Denny's Corp (DENN) 2008 Q3 法說會逐字稿

Good evening. My name is Heather and I will be your conference operator today. At this time, I would like to welcome everyone to the Denny's third-quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the conference over to Mr. Alex Lewis. Sir, you may begin your conference.

Thank you Heather. Good afternoon and thank you for joining us for Denny's third 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 and Chief Administrative Officer and Chief Financial Officer. Mark will begin today's call with a financial review of our third-quarter results. After that Nelson will provide his overview of the 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 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 our earnings provided on this call.

Such statements are subject to risk, uncertainties and other factors that may cause the actual performance of Denny's to be materially different from the performance indicated or implied by such statements. Such 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. One note -- our Form 10-Q for the third quarter will be filed later on this evening so you can pick that up as well.

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

Thank you Alex and good evening. I'll start my comments with a quick review of our third-quarter sales performance. Systemwide same-store sales decreased 5.1% in the third quarter comprised of a 2.7% decrease at Company restaurants and a 6.1% decrease at franchise restaurants.

There are many factors that might contribute to the difference in same-store sales between Company and franchise restaurants including the timing of pricing actions, geographical variances and the exclusion of same-store sales from restaurants sold over the last year. Looking at the details for Company sales performance, an 8.8% decline in guest counts was partially offset by a 6.7% 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 a reduction in discounting compared with the prior year period. In fact, our discounts for guests in the third quarter were down 26% compared with prior year as we've reduced our use of these less profitable sales drivers.

Company restaurant sales for the third quarter reflect the continuing impact of our franchise growth initiative or FGI as sales decreased $56.2 million or 26% due to 137 fewer equivalent Company restaurants compared with the same period last year. Since the beginning of 2007, we have sold 192 Company restaurants or 37% of the Company's store base at that time. As a result, we have increased the mix of franchise restaurants in the Denny's system from 66% to 78% over the last 21 months.

As the successful execution of FGI is ongoing, the sequential decline in Company units, Company restaurant sales and Company restaurant income is expected to continue while franchise revenue and franchise income are expected to continue increasing.

Turning now to the quarterly operating margin table in our press release, our Company restaurant operating margin in the third quarter was 13.3% of sales, an increase of 1.4 percentage points compared with the prior year period. We're pleased to have generated significant margin improvement in the third quarter as our primary costs -- food and labor -- have 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 1.4 percentage point decrease in food costs. 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 costs per guest while still providing a compelling value offering to our customers.

The Build Your Own Grand Slam continued to sell well throughout the third quarter after its second quarter launch and continued as one of our highest margin items. Payroll and benefit costs increased a slight 0.10 percentage points to 40.8% of sales in the third quarter as more efficient crew level and management level labor costs in the current quarter were offset by a one percentage point increase in workers compensation costs attributable primarily to a benefit in the prior year period. Utility expense in the third quarter increased 0.6 points due to higher energy costs which peaked in the third quarter and have since begun to subside.

On the franchise side of our business we were experiencing the offsetting positive impact from the FGI program as equivalent franchise restaurants increased by 141 units in the third quarter compared to the prior year. This contributed to a $4.1 million or 17% increase in franchise revenue.

This revenue growth was comprised of a $2.8 million increase in franchise rental income, a $1.2 million increase in franchise royalties and a $200,000 increase in franchise fees. Franchise operating margin increased by $2.2 million as higher franchise revenue offset a $1.9 million increase in franchise costs primarily related to rental expense on properties subleased to franchisees.

General and administrative expenses decreased $1.1 million from the prior year period due primarily to lower salary and other compensation costs attributable to the new organizational structure we announced in the second quarter. (inaudible) depreciation and amortization decreased $2.1 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 increased $4 million from the prior year period due primarily to a $2.9 million decrease in restructuring and impairment charges and a $1.1 million increase in asset sale gains compared with the prior year period. Including these items, operating income for the third quarter increased $4.8 million to $20.7 million.

If you exclude the gains, losses and other charges from both periods, operating income increased $800,000 in the quarter despite a decrease in total revenue of $52.1 million. Below operating income, interest expense in the third quarter decreased by $1.7 million or 17% to $8.8 million as result of a $70 million reduction in debt from the prior year period.

We reported net income in the third quarter of $10.6 million or $0.11 per diluted common share, an increase of $5.6 million compared with the prior year period. Because of the significant impact to our P&L from non-operating, nonrecurring or non-cash 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 third quarter was $8.5 million, an increase of $2.7 million or 47% over the prior year period. We're 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 strategic initiatives, in particular the success of FGI as well as our debt reduction efforts. To summarize our P&L for the third quarter, the sale of Company restaurants to franchisees resulted in a $56.2 million decline in Company restaurants sales and a $4.5 million decrease in Company restaurant income.

