Denny's Corp (DENN) 2009 Q3 法說會逐字稿

Good afternoon. My name is Lamont and I will be your conference operator today. At this time, I would like to welcome everyone to the Denny's third-quarter earnings release 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.

Mr. Enrique Mayor-Mora, you may begin your conference.

Thank you, Lamont. Good afternoon and thank you for joining us for Denny's third-quarter 2009 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. Nelson will begin today's call with an overview of our business and our strategic initiatives. After that, Mark will provide a financial review of our third-quarter results, as well as provide an update to key components of Denny's full-year 2009 guidance.

I'd like to note that as we are holding this call earlier on the calendar than usual, as such, we are targeting to file the 10-Q by tomorrow after the market close.

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 notes 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 in 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 31, 2008, and in any subsequent quarterly reports on Form 10-Q.

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

Thank you, Enrique, and good afternoon, everyone. Let me start by saying that we continue to execute toward our strategic goals of building new units, re-franchising Company units, paying down debt, and growing profitably. Our ability to accomplish these goals, despite the ongoing same-store challenges -- same-store sales challenges -- faced by the industry and Denny's is evidence of the brand strength of Denny's.

Denny's ongoing transition to a more franchised-based business model, inclusive of a more effective organizational structure, has allowed us to deliver profit growth consistently and predictably. Our progress towards the more franchise-based business model was characterized in the third quarter by an adjusted income before tax increase of $600,000, or 7%, despite a $44 million, or 24% decrease, in revenue. This increase in profitability was driven by a franchise profit contribution that exceeds the Company units, decreased G&A, lowered interest and depreciation expenses, and from cost containment and efficiency improvement in our Company-operated units.

In addition, we paid down $9.8 million of debt in the quarter. Since mid-2006, Denny's has paid down $248 million, or 45% of its debt. Denny's transformation has increased our operating margins, earnings power, and system unit growth while lowering both our business and financial risk. We firmly believe that our business model is now better suited to sustain in a challenging economic climate and succeed when the turn comes. Success for Denny's will largely be based on our ability to unlock our long-term growth potential through two avenues - individual unit development and same-store sales.

In respect to unit development, Denny's has made considerable strides. In an environment where the restaurant and retail industries are cutting back development, Denny's third quarter saw the opening of nine new franchise units. In the past 12 months, Denny's has opened 42 new units, of which 41 have been opened by franchisees. This represents the most openings in the brand since 2001 and is a testament to our brand strength.

As part of Denny's continued push for unit growth, we recently introduced a new incentive plan for franchisee unit development. This industry-leading program focuses on kick-starting development in markets across the country where Denny's is either under-penetrated or not represented. The program was launched in September at our national town hall meeting and includes generous initial fee and royalty abatements for units to be developed by franchisees in targeted markets.

The second key to unlocking Denny's long-term growth is improving same-store sales. The existing consumer environment continues to be the most challenging that I've seen. While the industry's same-store sales performance in the third quarter of 2009 was better than the 28-year low incurred in the second quarter, it was still materially negative. This is despite the industry's easier year-over-year sales comparables that began in the third quarter of last year. The most important drivers of the industry's sales challenges are low consumer confidence and rising unemployment. In September, both of these indicators worsened compared to their August measurements. That being said, we're committed to improving our sales and guest counts.

Some of the considerations for the sales challenges in our recent performance include, one, while we have great geographical representation across the country, some of our historically strongest states have been the most impacted in this economy, specifically California, Arizona, and Florida.

From a day part perspective, stepped up competition and discounted pricing have impacted our dinner and late night businesses. Denny's targets the most demographically representative slice of America. This is a great consumer, but they are also the most impacted in this economy.

Before I spend time talking to you about our lessons learned and how we will be refining our sales-driving tactics, I want to outline how we've strategically been approaching sales.

Starting in mid-2008, our marketing programs have pursued guest count growth through our positioning of Real Breakfast, with strong lunch and dinner offerings. and clearly a differentiated late night experience through our Allnighter program. We believe this will continue to differentiate us from our competitors. On the platform of real breakfast, Denny's has a three-pronged approach to driving sales -- a focus on our core equity of value, new product innovation, and improving the guest experience.

Denny's is recognized as a great value for our guests. Denny's Everyday Value is delivered through our starting-at tiered price points across all day parts. Over 50% of all our menu items sold at Denny's are breakfast items. And our competitive differentiation is based on Denny's offering a real breakfast. This is where we have focused our value offerings.

We also continue to offer a great value and choice to our customers with the Build Your Own Grand Slam offered at $5.99. The combination of the incredible equity in the Grand Slam name at a very attractive price point has driven the incidence rate to almost 20% -- incidentally, five times higher than the next most popular entree. This product also has a very attractive food cost and has supported our food margin rate objectives and improvement.

