant improvement in shareholder value.

Today, the first year into this five-year plan, I am happy to report we are on track to achieve those objectives. For the second quarter of fiscal 2011, we announced today a 52% increase in earnings per share before special items. These results build on the strong first-quarter performance and were driven by Chili's margin improvements, Maggiano's sales and margin growth, and judicious use of our cash.

Wyman and Guy will talk in some detail about the substantial progress that Chili's brand has begun to make in improving margins and better satisfying our guests, so they will come back more often.

So let me talk briefly about Maggiano's and our global business. As you know, the second quarter is a strong period for Maggiano's, November/December being the peak of both special occasion eating and private dining activity. For the quarter, Maggiano's achieved a comparable sales increase of 4.7%. This is the brand's fourth consecutive quarter of positive comp sales and fifth consecutive quarter of traffic growth.

Maggiano's sales momentum demonstrates the compelling value inherent in their new menu, which was launched with direct marketing in the second quarter. The new menu builds on Maggiano's historic reputation as the place no one ever goes hungry by offering classic pastas, in which guests who order a dish like spaghetti, gnocchi or lasagna are given another pasta dish to eat at home, compliments of our chefs.

Despite this investment in value to move Maggiano's beyond special occasion, the brand was also able to achieve a year-over-year 160-basis-point improvement in their operating margins. Maggiano's has been able to pull off a simultaneous feat of driving compelling value and achieving structural improvements in their P&L. This bodes well for the brand's future.

Turning to our International business, we are excited that Carin Stutz has assumed the role of President. She is well-suited for the role given her history of working closely with franchisees and her vast operational experience. In the past year, Carin has driven much of the work on our Chili's kitchen retrofit. The experience she has gained will be essential as we accelerate the development of smaller kitchens and lower investment models for global markets, in which real estate prices are higher.

Going forward, Ian Baines, our new Senior Vice President of Strategic Innovation, will manage the kitchen retrofit process. Ian brings extensive culinary experience, along with roles as Vice President of Operations at Romano's Macaroni Grill and, most recently, as President of the Smokey Bones. Ian's very unique background will be leveraged to lead many of our guest-facing initiatives at Brinker International.

Our last quarter showed the underlying strength of our financial strategy, as we continued to buy back shares, while at the same time reserving cash for the investment in kitchen technology, point-of-sale systems and restaurant remodels we will use to rejuvenate Chili's.

So that is a quick overview of our results so far. Let me now turn to Wyman to discuss specifically Chili's performance.

Thank you, Doug. Last year when we introduced our plan to win, I shared three beliefs. First, at a time when everyone in the industry was aggressively, and often indiscriminately, discounting to chase share gains, we said we would embark on a road less taken -- backing off from aggressive discounting and using operational best practices and technology to drive substantial margin improvement, with a target of 400 net basis points.

Second, we said that the adoption of these practices would not only drive more dollars to the bottom line, but also improve the [pace] of service and hospitality, as well as food quality and consistency, resulting in a better guest experience.

And third, that this heavy lifting, combined with some newsworthy marketing and targeted efforts to improve our product, would result in steady sales growth, something Chili's has not seen in recent years.

So not quite a year later, we've made significant progress on strengthening our margins and improving the overall guest experience. We are pleased to have realized the structural margin progress we have, especially given that it was done in a declining sales environment. In a minute, Guy will share the details of our business model improvements.

Right now, I would like to share our thoughts on how we are poised to make progress on that third belief -- steady sales growth. Obviously, when we achieve consistent sales growth on top of our improved operating model, we set our shareholders up for some very nice returns.

As we said when we made the decision to unplug the 3C promotion last year, we knew it would be challenging to roll over our top-line numbers, and our second-quarter results confirmed that. But as we looked at the trends from the first half of the year and consider that we will end the 3C rollover at the end of this month, there's support that with less promotional headwind and the implication of several new initiatives, we will begin to experience sales growth soon.

Our goal remains to get the sales growth the sustainable way, and our strategy for doing that is comprised of five elements. First, focus on key dayparts. Second, build a stronger base menu. Third, keep the brand relevant and fresh. Fourth, continue our commitment to improved operational excellence. And finally, do all these things consistent with our objective to improve the business model.

So let's start with our focus on key dayparts. We are currently targeting three key dayparts -- dinner, early-week lunch and happy hour, which for us is primarily 3 to 6 p.m. and after 9 Monday through Friday.

Early-week lunch has been particularly impacted over the years with the growth of fast casual and a more value conscious consumer. After testing our new lunch platform during November and December in three major markets, we launched a new line of Chili's combos featuring nine new items, including some great new sandwiches, like our California Club and Fajita Chicken, that get paired with a soup or a salad at $6, $7 and $8 price points, outstanding food that positions us better against fast casual and with food costs that work in our new economics.

At dinner, we've developed some products that leverage our unique positioning in the Bar & Grill space. Chili's is known as the brand with more kicked-up flavors. We introduced Mild and Wild this month, featuring new twists on our best-known categories, burgers, crispers and ribs. Our Blazing Bites, Maple Barbecue Crispers and Jalapeno Queso bring innovative news and visibility to these core categories and reinforce why Chili's stands apart from the sea of sameness that is sometimes at Bar & Grill.

And then after extensive testing in Q2, we've rolled out the first phase of our Happy Hour program, with specially priced beverage and [new] menu items. We know that the bar aspect of our brand has significant upside potential. Connecting with friends at Chili's is a major reason guests come in, and structuring a Happy Hour program that reinforces our ability to meet that need even better is a top priority for us. Our alcohol mix is solid, and we will leverage the favorable margins that the bar generates to continue to strengthen the business model.

So these daypart initiatives are just the first of a pipeline of product news which we will use to attract the attention of casual diners, reminding them why Chili's is the place to visit today.