We more than offset this loss Company restaurant income through the combination of a $2.2 million increase in franchise income, a $1.1 million decrease in general and administrative expenses and a $2.1 million decrease in depreciation and amortization expenses and a $1.7 million decrease in interest expense. We expect our P&L will continue to reflect these income and expense shifts as we continue our transition to a more franchise based business model.

To put this income shift into perspective, in 2006 our Company operations generated two-thirds of our gross profit and our franchise operations contributed one-third. In the third quarter of 2008, the contribution from our much higher margin franchise operations had increased to 48%.

We expect to continue this beneficial shift from Company operations with margins around 12% to franchise operations with margins of approximately 70%. By the end of 2008 we expect one-half of our gross profit will be contributed by our franchise business. This income shift allows us to lessen the risk and increase the predictability of our P&L.

The optimization of our business model is evident in our increasing Company restaurant margins, our increasing Company average unit volumes, the decrease in our capital spending and ultimately in our long-term free cash flow generation.

Turning to activity in the Denny's restaurant portfolio during the third quarter, the system decreased by a net seven units as eight new restaurants opened while 15 were closed. The eight new openings were were all franchise restaurants bringing the year-to-date franchise openings to 19 which already surpassed the franchise openings total in 2007 of 18.

We updated our guidance today for full-year 2008 franchise openings to a range of 26 to 29. This is a slight decline from our previous estimate as the difficult financing environment has slowed the development process and pushed a few expected openings into 2009. Of the 15 closures in the third quarter, 14 were franchise restaurants and eight of those related to one failed franchisee.

Moving onto capital expenditures, our cash capital spending for the third quarter was $6.3 million, a decrease of $1.5 million compared with the prior year period. We expect our cash capital spending to continue trending downward as we reduce our Company restaurant portfolio and limit our new restaurant investments. Today, we lowered our cash capital guidance for 2008 to $27 million which would imply a $6 million decrease from the prior year fourth-quarter and the prior year.

Turning to asset sales in the third quarter, we generated net proceeds of $8.2 million from the sale of 21 Company restaurant operations and an additional $2.2 million from the sale of certain real estate. On a year-to-date basis, we've generated net sale proceeds of $30.2 million on the sale of 62 restaurant operations and $3.8 million from the sale of certain real estate.

Excluding those receivables taken for $2.7 million of the sale proceeds, we took in $31.4 million in cash during the first nine months of the year. We used these proceeds to reduce our outstanding debt by $15 million during the year. In addition we held back a portion of the proceeds in cash as you can see in our cash balances which increased from $12 million at the end of the second quarter to $21.4 million at the end of the third quarter.

We chose to take a conservative approach to our cash management, particularly in advance of our October 1 semiannual interest payment on our senior notes of $8.8 million. We have made that payment and are once again building up our cash reserves. We expect to apply the majority of any fourth-quarter asset sales to debt reduction and may choose to make additional voluntary prepayments as we have done in the past.

Given the challenges facing our national economy and our industry, we're very pleased to have reduced our debt by $216 million or 39% over the last 2.5 years. Through our efforts over the past few years we're now in a financial position to manage through difficult operating environments like we find ourselves in now. I think it's worth restating that we have no material debt maturities in the near-term as our revolver is in place through December of 2011 and our term loan through March of 2012.

That wraps up my review of our third quarter results. Before I discuss our revised guidance for the year, I would like to take a minute to talk about the status of our franchise growth initiative or FGI.

We have made considerable progress through FGI to optimize our business model and energize growth across the Denny's system. Despite the headwinds in our industry and in the financing markets, we closed the sale of 21 restaurants in the third quarter consisting of four sold in August and 17 sold in September. As you saw in our release, we still expect to meet our original guidance range and close the sale of 75 to 85 Company restaurants this year, implying 13 to 23 more restaurants to be sold in the fourth quarter.

Transactions have certainly become more difficult to complete and lenders are requiring more conservative financing terms for buyers. But we still have considerable demand for the FGI program and we're still working on new deals. Several of the recent or pending deals are second FGI transactions, meaning the buyers completed an FGI deal last year or early this year and are back negotiating for more.

The financing bottleneck is challenging but as long as we continue to have the strong demand to grow with Denny's, we will continue to move forward on this important strategic objective. As I remind our team here, it's important to remember that we're selling these restaurants because it is the right strategic action, not because we have a financial requirement to do so.

In fact, our liquidity remains very strong with cash and revolver availability of over $70 million at quarter-end. As for our other guidance, we have updated certain metrics for the full year based on our year-to-date results and management's expectations for the fourth quarter.