Our add-on approach to our Build Your Own Grand Slam has also had the benefit of supporting our guest check average and, again, our food margin rate. Guests have gravitated towards the Slam It Up component in impressive numbers. Over a quarter, 25%, of all Build Your Own Grand Slams are ordered with a Slam It Up, which provides for an incremental $0.49 to $0.99 per additional item.

From a limited time promotion perspective in the third quarter, we continued to offer the $3.99 Everyday Value Slam. This plate was designed to protect our margins while delivering craveable value to our guests.

Our second approach to driving sales is the focus on delivering new product and program innovations across all day parts. Since late 2008, Denny's has been very active in this particular area. In the last ten months, Denny's has introduced an impressive amount of new products. They have included the Grand Slamwich, Pancake Puppies, Real Breakfast Burritos, extensions to the Sizzling Skillet platform, new salads, new coffee, new signature beverages, and multiple new late-night Rockstar menus.

Late in the second quarter, we introduced our Better For You menu, which provides choices, as well as our sports-themed kids menu. The Better For You choices include delicious items with reduced fat or sodium, such as turkey bacon, wheat pancakes, egg whites, fresh fruit, yogurt, and dippable vegetable sticks and apple slices for kids. Already one in five guests who order our Build Your Own Grand Slam is ordering at least one of these Better For You items. Our new kids menu eliminated or replaced certain meals on the kids menu determined to be higher in sodium or fat. As a whole, we have been pleased with the performance of our new products as they have collectively mixed at over 10%. Said another way, our new products sell an average of approximately 50 plates per day per store.

In the third quarter, we also introduced a new line of signature beverages. We have been pleased with their performance as well, as they are currently mixing at 5%, or an average of 25 beverages per day per unit. For the late night business, we've continued to update and strengthen our Allnighter platform. Our new Rockstar menu was launched late in the second quarter and includes a freestanding menu with items created by Rascal Flatts, Good Charlotte, Gym Class Heroes, and Sum 41. While we are pulling similar levels -- levers of price value and product innovation at both dinner and late night, these day parts have been more negatively impacted than breakfast and lunch by the current economic environment.

Denny's third area of focus is to improve the overall experience of our guests. Towards this goal, we've made system-wide progress along three fronts. First, our mystery shopper program continues to drive improved visibility to guest experience across the brand. Second, Denny's has successfully tested a low-cost kitchen equipment package focused on enabling faster table turns. This package is now available to all franchisees. Third, we established marketing, operations, and development brand-building committees between franchisees and the Company. These are delivering best practice programs to the system.

As an example, the new unit development incentive program was direct output from our development committee. We are confident that our strategic approach to driving sales is solid. However, we have learned key lessons. We are confident this will be translated into improved performance.

The lessons include -- we will build on our successful new product innovations by focusing more on the craveability and can't-be-made-at-home attributes of new products. We'll expand value and affordability more strongly into the breakfast and non-breakfast day parts. Two examples include a new Breakfast Lover's lineup to be launched in the first quarter that will focus on abundance, craveability, and value.

We just launched our new Better Burger bundle supported by a freestanding insert in many Sunday newspapers across the country just a few weeks ago. This product provides our lunch, dinner, and late-night guests with an incredible value of $6.99 for a burger, fries, and a Coca-Cola product. We will leverage recent consumer insight work into our core heavy users by communicating more directly and louder to drive frequency through targeted media.

Denny's is focused on driving sales by delivering new and craveable products at an affordable price and with great guest service. We are confident that this focus will drive improvements to guest count over time.

Our local marketing co-ops now in 15 DMAs, representing almost 45% of our system units, were relatively quiet in the third quarter. As a reminder, Denny's began this year to establish these co-ops and has made considerable progress in increasing our ability to communicate with our guests. We estimate that these co-ops will fill in approximately 12 weeks of media at the local level throughout the year at times when there is no national media. In the fourth quarter, the majority of our local co-op markets will be active.

We are confident and firmly believe that we are proactively and aggressively taking the right steps in terms of driving profitable guest count growth. Our continued migration towards a more heavily franchised business continues to provide us with a more profitable and predictable financial model. We've never been more excited or confident about the opportunity here at Denny's and believe we are well positioned to achieve further success next year and in the years to come.

As always, I thank you for your interest in Denny's. I'll now turn the call over to Mark Wolfinger, Denny's Chief Administration Officer and Chief Financial Officer. Mark?

Thank you, Nelson, and good afternoon everyone.

