Denny's Corp (DENN) 2006 Q1 法說會逐字稿

Good afternoon. My name is Lawana and I will be your conference operator today. At this time I'd like to welcome everyone to the Denny's Corporation first quarter and year-end 2006 earnings conference call. (OPERATOR INSTRUCTIONS) Mr. Lewis, you may begin your conference.

Thank you, Lawana. Good afternoon, and thank you for joining us for Denny's first quarter 2006 conference call. This call is being broadcast simultaneously over the Internet. With us today from management are Nelson Marchioli, Denny's President and Chief Executive Officer, and Mark Wolfinger, Denny's Chief Financial Officer. We will begin with the business overview from Nelson. Mark will then provide a financial review of our first quarter results. After that, management will be available to answer questions.

Before we begin, let me remind you that in accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, the Company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements. Such statements are subject to risk, 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 risk and factors are set forth in the Company's annual report on Form 10-K for the year ended December 28, 2005. With that, I will now turn the call over to Nelson Marchioli, Denny's President and CEO.

Thank you, Alex, and good afternoon, everyone. Thank you for joining us. Hopefully, you've had a chance to read our earnings release, which was published after the market closed today. We are pleased to have completed our tenth consecutive quarter of positive same-store sales despite difficult prior year comparisons. Even more encouraging, however, was the improved operating margins our operators brought to the bottom line as they leveraged our sales increases. The first quarter also marked a return to net income. While the dollar amount may be small, it validates the strategy we are pursuing is the right one. Denny's is on its way to profitability. We are confident that if we continue to execute our business plan, our bottom line will continue to grow.

While our sales and profits increased in the first quarter, our guest traffic did not. There was a bit of fluctuation due to mild weather and holiday shift, but the underlying trend remained weak. Our traffic was basically flat on a two-year basis, which seems to be about average for the industry right now. Though our traffic has been soft, we have been fortunate that we've been able to pass through our cost increases over the last year. In addition, our marketing efforts have resulted in higher average guest check, as our customers have chosen to trade up to new, higher priced menu items. Unfortunately, there is no one factor that we can isolate as the cause of our soft traffic. We have undertaken a considerable amount of consumer research to better understand the impacts on our guest traffic, as well as the positioning of Denny's in the marketplace. As we work through the data provided in this research, we will incorporate the findings in order to better meet our customers' expectations.

Clearly, there are macro economic factors that are negative impacting the lower to middle income consumer. The recent run-up in gasoline prices and the impact it will have on consumer spending is a justifiable concern. We certainly felt the impact of reduced discretionary dollars last year during the gas price escalation. As gas prices are not likely to moderate in the near term, the best outcome would be for prices to level off and exhibit some stability, in our view.

The summer is a peak sales period for Denny's due in large part to travel and tourism. Travelers' expectations for fuel prices will impact the distance and length of their travel this summer. With the increase in gas prices and the corresponding decrease in discretionary spending, value should play a larger role in the consumer's budget process. While our guest check average is notably higher, the increase is due not only to price increases, but also to menu mix shifts. We acknowledge the price increases taken over the last year may play a role in our soft traffic, though to what degree is uncertain.

Our research so far is mixed. In some more price-sensitive areas of the country, there may be a level of price resistance. However, in other markets, it does not appear to be an impediment. Denny's is and will remain a value-oriented brand. With complete, extensive menu research on all of our competitors prior to determining all our price increases, we are completely confident in our value proposition here at Denny's.

Over the past few years, we have made significant investments in our food quality and taste, as well as upgrades to our facilities. We believe these improvements warrant a higher price, though again our price points remain below our most competitive offerings. With our significant scale of operations and our incredible purchasing power, we are able to offer greater quantity and better quality than much of our competition. Above all other factors, the food is what attracts customers, taste in particular.

We are very excited about our new product pipeline including some great new offerings under our American Dinner Classics lineup. In each of our two marketing modules this year, we have unveiled three new dinners. The six new dinners have been well received. In fact, our dinner entrée mix is up 1.5 percentage points over the same time last year. While that may not sound impressive, in fact it is a significant percentage move in our dinner business. This mix shift is already having an impact on our average check. Denny's, as you well know, is known for breakfast. It's our core attribute. Building our dinner business will take time, even years, but we're confident that we have the right product development with marketing and operations teams in place to accomplish that goal.

