Good morning, ladies and gentlemen, and welcome to the Brinker International first quarter 2012 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mr. Tony Laday. Sir, the floor is yours.
Thank you, Kate. Good morning, everyone, and welcome to Brinker Internationals first quarter fiscal 2012 earnings call, which is also being broadcast live over the internet.
Before turning the call over, 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 you with insight in 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'll be silent on intra-period sales or other key operating results yet to be reported as the data may not accurately reflect the final results of the quarter referenced.
On our 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 take your questions.
Now I will turn the call over to Doug.
Thank you, Tony, and good morning to everyone. I'm going to briefly share with you our company results for the first quarter, how we continue to deliver on our calmness to strengthen the business model and drive shareholder value and then turn it over to Wyman and Guy for a deeper dive into Chili's and our total business results before we answer any questions you may have.
As you saw in our press release this morning, we reported an adjusted first quarter earnings per share of $0.30, and that's a 43% year-over-year increase. Brinker ended the first quarter with a 1.9% gain in both comp sales and traffic, and that is our third consecutive quarter of positive growth.
During the quarter, we continued to face challenging macroeconomic conditions. Unemployment rate remained high and the policy debates that occurred in Austin around the budget deficit along with the downgraded U.S. credit rating caused the consumer to form a more pessimistic view about the future of the economy. But we along with the industry felt the impact in our business from those economic headwinds.
Despite all that economic challenge, achieving strong earnings growth this quarter demonstrates our strategies to improve the overall business model are continuing to work. Our topline strategy of providing everyday value is attracting guests to our restaurants and allowing us to continue to outperform the industry in traffic growth.
So our primary value strategy is continuing to be: number one, Chili's $20 dinner-for-two; secondly, there are lunch combos; third, Maggiano's Classic Pasta; and fourth, we have a new offering from Maggiano's Marco meal-for-two. These are all increasingly important and appealing to our guests.
At the same time, we continue to work on the member appeal by focusing on improving operational efficiencies. The niches that we put in place continued to deliver results by not only improving our margins, but also elevating our level of service and increasing our consistency. Our ability to provide everyday value to our guests coupled with our continuous margin improvements are resulting in positive earnings growth.
Let me give you some quick highlights around Chili's results. We ended the quarter up 1.7% in comp sales and 1.9% in traffic, which marks our eighth consecutive period of positive growth. And we continue to see operating margin expansion year-over-year despite those commodity headwinds. In a few minutes, Wyman will give you a closer look at how the team gained traction during the quarter and will update you on the progress of our fiscal 2012 initiatives.
Maggiano's Steve Provost and his team continue to produce positive results as well. They had a 3.5% sales growth, marking our seventh consecutive quarter of positive comp sales. Maggiano's had a 2.1% increase in guest counts, marking two years now of positive traffic growth and had a 90 basis point increase in operating margins.
So although Maggiano's is lapping strong sales growth, sales momentum has continued driven by three key areas. First, the value we brought into our menu with the Classic Pasta offering which continues to be a distinguishing factor unmatched by our competition; and our new offering Marco's meal-for-two, with this offering the guests get a choice of an appetizer of flatbread or two-side salads for your first course, then two Classic Pastas for the main course, a dessert to share, plus two Classic Pastas to take home, all for $39.95. Great value offerings.
Second at Maggiano's are direct marketing program that gives us the ability to target loyalists and new prospects in every trade area with direct mail and e-mail is working fine. Third, delivering to go continued to contribute to Maggiano's topline growth.
On the global side of our business, we made some valuable contributions to Brinker results as well that comp sales across all of our global restaurants increased 7.5% for the quarter. We actually opened five net restaurants, bringing our total to 240 Chili's and 1 Maggiano's in 31 countries and two territories outside of the United States.
One of our openings was our joint venture in Brazil, marking another entrance into one of our strategic growth markets. The opening has been successful and we are pleased with these initial results. So Carin Stutz, the President of our Global team, and her team continue to work tirelessly to introduce Chili's to the world and deliver value to our shareholders.
So despite these crazy macroeconomic conditions, we believe our strategies are succeeding and our growth will continue to outpace the Bar & Grill segment. We've invested in initiatives that are driving sales and traffic, while at the same time focusing on increasing operational efficiencies to improve our margins, but equally important our level of service to our guests.
Given the results we achieved in F'11 and the progress we made in F '12, I continue to be confident we'll achieve our long-term goal of delivering 400 basis points of margin improvement and doubling our earnings per share by 2015. We've got great teams and the like strategies in place to continue to build on our momentum and generate strong returns for our shareholders.
Let me now turn it over to Wyman and share the exciting work taking place at Chili's.
Thanks, Doug. Good morning, everyone. So let me update on where we're at, at Chili's. Strategically, we're prioritizing value enhancing initiatives that drive traffic and we're challenging ourselves to do things differently rather than working harder on the same thing and hoping for better results.
If you look at our results over the last three quarters, we've been growing traffic significantly higher than the category. As measured by math, we're taking share, we're transferring into sales and we're hitting our earnings targets.
So we want to continue our momentum, and the key to doing that is following our five strategic pillars to shape our focus and drive our initiatives. So let's take the first pillar, building a stronger base menu.
The key focus for us here is creating value platforms that drive traffic. When we look at some of the things we've done recently with two-for-$20 and the lunch menu, there is a significantly different and powerful propositions and many of our guests are now enjoying, which is helping us change the perception of the brand from a quality and value perspective.
A great example of how we're doing things different at Chili's is our lunch menu. In the 36-year history of the brand, we've always had one all-day menu. And there are lot of beliefs within the organization that it's going to very difficult for our guests to accept a menu that was only available at lunch. But we push ourselves. We put it out there. We created a very compelling lunch menu, and we've had absolutely no issues with our guests. It opens up the opportunity for us to be much more competitive at lunch and our value scores are significantly higher than there have been in years.
