Edited Transcript of EAT earnings conference call or presentation 30-Apr-19 2:00pm GMT

And with that said, I will turn the call over to Wyman.

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Wyman T. Roberts, Brinker International, Inc. - CEO, President & Non-Independent Director [3]

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All right. Thanks, Mika. Good morning, everyone. As you saw in this morning's press release, third quarter was another solid quarter for Brinker.

We delivered adjusted earnings per share of $1.26, an increase of more than 16% over prior year. Total comp sales were up 2.6%. This performance was driven by Chili's comp sales growth of 2.9%, sequential margin improvements and positive traffic of 3% during the quarter.

Our momentum is broad-based across company and franchise restaurants, and it spans the country. It's not regionally driven, and it's withstood what's been a more challenging winter than normal. We continue to grow sales through traffic and gain share from our competitors. Q3 marked the fifth consecutive quarter of significantly outperforming the category in traffic and the third consecutive quarter with a positive sales gap.

Our consumers are in a good place. Economically, with record low unemployment and income growth now expanding throughout the middle class, more people are choosing to dine out, which is strengthening our whole industry right now, and we see this into the foreseeable future. While this environment does allow some pricing power to help manage costs, we've chosen to maintain a tight pricing strategy, staying in our targeted range of 1.5% to 2%, which we did take late this quarter. We believe this discipline further strengthens our value position for the long run versus taking a more aggressive approach to pricing.

A little more than a year ago, we transitioned our strategy from being more marketing-centric, leaning heavily into traditional marketing to continually bring new guests to the -- new news to the consumer, to a more guest-centric model, focused on the fundamentals of delivering a craveable, quality core menu at a compelling value, executing consistently for our guests. Because what matters most to us is that we create a better guest experience every day; that we strengthen the connection with our guests; we inspire them to visit more often with relevant, targeted communication; and we deliver better food and service every time they come in. And our guests are seeing the difference. When we look at our guest metrics compared to last year before we put this model into place, every metric is up significantly and climbing. We're increasing trust with our guests, which supports our business in the short term and increases the longer-term sustainability of our strategy.

In terms of our value proposition, what sets us apart is we've devised this flexible platform with the same commitment to quality and the experience our guests expect from us now. We haven't reduced our portions or compromised on quality. Instead, we've maintained and even improved our products, and we offer it at a price point that's compelling to our guests and works for our business model.

Take our $5 margarita program. We didn't go to the lowest possible price point. Instead, we created a program that features premium liquors, and we change the offering every month to keep it fresh and relevant to the changing seasons. For example, our recent value margaritas feature premier brands like Hennessy, St-Germain, Jameson Whiskey and Grand Marnier. The program generates significant social media buzz, drives traffic and strengthens the brand.

The same goes for our 3 for $10 program. I know there's been a lot of concern about the sustainability of this offering. Could we really deliver quality products at that price point and sustain the volume that it's helping drive? And the answer is yes. 3 for $10 has been in place for a year, and our business model has held up. Our cost of sales are in line, we're managing labor and delivering positive cash and flow-through. The value strategy is compelling. It's profitable, and it's a differentiator for us.

And like everyone in our category, we continue to be aware and engaged in growing our off-premise business to go with a solid driver again this quarter, with both brands up over 17%. We're starting to wrap on solid results from last year, and we're still seeing double-digit growth. We're getting smarter about execution and delivery -- delivering the best possible experience to our to-go guests. More than half of our order's coming through digital platforms, which integrates directly into our system and offers a seamless experience for guests and operators, enabling us to efficiently manage this ever-growing part of our business.

At Maggiano's, our delivery business continues to grow, up double digits year-to-date primarily through our third-party partnerships. We clearly see the opportunity delivery could bring to our business. And just like with our value strategy, we're holding true to what works for us, committing to do it right for the guest every time.

We've seen a lot of players skin their knees on the bleeding edge of this burgeoning business, and frankly, for us, it's been too high a risk as we worked hard the past year to build trust with our guests. Now that our foundational business is strong, we're committed to figuring out a delivery program that integrates with our system and delivers a high-quality experience to our guests just as they're experiencing inside the restaurants and with take-out. We're close to finding a partner capable of managing our scale, one who is just as committed to our guests as well as profits for our shareholders.

As we wrap on our first year of this foundational shift in our strategy, we're highly encouraged by our momentum, both from a sales and traffic standpoint but even more importantly, from a consumer perspective. We're strengthening the trust our guests have in us, and we've done that with a relentless commitment to operational execution. The momentum builds over time with every experience we create, so we'll continue working closely with our operators to understand what they need to run great shifts every day.

