EAT

Business Context and Reporting Period

Company: Brinker International, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 28, 2005 (Second Quarter of Fiscal 2006)
Business Overview: The Company owns, operates, or franchises restaurant brands including Chili's Grill & Bar, Romano's Macaroni Grill, Maggiano's Little Italy, On The Border Mexican Grill & Cantina, and Corner Bakery Cafe. Corner Bakery is reported as discontinued operations following an agreement to sell the brand in September 2005.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 10.9% for the quarter and 11.5% year-to-date compared to the prior year, driven by a net increase of 102 company-owned restaurants and comparable store sales growth of 2.2% (quarter) and 2.9% (year-to-date).
• Profitability: Operating income margin improved to 6.5% for the quarter and year-to-date, up from 5.6% and 3.9% in the prior year periods. This was aided by a significant reduction in restructure charges and impairments ($2.5 million YTD 2006 vs. $50.8 million YTD 2005).
• Stock-Based Compensation: Adoption of SFAS 123(R) effective June 30, 2005, resulted in a significant increase in stock-based compensation expense ($19.2 million YTD 2006 vs. $1.2 million YTD 2005).
• Discontinued Operations: Corner Bakery results are now classified as discontinued operations. The sale was completed in February 2006 for gross proceeds of $72.5 million.
• Debt and Liquidity: Long-term debt increased due to borrowings on credit facilities ($68.5 million net borrowings YTD), partially offset by the redemption of convertible debentures in the prior year. The working capital deficit widened to $206.3 million, primarily due to treasury stock purchases.

Guidance, Outlook, and Risks

• Third Quarter Outlook: Management estimates revenues will increase approximately 11% compared to the same quarter in fiscal 2005. Cost of sales is expected to be 0.2% lower as a percent of revenues due to favorable commodity costs. Restaurant expenses (excluding stock-based comp and refranchising gains) are estimated to be 0.3% lower.
• Capital Expenditures: Estimated at $99.0 million for the third quarter, funded by operations and credit facilities.
• Dividends: The Company declared its first quarterly dividend of $0.10 per share, paid in December 2005.
• Share Repurchases: The Company repurchased 4.3 million shares for $167.0 million YTD. Approximately $108.1 million remains available under the repurchase authorization.
• Accounting Changes: Implementation of FSP 13-1 regarding rental costs during construction is expected to increase rent expense by $3.0 to $4.0 million in fiscal 2006.
• Risks: Key risks include competition, seasonal sales fluctuations, commodity price inflation, energy costs, and the ability to secure real estate and permits for expansion.

Investor Verification Checklist

• Discontinued Operations: Verify the final accounting treatment and tax implications of the Corner Bakery sale completed in February 2006.
• Stock-Based Compensation Impact: Assess the long-term impact of the new SFAS 123(R) accounting standard on future earnings per share.
• Working Capital Deficit: Monitor the sustainability of the $206.3 million working capital deficit and the Company's reliance on credit facilities.
• Comparable Store Sales: Track the sustainability of the 2.2% to 2.9% comparable store sales growth amidst rising commodity and labor costs.
• Capital Allocation: Review the balance between aggressive share repurchases ($167M YTD) and capital expenditures required for the projected 152-169 new restaurant openings in fiscal 2006.