Denny's Corp (DENN) 2007 Q2 法說會逐字稿

Good afternoon. My name is Tasha and I will be your conference operator today. At this time, I would like to welcome everyone to the Denny's second quarter 2007 earnings release conference call. (OPERATOR INSTRUCTIONS) Mr. Lewis, you may begin your conference.

Thank you, Tasha. Good afternoon and thank you for joining us for Denny's second quarter 2007 investor conference call. This call is being broadcast simultaneously over the internet. With me today from management are Nelson Marchioli, Denny's President and Chief Executive Officer and Mark Wolfinger, Denny's Executive Vice President, Growth Initiatives and Chief Financial Officer.

Mark will begin today's call with a financial review of our second quarter results. Nelson will then provide an overview of our business. After that, management will be available to answer questions.

Before we begin, let me remind you that in accordance with the safe harbor provisions 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. Management urges caution in considering its current trends and any outlook on earnings provided in this call. 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 10-K for the year ended December 27, 2006 and in any subsequent quarterly reports on form 10-Q. One note on that, we will file our 10-Q for the second quarter this evening, likely before this call concludes, so you'll have our detailed financials for review, along with the earnings release.

And with that, I will now turn the call over to Mark Wolfinger, Denny's EVP and CFO.

Thank you, Alex and good afternoon. I will start my comments with a quick review of our second quarter sales performance. Company same store sales increased 2.8% compared with a 0.4% decrease in the prior year period. The sales increase in this year's second quarter was comprised of a 3.6% increase in average check and a 0.8% decrease in guest counts.

The restaurant industry as a whole continues to struggle with soft guest traffic and while we did not reach positive traffic in the second quarter, we did show significant improvement from the first quarter and performed well against much of the industry. Nelson will talk more about our sales trends and expectations in his remarks.

Denny's franchise restaurants reported a 4% increase in same store sales in the second quarter. This increase, combined with the Company performance resulted in a 3.6% increase in same store sales across the Denny system, a strong mark for our sector in the industry.

Looking at revenues for the quarter, sales at Denny's company-owned restaurants decreased $2.7 million or 1.2% from the prior year, due primarily to 25 fewer equivalent units, partially offset by a 2.8% increase in same store sales. The decline in equivalent units resulted primarily from the closure of 16 under-performing company restaurants in the fourth quarter of 2006, as well as company restaurants sold to franchisees this year under our Franchise Growth Initiative or FGI. The sequential decline in equivalent company units is expected to continue and, in fact, accelerate as we sell additional company restaurants.

Turning now to the quarterly operating margin table in our press release, our Company restaurant operating margin in the second quarter was basically flat with the prior year period at 11.6% of sales. Product cost increased by 0.9 percentage points due to the increases in commodity costs, which accounted for approximately half of the increase, as well as unfavorable shifts in menu mix. As an example, the strong sales of our $5.99 Mega Breakfast continue to have a negative impact on menu mix through the first half of the second quarter. In our new promotional module, which began in June, we made several proactive changes to our menu and product promotions, which have strengthened our menu mix.

On the commodity front, we were impacted most severely by higher costs for orange juice, bacon and shell eggs. We remain in a favorable position on many of our major commodity costs due to contract pricing through the end of this year.

Payroll and benefits costs increased 0.5 percentage points in the quarter, due primarily to wage rate increases, partially offset by improving experience in worker's compensation costs and medical benefits. We expect payroll cost pressures to remain a significant challenge throughout the year and into 2008 as many states and the federal government continue to raise the minimum wage.

Moving down to P & L, occupancy costs increased 0.3 percentage points for the second quarter, due primarily to a benefit to general liability insurance expense in the prior year period.

In aggregate, our other operating costs improved by 1.7 percentage points in the second quarter. Utility expense decreased 0.2 percentage points due to lower natural gas prices and legal settlement expense decreased 0.9 percentage points or $2.2 million due primarily to prior year increases in legal reserves. In addition, other operating expenses benefited from $400,000 in income related to the redevelopment of a Company-owned restaurant on the Las Vegas strip. The developer is reimbursing Denny's for lost income while redeveloping the location. Denny's will be a tenant in the new facility, once it has reopened.

On the franchise side of our business, our franchise operating margin increased by 1.5 percentage points or $400,000 over the prior year period. Franchise and license revenue increased $100,000 in the second quarter, despite a $1.7 million decrease in franchise rental income resulting from the sale of real estate previously leased to franchisees. Offsetting the lost rent was an additional $1 million in franchise fees, attributable to the FGI transactions, combined with $800,000 in additional royalties due to a strong 4% same store sales result by our franchisees. Costs of franchise and license revenue decreased by $300,000, due primarily to lower occupancy costs, resulting, again, from the sale of real estate previously leased to franchisees.

