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Executives

Tony Laday – VP of IR, Treasury and Global Finance

Doug Brooks – Chairman, President and CEO

Guy Constant – EVP and CFO

Wyman Roberts – EVP and President, Chili's Grill & Bar

Analysts

Bryan Elliott – Raymond James

Jeff Bernstein – Barclays Capital

Michael Kelter – Goldman Sachs

John Glass – Morgan Stanley

John Ivankoe – JPMorgan

Joe Buckley – Bank of America-Merrill Lynch

Mitch Speiser – Buckingham Research

Peter Saleh - Telsey Advisory Group

Sara Senatore - Sanford Bernstein

David Palmer – UBS Securities LLC

Brinker International, Inc. (EAT) F3Q12 Earnings Call April 23, 2012 10:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the Brinker International Third Quarter 2012 Earnings Conference Call. (Operator Instructions) It’s now my pleasure to turn the floor to your host, Mr. Tony Laday. Sir, the floor is yours.

Tony Laday

Thank you, Everett. Good morning everyone, and welcome to Brinker International’s third 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 the 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 Investors 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.

Doug Brooks

Thank you, Tony. Good morning, everyone. I’m going to briefly share with you our company results for the third quarter, provide you with an update on the strategies that we are implementing to continue to strengthen our business model and then turn it over to Wyman and Guy for a deeper dives into Chili’s and the number and then open it up to Q&A.

As you saw in our press release this morning, our results demonstrate how we are strengthening our business model with a balanced approach that drives both top-line sales and is improving operational efficiencies. We reported an adjusted EPS of $0.60, a 28% increase year over year.

Comp sales during the quarter increased 4.5% on a 1.7% gain in traffic. This is our fifth consecutive quarter of positive growth and we have successfully lapped positive sales from last year. Our top line growth is a result of the changes we’ve made to our business to attract guests providing everyday value, enhancing our menu and upgrading our atmosphere.

Guests are responding positively to the value platforms that we’ve built into our menus with the $20 dinner for two and lunch combos at Chilli’s and classic pasta and Marco’s Meal for Two at Maggiano’s, as well as the investments we’ve made in the Chilli’s core menu. This quarter alone we’ve upgraded our steaks, our fajita meat and salad mix and we’ve refreshed our lunch combo platform. Our guests obviously like what we are doing and we continue to outperform the industry in traffic and sales allowing us to take share from our competitors.

As you know, we’ve also focused on strengthening our business model by improving our operating margins. We are changing the way we operate our restaurants to become more efficient which is resulting in sustainable margin improvements, increased consistency and a better guest experience.

Two years ago at our investor conference, we committed to improving our margins by 400 basis points. By the end of June, we will have reached more than half of that goal. And by the end of December, the new kitchen equipment and the point of sale systems will be fully rolled out to all of our restaurants. So these two important additions will be in place to help us pursue the rest of that goal.

Let me give you some highlights first about Chilli’s results. First, we ended the quarter up 4.6% in comp sales and 1.8% in traffic. And we continue to see operating margin expansion year over year despite commodity headwinds. In a few moments, Wyman will give you a closer look at how the team gained traction during the quarter and he’ll update you on the progress of our fiscal 2012 initiatives.

At Maggiano’s, Steve and his team continued to produce positive results: 3.9% sales growth marking our ninth consecutive quarter of positive comp sales and a 1.5% increase in guest counts representing the tenth consecutive quarter of positive traffic. Sales growth continues across every part of the Maggiano’s business: the dining room, banquet, to-go and delivery thanks to two main and key strategies. First, the value that we built into the menu and second, our direct marketing program which gives us the ability to target loyal guests and look for new prospects.

As I mentioned, we anticipate new restaurant growth at Maggiano’s, so we’re still actively looking for new sites and we’re excited about the growth potential of the Maggiano’s business.

In our global business, we grew comp sales by 2.6% and opened six net restaurants. Now since the end of the third quarter, we’ve opened three more restaurants bringing our total to 250 Chilli’s and one Maggiano’s. The drivers of our global business continue to be Mexico and the Middle East which are crucial components of our long term strategy.

As many of you also may have heard the news recently the California Supreme Court reached a decision on litigation surrounding meal period and rest breaks for our team members. Basically the court decided that California employers need to provide breaks but don’t have to force employee to take them. I want to thank our legal team who put in many long hours working on this case. We’re achieving a positive outcome not only for us but for many other industries impacted by the court’s decision in the state of California.

So Brinker delivered another quarter of positive growth because of the investments we’ve made in our restaurants that are also elevating the guest experience. Our strategies are succeeding and I believe our growth will continue to outpace the casual dining segment. With our financial strength, the power of our brands and most importantly, our talent people, I am confident we will achieve our long term goal of delivering 400 basis points of margin improvement and doubling earnings per share by 2015.

Now I am going to turn the call over to Wyman Roberts to share the exciting work that’s taking place at Chilli’s restaurant.

Wyman Roberts

Thanks Doug. Good morning everyone. As you heard from Doug, it was a great third quarter for Chilli’s. We had our fourth consecutive quarter of sales growth and our fifth straight quarter of traffic growth. And it was balanced across both day parts. Both lunch and dinner saw sales and traffic improvements in the quarter.

And when you look at performance across casual dining, we outperformed KNAPP by 2.9% in sales and 2.6% in traffic. But it’s not just the sale and traffic story. It’s the seventh consecutive quarter Chilli’s has increased earnings. This was a particularly important quarter for us as we challenged ourselves to successfully lap the introduction of our new lunch menu last year.