Second, we're focused on creating a stronger base menu. Additions like 2 for $20 and the new lunch menu serve to enhance our everyday value on the menu. Our leaner business model provides a financial framework that allows propositions like these to work. At the same time, the team continues work around core menu categories, making sure we are using guest feedback to improve the food that Chili's is known for.

Innovation in key menu categories will be an ongoing process which systematically considers the performance of items on the menu, including the ingredients that go into them, to ensure that they embody our signature flavors and the quality our guests expect. In fact, our food scores today are some of the highest in recent years, a clear indication that the process is working and our guests are noticing the difference. But we still have a lot of work to do.

Third, it is about keeping this very strong brand relevant and fresh. Our work with the reimaging of our facilities is probably the most visible example of our commitment to this. We are in the process of finishing our first remodel market -- that is Oklahoma City. We are executing the design and various building prototypes and at different levels of investment.

It is early, but our initial guest response has been very positive, and results on both sales and returns have met our expectations to date. We will continue to read the results and add some marketing overlay to better communicate to the market the changes. And if the results continue positive in the third quarter, as we expect they will, we will begin aggressively rolling this remodel program out to additional markets.

But staying relevant and fresh isn't just about the building. It incorporates other elements, like our marketing tactics. A great example of more relevant marketing is our increased emphasis on connecting with our guests more directly through our database and social media programs. In the last six months, we've grown our database by 240%, significantly increasing our ability to communicate a relevant message to unique markets and individual restaurant trade areas.

Fourth, we will drive sales growth through a better guest experience, grounded in operational excellence. It is about empowering restaurant managers to be leaders and ensuring initiatives like team service both elevate the guest experience through a higher level of attentive service and improve the P&L. As subsequent phases of the initiatives like kitchen retrofit take hold, the guest experience will be further enhanced by a more consistent experience, with higher-quality food at an improved pace.

These investments require a longer leadtime in order to vet the possibilities, prove out the return on capital and select the best overall solution, but once in place, these programs will accelerate the gains from the previous initiatives and aggressively help us take market share.

Last, all of our strategies are filtered by the business model impact. We can create all kinds of sales-driving strategies, but the key is it must not deteriorate our returns or the guest experience. Clearly, our strategies are meant to be multi-dimensional, with the ability to impact the top line, improve the guest experience and maintain returns.

Now, this doesn't mean that we don't believe that there is a role for an exciting promotion and some targeted marketing, but they must be done in concert with the improved guest experience and in line with our margin transformation game plan.

So, as you can tell, there is a lot of work in process. We view the elements of our sales growth strategy, focus on key dayparts, building a stronger base menu, keeping the brand relevant and fresh, improving our operational excellence and improving our business model as collaborative, building off each other to help drive this steady sales growth. We will continue to measure our progress through improved guest feedback marks, better food scores, increased sales and traffic metrics, and a lower percentage of our guests reporting they are having a problem.

So in summary, we have shown solid progress on our margin expansion strategy, tracking with our 400-basis-point goal. We are delivering a better guest experience based on key metrics we monitor very closely. We are being -- we have been developing and testing programs to now address sustained growth on the top line. Several of these have just been rolled out with a pipeline process working to address future opportunities. At Chili's, we are very well aware of the challenges. We are very excited about the future.

Now let me turn it over to Guy for some detailed financial perspectives.

Thanks, Wyman, and good morning. The second-quarter results demonstrate continued momentum on what we discussed on our last call. We again delivered solid growth in both earnings and earnings per share, with EPS up 52% on a year-over-year basis, before special items. And, as noted in the earnings release, this adjusted earnings-per-share excludes an additional $0.05 of positive impact of tax expense realized in the quarter.

Sales at Chili's continued their year-over-year trends from the first quarter, down 4.9% as we lapped 10 weeks of the three-course promotion a year ago. However, Maggiano's continues to show impressive comparable restaurant sales growth at 4.7% for the quarter.

Beyond sales, what this quarter's results again demonstrated is the power of working on the middle of the P&L to improve the business model. And as the sales initiatives outlined by Wyman gain traction over the coming months, the resulting earnings growth will be considerable.

So let's talk about the results contained in our earnings release today. Brinker revenues decreased by $34 million, or about 5%, to $672 million. The overall decline is primarily attributable to the lower comparable restaurant sales and lower capacity, stemming from 10 fewer restaurants and the sale of 21 restaurants to a franchisee last December.

As we noted in the earnings release, while we did see some significant fluctuation in monthly sales within the quarter as a result of the impact of the 53rd week last year and holiday flips year-over-year, the adjusted numbers tell a much more consistent story through the quarter.

Chili's comp sales were down 4.7% in October, 5.6% in November and 5.8% in December. These numbers were very similar to the Q1 sales performance and consistent with our expectations.

Franchise royalties and fees decreased a little less than $1 million, due primarily to lower franchise fees, again as a result of last year's sale of 21 restaurants outlined earlier. However, International continues to show solid results with a comparable restaurant sales increase of 2.9%, while domestic franchise comp sales decreased 6.5%.

Cost of sales decreased by 270 basis points on a year-over-year basis to 26.7%. In order of magnitude, the improvement was driven by a sharply more profitable value offer and menu improvements, worth 160 basis points; favorable commodities, worth 90 basis points; and 40 basis points favorable impact from menu pricing and other items.

As we move into the second half of the year, the improvement in cost of sales will rely less on commodity favorability and stem more from menu improvements and actual versus theoretical gains related to the implementation of new kitchen prep processes.

With respect to commodities, we are 71% contracted through the end of the fiscal year, providing good visibility into the next two quarters. We expect commodities to be slightly favorable to flat on a year-over-year basis (technical difficulty) the third quarter, but switching to become slightly unfavorable as we move into the fourth quarter.

Restaurant labor improved 50 basis points to 31.8%. Two key initiatives resulted in the improvement in restaurant labor, and their impact more than offset some year-over-year headwinds.

