Denny's Corp (DENN) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Denny's second quarter 2008 earnings release conference call. (OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to Mr. Alex Lewis, Vice President and Treasurer for Denny's Corporation.

Mr. Lewis, you may begin your conference.

Thank you, Brandy.

Good afternoon, and thank you for joining us for Denny's second quarter 2008 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, Chief Administrative Officer and Chief Financial Officer.

Mark will begin today's call with a financial review of our second quarter results. After that, Nelson will provide his overview of our business and our strategic initiatives. After our prepared remarks, 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. Management urges caution in considering its current trends and any outlook on earnings provided on 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 26, 2007, and in any subsequent quarterly reports on Form 10-Q.

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

Thank you, Alex, and good afternoon.

I'll start my comments with a quick review of our second quarter sales performance.

Systemwide same-store sales decreased 2.8% in the second quarter, comprised of a 0.7% decrease at our company restaurants and a 3.7% decrease at franchise restaurants. We believe part of the difference in the same-store sales between company and franchise restaurants is the timing of pricing actions. There may be additional impact from differences in geographic concentrations as well.

Looking at details for company sales performance, a 6.7% decline in guest counts was mostly offset by a 6.4% increase in average guest check. Most of the growth in guest check was attributable to pricing actions taken over the past year to help offset minimum-wage hikes and commodity-cost pressures. The remaining growth in guest check was attributable to favorable menu mix compared with the prior-year period.

Company restaurant sales for second quarter reflect the continuing impact of our Franchise Growth Initiative -- or FGI -- as sales decreased $55.1 million, or 25%, due to 141 fewer equivalent company restaurants compared with the same period last year.

Since the beginning of 2007, we have sold 171 company restaurants, or approximately one-third of the company base at that time. As a result, we have increased the mix of franchise restaurants in the Denny's system from 66% to 77% over the last 18 months. As the successful execution of FGI is ongoing, the sequential decline in company units, company restaurant sales, and company restaurant operating income is expected to continue, while franchise revenue and franchise income are expected to increase.

Turning now to the quarterly operating margin table in our press release, our company restaurant operating margin in the second quarter was 12.5% of sales, an increase of 0.9% compared with the prior-year period. We are very pleased to have generated margin improvement during the quarter, as our primary cost, food and labor, had been under pressure for more than a year from substantial commodity inflation and minimum-wage hikes.

The most significant change in our second quarter P&L was a 1.9% improvement in our food-cost margin. In addition to price increases taken to help offset commodity inflation, we have been proactive in managing our menu mix in order to reduce our food cost per guest while still providing a compelling value offering to our customers.

Our primary product promotion in the second quarter was the "Build Your Own Grand Slam." The Grand Slam is our most recognizable menu item and is also one of our most profitable.

Payroll and benefit costs for the second quarter increased 0.2% to 42.3% of sales, due primarily to higher group-medical costs and increased restaurant management compensation partially offset by more efficient crew labor staffing and menu price increases intended to help offset minimum-wage hikes.

Utility expense in the second quarter increased 0.3%, due primarily to higher natural gas prices.

On the franchise side of our business, we are experiencing the offsetting positive impact from the FGI program as equivalent franchise restaurants increased by 134 units in the second quarter compared to the prior year. This contributed to a $4.4 million, or 20%, increase in franchise revenue. This revenue growth was comprised of a $3 million increase in franchise rental income and a $1.6 million increase in franchise royalties, partially offset by a $200,000 decrease in franchise fees.

Franchise operating margin increased by $2.8 million, as higher revenue offset a $1.6 million increase in franchise costs, primarily related to rental expense on properties subleased to franchisees.

General and administrative expenses decreased $1.6 million from the prior-year period, due primarily to lower payroll and other compensation costs.

Next, depreciation and amortization decreased $2.6 million from the prior-year quarter, due primarily to the sale of restaurant operations and real estate assets over the past year.

Operating gains, losses and other charges decreased $15.1 million from the prior-year period, due primarily to a $10.3 million decrease in asset sale gains compared with the prior-year period.

In addition, restructuring charges increased $4.5 million, due primarily to severance costs related from the organizational changes we made in the second quarter, as we transition our company focus towards becoming a franchisor of choice in the restaurant industry.

These changes included the elimination of approximately 50 field and corporation positions in June. Certain of these positions will serve out a transitional period so we don't expect to realize the full $6 to $8 million in annualized G&A savings until 2009.

Operating income for the second quarter decreased $12.8 million, due primarily to the reduction in asset sale gains and the additional restructuring charges. If you exclude these items from both periods, operating income increased $2.3 million, despite a decrease in total revenue of $50.7 million.