I will start my comments with a review of our third-quarter sales performance. System-wide same-store sales decreased 7.1%, comprised of a 6.6% decrease at our Company restaurants and a decrease of 7.3% at our franchise restaurants. Looking at the details for Company sales performance, a 7.3% decline in guest counts was partially offset by 0.8 of a point increase in average guest check. Denny's guest counts have been most negatively impacted in the areas of the country that have been hardest hit by the economic downturn. Those areas include California, Florida, and Arizona, which account for 41% of our system units.

Most of the growth in guest check was attributable to pricing actions taken over the past year to help counterbalance commodity and labor cost pressures. Partially offsetting the increased pricing was the unfavorable impact of a stronger value-oriented menu mix as well as an increase in discounts compared with the prior-year period. The decline in total Company restaurant sales in the third quarter largely reflects the continuing impact of our Franchise Growth Initiative, or FGI, as sales decreased $44 million, or 27%, due to 89 fewer equivalent Company restaurants compared with the same period last year.

I'll now turn to the quarterly operating margin table in our press release. The increase of 3 full percentage points in the third quarter for our Company-operated units was driven largely by favorable workers' compensation claims developments, which drove 2.2 percentage points of the overall margin improvement. Excluding this benefit, Company unit margins would have increased 0.8 of a percentage point. Other notable margin improving actions included efficiency gains in Company-operated units, an increase in check average, the selling of lower margin units through FGI, and lower utility rates. These were partially offset by the deleverage driven by negative same-store sales, commodity inflation, and by the investment in marketing through the establishment of local co-ops.

Product costs for the third quarter decreased 1.1 percentage point to 23.1% of sales, due primarily to higher average guest check, favorable mix impacts, and solid management at the unit level. This was partially offset by commodity inflation.

Payroll and benefit costs decreased 2.4 percentage points to 38.4% of sales, due primarily to favorable workers' compensation claims development that drove 2.2 percentage point improvement. Without this benefit, payroll and benefits would have been 40.6% of sales. This benefit is a result of multiple years of increased focus on safety at the unit level through well designed and executed programs. Management and team labor efficiency gains that were realized through FGI, management staffing level improvements, and crew labor productivity gains were offset by sales deleverage. Field bonus compensation was 0.3 of a percentage point lower than the same period last years, which reflected the quarter's sales performance.

Occupancy expense increased 0.8 of a percentage point to 6.7% of sales, due primarily to the decrease in same-store sales, FGI, and the positive development of general liability claims in the prior-year quarter. In the case of FGI, where Denny's owns the real estate, occupancy costs deleveraged due to the loss of Company sales that were not incurring any lease expense.

Utility costs decreased 0.7 of a percentage point to 5%. Denny's is benefiting from natural gas rates and electric rates that have fallen considerably from the levels seen in 2008.

Repairs and maintenance expense decreased 0.2 of a percentage point due to a reduction in unit level painting. This is being driven by a review of our remodel policy that currently requires a full facilities remodel once every seven years. In test markets across the country, we are currently testing a refresh approach that would result in more frequent updates to our facilities. This would have the dual benefits of keeping our facilities fresh and more contemporary as well as spreading out the lump-sum remodel costs.

Marketing expense increased 0.4 of a percentage point to 3.9% of sales in the third quarter due to the establishment of local marketing and advertising cooperatives with Denny's franchisees.

Legal settlements decreased 0.4 of a percentage point due to the legal -- due to limited legal activity in the third quarter.

Other costs increased 0.7 of a percentage point to 4.5%, due primarily to the loss of business interruption income and the subsequent pre-opening expenses incurred as Denny's reopened one of the units on the Las Vegas Strip. We do believe this unit could be one of the system's highest-volume units, as in its first four weeks of operation it has delivered $0.5 million in sales.

In summary, the gross profit from our Company operations only decreased $2.4 million on a sales decline of $44 million.

While sales on profit contribution from our Company restaurant operations is trending down, due to the sale of Company units, the offsetting effect is driving growth in the franchise side of our business. Specifically for the third quarter, we reported an increase in franchise revenue of $800,000, or 3%, to $29.5 million. This increase was due primarily to an additional 90 equivalent franchise restaurants compared with the prior-year period. The growth in franchise revenue included a $1.5 million increase in occupancy revenue, flat royalty revenue growth, and a $700,000 decrease in initial and other fee revenue, driven primarily by fewer re-franchised units in the quarter.

Franchise operating margin decreased $700,000 to $19.2 million in the third quarter. Net occupancy income grew by $200,000, driven by the FGI program. This was offset primarily by a decrease in initial fees due to 14 fewer re-franchises than in the prior-year quarter.