General and administrative expenses increased $1.6 million from the prior year period due primarily to higher incentive compensation expense, as well as additional staffing related to restaurant development and other strategic growth initiatives.

Depreciation and amortization decreased $1.6 million from the prior year quarter, due primarily to the sale of real estate assets over the last year.

The last item impacting operating income is operating gains, losses and other charges which increased $7.1 million over the prior year period, due primarily to $14.5 million of asset sale gains, attributable to the sale of 28 Company restaurant operations and related real estate during the quarter.

All of these factors combined to an increased operating income by $7.2 million to $24.3 million in the second quarter. Below operating income, interest expense decreased by $3.9 million to $11 million in the second quarter. This included a $3.3 million decrease in cash interest expense as a result of lower debt balances and improved borrowing costs. In addition, non cash interest expense decreased by $500,000 due to less amortization of deferred financing costs.

On the bottom line, we reported net income in the second quarter of $11.5 million, or $0.12 per diluted common share, an increase of $9.6 million compared with the prior year.

Our internal profitability measure, adjusted income before taxes, which excludes restructuring charges, excess costs, impairment charges, asset sale gains, share based compensation and other non operating expenses and income taxes increased $3.9 million to a positive $1.5 million in the second quarter. Given a challenging operating environment, we are pleased that our strategic initiatives succeeded in driving earnings growth during the quarter.

Regarding restaurant portfolio activity, we saw a net reduction of 6 restaurants across the Denny's system during the second quarter, as 2 new restaurants were opened while 8 were closed. The Company restaurant portfolio declined by 29 restaurants in the second quarter as 1 Company restaurant was closed and 28 were sold to franchise operators.

The franchise restaurant portfolio increased by 23 restaurants in the second quarter, as franchisees opened 2 new restaurants, purchased 28 Company restaurants and closed 7.

Moving onto capital expenditures, our cash capital spending for the second quarter was approximately $6.4 million, bringing our year-to-date total to $13.2 million We expect our capital spending will increase in the second half of the year as we open 4 or 5 new Company restaurants and pick up the pace of restaurant remodels after our higher volume summer months.

Turning to our balance sheet, we continue to make substantial progress on our commitment to reduce debt and improve our financial flexibility. We generated net proceeds from asset sales of $21.2 million in the second quarter, primarily from the sale of 28 Company restaurant operations and related real estate. During the quarter we paid down our debt balances by $12.5 million through proceeds and free cash flow. In addition, our cash balance increased by $12.1 million during the quarter. Subsequent to the quarter end we made a $15 million prepayment on our credit facility term loan, lowering the outstanding balance to $215.6 million and bringing our year-to-date debt reduction to $33.5 million. If we look back over the last 18 months since year end 2005, we have reduced our total debt by approximately 24% or more than $134 million.

That wraps up my review of our second quarter results. While our sales trends improved considerably in the second quarter and our earnings were up significantly over the prior year, we are most pleased with the progress we have made in our strategic initiatives to drive system growth and optimize our Company restaurant portfolio. Our Franchise Growth Initiative has demonstrated early success with the sale of 28 Company restaurants to franchisees in the second quarter. 22 of these restaurants were sold to two new franchisees. One new franchisee purchased all 19 of our Company locations in the state of Washington. This franchisee is a major quick service operator and a valuable addition to the Denny's system. We look forward to a long and prosperous relationship with all of our new franchisees.

While our FGI program includes the sale of Company restaurants, the primary goal is to grow the Denny's system. To that regard, we are pleased to report that the franchisees who purchased Company restaurants this quarter also signed development agreements to build 23 new franchise restaurants. This brings the year-to-date development commitments attributable to FGI to 26 new restaurants.

In addition to FGI, we are offering development agreements in markets that do not have Company restaurants for sale, but have significant opportunity for growth. In the second quarter we signed development agreements for 23 such restaurant locations. Subsequent to quarter end, we have signed commitments for an additional 8 franchise restraints. Through today, we have sold a total of 34 Company restaurants and signed development agreements for 57 new franchise restaurants. The momentum behind our growth programs and the demand for the Denny's brand is very encouraging. We are in discussions with current and prospective franchisees across the country to buy certain Company restaurants and to acquire rights to many of our growth markets. We will provide updates on our progress each quarter or more often if a situation warrants.

With regard to our outlook for the remainder of 2007, I am pleased to report that, despite economic and cost pressures, we remain on track to meet our full year earnings guidance. The only material change to our guidance is to lower our Company revenue assumption and raise our franchise revenue assumption based on the success of our FGI program and the shift in sales from Company to franchise operations.

That wraps up my comments. I will now turn the call over to Nelson Marchioli, Denny's President and CEO.