Below operating income interest expense decreased by $2.1 million, or 19%, to $8.9 million in the second quarter as a result of a $97 million reduction in debt from the prior-year period.

Other nonoperating income increased $1.4 million in the second quarter, due primarily to changes in the fair value of our $100 million interest rate swap.

We've reported net income in the second quarter of $3.2 million, or $0.03 per diluted common share, a decrease to $7.5 million compared with the prior-year period.

Because of the significant impact to our P&L from nonoperating, nonrecurring, or noncash items, we give earnings guidance based on our internal profitability measure, adjusted income before taxes. We believe this measure best reflects the ongoing earnings of our business.

Our adjusted income before taxes in the second quarter was $5.7 million, a $4.2 million, or 280%, increase over the prior-year period.

We are very pleased that we were able to generate significant income growth despite the difficult sales and margin environment for the restaurant industry. We believe this is evidence of the progress we are making on our strategic initiatives, in particular the success of FGI, as well as our debt-reduction efforts.

To summarize our P&L for the second quarter, the sale of company restaurants to franchisees resulted in a $55.1 million decline in company restaurant sales and a $4.8 million decrease in company restaurant income. We more than offset this lost company restaurant income through the combination of $2.8 million increase in franchise income, a $2.6 million decrease in depreciation and amortization expenses, and a $2.1 million decrease in interest expense.

We expect our P&L will continue to reflect these income and expense shifts as we transition to a more franchise-driven business model.

To put this income shift in perspective, in 2007 our company operations generated 60% of our gross profit, and our franchise operations contributed 40%. In the second quarter of 2008, the contribution from our higher margin franchise operations had increased to 47%. We expect this to continue this beneficial shift from company operations with margins of around 12% to 13% to franchise operations with margins of 68% to 70%.

Turning to activity in the Denny's restaurant portfolio, the system decreased by a net 5 units in the second quarter, as 4 new restaurants opened while 9 were closed. The net decline in units of this quarter is expected to be offset by a strong schedule of new franchise restaurant openings in the second half of this year, as the impact of new-store development from FGI begins to be realized.

Our guidance for new franchise restaurant openings remains at 30 to 34 for the year, of which 11 had opened through the end of the second quarter.

Moving on to capital expenditures, our cash capital spending for the second quarter was $7.9 million, an increase of $1.5 million compared with the prior-year period. Most of this increase was due to timing of expenditures, as last year's capital spend was heavily weighted towards the back half of the year and this year's capital spend has been more even.

Turning to asset sales in the second quarter, we generated net proceeds of $7.1 million from the sale of 20 company restaurant operations and certain real estate. As a portion of these transactions closed on the last day of the quarter, approximately $3.2 million of the net proceeds were not received until after the quarter closed and are, therefore, not shown in accounts -- are, therefore, shown in accounts receivable on our balance sheet.

On a year-to-date basis, we have generated net sale proceeds of $22 million on the sale of 41 restaurant operations and certain real estate.

Excluding notes receivable taken for $2.4 million of the sale proceeds and the $3.2 million in proceeds received just after the second quarter ended, we took in $16.4 million in cash during the first half of the year. Most of these proceeds were used to reduce our outstanding debt by $15.4 million since the start of the year. In these difficult economic times, we are very pleased to have reduced our debt by $214 million, or 39%, over the past two years.

That wraps up my review of our second quarter results.

Before I discuss our revised guidance for the year, I would like to point out the short-term impact of the Franchise Growth Initiative on our free cash flow.

When you review our second quarter 10-Q, which will be filed this evening, you will see a notable decrease in cash flow from operations compared with the prior year, despite our increased adjusted income for the year. The primary reason for this decrease is a runoff of working capital resulting from the sale of company restaurants.

Restaurants typically operate in a negative working capital environment, as sales are received in cash or through timely credit card receipts, while many of the costs associated with these sales are paid on delayed terms. Accordingly, we see a cash runoff from each restaurant sold of approximately $150,000 to cover payroll and other lagging operating expenses. This results in a year-to-date use of cash of approximately $15 million based on 100 restaurants sold at the end of last year and so far this year.

Despite the effect on short-term cash flow, we are very pleased with our progress on FGI and the resulting optimization of our business model. We continue to see strong demand from potential and existing franchisees to purchase Denny's company restaurants. The lack of liquidity and other challenges in the credit markets are making the process more difficult and more time-consuming, but our pipeline and timeline for FGI transactions remains on track to meet our guidance of 75 to 100 restaurants to be sold this year.

Again, despite the effect on short-term cash flow from the working capital runoff, we continue to have a very strong liquidity position with cash and revolver availability of over $70 million at quarter end. We also reduced our leverage in the quarter to 3.8 times based on total debt to adjusted EBITDA.