The increase in royalties, driven by the additional 90 equivalent units, was offset by the negative same-store sales reported in the third quarter.

Franchise operating margin, as a percentage of franchise and license revenue, for the third quarter was 65%, a decrease of 4.5 percentage points compared with the same period last year. The franchise margin decrease was due primarily to the increasing contribution of lower margin occupancy revenue, as leased Company units are in turn subleased to franchisees through FGI. Denny's is on the primary lease and subleases these properties to the franchisee. We recognize our sublease income as franchise revenue, but there is an offsetting cost in franchise expense for the primary lease. Therefore, the overall franchise margin rate on a percentage basis will decline.

From a gross profit standpoint, the franchise side of our business contributed more than our Company restaurants for the fourth consecutive quarter. This income shift allows us to reduce the risk and increase the predictability of our earnings.

General and administrative expenses for the third quarter decreased $600,000, or 3.9%, from the same period last year, driven primarily by Denny's continued migration towards a more franchise-based company. This benefit was partially offset by a $1 million increase in deferred compensation costs and a $300,000 increase in share-based compensation costs.

Next, depreciation and amortization expense for the third quarter decreased by $2.1 million compared with the prior-year period, primarily as a result of the sale of restaurant and property assets over the past year.

Operating gains, losses, and other charges on a net basis, which reflect restructuring charges, exit costs, impairment charges, and gains or losses on the sale of assets, decreased to $1.6 million in the quarter. This decrease was primarily the result of a $2.2 million decrease in gains on the sale of Company restaurants and real estate, as there were 14 fewer re-franchises compared to the prior-year quarter.

Including these items, operating income for the third quarter decreased $2.1 million from the prior-year period to $18.6 million. Excluding gains, losses, and other charges in both periods, operating income decreased only $400,000 despite a $43.2 million decrease in total operating revenue, attributable primarily to the sale of Company restaurants. To post only a $400,000 decrease on adjusted operating income despite a significant revenue decline again is testimony to the efficiency of our transitioning business model.

Below operating income, interest expense for the third quarter decreased $600,000, or 7.4%, to $8.1 million as a result of a $32.3 million reduction in debt from the prior-year period. Other nonoperating income increased to $1 million in the third quarter, due primarily to the recognition of unrealized gains and losses related to our interest rate swap and the natural gas hedge.

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 third quarter was $9.1 million, an increase of $600,000, or 7%, over the prior-year period. We are pleased that we're able to generate adjusted income growth despite the difficult sales environment for the restaurant industry. We believe this success is a direct result of our FGI program, our debt reduction efforts, and cost containment activities.

Turning to activity in the Denny's restaurant portfolio during the third quarter, the Denny's system increased by a net one unit, as nine new restaurants opened while eight were closed. The nine new openings were all franchise restaurants, bringing the year-to-date franchise opening figure to 29 and year-to-date system opening figure to 30. Denny's year-to-date net system growth, as of the end of the third quarter, is a plus four. These 30 units represent significant unit development progress for the Denny's brand and are also impressive in the context of an industry that is pulling back on growth.

Moving on to capital expenditures, our cash capital spending for the first three quarters was $12.5 million, a decrease of $8.7 million compared with the prior-year period. As we reduce our Company restaurant portfolio and remain selective on our new restaurant investments, we expect capital to decrease year over year. Our year-to-date spending was partially lower due to the timing of remodel spend anticipated during 2009.

Turning to asset sales in the third quarter, we generated proceeds of $2.1 million from the sale of seven Company restaurant operations, and an additional $5.8 million from the sale of seven real estate sites, including five that were previously part of an FGI transaction. On a rolling 12-month basis, we have generated net cash proceeds of $19.2 million from the sale of restaurant operations and $9.4 million from the sale of certain real estate. In total, we have taken in $28.5 million in cash proceeds in the past 12 months.

We have used these proceeds to support the reduction of $32.3 million of outstanding debt over the past year. While our cash balance at the end of the third quarter was $29.9 million, we did use $8.8 million on the first day of the fourth quarter to make our semi-annual payment on our senior notes. Our cash balance, combined with access to our credit facility, provides us with ample liquidity of approximately $70 million.

Given the challenges facing our national economy and our industry, we are very pleased to have reduced our debt by $248 million, or 45%, since mid-2006. We do believe we are in a financial position to manage through this difficult operating environment. 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. Our senior notes mature afterwards on October of 2012.

In respect to the FGI program to date through the third quarter of 2009, we have sold 268 Company restaurants, or 52% of the prior Company store base. This includes the seven sold during the third quarter of 2009. As a result, we have increased the mix of franchise restaurants in the Denny's system from 66% to 83%. While demand remains strong and we expect the mix to continue moving towards a more heavily franchised system, the current credit environment limits our visibility into the balance of 2009.