Thank you, Mark and good afternoon everyone. I agree with Mark's statement that we are pleased with the improvement in sales and the increase in second quarter earnings. But despite our successes, we continue to face a challenging operating environment. While Denny's promotional activities in the second quarter delivered much improved guest counts, we are not seeing improvement in the underlying traffic trends across the industry. Because of that, we are cautious about the second half of this year, particularly the third quarter in which we'll roll over a very successful traffic building promotion from the prior year. We are proactively managing our promotional calendar in order to find a balance between attracting customers and protecting operating margins. We may at times choose to use discount offers as an incentive to those consumers holding out for a distinct value. We may also at times go guest check by pulling back on promotional items and relying on Denny's everyday value.

We are segmenting our promotional activities during the week, when we may promote value on weekdays to take advantage of less price sensitive consumers on the weekend. These activities may result in some guest count volatility over the coming months, but should provide the greatest profit potential, as well.

We are also proactively managing our menu mix to increase average guest check and improve food cost margins. As Mark mentioned, our $5.99 Mega Breakfasts were very popular in the first half of the year. This negatively impacted our margins. We have made changes to our menus and other promotional materials which we expect will lower the incidents rate of our breakfast promotions on the weekends and at late night.

We are also focused on building off premise consumption at Denny's. In most Denny's, carryout is a very small component of sales. We're currently developing new products, packaging and delivery methods to leverage the strong Denny's brand to consumers seeking a quicker, more convenient dining solution outside our restaurants. We are confident that with a more portable product, Denny's can be a viable competitor in this space over the next few years.

While these and many other initiatives will help us to grow sales at our existing restaurants, we are just as focused on growing our restaurant base. The early success of our FGI program mentioned by Mark is a testimony to the strength of the Denny's brand over the last few years. We're pleased to welcome three new franchise operators to the Denny's system. Craig Herman, a former Denny's senior executive has become a new franchise in the Myrtle Beach and Charleston areas of South Carolina. [Nasar Farucki], a former franchisee of Hardee's and Jack in the Box has become a new franchisee in Southern California and [Hashad Narad], the largest franchisee of Carl's Junior has become a major new franchisee with his purchase of all our Company restaurants in the state of Washington.

The demand and enthusiasm for the Denny's brand, both from existing and potential franchisees, is providing momentum to our growth programs and are generating a healthy competition to purchase Company restaurants and to lock up development opportunities in available markets for the future. For example, two of the development agreements we signed outside of the FGI program were for the Long Island, New York area and Nashville, Tennessee. Both of these markets are currently without any Denny's presence. We have similar opportunities in other major markets, including Atlanta, Georgia, Memphis, Tennessee, Charlotte, North Carolina and many others. Our new development programs and the availability of Company restaurants have energized the Denny's franchise marketplace. Now is clearly the time to grow with Denny's.

I want to thank our employees, our franchisees for all their efforts to grow this great brand and our shareholders for their ongoing support and commitment. As always, thank you for your interest in Denny's. I'll now turn the call back to Alex.

Thank you, Nelson. With that Tasha, if you'd like to start preparing the Q&A?

(OPERATOR INSTRUCTIONS) Your first question comes from Reza Vahabzadeh.

Good afternoon.

Hi, Reza.

Just on the franchise margins, the franchise margins have been progressing nicely and in this quarter your franchise margins were well above last year. Can you comment on that?

Yes, Reza. Can you repeat that for us?

Yes. Your franchise margins, you know, franchise income as a percentage of franchise revenues, that margin seems to have been improving, especially in the second quarter versus last year.

Yes, Reza. That's going to be about a $5 million impact. $5 to $6 million impact this year from the rent. If you'll remember last year, we sold the real estate property that we owned.

Okay.

So, that was 5 -- well it was actually $6 or $7 million, but it happened over the year last year that had no corresponding expense. So, the minute we did that, we lost $6 million to $7 million of the margin on the franchise business. Now we picked it up, of course, in interest expense.

I see.

But see last year the property sales, the big bulk weren't until the end of the third quarter. So in the second quarter of last year you still had a lot of rent.

Got it. Same store sales front you seem to have weathered some headwinds reasonably well. Were same store sales trends relatively consistent during the quarter? Or how did they progress?

Yes. We're not going to get into breaking those down. Inside the quarter we think that's granular enough. But clearly as we said going into the second quarter, we were going to have different promotional periods and when we had the ADVO coupon going, that clearly is targeted more at traffic. So, you're going to get a traffic up tick at that point and time.

So, it's going to vary by promotion. I think as Nelson said in his remarks, we're not seeing a marked improvement in the underlying traffic trends across the industry. So, I think it is going to come down to how successful you are in your promotions and how much of a value you're perceived by the consumer.