I want to make sure that the message is clear that our cash flow is on plan and our financial position is as strong as it has been in the last 20 years.

As for our other guidance, we have updated certain metrics for the full year based on our positive year-to-date results and management's expectations for the second half of the year. Our sales outlook remains cautious given the economic pressures that continue to impact our customers.

However, the challenging sales environment has not kept us from making significant improvements in profitability during the year. We now expect our core income metric, adjusted income before taxes, to range from $13 to $17 million for the year. This is a substantial increase from our earlier guidance of $8 to $14 million and a 25% to 60% increase over our 2007 result at $10.5 million.

In addition, our expectation for capital spending has been lowered from $35 million in our previous guidance to $29 million now. This change is due primarily to fewer company restaurant openings than previously estimated. One planned Pilot Travel Center location will now be opened by a franchisee, and one traditional Denny's opening was delayed until 2009.

Most of the other guidance metrics provided in our press release have been updated moderately based on year-to-date trends and the impact of FGI transactions during the year.

That wraps up my commentary on guidance.

I will now turn the call over to Nelson Marchioli, Denny's President and CEO.

Thank you, Mark.

Good afternoon, everyone.

Let me start by saying I'm pleased with the progress we are making on our strategic initiatives, the most critical of which is our transition to a franchise-focused business model. It is through this change, along with a commitment to improve our operating margins, that we have been able to generate such strong earnings growth in the second quarter.

While improvement in the economic environment would certainly make our jobs easier, we don't foresee any material lift in the second half of '08 or into '09. We don't believe consumer spending is likely to pick up either, and inflationary pressures aren't showing any signs of weakening.

We have chosen to develop a long-term, multifaceted marketing strategy that addresses our guest-count weakness without sacrificing profitability. We do not believe there is an easy answer to attracting guests, particularly in this environment, but recognize the need for Denny's to be more relevant, more convenient, and more innovative in today's highly competitive marketplace.

While we want to drive traffic across all of our four day parts, we are using our core attribute, breakfast, to connect with the consumer. In our research, participants selected Denny's above all competitors when they thought of a real breakfast. We are using this connection as the foundation for our messaging and product innovation.

In May we began an aggressive campaign to energize our late-night business. While almost half of our late-night customers were already in the 18-to-30 age group, we had not effectively targeted this important demographic. Through our Denny's "AllNighter" campaign, we are using relationships with popular youth-oriented bands and targeted television and Internet media to build awareness for Denny's late-night experience.

While competition is strong at late night, Denny's can offer much more than a bag out of a drive-thru window. Only at Denny's can you choose from such a wide variety of offerings, including appetizers, sides for sharing, value-priced burgers and sandwiches, desserts to cure a sweet tooth, and, of course, all your breakfast favorites, and you can do it all while relaxing at a table, rather than in back of a car.

We know that it will take time and persistence to grow this business, but we are encouraged by our early results. We have seen late-night traffic improve substantially, but guest counts remain negative, as we fight the economic headwinds impacting all of our day parts.

In late June we launched our first comprehensive takeout sales initiative. While you've always been able to order food to go at Denny's, we didn't have a unified program to promote and execute it. It was more of an accommodation.

Our customers told us they wanted the convenience of having their "real" breakfast wherever they chose. The challenge was maintaining a quality breakfast in traditional packaging. Denny's solved this problem with a revolutionary new packaging system called "The Denny's Dome." This proprietary packaging is designed to keep every part of your meal hot and fresh. While it is very early in the program, we have seen an increase in takeout sales and expect to see continued long-term sales growth as we build awareness for Real B-FAST 2GO.

Our late-night and takeout initiatives were internally the first two parts of a three-part summer sales program we called "Triple Play." The third component of this program is the introduction of a brand-new product line, "Sizzlin' Breakfast Skillets." We are currently offering two variations, a Southwestern Sizzlin' Skillet and a Flatjack Sizzlin' Skillet.

The Southwestern comes to your table fajita style, sizzling on a hot cast-iron skillet. On the side are warm tortillas ready to be loaded up with scrambled eggs, fire-roasted peppers and onions, hash browns, bacon, and sausage. Fresh pico de gallo and sour cream are perfect on top.

The Flatjack Skillet also sizzles with traditional breakfast ingredients of scrambled eggs, bacon, sausage and hash browns, ready to be rolled up in sweet, thin pancakes and perfect with syrup on top.

We are very excited about the launch of these innovative new menu items and will begin a media teaser campaign this week and a full commercial schedule next week to support them.

We are confident that we are building a foundation for marketing and product development that can meet our goals of sustainable relevance, convenience, and innovation. With that said, we are also aware of how difficult it is to drive positive traffic in today's environment.

