Denny's Corp (DENN) 2003 Q3 法說會逐字稿

Good afternoon. My name is Jeff and I will be your conference facilitator. At this time, I'd like to welcome everyone to the Denny's third quarter 2003 earnings conference call. All lines have been placed mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Please limit your questions to one with one follow-up question. If you have more questions, please re-enter the queue. Thank you.

I'd now like to turn the conference over to Ken Jones, Vice President and Treasurer. Please go ahead, sir.

Thank you, Jeff. Good afternoon, everyone, and thank you for joining us. Speaking first today will be Andrew Green, Denny's's Chief Financial Officer, who will give you a financial review of our third quarter's results. I will then provide a liquidity update followed by a few words from Nelson Marchioli, Denny's President and Chief Executive Officer. After Nelson's remarks, we will open it up for a Q&A period. Let me remind you that a replay of this call can be reviewed later today either from Denny's web site or by dialing into the telephone replay number.

But before we begin, let me deliver these Safe Harbor disclosures. In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the company notes that certain matters to be discussed by members of management during this call may constitute forward-looking statements. Such statements are subject to risks, uncertainties, and other factors that may cause the actual performance of Denny's to be materially different from the performance indicated or implied by such statements. Such risks and factors are set forth in the company's annual report on form 10K for the year ended December 25, 2002, and in any subsequent quarterly reports on form 10Q.

With that I will now turn it over to Andrew Green, Denny's CFO.

Good afternoon. This is Andrew Green. Thanks for joining us for our third quarter 2003 investor conference call.

Let me start by reviewing our same-store sales results for the third quarter, which we previously reported in our September sales release. Same-store sales for the quarter were down 1.2% at company restaurants, as an increase in average guest check of 4.5% was exceeded by a 5.4% decline in our guest counts. Our sales improved steadily throughout the third quarter after a difficult July, when we were without media support compared with a full media promotion last year. In August, we went back on air with our three complete breakfast campaign, which been a successful promotion for us. Our sales began to improve as we went from down 5% in July to basically flat in August. Our sales turned positive in September, up 1.8% for the month. On Friday of this week, we will be releasing our October sales results. Our preliminary numbers indicate another month of improving sales with same-store sales up approximately 4%.

Now let me turn to an update on the Denny's restaurant portfolio. Our company and unit count at quarter end was 562 compared with 577 units at the same time last year. The reduction over the last 12 months is due primarily to the closure of 16 company restaurants. However, during the third quarter, we only closed one company unit. In fact, over the last three quarters, our company restaurant portfolio has remained relatively stable as we have closed only a handful of units and have not sold any to franchisees. I do expect this trend to continue with only a minimal number of closures or sales in the near-term. Also, we do not expect to open any new company units in the near-term. Regarding recent activity in the franchise portfolio of restaurants, in the last 12 months our franchisees have closed 49 stores while opening 23 new stores. During the third quarter our franchisees closed 22 units while opening 6 new units.

Now, let's turn to the P&L. Sales at company -- at company-owned restaurants decreased $8 million to $216 million in the third quarter. The sales decline resulted primarily from restaurant closures and to a smaller degree from our same-store sales decline. Operating income in the third quarter was down approximately $6 million compared with the same period last year, due in part to the decrease in company restaurant sales as well as the higher operating costs in our restaurants, especially food and labor. Operating income in the third quarter benefited from a scheduled $5 million decrease in depreciation and amortization expense.

We have experienced significant cost pressures over the last few quarters, which have continued into the third quarter. As a result, our company restaurant operating margin, as shown in the margin analysis table in our press release, dropped approximately 3 percentage points compared with last year's third quarter. The largest contributor to this margin decline was a 2 percentage point increase in product costs, which excludes .6 of a point of increase due to lower noncash deferred gain amortization in this year's quarter. The product cost increase is attributable to a combination of several factors. The first of which is higher commodity costs. Over the last few months, the restaurant industry has been hit hard by rising beef and pork prices, a trend we expect to continue into next year. In an effort to offset these and other rising operating costs, we will be rolling out a menu update during the fourth quarter, which will include a price increase of approximately 2%. The next factor in rising product costs was a shift in menu mix. Last year we were focusing our promotional strategy on the $2.99 grand slam breakfasts, and we have shifted this year to higher-priced menu items, which may have a lower percentage margin, but provide a larger dollar profit. The last component of the product cost increase is our investment in food quality. We have made numerous quality improvements to our menu through the addition of new items as well as upgrading the components of many established menu items.