I see.

I would add to that Reza, that as we go through the balance of this year and beyond, our internal measure of adjusted income, excluding taxes, we're driven to manage the business, obviously in a profitable way now that we have that opportunity. And we're going to be pulling different levers at different times, whether it's about guest count, whether it's about discounts as it relates to check averages and other opportunities and sales in and of itself.

So, we're going to pull those levers as we always have. I think the industry is still in a tough place, fighting for consumer dollars and eating out occasions.

I see. Thanks. And then as far as product costs and labor costs, do you think you're already experiencing the peak of higher product costs and labor costs? Or are the headwinds more challenging in the quarters to come?

I think from a labor standpoint, I think we ain't seen nothing yet, as they say, because of all the pressure around minimum wage and all the efforts in literally every state in the Union around that particular subject.

As far as commodity costs are concerned, hope is not a strategy, but I hope we've seen the worst of it, but I'm not convinced of that. I think we still are seeing a lot of pressure because of the uncertainty of energy prices and the effect on corn, in particular. And other products used for bio fuels.

Got it. Thank you much.

Your next question comes from Michael Gallo.

Hi, Mike.

Hi. Good afternoon. Congratulations on a successful quarter in a difficult environment. My question centers a little bit around the FGI. With the sale of many Company units, I was wondering if you can give us any color on what you might expect that to do to field, corporate and administrative expenses later in the year, particularly if we expect the program to accelerate? Obviously, for example Washington, if I heard you correctly, with a market exit for the Company. So, I was wondering, I guess, ultimately as this plays out, what we might expect that to look like?

Mike. Hi, it's Mark Wolfinger. And to answer your question clearly, as we go through the process of, certainly on a year-to-date basis and sell the restaurants, there is a shift that goes on in the field management structure. And that is, obviously, relatively easy for us to capture. But, obviously, we've not provided an outlook on the balance of the year as far as the sale of a certain number of restaurants and I wouldn't want to give any kind of forward-looking view of G&A or anything along those lines.

But, obviously, we are focused on it and that's probably how I'd like to leave that subject.

Okay. So I guess directionally, certainly there will be some opportunity to rationalize some of that expense.

You're not going to see that in G&A though. Those costs, the area manager costs and those costs are in our costs to goods sold. They are in the payroll line. So, you're not going to see that on the G&A line. You'll see those savings there and clearly there is a pick up. I mean, a Company restaurant area manager might cover 5 restaurants, where a franchise operations manager would cover 25 restaurants. So, clearly there is some pick up in those field expenses, but those run through the cost of Company restaurants sales, not through G&A.

Right. But just generally speaking though, that should help maybe somewhat offset some of the pressure that you've seen in that line item over the last couple of quarters. Is that a fair assessment?

In the G&A line item?

No. In the cost of sales?

Well, I mean, again that's going to be pro rata. Those costs were in there with the units so as they go away. Now, what we will say and what we've said before is we're trying to focus our FGI predominantly on lower volume, lower profitability stores. So, as those stores come out of our portfolio, clearly that will help incrementally raise our margin. So, we definitely hope that will be the case.

Have you made any further assessments as you look at the portfolio, in terms of how many Company stores you think you'd like to ultimately -- do you think you need to ultimately run?

Mike, it's Mark again. We obviously do get that question pretty frequently and as we've said before, without providing specific numbers, we obviously like to have a significant skin in the game, portion of the game, as far as running Company restaurants and obviously one can do quite well at the higher volume into these restaurants. But we've not given out specific numbers and, again, we'll continue to provide additional information as each quarter goes by or something significant happens in between the quarters.

Okay. Great. And then just a final question. I guess as you look at to-go, I know you mentioned it briefly. How far off are we on that before we see product testing? Is that something we could see in the stores later this year or likely not till 2008? Any further color you can give us on that? Thank you.

We are going to be testing this year.

Great. Thanks a lot.

Your next question comes from the line of Brian Moore.

Hi, Brian. Brian? It appears we lost Brian.

Mr. Moore, your line is open.

Brian? We'll let Brian jump back in.

Okay.

Any other calls?

Your next question comes from Joseph George.

Hi, Joseph. Okay, we have a trend.

With a minimum wage hike being implemented last week, what kind of reactions are you seeing from the franchisees? Is there a reluctance from the franchisees in terms of given commitments or in terms of them working those commitments into developments?