Given the economic pressures that continue to impact our customers, we expect our fourth quarter same-store sales will be similar to our third quarter results yielding a full year Company store comp of negative 1% to negative 2% and a full year franchise comp of negative 4% to negative 5%. The challenging sales environment has not kept us from making significant improvements in profitability during the year. We now expect adjusted income before taxes of approximately $20 million for the year. This is a substantial increase from our original guidance of 8 to $14 million and a 90% increase over the $10.5 million in adjusted income reported for 2007.

In addition our expectation for capital spending has been lowered to $27 million as we continue to adjust our capital expenditures based on our business model transition and in order to meet our cash flow objectives. The other guidance metrics provided in our press release have been updated moderately based on our 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 and good afternoon everyone. Let me start by saying that I'm pleased with the earnings growth we have generated this year. Our franchise growth initiative and the other strategic initiatives we have undertaken to optimize our business model are clearly making a positive impact. A 47% increase in core income this quarter would be welcome in any period. But to realize that achievement in such a difficult environment confirms our strategic direction.

While our strategic successes have provided some insulation against the current microeconomic pressures, they do not lessen the critical need to reverse our negative guest count trends. The improvements in our restaurant operating margins have resulted from higher menu pricing to offset cost pressures, the promotion of menu items with exceptional food cost margins and the sale of lower volume, less profitable restaurants. All of these factors have contributed to earnings growth as we had anticipated but we did not have the opportunity for organic sales and margin growth.

Consumers are eating out less when they do eat out, they are far more focused than ever on price. Our most successful promotion this year was Build Your Own Grand Slam which offered a strong value to our customers but also provided Denny's a strong food cost margin.

A couple of weeks ago, we launched our $4 Weekday Express Slam which provides a full breakfast at a compelling price point. We must continue to deliver value driven promotions such as these along with a continuous lineup of new product introductions in order to build profitable and sustainable sales growth. Value has always been one of Denny's primary consumer core attributes.

Our marketing team is following a plan that is focused around real breakfast and builds upon that core attribute with new messaging, new business opportunities and new product news. We are proud of the new initiatives we launched this year for late-night as well as to-go. The Denny's All Nighter campaign is consistently putting Denny's in front of an important demographic, 18 to 24-year-olds, for our late-night business. Our to-go initiative allows Denny's to enter the consideration set for off-premise consumption. We must continue to provide the support necessary to build consumer awareness for these opportunities to grow the Denny's business in all dayparts.

We have also been encouraged by the reception to our new product launches including the Sizzling Skillet Breakfasts and more recently the Sizzling Skillet Dinners. The repurchase intent on these items has been strong but we haven't been able to drive the incremental traffic we had hoped for. Attracting new customers or more frequent visits from existing customers is more difficult than ever to reduce consumer spending and increase competition.

We believe in the components of our marketing plan but understand that in this environment it will take continued reinforcement for a significant period of time before we can expect to reverse our sales trends. For that reason, we do not foresee a material change in our sales results over the remainder of 2008 and quite possibly for much of 2009.

This year we have successfully focused on profitable sales programs, cutting operating costs and improving the efficiency of our corporate support structure as we transition from a company to a primarily franchise-based business. We will continue these initiatives along with a conservative capital budget to ensure that we continue to produce positive free cash flow.

As you know, Denny's is a strong brand that has stood the test of time. Over the past few years, we have greatly strengthened Denny's financial position. While many in the industry were adding leverage, we were aggressively reducing debt and extending our maturities.

We are now in a favorable position to manage through these very difficult times. We will continue to focus on our core strengths of breakfast and value. Through our strategic initiatives and day-to-day execution in our restaurants, we believe we can continue our financial performance improvements and enhance shareholder value over time.

As always, I thank you very much for your interest in Denny's. I now will turn the call back over to Alex.

Thank you Nelson and I'll ask Heather to prepare the Q&A.

(Operator Instructions) Karen Eltrich, Goldman Sachs.

Hi guys, a couple questions. First off, obviously with corn coming down where it is I think probably the oulook for commodity costs next year have been altered. How has it altered your view? What have you locked in for next year and are there some things that maybe you're waiting on?

If you look at corn you're absolutely right. It has dropped quite a bit. But keep in mind two years ago, it was half the current selling price. So we still are in quite an inflationary period as we look at corn.

The only corn that we have locked in at at this particular time has been in our formula as we purchase our liquid egg product which is considerable but that is the only corn that we have locked in on. I don't recall what we locked in on it at but it is a place where we can live.

What about some of the other commodities? What is your outlook right now in terms of locking up current prices if you can or to wait and see if they come down lower as well?

I think it is more about as we look at commodities as we have always looked at the commodities, you have to -- you can't be greedy. You have to look at it and find a place where you can live with a price. I don't know where they're going to drop, if they're going to drop anymore.

There are a number of buys compared to what we have seen over the last two years, last year particularly. So we are locking in some things but we are being very careful and there's others that candidly we're going to continue to ride the market on because it just doesn't make any sense at this point in time.