So how did we get here? Well, Guy will give you some detail behind the numbers in just a few minutes but fundamentally, what’s enabled Chilli’s to achieve these results, what’s really at the core of our success over the last couple of years is our continued focus on our five strategic pillars. They are strengthening our base menu, making the brand fresh and relevant, targeting key day parts for growth, achieving operational excellence, and improving our business model. We base everything we do on these five pillars. So we ensure we’re working on the things that are most impactful to our guests and to our business.

Our goal is to create a strong foundation by making the right changes to our base menu and our operating structure. Changes that give our guests more reasons to come in day-in and day-out which eliminates the needs for promotional strategy and also makes it simpler for our operators to execute. For example, early in the third quarter, we introduced a new menu, making changes that align with our strategic pillars.

At lunch, we took our already successful lunch combo platforms and we refreshed it. We have now some new cheese steak sandwich and our new soup and we took off a few items. There were a lot of questions regarding our lapping the successful introduction of this platform. But we knew that since the introduction, we’ve maintained the higher level of performance. So the wrap wasn’t going to be that significant. It wasn’t like a one-time promotional spike that we had to repeat. Our base is up and sustaining and therefore more predictable.

But the biggest news though is probably the success we’ve had with our steaks. We touched on steaks during the January call because we had just rolled them out at the end of the second quarter but we are now a full quarter in. So just to refresh your memory why steak was important for us.

Well, we were considerably under indexed when compared to some of our benchmark competitors on steak, and we saw that as a big opportunity. But we also knew that to be successful we had to get a great product at the right price with a consistent quality and thickness so that we could execute it across the system. And our supply chain and QA teams did just that.

Now we’ve got a great top selling steak. We’re offering a 6 ounce cut at a value price and a (indiscernible) ounce options for folks that aren’t as price sensitive. And the results are really encouraging. We’re now selling three times more steaks than we were before this initiative went into place. Because we’re giving our guests another compelling reason to come in at Chilli’s.

One of the benefits of this new steak is its popularity among our lunch guests. We’ve seen a significant number of lunch guests trading up to this item, which is increasing our lunch check and at our price point, it still gets them a great value. So steaks are working for us at lunch and dinner and that’s one of the reasons we’ve seen growth during both day parts in this last quarter.

There are also a couple of our operational initiatives that I want to bring you up to speed on that are having a positive impact on our results and helping to take Chilli’s to the next level. First, we’re continuing our focus on alcohol sale. Even though we indexed fairly high on our alcohol mix relative to casual dining, we think we can take it even higher. The bars are real important area for us because the margins are good. They differentiate us from some of the fast casual competitors in the space.

So beginning this quarter, we set some goals for our operations teams to elevate the guest experience in the bar. We’re providing more teaching and coaching to our bar teams. We’ve created some great new drinks and incorporated marketing and incentives to keep our teams focused on bar sales throughout the year. We’ve already seen our alcohol mix increase 30 basis points and we believe these sustainable operations driven practices will help us continue to grow sales going forward.

Another operational focus that’s doing really well for us is team service, which we introduced almost two years ago. This new service model has increased our server earnings to an average of more than $18 an hour, which allows us to attract a high calibre team member. And now we are taking team service to the next level by helping them become a more effective selling team.

We’re coaching and teaching our servers to engage with guests in a way that build our check-out reduce and deliver the better guest experience at the same time. We introduced this new selling approach about half way through the third quarter and we’re already seeing solid results.

We’re continuing to move forward on our capital initiatives which are designed to keep our brand fresh and relevant and improve margins at the same time, full kitchen of the future, the reimages and our point of sale system. Guy will provide the details on those in just a moment. But at this point, the hard work in terms of provide, proving out these investments has been done.

Now we’re in the rollout stage where our talented operations teams are working to get the initiatives in place so we can reap the benefits as soon as possible. All the improvements we’re making at Chilli’s and staying focused on our five pillars are not just strengthening our sales, traffic, and earnings, they are also improving the experience of our team members and guests we’re receiving.

We survey every team member twice a year. We just got our most recent surveys back and for the third year in a row, our engagement levels have increased and our team’s belief in the direction of the brand is an all-time high. We place a high priority on measuring our guest experience as well and we continue to see those scores increase to new record high. And on certain attributes like value, we’ve seen a 50% improvement over the last two years.

So at Chilli’s we continue to have success at growing the business and taking market share. As you heard Doug say, we’re well on our way to achieving our goal of improving margins by 400 basis points. So in closing, we have made a lot of changes at Chilli’s. And one of the most significant changes we’ve made is how we look at ourselves. We are holding ourselves up to what we call benchmark competitors in the industry today.

With the improvements we’ve made over the last two years and the momentum we have, we’re more effectively competing with that group. And the third quarter was a great quarter for us. We’re excited about those results but we’re even more excited about what the future holds for Chilli’s.

And now I will turn the call over to Guy to review the financials.

Guy Constant

Thanks Wyman. As Doug mentioned, our third quarter earnings per share, excluding special items, was $0.60 versus $0.47 in the prior year, representing a year-over-year increase of almost 28%. These results demonstrate again our continued progress against our goals and reflect the engagement of our team members to ensure successful execution on each of our initiatives.

Our third quarter GAAP revenue included a one-time $5.2 million gift card revenue reduction. This reduction was a result of a change in the estimate of gift card breakage driven by an increase in redemption experience. As such, my comments concerning all line item percentages of revenue and year-over-year basis point explanations will be based on third quarter fiscal ’12 revenue numbers, excluding this negative gift card adjustment.

Third quarter revenues were $747 million, an increase of 4.2% over prior year. Total company owned comp restaurant sales increased 4.5% on a 2% price increase which is up from the first half of the fiscal year and closer to the top end of our 1% to 2% guided range, 1.7% traffic and 0.8% mix, which reflects the lap of lunch combos and the impact of steaks at lunch for Chilli’s as Wyman mentioned earlier.