Joseph, I saw your report today. I think you've missing a couple of things. One thing, a lot of the states, going back to the minimum wage, the federal impact on the minimum wage for us and for frankly our franchisees outside of the states that have already taken it, won't be that impactful because they didn't change the cash wage. And again, a lot of our wages come from servers who are paid a cash wage in those states, rather than the full minimum wage. So, for those folks, there was no increase in minimum wage and you look at the rest, and again, I can't speak for most franchisees; I'll assume it's the same. Our cooks make far above minimum wage; they won't be impacted. So, there is not a lot of job codes that are really impacted by the federal minimum wage. Now, certainly California earlier this year is a state that doesn't have tip credit. Very impactful, as we've said many times. It was a $5 million impact this year. So, our franchisees are seeing that. But I'm sure they, like us and most of our competitors, are going to take pricing to cover it.

Okay. Okay. And then when you mentioned that you have received 46 commitments in the last two quarters for developments, you still haven't raised the guidance for the number of franchise openings that we are seeing? Or the number that is given is a range of 20 to 25. Is that because the time lap between a commitment and an actual development is more than six months?

Oh. Absolutely.

Absolutely. Yes. I mean, this is Mark and clearly what we'll see is a majority of those stores that are signed in those development agreements will open sort of over the next 5 year timeframe. But the initial openings, as far as the early development agreements won't be until the 2008 timeframe.

Okay. Great.

It's about 14 months at the shortest from the time they sign to getting open, probably. Somewhere in that range, to a year and a half.

Okay. Got it. And the last question was in the context of the competition that you are facing from the quick serve guys and your strategy to emphasize on value in order to counter that, how would you explain the 3.6% increase in guest checks that we saw in the second quarter? Is that more because of a change in the product mix? And if yes, is that something that is sustainable?

Well, we've certainly had a lot of menu mix impacting our check over the past few years. So, the part of it that was that is the same. Also, we haven't taken pricing. We took our pricing back, and we've said this before, at the beginning of the year coming into the minimum wage. So, we will be reacting to the states that do have some impact from the federal. But again, that's not a very material impact so we will take pricing there, as well.

But we've taken our pricing to cover those costs this year and then you hope you get the guests that you intend to pay that. But yes, there will be menu mix and, again, we've got baked in pricing already this year.

Joseph George. Okay. Got it. Thank you. Thank you.

Your next question comes from the line of Bryan Hunt.

Thank you. To kind of follow up on that last question from the competition from QSRs. One, there's been several QSRs expand their breakfasts or move into breakfast for the first times. Are you noticing any pressure on your morning customer count? Or has your customer count decline evenly spread?

I would tell you weekdays we're not seeing that much of a change from what we've seen recently. Our weekend business continues to hold up. We're probably seeing more pressure on late night than anywhere else.

Is there anything that you're doing to actively counter that pressure? Or do you feel like that's just a situation of Wendy's and Taco Bell and others advertising heavily late night?

Well, I actually think over time they're going to expand the market, if you will, or the opportunity. But right now I do think the fast food folks, particularly with 18 to 24 year old males, are impacting our business in late night. However, we are putting in place initiatives. We have tested initiatives last quarter before -- well, I'll just leave it at this for competitive reasons. We've tested some initiatives and we'll be rolling some of those successful initiatives out into more markets early in the fall.

And is that product or marketing focused?

Both.

Okay. And last question. With the credit market weakening dramatically, which I'm sure you all have seen the headlines, is there the capability within your credit agreement to maybe going and buy bonds considering the weighted average cost of interest or debt in your bond relative to your bank debt?

Not at this time.

Okay. Thank you very much.

Thank you.

Thank you, Brian.

Your next question comes from [John Kalaba].

Hey, guys.

Hi.

Hi, John.

Hi, John.

A quick question for you. Actually, I have two questions. The first is, do you guys have any insights into why your franchises consistently beat the operating stores every single time in same store sales?

Well, that's a phenomena that, frankly, we're enjoying the last two years. If you look back to prior 35 years, that was not the case. And there are two reasons why, I think. One, they are remodeling in excess of a hundred a year and when we remodel stores, we get a benefit for that. And the other reason is they are operating from a lower level of volume. They now, I'm delighted to tell you, are at $1.5 million AUV. The Company is in excess of $1.7 million. And so they're operating from a lower base and they are enjoying an up tick and we're delighted. It demonstrates a very healthy franchise system and most good franchise systems I've been associated with always outperform the Company. This has been an anomaly of the prior 35 years from what I can tell. So, I hope that at least gives you our perspective on what's going on.

And then I guess not really a follow up, but an additional question, is that I'm assuming you guys are familiar with the IHOP transaction with Applebee's and what they're trying to do with that?

I've read it in the newspaper and in the models, the same as you have.

Okay. I mean, the question really is it comes down to, I mean, I guess you guys have a strategy and you've said for several quarters now that it's important, at least, to show your franchises that you have skin in the game by holding, I'm assuming that means several hundred operating stores?