Moving to labor, another significant margin issue for us has been payroll-related expenses, which were up .7 percentage points over last year in the third quarter. The payroll component was higher due in part to our efforts over the last two years to increase the number of managers in our restaurants in order to improve our service and hospitality attributes. On the benefits front, we continue to experience higher medical costs, similar to others in our industry and throughout corporate America. While payroll and benefit costs in total are higher than last year's third quarter, we were able to bring down these costs from the past three quarters through better labor management and improved scheduling.

Our third quarter G&A expenses increased $1.2 million from last year. This resulted primarily from the elimination of transition services fees, which we were collecting last year from our FRD subsidiary. The -- these transition services, fees, and our agreement with FRD ended in November of 2002. Franchise and licensing revenue in the third quarter decreased by a half a million dollars to $23 million as the number of franchised restaurants declined by a net 26 units since the same period last year. Franchise operating income was flat with the prior year at $16 million.

Regarding bottom line net income, for the third quarter we reported a net loss of $6 million compared with net income of $56 million last year. Last year's third quarter results benefited from a $57 million gain on disposal of discontinued operations, attributable to the divestiture of our FRD subsidiary. A quick note with regard to capital expenditures, our cash capital spending for the third quarter was approximately $9 million, bringing the year-to-date total to $23 million. We expect total expenditures for 2003 to come in around $35 million. General facilities upgrades will consume the bulk of this investment with our ongoing remodeling efforts making up the remainder. As you can see from the earnings release, we were able to improve on last quarter's margins but we remain down compared with the prior year. During the third quarter, our sales increased each month from July to September, and our operating margins showed some improvement. We will continue to tighten our operations and run more efficiently, but ultimately it will take consistent improvement in customer traffic and sales in order for us to post significantly improved results.

Before I turn the call back to Ken, I'd like remind everyone that Denny's fourth quarter results will include one extra week, or 14 weeks of operations, yielding a 53-week fiscal year for 2003. More specifically, the year will end on December 31, 2003, which puts one of our strongest weeks of the year, the week from Christmas to New Year's Eve, in December rather than January of next year. Now I'm going to turn the telephone back to Ken Jones, our Treasurer, for a liquidity update.

Thank you, Andrew.

At the end of the third quarter we had borrowings under our credit facility of $63 million compared with $50 million at the end of the second quarter. Letters of credit remained at $38 million, leaving availability under the facility of $24 million at quarter-end. On September 26, which was a couple of days after quarter-end, Denny's amended its $125 million credit facility to include a new $40 million term loan. We applied the $40 million term loan proceeds to pay down outstanding revolver loans, which improved our overall liquidity position. Effective September 30, commitments under the revolving portion of the credit facility were reduced to $123 million as scheduled in the credit agreement. The commitments are scheduled to reduce by an additional $2 million to $121 million at the end of December. As of today, we have outstanding term loans of $40 million, letters of credit remain at $38 million, and outstanding revolver advances of $20 million, leaving a revised net availability of $65 million. Regarding bank covenants, we met all of our financial covenants for the quarter, and under the most restrictive covenant we maintained an EBITDA cushion of approximately $5 million. Based occurrent trends, we expect to meet all of our financial covenants in the fourth quarter, as well.

Let me now turn the program over to Nelson Marchioli, the CEO of Denny's.

Thank you, Ken.

And good afternoon, everyone. This year has certainly been challenging. We discussed on previous calls the difficulties experienced by the restaurant industry in the first quarter from the war, harsh weather, and a soft economy. In the second quarter we certainly were optimistic about the opportunity raise our sales by promoting our dinner and late-night business. While we were successful in lessening the traffic declines in these day parts, customer counts at breakfast took a sharper than expected drop. We believe the breakfast decline resulted from the fact that we had not talked about our breakfast in our media all year long. Also, the prior year period benefited from a Grand Slam promotion, which is certainly designed to boost traffic, although at a lower price point and lower dollar margin. The second quarter traffic declines worsened in July when we were further impacted by a lack of media support. Without the media support in July, our sales declined 4.9%, which obviously put us in a big hole to start the third quarter. As we mentioned on last quarter's conference call, we went back on air in August with a strong breakfast promotion. This campaign featured our three complete breakfasts for an attractive price point of $4.99 and focused on the customer's core expectations of Denny's: breakfast and value. We began to see the impact of the promotion almost immediately as evidenced by our significantly improved sales and customer traffic during the month. The success of this promotion in August led us to add three additional weeks of media, split between fiscal September and October. This further contributed to sales improvement in September as we posted a sales increase of 1.8%. Even more encouraging was the fact that we closed the quarter with seven straight weeks of positive same-store sales.

