Denny's Corp (DENN) 2013 Q1 法說會逐字稿

Good day everyone and welcome to the Denny's first quarter 2013 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Whit Kincaid, Senior Director of Investor Relations. Please go ahead, sir.

Thank you, Anne. Good afternoon and thank you for joining us for Denny's first quarter 2013 investor conference call. This call is being broadcast simultaneously over the internet. With me today from management are John Miller, Denny's President and Chief Executive Officer, and Mark Wolfinger, Denny's Executive Vice President, Chief Administrative Officer, and Chief Financial Officer. John will begin today's call with his introductory comments. After that, Mark will provide a financial review of our first quarter results. I will conclude the call with commentary on Denny's full year guidance for 2013.

As a reminder, we will be filing the 10-Q later in the week. 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 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 most recent annual report on Form 10-K for the year ended December 26, 2012, and in any subsequent quarterly reports on Form 10-Q.

With that, I will now turn the call over to John Miller, Denny's President and CEO.

Thank you, Whit and good afternoon everyone. We are pleased to deliver another quarter of solid results as we continue to successfully execute against our key objectives, implemented to strengthen and grow our position as one of the largest franchised American full-service restaurant brands. We grew adjusted net income per share by 48% and generated $12.6 million in free cash flow in the quarter. We achieved these results despite what continues to be a challenging environment for growing sales.

We faced significant headwinds in this quarter as we lapped our strongest quarter of last year and our customers felt the impact of higher payroll taxes, gas prices, and delayed income tax refunds. As a result, we ended up with our first quarter of negative system wide same store sales in almost two years. Challenges aside, our performance is a testament to our franchise focused business model and the improvements that we've made today. Our continued success has enabled us to take advantage of the favorable credit markets and once again refinance our credit facility to the benefit of all stakeholders, which Mark will talk about in greater detail.

As we move forward, we will continue to work closely with our franchisees to increase restaurant level performance and new restaurant growth, while also balancing our capital allocation between reinvestments in the brand and returning value to our shareholders. We remain focused on executing against our three key objectives, revitalizing Denny's image with our America's Diner positioning, increasing the growth of the Denny's brand, and growing profitability and free cash flow.

Our first key objective is the revitalization of Denny's image through menu, service, and environment initiatives designed to fully leverage our competitively distinct America's Diner, always open brand positioning. We continue to balance our strong, every day value message with compelling, limited time only offerings. Our partnership with the Hobbit movie helped us finish 2012 with great momentum as a result. We started off 2013 with an abundant value proposition.

Our complete skillet meals featured a series of three-course meal offerings, including a starter and dessert, with a starting price at only $8.99. Skillets have consistently been a highly compelling platform for our guests and we saw this during the module as they generated around 10% entree incidence with restaurants selling approximately 250 promotional meals per week. In addition, dinner entrees reached record highs during the module, as 25% of dinner day [park] guests purchased a dinner entree.

We were disappointed that we did not generate the improvements in same-store guest traffic needed to offset the lower product margin, as the loss of full-price appetizers, desserts, and side items pressured our food margin compared to last year. We do believe that an abundant value meal platform can drive incremental lunch, dinner, and late night transactions and we'll be testing alternatives to find the best approach for our customers.

After getting through the traditional value season, we launched our Baconalia menu last month. Baconalia was first celebrated back in the second quarter of 2011, driving one of the strongest quarters of same-store traffic that we've had in the past two years. This celebration of bacon features classic breakfast bacon dishes, along with lunch and dinner entrees and very unique desserts like the encore performance of the maple bacon sundae. We are also leveraging our new coffee platform, featuring an LTL iced coffee with this menu. We continue to evolve our limited time only strategy and we'll be launching our third marketing module in late May in preparation for the Memorial Day holiday and the launch of summer.

One of the other key parts of our brand revitalization effort is to deliver consistent, reliable service across all of our company and franchise units. Our goal is to continue to implement the improvements we have seen in our service cores are reinforcing the best way to deliver this consistency. We recently completed our second annual road rally, where we conducted training sessions in 18 cities, working with many of the leaders of our restaurants, including restaurant managers, district managers, Denny's franchise business leaders, and our franchisees. We continue to be encouraged by the progress our Company and franchise operations teams have made, and look forward to continued progress in converting more guests to Denny's.