Capacity was slightly negative with less than 1% impact. For the quarter, Chilli’s saw 50 basis points of comp restaurant sales improvement due to weather year over year, comprised of 110 basis points in January and 20 basis points in February.

Maggiano’s who company-owned restaurants are in more weather affected states than the Chilli’s company owned domestic system saw 100 basis points of comp restaurant sales improvement due to weather, comprised of 220 basis points in January and 50 basis points in February.

Franchise royalties and fees increased 1.8% due primarily to seven net franchise openings in the last 12 months, an increase in domestic franchise comp sales of 3.8%, an increase in international franchise comp sales of 2.6% and lower development fees versus prior year.

Cost of sales increased by 30 basis points from prior year to 27.5%, driven by unfavorable commodities of 60 basis points stemming from higher meat, oil and dairy costs, partially offset by lower produce costs and unfavorable mix and other items of 20 basis points. This was partially offset by 50 basis points of favorable impact from menu pricing.

Currently, 83% of our commodities are contracted through the end of fiscal ’12 and 45% are contracted through the end of calendar ’12. As a result, we project the rate of commodity inflation to decrease throughout calendar ’12 averaging approximately 3% for the year.

Restaurant labor improved 50 basis points to 31.3% driven by 60 basis points of hourly labor savings as well as leverage on higher revenues, partially offset by manager salaries and bonus. Hourly labor costs benefitted from labor productivity gains associated with the implementation of kitchen equipment and lower steady state vacation expense associated with the change in policy.

Restaurant expense was $164 million or 70 basis points lower than prior year. The improvement was driven largely by leverage on higher revenues coupled with lower repair and maintenance expense, credit card fees and utility costs. Depreciation expense decreased about $1 million to $30.9 million, continuing the trend we’ve seen in recent quarters.

General and administrative expenses were $40 million, an increase of $4.4 million over the same quarter last year, driven by an increase in performance-based compensation expense and a reduction in transition services income. Interest expense was about $650,000 lower than prior year due largely to lower interest rates and lower commitment fees on our credit facility.

The tax rate, excluding special items, was 28.9% versus 27.1% in the prior year, driven by higher earnings. Capital expenditures for the quarter were $31.7 million with year-to-date cash flow from operations of $233.8 million. Currently, the new kitchen equipment is in about 360 Chilli’s restaurants with completion of all company-owned Chilli’s restaurant installations still anticipated by the end of December.

Our new point of sale system is in 144 restaurants today. With the final phase of implementation kicking off in June, we expect to complete our full rollout by the end of December. We’ve also completed 105 reimages to date and we project to have reimaged a total about 140 company-owned Chilli’s restaurants by the end of fiscal ’12. With the completion of our reimage effort in the Phoenix market, this brings our completed market total to six. And we now have begun reimage efforts in the San Francisco and Memphis market.

We repurchased 3.1 million shares for $82.7 million in the third quarter and we ended the quarter with approximately $73 million of available cash on our balance sheet. Since the end of the quarter, we’ve purchased 1.4 million shares for $39 million, funded in part by a partial drawdown on our revolving credit facility. This brings our year-to-date share purchase to $244.5 million or 9.7 million shares leading an outstanding authorization of about $200 million.

Going forward, we intend to opportunistically drawdown on our revolver to fund additional share purchase but always with a filter of maintaining investment grade credit metrics. On March 29, we closed on the purchase of two Chilli’s restaurants from our South Florida franchisee. With this acquisition, development rights to the South Florida market, already a very successful market in the Chilli’s system.

As we look ahead to the fourth quarter and reflect back on our original guidance for fiscal ’12, we wanted to provide some additional insights. First, given our updated reimage and point of sale rollout schedules, we expect fiscal ’12 capital expenditures to be around $120 million in total.

Next, full fiscal ’12 depreciation expense will be lower than our original guidance of $130 million to $135 million as mentioned last quarter. And we anticipate a fourth quarter and full year tax rate between 29% and 30%. And finally, we expect comp sales for fiscal year ’12 to fall within the 2% to 3% range provided in our original guidance and likely to be closer upper end of this range.

Every quarter is important. And as Wyman mentioned, this third quarter was particularly important. And we feel good having taken another positive step on the road to achieving our goal. We successfully lapped a positive sales growth from last year, combining that with positive traffic growth. And we grew restaurant operating margins by 100 basis points.

This led to a strong earnings performance for the quarter. We’ve accomplished a lot to date and we will continue to build on this momentum as we complete the transformation of the Chilli’s business. In fact, at the end of this fiscal year, we will have just crossed the halfway point to our 400 basis point improvement goal.

We are especially proud of the results delivered by both our operations and marketing teams to date and we have great confidence in their resolve to carry out the strategies we’ve established to strengthen our business model. And as you heard Wyman say, even though our results outpaced the industry placing us on par with the benchmark competitors who are leading the casual dining category right now, we know we have work to do and opportunities ahead of us as we continue to transform the Chilli’s brand into a compelling, relevant and formidable competitor.

With that, I’ll turn the call back to Everett to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from the line of Bryan Elliott with Raymond James. Please proceed with your question.

Bryan Elliott – Raymond James

Thank you and good morning. I guess, I’d like to get your thoughts on the industry environment. We just saw KNAPP numbers released this morning, and for margin, just so nominal demand has clearly slowed some here in margin. Just wanted to get your thoughts on your perspective on what you think might be going on?

Wyman Roberts

Bryan, as you said you’ve seen the numbers and we all know the category has slowed somewhat over the past four to six weeks. But when we look at Chilli’s for Q3, not only did we outperform the category for the quarter as a whole, but we got sequentially better as we moved through the quarter. So given our Q3 trends and given that we’ve seen so far in April, there is no reason for us to believe that Chilli’s won’t continue to see significant – to continue to outperform the category kind of significantly.