As Andrew mentioned, we will report our October same-store sales this Friday, which will indicate sales up almost 4% with positive traffic of approximately 2%. This brings the string of positive same-store sales to 11 weeks. One key learning from the first half of the year is that although Denny's is well-known for breakfast, we cannot stray too far or too long from that breakfast message in our media. We cannot forget that breakfast is Denny's most credible day part. Going forward, we intend to utilize breakfast media messages as pillars for guest traffic while building credibility in our other day parts. In fact, this past Monday, we began to air our latest media campaign, which will run for the next four weeks. This promotion features the meat lovers' breakfast, the most popular of our current promotion three complete breakfasts.

With our recent sales improvements, we are optimistic that our many investments in the Denny's brand over the last two years are beginning to pay off. As always, thank you for your interest in Denny's. Back to you, Ken.

Okay, Jeff, we will now begin the Q&A portion of our program.

At this time I would like to remind everyone, in order to ask a question please press star then the number one on your telephone keypad. Please limit your questions to one with one follow-up question. We will pause for just a moment to compile the Q&A roster. Your first question comes from Robert Gotch of Miller Tayback Roberts.

Hi. Good afternoon. Just a question, you -- you stated that you made the minimum EBITDA test this quarter with the $5 million cushion. I believe that EBITDA covenant does go up an additional $5 million for the fourth quarter of -- of this year, which would imply that you guys do expect to be, you know, flattish to up for 4Q to 4Q?

Robert, actually the covenant in the fourth quarter is a $90 million minimum. It does not go -- which is the same as the third quarter.

Okay. Maybe I -- maybe I looked at your -- your old covenants. Okay, and under the test, the bank's definition of EBITDA, what was the LTM number you came in at?

We came in right around 95 -- 95.1. It's a slightly different definition than what we report in the Q.

Right, that's why I asked. Thank you so much.

Your next question comes from Karen Altridge of Goldman Sachs.

As you look at the year past, and obviously you've had some hits and misses in what day parts you advertise and what meal promotions you do, have you kind of formulated what you want to do for next year? How you will divide up your advertising dollars? What new product promotions you'll be doing? And I understand you have a new advertising agency. What kind of vision do they have for the brand?

Hi, Karen, it's Nelson. We have had the same advertising agency, Publicist Mid-America, probably for a good -- since September of last year. We plan on continuing with the current strategy or vision, if you will, that we have: Denny's, a good place to sit and eat. We will build around that. Further, we intend on focusing on breakfast in our media messages next year. That appears to be where our strength is, and research tells us that we can talk about breakfast but also we can talk about lunch and we can talk about late night. And that's -- that will be our direction, but as you see our media next year, it will be focused on breakfast.

Great.

We'll focus on in-store as far as dinner is concerned as well as other day part opportunities.

And will that -- will that continue to be a new promotions like the barbecue line?

We will -- the barbecue line, although it did get us to literally almost flat -- we were in double-digit decline from prior year in lunch and dinner day part. And barbecue arrested that, if you will, and brought us back to flat. The problem was we lost breakfast traffic because we didn't talk about it. So, in our advertising campaigns going forward, you will see us trying to talk about two things at one time, but we're going to be very careful about that. I think you may have seen media already that talks about breakfast, but we also, at the end, have a tag about our late-night opportunities, as well.

Great. And promise, last question, I was very impressed to see the handle you've gotten on your labor costs. Do you think there's additional opportunity there? And is that reflective of you guys scheduling better versus cutting back hours?