One of the key elements of our plan is to revitalize the Denny's image through our remodeling efforts. We recognize that being a 60-year-old brand means that there are a number of locations with more than average wear and tear. We continue to make progress on reinvesting in our facilities, as franchisees remodeled 33 restaurants in the quarter. We remodeled one Company restaurant in the quarter and plan to remodel a total of 20 to 25 Company restaurants this year. The majority of these will be completed in the second and third quarters.

Most importantly, we believe that we have the right strategies in place to build on the momentum we established these past two years. We remain very focused on improving our same-store sales with the goal of generating sustainable, consistent, positive, same-store sales and traffic.

Our second key objective is to continue the growth of the Denny's brand through traditional and non-traditional venues, both domestically and internationally. We opened seven new franchise restaurants in the first quarter and anticipate opening between 40 and 45 new franchise restaurants this year with net growth between 10 and 15 restaurants. Although we did not open any new international locations this quarter, we do have global ambitions and are working to grow Denny's existing 98 international locations to a much larger global footprint. Our goal is to increase both gross unit openings as well as net unit growth. We currently have 176 unopened restaurant commitments and are focused on building pipelines for both domestic and international development in both traditional and non-traditional format.

And our third key objective is to grow profitability and free cash flow through our franchise focused business model that balances use of cash between making appropriate reinvestments in the brand, returning cash to shareholders, and reducing our outstanding debt. Our new credit facility marks another milestone for this brand as it provides significant flexibility for the use of cash, in addition to increase cash flow through lower interest costs. This facility gives us the flexibility to repay debt at a much slower rate than we have in the past. Although we believe it is important for Denny's to maintain a strong credit profile, we believe that it is also important to reinvest in the brand and return cash to shareholders as evidenced by the Board of Directors' authorization of an additional 10 million shares for our ongoing share repurchase program.

The credit facility also gives us additional flexibility for other purposes, like using our stronger balance sheet to help facilitate brand investments such as the investment in our new coffee program. In this program, we provided 12 month no interest loans to franchisees to facilitate the equipment upgrades. We're also pleased to own and operate a meaningful base of restaurants as it gives us a more powerful growth engine with more strategic options when it comes to increasing shareholder value through reinvestments in the brand and our company restaurants. We currently own around 90 parcels of real estate with plans to be opportunistic with any purchase options we have where there is an attractive return on investment. For example, we recently acquired the land under a Company restaurant and anticipate closing on another acquisition of land under a franchised restaurant in the second quarter.

As we continue to make investments in Denny's revitalization, we anticipate growing adjusted net income per share by at least 10% and generating at least $45 million in free cash flow in 2013. We will continue to utilize our strong businesses and free cash flow to invest in growth, strengthen the brand, and return value to shareholders via our share repurchase program. We will also continue to modestly repay our debt, albeit at a slower rate than recent history.

With that, I'll turn the call over to Mark Wolfinger, Denny's Chief Financial Officer and Chief Administrative Officer. Mark?

Thank you, John, and good afternoon, everyone. We achieved another solid quarter of results, which is highlighted by growing adjusted net income per share by 48% and generating $12.6 million of free cash flow. In addition, we recently announced that we refinanced our credit facility and that our Board of Directors authorized an additional $10 million shares for our share repurchase program.

In the first quarter, system-wide same-store sales decreased 0.7% with a 1.7% two-year increase as we lapped our strongest quarter of same-store sales last year. Same-store sales of domestic franchised restaurants decreased to 0.5% with an estimated 2% decrease in same-store guest traffic, offset by an estimated 1.5% increase in same-store guest check average. The increase in same-store guest check average was primarily driven by a 1.6% increase in menu pricing.

Same-store sales at Company restaurants decreased 1.5% compared with the prior year quarter. The decrease was driven by a 2.1% decrease in same-store guest traffic, which was partially offset by a 0.6% increase in same-store guest check average. The increase in Company same-store guest check average was primarily driven by a 1.2% increase from menu pricing, offset by an unfavorable mixed shift compared to the prior year quarter.

In the first quarter, more customers shifted from higher priced entrees, appetizers, and desserts into the skillet bundle meals limited time offering. In addition, the average mix of the 2-4-6-8 value menu was three percentage points higher during the first quarter of this year. In the first quarter, Denny's opened seven new franchise restaurants and closed six franchise restaurants, bringing the total restaurant count to 1,689.

I will now review the quarterly operating margin table provided in our press release. Denny's total operating revenue, including Company restaurant sales and franchise revenue decreased $12.2 million compared with the prior year quarter, primarily driven by a decrease in Company restaurant sales in the quarter. Sales at Company restaurants decreased $13.1 million, primarily due to 36 fewer equivalent Company restaurants, reflecting the impact of selling Company restaurants to franchisees.

