Brinker International, Inc Q1 FY2020 Earnings Call

Good morning, everyone, and welcome to the Q1 Fiscal 2020 Earnings Call. It is now my pleasure to hand it over to your host, Mika Ware. The floor is yours.

Thank you, Paul, and good morning, everyone. Welcome to the Earnings Call for Brinker International’s First Quarter of Fiscal Year 2020. With me on today’s call are Wyman Roberts, Chief Executive Officer and President; and Joe Taylor, Chief Financial Officer. Results for the quarter were released earlier this morning and are available on our website at brinker.com. As usual, Wyman and Joe will first make prepared comments related to our operating performance and strategic initiatives. We will then open the call for your questions. Before beginning our comments, it is my job to remind everyone of our safe harbor regarding forward-looking statements. During our call, management may discuss certain items which are not based entirely on historical facts. Any such items should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are subject to risks and uncertainties, which could cause actual results to differ from those anticipated. Such risks and uncertainties include factors more completely described in this morning’s press release and the company’s filings with the SEC. And of course, on the call, we may refer to certain non-GAAP financial measures that management uses in its review of the business and believes will provide insight into the company’s ongoing operations. And with that said, I will turn the call over to Wyman.

All right, thanks Mika. Hey, good morning everyone and thank you for joining us. Fiscal 2020 is off to a solid start for Brinker, right in line with our expectations for the year. Total revenues for the quarter were $786 million, a year-over-year increase of 4.3%. Comp sales were positive at 2.3%, with adjusted net earnings per share of $0.41. These results were primarily driven by another quarter of differentiated execution in Chili’s, with comp sales of 2.9%, marking our sixth consecutive quarter of positive comps. We’ve seen these trends continue into October. We’re pleased with our performance across the country, particularly in critical markets such as California, Texas, and New England. From a traffic perspective, we ended the quarter flat. We were relatively soft early in the quarter like the rest of the industry, but we saw sequential improvements throughout and ended September with positive traffic. Additionally, we drove more than a 300 basis points gap in both sales and traffic relative to the industry, marking our fifth consecutive sales beat and seventh consecutive traffic beat. As we head into our higher volume quarters, we’re confident that we have the momentum to deliver the sales and earnings growth we’ve outlined for the year. The performance we’re delivering today is a direct result of our relentless focus on the strategy we laid out nearly two years ago: delivering best-in-class operational execution, leveraging our scale, providing compelling everyday value, and leveraging our digital expertise to offer convenience the way our guests want it, primarily through takeout and delivery. Our operations team is more aligned than ever around our core operating systems, and we’re getting positive feedback from customers as guest metrics rise to an all-time high. We’re also focused on delivering new quality food with global flavor profiles while maintaining simplicity in our operations. For example, we just rolled out a new improved chicken product. We’re now pounding chicken breasts in-house and hand-breading them to order, which enhances the quality of our product. We didn’t do a broad menu launch that would add complexity; instead, we’ve focused on improving the quality of key products while introducing one bold new menu item to keep consumers engaged and drive frequency. We’ll continue to leverage this balanced innovation strategy while providing quality and convenience to our guests. Our off-premise sales have been a significant driver of overall performance, achieving year-over-year growth rates in excess of 25%. Off-premise sales now represent approximately 15% of total sales. The ongoing demand for the Chili’s brand internationally is a testament to our partners' belief in the strength of the brand, highlighted by the opening of 11 Chili’s restaurants during the first quarter. We've also completed our acquisition of 116 restaurants in the Midwest region, adding strong earnings potential to our business. I’m even more confident in our strategy and our ability to create ongoing returns for our shareholders. Now, I’ll turn the call over to Joe to provide more details. Joe?

Hey, thanks Wyman and good morning everyone. I’ll start with a quarterly overview, focusing on key insights. First, the solid performance of our first quarter positions us very well for the balance of the fiscal year. Second, at Chili’s, our sales and traffic momentum built through the quarter as our operators execute at a differentiating level. This day-over-day execution is growing sales effectively, managing the middle of the P&L, and generating meaningful cash flows in support of our capital allocation strategies. As reported, first quarter adjusted earnings per share came in at $0.41, aligning with our expectations. The quarter was impacted by incremental stock compensation expense compared to the prior year due to eligible executives. This expense of $3.5 million negatively impacted EPS by $0.08, but will reduce in subsequent quarters. Total revenues in the first quarter were $786 million, a 4.3% increase versus the prior year, driven by comp sales growth of 2.3% and additional capacity from our acquired restaurants. While these Midwest restaurants only impacted the last three weeks of the quarter, they’ll contribute approximately $250 million of company sales this fiscal year. Off-premise sales were the primary driver of overall comp performance with a year-over-year growth rate of over 25%. At the brand level, Chili’s reported quarterly net comp sales of 2.9%, outperforming the casual dining industry. Traffic was flat for the quarter, outperforming the industry by over 300 basis points. Maggiano’s first quarter results were below our expectations with net comp sales of negative 1.8%. Its performance was impacted by utilizing fewer resources and the migration to our exclusive delivery contract with DoorDash. Our restaurant operating margin for the quarter was 11%. Within performance, cost to sales had a year-over-year net inflation of about 30 basis points, primarily due to increases in commodity prices. We have established higher levels of commodity contracting to protect against volatility, and we see strong cash flow metrics showing good year-over-year growth. Operating cash flow for the quarter was almost $87 million, while free cash flow grew over $66 million. Overall, I’m pleased with the positive reception to our first fiscal quarter and our focus on delivering quality, value, and convenience for our guests. As we progress, we expect continued market share gains and positive top-line growth. Now, I’ll open the call for your questions. Paul, I’m turning it back to you.