Denny's will continue to provide updates on the progress of the FGI program each quarter.

Based on our year-to-date results and management's expectations at this time, Denny's is updating the following components of its financial guidance for full-year 2009 relative to the guidance given in its year-end 2008 earnings release on February 18, 2009.

Denny's updated fiscal 2009 full-year guidance reflects the top-line sales challenge the industry and Denny's continues to confront. Furthermore, the material benefits Denny's has derived by its ongoing transition to a franchise-focused business model are also incorporated and include a stronger new unit development pipeline as well as a more predictable and consistent ability to grow profitability.

These are annual guidance components. They were also included in our press release that we released after close of market today. So I'm just going to walk through those very briefly.

On franchise same-store sales, the original guidance was between minus 5% and minus 3%. Our updated guidance at this point is at the low end of the original guidance range. Our Company same-store sales original guidance was minus 3% to minus 1%. Our updated guidance is minus 3.75% to minus 3%.

As related to new store builds, our original guidance for new Company units was 3. Our updated guidance is now 1.

As it relates to new franchise units, our original guidance was 30 new openings. Our new guidance for 2009 is more than 30 openings for our franchise business.

As it relates to adjusted EBITDA, and this is in terms of millions of dollars, our original guidance was $73 million to $78 million for 2009. We are now guiding on an updated basis to the high end of the original guidance range.

Adjusted income before taxes, our original guidance was $15 million to $20 million. Our updated guidance for 2009 is now $21 million to $22 million.

And, finally, as it relates to cash capital expenditures, our original guidance was $23 million and our current guidance -- updated guidance for 2009 is now closer to $20 million.

I want to point out that a key consideration for understanding the Company's outlook for fiscal 2009 compared with its actual 2008 results is that 2009 includes a typical 52 operating weeks compared with 2008, which included an additional week that contributed approximately $3 million to income.

That wraps up my review of our third quarter results. I'll now turn the call back to Enrique Mayor-Mora.

Thank you. We will now move to the question-and-answer portion of the call.

(Operator instructions) Your first question comes from the line of Reade Kem with Banc of America.

This is [Mikey Kaplan] for Reade. I just wanted to ask kind of you guys talked about average check and you talked about it directionally. But could you kind of talk about it on an absolute basis and kind of thinking about that in the context of the sales decline and kind of how that fits in moving forward?

Sure. Our average check is about $8.60. And, as we mentioned, we did see an increase year over year of about 0.8%, which actually represents the lowest amount in increase of check we've seen in several years now, which really reflects the movement more and more towards value. So we had historical pricing baked into our GCA increase, or Guest Check Average, which was offset by our value promotions and reflected in our mix.

Okay. And then kind of just like looking at the comp trends, like where they are now, like how much kind of slack is less in the cost structure until you get to the point where operating margins potentially are uncomfortable? I guess is there still variability left in terms of -- in more efficiency that can be cleaned out of the cost structure?

This is Mark. I mean I would tell you that obviously that the sales trends -- we're not satisfied, I think, as Nelson referenced in his comments. We have over the last 24 months, 24 to 30 months, taken a considerable amount of our cost structure down as part of this franchise -- this transitioning model to more franchise. Are there -- is there more possibilities on the cost side? Certainly, there is. But I think, to Nelson's point, our focus, our challenge clearly is more towards the top line, and that's really where we're headed at this point.

Again, I think the good news is we continue to see some strong development coming out of our franchise system, which is part of this franchise model transition. And now being about 83% franchise, I think, again, speaks to the way to move forward here as far as our franchise model.

Okay, great. Thank you, guys.

Your next question comes from the line of Reza Vahabzadeh with Barclays Capital.

Good afternoon. So is it accurate to think that much of the same-store sales decline you saw in this quarter was driven by the heavy promotions coming out of the QSR segment, not to mention the casual dining?

Reza, it's Nelson. Easy answer would be yes. I think all those things have an impact. And also the fact, as Technomics has reported over time here, is that the general public is eating out about 50% less today than they did a couple of years ago. So we all are fighting for a tighter share picture. And it really is going to be about -- everyone likes to talk about price and value today, but in the long run, in my view, it's really going to be about the experience. Of course it has to be affordable and we talk a lot here strategically about affordability, and that is in fact part of we're doing in looking forward.

The reality is the service element and how well people are treated and how good they feel about the experience is going to determine repeat business. And in the long run, that's going to be the determining factor for not only Denny's but the restaurant industry as a whole.

