UPDATE: Brinker Sees Chili's Sales Stabilize, Driving Margins Up

Brinker International Inc.'s (EAT) fiscal third-quarter profits edged up 0.6%, fueled by higher operating margins and guest traffic, as changes at its Chili's Grill and Bar chain are now underway.

Brinker said its margins will continue getting stronger with remodels of Chili's restaurants, efficiency efforts in the kitchen and back-office, and continued strength of its smaller brand, Maggiano's Little Italy.

Brinker's total same-restaurant sales were essentially flat for the quarter ended March 30, primarily benefiting from a 0.6% rise in traffic and a 1.2% price increase. Maggiano's same-restaurant sales growth of 3.4% at company-owned locations was offset by a 0.3% decline at Chili's.

Chili's President Wyman Roberts said the restaurant's traffic rose higher than competitors in February and March. He credited its new lunch combo meals, ranging from $6 to $8, for driving lunch-hour traffic up ahead of other parts of the day.

If customers feel like they are getting a good deal, "that is, to us, a key indicator for future traffic and our competitiveness, and we are very encouraged by what we are seeing there," Roberts said on a conference call. "It also tells us that if we need to think about pricing down the road, we've got ourselves in a solid position."

Roberts said the chain plans to avoid price hikes in order to grow guest traffic while competitors mark up their menus.

"We'll take a look at prices, and maybe play the market a little bit toward the lower pricing strategy to drive traffic," Roberts said.

In recent quarters, Chili's sales slumped due to lower traffic while rival casual dining chains such as Ruby Tuesday Inc. (RT) and DineEquity Inc.'s (DIN) Applebee's have seen significant sales improvements.

Shares of Brinker fell 1.3% to $24.12 Wednesday. The stock is up about 23% over the past 12 months.

Chili's is also undergoing major changes with its "kitchen retrofit," new back office system roll out and restaurant reimaging.

The kitchen implementations, with 15 locations finished now, will likely take until fiscal 2013 to be completed, while the new back office systems' full roll-out is commencing in the first quarter of fiscal 2012.

About 50 locations have gone through reimaging so far, costing about $250,000 each, which $50,000 less than originally expected.

"The impact to next year will be dictated by how fast we can get the reimage program rolling through," Roberts said. "But we are optimistic we can move fairly quickly and that it would have some impact to next year's sales although it won't be huge."

The changes have already had some impact, as restaurant-level operating margins for the quarter rose 1.5 percentage points to 18.3%, making progress toward management's goal from a year ago of achieving net margin improvement of 4 percentage points.

Brinker expects its commodities costs to add about 1 percentage point to fiscal 2012's cost of sales. The company will have a better idea of the full impact once it renews its beef contract in August, which looks to be unfavorable at this point.

Restaurants are concerned with rising gas prices as customers tend to cut back on discretionary spending to conserve funds.

"While, historically, rising gas prices have not had a significant impact on the casual dining industry, we would be in uncharted waters if the prices significantly eclipsed the levels in summer 2008, particularly in the light of the slow economic recovery," said Chief Executive Doug Brooks on the conference call.

But Chili's has "lots of locations so there is a nice convenience factor," Brooks said, adding that employment rates have had a bigger impact in the past than gas prices.

Brinker reported a fiscal third quarter profit of $40.2 million, or 46 cents a share, up from $40 million, or 39 a share, a year earlier. Excluding so-called special items, earnings from continuing operations rose to 47 cents from 37 cents. Revenue edged up 0.5% to $717.1 million.

Analysts polled by Thomson Reuters most recently forecast a profit of 45 cents on $711 million in revenue.

-By Annie Gasparro, Dow Jones Newswires; 212-416-2244; annie.gasparro@dowjones.com

-Matt Jarzemsky contributed to this article.

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