UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 28, 2005

Commission File Number 1-10275

BRINKER INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

6820 LBJ FREEWAY, DALLAS, TEXAS  75240

(Address of principal executive offices)

(Zip Code)

(972) 980-9917

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý         No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ý   Accelerated filer  o   Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o        No  ý

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

BRINKER INTERNATIONAL, INC.

Notes to Consolidated Financial Statements

(Unaudited)

1.              BASIS OF PRESENTATION

The consolidated financial statements of Brinker International, Inc. and its wholly-owned subsidiaries (collectively, the “Company”) as of December 28, 2005 and June 29, 2005 and for the thirteen week and twenty-six week periods ended December 28, 2005 and December 29, 2004, have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The Company owns, operates, or franchises various restaurant brands under the names of Chili’s Grill & Bar (“Chili’s”), Romano’s Macaroni Grill (“Macaroni Grill”), Maggiano’s Little Italy (“Maggiano’s”), On The Border Mexican Grill & Cantina (“On The Border”), and Corner Bakery Cafe (“Corner Bakery”).  In September 2005, the Company entered into an agreement to sell Corner Bakery.  As a result, Corner Bakery is presented as discontinued operations in the accompanying consolidated financial statements.

The information furnished herein reflects all adjustments (consisting only of normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly state the interim operating results for the respective periods.  However, these operating results are not necessarily indicative of the results expected for the full fiscal year.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to SEC rules and regulations. The notes to the consolidated financial statements (unaudited) should be read in conjunction with the notes to the consolidated financial statements contained in the June 29, 2005 Form 10-K. Management believes that the disclosures are sufficient for interim financial reporting purposes.

Certain prior year amounts in the accompanying consolidated financial statements have been reclassified to conform with fiscal 2006 classifications.  These reclassifications have no effect on the Company’s net income or financial position as previously reported.

2.              STOCK-BASED COMPENSATION

Prior to fiscal 2006, the Company accounted for its stock-based compensation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations (“APB 25”), and adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.”  Under APB 25, no stock-based compensation cost was reflected in net income for grants of stock options prior to fiscal 2006 because the Company grants stock options with an exercise price equal to the market value of the stock on the date of grant.

Effective June 30, 2005, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment,” (“SFAS 123R”), which requires the measurement and recognition of compensation cost at fair value for all share-based payments, including stock options.  Stock-based compensation for the first two quarters of fiscal 2006 includes compensation expense, recognized over the applicable vesting periods, for new share-based awards and for share-based awards granted prior to, but not yet vested, as of June 29, 2005.  Stock-based compensation totaled approximately $11.4 million and $632,000 for the second quarter of fiscal 2006 and 2005, respectively, and $19.2 million and $1.2 million for year-to-date fiscal 2006 and 2005, respectively.  The total income tax benefit related to stock-based compensation was approximately $2.5 million and $221,000 during the second quarter of fiscal 2006 and 2005, respectively, and $4.4 million and $435,000 for year-to-date fiscal 2006 and 2005, respectively.

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Under APB 25, pro-forma expense for stock options was calculated using a graded-vesting schedule over the applicable vesting period, which generally ranged from 2 to 4 years.  Upon adoption of SFAS 123R, the Company records compensation expense using a graded-vesting schedule over the applicable vesting period, or to the date on which retirement eligibility is achieved, if shorter (non-substantive vesting period approach).  Had the Company used the fair value based accounting method for stock-based compensation prescribed by SFAS No. 123, the Company’s net income and earnings per share for the second quarter and year-to-date of fiscal 2005 would have been reduced to the pro-forma amounts illustrated as follows (in thousands, except per share amounts):

(1)          If pro-forma expense had been derived using the non-substantive vesting period approach, total stock-based compensation for the second quarter and year-to-date of fiscal 2005 would have been $6.8 million, net of tax, and $10.3 million, net of tax, respectively.  Pro-forma net income for the second quarter and year-to-date of fiscal 2005 would have been $35.0 million and $45.8 million, respectively.  Additionally, basic pro-forma earnings per share for the second quarter and year-to-date of fiscal 2005 would have been $0.40 and $0.52, respectively.  Diluted pro-forma earnings per share for the second quarter and year-to-date of fiscal 2005 would have been $0.38 and $0.50, respectively.

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(a)          Stock Options

Stock options generally vest over a period of 1 to 4 years and have contractual terms to exercise of 8 to 10 years.  Transactions during the first two quarters of fiscal 2006 were as follows (in thousands, except option prices and years):

The intrinsic value of options exercised totaled approximately $6.0 million and $7.2 million during the second quarter of fiscal 2006 and 2005, respectively, and $8.0 million and $14.4 million during the first two quarters of fiscal 2006 and 2005, respectively.  The weighted average fair values of stock option grants were $11.52 and $11.42 for the second quarter of fiscal 2006 and 2005, respectively, and $11.51 and $11.42 for year-to-date fiscal 2006 and 2005, respectively.