Well, we haven't given a number, but we've clearly said there is a level we won't go below and we have a lot of very profitable restaurants in our portfolio that we would be hard press to find a buyer that can give us equal value for those.

I mean, I guess where I'm leading with this question is, it's clear that the market values franchise cash flows at a substantially higher multiple than operating cash flows. So, my questions is, is it's clear that the market doesn't see value in having skin in the game in terms of having operating performance. So, I'm curious as to how you're adding to shareholder value by holding a substantial amount of operating companies that tend to have five times --?

Because we've run the analysis and to sell a certain number of our stores is not accretive.

I see. Okay. But in terms of -- but, you have run those models, I'm assuming and --

Of course.

In detail.

Good. Good.

We are here for shareholder value. Make no mistake.

Okay. Good to hear. All right. Thanks, guys. I appreciate it.

Thank you.

And at this time, there are no further questions.

Tasha, would you ask if anybody wants to get back in, please?

(OPERATOR INSTRUCTIONS) And we do have a follow up question from [Brian Moore].

Good afternoon. Can you hear me?

Yes, Brian, we can hear you this time.

Okay. I'm sorry about that earlier. Could you maybe speak to, I guess, the appetite for the franchise growth initiatives since, I guess, it was initially rolled out I think at your annual franchise meeting and then given the announcements recently?

Well, Brian, it's Mark. As I said in my prepared comments and I think Nelson reiterated his, as well, that clearly we've been pleased with the progress thus far and very excited about some of the new players, new franchisees that have come into our system. And, obviously, also pleased with the number of new store agreements that have been executed upon. But again, it's 34 stores that we have sold thus far on the Company side. We'll continue to focus on this initiative, but we're, obviously, still in the early stages.

I would add that interest has been, without exaggeration, robust. I sit just down the hall from the team that is involved in the core negotiations on these deals. And I am encouraged with the interest in this terrific brand for growth.

Okay. That's helpful. And then I guess following on the credit markets question earlier, could you maybe talk about the sources of available financing for your franchisees to either build or acquire units of their franchise growth initiative, as well as maybe any precedent for those that haven't been in the industry quite as long, in terms of the implications of a essentially tightening credit market on those sources?

Brian, it's Mark again. I think one of the things that we're also incredibly encouraged about is the number of financing sources that exist in the marketplace. And I can tell you right now that based on some of the progress to date in the first half of the year, we have not seen third party financing sources to be a problem whatsoever in these transactions. And again, I think that speaks to the strength of the Denny's brand and, obviously, the cash flow economics. And overall, I also think it speaks to the improvement in the franchise or balance sheet and the debt reduction comments that I made earlier in my script, as well.

And I would add it would also demonstrate the strength of the applicants and the kind of franchisees that this terrific brand is attracting.

Absolutely.

Okay. That's helpful. And then I guess a final question and I guess I'm just speculating that it would seem that maybe your customer might have adjusted to the year-over-year increases in gas prices and maybe we're seeing that in the guest count component of your same store sales number. But I'm wondering if you can speak to geographically the issues of sub prime, mortgages and I'm not really sure how many of your customers are homeowners? But talk to Florida versus California or other states in terms of what the macro factors are perhaps facing your customers?

Today I would tell you and if you ask me tomorrow it might be different, but just the West Coast is not nearly as strong today as it was a couple months ago. The East Coast is showing some real strength, whether that has to do with sub prime loans or mortgages or selling of homes, I honestly don't know. You can pick on the South. You know there are some parts of the South that are quite robust and others that, candidly, are quite weak. So, I don't think you can put your finger on it. I think the consumer is looking for value. I happen to agree with you. I think the consumer has adjusted to gas prices and frankly hasn't adjusted his and her appetite for driving and traveling. But they have made other adjustments, particularly as it relates to eating out. And I think that's why you're seeing an up tick, certainly in some of the large players in QSR. They're making choices and, obviously, in casual you're seeing a little more weakness. We're positioned in between the two and I see us getting more occasions at times and at others, not. But the geography isn't as simple as it once was.

Thank you very much.

Thank you.

Thanks, Brian.

Your next question comes from the line of Kevin Starke.

Hi. Good afternoon, gentlemen.

Hey, Kevin.

Pro forma for the debt payment you made after the end of the quarter, I'm showing you at 3.5 times leverage net of cash. First of all, I wondered if you could confirm that? And second, I know that your stated leverage target is 3 times, but you're getting there in a hurry. And I'm wondering when you do arrive at that number, supposing that you do, do you suppose that you will revisit that number and lower it? Or do you think that 3 times leverage is pretty much a good long term position to be in?