Team service has been in place at Chili's now for nearly six months and has delivered on each of its three goals. The program has delivered 100 basis points of margin improvement and has enabled our servers to increase their hourly earnings significantly. And Chili's restaurant leadership and team members are also delivering a better guest experience through team service. Since its implementation, we have seen guest satisfaction scores increase, specifically in the areas of attentive service and appropriate pace, but across other measures as well.

Secondly, our operators were also able to advance a portion of our kitchen retrofit program related to kitchen prep and roll it out at the conclusion of the second quarter. It focuses on optimizing the labor component of the prep process and maximizing food prep yield, resulting in noticeable reductions in both heart-of-house labor and cost of sales through reduced waste.

Results in our test restaurants were convincing, and while it contributed to only a small portion of the restaurant labor improvement in Q2 due to its rollout late in the quarter, we would expect to see even more impact as it gains traction in the third quarter.

While we would not ultimately expect the improvements in prep to deliver as much impact as we saw with team service, these changes will provide another meaningful component of the net 400-basis-point margin improvement goal. And as with team service, it will deliver a win for the guests, too, by contributing to more consistent execution of our menu.

These margin initiatives not only improve the cost side of our business model, but also transform the guest experience and generate savings, which provide us the flexibility to improve margins and potentially reinvest back into the business to fuel the next round of guest and margin improvements.

As we discussed on the last call, the manager component of the restaurant labor line is relatively fixed, and actually increased over prior year as a percent of revenues due to sales deleverage, merit increases and slightly higher bonus payouts resulting from improved earnings.

An additional headwind for the quarter was a change in the way we provide and recognize compensation for team members in our banquet business at Maggiano's, which is even more pronounced in this quarter given the high level of banquet business for holiday parties. Yet overall, it still results in better earnings for Brinker.

Restaurant expense increased 110 basis points to 24.1%, but was relatively flat in dollar terms. The increase as a percent of revenue is primarily due to the lapping of a favorable credit card key settlement last year, sales deleverage and year-over-year timing of repair and maintenance expense. This was partially offset by significant improvements in utilities, primarily due to the rollout of LED lighting to the entire Chili's system.

Depreciation and amortization expense decreased by $2 million to $33 million due to fully depreciated assets, which was partially offset by some normal asset replacement.

General and administrative expenses decreased nearly $1 million over the same quarter last year to $31 million. Income from a transition service arrangement with On The Border has offset some G&A expense, with the balance due to organizational changes made to better align the support structure to our current business needs.

During the second quarter, some aspects of the Macaroni Grill transition services arrangement concluded, and will no longer act as an offset to G&A going forward. And we expect to also see the OTB arrangement unwind over the coming months. We would expect general and administrative expenses to increase in the third and fourth quarter, with the full-year expense as a percent of revenue approximating fiscal year 2010.

The tax rate before special charges was 27.3%, similar to our prior-year rate of 27.1%, and indicative of a normal, recurring yearly rate. Please note these rates remove the resolution of certain tax positions which positively impacted the rates in both the current quarter and in prior year.

Other gains in charges for the period were approximately $3 million and primarily related to two restaurant impairments and one restaurant which we opted not to exercise a renewal option. And to a lesser extent, severance.

As you know, the second quarter is generally the time where we conduct our review for potential restaurant closures. Given the rigor of our process in previous years and the improvements in our business model, no further closures will be made at this time.

Capital expenditures for the year to date were $31.8 million. Phase 2 of the kitchen retrofit, which includes our new cook platforms, was tested and 5 restaurants, and we are now seeing the kind of improvements we discussed last spring. Our plan is to expand from this lab phase on to the test phase by installing new equipment into an additional 10 to 15 restaurants in the late part of the third quarter.

Our new point-of-sale and back-office systems are now in 25 restaurants, and we continue to work through the necessary steps of a successful implementation to prepare us for rollout to all Chili's and Maggiano's restaurants beginning in the fourth quarter, minimizing the disruption as much as we can, while ensuring we see the desired improvements to the business model.

Considering these factors, we expect fiscal 2011 capital expenditures to be around $105 million, about $10 million less than our original guidance. Year-to-date cash flow from operations is $70 million, and we concluded the quarter with $114 million of cash.

During the quarter, we completed an additional $157 million of share repurchase, buying 8.3 million shares. This brings our year-to-date share repurchase to $250 million or 13.6 million shares, and our quarter-ending share count is 88.9 million shares.

Looking forward, we expect the third quarter to benefit from Christmas Eve and Christmas shifting back into the second quarter. Additionally, gift card sales for the holiday period increased nearly 5%, and we expect approximately 70% of these gift cards to be redeemed during the quarter, providing positive support to comparable restaurant sales. And, as a reminder, we will lap the final weeks of last year's three-course promotion through the end of January.

In closing, we've spent a lot of time talking about margins and our goal of the 400 basis points of net margin improvement. Hopefully, today's call clarified the progress made and how we will reach the remainder of the goal. We expect to see improvement in sales, with particular traction coming later in the fiscal year. Cost of sales will continue to be favorable due to a combination of improved actual versus theoretical yield and more profitable value offerings.

The benefit of team service will continue at the current pace through the remainder of the year, and will be further supplemented with our kitchen prep process changes.

The financial health of the Company is strong. The business model continues to improve, providing flexibility to invest in the business and return value to shareholders through dividends and share repurchase.

There is still much work to do to achieve our goal of doubling EPS in five years, but we feel good about the progress made thus far. Now I will turn the call over to Holly to open the floor for your questions.

(Operator Instructions) Jeffrey Bernstein.

Barclays Capital. One question, and then just a clarification from your prepared remarks. In terms of the question, I know you don't want to give -- well, you gave sequential color in terms of comps through the quarter. I know there is no comment on January trends.

But I'm wondering if you could just walk us through the facts in terms of -- I think you said finally lapping the 3 for $20 end of this month -- so kind of the exact timing and perhaps what you think is the negative impact. I know we talked about it last quarter, but it seems like the focus now is on comps improving.