For the first quarter, adjusted EBITDA margin as a percentage of total operating revenue increased 0.7 percentage points to 16.1%. This increase was primarily driven by the franchise side of our business. Denny's franchise and license revenue increased 2.7% to $33.5 million in the first quarter. The $900,000 increase in franchise revenue was primarily driven by a $500,000 increase in royalties and a $400,000 increase in occupancy revenue, which were favorably impacted by 45 additional equivalent franchise restaurants.

Franchise operating margin increased $800,000 to $22.1 million in the first quarter. This increase was primarily driven by the items previously mentioned, but was partially offset by a related $100,000 increase in occupancy and cost. Franchise operating margin as a percentage of franchise and license revenue increased 0.6 percentage points to 65.9% compared with the prior year quarter, primarily due to the increases in royalties and occupancy margin. This increase was partially offset by lower initial fee revenue from refranchising six restaurants, which benefited the first quarter of last year.

The first quarter Company restaurant operating margin of 14.7% represents a 0.4 percentage point decrease compared with the prior year quarter and was primarily impacted by higher product and occupancy cost, which were partially offset by lower payroll and benefits cost. The increase in product cost was primarily due to the unfavorable impact of product mix, as well as higher commodity costs. The product mix impact was primarily driven by the unfavorable mixed shifts that also impacted our guest check average this quarter, as previously mentioned. The increase in occupancy cost was primarily driven by favorable general liability claims development in the prior year quarter.

The decrease in payroll and benefits cost was primarily driven by lower incentive compensation and medical costs compared to the prior year quarter. In addition, payroll and benefits cost were favorably impacted by $500,000 from favorable worker's compensation claims developments in this quarter. Gross profit from our Company restaurant operations decreased by $2.3 million to $11.9 million on a sales decrease of $13.1 million, primarily due to the impact of selling Company restaurants to franchisees in the prior year.

Total general and administrative expenses for the first quarter decreased $500,000 from the prior year quarter, as lower expenses across a number of areas were partially offset by higher share-based compensation expense compared to the prior year quarter. Depreciation and amortization expense declined by $800,000 compared with the prior year quarter, primarily resulting from the sale of company restaurants last year. Interest expense for the first quarter decreased by $1.7 million to $2.8 million as a result of a $26.3 million reduction in total gross debt over the last 12 months and lower interest rates.

In the first quarter, our provision for income taxes was $3.6 million, reflecting a 33.5% effective income tax rate. This is lower than our guidance range of 35% to 40% due to a $500,000 income tax benefit recorded due to the retroactive passage of the Work Opportunity Tax Credit back to January 2012 under the American Tax Relief Act signed into law in January of this year.

Due to the use of net operating loss and income tax credit carry forwards, we only paid approximately $300,000 in cash taxes this quarter. We will continue to utilize additional net operating losses and income tax credit carry forwards to eliminate the majority of our cash taxes for the next several years.

We generated $12.6 million of free companies in the first quarter, which allowed us to repay $4 million in term loan debt. Our total debt to adjusted EBITDA ratio was 2.4 times at the end of the first quarter. In addition, we repurchased 341,000 shares for $1.9 million during the first quarter. On April 25, we announced the refinancing of our existing credit facility, established in a new five-year, $250 million senior secured bank credit facility, comprised of a $60 million term loan and $190 million revolving line of credit. This bank facility is a testament to the tremendous progress Denny's has made over the past several years with its franchise focused business model.

As a result of our stronger balance sheet, growing profitability, and free cash flow, we were once again able to capitalize on the favorable credit markets. The refinance facility features interest rate adjustments based on the Company's total debt to adjusted EBITDA ratio. Since our current total debt to adjusted EBITDA ratio is less than 2.5 times, the new interest rate will be at LIBOR plus 200 basis points, which is 2.2% based on current rates. The LIBOR spread increases to 250 basis points if our total debt to adjusted EBITDA ratio is more than 2.5 times and decreases to 175 basis points if the ratio is less than 2 times.

When compared to the previous facility, which had an interest rate of LIBOR plus 275 basis points, the new facility will lower our interest costs by 75 basis points based on current interest rates. The estimated annualized cash interest savings is approximately $1.3 million, which also takes into account the interest rate savings on our outstanding letters of credit and higher fees for the unused portion of the revolver facility.