Where the category goes, we’re not exactly sure, with the softness that has showed up, it looks like it’s leveled off but we’re not exactly sure where it’s going from here.

Bryan Elliott – Raymond James

And didn’t mean that to be a defensive question, you guys are kind of back in the saddle and clearly gaining share, doing a great job and re-establishing Chilli’s as important and relevant and successful brand in the space. So given that position of strength, I was more interested in what anecdotally you might be seeing or thinking about or hearing. Are we look at, for example, maybe the lower ticket spenders reducing their spending a little more to check pressure at the bottom end of the range of checks, for example, or maybe fewer checks at the bottom end of the belt curve, or is it more kind of across the board just any kind of help in understanding where the deltas might be from a consumer behaviour standpoint based on your broad position out there geographically and etcetera?

Guy Constant

So Bryan, hey this is Guy. It’s hard to look and see any real pockets of weakness across the entire business. So we look regionally and really almost all the regions are performing really well, maybe a little bit not quite as well as on the northeast but California has picked up really well for us. And Texas continues to be extremely strong for us. So really we saw consistent strong performance across all regions.

When we look at day parts, still strength in all day parts, week-day, weekend dinner and lunch, have all done well for us. Maybe lunch is not quite as good as the rest of the business but still very good, even considering the fact that we lapped the introduction of lunch combos a while ago. Wyman mentioned our alcohol percentage was up and if we look at add-on, appetizers, desserts have all been strong for us as well. So we don’t see any pockets in our business. I mean, I guess we can speculate like everyone else about why the softness.

Typically as you and I discussed many times gas prices are not a long term impact on the casual dining space in our opinion. Although you have seen historically sometimes when the prices move very quickly, you see a little bit of a wobble for a four to six week period. So perhaps that’s what we’ve gone through here, and now that gas prices have leveled off over the last couple of weeks maybe things returned to the normal somewhat weak but positive trajectory that we’ve seen in the casual dining space for the past year and half or so. But other than that, we don’t have a lot of color in our business we can lend to you that would tell why there is softness elsewhere in the space.

Operator

Thank you. Our next question comes from the line of Jeffrey Bernstein with Barclays Capital. Please proceed with your question.

Jeff Bernstein – Barclays Capital

Guy, just one clarification and then a separate question. The clarification kind of on your update for the fiscal ’12 guidance with only one quarter to go, I believe your fiscal ’12 guidance at $1.80 to $1.95 was a non-GAAP kind of ex-special items which would, I guess, related to the $0.60 this quarter. It does seem to imply a fairly wide fourth quarter of what looks like $0.43 to $0.58. Just wondering if we can get any kind of color and I know Wyman mentioned the five noting any major weakness or what not. But any help in terms of narrowing that range, I think you previously said stable through the year which kind of would imply that high end but we would have thought we would have seen some tightening with only a quarter to go? And then I have a follow-up.

Guy Constant

Well, Jeff, historically we haven’t gone out and changed that guidance unless we think there is a material change to what we are seeing going on. But I think it’s fair to assume that any sort of reasonable look at the fourth quarter would tell you we’re likely to be at the top end of that range.

Jeff Bernstein – Barclays Capital

And then as you talked about the margin side of things, it seems like you will get the first 200 basis points over the next couple of months or at least achieve that level. Just wondering if you can just talk kind of bigger picture, we hear a lot of people talk about the first 200 basis points was low hanging fruit and the next 200 there’s going to be whole lot more challenging. We’ve always kind of viewed it as that next 200 basis points not necessarily harder to achieve, it’s just likely to take longer because it’s more technology and equipment rollout rather than just removal of labor. But just wondering if you could talk kind of theoretically about the 400 basis points and whether the next 200 you would view as a greater challenge or kind of timing wise or how you kind of think about that?

Guy Constant

Well, I think it’s fair to say, Jeff, it’s little bit challenging. We’ve asked our operators to do a lot in order to deliver on these results. At the same time that they are seeing higher traffic numbers in their restaurants and lots of momentum on the top line. But so I don’t view this as necessarily any harder than the original ones were. I think they’ve all been hard. What we can say though is with 360 kitchens today with the new line equipment with 150 or so restaurants at the new point of sale equipment, we are getting the results that we need in order to achieve the 400 basis points in restaurants today.

So building up Wyman’s commentary earlier, we’re in rollout phase now. We’re done testing it. We know the results are proving themselves. We have a significant majority of our restaurants that have that equipment today that are delivering on the productivity goals that we need to get the 400 basis points of margins. So while never easy to complete the rollout of those types of things, we know we are delivering it today in restaurants, it’s just a matter of locking it down and delivering it throughout the whole system by the time we roll out the equipment in late December.

Jeff Bernstein – Barclays Capital

I think you have previously said that once you start achieving that, is it possible maybe reaccelerate the refranchising or what not, I am just wondering whether that kind of is the consideration as these trends continue to improve?

Guy Constant

I think what we said Jeff, is that if we are going to do any refranchising we would wait until we had the margin improvement delivered because why sell now when we could sell for later at a higher price. What we are seeing though is that with these kinds of results that you’re seeing today and kind of returns we’re getting in our restaurants, if we can deliver this kind of top line growth going forward is the need to do refranchising is significantly reduced if we can deliver this kind of results on a consistent basis.

Operator

Thank you. Ladies and gentlemen, our next question comes from the line of Michael Kelter with Goldman Sachs.

Michael Kelter – Goldman Sachs

I wanted to ask about your advertising in the quarter. I know earlier in your fiscal year, you had moved some things around that it was impacting sales. The strong results you had this quarter, was it in line or increased number of weeks on air on GRPs and was that a big driver in the quarter?