The fair value of stock options is estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

Expected volatility and the expected life of stock options are based on historical experience.  The risk-free rate is based on the yield of a five-year Treasury Note.

(b)          Restricted Share Awards

In October 2005, the shareholders of the Company approved the Performance Share Plan and the Restricted Stock Unit Plan (the “Plans”).  The restricted share awards issued under the Plans represent a right to receive a certain number of shares of common stock upon satisfaction of performance goals or other specified metrics at the end of a three-year cycle.  Payouts made in common stock will be fully vested upon issuance.  The fair value of performance shares is determined on the date of grant based on a Monte Carlo simulation model and the fair value of restricted stock units is determined based on the Company’s closing stock price on the date of grant.  Expense related to performance shares and restricted stock units is recognized ratably over the three-year vesting period, or to the date on which retirement eligibility is achieved, if shorter.

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Other restricted share awards include restricted stock and restricted stock units issued under the Company’s stock option and incentive plans.  Restricted share awards issued under the Company’s long-term incentive plans vest one-third per year beginning on the first or third anniversary of the date of grant, and restricted share awards issued to non-employee directors vest in full on the fourth anniversary of the date of grant.  The fair value of restricted share awards is based on the Company’s closing stock price on the date of grant.

Transactions during the first two quarters of fiscal 2006 were as follows (in thousands, except fair values):

At December 28, 2005, unrecognized compensation expense related to restricted share awards totaled approximately $24.9 million and will be recognized over a weighted average period of 3.3 years.

3.              EARNINGS PER SHARE

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the reporting period.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  For the calculation of diluted net income per share, the basic weighted average number of shares is increased by the dilutive effect of stock options and restricted share awards determined using the treasury stock method and convertible debt.  The Company had approximately 2.3 million and 2.6 million stock options outstanding at December 28, 2005 and December 29, 2004, respectively, that were not included in the dilutive earnings per share calculation because the effect would have been antidilutive.  The components of basic and diluted earnings per share are as follows:

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4.              DISPOSITION OF CORNER BAKERY

In September 2005, the Company entered into an agreement to sell Corner Bakery.  The decision to sell the brand was a result of the Company’s continued focus on maximizing returns on investment.  As of December 28, 2005, the net assets to be sold totaled approximately $65.1 million and consisted primarily of property and equipment of $63.7 million, as well as liabilities of $7.4 million primarily associated with severance and selling costs that will be paid by the Company in connection with the disposition.  The sale was completed in February 2006.  The Company has reported the results of operations of Corner Bakery as discontinued operations which consist of the following:

(1)          The sale of Corner Bakery is expected to result in a taxable gain due to $11.0 million of goodwill not being deductible for tax purposes.  The $10.0 million loss includes tax expense totaling $634,000.

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5.              SHAREHOLDERS’ EQUITY

In August 2005, the Board of Directors authorized an increase in the stock repurchase plan of $150.0 million, bringing the total to $1,160.0 million.  Pursuant to the Company’s stock repurchase plan, the Company repurchased approximately 4.3 million shares of its common stock for $167.0 million during the first two quarters of fiscal 2006. As of December 28, 2005, approximately $108.1 million was available under the Company’s share repurchase authorizations.  The Company’s stock repurchase plan will be used to minimize the dilutive impact of stock options and other share-based awards.  The Company will consider additional share repurchases based on several factors, including the Company’s cash position, share price, operational liquidity, and planned investment and financing needs.  The repurchased common stock is reflected as a reduction of shareholders’ equity.

6.              SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid for interest and income taxes for the first two quarters of fiscal 2006 and 2005 is as follows (in thousands):

Non-cash investing and financing activities for the first two quarters of fiscal 2006 and 2005 are as follows (in thousands):

In the second quarter of fiscal 2006, the Company purchased certain assets and assumed certain liabilities in connection with the acquisition of restaurants.  The fair values of the assets and liabilities recorded at the date of acquisition are as follows (in thousands):

The assets acquired and liabilities assumed are recorded at fair values as determined by management based upon information available.  The Company will finalize the allocation between goodwill and reacquired franchise rights (included in other assets) once information sufficient to complete the allocation is obtained.

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7.              CONTINGENCIES

The Company is engaged in various legal proceedings and has certain unresolved claims pending. The ultimate liability, if any, for the aggregate amounts claimed cannot be determined at this time. However, management of the Company, based upon consultation with legal counsel, is of the opinion that there are no matters pending or threatened which are expected to have a material adverse effect, individually or in the aggregate, on the Company’s consolidated financial condition or results of operations.