We currently have a LIBOR interest rate cap at 2% covering $125 million of debt from our previous credit facility, which will apply to the current facility and extends to April 2014. Although there is no interest rate swap or cap requirement for a new credit facility, we have entered into an additional 2% LIBOR interest rate cap covering $150 million of debt from April 2014 to April 2015. In addition, we have entered into a 30-day LIBOR rate swap contract from April 2015 through March 30 of 2018 for approximately 1.1% on $150 million of debt through April 2017 and $140 million of debt through March 30, 2018. Based on our current LIBOR spread of 200 basis points, this would translate into a fixed interest rate of 3.1% during this three-year period.

In addition to the interest savings, the new facility offers enhanced flexibility for the use of cash, whether it's towards debt repayment, returning cash to shareholders, or using our balance sheet for brand investments like direct loans to franchisees and franchisee loan guarantees. The $60 million term loan will be amortized 5% in the first two years, that's 5% per year in the first two years, 7.5% in the subsequent two years and 10% in the fifth year with the balance due at maturity. This translates to minimum payments of $3 million to $6 million per year, which is substantially less than our previous facility, which had a $19 million amortization requirement.

Our basket for cash allocation to share repurchases and/or dividends will be capped at $44.6 million each year, which is an increase of $10 million compared to the previous facility. If our total debt to adjusted EBITDA ratio is below two times, the $44.6 million cap will be removed except for the requirement to have a minimum revolver capacity of $20 million.

We have made great progress deleveraging this business and erasing the history we once had as an overleveraged company. Our stronger balance sheet has helped us attract new franchisees, new third party lenders, facilitate franchisee growth, and make brand investments. In 2013, we will continue to use our free cash flow after reinvesting in the brand towards both share repurchases and, to a lesser extent, debt repayment. In addition, we will opportunistically use cash to either purchase franchise locations that enhance our Company restaurant portfolio or acquire real estate to improve our returns on Company or franchise restaurants.

As a result of this new credit facility, we will look to repay debt at a much slower rate than we have in the past, as debt repayment becomes less of a priority. We are currently focused on keeping our total debt ratio below 2.5 times versus getting below 2 times unless there is a need to free up flexibility for returning cash to shareholders or increasing our ability to use our balance sheet for other purposes, such as third party loan guarantees or franchisee loans.

In conjunction with the refinancing, the Board of Directors has authorized an additional 10 million shares of common stock for our ongoing share repurchase program. Since November 2010, we have invested approximately $53.3 million to repurchase 12.6 million shares through April 24. We now have a total of 12.4 million shares authorized for our ongoing repurchase program, which includes 2.4 million shares remaining on the current authorization, and the new authorization of 10 million shares.

That wraps up my review of our first quarter results. I'll now turn the call over to Whit, who will comment on our updated annual guidance for 2013.

Thank you, Mark, and good afternoon, everyone. I would like to take a few minutes to expand upon the Business Outlook section in today's press release. The following estimates for full year 2013 are based on first quarter results and management's expectations at this time.

We now expect full year system-wide same-store sales to perform between flat and positive 1.5% as we take into account the challenging first quarter. We anticipate that both franchise and Company same-store sales will be between flat and positive 1.5%. We anticipate that we will take approximately 50 basis points of core menu pricing in July when we roll out our new core menu. This is in addition to the 1% price increase implemented in January of this year. Based on our current thinking, we believe that commodity cost pressures will be in the 2% to 3% range this year and are currently locked into approximately two-thirds of our needs for the year.

We expect our Company margin to range between 14% and 15% and our franchise margin to be between 65% and 66%. As a result of the lower interest rates with our new credit facility, we expect net interest expense to now be between $9.5 million and $10.5 million with net cash interest expense to between $8 million and $9 million. We estimate that the closing of this new bank facility will result in a one-time, non-cash charge to other non-operating expense of approximately $1.2 million in the second quarter of this year, as a result of the charges for the unamortized portion of the deferred financing cost related to the prior facility and a portion of the fees related to the new facility.

As a reminder, there was a one-time non-cash charge to other non-operating expense of approximately $7.9 million in the second quarter of last year when we refinanced our previous credit facility. Our updated estimate for capital expenditures is between $19 million and $21 million, which includes remodeling approximately 20 to 205 Company restaurants with most to be completed in the second and third quarters. This estimate now includes the purchase of two parcels of real estate in the second quarter of this year for approximately $2.4 million.

As a result of the higher capital expenditures, our annual guidance for free cash flow is now between $45 million and $48 million. Please refer to the historical reconciliation of free cash flow, the net income, and today's press release.

That wraps up our guidance commentary. I will now turn the call over to the operator to begin the Q&A portion of our call.