Before I turn the call over to Mark, I just wanted to reiterate that I am pleased with our improved results in the first quarter. That said, I know that we must improve our execution if we're going to continue posting such strong quarters. It's easy to fall back on the many external factors that are negatively impacting our sales, but there are just as many internal causes that we can and will improve. We cannot lose focus on hospitality, cleanliness, and speed of service in our restaurants. The experience you had on your last visit will most often impact your decision to return. We cannot allow our value perception to be weakened. While we're committed to maintaining our margins, we'll seek to optimize both our check and traffic growth. We must continue to invest in our facilities in order to provide a more inviting environment for our guests.

Our remodels, particularly of the last year, are making an impact on customer perception. All this we must and will do. This is a great time to be involved with Denny's. The potential of this great American icon is clear, and we intend to maximize it. As always, thank you for your interest in Denny's. I will now turn the call over to Mark, who will take you through a review of the fourth quarter financials.

Thank you, Nelson, and good afternoon. I will start my comments with our first quarter sales results, which Nelson touched on in his remarks. Our positive sales trends continued in the first quarter, as both Company and franchise restaurants generated strong same-store sales increases of 4.6% and 6.2%, respectively. On average, same-store sales across the Denny's chain increased to 5.6% in the first quarter, which is particularly impressive as we are compared against a 6.8% sales increase in the prior year period.

Our Company same-store sales were comprised of 8% increase in average guest check, and a 3.1% decrease in guest counts. The increase in our average guest check resulted from a combination of price increases and menu mix shifts. Of the 8% in check, we estimate that 5 percentage points came from price increases taken over the last year to offset cost pressures including rising wage rates and utilities. The remaining 3 percentage points resulted from a shift in menu mix, particularly in an increase in dinner entrees and a shift to higher priced breakfast offerings.

While our guest check average showed strength throughout the quarter, our guest counts were inconsistent. January traffic clearly benefited from better weather year-over-year. March traffic suffered from the movement of the Easter holiday and accompanying spring break traffic into April this year. For the quarter, guest counts were down 3.1%, which is a reasonable indicator of the underlying traffic trends when the positive and negative factors are averaged out.

Turning now to our income statement, first quarter sales of Denny's Company-owned restaurants increased $7 million, or 3.2%, compared with the prior year. There was a 4.6% increase in same-store sales, more than offsetting four unit reduction in Company restaurants. While we are pleased with our sales growth in the quarter, the more encouraging result was the improvement in operating margin at Company restaurants. The quarter operating margin in our press release summarizes these year-over-year operating comparisons.

In the first quarter, our Company restaurant operating margin increased 80 basis points, or 0.8 percentage points to 13.2% of sales. More directly, we generated $2.8 million in additional margin on a $7 million increase in Company restaurant sales. These incremental sales flow-through of approximately 40% was accomplished despite a $1.4 million increase in utility costs.

Moving to the individual line items, product costs were 24.8% of sales in the first quarter. This improvement of 1 percentage point was attributed to a combination of higher guest check average and moderating commodity costs year-over-year. Payroll and benefit costs were 41.8% of sales in the first quarter, which was an improvement of 2.2 percentage points compared with the prior year quarter. This improvement is driven primarily from higher average guest check as we continue to balance staffing levels against increasing wage rates.

Occupancy costs were 5.8% of sales in the first quarter, which was 0.2 percentage points lower than the same period last year. This improvement is also attributable to operating leverage on our sales increase.

Other operating expenses were 14.4% of sales in the first quarter, which was 0.6 percentage points higher than in the prior year. The primary driver of this increase was utility costs, which were up $1.4 million, or 0.5 percentage points over last year. In aggregate, the remaining components of other operating expenses were only slightly unfavorable.

On the franchise side of our business, our franchise operating margin improved 0.4 percentage points due primarily to operating leverage on a $900,000 increase in franchise revenue. Royalties and rental revenues were up 4.2%, and same-store sales growth of 6.2% offset an eight unit decline in franchise restaurants.

Turning now to G&A, our first quarter expense increased approximate 1.2 million from last year resulting primarily from increased staffing necessary to execute Denny's sales growth in restaurant development plans. We have added staff in our marketing, product development, franchise development, and financial planning departments. Most of these departments are directly responsible for growing our sales and unit counts.