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Item 2.           MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table sets forth selected operating data as a percentage of total revenues for the periods indicated. All information is derived from the accompanying consolidated statements of income.

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Restaurant expenses, as a percent of revenues, decreased 0.8% and 0.3% for the second quarter and year-to-date fiscal 2006, respectively, as compared to the same periods of fiscal 2005.  The decreases were primarily due to the $17.3 million FICA tax assessment recorded in the second quarter of fiscal 2005 and an increase in sales leverage.  These decreases were partially offset by increases in utility costs, stock-based compensation, and advertising.

Depreciation and amortization increased $3.0 million and $5.7 million for the second quarter and year-to-date fiscal 2006, respectively, as compared to the same periods of fiscal 2005.  The increases in depreciation expense were due to new unit construction and ongoing remodel costs, partially offset by a decrease in depreciation related to store closures and a declining depreciable asset base for older units.

General and administrative expenses increased $9.7 million and $20.6 million for the second quarter and year-to-date fiscal 2006, respectively, as compared to the same periods of fiscal 2005. The increases were primarily due to an increase in incentive and stock-based compensation.

Restructure charges and other impairments recorded during the second quarter and year-to-date of fiscal 2006 consist of charges associated with closed stores.  Restructure charges and other impairments recorded during the second quarter of fiscal 2005 include a $4.8 million charge associated with the disposition of Big Bowl Asian Kitchen (“Big Bowl”), a $1.0 million charge for an existing lease obligation associated with a sub-lease, and a $1.7 million gain associated with closed restaurants.  Restructure charges and other impairments recorded year-to-date fiscal 2005 include the charges previously mentioned, a $31.2 million impairment charge resulting from the decision to dispose of Big Bowl during the first quarter, a $16.9 million charge to fully impair the investment and notes receivable associated with Rockfish Seafood Grill, and a $1.4 million gain associated with closed restaurants.

Interest expense decreased $856,000 and $2.6 million for the second quarter and year-to-date fiscal 2006, respectively, as compared to the same periods of fiscal 2005.  The decreases were primarily due to the redemption of the convertible senior debentures and the payment of the remaining principal balance on the senior notes in fiscal 2005, partially offset by increased average borrowings on the Company’s lines-of-credit.

INCOME TAXES

The Company’s effective income tax rate related to continuing operations increased to 34.0% from 5.8% for the second quarter of fiscal 2006 and to an expense of 33.7% from a benefit of 4.7% for year-to-date fiscal 2006 as compared to the same periods of fiscal 2005. The increases in the tax rates were partially due to stock-based compensation related to incentive stock options, which is not deductible until exercised.  The increase during the second quarter was also attributable to the income tax benefit of approximately $16.9 million, consisting primarily of federal income tax credits related to the additional FICA taxes paid as a result of the IRS resolution in the second quarter of fiscal 2005.  The year-to-date increase in the tax rate was also attributable to the disposition of Big Bowl in the first quarter of fiscal 2005, which allowed the Company to take tax deductions for goodwill impairment charges totaling $48.6 million.

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LIQUIDITY AND CAPITAL RESOURCES

The working capital deficit increased to $206.3 million at December 28, 2005 from $117.0 million at June 29, 2005, primarily due to purchases of treasury stock.  Net cash provided by operating activities of continuing operations increased to $­­­281.3 million for the first two quarters of fiscal 2006 from $191.2 million during the same period in fiscal 2005 due to increased profitability and the timing of operational receipts and payments. The Company believes that its various sources of capital, including availability under existing credit facilities, ability to raise additional financing, and cash flow from operating activities of continuing operations, are adequate to finance operations as well as the repayment of current debt obligations.

Capital expenditures consist of purchases of land for future restaurant sites, new restaurants under construction, purchases of new and replacement restaurant furniture and equipment, and ongoing remodeling programs. Capital expenditures were $164.2 million for the first two quarters of fiscal 2006 compared to $159.1 million for the same period of fiscal 2005.  The Company estimates that its capital expenditures for continuing operations during the third quarter of fiscal 2006 will approximate $99.0 million.  These capital expenditures will be funded entirely from operations and existing credit facilities.

In the second quarter of fiscal 2006, the Company acquired sixteen restaurants from its franchise partners for approximately $23.1 million.

In February 2006, the Company completed the sale of Corner Bakery for gross cash proceeds of $72.5 million.  Additionally, the Company sold six Chili’s restaurants to a franchise partner for cash proceeds of $14.6 million during the third quarter of fiscal 2006.

In September 2005, the Company announced the declaration of its first quarterly dividend to common stock shareholders in the amount of $0.10 per share.  The dividend was paid in December 2005 and totaled approximately $8.6 million.