Yes, a lot of things don't make sense right now. I can appreciate that. Final question -- I do think a lot of the strategies you have undertaken with your menu this year have been beyond innovative and creative. It sounds like you're a little frustrated that they haven't necessarily taken hold.

I'm curious to see what traction are you seeing that keeps you encouraged particularly for the late-night menu as well as for the takeout? Do you feel that with additional marketing or just with time and a better economy they will take hold? What are your kind of thoughts so far on the progress?

Well, in the past -- and I'm probably going to quote some numbers here that haven't been quoted before and my CFO will look at me here in a moment and wonder why I said this. But our average on takeout sales across the chain for Company store sales was 3.6%. And when we introduced our new takeout packaging and began talking about takeout on television at the back end of our commercials, we saw that rise to almost 5% incidence and of course takeout is very profitable for all of us in the restaurant industry because it -- candidly it doesn't take a lot of effort and doesn't take a lot of incremental labor.

So one of the reasons why we continue to talk about takeout and we want to encourage takeout sales and continue to put that in front of our customer is that it is profitable and they have responded. On late-night almost the same story but not quite. Late-night with fast food a couple of years ago and many of our competitors entering the 24-hour market which we frankly almost owned alone is our second most frequently mentioned core attribute from our consumers, that being 24/7. We saw a significant decline in guest count over the last two years. We have stopped that decline and in fact reversed it. Although I am still negative, I'm far less negative.

And we began speaking to our 18 to 24-year-olds. 48% of our customers that are our customer between 10 PM and 5 AM are 18 to 24-year-olds and we never spoke to them before. So we began Internet advertising. I think I mentioned on one of the earlier analyst phone calls that we invested $5 million earlier this year in Internet advertising and MTV late-night, things like Adult Swim and other things frankly that we hadn't spoken to 18 to 24-year-olds before.

They have responded. In fact it is one of our strongest dayparts now and now we need to do the same thing with the other dayparts. But I'm particularly encouraged by the fact that our late-night customer has responded when we have spoken to them. We have changed the environment and the level of friendliness and menu items and offering value at late-night. And going back to the takeout, we obviously are making it more of a -- giving it more visibility and that's why I am encouraged by those two things.

And where we have to continue to work to build our business for the future and why I am encouraged by it is when people think of Denny's, they still think of Denny's first and foremost as a breakfast place. And our weekday breakfast candidly for the entire history of the brand from what I can tell, on weekdays has never been our strong suit. And that is a huge business thanks to fast food and now participating at a $4 dollar level, we're now a player particularly if you consider takeout and you don't have to settle for a real breakfast and our research is telling us that. And we're seeing improvement in that daypart although it's too early to make a call.

I knew there was more to brag about than what you let on in your opening comments (multiple speakers)

There's more than that but hopefully I will restrain myself for the balance of a call.

Michael Gallo, CL King.

My question is obviously you guys have done a very good job over the last couple of quarters of improving profitability even as you've obviously had some topline softness. My question is as we go forward assuming we're going to be in a difficult topline environment, for the foreseeable future are there still things that you can continue to do to improve results from here?

Do you feel like you're going to need to see the topline turn around in order to continue to see improvement or --? Just any color you can give us on some things you're working on over the coming 12 months; certainly it sounds like your expectations for '09 is you're going to continue to see a tough topline environment. Thank you.

I would respond, Michael, by telling you this is a group of management that is focused on continuous improvement all the time. That is how we have been able to achieve what we have achieved and we continue to do that everyday and every quarter and every year. We spend -- my team and I spend an extraordinary amount of time looking for improvement.

But our primary focus beyond being well-managed and making smart decisions as Mark likes to say, there's three things we have to do and that is sales, sales and sales. We have to give the consumer a compelling reason to visit Denny's. Topline would solve a lot of issues for all of us in the industry but I think Denny's has a unique position because of its brand, the visibility, the fact that it's an American icon.

We just have to work much harder at putting Denny's in the consideration set to the consumer that is eating out and we have got to give them reasons to choose us. Value is part of it but service and comfort is another part of it. Particularly in lunch and dinner, the entire industry is being hit by lunch and dinner and so are we.

We've got some initiatives. We're going to our franchise convention here next week and we are going to talk about sales, sales and sales. It will be the most hard-driving sales-driven discussion this brand has ever had with its franchisees and so everyone understands that that is the focus. We have the systems in place, we understand how to buy commodities and we understand how to flow cash to the bottom line.

We have as one major investor said the other day -- not the other day. Actually it's more than two months ago. He made the comment that children are no longer running Denny's. It's run by adults and ultimately the long-term view will bear that out.