Moving down to P&L, operating income increased $3.8 million, or 33.5%, compared with the prior year due in large part to leverage on sales increases, but also to a $1.6 million reduction in restructuring charges, and a $700,000 increase in asset sale gains.

In the first quarter, we sold five surplus properties, one of which will soon reopen under a new franchise operator. The gross proceeds from these property sales were approximate $3 million. Below operating income, interest expense increased by 1.4 million to 14.6 million for the first quarter as a result of increases in the interest rates underlying our floating rate credit facility. Our long-term debt is approximately 50% floating rate and 50% fixed.

Now to the bottom line. We reported net income in the first quarter of $480,000, excluding the cumulative effect of change in accounting principle, which reflects a $1.9 million improvement from the prior year loss of 1.5 million. We are certainly pleased with our return to net income and look forward to growing our profits over time. The change in accounting principle is a one-time adjustment related to the adoption of FASB statement 123R, and is not recurring.

While we are excited to return to positive EPS, we still feel adjusted EBITDA, as calculated in our press release, is the best measure of our earnings. In the first quarter, our adjusted EBITDA increased $2.2 million, or approximately 8% compared with the prior year quarter.

Moving on to capital expenditures, our cash capital spending for the first quarter was approximately $7 million. As in years past, we expect our capital spending to pick up pace as the year progresses. We have a significant number of remodels scheduled for completion in the second quarter, which should put our capital expenditures back on pace to reach our full-year guidance of $45 to $50 million.

With regard to our balance sheet, the only significant movement was our seasonal reduction in accounts payable from a high point at year-end to a more normalized level at the end of the first quarter. In addition, in early January we made the final cash payment of approximately $4 million in regard to the legal settlement from last year.

Our liquidity remains strong at quarter end with $32 million available under our revolving facility, and approximately $30 million in cash. That total liquidity of $62 million is up approximately $5 million over the same time last year. Subsequent to quarter end, we made a semi-annual interest payment on our 10% senior notes of approximately $8.8 million.

Regarding portfolio activity, we saw a net decline of three restaurants during the quarter. In the Company portfolio, we opened one new restaurant in Hawaii and acquired a unit from a franchisee in Florida. No Company units closed during the first quarter. Our franchisees opened four other units during the quarter, sold one to the Company, and closed another eight.

Turning back to the new unit in Hawaii, it is performing exceptionally well. In fact, it is succeeding our expectations. Through its first seven weeks, which is admittedly the honeymoon period, the restaurant is averaging $70,000 a week in sales. We continue to be amazed at the strong reception that can be given to a shiny new Denny's in the right location.

Taking all of these data points into consideration, we are pleased with our first quarter results. We generated strong sales increases, leveraged those increases into margin improvement and returned to positive net income. While all of these accomplishments are encouraging we are concerned about continued softness in guest traffic and the negative outlook for discretionary spending among the lower to middle income consumer.

At this time, management's expectations for 2006 are unchanged, and we reiterate our annual financial guidance for the year as provided in our fourth quarter 2005 earnings release. Before you ask the question, here is our answer. While we are pleased with our results in the first quarter, it is our lowest volume quarter of the year. At this time, with concerns about gas prices, hurricanes, and all other factors that impacted our results late in 2005, we feel it would be imprudent to make any statement other than to reiterate our previously issued guidance.

Before I conclude my remarks, I want to reconfirm our focus on cash generation and debt reduction. As I said last quarter, our first objective is to enhance the cash generation of our business in order to fund growth and delever our balance sheet. This cash flow first comes through increased operational discipline and greater scrutiny of capital expenditures. We have put in place a new financial analysis and communication process that allows us to understand changes in our P&L more quickly and in greater detail, and then disseminate those findings to our operating group. I think the result of these efforts is beginning to show in our improving operating margins.

The sale of some of our real estate assets may be another source of cash flow. As I mentioned earlier, in the first quarter we sold five surplus properties for a total proceeds of approximate $3 million. In early April and subsequent to the quarter end, we sold another two surplus properties for total proceeds of another $3 million. With regard to the remaining [inaudible] real estate, we are working through the process of valuing the property both internally and through external resources. As we have stated before, we are most likely to pursue the sale of property that we own and lease to franchisees. We have begun discussions with many of these franchisees as well as potential third-party purchases.