Wyman Roberts

Hey, Michael, Wyman. We were basically in line with what we did last year, within 100 basis points GRPs. So pretty much similar media plan as we had last year. The big difference was in the first half where we actually had several hiatus weeks less this year than last year. So more comfortable and as we look forward into the fourth quarter we should be actually little heavier in the fourth quarter than last year. But again, pretty much in the same ballpark.

Michael Kelter – Goldman Sachs

And the steaks, you said you sold three times as many as pre-promotion. Just curious if you could talk about, now that it’s kind of gone on a little bit here. Is there any evidence that this is a legitimate step change and can be sustained for a while and change in the way consumers have consumed the Chilli’s brand or is there evidence that maybe was just a very successful promotion and the sales lift might be a little flipping?

Wyman Roberts

Yeah, absolutely. We feel it’s not a promotion. It’s on the base menu, it is something that we think will change how a segment of the casual dining population use Chilli’s, didn’t necessarily think of us as a place to go get steak and now I think we are going to be putting that consideration set which opens us up for an ongoing opportunity. And that’s again why we don’t – why we are focused on building these foundational platforms that are not really promotionally driven. The sustainability we think is going to be very similar to what we saw with our lunch platform which now that we’ve lapped that for over a year, we anticipate seeing the similar kind of results with the introduction of steak.

Operator

Thank you ladies and gentlemen. Our next question comes from the line of John Glass with Morgan Stanley.

John Glass – Morgan Stanley

As all of us are trying to understand how sales build year on year, and Wyman I think you talked about improving the menu and core items and steak was a highlight and maybe I under appreciated this quarter we got the lunch but steak was maybe a little bit of a surprise. You talked about how you under image or under index in that category, what are the major categories do you think you under index in and that may be relevant to take a look at again, and maybe just what size steak for is this -- how big a category is it for you, is it 5% of your sales typically, and it’s now 10% or maybe give us some relative expectations on that?

Wyman Roberts

Well, it’s interesting John. I don’t want to really give you too much because I think there may be some other people listening that I wouldn’t necessarily want to have them know what we are working on. But I will tell you this. There are other options. There are other categories that we think are viable for Chilli’s to continue to steal share from. If we are not taking our fair share in today, they are significant and they work really well off our new kitchen platform.

So as we look start to finish the rollout of our new kitchen, that also opens up opportunities in these areas where we may be under penetrated today but we may have been under penetrated because we couldn’t deliver the product. And now we’ll have a platform that will allow us to deliver that product. So there are several – there are basically four that we are very excited about and I am not going to get into details of what those are but I will tell there are four that we think could be very viable for us as we look to the future how we grow the business and to continue to make Chilli’s even more relevant going forward. Without necessarily adding to the complexity of the operations which is always our balance right.

John Glass – Morgan Stanley

And then as you – so that steak ways into the new kitchen equipment and POS are coming into restaurants now and you mentioned it gives you confidence in the next 200 basis points of margin capture or part way there. What have been the experiences so far, in other words, have there been positive or negative incremental training costs you didn’t expect or people understanding how to use this, going faster? Has it been difficult to put POS and the kitchen equipment in the restaurant at the same time? So is there anything that you’ve taken away from this either upside surprise or maybe one that’s more cautious in terms of either the pacing or the expensive role to get out, that would be helpful.

Wyman Roberts

Well, John, I will talk to you about the experience. Guy can update you on kind of how the financials have played out. From a – listen, when we go into a restaurant in some places we have actually done a reimage, a kitchen of the future and the new POS, it’s a lot. I mean, that is a lot to ask for our operators. But they are very excited about it. They are asking for it. And while it takes them a little bit of effort, lot of effort trying to get everything put in, they are actually getting that in place in a relatively short period of time. And when they are through with the introduction and the new learning, there nobody would go back.

So when we ask our cooks, after they have learned the new line, if they would like us to bring back the old equipment, there is nobody to sign in up for that. So we think the investments are obviously working for us but they are also helping to deliver better guest and team member experience. But there is effort. I mean it’s hard work and our operations team has done an outstanding job just getting themselves aligned and focused on making this happen. This doesn’t happen without some really good operators putting a lot of hard work and effort into changing our system.

Guy Constant

Hey John, let me jump in on your question around some of the financials and what we are seeing. So in terms of training costs, really we do a lots of training every quarter, every year. And so really all we did was shape the existing training but it’s just to focus more on the rollout of the new equipment and the new point of sale system. So no significant increase there in terms of the costs.

In terms of the results, I think what’s interesting is, and where frankly we’ve had some challenges is the way we decided to roll this out is by putting some kitchens in every area or every region of the country first so that we could bring the people there to do the training as opposed to flying people around the country. So much more efficient from a training point of view. What it did though is we created situations where an area director, region director had only partial or portions of their area that had the kitchens and other portions that didn’t. And so as you can imagine, managing the old kitchen line and the new kitchen line within your same area you don’t get quite the same efficiencies that you would if you had the entire area all with the kitchens.

Now that being said, we still have the vast majority of our restaurants that are hitting on the labor productivity goals and you really see that kicking to gear when we get a whole area populated with the kitchen line equipment. So do we think there is upside – once our operators get their hands on new equipment and consistently operate, I think things like the prep initiatives that we came out with earlier, that was driven by operators getting new tools and new reporting and new processes in their hands, and working it and driving better results , I think once they get the same sort of familiarity with the new kitchen line equipment, there will be opportunities to deliver even better results, not just in terms of labor productivity but in the guest experience as well.

On the POS side, look, we thought we would be more rolled out today than we are at this point right now, and again back to that, we want to get it right. We don’t want to mess up the experience with the guests by throwing technology at our servers that they may not be able to execute on. We now feel like we have it right and that’s why we are kicking off the last phase of the rollout in June and will be done by December. So that didn’t come without some difficulty but the results are there now and we feel like it’s just a matter of rolling it out and locking it down.