Yes, I hear you, but in the short term, lots of $1, $2 promotions and I guess I'm just trying to find out how do you combat that in the short term? In the long term, I get your game plan.

Well, you serve a better product. Most recently, our introduction of a better burger. Our chefs traveled the country here over the last 12 months, found out what great burgers are like, and we've taken our classics, which we thought were pretty good and we plussed them up. And we're offering that -- we dropped this FSI I talked about and provided a buy one, get one opportunity. And in-store, we've provided nationwide in almost every restaurant the opportunity to get this terrific new gourmet burger for $6.99 with a side and a Coco-Cola product that, frankly, I noticed one of the burger chains that is offering dollar opportunities on their menu actually has a $6 check. Well, this thing is $6.99 and is far more than you can get at fast foods. So, as people begin to realize that and realize value, I'm confident those kinds of introductions.

We also have daily breakfast specials in our co-op markets. And you'll see us continue to offer value every day. It is about value. It is about entry price levels and starting at. The dollar menu has been around a long time and it's something we've all had to deal with. But we are dealing with a smaller population base that is able to go out as often.

Right. On the cost of product, obviously that cost has come down for you over the last year. Do you sense that is going to continue in the near future, the next quarter or two, either because of the lower commodity costs or your price mix trend?

Well, it's Nelson again, Reza. What I see happening is -- first, let's talk about this year. I see us winding up at the end of this year as we literally are coming to the close here ultimately pretty quickly. I see year over year, 2009 over 2008, winding up at about 1% over -- year over year. And next year, I see no increase year over year. So 2009 compared to 2010, we are projecting no increase year over year.

And that's because you've already contracted a portion of your costs or is that just your early indication?

Well, both. We've contracted about 40% of our needs for next year and the rest is based on market conditions and foresight.

Got it. Thank you very much.

Thank you, Reza.

Your next question comes from the line of Michael Gallo with CL King.

Hello, Michael.

Good afternoon. A couple just follow-up questions. I think you mentioned, Mark, I thought I heard you mention that you still had commodity inflation in the third quarter. How much was that in your -- just in your basket of goods?

It was about 2% in terms of commodity inflation. One consideration with Denny's is that when you look at inflation here, last year the group did a stellar job in terms of locking us in below market rates. So this year when we came off some of those contracts, we may have a little more inflation than other people had in the third quarter coming off very favorable contracts last year. So -- but about 2%.

Would you expect that to moderate to more or less flat in Q4?

Yes, we do. It will moderate somewhat. And certainly as we look forward to next year, as Nelson mentioned, we see that moderating even further.

Have you looked at all at, as you head into 2010, at lock -- trying to lock in either natural gas or utility rates where possible?

Yes, I mean, we continue to look at it. I think, as I mentioned in my comments, Michael, we've seen some favorability in the most current quarter. And we're going to continue to look at that on a regular basis. That's been, having gone through some of the dramatic ups and downs, or primarily the ups of a few years ago, we'll continue to watch that. Because obviously we, especially on the natural gas side, we're obviously a large natural gas user.

Right. Okay, great. Just wanted to switch gears here just to move over to the balance sheet. I mean you continue to do a nice job chipping away at the debt load. Certainly that's continued for a couple of years of now. With the bonds callable now and the bank debt kind of rapidly moving towards the $100 million range, I was wondering if you, given where rates are, if you started to look at some further capital structure opportunities again?

Well, I think, Michael, yes, we -- I would say, given the fact that this is a group that obviously focuses a lot on liquidity on our balance sheet and obviously that speaks to the significant debt reduction over the last few years, we constantly look at it. Obviously, our views today are very different than a year ago.

As far as the bonds themselves, there's still a premium to be paid if we called them before October of next year. So, obviously, we've taken that into consideration. And quite candidly, we have a very attractive facility in place and a very good relationship with our key bank. So we'll continue to watch it. We know that obviously we have the 2011 and 2012 time frame, but that is a bit of a ways off. But we'll stay on top of it.

I mean, is there a target you think you would have to get to where you might look to replace the notes with just a single bank debt facility? I mean is there a sort of targeted leverage ratio you think you need to get to?

Well, I mean I tell you that I think our current leverage ratio at the end of this quarter was probably the lowest, the best leverage ratio we've had, certainly since I started with the Company four and a half years ago. I think we were under 3.6 times levered, probably closer to 3.5 times levered actually. And so I don't know if there is a magic number there. Clearly, this is a management team that -- each quarter we speak to a debt reduction figure that we're focused on and hopefully have made that payment. So that's something that's very important to us as a management team.