I think you had said last quarter that your guests would be 300 to 400 basis point of an improvement, if that was right from perhaps what you talked about in September. And if that's the case, just wondering whether you think the flat to down 2% comp is still reasonable for fiscal '11. And then I had a clarification. Thanks.

Good morning, Jeff. Good to hear from you. A couple thoughts around that. Just to clarify, we expect to have three weeks of lap of the three-course program here in the third quarter, and those are effectively the last three weeks of January, where we were lapping three-course last year, to provide that clarification.

You may recall when we talked about the preference for the three-course promotional last year, that early on, it was above 30%. In its second iteration, which was in the second quarter we just lapped, it was about 30%. And in the third quarter, it was about 23%. So if you use order of magnitude off that 300 to 400 that you commented, this iteration we are lapping now in January had a little less preference than it did in the second quarter, if that helps provide clarification.

As for the guidance of flat to down 2% comps, I mean, I guess I would just comment that our commitment has been to let you know if we believe that there is a material change to what we've provided in guidance, and only upon that would we give you a different number.

Okay. And then just the clarification. I think Doug and Guy, you both mentioned long-term EPS growth reiterating the plan to double in five years, which I think you guys had said gets you to 284 by fiscal '15. Just wondering whether you can give any color on the sequential pacing of that growth. I thought in the past year you had said it was going to be outsized in the early years.

And if there was any impediment in terms of achievement -- I know your guidance was the 3% to 4% comps. That seems like that is going to be harder to achieve in the near-term. So just kind of wondering the pacing and whether 3% to 4% is still realistically achievable within that doubling.

Okay. Again, I will try and take you through that as best I can. The number -- again, we are looking to double EPS off our fiscal 2010 numbers, which was about $1.40 EPS. So call it $2.80, was the implied number when we talked about doubling EPS.

The 3% to 4% comps was really once we had steady-state and started seeing the impact of reimage, so that was more a fiscal '13 to '15 number. Implied in our guidance was more a 1% to 2% comp increase in fiscal '11 and fiscal 2012; so just wanted to clarify that as well.

And on the margin improvement goal, things will move around a little bit, as we expected them to. But the good thing about what we are able to do at the margin improvement goal is we are able to pull some things up while other things might take a little bit longer to implement.

So I think we had originally guided that we would be rolling out pretty aggressively the kitchen of the future, the line component or the cook platform component, as we entered into the fourth quarter. Obviously today, we talked about how we are going to roll that to additional 10 to 15 restaurants and test in the third quarter. So you could say perhaps we are a little behind on that initiative.

But we were also able to pull up that prep component, which originally was designed to roll out consistently with the line over six quarters, and perhaps not be completely done until the end of 2012. We were able to pull that up and get it rolled out by the end of this last second quarter, effectively keeping us on track to our original margin goal.

So our assumptions as we outlined them, with higher EPS growth in the initial two years and then settling into 10% to 12% as we get into fiscal '13, '14 and '15, we remain comfortable with that outline.

Thank you.

John Glass.

Morgan Stanley. Two questions. One is regarding the lunch promotion you are running now, the $6 lunch. Is that a permanent value layer? Is that how you think about building that lunch business? Or is this more of a limited time and we are going to be thinking about in three or six months, how we are going to lap it next year? So if you could just talk about the strategy behind that lunch business.

Absolutely not a promotion. It is part of the menu. So it is on the menu and printed on the menu, not as kind of a promotional flyer, which typically signals our guest that if it is on a promotional flyer, it is a limited time offer.

So we've built and committed to the lunch combos as an ongoing part of our lunch offering, and look to build the business around it going forward. Very excited about what it is doing.

Maybe just could you talk a little bit more about what gives you the confidence that sales really improve when we -- I understand you lose the negative traffic drag from 3 for $20.

But this quarter was different in the sense that your major competitors actually really showed some improvement in their sales, both Applebee's and Ruby Tuesdays. So it's some real improvement at the time you didn't. Do you think there's -- do you share customers with them substantially?

Do you think they are starting to migrate back to the category, but they are not going to Chili's, for example? How are you thinking about their improvement in the light of what you guys have run? I mean, two quarters ago, everyone was doing poorly, so one could argue people just weren't going out as much. But they clearly are now, right?

Without getting specific about how other companies are growing their business or driving sales, I will just talk about how we see the business at Chili's and our opportunities.

I think there is some headwind, obviously, with 3C. We probably talked about that a lot. But there are also opportunities for us to provide guests a better reason to come. So that starts with the product, and I think lunch is a real tangible example of putting a better product out there for them.

There's also the issue around the relevancy of the brand and how we keep it fresh, both from the way we communicate with our guests and our marketing approach, as well as the way the buildings and the atmosphere of the restaurant kind of connects with our guests. So we are working on those -- kind of some shorter- and some longer-term initiatives to address those issues.

And then our opportunity is also to just make the experience better. We've got great operators. They are doing a great job. But we still see opportunities to provide a more consistent experience, and we are doing everything we can to make those things happen every day.

So that is what we are doing, and we think those initiatives well drive ongoing -- will be the key to driving our sales growth going forward and make it tougher for the competition to deal with us.

Thank you.

Bryan Elliott.

Raymond James. And just, Guy, wanted to clarify and better understand the food cost guidance you gave us. Essentially, if I heard it correctly, you said that the commodities side would continue to be beneficial until the fourth quarter, when it would be a slight headwind. I assume by that, that is just the raw material costs, and so any mix and/or pricing and/or TA, et cetera, would be offsets to that sort of lessening of benefit and eventual pressure from raw commodity prices. Is that -- did I hear the message correctly?

The reference I was making was to raw commodity prices, Bryan. So we -- with that visibility you have with contracts, we know that year over year we have a slight good guy still in the third quarter, but that swings to become a slight bad guy in the fourth quarter.

Okay. But that doesn't necessarily imply food cost ratio year on year rising because of pricing and theoretical versus actual and other things that might go on in the fourth quarter, correct?