Operator

Thank you. Our next question comes from the line of John Ivankoe with JPMorgan.

John Ivankoe – JPMorgan

Just following up maybe on that, on the last point in terms of getting the point of sale system right. Discuss, I guess CapEx coming in a little bit below where you had modelled in fiscal ’12, and what that may mean in ’13 as you kind of catch up I guess with the point of sale system and continue the kitchen of the future. And talk about the remodel budget, that you have for fiscal ’13 as well in terms of total capital spending. So that’s I guess the first part of the question.

And then secondly, maybe the opposite of refranchising you acquiring the franchise rights for South Florida, including development of that obviously important market. Is it the case now or we should expect new unit CapEx from Chilli’s, materially in fiscal ’13 or is that a fiscal ’14 event and are you beginning the plan for that?

Guy Constant

John, I will take both of those. So CapEx, we think, is probably going to be in the range of about $150 million in fiscal ’13. We will provide lot more specifics when we get to the August call. But as a ballpark number now to work from, that’s probably pretty consistent to where we thought was going to be even at the start of fiscal ’12. But clearly you are right, our capitals come in a little bit lower than that.

The remodel is probably about $60 million of that budget for next year, and again our goal is to try and get anywhere between 60 and 75 remodels a quarter done in the system. And we have lots of markets teed up now after the first steaks that are ready to go. Permits are being done and drawings are being done. And so all the legwork that you need to do before you can kick that off is well underway.

In terms of new unit growth, other than focusing on trying to get some restaurants that are company-owned near you, John, no, I think going forward, new unit growth is going to be a part of the facilities plan we had talked about turning that on, starting in fiscal ’13 at both Maggiano’s and Chilli’s. We are actively looking for sites right now. We’ve identified some relocation opportunities for Chilli’s at the start of the process. But there will be, as we talked about in the last call, probably 1% to 2% unit growth at Chilli’s on an annual basis starting at some point in fiscal ’13 as we start to get new units seeded.

In terms of a broader sort of strategy to buy back franchise locations, it’s possible. It’s an avenue by which we can add store weeks fairly quickly. So it is an opportunity for us to look at that but I wouldn’t consider that a material part of our strategy going forward.

Operator

Thank you. Our next question comes from the line of Joe Buckley with Bank of America-Merrill Lynch.

Joe Buckley – Bank of America-Merrill Lynch

Can you talk about the supply for the steak product and if you think you can stay at the price points that you are currently featuring for extended length of time?

Guy Constant

Hey Joe, it’s Guy. There is no doubt there is pressure on these prices out there. I don’t think we would be unique in talking about that. But this is why the broader strategy that we are operating right now fits, Joe. So I know some have been concerned about when we cut costs that we are taking too much away from the guests, so whatever that case might be. What we are really doing is reinvesting back into the guest value proposition, be it reimages to improve the atmosphere, be it kitchen line equipments, we can cook food faster and we can introduce new platforms. Or introducing value platforms like lunch combos and two for twenty or being able to put higher quality products on our menu where guest feedback has told us that we are not hitting the mark the way we should.

And steaks are one of those areas and so yes, we do believe we can hold the price points. When it comes to steaks, and yes the price will be a little bit more expensive but I think when you have the strength in the middle of the P&L you can make these kinds of investments that I think has value proposition better and it’s showing up in our sales now.

Wyman Roberts

One other point, Joe, I think when we look at the category, while we have significantly increased our steak presence, we are still well below some of the key competitors. And so its impact on us relative to the impact it’s going to have on some of these other key competitors is going to be less. And so from a pricing standpoint and our ability to move through fluctuations in the price, we will be less impacted than those folks. And so our ability to weather it and maintain pricing, as Guy said offsets that impact with others – with other things we do in our business to maintain that 400 or deliver that 400 basis point improvement net of all these things, it’s still very doable.

Joe Buckley – Bank of America-Merrill Lynch

And Guy, just one more on the expense line, when does the depreciation line start to show year over year growth?

Guy Constant

Again, we will be able to give you a little more color on that starting in August, Joe. We talked about fiscal ’13 but clearly this year is when – this calendar year is when we are putting in the bulk of the 800 kitchens and we’ve now got 100 reimages done, we’re going to be 60 to 75 a quarter or so. I believe it would be in fiscal ’13, you will start to see a little bit of a tick up in depreciation but we will give you a lot more color on that in August.

Joe Buckley – Bank of America-Merrill Lynch

Okay. Is there anything significant that sort of ran off that depreciation numbers are down?

Guy Constant

I think some of it is just the timing of the capital spend, Joe, this year. So we had thought the start of the year we might be something more in the 150 range and now we are around 120. And then you may recall as well Joe that five years ago at this time is when we were kicking out in terms of our unit growth plans in 2007, I think we built 150 restaurants that year. So some of those five year life items associated with those builds are starting to come off.

Operator

Thank you. Our next question comes from the line of Mitch Speiser with Buckingham Research.

Mitch Speiser – Buckingham Research

Definitely a strong quarter with a very solid comp, if I look at the monthly, so it does seem like March bit slowed a bit and we know the industry slowed. But I was wondering just maybe putting aside the industry pressures, was there anything to point out as to why traffic at Chilli’s did decelerate from the January and February? Of course there was weather too but the up 0.5% traffic in March, just wondering if that was in line with internal targets and if you feel if that 0.5% was maybe – could you explain that why by some other factors?

Wyman Roberts

Mitch, it was mostly the – if you look at the weather going through the month, if you strip out the weather we were 4.7, 4.3, 3.5 on the sales line. So a lot more consistent than it might appear at first bust when you look at it. But no, other than that, nothing unique that we would point to necessarily in terms of traffic trends, we are very pleased with how that went and of course on that sequentially we got significantly better than KNAPP over those three periods. Actually March was a better performance versus the category even January was.