Our revised sales guidance for the year anticipates continued negative guest count despite our enthusiasm for our new sales initiatives. We all recognize that the US economy continues to experience significant negative pressures. Nevertheless, we are confident about our strategic initiatives and believe that our current actions create long-term shareholder value.

This quarter's results are evidence of that success, as we continue to optimize our business model, increase our profitability, and strengthen our financial position. We have completed our organizational changes and are now focused on meeting our strategic goals while ensuring and improving day-to-day execution in all of our restaurants.

I want to thank our employees, our franchisees for all their hard work to grow and energize the Denny's brand. I'd also like to thank our shareholders for their ongoing support.

We're pleased with our progress, but we believe the opportunities ahead are far greater.

As always, thank you for your interest in Denny's.

I'll now turn the call back over to Alex.

Thank you, Nelson.

And with that, Brandy, if you could get the queue ready for question and answer.

(OPERATOR INSTRUCTIONS)

Your first question comes from Reza Vahabzadeh from Lehman Brothers.

Hi, Reza.

Hi. The cost of sales, as you mentioned, was significantly lower than prior year as well as the preceding quarter as a percentage of restaurant sales. Can you talk about that?

Hi, Reza. It's Mark.

Hi, Mark.

I briefly talked about it in my comments, but it's primarily driven by the success of "Build Your Own Grand Slam." I mean, that is -- obviously, it's as popular a brand, per se, as the Denny's brand. I mean, that's sort of what we're known for, the Grand Slam. And it also has a very, very attractive food-cost structure to it. So we were very pleased with the kind of mix we saw in that product line during the second quarter, and that was the, I mean, the key contributor to that movement.

Okay. But are you actually experiencing food-cost inflation and just offsetting it with the menu types?

Well, I would say, yes, we are experiencing, definitely, food-cost inflation on a commodity side, and, again, we don't see that changing whatsoever. I mean, I think, if anything, the inflationary factors continue to build.

I also mentioned in comments, obviously, we have taken pricing actions over the last 12 months as well. But at the same time, when you look at our product cost lineup and you go -- if you go to our menu items, the Grand Slam is a very attractive food-cost structure just out of the gate to begin with.

Got it. Okay.

And then as far as your refranchising activities, are you encountering any slowness in terms of financing availability to your financing refranchising activities?

I mean, it is -- this is Mark again, Reza. It is getting tougher, no doubt about it. And I would say the word "slow" is probably the way to put it. I think that -- there's a number of transactions out there that we're very positive and optimistic about, but it is definitely a slower process when you go through the financing metrics now. Again, I think there's just, obviously, a stronger selectivity there on the part of the third-party financing entities. Rightfully so, I think, just in the given -- the credit market situation out there.

But as I mentioned on my comments as well, we remain on target to our original guidance of 75 to 100 company stores to be sold during 2008, and obviously we have 41 under our belt in the first half of the year.

Got it. Thank you.

Your next question comes from Bryan Hunt with Wachovia Securities.

Thank you. I was wondering if you could talk about the movement in your EBITDA guidance? You moved the lower end up $3 million. Was that because of confidence in some of your activities that you put in place either in the cost-savings or sales side, or did you just outperform what you anticipated to do in Q2 on am EBITDA basis?

Well -- Bryan, hi, this is Alex. I think it's a combination of the fact that we've seen already this year -- I mean, certainly the product cost line was a benefit, but it is one that we had certainly modeled coming into the year. We're well aware of how profitable the Grand Slam is, but we needed to get into the year, see what the mix was going to be on the "Build Your Own" and those things. But certainly there's upside there.

And then I think the other piece of it is just the FGI. We closed a considerable number -- or sorry -- sold a considerable number of restaurants, literally, at the very end of last year, which is really sort of in front of our planning -- or after our planning period so we needed to see the impact of those roll through.

And I think you're seeing it in our P&L. You're seeing that transition of the business model really come through. Those transactions are very accretive. We do an accretion test on every transaction we complete, and you're seeing exactly what we expected to have happen. You're seeing interest come down, you're seeing depreciation come down, you're seeing the transition -- while you lose a little income, certainly, from the end -- from the switch from company to franchise, you've got a nice consistent, very high-margin business on the franchise side.

So I think we just had to get into the year and continue to see the realization of our initiatives, and I think that's what we've seen so far.

And the follow up on your FGI initiatives, it appears that the cash proceeds per unit has come down in the most recent quarter, and, additionally, it doesn't look like you signed any new franchise agreements along with the most recent transaction. I was wondering if you could describe what's going on in those two instances?