I guess some of the things -- clearly we made a lot of very positive moves on the product cost line. As we said, we focused a lot this year on the Build Your Own Grand Slam. That one is going to be real hard to top, to be quite honest. I mean we're working hard on our commodity plan, we're working hard on our marketing plan for what we are going to sell.

Some of these things that we have done are going to be hard to repeat. Now that said, I think we're still going to continue to have very competitive food costs versus a lot of different segments of the industry. And you know again, it's going to take topline to really make the margins move a whole lot more.

That's helpful. Then just a follow-up to a prior question; you mentioned that you saw some lessening of the guest count declines in late-night. Have you seen any changes in the weekday breakfast? I know that's been an area that's been under pressure over the last year or so as well.

We just launched that weekday price point a couple of weeks ago. So it's too early to tell on that one. I think we're going to have to take more of a wait-and-see approach to that. But that's the most competitive business there is right now probably for us. So we are going to keep going after it.

Great, keep up the great work. Thanks.

Reza Vahabzadeh, Barclays Capital.

You talked about your focus on sales, sales, sales in your meeting coming up next week. I am wondering if you have found the right balance between hitting on sales, sales, sales versus protecting your margins. Protecting your margins it seemed like [this was a quarter] on that front. But the 24% cost of products is the lowest cost of products (inaudible) you've had in I would say 20 quarters. So I'm just wondering if you need to move that in a different direction to strike the right balance.

Well you have to have -- you're right, it's Nelson. You have to have the right balance without -- you have to have sales, they have to be profitable sales and the margins have to be where they are. We feel comfortable with the -- I think we mentioned in a recent press release the new alignment in our organization as it relates to how we are managing operations. And I give operations frankly an incredible amount of credit both in managing our Company and our franchise business with these strategic business units that we've will that we set up.

To have, to experience that 24% that you just mentioned, I don't see that as a one-time event. I don't see that as a result of doing anything different. What we need to do is drive more sales and enjoy those kinds of margins and I am convinced we can do that without candidly any more effort in that regard.

What do you think is the key to getting better sales? Is it the products? Is it the pricing, is it the communication?

Yes, but I will tell you it isn't all about value. This $4 value is just in my opinion terrific but it isn't necessarily -- it's driving some guests in but that isn't the only issue. So I think we have to do a better job of communicating. I think we have to give a better compelling reason to potential customers.

I think we have to get (inaudible) users back and I think it's a concerted effort at the restaurant. It is about having the right sales team on our restaurant floors everywhere in the system which is everybody's job especially now our franchisees I think particularly understand that let's face it -- I have got what, 80-20 I expect we will be at the end of this year, 80% franchise, 20% Company.

It isn't so much about the marketing program, the communications piece although that is important to drive more people in. We still have a lot of people that come in every single week. We need to have them come in more often. Having the right sales team on the floor providing the right service and the right product mix is really going to be the answer and it's not easy.

If it had been easy, we would have done it long ago. But now that we are properly organized and focused, I think all our operators, both Company and franchise understand that they have a huge responsibility in getting those customers to come back again and again. There was a time in this industry that we all got to enjoy where if the door was open and the lights were on and you were prepared to serve, that was about all you needed to do.

That's no longer the case. You have to give people a reason to go because they don't go all that often and when they go, they are intolerant for being disappointed.

Got it. And you're going to have, Mark, a decent amount of free cash flow this year whether from the base business or the refranchising. What is the primary uses of the free cash flow?

Obviously we talked about -- we talked about obviously the debt paydown focus and clearly as Alex mentioned, we basically built a little bit of cash into the third quarter given the timing of the interest payment on the bonds. But as I also mentioned in my notes, obviously in the fourth quarter through asset sales (inaudible) free cash flow, we hope to continue to pay down the debt.

On the free cash flow side again, this business and the way we look at this business is regardless of asset sales or the FGI strategy or even the previous real estate asset sales that we've been through. This business should generate as you put it decent organic free cash flow type of metrics and we continue to focus on that.

I think one of the drivers there as well is obviously as we transition this model from more -- to a more franchise operated model and you can see what is happening in our capital expenditure side. And that number has moved down from I think back in '05 we spent something north of $40 million and I think our current guidance for this year is in the $27 million range. So that's a significant change obviously in that free cash flow calculation as well.

Would the free cash flow and the debt paydown that you're talking about, Mark, is that all bank debt or do you see a reason to reduce other debt like your bonds as well?

Well I will let Alex respond to that. It's one of his treasury frustrations.

Yes, we would love to be buying the bonds obviously particularly at the current levels but we're prohibited by doing that from the credit agreement and the syndicated banking world is in as much disarray as the bond market and there's really just no opportunity to do anything different at this point in time. So all proceeds per our credit agreement calculation, the net number will be applied to paying down debt. It's not optimal but it's debt and we're going to keep paying it down until the market has changed to a point where we think we can get something else done.