Mitch Speiser – Buckingham Research

But on a fundamental basis, that traffic of 0.5% it seems like that wasn’t affected by weather and the first two months were that you’re comfortable that -- if that were run rate, you would be comfortable with that or I am just trying to get a sense of that 0.5% was I guess internally considered good. Of course, the category was slow but you also have done of lot of initiatives and the expectations of certainly, (indiscernible) on your ability to drive comps?

Wyman Roberts

We’re looking to drive better traffic than that. If that’s what you are asking, we are looking to drive better traffic than that long term.

Mitch Speiser – Buckingham Research

On Maggiano’s, that March traffic did slip, were there any calendar mismatches in March from Maggiano’s?

Doug Brooks

Hey Mitch, well Maggiano’s did get more help in January and February because of weather but again if you look at Maggiano’s over a period of time, they are on a pretty remarkable around ninth consecutive quarters of sales and tenth in traffic. And although we are disappointed with the March numbers, Maggiano’s really mirrored more where the industry was and just in terms of what Steve and his have done was two value menu options, their preference continues to grow. So we believe that it’s going to help in the future to make Maggiano’s a choice, not just for special occasions but just for Tuesday night when they are looking for something to go eat pasta.

They’ve also seen just like at Chilli’s great guest experience numbers, they’re seeing some growth in their value scores which is really important in these sort of times. So we weren’t as pleased as March as we’d liked but we see continued positive movement going forward at Maggiano’s.

Mitch Speiser – Buckingham Research

On the franchisee group of about 35% of your units, have any implemented the point of sales system or the new kitchen equipment or have they got any reimaging just yet?

Guy Constant

So Mitch, this is Guy again. So point of sale systems, they have a number of different point of sale systems within our franchise system but some do have. They will have menu like systems that we are implementing at Brinker. So we are not mandating that they change their point of sale systems. We feel comfortable on our ability to get the data and the information from them even with the systems that they have.

As for -- some implemented kitchen, yes, some have and they have certainly implemented some of the reimage elements. In fact, some of the elements we have included in our reimage came from some of the work that the franchisees have been doing as well. So it’s a good partnership in rolling those two initiatives.

Mitch Speiser – Buckingham Research

And just one last one, just on the breakage, we’ve seen other companies report that over the years, is that – and at some time there might have been a second breakage adjustment, are you comfortable that this is the full breakage adjustment and is that I guess that’s how you do promotions or coupons as now the consumer seems to be using that more which of course could be somewhat of a margin hit?

Guy Constant

Well, Mitch as has been the case with many retail and restaurant peers as you said, we have seen that gift redemption experience change over the past few years as the economies become a little software and specific maybe to our industry is the mix and sales channels. We used to sell a lot of gift cards in restaurants and now we sell them on third parties as well. But we review breakage regularly and our analysis this quarter just had us reached the conclusion that the redemption experience is adjusted to an extent that we just needed to reduce our breakage assumptions slightly. And now given the volume in gift cards that we sell, a small adjustment in breakage resulted in the estimate that you saw.

But as it has been the case in the past, we will continue to monitor but based on the best knowledge we have today of redemption, we believe this is the change we need to make at this point.

Operator

Our next question comes from the line of Peter Saleh with Telsey Advisory Group.

Peter Saleh - Telsey Advisory Group

Just a quick question on FY’13, I know historically you guys have said, you expect the earnings there to be well above the 10% to 12%. Just wondered if anything has changed in your thought process there and then my second question is on comp sales, where do you stand on mix as a percentage of sales today and where have you been historically?

Guy Constant

And maybe I will take the first one, Peter and I will let Wyman take the second one. No, our thoughts have not changed in terms of fiscal ’13, we do think that it will still be well above 10% to 12% range.

Wyman Roberts

Peter, we run around slightly below 14 and now we are moving up over the 14% of total sales now at Chilli’s.

Operator

Our next question comes from the line of Sara Senatore with Sanford Bernstein.

Sara Senatore - Sanford Bernstein

A few follow-ups. First just on the margin benefit with the buck margin expansion you saw this quarter, I guess a 100 basis points if you strip out the breakage, that’s obviously quite good. You did have a 4.5 comp, so sort of in line with maybe whatever is expected, you usually do like 20 bps for a point in comp that kind of leverage. I guess I am just trying to figure out, are you still seeing lingering benefits from some of the other initiatives that you’ve already had in place, are you doing just the normalization around whether it was like you talked about the kitchen prep for that – those things usually build the long term but eventually you kind of lapped the full benefit. That was one part of the question.

And then the other part was with the POS I don’t know if you ever broke out what the impact is, a lot of people seem to be doing in restaurants, doing new things as POS if you could just talk a little bit about what the margin benefits – remind us again what the margin benefits might look like there?

Guy Constant

Sara, this is Guy. So the commentary around margin improvement, so clearly strong comps helped us in terms of leverage on some of our fixed costs and our commentary earlier certainly not to that end. We do need comps that are , perhaps not a stronger comp than we used to need before in order to generate that kind of leverage given strength in the P&L.

In terms of team service and the original prep changes that we made both of those now well beyond the year ago, I think we fully lapped the impact of those. And interestingly we had thought that this third quarter might be a little bit of a low in margin because the real heavylifting on rolling out the kitchen equipment where we are seeing great results to date. But it’s still fairly early on in the process. We had 360 done by the end of the quarter but a lot of those were put in during the quarter. So we would expect that as well as the point of sales back up to system to start to kick in now and pick up this lag. Now that the previous two initiatives have been fully lapped.