Moving forward, our goal is to keep our platforms fresh rather than resorted to limited time promotional strategy every six to eight weeks. So we're continuing to innovate our two-for-$20 and lunch. Today, we're on air with new taco and KPD for our two-for-$20, and we're working to bring on new news on our lunch combo platform in the very near future.
So that's where we're building a stronger base menu. We're really pleased about the work that's been done there and the result we've gotten today.
Our second pillar is this idea of targeted day parts. We just talked about lunch and dinner, so let me update you on our Happy Hour strategy. After successful test phase, we're now rolling out a full-blow Happy Hour program that includes new food and beverage offerings like our fresh platinum margaritas and sangrias with both operational training and marketing support behind it.
And we love the fact that focusing on Happy Hour also supports our need to keep Chili's fresh and relevant, which is our third pillar. One of the key initiatives here is our reimage, where a lot of the energy in the investment is focused in the bar area. So we feel great about how the reimage and our Happy Hour strategy work together to drive stronger business in our bars going forward. But as you know, our reimage product is beyond the bar. It's about creating a much more compelling environment throughout the dining room as well. It elevates our look and makes this more competitive in the marketplace.
And as we elevate our look, we're also challenging ourselves to elevate the level of service we offer our guest, which brings us to our fourth pillar, improving operational excellence. The team service was the first big initiative and that's helping us deliver much better guest experience. The guest appreciate the more attentive service and our guest satisfactory score similar to our value scores are at levels we haven't experienced in years.
And because we're delivering better service, our team members are making more money. Being a server at Chili's is about a $20-an-hour job now. So we're able to get more engaged, higher quality team members, who are capable of doing more. So now we're focusing on improving our server sale skills, so they can do more to drive that check.
We're teaching them to give our guest the opportunities to buy things on the menu that may not have been top of mind. We've had pockets of success with selling when we've done in on a more promotional basis. So you know from experience that when we get the skill set into our DNA everyday, we'll significantly improve the guest experience, with high sales and will increase the profitability of this brand.
As you know, we're in the midst of very big initiatives. We've got kitchen of the future, the reimage, Happy Hour and theme service. And now we're starting to see the impact and get some momentum on a larger scale. And you'll see those initiatives to significant number of restaurants in the next six months.
So for our team, who are focusing on two key things, making sure we're implementing the initiatives at a manageable pace for them. And then once we've rolled them out, that they stick. That's one of the things we struggled with in the past, the stickiness.
In the short-term, we could ask our operators to do almost anything and they'll deliver that specific result, and when we move to another area focused, we'd often lose the impact we got with the first initiative. And so we want to make sure that we create stickiness. That all of our traffic driving initiatives making to the DNA of the operation and everyone's got it, before we move on to the next one.
And more methodically, laying out our rollout strategy making sure that various initiatives hit the restaurant in ways that allow them to absorb them, implement them and then take on the next one. We've created a staggered approach that is very-well planned and thought out. It allows us to implement multiple big initiatives over short period of time without stacking too much on any one restaurant at once.
Then finally and the last thing, and really it overlays everything, is that with all our initiatives and everything we do, we're doing it with an idea towards improving our business model, which is our last pillar. Making sure that all of the different initiatives are going to be positive for the guest and the value proposition and at the same time deliver more profitable business model, one that's 400 basis points stronger and helps double our earnings per share by 2015.
One of the ways we're fulfilling our commitment to improving our business model is by putting the more efficient marketing strategy in place and mitigate the significant cost increases seen this year in TV advertising. So for example, September is historically the lowest volume period in our restaurant. It's also the most expensive quarter in network advertising. So we made the decision this year to take a three-week hiatus and augment our marketing strategy with more efficient social media and local marketing elements.
While sales weren't strong, as you would expect with less TV advertising, we met our targets in both sales and profits. So we won't be that aggressive with hiatus weeks at any point in time during the rest of the fiscal year and we will be diligent and making sure that we maintain and grow our margins.
It continues to be very competitive environment, we track it very carefully to ensure we deliver a competitive value proposition that we're driving the business as much as possible through traffic-oriented strategies. We think we've got a lot of opportunities and we move forward at Chili's. We're excited about the back half of this year and what it's going to bring for us and our shareholders.
And now I'd like to turn the call over to Guy, to walk you through our first quarter financial results.
Well, thanks Wyman. As Doug mentioned our first quarter earnings per share before special items was $0.30 versus $0.21 in the prior year. Including a write-off of financing fees it was about $2 million last than originally expected. These results demonstrate again our ability to drive sales and traffic through everyday guest value, while also continuing to work at middle of the P&L.
Brinker Q1 revenues were $668.4 million, up from $654.9 million a year ago. Total company-owned comp restaurant sales increased 1.9% on 1.9% traffic, a negative mix of 1.4% was equally offset by price increase of 1.4%. Capacity was slightly negative with less than 1% impact and the impact of weather was immaterial for the quarter.
Franchise royalties and fees increased 5.2%. This is due primarily to 25 net international franchise openings in the last 12-month, as well as an increase in international franchise comp sales of 7.5%.
Cost of sales increased by 60 basis points from prior year to 27.2%. The increase was driven primarily by unfavorable commodities of 80 basis points stemming from higher oil, beef and produce, partially mitigated by lower poultry cost. This was offset by 20 basis points of favorable impact from menu pricing and other items.
Currently, 79% of commodities are contracted through the end of calendar '11 and 51% are contracted through the end of fiscal 2012. Restaurant labor improved 90 basis points to 32.3% driven primarily by hourly labor savings. Management expense was essentially flat.