Well, I think the proceeds are always going to move around. I think if you take the -- again, this is Alex. If you take the total dollars that we took in this year and divide it by 41, you get a little over $0.5 million, and that's what our proceeds have been through the whole program on average.

Now, each quarter's going to be a little different, but what we've seen now after 171 probably goes back to being around $0.5 million a piece on a net proceeds basis.

It's challenging to look at the quarters because we got proceeds in the second quarter that related to first quarter transactions, we haven't gotten all the proceeds from the second quarter because some of those were on accounts receivable balance for one day at the end of the quarter. So it's hard to look at all that, but as we gave in the script --

And the other part of the question was, I mean, at the end of last quarter, I think you all had agreements from franchisees to open 135 locations as of the last conference call, and now it's only 136 and you've sold an additional 20 locations. I mean, what's going on on that front?

Well, and that too is going to vary dramatically. I think we had 3 new contracts that were -- contracts for 3 new units that signed up for in the second quarter. And that, again, is going to vary greatly. In some areas in the country, we're not going to get any development agreements -- and we've been saying this all along. There are areas we can get very strong development agreements. So, again, you've got to just sort of go back to the averages as we work our way through this, and we're ahead of where we thought we'd be on a development standpoint so we're pretty pleased.

I appreciate it. I'll get back in the queue.

Thanks, Bryan.

Your next question comes from Michael Gallo with CLK.

Hi, good afternoon.

Hey, Mike.

Couple questions. I was wondering, you've obviously done a very good job of managing the food costs this year. Certainly, the Grand Slam promotion mixed very well. I was wondering if you expect to have similar food costs on the skillet promotion or whether you expect the mix to be not quite as favorable in the second half?

Well, I don't know whether we'll get real specific because we're still going to be running the Grand Slam. That's one thing to know, the Grand Slam -- the Millionaire Grand Slam will still be available in the restaurants. It may not be the focus of our TV advertising at certain times, but it is still going to be a promotion that will run all year, and we expect to have a strong mix all year. The skillets have a good food cost. Nothing touches the Grand Slam, but we're very comfortable with what the skillets' food cost is.

Great. That's helpful.

Second question I have, I just wanted to drill down on 2GO. I know it's only been in the system for about a month, but I just wanted to get a feel for what kinds of things you're seeing, whether you're seeing it help the midweek business, whether it's helping somewhat on the weekend, when there's a long wait on a Sunday for breakfast, or what you're expectation is over a longer period of time, whether you think that can be a 2%, 3%, 4% add-on to sales? I mean, certainly, breakfast is more difficult to do, but I was wondering what kind of customer feedback you're getting on the new packaging, keeping the product fresh, and whether you're starting to get some repeat business either during the week or just people come in and see a wait on the weekend type thing?

It's Nelson. Where we're seeing the greatest increase is in late-night for takeout. And most folks in this industry do about 5% to 15% in takeout, and we are now in that range of about 5%. Prior to starting, over the last several years, we've been between 3.4% and 3.6%. So we're seeing a nice lift. At least we're in the average of where the rest of the industry is.

I said in my comments that it's been pretty much of an accommodation at Denny's. We are building that business. We haven't seen the benefit in some of the other day parts that, candidly, we thought we would. But we knew from the start it would be a slow grow, and we're seeing nice growth. We're pleased with where we are so far.

I mean, it seems like it's actually ramping faster than I would have thought given it's really only been in the system for a few weeks.

Amazing, when you talk about something, what happens. Internally, our employees are excited about it, they see it as a unique offering, and it's something that they can do. It's not a new product; it's just a new offering. Gives them an opportunity to go out into the marketplace and to the neighborhoods where they do business and to demonstrate their pride in the brand.

Okay. Great.

And then final question, you talked about Pilot over the last couple quarters, the initial units were exceeding expectations. As I recall, you were going to be evaluating Pilot -- or the pilot test in Pilot later this summer for potentially expanded rollout or retrofit. I was wondering if you can give us an update on where you stand with that, whether you plan to -- obviously, you're starting to open it up to franchisees -- but just kind of what you see the longer-term opportunity there and when you expect to make a decision on a more expanded rollout? Thank you.

Well, we have a meeting with Pilot in the fall, as we had promised last year we would, with management there. We have been very pleased with our relationship. It's my understanding they're very pleased as well. I would tell you that, in my mind, it's no longer a test. We have already opened it up to franchisees. We clearly will have somewhere between two and four franchise units open this year with Pilot, and based on the locations, we're very excited about it.

So I think we're off and running. I think it's been a good partnership and we're going to continue to make that work, and I'm going to be meeting with their CEO, along with our CFO and Chief Operating Officer, in the fall, as I said, to bring some clarity as to what all our expectations are, but I think they'll be more rather than less.

