EAT – MANAGING THROUGH TOUGH TIMES

EAT proved again that it is managing the aspects of its business that it can control in today’s difficult economic environment. The company experienced sequentially worse same-store sales results in fiscal 2Q09 across all of its concepts with the overall company down 4.5% (following a -3% number in 1Q). Despite this sequential quarterly slowdown, which was felt across the casual dining industry (on average, 4Q casual dining same-store sales declined 190 bps from 3Q according to Knapp Track data), EAT’s fiscal 2Q09 restaurant and operating income margins improved about 140 bps and 130 bps, respectively, from the prior quarter. Additionally, although the company did not provide an update to its previous guidance, which included the expectation of a 2%-4% decline in same-store sales and a 15%-25% decline in EPS, management stated that relative to its internal targets 2Q results came in better than expectations from a cost perspective, and that was with comparable sales coming in lower than the company’s guided range. The company attributed this better margin performance to better cost control across the business. Specifically, the company benefited from better management of food costs, increased labor efficiencies and more disciplined G&A spending.

Management said that it is managing its business under the assumption “that this could be a protracted economic downturn...rather than just being a short-term blip.” To that end, management recognizes the need to make some real changes to its business, with value being the key to those changes. Management acknowledged that “faster and cheaper is the American way” so it is reviewing all aspects of its business to see how it can increase turnover times, decrease labor costs, create exciting new food products, etc. Specifically, management recognizes that the gap between QSR and casual dining has widened in terms of check averages and with faster and cheaper being what people want that EAT is effectively fighting against QSR for market share. This does not mean that EAT wants to compete on price with QSR, but instead that it needs to improve the relative value of the entire Brinker dining experience based on pace and convenience, better food quality and service, facility relevance, price and overall customer satisfaction at a lower cost. Ultimately, management knows that it must get more people into its restaurants.

After examining its entire restaurant portfolio, EAT announced that it will be closing 35 underperforming restaurants, which is expected to boost operating margins by 30 bps. Most of these closures are expected during 3Q with some to follow in upcoming quarters as current leases expire.

EAT had already significantly cut its capital expenditures in fiscal 2009 (down $99.6 million YOY in 1H09 from its reduced new unit development), but management again lowered its capital spending guidance to $110 million from its prior range of $135-$140 million. The company decided it would be prudent to push out the timing on some of its Chili’s reimages to provide increased financial flexibility relative to its current declining sales trends. Management is also committed to using its free cash flow and cash proceeds from the sale of Macaroni Grill to pay down debt and has suspended its share repurchases to further preserve its strong balance sheet in this difficult environment, in which it has little visibility of when trends will materially improve. That being said, EAT stated that after a weak start to January, that sales trends “have firmed up” in the last two weeks. Although two weeks do not make a trend, on the margin, some stabilization is a positive as it relates to recent results.

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