As you recall, last year, we introduced team service in the first quarter and our new kitchen prep procedures in the third quarter. So while we are now lapping the benefits of team service, we continue to benefit from the first phase of our kitchen retrofit as these changes to our prep procedures drove 60 basis points of labor savings over the prior year, continuing to accelerate above our previous Phase 1 projected benefit of 50 basis points.
The balance of savings came from other items, including lower steady-state vacation expense associated with the change in policy at Chili's. We also started ramping to second phase of kitchen retrofit program, which involves the rollout of new line equipment. While the impact from this equipment will be more significant in fiscal '13, we do expect some increasing benefit throughout this fiscal year, as the number of restaurants with the equipment grows to more than 500 by the end of fiscal '12.
We expect to complete the rollout of new line equipment to kitchens in all of our company-owned restaurants by the end of the second quarter of fiscal '13. We've completed these new kitchen installations in 66 company-owned restaurants and four franchise restaurants. And the labor productivity savings are tracking inline with our expectations. In addition, we're seeing improved ticket times, more consistent food quality and of course the future opportunity for culinary innovation.
Given the success of Phase I and the initial success of Phase II, we're confident the changes we are making to our kitchen will play the key role, we expect that they would in delivering the overall 400 basis point margin improvement. Restaurant expense was 40 basis points lower than the prior year, primarily due to leverage on fixed cost related to higher revenue.
Depreciation expense decreased to $1.4 million to $31.2 million due to fully depreciated assets and restaurant closures partially offset by normal asset replacements. General and administrative expenses increased $2.8 million over the same quarter last year to $32.8 million. The increase was primarily driven by reduced in transition services income, the impact of which should step down in the third and fourth quarter of this fiscal year as those arrangements concluded during the back half of last year.
Interest expense was slightly lower than prior year due largely to a lower interest rate and a lower commitment fees on our new credit facility, offset by a one-time write-off of approximately $0.5 million of deferred financing costs on our previous credit facility. Tax rate before special charges was 30.2% versus 27.9% in the prior year, an increase of 230 basis points driven by higher earnings.
Capital expenditures were $27.7 million with year-to-date cash flow from operations of $30.9 million. In addition to the new line of equipment associated with our kitchen retrofit, capital expenditures also include those related to our Chili's reimage. And new point of sale back office restaurant system.
We've completed the rollout of 65 reimages in our forecast markets, and we continue to move forward with additional markets during the second quarter. And our new point-of-sale back office systems are in 86 restaurants today with an additional 56 installations expected before the end of the second quarter. And full rollout projected to be complete by early fiscal '13.
We repurchased 3.2 million shares for $75 million in the first quarter, leaving an outstanding authorization of $370 million in the end of quarter with approximately $64 million of available cash on our balance sheet.
The financial health of the company remains strong. We've once again seen positive comp sales at Chili's, Maggiano's and our (inaudible) business. The results we've achieved in labor productivity and cost control efforts are in line with our expectations and allow us to continue to roll out our key initiatives.
And our bottomline results continue to demonstrate our balanced approach in investing in our people and asset, managing debt, maintaining appropriate liquidity and returning cash to our shareholders. This includes the recent 14% increase in our quarterly dividend from $0.14 to $0.16 per share.
The year is off to a solid start, still there is much work to be with each passing day we make progress towards both our short-term and our long-term earnings goals.
With that, I'll turn the call over to Kate to open the line for questions.
Thank you. Ladies and gentlemen, the floor is now open for questions. (Operator Instructions) Our first question today is coming from David Palmer. Please announce your affiliation and pose your question.
David Palmer - UBS
Just a quick question. I think the market and I think a lot of investors wonder about this quarter in light of the entire year. Basically people are wondering about whether the traffic in the margin gains you're getting today if you can sustain those as perhaps the margin comparisons and the sales comparisons get tougher as the year goes on.
I oftentimes look at things in terms of over the trend, but I think the comparison sometimes scares people with regard to Brinker and its story. So anything you can say that give you comfort about how view the year playing out versus those concerns about tough comparisons?
As we look at wrapping on some things and maybe some tougher comparisons, I think people are more focused on the back half. But really in the first quarter here, we wrapped on the introduction of two-for-$20. So that was in mid-August, and now we've wrapped that. And as you can see, we're still running positive traffic in sales. So we've gotten past one of the big wraps.
When we look at the fundamentals outside of the specifics of we've got a lunch introduction and a dinner introduction that we got to get over, we look at the fundamentals of the business and what our guests are telling this. And the key we think for momentum is how that value proposition playing out.
And so we really are focusing on that, and the scores that we are getting from our guests right now with regards to value proposition at Chili's are outstanding. They are the highest they have been, and they are continuing to strengthen even as we don't necessarily provide a deeper discount, it's just I think with the consistency of the offer, the higher execution level that the restaurant, we're seeing better value scores which bode well I think for the utility to maintain traffic growth.
Our next question today is coming from Jeff Bernstein. Please announce your affiliation and then pose your question
Jeff Bernstein - Barclays Capital
Great, thank you. Barclays Capital. Two questions for you. First, I guess in your prepared remarks you talked about the ever popular food inflation. I think you said you're now 79% through calendar '11, if I heard that right, taking you into the end of fiscal '12. I am just wondering if you could package that for us in terms of what you think the overall basket of inflation will be. Obviously, you have to make some assumptions on the other 50% for fiscal '12.
And then in terms of the pricing that you think you'll need to offset that, I know in the past you talked about 100 basis points of pressure on fiscal '12 based on your prior knowledge. Just wondering what your pricing thoughts are? And then I had a follow-up question on labor.
I'll let Wyman handle the pricing question in a second. You're right, Jeff. We thought at start of the year, we'd around about 100 basis points of inflation on our commodity basket. And you heard in my comments that it actually is 80 in the first quarter. And actually as we look at our commodity basket now, I'll say that's actually mitigated or abated a little bit.