Okay. Great. Thanks a lot, and congratulations again on the solid second quarter results.

Thank you.

Thanks, Mike.

Your next question comes from Brian Moore with Wedbush Morgan.

Hi, Brian.

I guess I'll try my interquarter monthly same-store sales question, and really what I'm trying to understand is, from a macro view, the impact of trade down, tax rebate checks and gas prices. And if you want to, you can address it perhaps, I think, the industry seems to have had a pretty good April, a really good May, and a somewhat disappointing June.

I don't know that we buy off into any of those numbers, Brian, but I think we've got our guidance, our guidance is flat to down for the rest of the year based on where we're at right now. So I think we take a very conservative look at the marketplace for sales right now. We're not seeing any improvement. We put that -- Mark spoke to that, as did Nelson. We're very pleased with some of the opportunities that we've been able to create with some of our new programs, but the headwinds aren't get any easier, particularly in some of those really challenging areas of the country.

And I'll see if Nelson has anything else?

I really can't add much, Brian. It's still a real tough trading environment. The trends -- I would tell you that, from where I sit, the trends in June continue, and that's probably all I'm going to say about that.

I guess I'll just ask the question, though, is it fair to say you didn't see a benefit in May from tax rebate checks?

No. No. You know, people talk about that. We were recently at the Oppenheimer conference, and there was quite a bit of conversation about it. We haven't seen it.

Okay. And then, I guess, a question for Mark -- thank you for that, Nelson.

And, if I look at the G&A, the $6 to $8 million in annual savings, how should I think about the base year? Is that 2007 as the base year or from '08?

It sort of run rate from where we were at that point in time, Brian. I mean, because we were still ramping up and hiring, and, frankly, we're still hiring. We've got some positions that we think can help build our franchise business, and we've been working on that regard. So it's really sort of at that point in time.

Again, our biggest focus is that you'll start to see the impact won't be necessarily in the third quarter. It'll be more in the fourth quarter and then more again next year. But that's not -- we're not giving guidance for next year's G&A number.

One final question. I guess we're going back -- way back -- to the five quintiles and the spread in terms of profitability. Is there any (inaudible) to provide an update in this environment as to how the top two quintiles have performed versus the bottom three?

I don't have any exact numbers in front of me, Brian, but, clearly, all units are struggling with margins. We are very pleased with what we did in the second quarter by having a margin lift across our business in this environment, but we've had, certainly, impact at the high stores and had impact at the low stores.

What we've been pleased is is we have been able to execute our quintile strategy, if you will, and we've been able to sell a considerable number of stores out of quintile five, which we consider the low quintile, four and three. Those have been our target areas, and that's what we've been able to do.

So we're continuing to optimize our business model, but it is a challenging environment to do that because all units are under pressure. I mean, all of our units have wage issues. All of our units have commodity issues. It really doesn't change. We've been very successful in trying to overcome that.

I would add that -- I would give you this, Brian, that those restaurants that are located around theme parks, Hawaii, Vegas, Disney, major attractions, our restaurants continue to do well. It's a mixed bag after you leave those particular venues. It appears that the American consumer that planned on going to Disney or to the Alamo or to Hawaii or to Vegas, they're still going, and they're going to Denny's for value. But when you get away from those central locations, it turns out to be a mixed bag.

Thank you very much.

Your next question comes from Steve Anderson with MKM Partners.

Hi, Steve.

Hi. Very quick question. What can we assume for the average sales price of each individual restaurant to the franchisees in the first half? I think in 2007 somewhere a little north of $500,000?

Well, yes, I think we said year to date has been $22 million, there was 41 sold, so that's about $500,000.

Okay. So running about that rate.

Yes.

And also a very quick question for you, Mark. On the -- or rather -- so I wanted to ask about the -- any progress we hear about on Fresh Express at all?

We continue to look at Fresh -- this is Nelson. We continue to look at Fresh Express as our area for research and development to find more relevant portable products. The Sizzlin' offerings that we're introducing -- that we introduced last week and we begin to go on air this week with, that actually came from our team that works in Fresh Express. We continue to work on nontraditional units as it relates to Fresh Express. We still have work to do before we would roll that out other than in a nontraditional situation. But we see it as a great avenue or laboratory for us to develop new and relevant and exciting new products and pull it into the base brand, where we get the most benefit.

Thank you.

You're welcome.

Your next question comes from Eric Wold.

Hi, Eric.

Eric, you there?

(Inaudible) mute button.

Good afternoon, guys.

Hey, Eric.

