EAT - EARNINGS PREVIEW

The three biggest unknowns in the quarter relative to my estimates are, most obviously, top-line trends, the margin impact from current promotions and the level of investment needed to support changes at Chili’s (any change under the new direction at Chili’s). 

EAT is scheduled to report fiscal 2Q10 earnings next week on Wednesday, January 20th before the market opens.  My ESP estimate of $0.22 is in line with the street and my comparable sales expectations of -4% at Chili’s and on a blended basis are only slightly better than consensus estimates of -4.2% and -4.3%, respectively.  It is important to remember that Todd Diener, the former president of Chili's Grill & Bar and On The Border Mexican Grill & Cantina left the company in the middle of the quarter.  The timing of his departure was odd and may have caused some dislocation within the Chili’s and On The Border systems during the quarter.

The three biggest unknowns in the quarter relative to my estimates are, most obviously, top-line trends, the margin impact from current promotions and the level of investment needed to support changes at Chili’s (any change under the new direction at Chili’s). 

Sales: Management did not provide any comments on how the quarter started out from a top-line perspective on its last earnings call and did not reiterate its prior full-year same-store sales guidance of -2% to -4%. 

Although we have not learned too much from Brinker, specifically, we have gotten a few industry data points that give us some idea of how the casual dining industry fared during calendar 4Q09 (EAT’s fiscal 2Q10).  We know that through November, casual dining same-store sales, as measured by Malcolm Knapp, improved by nearly 90 bps, on a 2-year average basis, from calendar 3Q09.  Brinker outperformed the Knapp benchmark during its last reported quarter by 80 bps on a 1-year basis (reversing the two prior quarter of underperformance) and by nearly 90 bps on a 2-year average basis.  Since November, we have heard a few companies talk about challenging weather in December.  We have also heard quite a few comments about recent regional underperformance in Texas, which is an important market for Brinker, representing about 18% of the company’s restaurant base (about 17% for Chili’s and 25% for On The Border).  Much of this weakness in Texas can be attributed to tougher YOY comparisons as Texas held up much longer than other parts of the country in late 2008, but it will have an impact on EAT’s trends, nonetheless.

Brinker management did not provide a quantitative look at October on its 1Q10 earnings call, but it did say that it was again running its 3 Courses for $20 promotion at Chili’s in October after taking a brief pause from offering it in September.  For reference, Chili’s first started offering 3 for $20 in late July, continued it through August and then stopped offering it in September so that the company could make some adjustments to the promotion.  Brinker’s same-store sales in July were -8.8% (from down low double digits prior to the promotion), -3.1% with the offering in August and -5.4% in September.  The sequential improvement in trends in 1Q10 and subsequent fall off seem to be driven largely by the timing of the promotion (though July was a rough month for much of the casual dining industry) as EAT’s year ago comparisons in the July through September timeframe were not too different and actually got slightly easier in September by about 100-150 bps. 

Based on the better performance with the promotion in place in 1Q10, my -4.0% 2Q10 same-store sales estimate for Chili’s does assume about 40 bps of sequential improvement on a 2-year average basis.  Again, Mr. Diener’s leaving may put my numbers at risk, particularly if his leaving was not by choice and signals that business trends may not have been improving under his direction.

Restaurant-level margins:  EAT’s restaurant-level margins declined more than30 bps during the first quarter after improving in the prior two quarters.  The company’s promotions, particularly 3 for $20 at Chili’s and Today and Tomorrow at Maggiano’s, were largely responsible for the increased pressure on margins.  Helping margins in 2Q10 relative to 1Q10 is the fact that management guided to less food cost inflation during the quarter and had relatively good visibility on these costs as the company was locked in on a significant portion of its costs through the end of the calendar year.

Although the margin impact of 3 for $20 could be greater during fiscal 2Q10 due to the fact that the promotion was available for most of the quarter, management did say that the second introduction of the promotion (after stopping the offering in September) would yield better margins.  EAT’s CFO Chuck Sonsteby said, “Well, we are trying to get a little bit smarter after having the experience of going through it one time. So we are working hard on getting the labor back in line. This is the second time our operations team has had a chance to go through this promotion. So that replication is going to help them a little bit more trying to gain that back. So we would anticipate both some changes to the menu and also some labor efficiencies will help us a little bit more in terms of profitability this time around.”  Specifically, management stated that Chili’s will not require the same level of incremental traffic to hits its margin targets as compared to when it offered the promotion during the first quarter.  So the question is to what extent Chili’s will become more efficient with its execution of the 3 for $20 offering during the second quarter and mitigate pressure on margins.

Revitalization at Chili’s:  Management stated that as the next phase of menu enhancements at Chili’s start to roll into the system that the company would incur approximately $0.01-$0.02 of one-time investment costs for “things such as training, small pieces of equipment needed to efficiently produce certain products, and other smaller items utilized in the preparation or delivery of the new menu items.”  These costs are expected to primarily hit the P&L during the second quarter, with a small amount in 3Q10 as well.  The exact timing of these costs will matter to the bottom line in 2Q10, but more important, I question whether the level of investment will remain unchanged under the direction of Wyman Roberts, the new president of Chili's Grill & Bar and On The Border Mexican Grill & Cantina.