(Operator Instructions) We'll take our first question from Will Slabaugh with Stephens.

Thanks, guys. Wondering if you could talk just a little bit more about the uses of cash given the refinancing and just really your willingness to buy back stock here at these levels versus instituting a potential dividend down the road. And then I would assume that this is a fairly good indication that the debt pay down, as you may have alluded to earlier, is sort of falling to the back of the list.

Hi Will, it's Mark. How are you?

Doing well. Thanks.

We thought we might get this question. So thank you for kicking off. We obviously are real pleased with the new facility we put in place and for those that know the history of Denny's, the fact that right now at the current rates the average cost of our debt is going to be in that low 2% number, that 2.2% number I think is a real tribute to obviously the turn around on the balance sheet and the cash flow of the business.

I mentioned in my comments that that basket that we have for both, I think it was either or, but it was a combination of share repurchases, dividends, was increased by $10 million up to that I'll call it around $45 million, I think it was $44.6 million. And right now, as I talked about the share repurchase program and the fact that we have this new authorization and that we've used over $50 million to buy back our stock. We obviously are very focused on that and albeit we do get questions about dividend payments, and at this point in time, we see, again, the cash primarily towards share repurchases.

As far as our free cash flow usage, we like the fact that also in this facility, Will, we got an increase in the level of direct lending that we could do to our franchise community and we also got an increase in the ability to backstop franchise loans. Both of those went up by approximately $10 million. So again, it's also about growing and investing the brand. I also mentioned in my comments, I think John mentioned this as well is the repurchase of a couple pieces of real estate again at very attractive rates.

I think the dividend question is always there for us. At this point in time, though, I think the focus is going to be on share repurchases as well as investing in the business at the appropriate return levels.

And then also wanted to ask you about trends throughout the quarter. Wondering if you saw -- you did mention the 3% higher incidence of the 2-4-6-8 menu. I wondered if that was more throughout the quarter or did you see it quite a bit higher in February as things were difficult in the industry? And then just really your overall take about how you guys performed given how difficult the market was for these past three months?

This is John. The quarter was certainly more volatile than normal due to a combination of factors that we're all aware of by now. Certainly, the weather was much more favorable during January, February of last year. There was higher gas prices. Certainly, the income tax refunds were delayed and then what we don't know how to read now throughout the whole year is the impact of the increased FICA tax. Our consumers at about a little more than 50% below $50,000 household income we think might have been impacted just a little more. So how the quarter might have affected us perhaps a little bit different than the industry at large.

But our system-wide same-store sales were positive in March. We benefited from the early timing of Easter. We were down 7.25 as I mentioned. We were up 1.7 on a two-year basis and we had our best -- and we had a very strong quarter to get over. We also had some good momentum going into January, Will, with our Hobbit promotion. That carried into January a little bit and we also benefited from the timing of the New Year's flip into January. So sort of a good start, a good finish, and in the middle it was a challenging quarter to say the least.

Thanks, guys.

We'll take our next question from Michael Gallo with CL King.

Hi, good afternoon and again good results. My question is for John. The promotion that you ran in the quarter, obviously you saw some pressure on the Company unit restaurant margins and you mentioned some things you were tweaking with that. Can you talk a little bit more about that, kind of what happened, why the margin expectations were different than what you saw? And what kind of adjustments you make to that so that, obviously, you don't see the same kind of margin impact and whether we should expect that Q1 will be the high point for food costs for the year.

Right, well Q1 product margins we were about 26.1%. It's about 1.1% up primarily due to the impact of unfavorable product mix versus prior year first quarter, about 6 points. In addition, 2% increase in commodities. So there's basically the story of Q1. The unfavorable mix is primarily driven by customers shifting from higher priced entrees and then also it affected appetizers and dessert sales into these bundled meals. A bundled meal is a value proposition designed to drive traffic and we have a lot of confidence in our skillet program. It's been a top seller for us.

There's been a lot of affection that our customers have for that program. It helps build lunch and dinner incidence. But because of the headwinds in the quarter, we didn't get the transactions that we expected with this promotion. So we do believe value platforms, abundant value platforms in programs like this have a place in our program. And so we just continue to test ways in which they can be more effective in driving transactions. But that's the story of the margin hit during the quarter.

In terms of just some tweaks you're going to make to those, I think you alluded to that.