We are not cutting back hours; we are managing it a lot more closely. We continue to invest, but we are much stronger with our operators to make sure that they are spending it at the appropriate time. We had a learning curve to go through, as I think I mentioned on the last call, for our operators to get through because we had frankly starved the system so much on not investing in labor appropriately nor in management to cover the appropriate day parts. So, we -- we do have a -- probably a better handle on it because our people are getting better experienced at it, and we're verifying that they're spending it during the right times. So cutting hours, well, we probably are cutting hours and hours where they shouldn't have had labor to begin with as they went through that learning curve, but we're not cutting hours in the most important Friday, Saturday and Sunday day parts that are critical to our business.

Great. And do you see further opportunities?

I do. I do. Some areas of the country have been quick to respond to this additional focus, and I do see some additional opportunities. I think the fourth quarter will demonstrate that in preparation for us to enter the 2004 year on good footing.

Great. Congratulations on your progress.

Thank you, we need a lot more!

Your next question comes from Tijal Patel of Deutsche Banc.

Hi, good afternoon, guys. Actually just sort of carrying on with that line of questioning, do you guys feel that the operation is now right-sized, and so we're looking at something that's more of a top line issue? Or is there something still on the cost structure that you feel like you've got to undertake -- or even on a Cap Ex standpoint terms of remodeling, building new stores out, along those lines? I'm trying to get a feel for whether the business can actually grow into the balance sheet from the perspective of it just being either top line issue or if there's still an issue in terms of the cost structure, where, you know, you have the investment behind the labor, investment behind getting customer satisfaction up.

I would say it's still both. There's no question that growth in the top line, long-term, remains very critical. We need to grow our customer counts, they've gone down a lot over the last 10 or 15 years. And we need higher average unit volumes than we have today. At the same time, though, as I look at the P&L, I still think we have a little more work to do. Some areas have been not so much under our control, such as utilities or health costs in the short-term, but I can tell you right now, using that example, we are aggressively working with our health insurance brokers to really evaluate what is the right health insurance cost structure for an entity, you know, a retail restaurant entity like us. And that's an area we're looking at aggressively. Product costs are up a lot. And, you know, while we're committed to maintaining and improving our food quality, we're looking hard at all the components that go into our product cost line to see if there's any tweaking there. So, I guess the answer to your question: I still think there's some more work to do on the cost lines, and I'm hoping, frankly, for a little luck on some things like utilities and some things that have been outside our control. But in the long run, certainly top line growth is critical.

And then in terms of the product cost, are you guys locked into any contracts or do you have certain contracts for the supply of -- of beef or pork or whatever -- you know, dairy products, things like that? Is there anything that you have that protects you from some of the raising commodity costs? Are you going to be renegotiating some of those contracts?

We're in renegotiations on an ongoing basis, but we have just successfully negotiated what we think, based on market, very good steak agreements for the next 14 months. It actually would take us through the end of this year, so it would be for 2004. We are about to go into negotiations on our hamburger for next year, and pork is one of those things we ride the market. And we are exploring other alternatives because bacon and sausage come from pork bellies, and that is literally a real commodity on -- in that particular market. It's very volatile, needless to say, depending on what time of year. We're looking for other options on processing, purchasing in advance and whatever other measures we can take. So, the pork side of our business, which is extremely important, is still work in progress.

Okay. And then in terms of the price increase, what historically has been your ability to have that stick?

Well, as you look back over the last two to three years, we have held our price increases to less than 2% per year. And that's really been our philosophy, because for several years prior to that, frankly, the brand had taken price increases of close to 5% a year. I believe if we stay, you know, at 2% or less, I think it will stick. I think in the years when we were taking 5%, that was too much and we lost customer counts as a result.

Okay. And do you have a rough estimate of what the extra week might add this year in terms of either top line or EBITDA?

The -- on a -- on a top line standpoint, it's around $17 million of company sales, and it has about a $5 million positive EBITDA impact.

Okay. Great, thank you.

Bye.

Your next question comes from Andrew Ebersole of KDP Investment.

Good afternoon. I was hoping you could discuss what your capital budget outlook is for 2004? And maybe break it down in terms of how the money is going to be allocated, please.

You know, we've been running in the neighborhood of $40 million a year in total, and at this point that's about the range I think we'll -- we'll be next year, although we are still working on our plan for next year. This year we -- we are spending somewhere in that 35, 37-range, I think. We're doing 50 to 60 remodels at about $150,000 a piece, so, you've got say 8 to $9 million in remodel money with the bulk of the rest really being our what we call facilities capital.