So where we thought maybe that 100 basis points or 4% to 5% inflation, maybe that's now 3.5% to 4.5%. We actually think it's going to be a little bit better than we originally thought. Some of that was a result of contracting strategy we employed. We didn't contract a lot early in the year. And as you've seen things soften a little bit over the last three months, we've taken advantage on the commodities where we think there is an opportunity and decided to lock those in.
But still there are other commodities that we think do we still have a little bit of an opportunity to run down a little bit more, and those are other ones we're not contracted to. The ones where we think that things could get worse, we are contracted.
Overall, I would say we don't think things are going to get a lot better than they are today, but not necessarily a lot worse either. But nothing that we've got in our plans is banking on huge good commodities in the back half of the year.
Well, I think we're going to put in context. We're still committed to that 400 basis points and we're on our way. So we are going to maintain and actually improve our margins. So our objective there is to do that with right now we're thinking 1% to 2% price, which is probably a little lower than a lot of other folks out there are taking.
And strategically, we want to continue to have a real strong value proposition. We want to continue the momentum on strengthening our life propositions. So we're looking to stay in that 1% to 2% range and continue to grow margins. So we're counting on the initiatives that we've played out for you with regard to getting to the future and other things that we're doing to help us mitigate maybe some of the other pressures that we're working on.
Jeff Bernstein - Barclays Capital
I appreciate all the color you gave on the labor, and we know you're lapping some big initiatives there. I think you said the retrofit still gave you 60 basis points of benefit in the first quarter. Just wondering as we look at the labor line as a percentage cost of sales for the reminder of next three quarter, I should say, would you expect that you could still see significant favorability on that line or that retrofit helped in the first quarter, but over time you'd expect the labor initiatives to be mitigated and therefore less year-over-year benefits as you move through this year?
Well, a lot of moving parts in there. The kitchen retrofits, we're well on our way now to rolling that out and we're certainly seeing labor productivity benefits from those. So as we continue to put more and more kitchens and restaurant, we'll get that at labor benefit. We've now lapped completely team service. So that's fully in the bank, and we're still building off that.
Because we didn't roll up the prep procedures until the third quarter last year, we still have a little bit of opportunity here in the front half of the year and the third quarter to benefit from that, not even taking into account that we are getting better savings from that initiative than we even originally thought. So we'll continue to benefit from that going forward.
But all that being said, we were seeing this all last year. We talked about how manager compensation was higher, because we happened to do such heavy lifting. And that we were going to build that into the plan this year, and that's in the plan this year. That's why you're seeing management expense fairly flat, but you're seeing the huge labor good guys, because we're able to expose that a little bit more now, because you are not seeing it offset by increases in management compensation.
Our next question today is coming from Bryan Elliott. Please announce your affiliation and pose your question.
Bryan Elliott - Raymond James
Raymond James. I'd like to drill down on the sales. I may have missed this, but I assume that the negative mix shift is a function of the success at lunch?
It's a combination. So lunch is driving that. We had less mix, in fact, as we rolled over the two-for-$20 introduction last year. So part of the mix issue in early July and August was two-for-$20 this year, not last year. And you can see when you look at the September mix not nearly as significant as we've now got that wrapped under our belts.
Bryan Elliott - Raymond James
As we look forward, given that wrapping now, if you could remind me when the $6.99 combo lunches came out? You'd expect it to look more like September than the whole quarter though.
Yes, in that ballpark, 50 to 100 basis points, not the big number.
Bryan Elliott - Raymond James
There are still obviously a lot of investors concern and uncertainty about the competitive environment at the Bar & Grill space. In particular, we are all seeing more discounting and more aggressive actions from some other players in that space. Just looking at monthly trends and listening to you, it doesn't sound like you're necessarily seeing any impact on the behavior of your customers from some of those offers from competitors anymore. Is that a fair read?
We haven't seen anything specific. I'll say that there hasn't been an action taken by a competitor that's really changed anything dramatically in our trends. We obviously are always evaluating and watching what's going on in the competitive marketplace. So I'd say it's more about what are the consumers' thoughts in general. And obviously, we're hoping for some improvement in the job market, because at the end of the day, that's going to be the key for further category. I think they start to see some more robust gains.
Bryan Elliott - Raymond James
What I am thinking is that it sounds like your research is telling you that your value proposition and value perception now within the Bar & Grill consumer is strong enough to withstand other people giving away food.
We put into our base business now is much more competitive than it was a year ago. So just from the standpoint, if somebody wants to take a shot from promotional or discounting perspective, we are going to be better position to deal with that. Doesn't mean if somebody wants to give away the fund that they won't have an impact on us, but we know we're in a much better place today with consumers and the value proposition that we're offering today at Chili's day-in day-out.
Our next question today is coming from Destin Tompkins. Please announce your affiliation then pose your question
Destin Tompkins - Morgan Keegan
Morgan Keegan. I just want to see if I could get a few more details on the remodel program. Guy, I think you gave some numbers there, but I wasn't exactly sure what period those apply to. So if you could just kind of walk us through maybe how many remodels in the first quarter and what it looks like as you go through the year and any details along the lines of what kind of experience that you were seeing from those remodels will be helpful.
So I guess 165 restaurants now with the remodel. So that basically encompasses the original lab market we had which is Oklahoma City as well as a couple of units in Dallas that we originally did to prove out the design and to get the initial customer feedback. And now, we've completed the test in our four test markets, which really encompass markets both on the East Coast and the West Coast. The remodel themselves are all complete as or about a month ago or two weeks. The actually construction is that.
Obviously, some of those were done much earlier in the quarter, and we're getting a good chance to read the reaction of guests, from the ones that were done earlier. And we are getting a chance to implement all of the strategies around those remodels like retraining the employees, trying to capture some of the excitement around the investment in the building, giving some marketing to guests to get them to come in and introduce them to the changes.