Right. Not necessarily -- that's right.

As then we are all seeing spot prices start to go up for foodstuffs and, obviously, grain prices up dramatically, as you are talking to your suppliers for fiscal '12 in the second half of this calendar year, what is your sense of where we are now and what the risks might be?

Well, we certainly see, as you do, that there is the potential for commodity inflation in our fiscal 2012. And we expect to see that first as we renew our state contracts here coming up in the next couple of months. That will be the first indication for us. That is a fairly small percentage of our basket, but is the one item that we think, at least in the short term, we will see some inflationary pressure.

Spot is always a little different than it is for the companies as it plays out because it always depends on what you are lapping from a contracting perspective. So in some cases, contracts we had that perhaps aren't as favorable as you might think, you might not see inflationary impact on. But we definitely saw some increase in our burger contract when we just renewed it in the last couple of months, and we expect to see that on steaks as well, as the first indicators of some inflation perhaps for fiscal '12.

Great. Thank you.

David Palmer.

Just -- wanted just to dig in. You guys know where investors heads are, which is that your productivity story seems to be real. Your sales controversy, I mean, there is obviously a lot of controversy about whether you can deliver the positive sales here that your guidance implies.

If you were to sort of bridge us in terms of improvement, in the biggest chunks of improvement, it really comes down to the laps on the 3 for $20 versus an ongoing 2 for $20. Then, some of these other things, like lunch being a permanent, perhaps a stabilizer of that daypart where you've gotten particularly hurt. And then maybe customer satisfaction scores. And then how much are you additionally thinking about the industry. If you were to sort of pie chart it out in terms of biggest chunks of improvement that you would think where it is coming from, could you lead us through that?

Sure. You hit on a lot of them, so we will just -- so you are doing the same tracking we are. So there is the lap on the 3C, which we know that was an aggressive promotion that drove a lot of traffic. And as we've mentioned, we get pass that in January, at the end of this month.

We've got 2C now on the menu permanently, and we are building a solid kind of constituency around that part of the menu. And so that is out there now. The introduction of the lunch menu, again, so not a promotion, but an ongoing addition and improvement to our lunch offering, with a very strong value component, but also very strong guest satisfaction ratings.

The other thing we are seeing and we are very encouraged by is just the overall experience that our guests are having and how we measure that with our guest satisfaction scores are showing very positive trends. And we know that as we get a better guest experience out there, that that translates into an intent to return that is more positive, and we will see that start to impact us as we move into the second half also.

Gift cards has been a nice pop and should help us to continue to see some positive improvements here into the third quarter. And then we talked about happy hour -- or I touched on that in my prepared notes. And we think the bar business for Chili's has been underserved, if you will. We've gotten some very positive preliminary indications in our test markets with our Happy Hour program.

We also see a log of synergy between our reimage and what we are doing in our reimaged restaurants and the ability to create a better bar experience and a more compelling bar experience for our guests. And we know that a lot of the guests that come and visit us do so to just connect with family and friends in a more casual bar environment. So we are very excited about kind of turning up the volume there.

And then a lot of this gets supported with our ability to talk more locally. We love the ability to talk on a network basis, and the fact that we have that flexibility to use network advertising and leverage the efficiency of network advertising is fantastic. But we need to be a little more targeted with some of these messages and product offerings. And as we grow our database and our ability to talk to trade areas and restaurants more specifically, that is going to help us address specific opportunities in specific markets to drive sales in those restaurants.

So those are some of the components of how we see ourselves getting the sales trend turned around at Chili's.

And you're not really expecting much of an industry improvement by the end of your fiscal year in this sort of guidance that you are implying?

No, we anticipate pretty much steady-state, I think, is kind of how we are seeing it right now.

Thanks very much.

John Ivankoe.

JPMorgan. Thank you for the update on the fiscal 2011 CapEx guidance. The last guidance that we could find for fiscal 2012, I think, was $165 million. And given kind of your thoughts on remodels and kitchen retrofits, what have you, should there be a substantive change to that number?

No, John. We would expect we would be right in that neighborhood for fiscal 2012.

Okay. Very good. Secondly, a little bit of a housekeeping question. The Macaroni Grill shared service agreement, the On The Border shared service agreement, could you remind us how much you were receiving to offset G&A expense for each of those? And when -- if you said it, I'm sorry, I missed it -- when On The Border will end?

We expect On The Border will roll off -- it will be staged on the ISP, so it always takes a little bit longer to roll off than some of the other services. So I would say a good chunk will roll off by the end of the third quarter; the balance will roll off by the end of the fourth quarter. Mac Grill is almost essentially rolled off by this point now.

Combined, they are probably $3 million annually -- $3 million to $4 million annually of costs. And obviously, when they roll off those services, we will be able to offset some of that with G&A reductions that are currently used right now to support those services.

Okay. Then just one final question. Lower turnover has been a big service and cost benefit to the industry overall through this cycle. What are your -- what is your current turnover at the manager and staff level, and do you think an improving economy necessarily changes it?

We are experiencing some favorability there. We think it's the industry, but we also are taking some credit for managing our turnover. And things like team service, where we were able to put more money in our servers' pockets and really focus on making the job a more profitable job, we've seen significant correlation between when our servers make more money and how long they stay with us.

And so, again, yes, the economy has helped turnover to some degree, but we've also been very cognizant about managing that aspect of our business ourselves. We are running about 70% team member turnover and about 20% manager. We feel good about those numbers, and we think that there is not a whole lot of -- we don't see a whole lot of risk with those numbers going up (multiple speakers). And there's potential to bring them down.

Okay. Sorry for almost interrupting. But did you see a substantive change, as you expected, in front-of-house compensation therefore with team service?

Oh, absolutely.

Could you quantify it, round numbers?

Well, our target is to try and get $1 or $2 more per hour in every server's pocket. So if you think about how servers make a lot of their money, which is through tips, we are trying to increase the level of tips that they bring in by becoming more efficient and working more as a team. And we think the upside to that is as much as $2 an hour or more.