Thank you.

Your next question comes from Marty Murray of Murray Capital.

Hi, good afternoon. You've obviously done a very good job stabilizing the business from what started out as a difficult summer. And you've also improved the -- the immediate liquidity issue that the company had by terming out some of the bank debt and increasing your availability. My question is that I suspect that the continuing high leverage that's on the company is preventing the brand from really reaching its full potential. And I just wanted to know whether you agree with that. Right now a significant amount of your capital structure is trading at a big discount. And whether or not you see an opportunity there in the next 12 months or so to do something about that, that might be to the benefit of all constituencies.

Well, we've certainly recognized that the company is highly leveraged, and we do not have a lot of flexibility for future growth. And we do have our credit facility coming due next year, so, that's obviously something we need to be looking at. We can't rate until the end of the year. And as we stated in the past, we -- we are always looking for ways to improve our capital structure and -- and also our more long-term liquidity position. But at this time, it's just not appropriate to really speculate on what we may or may not do in terms of the specific transaction.

Do you expect that there will be some kind of a transaction in the next 12 months, let's say?

Well, we're not going to speculate. I mean we have -- we're always looking at opportunities.

Your next question comes from Nick Pie of Syler and Company.

Can you give a sense of how much lower gross margins can go? Have we seen the worst from beef and pork prices, or is there another leg down to come, you think?

I know that our purchasing people talk about beef and pork remaining high, so I don't know that we're going to see a lot of relief there in the near-term. And that's why, frankly, we've chosen to lock in on our beef price -- prices. I -- I don't know, I'm looking at Nelson, I don't know that we necessarily see escalating prices there, but I mean predicting the market, obviously, is tough.

Right, of course. I'm relatively new to the story. Was the fourth quarter of last year an [outlyer] in terms of gross margins, you know, under 16%? Or is that to be expected for the busy fourth quarter period?

We've made a lot of quality improvements in the product that are hitting this year that probably didn't have their full impact on the fourth quarter last year. I -- so, I would go ahead and tell you that I wouldn't expect the margin to go down any worse, assuming commodity prices don't get any worse than they already are. My expectation would be that margins should actually improve in the fourth quarter and next year as we take our price increase and as we manage our food ever more closely. So, I really don't see the margin -- I do think we've seen the worst of it at this point, but markets could take a -- an ugly turn.

Got it. And then one last question. If the Cap Ex for '04 comes in as you expect, you know, 35, $40 million range, where would you guys put yourselves in terms of being comfortable with the stores' general upkeep? Would you think you're there and then you can go back to a regular maintenance Cap Ex cycle? Or is there still much more improvement that needs to be done in the store base?

We certainly speculate that certainly next year a year as Andrew described, 35 to $40 million, and we speculate that the following year will be similar to that. Beyond that, we do think we're going get to benefit of having made all these investments, but as I've stated on these calls before, we are dealing -- we call them remodels, but the reality is it's just major facilities deferred maintenance, when you get right down to it. So, we think we have at least one more year, maybe two.

Got it. Thank you.

Your next question comes from Arthur Rollick of Banc of America Securities.

Hey, guys. Can you tell us how much dark leases cost you this quarter?

For the quarter --

We aren't going to be able to give you that one, Art.

Yeah, we have to look for it here.

Maybe, then, can you tell us how much you think it would be for the second half of '03, then third and fourth quarter combined? Do you have that?

Yeah, give us -- give us a couple of seconds, Art.

Okay. And then I will go ahead and ask the next question. Can you talk a little bit about, you know, I-Hop on their conference call earlier this week said they had been taking some share from you. Can you talk about what they're doing in terms of their expansion and moving a little bit more into the late evening segment is impacting you and what you sort of intend to do to confront that?

Well, as far as late night is concerned, I-Hop is just one of several over the last couple of years that have announced -- most recently it's gotten a lot of coverage, but McDonald's has announced they're going to stay open until 4:00 A.M. Certainly I-Hop has released a press release here about a month or two ago that they were going to open another 200 restaurants on a 24-hour basis. We have Jack in the Box out there far our more aggressive opening on 24 hours. Taco Bell and Wendy's have extended their late night hours at their drive-thru. As far as impact is concerned, obviously we the first to be 24 hours in every location except where legal requirements prohibit us from doing so. So, market share was something that we have that others want, and some people have been successful in getting that. Whether I-Hop has been successful or not, I really can't respond to that, but clearly late night is a way for many brands to increase their sales. That's about all I can say about that.