As there are more than 80 franchise operated properties and 20-plus franchisees involved, the process is complicated. We will continue to provide updates each quarter on any property sold whether they are surplus, franchise operated, or possibly Company operated.

That wraps up my portion of our prepared comments. I'll now turn the call back to the operator to begin the Q&A portion of our program.

Thank you. (OPERATOR INSTRUCTIONS) You first question comes from Karen Eltrich, Goldman Sachs.

Hi, Karen.

Hi, guys. Great quarter. Congratulations. A couple of questions. It does sound like you're making great progress, and I'm glad to see it going well this time. Are you seeing actual increases in traffic to that [day part], or is it just more mix shift?

Karen, this is Alex. We are seeing increase there. Again, it's mixed in different places, but the big items that we talked about before is just a mix shift. A lot of that is coming into dinner hour. You're not going to serve a whole lot of those breakfasts in the morning, so most of that is coming into dinner hour.

Great. And with the advertising now being focused on dinner, have you felt that it impacted your breakfast business at all, or do you think in general that is paying off?

Yes. I think we're pretty comfortable. Again, most of our advertising, it's still focused appropriately on the breakfast. All of our national network is focused on breakfast. We're using all of our national cable spend on dinner, so we think we've got a pretty good balance there this time.

Great. And, you know, with gas prices spiking, is there any thought to going back to a $4.99 promotional price point?

We haven't made any such plan.

Okay. Final question. You've talked about this in the past. On your new format, are you able to give the economics for the build and the returns yet?

I don't think so yet. We're on unit No. 3 or 4 under this new build, so we're not quite there yet, but hopefully that will be soon, and as we've talked about before, although in the process of designing a new prototype, which we're hopeful to have available late this year, and that can change the economics as well.

Okay, fair enough. And, actually, I'll slip in one final. Have you had any conversations with the rating agencies? I mean, for the number of quarters, for the results, it would seem that the Triple C is really not warranted anymore.

Well, we do continually talk to the rating agencies, and certainly we want to see ratings increases and we're working towards that. I think if we meet our goals operationally and our goals to delever, I think that will certainly be a possibility.

Great. Thank you very much.

Your next question comes fro Eric Wold, Merriman Curham Ford.

Hey, good afternoon. Thinking about the end of this year, I know one of the wildcards on the Q4 call was just how many franchises you might close and opt out or opt in on the remodel program towards the end of the year. Any clear indication on -- I know we're not in the busy season yet, but how many you might be looking to close or opt to remodel?

Eric, it's Mark. I think as I said in my comments, we're going to pretty much at this point stick with what our sort of annual guidance figures were that we gave two or three months ago.

Okay. So, not just EPS, all the same closures and everything as well?

Exactly.

Okay. And on the Company side, was the lack of closure in Q1, was that kind of on track, or were any of those just pushed out to later in the year?

Eric, as we've said before, the closure is really on the Company side oftentimes come down to lease issues, so they tend to be scheduled out when leases come due that we may no longer find favorable. Again, we'll stick -- I mean, we didn't give guidance for closures, but we'll probably stick to what we said before, which was -- until we see something different, we'll consider last year to be a pretty good indicator.

Okay. Then lastly, on the remodels, how many stores are being remodeled in Q2 right now, you said a significant number. And then what's the schedule for the remainder of the year in total numbers?

I think you'll see on the Company side we're going to be in the 50-60 range, somewhere in that neighborhood for the year, not for the quarter. In the franchise we're planning on well over 100.

How many of those are in the second quarter?

Gosh, I don't know. We don't have that scheduled out here in front of us.

Okay, perfect. Thanks, guys.

Your next question comes from Reza Vahabzadeh with Lehman Brothers.

Good afternoon. In terms of just your traffic counts and the price mix trends in the near term, call it second quarter, is there anything that would make those trends to be different than the first quarter given the fact that fuel costs have risen quite significantly?

Well, my belief is -- this is Nelson -- that we're going to stick with our guidance as you've heard us state earlier in this call, but softness would be expected based on energy prices and consumers making choices, and I'll leave it at that.