Our leadership team is spending more and more time in the restaurants with our operators and guests to understand where our opportunities are, what we can do to better support our team and remove any obstacles to better enable them to connect with our guests and drive traffic. We'll continue to keep our team aligned and focused and eliminate any distractions that may drive a short-term lift but create chaos for our operators and confusion for our guests. That discipline and commitment runs across every part of our business, from our value proposition to how we execute our food, to what our service model looks like, to how our off-premise business operates and how we set ourselves up for success in that rapidly growing part of our business.

I'd like to thank our operators at both brands for their continued hard work and dedication to making our guests feel special every day.

And now I'll turn the call over to Joe to walk you through the numbers. Joe?

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Joseph G. Taylor, Brinker International, Inc. - Senior VP & CFO [4]

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Thanks, Wyman, and good morning to everyone. The third quarter results we reported this morning represent another step forward for both our top line strategies and our efforts to continue the upper trajectory of our bottom line earnings. Our third quarter revenues of $839 million, up 3.3% from prior year, were driven by positive comp sales at both Chili's and Maggiano's. The combined Brinker comp sales growth for the quarter was 2.6%. Franchise and other revenue was up $5.7 million year-over-year effectively due to our adoption of the revenue recognition accounting standard.

At the brand level, Maggiano's continued its streak of positive comp sales, reporting a 0.4% gain for the quarter. Chili's reported its fourth consecutive quarter of positive comp sales, up 2.9% driven by traffic gains of 3%. With our acute focus on traffic-driving strategies, our outperformance of the casual dining sector accelerated in the third quarter. Chili's outperformed the sector by nearly 5% in traffic, driving a positive gap of more than 2% in comp sales. Chili's has now maintained a positive traffic gap to the casual dining sector for 5 quarters.

These results are also in the context of some tougher weather months, with Chili's comps being negatively impacted by 70 basis points for the quarter, while Maggiano's was impacted by approximately 140 basis points. Overall, the combined Brinker comp sales performance would have increased approximately 80 basis points without the weather impacts throughout the quarter.

We reported restaurant operating margin of 14.3% for the third quarter, a meaningful sequential improvement from our last quarter. While this is a reduction compared to the third quarter of last fiscal year, the change is almost entirely due to our sale-leaseback transaction and our adoption of the revenue recognition accounting standard, moving franchisee marketing contributions out of our ROM calculation. Without these 2 planned impacts, our third quarter restaurant operating margin would have been flat to the prior year's level.

Cost of sales for the quarter increased 50 basis points year-over-year primarily due to our investment in our successful value platforms. Overall, the commodity environment remains in line with our expectations, and we continue to manage price volatility with effective contracting.

Restaurant labor was up a modest 20 basis points comparatively for the quarter. Wage rates continue to increase although staying in our expected range of 3% to 3.5%. We invested incremental hours into the restaurants, particularly in the high-growth area of to-go sales, and overall operating performance increased our manager bonus payouts by almost 30% year-over-year. These increases were offset by sales leverage, efficiencies from our broadening CSL program and improved health care experiences.

The largest change in our operating margin is in the restaurant expense area, which is where the impact of the revenue recognition accounting change and sale-leaseback rent is recorded. Restaurant expense was negatively impacted by 180 basis points in the quarter from these 2 items. 70 basis points of that impact was offset by sales leverage and lower marketing costs driven by our shift to more effective digital marketing. The net result was a 110 basis point increase in restaurant expense margin.

Further down the P&L, depreciation expense was down 40 basis points due to the impact of our asset sales, but G&A expense increased 40 basis points due to IT investments and higher performance-based incentive compensation when compared to third quarter of last fiscal year in both cases. Our quarterly adjusted tax rate of 9.6% reflects the true-up for 3 quarters of a slight downward revision in our forecasted annual tax rate. We believe our annual rate will be at the low end of our 10% to 11% forecast primarily due to increased effectiveness of tax credits emanating from top line performance. The resulting adjusted earnings per share reported this morning for the quarter is $1.26, close to a 17% increase in third quarter earnings.

This quarterly result, combined with our expectation of the final fiscal quarter, leads us to believe our annual EPS achievement will be in the upper half of our guidance range. The cash flow-generating capability of our business model remains sound. EBITDA generated during the quarter exceeded $103 million. After capital expenditures, there were approximately $49 million. Our adjusted free cash flow for the quarter was $53 million, bringing our year-to-date adjusted free cash flow total to almost $98 million.

Free cash flow from the quarter was primarily used to repay revolver borrowings, maintaining our lease-adjusted leverage at 3.9x. As we move into the final quarter of this fiscal year, we remain confident in our strategies to sustain the positive growth of our business, whether the guest is dining in our restaurants or getting food to go. Importantly, we're increasingly aligned with meeting their needs for good food, improved service and everyday value across a varied menu.

With our comments now complete, we can move to questions, which will last until the top of the hour. (Operator Instructions) Kate, let's open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today is coming from John Ivankoe.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [2]

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With JPMorgan. I was wondering, in an environment where you're focused on value and, obviously, labor costs are higher for everybody, what type of initiatives that you have in test or that you're looking at or that you think have promise to either stabilize or grow your restaurant-level margins in '20 and, perhaps, '21?