What we are really watching now is where that settles. Following the introduction of those guests on the retraining of the team members, where is this going to land. Once they get a chance to experience, it doesn't increase the frequency to restart to bring new guests back into the brand.
I'll say though what can give you the most confidence that we're pleased with the progress we're making, we're continuing to roll it out to additional markets, and we still think that 200 to 250 range is where we'll be by the end of the year in terms of number of remodels completed.
Destin Tompkins - Morgan Keegan
Wyman, you talked about the marketing, and I may have missed some of it. The change in the marketing plan for September, I believe it was. Can you maybe go through the details again? And did you expect to continue to use more social media in the rest of the year, or should we expect that you'll maybe use some of the TV savings and use that in a period where maybe it's more cost effective.
So in September, we did see the opportunity just given the level of increase that we're looking at this year to reduce of our rate levels and rely more on the significant database and social marketing programs that we have now to carry the business.
So we had a couple extra hiatus weeks during that month. Again, cost a little of topline from an overall finance perspective is the right thing to do. We don't see ourselves, because again the factors that drove that were the cost of the media in that quarter as well as it's just a slower time in our restaurants. So we don't see that opportunity as much going forward.
But we'll be leveraging social and direct marketing more. We've been investing in it. We're growing the capability and it's working very well for us. So we'll continue to use that to help deliver an efficient marketing program going forward.
Our next question today is coming from Chris O'Cull. Please announce your affiliation, then pose your question.
Chris O'Cull - SunTrust
SunTrust. My question relates to traffic. I'm a little surprised that traffic has now improved at a great pace, especially given the comments you provided around the survey information you collected. What do you think needs to change at Chili to drive that traffic? Is the advertising message an issue?
We're always looking to the power advertising work at hard force as possible. I think there is the fundamental issue that we're talking about in terms of growing traffic in an industry that's actually down traffic. So again, when you look at the absolutes, they may not be as impressive as you like, but the category is down. So relative to what everyone is experiencing, we've still fairly significant share in traffic.
So we're happy with where we are, where we like it to be better. Obviously, we had always liked to steal more share. But a key to that is the value proposition. I mean staying focused on are we delivering a better value for our guests everyday.
And when I say value, I know a lot of times in the category, people just rush there for price or discounts. We're talking about the whole equation. So the service, the atmosphere, the quality of the food. Some of the bigger drivers when we look at the details are quality of food and the experience and the service that we're giving. That's driving our value propositions as much as pricing is.
And so that's where we're focused on. Just a better guest experience is the key. And then making sure these platforms that we're putting in place are getting stronger and stronger and that people can then count on Chili's day-in and day-out to be their place. So that's the strategy we're using to drive traffic. It's working for us fairly well right now. We're happy with a straight period of stealing share and growing traffic. And we're going to continue leverage that going forward.
Chris O'Cull - SunTrust
Guy, what were the year-over-year advertising savings during the quarter? And do you expect to redistribute those monies to the second quarter?
Well, I mean the budget overall for the year is pretty flat. So clearly that will allow us to make some investments in other parts of the year as well. It was a material for the quarter, but the opportunity of what we saved in September will allow us to make some reinvestments at other points in the year or so.
Chris O'Cull - SunTrust
What was the magnitude of the labor benefits from the Phase II rollout? What do you expect to receive this fiscal year from that rollout?
We haven't specifically talked about that detail. It's meaningful. It's on the team service side that we think we going to accomplish with really all of what we get from the kitchen rollout budgets, labor productivity. But we get utility savings from the new equipment. And that's not even counting if that's the ticket times and food quality and culinary arrangements. I'm more just talking about the margin improvement opportunity.
Our next question today is coming from the John Ivankoe. Please announce your affiliation, then pose your question.
John Ivankoe - JPMorgan
Actually, it's a follow on that last one. I mean if we could talk about when we think that the new point-of-sale system in the kitchen equipment actually becomes fully effective to a level once it rolled out, we just think about the overall plan, how much the investment would be at the store level of cost of training or inefficiencies and what have you until you can get the system up to where you want.
And Guy, if you could just clarify that last point that you made in terms of benefit to margins. I mean is that kitchen of equipment and the point-of-sales system that you meant to discuss?
What our practice has been is to wait until it's rolled out before we know exactly what the benefit was. We talked about team service. We got a 100 basis points. We're now lapping that. Kitchen, Phase I which was the prep component, we thought that would be 50 basis points. It was actually 60 in this quarter. We actually had weeks where it's being 70 or better. So we do continue to see some accelerating benefits from that.
We think the Phase II, the rollout of equipment could be of the magnitude of team service, although we hate to be coy on that, but we really like to see how plays out, because it's only about 60 restaurants to date. So we still think that light kitchen of the future Phase I once we get it in, we'll get a real good sense or whether there can be more opportunity there than we think there will be. We're very happy with what we are seeing so far in that.
And then the rollout of the new point-of-sale systems, it's probably more in the order of magnitude of the prep procedures, not as big as team service or the lab equipment.
So that would be the benefit of all those. In terms of the timing, it would be rolled out with the whole menu linked by July of calendar 2012. So the first period of fiscal 2013. It's going to take couple of months or more for restaurants to get that system before they really get good at exercising and flexing the muscle on using that data and seeing improvements in cost of sales. So it's probably the most difficult of the transitions of any of the initiatives that we've rolled out for the restaurant managers to still run with and adopt to see the benefit.
The kitchen equipment, our expectation is by three or four weeks after we've rolled out the kitchen equipment that we should be scheduling based on the new paradigm now. Does that mean you always get all the labors right away? Maybe not, but we believe that by time you're into the end of the first month or the start of the second month after receiving the equipment, you should be scheduling to see the labor productivity savings that we're seeing in the restaurants that have it already today.