I think our standard answer is we'll let you know when we get there. Again, at the end of the quarter we had a pretty high cash balance. That is not in our cash balance run. So, I'm not going to talk about the ratios of those things. Everybody calculates them just a little differently. But clearly, we're pleased with the pace of our debt reduction. And as we move forward we'll look at the markets and we'll look at our capital structure. We do it on an on going basis.

Okay. Second question. Nelson just commented very favorably on the quality of new franchisees being attracted to the system. In our conversations, one measure of quality is the ability of the franchisee to retain employees and I was wondering if you have evaluated these franchisees on that basis and what you could say about that?

Well, I would tell you that we are establishing initiatives this year on a go forward basis to help our franchisees become better employers and businesses of choice in the communities where they represent the Denny's brand. This is particularly important understanding the fact that we are going to become more franchise driven as an organization and are going to depend on franchisees even more than we do today to deliver our brand in a quality way with quality people. So, you'll see our franchisees, the new franchisees will see, and hopefully ultimately our customers, will experience an improved relationship. And I would also tell you, as far as turnover is concerned, generally speaking franchisees have less turnover than the Company does. Significantly so. So, generally franchisees do a better job of holding onto and retaining personnel on a go forward basis than most companies do, ours included.

But when you're looking at new franchisees, is that something that you specifically look at, their performance in that regard?

We talk about it. Franchisees typically don't keep track of it as well as large organizations do. It is certainly -- we talk about the quality and the benefits that are going to be offered to our employees and what kind of equity opportunities in the new business our current employees will have in the future. We are concerned about our employees and it is very much a cared for and cared about culture we're trying to create. So, we do spend a lot of time talking about this.

Okay. Thank you.

Thank you.

Thanks, Kevin.

Your next question comes from the line of Eric Wold.

Hey, good afternoon. I'm flipping back between a couple of calls so I apologize if one of these is answered. On these --

Oh, get off the Wild Wings call.

On the re-franchising, I don't know if you've done this, but the stores you've re-franchised so far since the program started, can you classify maybe kind of where those are on a spectrum of kind of how they perform versus maybe like bottom 20%, top 20%, somewhere in the middle? And then maybe kind of how that might shift kind of going forward?

Well I mean, as we've said, part of the difficulty in modeling this is because it is going to bounce around a little bit. There is going to be some transactions that will be quintile 5's if you will and I'm taking you back to our presentation, as you said the bottom 20% that we show in all of our presentations. Clearly, we're targeting the lower 2 or 3 quintiles. Quintile 3, 4 and 5. I will say year-to-date most of them have been in that range and we would expect most of them going forward to be in that range. But on a transaction by transaction basis, that will vary, just based on geography.

Okay And then when you talk to these franchisees, obviously they're looking to come in here and acquire these stores because they believe they can do something with it. Do you have an idea kind of what they've said or what you think? Or, you know, I'm not looking for specific guidance, but do they think they can significantly boost numbers from where you've had them just because now they're got more attention on them versus one or two stores in a large group of a company cluster versus now they're coming in and actually paying some closer attention to it?

One word answer, Eric, this is Nelson, is yes. They believe and they have demonstrated in the businesses, particularly the franchisees that are coming in that own other franchises or come in with prior franchise experience, clearly are coming in saying that and have demonstrated in their most recent past experiences that they can increase sales. Some double digit.

Okay. And then lastly, on the 34 or so, the ones you've done so far, how many different transactions were those?

Probably 7 or so.

7.

7.

Okay. Perfect. Thanks you guys.

Thank you, Eric.

Your next question comes from the line of Alex Yaggy.

Good afternoon everyone. Just a quick question on the franchise. You have, I think, 23 new units that are outside the FGI program. I'm just wondering because it doesn't look like you've talked about those kinds of numbers in past releases, whether that's an unusual number and how we should think about that number going forward? Whether you can add 15 to 20 units on a quarterly basis? And then typically how long will it take? I think you sort of addressed this, but how long should those units take to be fully developed?

This is Mark. I mean, as I mentioned in my script, there's really two separate growth vehicles as far as development. One is obviously the new store development agreements that come out of FGI and that number, again, is based on the sale of 34 Company restaurants year-to-date. There is 26 new stores that came out of development agreements there. The 23 is the market growth incentive plan, as we call it internally, which again is not relating, these are growth markets, but not relating to the sale of Company restaurants. And actually there were 8 additional agreements signed beyond the quarter. So, the total is actually 31 if you include early into the third quarter here.

And again, this comes down to specific growth markets that may not necessarily be seeded by the sale of a Company store, but as we mentioned in our comments, there are a number of what I would call top 50 DMAs in the country that the Denny's brand is definitely underdeveloped. And so we continue to look at that as an opportunity.

So, again, the total new store development number to take away here is 57, which is the combination of those new store development agreements, signed as a result of FGI, and also the new store development agreements signed under the market growth incentive plan.