Couple of follow-up questions on some of the earlier questions. One, obviously, you've done a great job of controlling costs on the food-cost line that's environment with the rising commodity cost. Talk about where you guys stand with what contracted and how much is contracted and, I guess, take the view -- obviously, you guys will start renegotiating those contracts towards the end of this year. Assuming prices for the contracted items kind of shift to more current market levels, what kind of impact would that have?

Well, we're done for this year. We're into '09 at this point and trying to be opportunistic. Opportunistic, however, this time isn't about how low you can buy it at, but how realistic and how quickly we have to make decisions to make sure we understand what we're going to be dealing with. Grains are the most difficult, and we're making partial-year commitments at this point for '09 where we've received advice.

So we moved early this early in our contracts for grains and other commodities, and at the time, boy, it didn't seem like a value, but in retrospect, we made some incredible buys, although quite escalated from prior year. I think that's what we're dealing with in '09 as well. People ask me -- particularly at the Oppenheimer conference recently in Boston -- they asked, "Well, gosh, what do you think food inflation is going to be?" And I think it's going to be in a range of between 6% and 14%, and it really depends on a lot of things. It's not an easy one to predict.

I think we've got, Eric -- there's still a ways to go in this year before we start doing too much guidance on next year, and most of our buying has typically been towards the end of the year, first of next year to lock in for the year. So I don't think we have -- we're ready yet to give you any guidance for next year on that.

No, I appreciate that.

And last question, on the refranchising, obviously, 75 to 100 is a wide range. Seventy-five is probably, my guess is, kind of what you've got pretty fairly well locked up with current discussions and things that are kind of in place. What needs to happen to get to that 100? Are discussions kind of going with the banks and kind of into creditors right now to get to that 100, or is that more of a stretch, or that's still a realistic possibility at this point?

Eric, hi, it's Mark. I mean, the way I look at this is the midpoint between the 75 to 100 is sort of 80's, and we've done 41, I guess, after the first half of the year. So we're sort of targeted if you just analyze that.

But to answer your question, it is so wide range because some of these transactions are 1 or 2 stores, but some of these transactions are 10, 12, 14 stores. So if one of those larger transactions moves the wrong way, happens to move into the next fiscal year, obviously, that can influence the number substantially.

We've got a number of discussions underway, but, again, there's still approximately 5 months left in the fiscal year so there's still a ways to go. And so what you're hearing is, obviously, the normal conservatism you hear from a CFO having, obviously, sold as many as we've done in the last 18 months.

But as I made my comments -- as I opened my comments, we're still in that range -- 75 to 100 -- and, clearly, when you look at that guidance that was put out there in February and you look at where we are today, I'd have to say the environment's gotten a lot tougher in the last 5 months. So, obviously, we're satisfied that we're still within that annual guidance range, and we'll continue to push hard.

But it's definitely a tougher environment that we're dealing with both -- obviously, when you look at the consumer situation, but also the credit markets. Again, it's not that deals can't get done, it's just it's slower, it's tougher with tougher terms and conditions on those transactions.

It's Nelson, Eric. I would add to Mark's comments there's still an incredible interest on behalf of new and existing franchisees to purchase these restaurants and commit to growth, but the lending market is -- as Mark said earlier -- slow, and so how much we get done this year is kind of up for grabs at this point. We're comfortable with the guidance. I know it is a wide range, but we are comfortable with it, and in the third quarter we'll give you a better idea.

Although, I will tell you, last year it really didn't get interesting for us until October, early November to make our fourth quarter more than we ever anticipated. But we'll give you an update on our third quarter call.

I appreciate it.

One quick follow-up on the last comment then on FGI with, I guess, the difficulty being across the board, if you guys are going to do 1 or 2 units or 12 to 14. Is there any kind of -- is it more difficult for the much smaller transactions, or is it more difficult for the larger transactions, or does it make a difference?

I would tell you that -- the only way I can answer that question -- this is Mark again, Eric -- is I go back and look at the 171 that we've done. It really didn't come down to the size of the transaction as far as degree of difficulty. It comes down to where in the country, the success of those stores, the type of franchisee, is it a new franchisee or an existing franchisee in our system. And, again, we've been ecstatic that both, obviously, our existing franchise base and the stores they purchased and the new franchisees that we've brought in.

And it can come down to the financing entity. I mean, some of the third-party financing entities are -- I don't want to say more challenging to deal with, but have different type of parameters and metrics, and depending upon how they move through internally, that can either move a transaction faster through the pipeline, or it can slow it down.

So it ranges broadly, and, again, I think we've got a very strong systematic method in which we do these transactions from start to finish, and I'd like to say that we'll continue to have the success factor we've had.

I appreciate it. Thank you, guys.

Thanks, Eric.

Your next question comes from Mark Smith with Sidoti & Company.