I think that's the critical point that Alex made there is obviously we continue to focus on the capital structure long-term and although we're paying down the less expensive portion of our debt, ultimately it is the long-term focus on our capital structure that we continue to make sure is the key trigger point there.

Just one kind of a modeling question. Your franchise, your revenue growth seemed to have exceeded the rate of growth in your franchise units. So were there unusual factors driving revenue growth there?

The bigger piece is always the rental income. I don't know exactly how you're modeling so it really depends on the mix of how many lease and sublease or how many owned and leased properties there are in any particular transaction.

So the 10-Q will be out tonight and we gave the detail in Mark's numbers but it will have the breakdown in the 10-Q that you can see what was rental income versus what was royalties and then also fees as well. We get front-end fees every time a new unit opens or a unit is sold so that fee runs through that income line as well.

Bryan Hunt, Wachovia Capital.

I was wondering if you could talk about where you are on your cost savings target. You had this big organizational change in Q2. SG&A came down by a little over $1 million this quarter year-over-year and you were targeting $6 million to $8 million on a runrate basis. Do you think that $6 million to $8 million is still attainable or do you think you might be able to do better than that? Could you describe where you are?

Well I will say the actions that we took in the second quarter if you go back and read that release, we said it really was going to transition in. There wouldn't really be much savings at all in the third quarter though we did see some. You'd see more in the fourth quarter and then ultimately by the time we get around to first quarter next year, they should be sort of fully implemented.

I think we're going to try real hard to make sure we meet that target and then we will keep looking at it from there. This is the same issue obviously we talk about a lot. A lot of things that we do hear in the corporate structure are not Company store related. They're brand related.

We do the purchasing for 1500 restaurants. We do the marketing for 1500 restaurants. There's a lot of things that we do that are not pro rata going to come out with Company stores. So we think we've taken a big step in that direction over the past two years in two separate actions and we will continue to be committed to being as competitive on a support cost basis as we can be.

So, could I take that $1.1 million decline to -- can I infer from what you just said that that really doesn't reflect any of the six to eight?

No, it reflects some of it, just not all of it yet. It is transitioning and not all of those folks were let go on that day we announced that press release. There were many transitional type services that were going through. So we still think runrate will get to that 6 to $8 million but it will be the '09 numbers before you will see all of that.

Some of my questions were taken on your sales growth initiatives but I was wondering if you could talk about, Nelson, where do you see your biggest opportunity over the near-term? Is it products, in terms of new products? Is it promotion or do you feel like your dome to-go initiative is really your biggest opportunity over the next call it three to six months?

I think our biggest opportunity is to encourage our existing customers to come back more often. That is really where our biggest opportunity is and to build our weekday breakfast. That's really where it is. Now we have to continue to work on the to-go program and I think that's an incremental build. I would like -- this is my speculation, nobody else's. I suspect if we continue to work on to-go, we could increase that business another 2% before we're through next year.

So I see that and that is very profitable business for us. I see us still having an opportunity at late-night to frankly as I say here take back the night and to to get into positive territory. So we will continue to work on our late-night initiatives to keep that fresh with new menu offerings. But our lunch and dinner business is under pressure as well.

So the great news is we have four dayparts and we have got all these business elements. The bad news is I have all these business elements and I have got to talk to all these different consumers at the same time without confusing them about what we are, understanding our core strength is breakfast and value and 24/7. So the real issue here is about communication. So the easiest thing for us us to do, the highest probability is to get our restaurant operations focused on getting existing customers to come back one more time and that is huge for us.

Mark, one last question and I don't want to leave you out. I look at what you described with regards to continuing FGI in Q4 and who the potential buyers are. It sounds like you're looking at a pool of very well-capitalized buyers that obviously have access to capital in pretty much any environment. Is that a reasonable description of who these FGI partners are who are coming for the second helping?

I think on the second helping piece I would say they're reasonably well capitalized. Obviously there's the normal range you would have with their specific asset bases. But I think what we're seeing that continues to be very exciting regardless of how the credit markets are currently acting out there is the fact that there continues to be a high demand for the product. And that high demand is coming from existing franchises, some of whom did purchase stores in sort of the first round of FGI but some of those existing franchisees are coming to us for the first time.

So we have got really two different groups out of the existing base and we continue to see a very solid level of interest from players outside of our system which again I think speaks to the economic model of Denny's and the long-standing model of Denny's having been in business for over 50 years. So it is a combination.

And before you ask your second question which might be sort of well who are the lenders in this kind of environment, some of them are the ones you would expect, the names you would expect to hear. But there's other newer players out there that again see the opportunity in this restaurant sector long-term and see the opportunity in some of these buyers and the experience level and the strength of these buyers and are willing to lend into this type of environment which is obviously in general in the US and the credit market and the restaurant sector a relatively volatile environment right now.