Okay. All right, great. Thank you.

Joe Buckley.

Bank of America Merrill Lynch. Guy, describe the food costs benefits, about 160 basis points, lapping 3C, and 90 basis points lower commodities. Given that kind of breakdown, how much of the margin improvement that you are showing is sustainable, and how much of it is simply what you describe -- the lower food costs and less aggressive promos?

Well, we know -- so I talked to Joe about the 100 basis points of team service -- impact of team service -- so we know that is sustainable. And potentially, even an opportunity there to increase that as we get even more efficient and hit some of those server earnings goals that Wyman talked about, would allow us to even get a little bit more from that.

The prep component that we just rolled out in Q2, which really had very little impact on Q2, will be a tailwind. We will actually produce better margins in the third quarter once that gets completely rolled out.

And given that we are still very early on in the stages of KOF and of the point-of-sale implementation, we still have all of that opportunity and what that comprises of the 400 basis point of net margin improvement as a benefit, too.

Now, there is no question as the commodity environment, if we start to see a little more inflation, we will see less of a benefit from that going forward. But obviously, it is key in our mind, as we think about new menu rollouts and options of what we are doing with the menu and the restaurant, that we can maintain that food cost. And then as these other margin improvements layer in, certainly offset any inflation and then some, with some of the initiatives that are yet to come.

Okay. And then a question on guest service. You mentioned the scores going up, yet the same-store traffic is down high single digits. Are you getting kind of a survivor effect? I guess looking back at the Mac Grill days, those guest scores and brand ratings were always very high and the sales were kind of stuck in a real negative trend. I'm wondering what makes you confident that's not the case at Chili's.

It's a good question. There is that belief sometimes that your last guest score -- when you've got your last guest in the restaurant [maybe] left your best guest score.

But we watch the composition of our guest scores. We look at light users and heavy users, and we understand what is driving the lapse in our user base. So again, it is making sure that we take the data and really tear it apart to really understand that it is not just happening through a heavier concentration of heavy users, if you will, that we understand exactly the composition of the scores and how we are getting them. And it continues to be a very balanced score, not one driven by that heavy user mentality or focus.

So good question. We just have to keep our eye on it. A lot of what we are seeing in the traffic, as we've talked about, has more to do with the promotional aspect and our less aggressive promotional strategy, and not as much to do with what we are doing.

We are also very specific about our initiatives. Joe, we have been targeting specific menu items to fix and improve the guest satisfaction on those. And when we go in and make those changes, we are actually seeing those items and guests that are eating those items give us better scores. And that is what is driving the improvement.

When we made the service initiative change, we saw attentive service and speed of service drive the better guest scores. So it is not an overall movement that is just kind of haloing to a decrease in maybe less satisfied guests. It is actually initiative-driven that is making the improvement in the guest satisfaction scores move.

Okay. My last question, the kitchen of the future rollout, it sounds like it is being pushed out a bit. I think at one point you were targeting maybe 150 stores by the end of this fiscal year. Could you give us an update on that, and maybe more importantly, talk about why it is proceeding more slowly?

I guess I would characterize it as it is probably moving just as fast as we thought, but maybe in a different way than we might have originally communicated.

So kitchen of the future was always both about what we were doing on the line and what we were doing in prep. And in the initial discussion about that at the March Investor Conference, we envisioned that both would move together, that line and prep would move, as you correctly identified, 150 restaurants a quarter starting in the fourth quarter.

Really what has happened now is we have taken the prep component of that and basically rolled out all of it now, which would be way ahead of schedule based on what we originally said. Whereas the actual line equipment or the cooking platforms is probably going a little bit slower than we originally thought. So maybe not until late in the fourth quarter, as opposed to starting the fourth quarter.

I will say one thing, though. There is a piece of equipment that we use as part of the prep component that has actually been ordered and is starting to be installed in the restaurants. So some part of the equipment package is coming. But that piece of equipment has more to do with assisting prep, and cooking some of those items that you can cook the morning of and have be line-ready, as opposed to be cooked to order when the guest comes in.

So overall, I would say kitchen of the future is on track. You might even say from a margin perspective, it might even be a little ahead of what we originally guided at the March Investor Conference.

Okay. Thank you.

Jeff Omohundro.

Wells Fargo. My question relates to an update on the Chili's marketing strategy. For example, it seems like the lunch break combos have had some pretty significant TV support. And I'm interested in particular on TV how you're thinking about the weightings in fiscal H2 versus the first half of the year, and also versus fiscal H2 of last year. Thanks.

So if the question is are we looking to increase our spend in the second half this year versus last year --?

Yes, just the relative spending levels.

The current plan is to be fairly consistent with what we did last year. No major change in how we will spend on network advertising, especially this year versus last year in the second half.

Then as a follow-up, if I may, you addressed the Maggiano's banquet business. Could you talk a bit about how the mix performed through the holiday period? And also elaborate a little bit on the compensation change that you mentioned around banquets. Thanks.

There wasn't a big change in probably the composition at Maggiano's. Maybe a couple of the headlines, playing to what Wyman talked about. Maggiano's has done a great job of growing their e-mail database. They have about 1 million names now. So a lot of the messaging, particularly on the classic pasta, has gone to individual messages by restaurant for just the specific customers and guests of that restaurant marketplace.

The other thing at Maggiano's that has been exciting is they've increased their catering and delivery business. So if you actually look at December, if you take their to-go and add the cater and delivery, it is about 9% of their total sales. So that is a new piece of business.

If we look at the banquets, it was driven, as it normally is in that time of the year, by business events and professional meetings, and it was very, very good.

I just think the other piece of Maggiano's, besides the key things it has always had -- the chef-prepared food from scratch, the large portions, the ability to serve large parties -- now with the addition of classic pasta, you have this everyday value part of the menu, and we've seen a big increase at lunch. And a lot of the business and social guests at lunch are taking advantage of that classic pasta.