Certainly. The first question is coming from Jeff Farmer at Gordon Haskett. Jeff, your line is live. Please announce your affiliation and ask your question.

Yes. Gordon Haskett. Earlier in the call you commented that trends continued in October. I was just curious if you can provide some incremental detail on that?

Hey, Jeff. Yes, no more detail than that. We tend not to give a lot of quarter-out guidance, but the trends we laid out in the first quarter are largely continuing here in October. So, we’re off to a good start in the second quarter.

Yes. One more question then. I appreciate that it’s only been a month since the delivery functionality went live in the Chili’s mobile app. But what percent of your delivery sales mix is coming from the Chili’s app and website versus the DoorDash marketplace? And where do you think that can trend in coming quarters?

Yes, we’re probably not going to give that level of detail. It’s early, as you said, Jeff, on kind of all of our initiatives around convenience, whether they are to-go or delivery. We’re very pleased with the results we’ve experienced, both with third-party, as well as our independent takeout and delivery initiatives today, and we’re excited about what we can do moving forward. Thanks, Jeff.

Thank you. And the next question is coming from Stephen Anderson, Maxim Group. Stephen, your line is live. Please announce your affiliation and pose your question.

Yes, with Maxim Group. I wanted to follow up on your comments on food commodity costs now. In the last few quarters, we’ve talked about the potential impact from the swine flu coming out of China. Just want to see, if you have additional comments on that and whether you changed your overall commodity cost outlook?

No. Hey, good morning Stephen. We haven’t changed anything from a commodity outlook standpoint. As we indicated before, we continue to believe we’ll see low levels of inflation, putting it in the 1% to 2% range throughout the year. The majority of that is based on the low points returning from the last three years rather than African swine fever. We’re monitoring that closely, and we’re ahead of where we typically are in terms of contracting, particularly for proteins. We want to ensure we’re minimizing potential volatility. We’re comfortable with what we’re seeing.

Okay. Thank you. I’ll be on the queue.

Thank you. The next question is coming from Brian Vaccaro, Raymond James. Brian, your line is live. Please announce your affiliation and pose your question.

Thanks, and good morning, Raymond James. Just on the commodity contract. Joe, I appreciate the color you provided. Just curious if you've made any progress or tried extending those contracts, particularly around the proteins for the back half of calendar 2020?

Yes, without getting into great detail, we are looking at term contracts and have taken some steps for proteins extending into calendar 2020. We want to maintain certainty for our operators, so we are looking into that.

Okay. And then Wyman, could you elaborate on some opportunities you see to improve operations further, and provide an update on the rollout of handheld devices and any key operational initiatives for fiscal 2020?

Hey, Brian. What I was referring to is as we lock down the systems our operators focus on, it allows us to pinpoint where there are challenges, and we can energetically put our support into those areas. Our operators have done an amazing job in creating a better guest experience. Our guest satisfaction levels are now significantly better than they’ve ever been. Concerning the initiatives, we’re moving forward on technology fronts, with new tabletop devices expected to be rolled out in the third quarter. The handheld devices are continuing to evolve, and we’ll have more to share on that in the third and fourth quarters.

Okay. And then just two on the model real quick. Joe, does the shift in the timing of stock-based compensation show up in an outsized way in any specific quarter of the rest of fiscal 2020 or will that be layered in through the next few quarters?

No. The only outsized impact is this quarter in the G&A side of the equation. You’ll see it in slight benefits through the second, third, and fourth quarters.

Okay. And just on the depreciation and amortization line, there’s a wide range of estimates on the street. Would you be willing to tighten that up, in regards to what’s embedded in your fiscal 2020 guidance?

Yes, we’re sticking with the guidance as previously provided. The Midwest region is part of that year-over-year delta. Overall, I do expect it to be up in the high-single millions in that $5 million to $8 million range as we move through the year.

All right. That’s helpful. Thank you.