Right. But just in terms of on a go-forward basis, it sounds like that number, exclusive of FGI, should remain at a pretty healthy pace?

Well, you won't hear a projection coming from me, but clearly we're focused on both spectrums as far as growth for this brand. And as we've said throughout this conference call, we're obviously very encouraged about both of those growth corridors.

Alex, this is Nelson. I would tell you that when I first came here six and a half years ago, we stopped development here because, candidly, we couldn't get it right. Well we absolutely are getting it right now and growth, as our development team says, growth is back on the menu. So, the kind of results you're seeing, obviously, are a result of a lot of hard work and us filling a pipeline. We are reluctant to make projections, obviously, because we don't want to disappoint. So, I would encourage you to stay tuned and to realize that we're going to continue to do more, not less, to make Denny's all that it can be as we have, obviously, growth back on the menu here.

Right. But just -- and just on the timing in terms of when someone signs an agreement, they typically are required to have their first unit up and running within what timeframe?

It's somewhere between 14 and 18 months. So, if you look at these figures, I think as we might have mentioned earlier or not, but if you look at these figures, the initial opening of new stores from these development agreements will be sometime probably the second half of '08, 2008 timeframe.

Okay. Thank you.

Your next question comes from Dan Khoshaba.

Hi. Good afternoon.

Good afternoon, Dan.

Good job. Just a real quick question. On this increase in staffing, the SG&A was up. Some of that was incentive compensation and some of that was staffing. Could you go into a little bit about what is the increase in staffing for? What's it focused on? How much more is it? And what is kind of the payback you're thinking?

Well, I would tell you that the staffing that we're doing at this time is about muscling up. It's about hiring great people that know how to do things that we currently don't have that expertise on board. And when we talk about as an example, new concept development. This brand has never had a senior officer responsible for new concept innovation. We have that now with Mark Chmiel, a seasoned veteran from this industry. So, we are muscling up, as they say, to take advantage of opportunities this brand hasn't had an opportunity to do before. So, actually it is a pretty exciting situation. But it isn't more of the same; it's about hiring specific talent to take us to the next level.

Sounds good. That's great. How about -- just real quickly if I could follow up, on the take out situation, do you have any of these new restaurants going up with the opportunity to kind of do a drive thru?

We're looking at that. And that's probably all I'm going to say at this point. I'm anxious to test a lot of things this year. Mark Chmiel, who I just mentioned is looking at a lot of different options and you'll see us this year testing various models, as well as next year.

Yes. I would think that the Denny's restaurants, because most of them are in stand alone facilities, actually would lend themselves to if you wanted to go through drive thru that situation. So, you'd be able to alter the infrastructure.

Well, I would tell you that 43% of our restaurants are on major highways and interstates and I hope you're right. But the permitting and the selection of those restaurants and where those restaurants are located, is important.

Yes. Okay. Great. Thank you.

Your next question comes from [Bob Nicholson].

Yes. Good morning, gentlemen or good afternoon, gentlemen. Nice quarter. The question I had for you, one of the earlier callers talked a little bit about the comparison with IHOP. That management team, obviously, has made a transition over the last 5 years to more of a company-owned like model in a very successful franchising program. I understand you guys are reluctant to give specific guidance, but what timeframe would you guide investors to when you're going to clarify exactly what the goals are for the program? And how you see things developing for the Company?

Well, I think we're going to continue to do what we said, Bob, and that's to talk about it each quarter, talk about our progress as we do more. We've sold 34 so far; we're very excited about 34. But it's 34. So, as we move forward, I think we'll have a better idea. But it's going to take some time to get out there and we're not marketing the entire country all at once. Our team is moving through the country, moving it different locations. So, this process is going to take some time and we're ready for that because we're trying to do it in a very quality way. We're trying to attract quality operators to the brand and grow with the quality operators that are already in the brand.

So, I think over the next few quarters we'll get more and more of an idea.

And I guess one quick follow-up question. As you guys are doing the analysis of what restaurants make sense to re-franchise and not, you talk about whether a sale is accretive or dilutive. Do you factor into that analysis, at all, the higher multiple, which investors place on franchise-oriented businesses and cash flow versus company-owned asset intensive revenue and cash flow?

Well, we certainly look at it from a global perspective, yes. When we look at our modeling, we take that into consideration. I'd say I don't think the market is taking that into consideration right today. If you look at the significant cash flows we get from our franchise business today, that doesn't appear to be in our valuation today so maybe you should spread the word.

Will do that. Thank you, guys.

Thank you.

At this time, there are no more questions. Mr. Lewis, are there any closing remarks?

No. I think -- thank you for joining us and we'll talk to you next quarter.

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