Do you see anybody stepping up and buying into these new markets where you don't have any stores such as Charlotte and Nashville? Have any of those been taken down in the last quarter?

Not in the last quarter. As you recall, that is a separate new store development program called the MGIP, the market growth incentive plan. We continue to offer that, provide that. And I believe of the 150 some odd development agreements, probably around half are probably MGIP type of development agreements which means they were not related to an FGI, to a sale of a Company operated store. But I would agree with what your propositioning is that is we have many large DMA's in the US where there are literally no presence -- there's literally no presence of the Denny's brand and I think that continues to be a development opportunity for us.

Tony Brenner, Roth Capital Partners.

Can I just expand on that financing aspect a little bit? Mark remarked that the number of franchise openings in the fourth quarter would be a little bit less than had earlier been intended or expected due to financing restrictions.

I am wondering if that slowdown simply reflects some franchisees that have less than pristine balance sheets having a little more difficult time obtaining financing or whether financing is amply available for financially healthy businesses. A lot of people seem to be worrying that banks will be going into plastics instead of lending money for the next twelve months or so. I'm wondering if you could just expand on that a little bit.

I will just go back first, the change in guidance. Again we have brought our guidance down by a couple units as far as total openings for the year. The range on the franchise opening number is 26 to 29 stores. Again in all of 2007, we opened 18. So it's about a 50 to 60% increase in openings for our franchise system.

That slippage is clearly a little bit in the credit market situation. But part of it as well is again these folks are dealing with developers all over the US. Some of the metrics on the development side has obviously changed as well partially due to the lending environment to developers. And slippage from a fourth quarter opening into a first-quarter opening is not uncommon. We saw the same thing occur in the last couple fiscal years.

So you know it's again, certainly the lending market is tougher today than it was 90 days ago or six months ago. But I would say given that environment and given the pressure that is on the consumer right now, to open between 50 and 70% more stores this year than last year I think is a very strong track record.

Most of those openings being in the second half of the year, too.

Absolutely.

The stores that you're negotiating to sell to (inaudible) these will be financed transactions I take it judging from your (multiple speakers)

Yes, that's right, Tony; yes.

Why was depreciation in the quarter higher sequentially than in the second quarter given the lesser number of stores owned?

I think it was related to franchise agreement write-off. You've got to remember there's a big component of amortization that's in that depreciation and amortization. So it's not all asset depreciation that's in that line.

Last question -- sort of I guess anecdotally since much of it has happened subsequent to the end of the quarter, with gasoline prices about 50% lower all over the country just in a very short period of time and having been cited as a major factor that hit Denny's core customer, wondering if any of that direct infusion into disposable income is being expended at Denny's.

I would tell you Tony -- it's Nelson -- my view and since it is somewhat speculative, I would tell you that my view is look -- my customer is the Wal-Mart customer. You have heard me say that before. So they really don't work on Wall Street and typically don't work in the financial markets. They really haven't been all that affected. If you own home or if you own a home or you rent and you feel pretty secure in whatever the arrangement is, you clearly with this gas price drop you clearly have far more money in your pocket today than you did literally 30 days ago and that should have a real positive effect on my customer in particular.

The problem is consumer confidence in my view. Until that customer believes that they actually -- their life is getting better and yes, their life is getting better, commodity prices are going to come down; they don't feel secure yet in my opinion. Until they do, until this -- maybe after the election they will feel better. And I think Denny's will benefit from that if that is the case. But I think it is too soon.

I think they need to be reassured and feel more secured or more secure because actually their life is getting better. I just don't think they are willing to -- I think they have just pulled everything back and they're waiting to see what happens. And I'm hopeful that after the election consumer confidence will begin to go up because that's the problem at the moment.

Eric Wold, Merriman Curhan Ford & Co.

Most of my questions have been answered so it saves me a little bit of time and you guys some heartache there. But one thing -- I just wanted to make sure I'm not missing anything. With the guidance for the year of adjusted income before taxes of $20 million and doing $16.2 million through the third quarter and $8.5 million in the third quarter, what is the main trend going into Q4 versus Q3 that would cause Q4 to be so much lower than Q3 or is it just conservativism?

Mr. Lewis, I show that we do have five minutes remaining.

Okay, thank you. Well, you know I think we have some impact obviously that you're seeing from these sales trends that obviously are going to be impacting numbers as well. But it's really a year-over-year number and frankly last year's fourth quarter number had some benefits in it -- workers comp and some other onetime numbers that made last year's number probably a little bit higher than normal as well in the fourth quarter.

Not even looking at year-over-year, if we just look at -- if I take the $20 million, subtract out the 16.2 you have done year-to-date, that leaves 3.8 for the fourth quarter and you did 8.5 in the quarter that just ended. So I mean is it -- I've got to assume a lot of it is just conservativism that keeps -- I don't think things deteriorate that quickly and I don't think they have been.