So with positive 5.7 four periods in a row, Maggiano's on a nice roll, both from the dining room, where they had positive sales, as well as in their banquet business.

Guy, you want to mention anything about changing Maggiano's labor business?

Oh, and the banquet composition. I'm sorry, Jeff. What we did is -- what the Maggiano's group did was just went and looked at how exactly those banquet team members are compensated and restructured it, I think, to reflect more fairly what a competitive wage would be for that sort of service. And the net effect of it was a good guy to the profitability of the brand as a result.

The reason we mentioned it this quarter is it is not -- I wouldn't describe it as material -- it's certainly not material outside the banquet business, but because the banquet business is so significant in the second quarter, we thought it warranted being mentioned at this time.

Thanks for that added color.

Destin Tompkins.

Morgan Keegan. Just a couple quick questions. One, as we've talk a lot about lapping the three-course promotion, can you give us some idea of what the mix is on the two-course promotion that you guys have had, and maybe how it has trended and what it looks like as it is a part of the permanent menu?

We've seen it -- obviously, when we put it on the menu, we've seen a slight drop in the mix. So it was running around 20% for 2C when it was out there, being merchandised as kind of stand-alone.

And early in December, we put it in the menu, and we've seen now that we've gotten off air and not supported it with media that it has dropped down into that mid-teens. So somewhere in that -- we would anticipate it will settle in somewhere around 15% to 17% of our overall mix.

Okay, great. And basically on the share buyback, Guy, you guys talked about what you have done year to date and the amount of cash you've got on hand seems to be a pretty comfortable level.

What is the right amount? Where would you guys -- I mean maybe what is the minimum amount you would feel comfortable with, as we think about could you accelerate your repurchases over the next couple of quarters, given the cash build and kind of what is the magnitude of that?

Destin, we've talked before on this call -- I'll just reiterate -- we are following four tenets, as we think about managing our cash. The first is the CapEx expectations that we've laid out. You know what that is F11. We talked about that. John earlier asked a question about fiscal '12. So we feel like we've laid that out pretty clearly.

We do have $20 million of debt amortization payments we need to make each year. We've committed to a 40% dividend payout ratio as well. And we believe that $50 million is an appropriate cash balance for the Company. And really after that, all cash returned to the shareholders.

So that should give you an idea of what flexibility and ability we have to do additional share repurchase if we choose to.

Great. Thank you.

Mitch Speiser.

Buckingham Research. First, on the new equipment, I guess in particular the new conveyor oven, how many restaurants is it in right now? And can you give us a sense -- I think back at the Analyst Day, you mentioned it could reduce the number of cooks from eight to five in the back of the house. I take it those are general averages. But maybe could you give us a little more detail? Does it -- can it eliminate the labor headcount as significantly as you laid out in March?

We've got the kitchen retrofit line equipment -- Guy touched back on the prep -- rolling that equipment out everywhere. But the line equipment is in five restaurants today. We are looking to move it forward to 10 in the next quarter, 10 to 15. And so we are moving forward with what we call moving it from like the lab, which is those five restaurants, into really the test phase, which is a much broader sample for us.

So we are convinced that we can hit the three hurdles that we had for that initiative, which are the significant improvement in labor -- maybe not to the extent you are talking. If you just did the math, going from eight to five, we are not looking to reduce labor to that percentage. But the improvement is significant and in line with what we have in our 400 basis point margin improvement plan.

And we are also really having to make sure that the product that comes out of that kitchen is as good, if not better, than what we can do in our current facilities. And that is what we are spending a lot of time working on today, and that is why this project on the line side has been slowed up.

The pace of the -- the third hurdle was really speed, and we are getting speed. So we are getting the labor and the speed, and we are just being ultra-cautious on making sure the quality of the product is as good, if not better, than what we can make today in our current environment.

Great. I think you did mention the point-of-sale system. And can you just provide a little more detail when you think the new POS is going to be systemwide?

We think it will start rolling in the fourth quarter, Mitch, but -- so probably, it will extend into the first quarter of fiscal '12 before we get it completely rolled out. And of course, the benefit there was to come in reduced waste through actual versus theoretical improvements. But frankly, we get a little bit of that from the pull-up of the kitchen of the future prep phase that already happened in the second quarter.

So again, we've been able to replace some of the margin get we thought we would get from those in late fiscal 2011 by pulling up the prep component of the kitchen project.

Great, thanks. My last question is just more on the top line. Going back to the light user versus heavy user breakout of your customer base, just maybe in this quarter, in this fiscal second quarter in particular, can you give us a sense of what was, I guess, weaker year-over-year to drive that traffic decline? And I guess on the flip side, where do you see the most upside or is it really just trying to build both types of users?

Again, I think the biggest single component is really those promo guests that were coming in for the 3C promotion. Those were typically more lighter users that came to that value promotion. So we've seen some of that move away.

As we look at the future, we think there is opportunity really against both segments. When you identify each of the initiatives we are focused on, they all work against both categories. Some of them a little more designed to talk to a current guest, especially when you talk about operation initiatives that are around better guest experience and really locking those heavy users into loyalists.

When we talk about things like our new lunch menu, that opens up Chili's for some folks that may not have been thinking about us for lunch, when we offer the kind of the food offerings that that brings to the table, as well as the price points. So we've got initiatives that are working on all fronts.

Thanks.

Steve West.

Yes, actually it's Pat (inaudible) on for Steve from Stifel Nicolaus. But, thanks. Quick question on the lunch break menu. Could you just give us a sense of what maybe the average check is for those customers? Or just in relation to maybe lunch sales in previous years and kind of how that breaks out, and maybe from a margin perspective, how it compares. Are you going to need more traffic or less traffic to kind of either get to a breakeven or a build from there?