Back to the question about a large bank facility versus the bonds, a large portion of that bank market has really shifted and changed over the last 12 to 18 months. Clearly, it's been a significant change there. And so, again, not speaking to what I think our future capital structure is going to look like, we're going to continue to focus on the debt reduction and at the appropriate time we'll make our move on the capital structure.

Okay, great. And then just final question. As you go through FGI, obviously this quarter you only closed about seven transactions. Certainly, again, you've done significantly more of these transactions than we would have thought when you started the program. Do you feel like this is starting to wind down or is there still a good pipeline of stores and interests where you'd expect to continue to see a significant number of transactions the coming years or are we more or less in a wind-down phase in FGI?

I think just in the mathematics, obviously you could argue that. In the first year I think we did 130 FGIs. So it has wound down a little bit each year the last couple of years. But when the opportunity presents itself with either a new or existing franchisee to move forward with an FGI transaction and those mathematics are accretive to us and to our shareholders, then we'll move forward with a transaction. So I think it's going to continue to be on a selective basis.

Obviously, as I think I mentioned in my comments, part of that is obviously in reference to the current credit market situation. And although the credit markets are certainly a lot better than they were six to nine months ago, it's still a tough market out there as it relates to third-party financing for restaurants. But, again, we are going to continue to plug forward. FGI, obviously, has had a significant impact on our balance sheet and on our model and a significant impact on our growth. I mean a lot of this new store development that we noted in our comments, both Nelson and I today, a lot of that new store growth is due to FGI and due to development agreements that came out of FGI, which we're obviously very pleased with.

Okay, great. Thanks a lot.

Your next question comes from the line of Mark Smith with Feltl & Company.

Hi, Mark.

Hi. First question. The two Company-operated unit openings that you pulled out of your guidance, were those delayed and pushed into 2010 or are those scrapped?

I would say that they were probably delayed. I don't want to give a lot of specifics there. They were delayed. Clearly, it's a tougher market out there. But we continue to believe -- I don't want you to read the wrong thing into this -- we continue to believe on a selective basis we can open very strong Company-operated units. And I referenced in my comments the store we just reopened. It was a store that closed due to development, but we reopened on the strip in Las Vegas. And that store is doing phenomenally well for us.

We also opened one in Hawaii. That was a reopening, so it didn't count as a new Company store. Our new Company opening was out in Hawaii. That was in, I believe, March of this year. And that store is doing very, very well for us in Hawaii. So, again, on a selective basis, we're going to continue to tap in the Company development. But saying that, obviously a majority of our development will be on the franchise side of our business.

Okay.

I would add -- this is Nelson -- I would add to that that the two stores that were delayed were actually part of a larger development opportunity that has been delayed. So were part of a larger development plan and that was actually what was delayed. It wasn't anything on our part that would have caused us not to want to open those restaurants. It was more of a larger development opportunity. And because of that developer's change in focus, it will be delayed.

Second question. Just looking at the health of your franchisees, can you comment on, I guess, bad debt and also on the demand that you're seeing for FGI transactions currently?

I'll take the second part of that question first. As far as demand for FGI transactions, it continues to be very strong. The challenging part, as I mentioned, is the financing piece. Again, it's a tough financing market out there in the restaurant sector. But as far as demand for FGI, that really has not let up whatsoever. And I say that on an all inclusive basis sort of almost anywhere in the US. So, clearly, that's not the issue.

Can you repeat the first part of your question?

Just looking at bad debt from --

On a bad debt basis, and I think we've commented on this before in our presentations, a large portion of our franchise system sits within the umbrella of a credit card system that we have. We, obviously, are able to reduce the cost on an umbrella basis. And so from the standpoint of how those payments take place, the credit card receipts come to us first as the franchisor. We pull out of those credit card receipts the payments that are due to us for things like royalty, advertising contribution, and rent. And then the balance goes on to the franchisee. So our bad debt expense is very, very low on a monthly basis.

And then last question. Nelson, can you just talk really broadly over the last 60 to 90 days, are you seeing any improvement in the consumer?

The short answer is no. The longer answer would say that I have seen over the last few weeks an improvement, but it's not anything I could comment on, other than I am seeing a slight improvement and I can't tell you why. But as long as we deal with the kind of unemployment numbers that we're having to deal with, the repossessions or foreclosures of houses in major metropolitan areas where we're located, and consumer confidence that continues to go down across the general population -- I know there's certain segments or sectors of business and the industry that are showing signs of improvement, but remember we deal with the average consumer. That is the majority of my customers, or, as I've said before, the Wal-Mart customer. Those folks have been hit the hardest as it relates to housing foreclosures and unemployment. So -- and consumer confidence, therefore, is materially affected. So until we see that, I don't see retail coming back anywhere, including the restaurant industry and Denny's.