I understand. I wasn't talking about a four-year forecast, but in near term, you know, there's no calendar issue, there's no special promotion previously scheduled --

We have a calendar issue with regard to Easter and Spring break that moved out of March and into April this year, but that's the only real calendar issue we have.

Okay. Labor costs, obviously labor expense ratio was good in this quarter. Do you see any pressure on wage rates going forward?

This is Mark. I think certainly the pressure is always there on wage rates, and that clearly we're satisfied with the kind of leverage we got out of the labor line in the current quarter, the first quarter. But, yes, that pressure is always there. Obviously, we, as I mentioned, I believe, in my comments, we took certain price increases to offset some of the increase in cost structure there, both labor and utilities. I obviously don't have a view of what the balance sheet is going to look like on a state-by-state basis.

Okay. And last question for Nelson. If you -- if Denny's offers a value at competitive prices and your traffic trends are negative recently, could you think you're losing traffic share too? Is it QSR?

Well, I'm going to give you a two-part answer. The first part is about our sales continue to be positive. We're one of the few companies at this particular time, particularly in our segment and casual as well, that report guest count increases. The entire industry -- and we continue to perform certainly at the upper end on year-over-year sales performance. I do think QSRs, as people make choices and having to pay more for gasoline, I think they are choosing QSR probably more frequently than they once did out of necessity as they plan their budgets appropriately. You've heard me say before that I believe our customer is the Wal-Mart customer, that is looking for value, and I think Denny's provides a terrific value for those folks when a sit-down family environment, come-as-you-are, is required. However, there are a lot of other opportunities were fast food restaurants would suffice.

Thank you much.

Thank you.

Your next question comes from Stuart Kwan, Vander Capital.

Hey, guys. Hey, Mark, could you just repeat, you said in early April you sold for $3 million, how many locations was that?

It was two other surplus properties.

Two surplus, okay. And 3 million in March was five.

Three million in the first quarter.

Was five locations.

That's right.

Okay. Thank you.

Your next question comes from Michael Gallo, CL King.

Hi. Good afternoon. The question I have, I just want to drill down on dinner a little bit. It seems like you're getting some good traction, although it's very early with the American Dinner Classics. I noticed that you recently, it looks like doubled the size of those offerings. Any sense for where you're getting the guest counts for that? Is it people that come to Denny's normally? Are you getting a lot of just brand-new customers in the door for casual dining? Any color you can give us and kind of what you're seeing with just the dinner day part.

I think it's too early to tell. We are pleased thus far. Of course, Denny's is known for breakfast and we're beginning to have some excellent dinner offerings. The most exciting part I think about this whole program is the fact that we are developing quite a terrific, great-tasting, abundant pipeline both for dinner as well as breakfast. So, we're very excited about what we're going to be able to offer on a continuing basis as we build that dinner day part and continue to grow breakfast as well.

Great. And then second question, obviously there's been a lot of talk about the California minimum wage. I mean, does that look like an '07 issue at this point? Any sense of where things are there?

Well, there appears to be several states, as well as Congress, California being probably the most obvious ones, since most of our restaurants are located in California. I would anticipate a wage increase, minimum wage increase. So, there are several being considered at this time, some with escalators and stair-steps. I would suspect that one of these things will be passed by the first of the year. It is an election year, after all, for Congress as well as for people in state government.

Okay. Thanks a lot.

Thank you.

Your next question comes from Alexis Gold, CIBS.

Hi. This is actually Andy Davis for Alexis. It looks like utility distribution costs were better than you had expected this quarter, and given the rise in gasoline prices, have you talked about any potential pricing changes, and would they come in the form of like [inaudible] or promotions? And also you reiterated your EPS guidance. I was wondering if you are still comfortable with same-store sales of up to the 3% given the commentary you made on consumer spending [inaudible] mix shift more value items?

It's Mark. I didn't hear the last part of your statement about utility expenses, but clearly as we discussed during our year-end call, actually even in our third-quarter call, we were obviously very concerned about the rise in energy prices, the impact obviously it has on our customers from a gasoline price standpoint, but also the natural gas cost inside of our restaurants. I don't want to say that we anticipated that increase in Q1, but clearly we expected there would be an increase in energy costs for our restaurants, and obviously to offset those costs, we did take certain price increases.