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Wyman T. Roberts, Brinker International, Inc. - CEO, President & Non-Independent Director [3]

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John, we're looking at a couple of things on the technology side, obviously, wherever possible, if we can leverage the technology to make us more efficient and effective. And I think, again, one of the keys to being a bigger player in the space is our ability to invest in technology and then bring it to the restaurants in a way that really supports our overall experience for the guests. That's probably the biggest area we see to gain efficiencies.

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Joseph G. Taylor, Brinker International, Inc. - Senior VP & CFO [4]

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Yes. John, the other one I would mention with our version in the comments is the -- at the managerial level, the CSL program, we are in the process of rolling out. And it's probably about 3/4 to 80% of the way rolled, which is a certified shift leader, one that's creating a great career path for team members who wanted to move into that part of the business. And it's helping to offset some of those labor headwinds and make it a more efficient operation.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [5]

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And Wyman -- sorry, go ahead.

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Wyman T. Roberts, Brinker International, Inc. - CEO, President & Non-Independent Director [6]

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Let me just add one other thing to the list. As Joe was talking, it reminded me that we're really getting much more effective with our marketing programs. So the old model of just using traditional media to kind of throw it out there en masse just hasn't been as effective as we found our much more targeted programs, whether using digital and, obviously, using our loyalty databases. It's just much more effective allowing us to kind of reduce some of our traditional marketing expense.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [7]

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And on the technology side, I mean, is it front of house? I mean, I know we've -- pay-at-the-table has been for a long time, but we've talked about the handheld ordering. Or does Brinker now have the scale where you can start to explore more technology in the back of the house? Is there anything that can be done from an automation perspective there?

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Wyman T. Roberts, Brinker International, Inc. - CEO, President & Non-Independent Director [8]

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I think near term, it's still some of the front of the house, although we're bringing even more and more technology into the back, mainly more from a management perspective, just to help them understand exactly what they need to be doing and how to do that efficiently, not so much the robotics side of it. But that's -- believe me, we're looking at everything, and we've got ourselves kind of pushed out on some pretty interesting stuff just to make sure we're not leaving any stone unturned.

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Operator [9]

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Our next question today is coming from Jeffrey Bernstein.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [10]

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From Barclays. Two questions, one just following up on the labor topic. And Joe, I think you mentioned that the third quarter inflation was within, I believe, what you reiterated for full year, which was at 3% to 3.5%. Just wondering if you can give us any more color. Obviously, you had 3%-plus traffic growth. Just wondering, is that inflation prior to the incremental labor you need for that traffic growth? And maybe any color around just how much is mandated versus market pressure, where your turnover stands, anything along the labor line will be great.

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Joseph G. Taylor, Brinker International, Inc. - Senior VP & CFO [11]

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Jeff, thanks. Yes, that is looking at wage rate pressure, which is one of the components. On top of that, as I indicated, we have added labor hours back into the restaurants, both from a volume standpoint and then also making sure that we're effectively staffing an area like to-go, which, when you have that double-digit year-over-year growth, you want to make sure that you're providing a good guest experience. So that's probably the highlight area when I think about hours going back into the system. Clearly, you have upward expense related to manager bonus, that 30% year-over-year. That's an expense we're glad to see because that's driving up the entire P&L performance of the restaurants. So great job. And our -- and we're pleased to be able to reward our managers for the efforts they're doing in that regard. There's -- labor headwinds are out there. I think we consistently talk that we expect to see them remain out there. The only particular pressure, I guess, I would add in addition to where we're investing into our business is in the back of the house, you do see some higher wage pressure around the cook position. But again, it's well within our ability to manage the business, and it's meeting kind of the expectations. We're not seeing anything really coming out of line with our thought processes for how that would develop.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [12]

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Got it. And my other question was on the outlook, whether it's the -- I guess we have an implied fourth quarter at this point. It seems like the comp range is rather wide considering what your full year comp guidance is. So I'm wondering if there's any help you can give in terms of tightening that range or whether there's any color on trends quarter-to-date and, in conjunction with that, whether you have any directional thoughts, at least, on any specific areas where you have visibility going into fiscal '20.

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Joseph G. Taylor, Brinker International, Inc. - Senior VP & CFO [13]

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Again, we have a guidance policy, so the guidance that is in place stands unless we change it. I think we'll just reiterate the color I gave you in my comments, which we do expect the upper half of the range as it relates to EPS. We're doing well across -- our performance is doing well across the board of our guidance that we provided you for the year. But I'm very comfortable with the ranges we provided and very comfortable how we're performing against those ranges. So that's kind of the -- we'll talk about fourth quarter in August.

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Operator [14]

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Our next question today is coming from Chris O'Cull.