Perfect. Thank you.

And Mr. Mayor-Mora, I am showing that we do have five minutes remaining in the call. Would you like to take additional questions?

Yes, let's take a couple more.

Okay. Your next question comes from the line of Steve Anderson with MKM and Partners.

Good afternoon.

Hey, Steve.

Actually I called to ask about your Fresh Express initiative, if you have any plans to roll that out to additional stores?

We are looking at growth opportunities and we're looking specifically at how we can use the Fresh Express and use the equity of the Denny's brand to position ourselves for the future. And I'm pretty excited about that, but not in a position today to talk much more about it. Because -- and, candidly, it won't make -- if we are successful with these new concepts that we are looking at internally, it will not -- they will not make a material contribution to the P&L for years. So -- but, clearly, they're on the horizon and you'll hear more about it and you'll see more about it in 2010.

Okay. Thank you.

Thank you.

And just a little follow-up, too, about your Las Vegas location. Can you give a tally of how much your pre-opening expenses were for the -- for that location?

I'd have to say I could better answer the question probably next quarter, once we get sort of all of the final figures in and certainly would be happy to address that.

Okay, thank you.

Your next question comes from the line of Tony Brenner with Roth Capital Partners.

Hey, Tony.

Good afternoon. You mentioned that dinner and late night were particularly being affected by the poor economic conditions and by discounting. I wonder if you could talk a little about what's happening with weekday breakfasts, including who exactly is the core customer for that day part? And is that the area where the high unemployment states, such as California, are being most affected?

Well, I would tell you, Tony -- it's Nelson. I would tell you, Tony, that our breakfast and lunch business, weekday as well as weekend, are holding their own and I'm quite proud of it. The real opportunity for us, as we look at sales, is, as I mentioned in my script and I think Mark did too, is during that dinner and late-night day part, I'm quite proud of the performance that we've had in weekday and weekend breakfast and lunch.

Hello, Lamont?

Your next question comes from the line of Jack Wagner with MJX Asset Management.

Good evening. Could you share with us the percentage of your properties that are leased and the percentage that is owned?

Yes. I can -- I mean, if you look at the total restaurant grouping we have, I would tell you that probably on the owned, what we call "C" properties, is probably approximately 110 C's that we currently have. Again, back in 2006 time frame, September 2006, we sold -- during that year we sold over 80 C properties as part of one large transaction, but several others. So it's probably around 110 C's we have at this point in time.

Yes. We have about 80 of our Company units, we own the property. And that's of about 236 Company units. And then there's a good 30 sites where franchisees operate units where we own the property.

So that's 30 properties.

Where franchisees operate.

Yes, where we serve as the landlord --

(Inaudible - multiple speakers.)

-- but we own the dirt. We serve as the landlord for the franchisee. And a large number of those properties is due to the FGI process where we have not sold the underlying real estate at this point in time.

But what percentage of your properties would you consider to be owned and what percentage are leased?

I would say 35 -- about 35% of our Company-operated units own the land. And so the inverse is 55% would be leased.

Okay. And with your initiative to increase your franchisees, how do you, with the current tight credit market, how do you anticipate your franchisees -- getting more franchisees in the current credit environment?

I mean I'll answer the question with a few specifics. This is Mark. I mean, firstly, we've been incredibly encouraged I think since 2007, so just two years ago -- in the last two years, I think 18% of our franchise owners or franchisees are new to our system. So there's been a tremendous growth in our system from outside of the Denny's system as far as folks interested in coming in and becoming franchisees, again, 18%.

As far as the question around financing and credit markets, I think, as I mentioned in my comments, our trailing 12, last 12 months of openings, are far beyond what we saw as far as a run rate in sort of the '05, '07 time frame. So, again, those are franchise openings. Those franchisees are arranging their own third-party financing. So don't know how else to answer your question except to answer it with those kind of data points.

Do you know where that financing is coming from? Is it more local? Is it more national?

All kinds of different sources. Obviously, GE Capital remains a very strong player. Irwin Financial, a very strong player. But at the same time --

I'm sorry, the last one was what?

Irwin, Irwin Financial.

Owen?

Irwin.

Okay.

And at the same time there's a lot of regional lenders that play in that, as well as equipment lenders as well.

And Denny's does not provide any financing?

No. We -- no, we don't operate in the financing business.

Okay. All right, thank you very much.

Thank you. Lamont?

Yes, sir?

I think that's all that we have the time for today.

Okay. Do you have any closing remarks?

No, that's it.

Well, this concludes today's Denny's third quarter earnings release conference call. You may now disconnect at this time.