John Ivankoe - JPMorgan
So the menu link taking a couple of months, the kitchen equipment taking a couple of weeks, three or four weeks. I mean do you see different margins before it can stabilize and improve, or are you able to accomplish it with the hours that you're currently using in the store?
The way we've rolled these out and it's fairly traditional in how we've typically rolled these out. And that's why early on, you might go up. 500 this year and you only have about 60 kitchens run right now. It shouldn't be further along. What we're really doing is receiving them in markets as we along. And so what we are doing is, for example, you put four in Oklahoma City and then everyone tells that Oklahoma City's surround area, you can all go there to train, which really allows you to manage the cost much more effectively, so mushrooming it out so to speak.
So it takes longer to put four or five in each of the markets when you start. But once you get them in those markets, then you can really start to gain traction on the rollout and move much quicker. And that's why we can do 500 into the year versus 40.
The training cost, they are not material. We don't think it's material in fact to the P&L, more material with making sure that once they have it they get traction as quickly as possible.
Our next question today is coming from Joe Buckley. Please announce your affiliation, then pose your question.
Joe Buckley - Bank of America-Merrill Lynch
Bank of America-Merrill Lynch. Just a couple of question on the kitchen in the future. So is Phase I will simply be prep worker change that was effective lat January?
Joe Buckley - Bank of America-Merrill Lynch
Phase II is the actual installation of the equipment. And as you've done this first 60-some-odd company restaurants, any takeaways that you didn't get from the 15 unit test market in terms of how it's implemented or what kind of impact it has on the operations of the store?
Some of that was how we phrase the goals that we're trying to get the managers to achieve. So everybody on this call talks about it in terms of basis points, because that's how we understand it. Restaurant managers work it out in terms of hours. So when we were setting some of the initial goals and having basis points of the goal hours, not as easy for them to translate into what that really meant in terms of want you needed to get.
What we've now done as we started to roll it out and we have learned in the rollout in these markets was to frame it in terms of the number of hours you need to get out of your schedule. And that's allowed us to get a lot more traction more quickly than we first rolled it out. So that was one of the things we wanted.
Yes, and we've actually taken out scheduling tool and make it specific to this new line. So we provided them much better tools. Once they have the line in the key set, they get a couple of week to get familiar with it, and then the tool actually tells them here is how many cups you need on this new line, and they very quickly kind of get into that level?
Joe Buckley - Bank of America-Merrill Lynch
From the operations standpoint, are there any new learnings as you begin to roll out?
I think servers need to get used to the fact that the food hit the window a lot faster than it used to. So that's been an interesting impact on us. But this was primarily a hard issue. I think that we learned very quickly is that the servers weren't expecting the food to come out as quickly as possible. They had to learn to get to the window a little bit quicker to see the food come out.
Of course, it's much harder than it was before. It's more consistent. We melt cheese very effectively now in this new kitchen. We had a lot of times before we struggled melting cheese, and this is a much better job of that. But I would say operationally, that's the one big learning that had an impact on us where we might have initially thought so.
Joe Buckley - Bank of America-Merrill Lynch
And just a question on sales. The outlier in the quarter seemed to be the month of August, and I'm just curious if there is any media mismatches there. I'm also curious why you think lapping two-for-$20 when you come down so much last year is like a challenge. I don't get that.
Well, Joe, one thing I would mention, and this is talk in the peers of the industry, all the conversation is in DC about the debt ceiling and years credit down rate. When we saw the consumer confidence score the lowest since 1981, so there is no question that country got shook up by what was going on. But our traffic was still 1.6% higher.
So the whole market kind of dipped down. And then as Wyman said, in September, we have made a more holistic view of the business, managing costs and using slightly different marketing programs. But I think people got one over. So we still outperform the industry by 1.6%.
Joe Buckley - Bank of America-Merrill Lynch
Your results are lapping two-for-$20 successfully. You have a two-for-$20 last year, for the quarter it comes down five, for August it comes down eight. Why do you view that as a challenge or the successful lap so important to the remainder of the year?
Well again, the two-for-$20 is one of the key drivers for our sales and dinner business. And so as we introduced it last, we saw a nice movement. Now what you've got to do as you're looking at three years now, two years ago when we're wrapping three-for-$20. And now it was an extremely powerful promotion in terms of traffic drivers, it didn't do a whole lot for our margins and we were giving too much away.
So as we wrap that, we didn't see the same level of traffic, but obviously with last year's results, we're happy with the overall performance from a financial perspective and from a shareholder perspective. So now that this is our base platform, two-for-$20, now that we've gotten past the introduction of that which was very successful, again from an earnings perspective if you just look at the profitability of the brand over the last now three years, the trajectory is going the right way.
Now we can afford this platform and we have now introduced it and we're keeping it fresh, and it's continuing to gain momentum with our consumers both from a preference standpoint and from a value perspective. So it's really about the relative impact, not just to the topline, but also to the bottomline.
Our next question today is coming from Michael Kelter. Please announce your affiliation and then pose your question.
Michael Kelter - Goldman Sachs
Goldman Sachs. Question on the longer-term outlook and guidance in how you're going to get there. As I've understood it in previous calls or meetings you had, you always talked about getting up to 3%, 4% comps in 2013, '14 and '15 to enable you to get to your 400 basis points of net margin expansion.
I am curious as to why you have the confidence that your comps are going to accelerate to that level? Is it that you think that the broader industry is going to rebound with the economy? Do you think your market share gains are going to accelerate? And why do you have such confidence in one of those two things happening that you've incorporated it in your guidance.