We do believe we will need traffic to break even on the lunch program. From a margin perspective or a cost of sales perspective, we believe it is comparable with what we have previously run at lunch. But obviously, it is at somewhat lower price points -- or it can be at lower price points, so we need some traffic to achieve breakeven.

Although we do have some $8 sandwiches in that lunch combo as well that are also popular. So when the guest orders up at the $8 tier, then we get something that obviously gets a lot more comparable to typical lunch guests than perhaps at the $6 tier. But the incremental traffic that we believe we will drive with how compelling the program is is where we can get the breakeven and hopefully even more.

Okay. And then on the advertising side, have you guys -- I guess, where are you in terms of trying to use some of the more maybe high-tech or alternative advertising that we are starting to see, whether it be through social networking like Facebook or just building your customer database to more directly market to them?

Is there an opportunity to save going forward? Or if those start to work, will you just maybe keep the advertising spending on a fairly flat relative basis and just be able to get more touches to your consumers? I guess maybe just some of your thoughts around that.

I think the opportunity to connect with our guests more individually and more directly is a priority for us. And so we have put a lot of energy and emphasis behind that. Some of the learnings we've seen from Maggiano's, who over the years, has primarily used that as their form of marketing and the impact we've seen is encouraging us at Chili's to learn that lesson and take that learning into this brand.

We've, as I mentioned, grown our database 240% in the first six months of this year. It's a significant database now. We still have very high goals to finish the year out and to continue to grow it.

And then as it becomes larger, it does become a much more viable option to other forms of marketing. Whether or not we will shift dollars or reduce dollars and use these other forms of marketing to reduce our spend, it is too early to tell. But once you get a database and your connection to your guests, it becomes an option. I think it's definitely something for us to consider.

All right. And then one final question. On commodities through the rest of the fiscal year at least, is the part that is uncontracted just some products that just don't offer much long-term contracting? Or are there certain products that just weren't at the price levels that you found compelling to enter into a contract? And if there is any specifics that you could say that might cause some exposure, whether up or down, going forward.

On the commodities side, it is probably more the former -- items that you can't contract, things like produce items that are difficult to contract. But there are some of the latter, and particularly on the dairy side, we are riding some portion of our cheese contract at market today. We have some of it locked, but some that we are riding without a locked contract as we wait and see what happens with price movements going forward.

All right. Thank you.

Peter Saleh.

Telsey Advisory. Just wondering if you guys had any comments on what the weather impact might have been in the month of December.

How is the weather where you are at today?

Terrible.

Yes. That's kind of what the Northeast has been like. And while we were very careful not to really talk about weather because we know that no one wants to hear about weather, it has been a tough start to the winter. This December and January have been tougher than prior year. And if we were to --

We did think, Peter, overall for the second quarter, we thought it was about a 20 basis point bad guy related to weather. And most of that obviously in December, as Wyman said. But if you factor it in over the larger component of the quarter, it was about 20 basis points bad guy.

And then just real quick on the remodels, any comments on what performance in terms of same-store sales you're seeing from the remodels?

It is very early. We are actually still under construction in several of the restaurants there. So it is too early to kind of talk about a sales improvement. But we will say that what we are seeing to date -- and we've been in one restaurant for several months now, and in that market now for several weeks -- is encouraging. We've got great consumer feedback and guest feedback. And we are seeing some positive sales numbers. But probably better to wait until next time to give you some specifics.

Great. Thank you.

Howard Penney.

I didn't know I was French. Can you just share what the test markets did -- the three test markets did, the lunch, in terms of the sales lift? And then more importantly, I guess the industry has noted that some test markets don't always turn out to reflect reality when they are rolled out nationally. And why do you think this is different?

Maybe just sort of -- so given that is a big component to why you think comps are going to improve, can you shed some color on all that? Thanks.

The test markets -- first, we didn't go in with on-air advertising. So really, we are looking at some direct marketing to support the initiative. But what was really encouraging to us was the guest response, both in preference -- the number of our guests that are eating this menu is significant; and the response they are giving us with regard to their feedback is very positive on key attributes that would indicate a desire to return.

Also, all the research we did leading up to this offering was obviously instrumental in addressing opportunities certain segments of the market have that we don't fill as well and that fit well within our brand still. So without a specific number in terms of what the sales were up, obviously we felt good enough there is a breakeven, as Guy said, that we would be able to more than overcome the breakeven with this offer.

We also put this into a franchise test market. So we are using our franchisees to help us partner with us on these initiatives going forward, and their insight and input is extremely valuable.

So that is kind of how we went from learnings in the test to where we are at and why we feel good about potential to grow the business at lunch with this offering.

So -- but it is being supported with advertising and it wasn't in the last market.

Correct. Well, it had some direct marketing. We used our database a little bit, but it had no on-air.

But you can actually see a bigger lift when you support something with advertising (multiple speakers).

That's our expectation.

Got it. Okay, thank you.

Okay. Well, appreciate everybody's questions and involvement this morning. Heard a lot of questions about the commodity outlook, and I hope you understand where we are at least through fiscal '11. I know Wyman talked a lot about some of the initiatives for sales sustainability, and certainly our confidence in the margin promises that we've made to all of you.

And back to that conference last March, we've laid out those clear goals and defined strategies to achieve those plans. Hopefully today we've kept you appraised of our progress and the recent results, which demonstrate our ability to implement changes and deliver better earnings. As you heard from Wyman, again, the components of some of those sales-focused strategies are taking shape, and we think that does put us in a place for meaningful sales growth in the future. Ultimately, all of our initiatives are going to be geared to generate profitable and sustainable sales growth.

Back to the goal of building EPS, we do remain committed to our objective, and the initiatives in place today are providing the financial flexibility to reinvest in the guest in a variety of ways. We've got a balanced and disciplined approach to our use of capital, and that will further enhance our earnings. And when the collective components of all those strategies come together, we believe the shareholder value proposition at that time will be undeniable.

So thanks for all of you for joining us on the call today, and we look forward to speaking to many of you later today.

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