Art, regarding the cash payments related to exit costs or leases, for the third quarter we paid out about $1.2 million, and we expect for the full year we'll be in the neighborhood of almost $8 million -- in that range. And I will go ahead and give you the estimate for '04; we're expecting around $4 million.

And that was '04?

Yeah.

Okay. I think that is it. Thanks a lot, guys.

No problem.

Your next question comes from Ken Bann of Jeffries and Company.

Good afternoon. With your new marketing programs and you're trying to build the lunch and dinner menu items, can you give us an idea as to when you expect this to turn EBITDA around? Where you -- is it late this year? Next year? The year after? Can you give us a ballpark as to when you think,your plans, this will turn earnings positive?

I guess I'm not sure I understand your question as to what turn-around you're --

Well, I mean earnings are down, you know, roughly 30% so far this year. When are we going to get at least flat with the prior year? And when are we going to hopefully -- hopefully in your plans there's some idea that this might term positive rather than continuing to be negative versus the prior year. When --

Yeah, I would --

When in your plans is that going to happen?

I would expect that 2004 will be positive.

For the full year?

Yes.

Do you think it's going to be stronger in the second half than the first half? Is that what you're looking at or what your current thinking is?

You know, the first -- to be honest with you, that's a hard question to answer. Summer is our big season. We had a real weak July this year, so I'm expecting, frankly, to have a much stronger summer season. You know, we had some rough weather early in the year, you know, this year. You know, I can't predict the weather for the coming winters, so I'm a little hesitant to tell you that it will be better this year, but I certainly hope that it will be better earlier in the year, too.

Okay. And can you give us an idea how much in sales is derived really from the pork products or steak or hamburger? How important are those three items in the menu? If you can give us some kind of figure as to, you know, how much in terms of sales they represent.

I really don't have that in terms of sales. They are certainly important products on our menu.

Is pork the largest?

Yes.

Is it a -- is it the largest by a large margin? Is it pork, hamburger and then steak? Is that the way it.

I'm not sure. Do you think it's that order?

It's probably pretty close.

We sell a lot of steak because of the T-bone breakfast and all, but pork is definitely the biggest, I'm not sure between the hamburger and the steak.

But you're totally exposed on pork at this point?

That's correct.

Okay. Thank you.

Your next question comes from Georgia Shore of Fleet Securities.

Actually it's David Brecht. Good afternoon. Most of my questions have been answered, but have a question on the balance sheet. What is the large decrease in payables and accruals? It's about a $30 million decrease from year-end.

We're looking for the answer. One second.

And also, can you talk at all about the customer traffic trends by region? Is there any kind of like regional differences there, significantly?

The west and the east have performed relatively well all year long. Midwest from Texas to Chicago have been negative for us, and we've put some initiatives in place that have worked over the last 11-odd weeks. So, there clearly is a difference in the way the different areas are performing.

I mean does that seem to be more tied to the economy, or is it kind of just general, you know, competition issues or --

I think the economy first, and I think competition second.

Okay.

Now, you were quoting a 30 million --

Yes, in December, it was $148 million and then in September it's 118, accounts payable and other accrued liabilities.

Yeah, most of the accounts payable items are going to be timing issues.

Okay.

They're not going to be anything other than timing.

I mean the --

There's got to be some accrued interest because at year-end we had 5 1/2 months of accrued interest on the 11 1/4 notes.

Got it. Okay. So, you basically dealt with the dark leases, it's under $10 million, so, that's not a big issue here.

Right. Well as Andrew mentions, we had about a $10 million reduction in -- in payables or what we call cash overdrafts, which is really just a timing of checks as they clear. Most of it is payroll-related. We had about $4 million related to the closed stores -- payment of leases on closed stores.

Okay. Great, thanks.

Your next question comes from Mary Gilbert of Imperial Capital.

Could you talk about where you expect -- how much you expect working capital to increase next year and also where it's -- you know, where it looks like it will end up this year?