Thank you. The next question is coming from Gregory Francfort, Bank of America. Gregory, your line is live. Please announce your affiliation and pose your question.

Hey, it’s Greg Francfort for Bank of America. Two questions, the first for Wyman, and actually maybe both for Wyman. Just on guest metrics, you alluded to a stronger performance earlier on. Could you expand on what you’re seeing?

Sure. We look at various metrics, and we’re focused particularly on several key in-restaurant metrics that we extract from our guest feedback. We’re seeing broad-based improvements across the board, from food to service, with guests who experience any kind of difficulty. For value, our scores have reached all-time highs, indicating strong positive feedback.

Great. And then on delivery, could you discuss how customers are using delivery right now, and any early learnings from that launch?

Certainly, usage is broad-based across the country, with increased adoption during dinner and lunch. We’re excited about what we can do going forward, leveraging the data we gather from this new initiative to better market to our delivery consumer.

Thank you.

All right, Greg.

Thank you. The next question is coming from Chris O’Cull, Stifel Nicolaus. Chris, your line is live. Please announce your affiliation and pose your question.

Thanks. It’s Stifel. Wyman, the consolidated comp sales for the quarter were lower than the full year guidance. Are you still comfortable with that range and what opportunities do you see to improve Maggiano’s performance?

Yes, we’re still comfortable with our guidance. For Maggiano’s, although it was a tougher quarter with some headwinds, we believe in their potential. They’re focused on the holiday season and marketing their catering services more aggressively, which we think will improve performance and drive traffic as we approach this critical time of year.

Chris, for context, a 20 basis point impact at Brinker level was due to weather, which also hit Maggiano’s harder.

Okay. And Wyman, now that Chili’s digital platform offers delivery, when do you expect to begin advertising that service more aggressively?

We’re already marketing delivery both nationally and through various digital channels, so we are actively promoting our new delivery service.

Are you seeing stronger performance on the digital platform than from the DoorDash marketplace?

We’re pleased with both third-party delivery and our white label service. They’re complementing each other well.

Lastly, Joe, could you remind us of the incremental sale leaseback impact for the quarter?

Sure. Last year we recorded a net gain of over $13 million in the first quarter, which we dialed out from an adjusted standpoint. Incremental rent from the sale leaseback impacted us about $4 million this year.

Perfect. Thanks guys.

All right. Thanks, Chris.

Thank you. The next question is coming from David Palmer, Evercore ISI. David, your line is live. Please announce your affiliation and pose your question.

Thanks. Evercore ISI. A question on the comps. The company seems to be seeing a sales trend much higher than the franchise. You mentioned a few regions that were stronger. Was that primarily due to these factors or other reasons causing that gap?

Yes. There are several factors, including regionality and the variances in delivery usage across markets. We also leverage our CRM and the Chili’s Rewards program differently across markets. Over time, we tend to align ourselves with franchise performance, but there may be fluctuations.

And Joe, regarding the initial guidance provided for fiscal 2020, is the restaurant level margin guidance ranges still intact?

Yes, the guidance remains intact. We are comfortable with the direction we’re seeing for the remainder of the year. Labor efficiencies and the top-line leverage from acquisitions will play into this along with managing commodity inflation.

Thank you.

Thanks, David.

Thank you. The next question is coming from Will Slabaugh, Stephens. Will, please announce your affiliation and pose your question.

With Stephens. Thanks guys. I had a question on the three for $10 promotion. Is it still performing well, and how do you see menu innovation affecting that this year?

Yes, three for $10 continues to perform as expected. We’re seeing consistent mix as we’ve seen previously. It’s not currently available for third-party delivery, which is interesting. While our culinary and marketing teams have been quietly testing exciting ideas for the back half of the year, we’ll see opportunities to innovate even more.

Also to point out, we saw a 60 basis points positive mix, indicating that our mix categories are performing well as we realize the benefits of a steady state now.

Got it. That’s helpful. And then on the margin side, Joe. It looks like only about 10 basis points, roughly flattish year-over-year. Is that how you would characterize it?

Yes, the restaurant operating margin has mirrored our expectations with only minor variance. We’re maintaining our outlook across the board.

Good to hear. Thanks guys.

All right. Thanks, Will.

Thank you. The next question is coming from John Ivankoe, JP Morgan. John, your line is live. Please announce your affiliation and pose your question.

Hi, thank you. I wanted to go back to some comp commentary. Wyman, you were unusually specific about September, indicating positive traffic, which is important. Did that positive traffic continue in October, and should we expect the second quarter to be more difficult than the first?

Yes, we continue to experience solid sales and positive traffic in October. For the second quarter, we don’t anticipate significant headwinds, and our position is stable, which bodes well for continued performance.

Thank you. And regarding DoorDash, what is the current status of that relationship and any updates on initiatives?