The second part of your question as far as the overall annual guidance I think was the other part of your question.

Yes, the EPS guidance.

Right. How I would respond to that is just picking up from what I said in the script is that we are reiterating our annual guidance and that would include the components, all the components of our annual guidance.

Your next question comes from Bryan Hunt, Wachovia Securities.

I've got an eight-part question, I'm going to phrase it in two questions for you. Just a couple of questions. Could you describe the property mix between non-strategic surplus, franchised locations that you own, and then Company operated?

I don't think there's a whole lot of surplus. I don't have the list right in front of me, but there's only a handful of surplus properties. I think four or so. Most of those have been gone through, and then moving back to the numbers we've given previously, there are 80-some franchise operated but company-owned properties, and another 130-plus Company owned, Company operated properties.

Thank you. And next question and a general question. What do you feel like is the proper leverage point for the Company to begin to accelerate remodels and growth of Denny's?

It's Mark, Bryan. We've been certainly over the last few months very open about what our targets are both near and long-term for leverage. Near-term we sort of defined in the next 12 months we'd like to get under 4 times lever. We're currently about 4.4 times levered as a starting point based on last year. We said that longer terms, so think 24 to 36 months plus out we'd like to get something in the low 3's, as far as leverage.

All right. And then lastly, it's obvious that you made a push towards dinner recently, and it appears to have some traction. Could you talk about other marketing, advertising and/or menu changes you may make over the short-term, as well as maybe any success you're getting with sponsoring the PBA?

Well, we've had an excellent relationship with the PBA that continues through two more years. We are extremely pleased with that relationship. Although I can't quantify for you the specific sales, we are in fact in a cross-promotion with them at this particular time at the store level that has just been announced and I'm not going to go into the details of that here, but we've been very pleased with the PBA, and we're looking forward to that -- that's our customer and actually it's been an exciting first year in that relationship. As far as in the short-term, we're going to continue to look for those opportunities in areas where we can promote and drive incremental traffic. I won't get into specifics because of the competitive nature of our business, but rest assured we are looking at areas in the country where the research is coming back and indicating that we need to jumpstart from an economic standpoint our traffic, and that's exactly what we'll do in traditional terms.

All right. Thank you.

Your next question comes from [Riche Ferrer], RBC Financial.

Hi. We echo the Triple C comment, by the way.

Thank you. We need some more people echoing it.

The new format stores, where are those located, can you tell us?

Well, our latest new builds, as we said, we just opened a new on in Hawaii. Prior to that we have one in Monterey, California. We have one on the Strip in Las Vegas. We've also rebuilt a unit in Pensacola, Florida, and refurbished one in Monterey, California here recently. So, those are the new ground-up on the Company side. We've been remodeling under the Vision 3 look for probably a year and a half now, so those are going to be scattered throughout the country.

How long does it take for one of these to be executed?

A remodel?

Yes.

It takes about a week, bearing any unforeseen circumstances as it relates to permitting and the like, and trades.

You guys have obviously done a real good job in managing the check in the sales. When do you start to worry more about the traffic?

I'm worried about it now. I've been worried about it since last May. Traffic in my view is one of the three most important metrics -- check, positive sales and positive guest count are absolutely critical to a brand. So, although we are managing two out of the three metrics, the third metric is absolutely critical for the future of this brand. The other two are buying us time as we evaluate the research and determine what our messages are going to be and what our execution is going to be at the operations level, but people sometimes ask me what keeps me awake at night? Guest count keeps me awake at night at this particular time, and has since May.

It seems the hardest part to control. Is it something you could just buy by throwing more advertising dollars at it, or --

You can discount, you can advertise more, you can reduce portions, you can cheapen the product. Those things we just won't do. I don't believe in discounting, per se, unless it's a specific targeted activity that we know is going to drive results in a profitable way. But traffic is the key ultimately, and you use those three metrics as your levers in this business, and right now there's a lot of macro economic issues that are driving that in the industry and retail overall. Gasoline prices, if we could get some stability in gasoline prices, I think we'd be in a good place. I didn't say I expected it to go down, but stability for the American public I think is critical. I think the uncertainty is what's causing softness throughout the industry right now.

Thank you.

Your next question comes from [Sanjay Christian], ING Capital.