We think it's going to end up the year at about $105 million, which is about where we have it right now. Where it is at the end of the quarter.

Okay.

So I'm not expecting a big variance in the fourth quarter. As far as next year, I really don't know. I can't give you anymore detail at this point.

But we can say this much, we still expect working capital to be a use of cash for 2004.

Is there like a range that we could use?

I would say 5 to $10 million.

Okay. And then also -- is the company -- would they look at doing a sale leaseback transaction on the real estate?

It's something we've considered but not seriously. We like -- I personally like having the flexibility of those owned units, but it's certainly an option for us as we look into refinancing the credit facility next year.

Okay. And when do you expect that process to begin, and when do you expect to have something complete completed on that?

I mean as I mentioned earlier, Mary, I mean we're looking at things now, but that's not to say we're going to do anything now. So, I couldn't really give you a specific timetable. I mean the calendar would dictate we have to be seriously considering something by mid-year to the third quarter of next year.

Yeah, but I guess before you put the 10K out you've dot to have something done essentially.

No, we don't.

Well, I'm just saying if you don't want to have a, you know, qualified statement in the K, right?

That will not dictate whether we refinance by the end of the year or not. And I will say we will not refinance our credit facility by -- by the end of the year for that purpose.

But I guess I mean by the -- at least by the end of the first quarter.

No. I mean, again, the -- whatever the auditors have to say regarding our liquidity position does not really have a direct bearing on what we do. I mean it is what it is. We have until the end of the year; the facility expires in December, not March.

Right. I understand. Okay. Thank you. Oh, wait, actually, one last question, can I get the amortization of deferred gains?

Yes.

For the quarter. And this finishes that off, right? That goes away?

That's correct. It was about $700,000 for the quarter, Mary.

Okay. Great, thank you very much.

Your next question comes from Jeff Graham of HPV.

Good afternoon. I'm concerned about the financial on health at the franchisees, and my fear is that the damage done in -- in June and July will kind of come to light in Q4 and Q1 through a spike in closings among -- of -- of franchised restaurants. And I was just curious if you could give us some guidance on -- on -- among your expectations for closings?

You know, it's -- I really can't give you guidance as far as closings in the fourth quarter and through the winter. You know, as we've said, we don't envision many more company closings, but the -- you know, we sort of said in the past, the franchisees sort of trailed the company in taking a good, hard look at their portfolio, and we realized they now are doing so, but it's hard for me to predict, you know, what the pace of that will be over the coming quarters.

Thanks.

Your next question comes from Lee Hartman of CRT Capital.

Good afternoon. I also had some questions with respect to the franchisees. What's the level of receivables at the end of the quarter owed by franchisees to you?

It's about $8 million.

Okay. And the bad debt expense associated with that? Are you tracking to your reserve levels?

Yeah, we absolutely are. I don't think we've booked any bad debt expense in the quarter.

No bad debt expense.

Do you have a sense, again, within the franchisee pool of those leases that were either you owned the property and are leasing to to them or you're guaranteeing the leases, how healthy is that pool of franchisees?

I really don't have an answer to that. I know what you're saying. There are about -- there are properties, obviously, that we sublease to our franchisees, either that we own or we lease ourselves. But I don't have an evaluation for you of that particular group of units.

Could you characterize those franchisees that are leasing property from you? Would they be like multiple properties that they're running of Denny's or, you know, are they your larger franchisees? Your smaller ones? Is that a mix?

It's a mix. It really is a mix.

And then back to what Mary had asked about this deferred gain that you had in the product. There have been three pieces of those, I think, or three contracts, and this is -- this brings it to conclusion for all of those at this end of this third quarter?

Yes. It is completely gone.

Okay. So what we see on product gross -- or product costs going forward on the margins is clean.

Correct.

And the final question is could you tell me what the bank amendment cost you?

The bank amendment? Are you talking about the restated -- the $40 million term loan?

Yes, didn't you get waivers, or am I confusing my quarters? Was that the prior quarter?

You're confusing -- We got an amendment to fix the covenants back right around the second quarter.

That was Q2, okay.

I don't have the numbers handy.

That's okay, I will follow up. Thanks.

Next is John Tekke with Trust Company of the West.

Hi. Question I had was how sticky you think the recent traffic gains have been. It's been encouraging, if you were to come off the promotional pedal, how sustainable you think traffic gains or at least having flat traffic would be without having a constant on-air promotion?

