EAT

Business Context and Reporting Period

Company: Brinker International, Inc. (Operator of Chili's, On The Border, and Maggiano's)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Thirteen and twenty-six weeks ended December 24, 2008 (Fiscal 2009 Q2)

Overview: The company operates in a challenging economic environment marked by volatile financial markets, rising unemployment, and cautious consumer spending. The period was defined by significant strategic shifts, including the sale of a majority interest in the Macaroni Grill brand and the closure of 35 underperforming restaurants to improve long-term profitability.

Key Financial Metrics

Margins (13 Weeks 2008 vs 2007):

• Operating Margin: -3.6% (vs. 8.7%)
• Net Margin: -2.3% (vs. 5.3%)
• Cost of Sales: 28.2% (vs. 28.3%)
• Restaurant Expenses: 58.0% (vs. 56.8%)

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 7.8% in the quarter and 7.2% year-to-date. This was driven by a 5.4% decline in comparable restaurant sales (due to lower traffic and unfavorable mix) and a 3.3% reduction in capacity from closures and divestitures.
• Profitability Collapse: The company swung from an operating profit of $89.7 million in the prior year quarter to a loss of $34.2 million. This was primarily due to Other Gains and Charges totaling $85.1 million in the current quarter (vs. a gain of $16.3 million in the prior year).
• Major Charges:
  • Asset Impairments: $45.7 million charge related to closing 35 underperforming restaurants.
  • Macaroni Grill Sale: $43.3 million loss recorded upon the sale of a majority interest in the brand.
• Debt Structure: Moody's downgraded the company to non-investment grade (Ba1/Ba2), while S&P maintained an investment grade rating (BBB-). Consequently, $250 million in uncommitted credit facilities became unavailable, and borrowing costs increased. $90 million of the revolving credit facility was reclassified as current debt due to its 2009 maturity.

Guidance, Outlook, and Risks

Management Commentary & Strategy:

• Capital Discipline: Management has placed a moratorium on share repurchases and eliminated virtually all company-owned restaurant development for fiscal 2010. Capital expenditures for fiscal 2009 were reduced by $30 million.
• Debt Reduction: Proceeds from the Macaroni Grill sale ($88 million) and free cash flow are being used to pay down debt. The company aims to reduce leverage to regain investment-grade status from Moody's.
• Dividends: The company plans to maintain the quarterly dividend at $0.11 per share.
• Outlook: Management expects continued pressure from the economic recession but remains confident in the long-term prospects of the brands. They anticipate reduced borrowing needs due to the divestiture and reduced development.

Risks and Contingencies:

• Goodwill Impairment: Declines in stock price or consumer spending could trigger non-cash goodwill impairment charges.
• Legal Proceedings: A class-action lawsuit regarding California labor laws (meal/rest breaks) is pending review by the California Supreme Court; potential loss is indeterminable.
• Lease Guarantees: The company remains secondarily liable for $228.9 million in lease payments related to previously sold brands and restaurants.

Investor Verification Checklist

• Debt Covenant Compliance: Verify the company's ability to meet covenants given the split credit rating and reduced liquidity access.
• Macaroni Grill Transition: Confirm the status of the remaining 19.9% equity investment and the $10 million standby letter of credit provided to the new entity.
• Restaurant Closures: Assess the impact of the 35 closed locations on future capacity and the timeline for lease termination costs.
• Gift Card Redemption: Monitor Q3 revenue, as a 15% decline in gift card sales in Q2 may negatively impact future quarters when redemptions occur.
• Share Repurchase Moratorium: Confirm if the moratorium on buybacks will be lifted given the $60 million remaining authorization.