Hey, guys, how are you doing? A few questions here. First, when it comes to what you're seeing by geography given whatever's going on with the OEMs in the Detroit area, are you starting to notice any weakness concentration geographically anywhere at all? And in addition to that, you talk about how you're keeping all the components of your forecast intact, so what I'm wondering is that, given the increased weakness or higher priced commodity prices that you have right now, as well as the higher potential labor costs, in order for you to keep your forecast flat, does that mean that incrementally you believe that you are going to be able to raise prices in order to offset that at all? I'm just curious because it seems to me that those fixed costs [inaudible].

We do not plan on taking any price increases. We think the American consumer has had enough of that. Of course, we would pass on any cost increases that we would experience as it relates to minimum wage or some other commodity issue, but at this time, commodity prices actually were about a percent down from where -- from prior year, as I recall, in the first quarter, and we have gotten a break on natural gas as a commodity, and you can track that as well as we can. I don't know how the energy piece is going to hold up for the balance of the year, but I'm quite comfortable that our food commodity prices are going to be a benefit to us throughout this year.

And in terms of geography, are you noticing, like I said, any weakness or change in traffic in one geography versus --

Well, the simple answer is yes. We do see fluctuation based on geography. A lot of that is affected by the hurricanes in the Gulf and people moving. So we saw some increases, and we also saw some decreases in areas. But to your earlier point, the Detroit market, the Chicago market, with all the automobile issues that the auto industry is going through right now in the United States, is having an effect. Those are my customers as well. So, we are seeing fluctuation, but we're seeing fluctuation everywhere right now, and I think it's because of the energy crisis.

And just to clarify. You said you sold two properties in April; is that correct?

We sold two properties, yes, right, between -- basically at the end of the quarter.

And that was for 3 million?

That's correct. The confusing number here is the fact that there are two $3 million numbers. There were five sold in the first quarter for 3 million, and there were two more sold for 3 million between the end of the first quarter on today's call.

And you're targeting long-term leverage of around 3 times. You said that was for 36 months though?

Right, 3 to 3.5 times, basically. I think I said low threes, so I'll split the difference. And I said we're targeting near term, which is sort of within the next 12 months to be under four and leverage --

That's great.

[Inaudible] by the way.

Of course.

Your next question comes from Tavacole Nader, Eagle Rock Capital.

Yes, thanks. I joined the call a little late, so if the questions have been asked, I apologize. So, it looks like you're losing customers and your guest check is up an average of 8%. I'm just curious where the 8% is coming from? Is it coming from mix? Is it coming from price increases? How are you generating the 8% check increase?

It's Mark Wolfinger. The 8%, a far as the GCA change, about two-thirds of that change is price-related, and about a third of that is mix.

Okay. How much longer do you think, what's your elasticity here? Obviously, you said you're concerned about the customer losses, and obviously customers lost are hard to get back than to keep. How much longer do you think you can price increase yourself into same-store sales gains?

We've taken all the price increases that we plan to take this year. So we will find an answer for the customer down issue.

Right. And have you disclosed your capex budget for the next couple of years?

Well, we have our annual guidance year, which is 45 to 50 million.

And what's the revenue guidance?

Well, you can refer to our fourth quarter earnings release for that.

Okay. It probably would have been quicker to just tell me, but whatever.

I'm afraid you're going to go down the list.

No, I'm just trying to see what capex is a percentage of revenue. It looks to me as though, you know, just anecdotally the stores are a little bit starved of cash, so I'm sort of curious how you get the customer back and price increase if the stores don't look good. Is this an issue?

This is Mark Wolfinger. To answer your question, all of the annual guidance components are within the press release.

Right. I'm just sort of curious. It just seems to me that capex is a percentage of revenue is on the low side and how do you get customers back if the stores don't look good. Are the remodels within that capex budget?

Yes, they are. As we discussed earlier, there are about, I think, about 50 remodels on target for the Company restaurants this fiscal.

And I guess I'm sort of curious as to your subjective thought on your capex level. Forty-five to fifty seems relatively low percentage of revenue particularly given that you guys are coming out of a period where you probably didn't spend enough.