Michael, we think it was more as 3% or 4% revenue growth, but actually as we've looked at our longer-term models, we actually don't even think we need that. Now going forward, we think 2% to 3% revenue growth is enough to allow us to hit our overall goal. In part, that's because we see these margin improvements are getting even more traction than we might have thought initially.
We do have new unit growth in our long-term plan. We talked last call about how we turned on Maggiano's growth. We believe we're very close to doing the same thing with Chili's. In fact, we'd probably be doing that with Chili's right now. But for the fact that we have a lot of these initiatives really in the next six months, it's critical to us to get these seeded and blocked down and margins working, which we believe will happen that we don't want to necessarily introduce the distraction of new unit growth at this time, but we don't believe we're that far away from doing that.
And if this space continues to sort of wangle at 1%, 2% sales growth, all we got to do is hit the space at 1% to 2% unit growth on top of that, get a little bit of benefit from the reimage. And the math really is not that difficult to get that 2% to 3% revenue growth, which is what we think we need now long-term in order to double our EPS.
Michael Kelter - Goldman Sachs
And on the traffic, while it was positive the two-year trend actually did decelerate from the last couple of quarters. And just backing it with math, if the current traffic levels hold, I think traffic might flip back negative again by the back half of this year, your fiscal year. Is that math wrong or is there some reason why perhaps that won't necessarily play out?
We've got a lot of questions from you guys on the call, but in the back half of the year when you start seeing your positive traffic, can you lap that, and that's where things look like Wyman talked about. Handling good value proposition for the guests, having faster ticket times from a new kitchen, continuing to innovate well with food and deliver good food quality all become important things for us to continue to do, and really nothing in the initiatives rolling out that would cause us to be any less confident in the work before we continue to deliver positive traffic.
Our next question today is coming from Brad Ludington. Please announce your affiliation and then pose your question.
Brad Ludington - KeyBanc
KeyBanc. I just got a couple of quick questions. You talked about lower steady-state vacation expense helping the labor line due to some change in policy. Can you explain that a little bit more?
Yes, we had a policy actually that was not as inclusive as we'd like it to be. So what we actually did was we were able to come up with a policy that actually became more inclusive to more of our team members, follow-up the same time, making a little bit easier for our operators to manage.
As you might imagine, there are just times of the year where it's difficult to operate a restaurant because a lot of people are on vacation. So it was very difficult for operators to manage.
So we made those two changes, but we also added a vacation policy for that less inclusive group of people that was richer than the competitive stand. At the same time, we broadened the inclusiveness of the policy. We also made it more competitive with the rest of the space. And that's why we think we can get the long-term savings.
Brad Ludington - KeyBanc
When you talk about the trends last quarter, you guys mentioned that the West was getting stronger. Are you still seeing improvement in the West, or has that changed over the last quarter?
Yes, the West is getting stronger. It's really Northern versus Southern, and Southern California is performing better than Northern California. It's still one of our bigger challenges. The far Northeast continues to be a bigger challenge for us. So we are seeing pockets of softer results, if you will, in the Northern California area.
Brad Ludington - KeyBanc
And does that extend into the Pacific Northwest? I think you just said that that's been one of the strange regions?
Yes, we don't have lot of presence there, and so it's not a big impact for us. But I would anticipating based on the industry and looking at the math number, it is kind of moving that way. Based on franchisees in Northeast, they've been running a little bit softer than us. That's part of the issue there, the geography. So we're working very diligently to understand exactly what we need to do give better results in the Northeast than in Northern California.
Our next question today is coming from Jeff Omohundro. Please announce your affiliation and then pose your question.
Jeff Omohundro - Wells Fargo Securities
Wells Fargo Securities. Just a question on Chili's and menu evolution and in particular on the $20 dinner-for-two. Just wondering how far you can take that. It seems like you've been introducing more or broader flavor profiles. I think it's a margarita chicken tacos, for example. I'm just wondering if how you guys thinking about on efforts such as that in consumer acceptance of a bolder flavor profile on dinner-for-two.
First, thanks for eating some of our food. I appreciate that. We are all about differentiating ourselves more in the category, and we have a lot of confidence as well on our consumer support for taking a bolder flavor profile approach. We have plenty of variety on our menu for guests that are now necessarily looking for that with a name like Chili's. There is an expectation and there is a lot of consumer trend data that says people are looking for some bolder flavor profiles.
So we are going to continue to read into that as our point of differentiation is the thing that not only works because of who we are, but works because of what consumers are looking for today. And you don't have to look too far in the category. We resonate with bolder flavors. We have that in our DNA, and we're going to continue to put.
Jeff Omohundro - Wells Fargo Securities
In terms of your guest satisfactions scores, is it leaning toward price or the product evolution driving the improvements there?
Yes, it's really both. It's not that we've made significant changes to our pricing strategy. We're continuing to see improved scores, and that's directly related to the quality of the food, scores going up and the food that we're putting out on the menu now is bolder. If you look at what's out there today, those new taco and KPD offerings, the one you mentioned, they are bolder flavor profiles. We are getting better response with those two types.
Our next question today is coming from John Glass. Please announce your affiliation then pose your question.
John Glass - Morgan Stanley
It's Morgan Stanley. My first question has to do with the cadence of margin improvement through the rest of the year. I am thinking about the operating margin improvement. I think, Guy, originally you said 50 basis points was a good number for this year in light of better contracting on food commodities and in light of your performance in the first quarter. Is that still the right way to think about it? And is it maybe just going back to the pressures on how lumpy it is expected to be throughout the next three quarters?
Our feeling was not just in term of margins improvement, but EPS growth, we would be fairly consistent throughout the year. So there is nothing in the numbers that will necessarily make it lumpy. Yes, we've finished lapping the prep procedures in the back half of the year. But they're not too in the new kitchen rollout starts to pick up some of that as well.