In August 2005, the Board of Directors authorized an increase in the stock repurchase plan of $150.0 million, bringing the total to $1,160.0 million.  Pursuant to the Company’s stock repurchase plan, the Company repurchased approximately 4.3 million shares of its common stock for $167.0 million during the first two quarters of fiscal 2006. As of December 28, 2005, approximately $108.1 million was available under the Company’s share repurchase authorizations.  The Company’s stock repurchase plan will be used to minimize the dilutive impact of stock options and other share-based awards.  The Company will consider additional share repurchases based on several factors, including the Company’s cash position, share price, operational liquidity, and planned investment and financing needs.  The repurchased common stock is reflected as a reduction of shareholders’ equity.

The Company is not aware of any other event or trend that would potentially affect its liquidity. In the event such a trend develops, the Company believes that there are sufficient funds available under its credit facilities and from its internal cash generating capabilities to adequately manage the expansion of its business.

RECENT ACCOUNTING PRONOUNCEMENTS

In October 2005, the Financial Accounting Standards Board issued Staff Position 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP 13-1”). FSP 13-1 is effective for the first reporting period beginning after December 15, 2005 and requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense.  The Company currently capitalizes these costs.  The Company estimates that rent expense for fiscal 2006 will increase $3.0 to $4.0 million ($1.9 to $2.5 million after taxes) as a result of FSP 13-1.

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Item 3.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the quantitative and qualitative market risks of the Company since the prior reporting period.

Item 4.           CONTROLS AND PROCEDURES

An evaluation was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures [as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)], as of the end of the period covered by this report.  Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective by making known to them in a timely manner material information relating to the Company required to be disclosed in the Company’s reports filed or submitted under the Exchange Act.

There were no changes in the Company’s internal control over financial reporting or in other factors that could significantly affect this control during the quarter ended December 28, 2005, that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

FORWARD-LOOKING STATEMENTS

The Company wishes to caution readers that the following important factors, among others, could cause the actual results of the Company to differ materially from those indicated by forward-looking statements made in this report and from time to time in news releases, reports, proxy statements, registration statements and other written or electronic communications, as well as verbal forward-looking statements made from time to time by representatives of the Company.  Such forward-looking statements involve risks and uncertainties that may cause the Company’s or the restaurant industry’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.  Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include matters such as future economic performance, restaurant openings, operating margins, the availability of acceptable real estate locations for new restaurants, the sufficiency of the Company’s cash balances and cash generated from operating and financing activities for the Company’s future liquidity and capital resource needs, and other matters, and are generally accompanied by words such as “believes,” “anticipates,” “estimates,” “predicts,” “expects” and similar expressions that convey the uncertainty of future events or outcomes.  An expanded discussion of some of these risk factors follows.

Competition may adversely affect the Company’s operations and financial results.

The restaurant business is highly competitive with respect to price, service, restaurant location, nutritional and dietary trends and food quality, and is often affected by changes in consumer tastes, economic conditions, population and traffic patterns.  The Company competes within each market with locally-owned restaurants as well as national and regional restaurant chains, some of which operate more restaurants and have greater financial resources and longer operating histories than the Company.  There is active competition for management personnel and for attractive commercial real estate sites suitable for restaurants.  In addition, factors such as inflation, increased food, labor and benefits costs, and difficulty in attracting hourly employees may adversely affect the restaurant industry in general and the Company’s restaurants in particular.

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PART II. OTHER INFORMATION

Item 1.           LEGAL PROCEEDINGS

Information regarding legal proceedings is incorporated by reference from Note 7 to the Company’s consolidated financial statements set forth in Part I of this report.

Item 2.           UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Shares repurchased during the second quarter of fiscal 2006 are as follows (in thousands, except share and per share amounts):

(a)          All of the shares purchased during the second quarter of fiscal 2006 were purchased as part of the publicly announced programs described in part I of this report.

Item 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company’s Proxy Statement dated September 9, 2005 for the Annual Meeting of Shareholders held on October 20, 2005, as filed with the Securities and Exchange Commission on September 9, 2005, is incorporated herein by reference.

(a)          The Annual Meeting of Shareholders of the Company was held on October 20, 2005.

(b)         Each of the management’s nominees, as described in the Proxy Statement referenced above, was elected a director to hold office until the next Annual Meeting of Shareholders or until his or her successor is elected and qualified.

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(c)          The following matters were also voted upon at the meeting and approved by the shareholders:

(i)                                     proposal to ratify the appointment of KPMG LLP as Independent Auditors for Fiscal 2006

(ii)                                  proposal to amend the Stock Option and Incentive Plan

(iii)                               proposal to amend the 1999 Stock Option and Incentive Plan for Non-Employee Directors and Consultants

(iv)                              proposal to approve the Performance Share Plan

(v)                                 proposal to approve the Restricted Stock Unit Plan

(vi)                              proposal to re-approve the Profit Sharing Plan

Item 6.           EXHIBITS

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