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    MARKET EDGES

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I have made the call that I think full-service restaurants (FSR) will outperform in early 2009 as their top-line results improve, on the margin, or become less bad, largely from Obama’s expected fiscal stimulus plans. I have also said that from a fundamental standpoint, I would expect DRI and EAT to benefit more proportionally from any economic stimulus as they both have strong balance sheets and concepts that are not going away. That being said, all FSR operators would benefit.

All full-service restaurants faced two obvious fundamental challenges in 2008: deteriorating top-line results and historically high commodity costs, which combined drove average FSR operating margins down over 250 bps on a year-over-year basis in 3Q08. The third major issue that hurt FSR stocks in 2008 (on average, down 48% in 2008) was the fact that the industry as a whole significantly increased its leverage at exactly the wrong time. On a debt (including the present value of operating leases)/EBITDAR basis, average FSR leverage increased to over 4x’s at the end of 3Q08 from about 3.3x’s at the end of FY07. Unlike the first two challenges met by the industry, not all FSR companies exposed themselves to the liquidity issues that emerged. Although we would expect all of the FSR operators to benefit from marginally better sales trends in 2009 and lower YOY increases in commodity costs, particularly in the second half of the year, only those companies with strong balance sheets heading into the year are positioned to outperform. Using the industry average debt/EBITDAR ratio as a reference, BWLD, CPKI, DRI, EAT, PFCB, RRGB and TXRH stood out as the companies in the best liquidity position.

Again, I would expect all of the FSR companies to be helped by Obama’s anticipated stimulus package, but from a macro perspective not all of the companies’ restaurant bases are created equal. As we have heard on earnings call after earnings call, dining out trends have underperformed in certain regions of the country, particularly California, Florida and Arizona to name a few. DRI commented last month on its conference call, however, that it is seeing weakness across the country and that some of the regions that had been strong, Texas in particular, did soften up in the second quarter. Using those comments as a backdrop, I set out to determine which FSR concepts are more regionally exposed to the issues currently facing the U.S. consumer, specifically gas prices, unemployment and housing market weakness. From the companies’ labor cost standpoint, I also looked at which restaurant companies are located in states least impacted by both federal and state minimum wage increases in 2009. Please refer to the matrix below for details.

Based on my more positive bias toward EAT and DRI prior to doing this analysis, I was not surprised to learn that both of these companies’ restaurant bases are well positioned from a regional standpoint. I was surprised to see that TXRH, PFCB and RT all screened relatively positive as well.