So again, we don't really comment on changing the numbers unless they are materially different, but obviously we are pleased with the margin performance in the first quarter.
John Glass - Morgan Stanley
And then how much did the pulling of the ads in September hurt comp do you think?
I don't want to give you a number, because it's very difficult to separate everything that's going on in the environment. But it did have an impact. You look at the trend in September and obviously when we give you the second quarter, it'll be a lot easier to make an estimate, but it took a fell by trend a little bit, not huge, but it had an impact.
John, I think the way I want you to look at it is just sort of business judgment. If you were sitting and as you look at what advertising costs were about to be and traditionally September is one of your lowest month of the year, we just feel like it was good business judgment to take advantage of these new marketing platforms that Wyman's team has created and avoid the urge to overspend a ridiculous amount on TV advertising when consumers are going to be in the restaurant as often. So we're well into balance top and bottomline to be the right thing for the shareholders. But hard to put a number on what the topline could or what it should have been.
John Glass - Morgan Stanley
Absolutely. My goal is more just to assess what the current state of the business was rather than question whether it was a right decision.
Our next question today is coming from Peter Saleh. Please announce your affiliation and then pose your question.
Peter Saleh - Telsey Advisory Group
Telsey Advisory Group. Just a quick question on the Happy Hour. It sounds like you guys are going to get a little bit more aggressive with that. So maybe you could give us some update on where you stand with Happy Hour, where you think you can go. And then should we be expecting some TV advertising to support that as well?
Well, we're very excited about the Happy Hour and really growing the bar business. It's really an overall strategic focus for us and it links the operations, the marketing and the amateur and the reimage together.
So when we talk about the reimage, we will start there a lot of the energy and the emphasis on that in the bar area. We upgrade our video presence. We really transformed the bar into a much more competitive bar.
What we are doing now is getting ahead of that with the product offering. So we'd made menu changes already both on the food and on the beverage side, and we're working on the operational piece now. Those are always the tougher pieces. The human element of the restaurant business is always the most difficult.
So we are very much focused now on getting the bartenders where we need them to be and the service in the bar where we need them to be with regard to quality of the bar operation. We think we've got a lot of upside there, and we're working on the introduction of that program right now. And we are very pleased with some of the initiatives that we're seeing.
Our next question today is coming from Mitch Speiser. Please announce your affiliation then pose your question.
Mitch Speiser - Buckingham Research
Buckingham Research. First, on the first quarter comps, can you break it down and let us know on lunch, dinner, Happy Hour for all of these positive and maybe which one was the best if you can rank them?
So on the comps in Chili's, we saw growth on really all date parts and all week parts. So there was a very nice consistent growth in lunch and dinner across the weekend. So it was a very nice balanced approach. Lunch continues to be a little stronger and early week a little stronger because of the lunch impact. But we did see balanced traffic and sales movements. And so obviously the weekend was a little softer as we wrapped two-for-$20 introduction last year, we got a little softer on the weekend where that has a bigger impact, but still positive.
Mitch Speiser - Buckingham Research
And how did Happy Hour do in the quarter?
Well, Happy Hour is more about going forward for a Happy Hour stores in test. So we'll have more specific story on Happy Hour programs next quarter.
Mitch Speiser - Buckingham Research
Could you give us a sense with franchisees about 35% of your store base, just the general health of your franchisees and the likelihood with a timetable that they will adopt some of the equipment upgrades or the imaging that you talked about?
Well, we just got off the road. We did our manager meetings around the country in the last three weeks and incorporated into that all our franchise partners joined us. So we are all along the same page. I'd say I feel great about the franchise community and the relationships and continuity between company and franchisee.
We are using our franchisees and partnering with our franchisees, and all of these initiatives as partners. They are in the tests. Franchisees are testing the kitchen of the future. They are up to speed on the reimage. So we're now just working out the calendar on how quickly they can implement the initiatives. I don't have a specific date for you there, but everyone is one the same page, and they know what we're shooting towards in terms of timelines and especially with the kitchen of the future where there will be menu innovation that sprung from that new kitchen.
It's important that we're all kind of aligned at some point down the road when we'll then be able to start changing menus and marketing new innovations.
Gentlemen, that's all the time we have for today. Do you have any closing statement?
Well, I appreciate everybody's interest and questions today. And I guess I would just say there were a lot of questions about our confidence moving forward. I think we're confident both in the top and bottomline. The topline, our approach to driving sales and traffic by, as Wyman mentioned, delivering everyday value, and some menu innovation that's coming on the road.
On the margins side, we believe the initiatives that we discussed quite a bit this morning, the kitchen of future Phase II, the point-of-sale, even the reimage that are going to help us drive margin improvement, but equally important investing value and on the guest experience. So we are confident about all those.
As Guy said, the commodity market maybe looks just a little more favorable than it did before. So value is going to be important for us. We're going to be cautious about pricing not because we don't think the guests will accept it, but because we want to continue to build on that value score that goes up. And we didn't talk about margin as much this morning. But again, we're on a great run. We're getting great values scores. We've added some new items.
To Wyman's point, there is markers meal that's $39.95 for two. The value scores the guests were giving us for that are even higher than the Classic Pasta where you get two meals for $12.95. So it is about the overall experience and about the quality of the food that you get.
We didn't talk about guest feedback. I know sometimes on these calls, you hear about what the guests are telling us. But at both Maggiano's and Chili's over the past couple of quarters, we are seeing the highest scorers since we track these guess metrics across the whole guest experience, the service, the food, the overall experience. So scores can go up.
So that confidence is for us and all the initiatives that we have in place. And if we just get a little help from the economy in Washington DC, it will just get better.
So we appreciate everybody's support. Look forward to talking to you again in January. Hope everybody have happy holidays and great business. Thank you so much.
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.
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