I want to thank you for saying my capex expectations are low, because you're the only person, including the financial people in this room, that feel that way. I got to tell you, we have spent well over $175 million in the past four years bringing these restaurants up to standard for the very reason that you spoke to, tired restaurants, restaurants that weren't appealing, and now we're in the throes of remodels. So, I feel very good about where we are compared to where we were. I'm very proud of the restaurants that we have. Our franchisees have stepped up as well. You might have missed this part of the call, but I expect 50 to 60 company stores to be remodeled this year, and that has been the rate that we've enjoyed over the last five years, and I expect the franchisees this year to exceed 100 remodel stores as they did last year, and they did the year before. So, I see this brand becoming a real contender and representing this great American icon brand quite nicely, and I'm delighted to hear that you think this is a small capital number. I'm going to use that on my -- internally here, I assure you.

Well, it's just based on sort of the customer losses and the anecdotal evidence on the stores, but that's great. I guess the question I have just -- again, I'm relatively new to this story -- is looking at the contribution from the franchise stores and the margins on the franchise stores versus the Company owned stores, as you sort of run through the numbers, why is this not a franchise store as opposed to a Company owned store? What are your thoughts on that? What is the direction of the Company in that regard?

Well, actually it's a two-prong story. We are a restaurant operating Company. About one-third of our restaurants are Company, two-thirds are franchise, and we think that plus or minus a few, that's probably a good mix. Our belief is you have to be in the business to understand it, to support it, and have successful franchisees, and have a good development pipeline on a go-forward basis with minimum litigation. So, I would tell you that the returns on the franchise business are quite nice, but at a 4% royalty, you tell me. If I can get a 4% royalty on a million-dollar restaurant, or a 40% flow-through on a million-dollar restaurant, which one would you rather own?

How do you get a 40% flow-through?

Well, actually, that's part of the call that you missed as well. We actually enjoyed a 40% flow-through this past quarter on our increased sales position.

Increased sales?

That was the leverage that came off the sales increase.

Okay. I'd have to, I guess, look at the numbers to figure that out. Just looking at your guidance --

Okay. We're going to go on to the next question. If you have another one, you can jump back in the queue.

Your next question comes from David Lindquist, MCM Partners.

Hey, guys. Congrats on a good quarter. I have a quick question for you. Given how generous the credit markets are nowadays and you guys have putting up some good consistent numbers over the past, I don't know how many quarters now, have you given any thought to throwing an amendment out there to get your bank facilities repriced? You're paying what looks to be about 125 basis points over market.

I like that number. I'm not sure I believe that number, but we've clearly talked about refinancing our debt. We agree that we feel like our performance has warranted lower spreads, and we will probably be embarking on that. We do have a date at the end of the year, on an anniversary date that makes that a little more economical, so we'll be looking at that farther in the year.

Gotcha. Okay. Thanks, guys.

You have a follow-up question from the line of Tavacole Nader, Eagle Rock Capital.

Yes. I guess the question -- I have a follow-up question, that was rather quick. Who owns the land underneath the franchisees, and what are your plans with respect to the land, if you own it?

This is Mark Wolfinger, the CFO. In the script that we delivered earlier in the discussion, as we mentioned, there are 80-plus properties that are franchise operated which we own the real estate, and we're currently taking a hard look at that real estate in determining obvious evaluations in that real estate and potentially targeting some of that real estate for sale to the operating franchisees.

I heard you say that you're hoping to get longer term leverage down to 3, 3.5 times. Have you given sort of near-term targets in terms of what you want to pay down on the debt over the next year say?

We did, actually. In the other part of my commentary is that near-term leverage target is to get under 4. We're about 4.4 times right now, near term defined as 12 months. Longer term, sort of 3, 3.5 range, low 3's is what I actually said.

Thank you.

You have a follow-up question from the line of Stuart Kwan, Vander Capital.

Stuart Kwan. Hi. Just a clarification on the real estate. Those eight locations, those are all surplus locations, so there is no franchisee. Those are closed, there is no franchisee operating them?

That's correct, Stuart, yes.

In fact, one of them is going to reopen as a franchisee.

Okay. And how many more surplus locations do you have?

About four.

Defined as true surplus, yes.

Four, okay. Thank you.

All right. One more question?

Thank you. At this time there are no further questions. Mr. Lewis, are there any further remarks?

No. Thank you for joining us and we'll talk again next quarter.

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