Just a couple questions, and sorry if they're repeats as I've been bouncing around on calls.

First, the company operated restaurant guidance was 3 total for the year; is that correct?

That's right. And we've done those 3.

And you've done those 3. So no more. Is that part of kind of the new strategies? You turned to a higher franchise base to kind of pull back on those company-operated openings?

Well, I mean, it certainly is. I mean, we've said the growth out of this brand is really going to come through franchising. But we did decide -- we had one other Pilot unit, as we said in Mark's script, that we decided to offer to a franchisee, and they jumped on it pretty quickly. And we had another unit -- more of a traditional unit -- that's just been pushed back to early '09. So it was timing a little bit there. That was five, and we sort of came into the year thinking four, five or six, and so that's how we got back to three.

I mean, I think we've pretty uniform in saying we're going to do new units that help develop new development programs for us, things like Pilot and other avenues where we can build something new for franchisees to use to help them grow. And we're always going to continue to look at the real high-volume flagship locations: Vegas, Hawaii, Orlando. Places like that we'll continue to look at as well.

Second, can you just talk about if you received any pushback from consumers on some of the menu price increases?

No, we really haven't because our menu is -- most of them start -- you can get a complete breakfast for about $4.39. You can get appetizers for less than that. So there's a wide range of value options for our consumers so we -- and we're very careful when we review where our competitors are. And, generally speaking, we're priced below our national competitors, and our regional competitors, we're either at parity or below, even with the price increases that we've taken.

And last question, can you just talk a little bit about the health of your franchisees? You maintained your guidance for new openings and what you expect to be sold to franchisees, but can you talk about any attrition with franchisees, especially as we see other chains closing up shop these days?

I don't think we have any real news there. I think we're pretty pleased with where we've been the past couple years. I mean, I think the new development agreements we've gotten out of franchisees, the fact that we're going to open 30 to 34 new franchise units this year and we're still on pace for that, still feel very good about that, and that's going to be considerably more than we've done the past couple of years. We continue to get a lot of demand to buy company restaurants. I mean, again, the financing sources are a little challenging, but the demand isn't the issue on FGI right now, for sure.

So I think we feel pretty good about it. Things like Grand Slam put more cash in their pockets as well. So when we're doing better on a margin basis, generally, they're probably doing better on a margin basis as well. So it's hard to have a -- we've got 250-plus franchisees so I'm sure there are some that are more challenged than others, but I think as a whole we're very pleased with where the brand is right now.

And we work closely with our franchise association, we work hand-in-hand on the purchasing side, and we all, obviously, are working together to drive more sales. They were very much in support of our new Sizzler rollout, as well as the takeout rollout and the late-night.

So it's been a tough environment but a lot of harmony and a lot of working together, more than we've done in years. Our relationship with our franchisees, I would tell you, is the best its been in a long time, and it's been that way for a while, and we are always concerned about the profitability of restaurants, both the company's and the franchise.

So I would tell you we have a healthy system. We have almost no accounts receivable at this point in time. Every brand has a handful of franchisees that struggle, in my experience, but nothing that I would suggest to you would be out of the ordinary.

And I'll sneak in one more question. Just with what happened in California today, any initial feedback on any damage or any closures there, especially since you've got so many company-operated restaurants in California?

Nothing that we're aware of.

Okay. Great. Thank you.

Thank you.

And, Mr. Lewis, would you like to take any other questions?

Yes. Let's try to squeeze one or two more in quickly.

Okay. You're next question comes from Tony Brenner with Roth Capital Partners.

Hi, Tony.

I'm curious regarding gas prices, given the large number of highway locations, and especially with the summer driving season being a big sales period for Denny's, whether, when you have abrupt changes in the price of gas, such as we had both in June and in July -- whether that has a noticeable effect on customer counts?

I think it does. Tony, it's Nelson. I think consumer confidence, as it relates to gasoline prices, is probably more important than the price itself, and I think the energy policy that will be forthcoming from whoever becomes president will be critical in how the consumer looks forward, both short term and long term.

But I do think the gas price run-up early in June and then again in July, I think, had a negative effect on all retail, and I think that's coming out in all these earnings reports. And they were anxious -- the media was anxious yesterday to talk about how it had dropped to $3.95. Well, nobody really pays too much attention to those kinds of drops, unfortunately.

By the way, you can tell your previous caller or questioner that most structures in California, I believe, remain standing.

Are you okay, Tony?

All right. Thank you.

Okay. Any other questions, Tony?

No.

I think he's gone.

He's gone.

And you have no other questions at this time.

Okay. Well, thanks, everyone.

Actually, let me -- for the analysts on the phone, if you've got reports or questions that you need to get answered, I've actually got to be out of the office --