In terms of the point of sale systems, and the benefits associated with that, where we really hope to see that is on cost of sales which as I look back to you earlier commentary on margin and leverage related to cost of sales, you can’t overlook the fact that we are dealing with a lot of headwinds in the commodity environment as well, and we are still able to deliver 100 basis points even despite that. But that’s really where the back up the systems will help us by reducing wage giving real time reporting to our managers that help us control cost of sales. And we’ve commented earlier that we think that could be in the neighbourhood of 50 basis points of benefits to cost of sales over and above the impact associated with the inflation in the commodity basket.

Sara Senatore - Sanford Bernstein

Just one last thing on the franchisees, I know we had question about where they are in kitchen equipment and that kind of thing. Can you – if some of what you – I think you talked about where this – is it big to sort of 4 areas where you think you are under indexed, can you make a push a national advertising campaign to tell consumers that you are offering these things if the franchisees are sort of behind or lagging or whatever haven’t yet quite done the kind of kitchen equipment and remodelling the companies. I guess, I am trying to figure out if you can have like a system wide push, part of the system maybe doesn’t enough kitchen?

Guy Constant

Again, reminder that 65% of our system is company owned versus 35% franchise, so we are little different than the typical franchise system where the vast majority of restaurants are owned by franchisees and not by the company. And so what that creates is a great situation where we are in the same boat the franchisees are, and it’s very important to us that we roll out compelling new platforms that drive sales and improve the P&L because that matters to us as well as it matters to the franchisees.

And Wyman and his team have done to create this great partnership where we test new menu items with franchisees, we get there honestly back of a how easy those are to execute and how compelling those are to the guests. And we do have franchisees that do have the new kitchen line equipment so we will be able to test these items with franchisees as well, and we think as they see the compelling nature of those items, in addition to labor productivity that they are getting, we do think they will come along with us and implement the kitchen.

Operator

Our next question comes from the line of David Palmer with UBS Global.

David Palmer – UBS Securities LLC

I missed a lot of the call, so apologies if I missed something. The new ovens, they are in place, are you seeing a direct benefit to sales from table turns improving?

Guy Constant

We are certainly seeing tick items improved, David, so more than a minute to two minutes faster times in the restaurants where we have the new kitchen equipment. So equating that directly to table turns we haven’t done that. We certainly know that our ticket times are faster and particularly at lunches David, we are competing against some fairly benchmark competitors there, the speed of being able to deliver our product is very important.

David Palmer – UBS Securities LLC

And when you were talking about 50 basis points before, was that menu linked, ordering in sort of anticipating what sort of inventory you need, is that what you were talking about there?

Guy Constant

Yes, today David, our managers don’t get a report on where they are wasting items until a couple weeks after the period ends and what we will be able to do now is get them day reporting is fast, if need be and those are that are struggling the most and be able to tell them exactly what happened the night before, as they can very quickly jump on waste and reduce that can point to cost of sales.

David Palmer – UBS Securities LLC

And there is a separate perhaps additional benefits from the conveyor belt which might improve the consistency in the cooking and therefore avoid waste issues that way from overcooked or undercooked items?

Guy Constant

Yeah the great news about those, David, is they pay for themselves on labor productivity with very good returns but they also give us faster ticket times. They also give us more consistent product which reduces waste and number of meals we need to comp, create a better more consistent hotter food for guests and also allows us to do these new platforms. So it’s a win all the way around and we’re only early on the wage and labor productivity settings are coming and even less than half the system with that today but all the other benefits are yet to come.

David Palmer – UBS Securities LLC

Guy, do you feel like the reimaging, are you continuing to tweak that – are you engineer that – can you give us a sense of maybe some of the qualitative stuff around the reimaging?

Wyman Roberts

Yeah, so we’ve gone through several phases of kind of fine tuning the reimage and I will tell you that design team and construction teams that we’ve got have done an outstanding job. Every market I have gone to, that has taken the learning from the previous market and made the reimage that much better, and that much more effective. And the results would indicate that and what we are seeing in terms of the sales lift.

I think we are probably pretty close to having what I would consider the lock-down version. Of course every market and every -- has its idiosyncrasies and we are in a lot of different buildings and what we have prototypes, there is really hardly ever anything that’s exactly the same. But we feel really good about where we are sitting today in our most recent market, Phoenix market where we put all of the prework into that market is delivering some outstanding results and got it very optimistic about impact that we’re just going to have for the business moving forward.

David Palmer – UBS Securities LLC

In that pace, for company stores are going to be how many a quarter?

Wyman Roberts

60 to 75.

Guy Constant

Yeah, we think 60 to 75 a quarter David but we are still rolling out kitchens and POS systems so we want to be careful about not putting too much on the operators at once. But once that gets done by the end of December, roll the card to see if we could pick up that pace little bit as well.

Operator

Thank you. We have no further questions in queue at this time. And I would like to turn the floor back to management.

Doug Brooks

Hi, Everett, thank you all. I want to thank everyone for joining us on this morning’s call. We’re obviously excited about the positive momentum of our business and the results of the recently completed third quarter. We are also confident our strategies are working moving forward. We are going to continue to take costs out of the business and reinvest dollars in the guest experience. We are upgrading the atmosphere and we’re enhancing the menu and providing everyday value during these sort of crazy and fragile economic times.

Just reiterating, sales strategies at Chilli’s are working, the new equipment is providing additional opportunities, the reimages as they’re testing them, will also be a tailwind and as we said earlier we do have visibility into those next 200 basis points as the kitchens and the POS systems get in place.

And most importantly, we successfully lapped the introduction of the Chilli’s lunch menu last year and we grew both sales and profits year over year materially truncating the series that we couldn’t lap success with more good news. Have a great day and thanks for your interest in Brinker International. Good day.

Operator

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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