I wouldn't say we have a constant on-air promotion. It's almost -- this $4.99, in my view, is more like everyday value. We are on-air, but we are not on air all the time. I wish we were.

Yeah, I think he's asking in the non-air weeks.

Well, I can tell you --

You know, what happens?

Well, I can tell you that this promotion has been running since August. We have been off air for approximately two three-week periods, and we uncharacteristically, for Denny's, I might add, have remained positive during our off air weeks. Now, clearly we get a bump when we go back on air, which we experienced again this past Monday. But the -- the encouraging thing is that this particular promotion is relevant enough our consumers that -- and credible, because it is breakfast -- that we've been able to maintain positive sales throughout the hiatus periods, which, candidly, hasn't happened here that we can tell. So, it's been very encouraging.

So, the -- the share, I guess that you're gaining back that may have shifted to other competitors over the course of the last few months, do you -- I guess what I'm trying to understand, too, is whether or not -- there's a certain segment of the population that you've gotten back because you've drawn attention to the three complete breakfast items that maybe they didn't know about, and if this share will continue to shift around based on whoever is promoting at the time. So, if you come off air for a month and I-Hop does something, the share shifts over there and vice versa. Do you think that's the case with the numbers bear out?

I would tell you that if we don't talk about breakfast, our breakfast share from this past year's or this current year's experience does go somewhere else. That's not our intention. We will continue to talk about breakfast going forward. It is our number one attribute, and we will continue to talk about it. So, I don't think there's -- I-hop and other competitors are going to talk about breakfast. It's the business that we collectively, in this segment, specialize in that we're in. So, I would tell you that we're not going to stop talking about breakfast; therefore, I expect our share will be back where it belongs.

I think the other thing that I'd add to that is I think the $4.99 price point, particularly for the abundance of food -- I don't know if you had one of our three complete breakfasts -- but we really think it's a very powerful combination of a good price point with an abundance of food.

And the only follow-up I had was with respect to the outlook for store closures, I don't think we talked about that, but do you have any -- any comments, are you comfortable with the way the store base is performing? Is there a segment of the store base that you've been monitoring that potentially could be closed to -- to -- to enhance the performance of the chain as a whole?

As far as company stores, we are always monitoring and that's part of the way we run the business. And we're not afraid to close down a store that we don't think has potential. But we've really worked our way through most of those. So, I think what you're going to see now is what I would call a normal portfolio churn for a brand this size. There are probably going to be a handful of units each year that you make a decision to close or a lease expires and the renewal is too costly given the sales level. So, I think -- I think you're looking at, you know, five, 10 units a year on the company side, just in the normal course of -- of good portfolio management.

But just in the normal course, the overall consolidated results wouldn't benefit from, let's say, that flood of 10% of stores that if they closed it would suddenly be accretive to cash flow?

No. Those were really the stores if you go back 12 to 24 months, that was the group we were closing back in 2001 and 2002.

Okay, thanks.

Mr. Jones, we have five minutes until 2:00. Would you like to take any more questions?

Let's take one more question.

Your last question is from Jason Koch of Sandal Asset Management.

Yes, hi. Pressure's on. I -- I actually wanted to get -- get a better understanding of what's going on with your competition. Do you track your competition and -- and -- and what's happening on that front?

Well, certainly we track our competition. And I'm sure you guys pull the numbers, too, and watch the whole industry. You know, casual dining has been up a bit in most of the chains. Two, three, four percent. Fast service -- quick service has been all over the place, frankly, McDonald's just reported some -- some really high numbers. They probably picked up a little bit. You know, and within family dining, I think it's been a mixed bag. I-hop has reported some good numbers as was eluded to earlier, but I think we're neck in neck with a lot of the family dining chains where we're running right now.

Right, I mean this trend you've seen over the last month or so, is that in line with what your competitors have been experiencing?

Well, not everyone's reported, so, I can, you know, I -- I've seen some numbers out there. I think it's in line in answer to your question. I think a lot of chains have seen some improvement in the economic picture through August and September and into October, and I think that's helped all of us.

Right. Okay. That's what I was trying to figure out. Okay, thanks a lot.

Okay, thanks.

This concludes today's conference call. You may now disconnect.