Our guidance is our guidance, Eric.

Easy enough, thank you guys.

Mark Smith, Sidoti & Co.

Just a couple quick ones since everything has mostly been answered. You have talked a lot about the openings of franchisees but I want talk about the closings that we saw. It looks like one franchisee failed. Can you talk about the health of your franchisees and what if anything you're doing and can do to kind of prop them up in difficult times?

You know it's tough. It's tough to predict that. It's tough to accurately measure the health of the franchise system. I think we feel like over the past few years our franchisees have done pretty well and probably have built up some strength there. We think we have added some very strong franchisees to the system here over the past couple of years with the actions we have been doing.

But that one particular franchisee has been on the list so to speak for quite some time. This wasn't a third-quarter economic issue. This was probably a three-year or four-year, five-year economic issue. So it's unfortunate when those things happen. We will -- those units if they're viable will be looked at by other people as they always are in these situations.

But we feel like in this economy, you're clearly going to have some marginal operators that might have issues as you would with any brand. We are in a very good position from a credit standpoint from the benefit of our credit card system that we've talked about a lot. We work a lot with our franchisees and try and do our best to help them. But these kind of things are pretty hard to predict. We just feel like our franchisees have built up some strength over the past couple of years.

Secondly, one of your favorite questions, can you talk about the same-store sales trend during the quarter and outside of your guidance how you feel about October at this point?

We're not going to go to October. We're not going to do that but again, our guidance was that fourth quarter would look like third quarter and third quarter wasn't all that different through the quarter, probably got a little tougher towards the end. But guidance says fourth quarter will look a lot like third quarter and we will have to see about next year. It's tough out there and we're not expecting any overnight changes.

Last on same-store sales, what availability do you have to still take any pricing and are there any plans to take any more pricing through the end of the year?

Well I don't know about the end of the year, but as always we are going to look at our commodity costs and our utility costs and our labor costs and those things and we're going to adjust accordingly. We don't have the luxury to pass through a whole lot of those pressures so we will have to take pricing where we do. But I think clearly as Nelson said, we're focused more on value.

We're really trying to make sure we have products that make money for our Company restaurants and our franchise restaurants and products that are attractive to our customers. We will take more pricing. It's not like we will stop taking pricing if commodities are up and labor is going to be up again and those things.

Steve Anderson, MKM Partners.

Very quickly, talking about MGIP, have you noticed any kind of a slowdown in requests for new franchise development areas obviously because of the credit crisis?

I would say there's clearly a reaction over the last 30 days I think just across the board in the US as far as -- Nelson mentioned consumer sentiment. I think there was a statistic that came out today about the lowest measurement in decades. But I just go back to the overall growth model for Denny's and say that in the last 21 months, we have signed up for 150 new store development agreements, a little bit more than a dozen of those have already opened. We continue to see demand coming out of FGI. Again I think taking a long-term perspective here, there's some pretty strong vibrancy out there as far as development.

The difference between FGI and MGIP, it is clear as it should be that you would rather go in and buy a market and buy some restaurants and have scale day one. It is tougher to develop a new market. There's no doubt about that and in these economic times, that probably makes that split even wider. So I think that's why FGI -- we put big new players from other brands into our system and FGI was a great way to get them into the system because day one they have the kind of scale that they are used to to be profitable.

Ken Bann, Jefferies & Co.

I was just wondering with the reduction in Company-owned restaurants, how much would that reduce your sort of maintenance CapEx going into 2009? Do you have yet -- I'm sure you're formulating plans right now but what do you think you're going to reduce CapEx in 2009 to?

We give a pretty consistent metric for maintenance capital. We spend about in the neighborhood of $26,000 or so, sort of what we model out for maintenance capital on a per unit basis. And then on remodels, we throw in another $30,000 or so for an every seven-year remodel. So the remodel costs you a little over $200,000 probably.

So that's sort of -- we look at $55,000 or so per unit per year. Anything above that is typically capital for corporate type needs. It's any new development we do, any strategic initiative spending we do and those kind of things. But clearly that number will continue to come down.

Now the one delta that people continue to miss is frankly we have been remodeling at a level over the past couple of years that anticipated FGI. So remodel dollars really haven't come down the past two or three years because we have been remodeling to an end point rather than to the number where we were. But we're not going to get into '09 specifics at this point. But it will be less --

Will remodeling expenditures now that you've sold off quite a few units, will that come down?

No, because again we have been remodeling to the number that we're probably going to get to, not to the number we had.

There are no further questions at this time. Do you have any closing remarks?

Thanks everyone for joining us and as always, if you have any follow-up questions feel free to give me a call and I will be happy to try and answer them for you.

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