We’re happy with our partnership with DoorDash. The delivery integration was completed quickly, and they’re now marketing the brand alongside us to help grow our presence in this channel.

Thank you.

Thanks, John.

Thank you. The next question is coming from Nicole Miller, Piper Jaffray. Your line is live. Please announce your affiliation and pose your question.

Piper Jaffray, thank you and good morning. I wanted to revisit your packaging initiative for delivery. Could you explain the current progress and timeline for implementation?

Yes, we’re evaluating how to improve our packaging to enhance the food experience while reducing costs. We expect to see implementations by the second half of the fiscal year.

And regarding Maggiano’s, given its upscale positioning, are there worries about the higher-end consumer, particularly for the holiday season?

While the upscale casual segment may face pressures, we’re optimistic about the holiday season based on early bookings and initiatives we’re executing.

Thank you.

All right, thanks Nicole.

Thank you. The next question is coming from Jeffrey Bernstein, Barclays. Jeffrey, your line is live. Please announce your affiliation and post your question.

Thank you. Two questions: Joe, on the labor line, how are you managing to hold it flat as a percentage of sales in the current environment?

The ongoing execution and simplification of operations have allowed us to utilize our labor models effectively, thus stabilizing our labor costs despite inflationary pressures.

Got it. And then Wyman, regarding the challenging environment you mentioned earlier, can you clarify what you mean? Is it traffic, competition, or something else?

The challenges mainly reflect industry-wide traffic pressures. We’re striving to differentiate our strategies to drive traffic and maintain our position.

Understood, thank you.

Thanks.

Thank you. Our next question is coming from Sara Senatore, Bernstein. Sara, your line is live. Please announce your affiliation and pose your question.

Thank you. Just a couple of follow-ups: first on the labor line, was the increase in managerial compensation expected, and should we assume a similar impact going forward?

Yes, the incremental level of managerial bonuses, about $0.04 in EPS, is tied to their performance. We’ll keep evaluating based on top-line results and overall performance.

And on delivery, are you expecting increased competition in the near term?

We believe that our partnership with DoorDash positions us well amid the competitive landscape. We’re excited to continue growing delivery alongside our takeout business.

Thank you.

All right, thanks, Sara.

Thank you. The next question is coming from Eric Gonzalez, KeyBanc. Eric, your line is live. Please announce your affiliation and pose your question.

Hey, it’s KeyBanc. So just a question on takeout, I think you said this was the eighth quarter of takeout growth, but could you share what that growth rate was during the quarter?

Yes, off-premise growth was high-single digits. Additionally, our marketing was heavily focused on delivery, yet takeout continues to thrive, showcasing our efforts in providing convenience.

Thanks.

All right, thanks, Eric.

Thank you. The next question is coming from Bob Derrington, Telsey Advisory. Bob, your line is live. Please announce your affiliation and pose your question.

Yes, hi, Telsey Advisory. One quick question. Wyman, on product innovation, should we anticipate that this will be a less complex year compared to typical years?

Yes, last year was simple, but effective. We’re focusing on meaningful innovations that could resonate with guests, rather than frequent major changes, ensuring operators can execute successfully.

Okay. And Joe, regarding commodity outlook, is your concern primarily around swine fever, or is it more about securing certainty in your costs?

It’s about minimizing volatility and providing price certainty to operators. We’re locking in contracts for important commodities while monitoring market dynamics.

Got it, thank you.

Thank you. The next question is coming from Andrew Strelzik, BMO. Andrew, your line is live. Please announce your affiliation and pose your question.

BMO. Thank you. I was hoping to get an update on the loyalty program, particularly on sign-up and membership. Are you happy with it and what’s the timeline for future plans?

We’re actively building our loyalty database, and our operators are effectively communicating the benefits to guests. We see all positive trends moving forward as we leverage our data.

Great, thank you. Just a follow-up on value and promotions. Are you seeing increased competition, and how does Chili’s position itself?

Yes, we notice enhanced promotional activities, but we are committed to our solid everyday value strategy, and it’s resonating with our guests. We will continue to strengthen our image.

Thank you very much.

All right, thanks.

Thank you. The next question is coming from Howard Penney, Hedgeye Risk Management. Howard, your line is live. Please announce your affiliation and pose your question.

Hedgeye Risk Management. If you were to change your delivery provider, how complex would it be, and how long would it take without losing momentum?

We have no intention of changing our current partner. We’re satisfied with DoorDash and excited about how well we’ve integrated delivery into our operations.

Thanks.

Thank you, Howard.

Okay. Thank you everyone. I think we’re out of time. We appreciate everyone joining us on the call today and look forward to updating you on our second quarter results in January. Have a wonderful day.

Thank you everybody.

Thank you, ladies and gentlemen, this concludes today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.