Well, I think the way we look at it is the annual marketing calendar has its own rhythm. Q1 is a value season for us. So we had a value transaction driving strategy and other headwinds got in the way of that being fully realized. So as we go into the year, other strategies now take place with maybe check building, or lunch or dinner incident builders. If you look at current trends, we're in our Baconalia program and Baconalia is a higher check but lower percent margin promotion compared to last year when we offered our build your own pancake promotion. So this will have percentage implications, but beyond that, it's too early to talk about the balance of the quarters for the year, obviously, you've seen our recent guidance updated. We do believe we have the right strategies in place overall.

Okay, great. And then a follow-up question for Mark. With the new credit facility, obviously you did repurchase a lot of stock in the first quarter. Correct me if I'm wrong, the $45 million would be use it or lose it. If you don't use it this year, it's kind of gone. You start on the new basket next year. Can you use the entire $45 million this year, and if so, should we assume kind of a 2.5 million share kind of rate that you'll step up and complete that to the end of the year? Obviously, it might not be even, but can we expect given where you're at now that you'll look to buy as much as you can under that program this year? Thank you.

Mike, we haven't obviously given real specific metrics as far as anticipated dollars or shares for the balance of the year really on any annual basis. I probably would just go back and take a look at what we've averaged annually the last couple years. That number has come in about, call it about $22 million a year at least the last couple years, again with different or lower limitations on that. But I think the big difference here, obviously, is the fact that we had an annual amortization on the debt, the previous facility of $19 million a year. Obviously, the early years of amortization was in the low single digits as far as millions of dollars.

So again, we continue to be consistently in the market as far as repurchasing shares, but I don't feel comfortable giving specific guidance on a dollar amount or share count amount for the balance of the year.

Is it fair for me to assume that given the increase and the new authorization, which is obviously well in excess of what you could even buy under the current facility that we should see an accelerated rate of share repurchase for the remainder of the year, assuming the stock price stays where it is?

I would say it's fair to say that we continue to view our share repurchase program as a consistent and strong way to invest our cash, and clearly, in this new credit facility we were very focused on the size of those baskets and the use of those baskets, not just for the share repurchase and/or dividend piece, but as I mentioned earlier, also reinvesting in the brand. So the nice thing about this new credit facility is that it's a combination of obviously the structure of the facility, the costs from an interest rate standpoint, that's that 2.2% number, but also the flexibility that we received and the support that we received from the banking community when we put this deal together.

So it gives us some tremendous options and flexibility, which we're excited about both to your point repurchasing shares, but also investing in our business.

Thanks very much.

We'll go next to Tony Brenner with Roth Capital Partners.

Thank you. Two things. You touched on this several times already, but regarding your same-store sales guidance, calling for an increase of up to 1.5% both company and franchised implies a pretty nice swing from the first quarter. And there are still plenty of headwinds on a macro basis out there. Other than a price increase at midyear in the third quarter, I guess, what are you assuming specifically that's going to turn that number around?

Tony, this is John. Well, we're just getting through the noise of Q1. I think it's too early to get into all the specifics, but what we do see is improved housing starts. It's a volatile, choppy recovery. We'd all like it to be stronger, but it is a recovery nevertheless. And we see continued improvements in key states for us, like California, Texas, Arizona. There is softness in a couple of places, but those continue to show good signs. We have an overweight percentage of our units there. Not to say we don't care about a national recovery. We do. But we have some positive signs in those states that matter.

So it's essentially a macro driven change for the balance of the year.

That and bear in mind the 33 remodels were completed in the first quarter. We have 20 to 25 company, expect to be completed in the second and third. And so, again, we expect the normal mid-single digit response from those and that plays a role.

Are any completed yet of company stores?

We've completed one in Q1 company.

Can we stretch a black string from the sales at that one store?

Yes, we don't get into single unit performance, Tony, but as we've shared a number of times, it's just part of the ongoing evolution of a brand to refresh units as they're due and we get sort of the normal (inaudible) from that.

Okay, and what's your timeframe in remodeling the entire Company's store base, 164 stores?

The overall brand has a seven-year rhythm on the whole that was interrupted a little bit, as you'll remember from the two-year hiatus that we provided. And so it creates this little metric or matrix of seven-year remodel cycles and five-year remodel cycles from a number that straggled 2010, '11, and a little bit into '12 of what we called our new day or our lighter refresh program. So about, I think we've guided a little bit on the number of units that is over the next five years. But it's --

About 25 or 30 a year basically.

Yes, on the company side yes, you can sort of divide by seven, one-seventh is a pretty good guide.

Thank you.

We'll take our next question from Mark Smith with Feltl and Company.

Hi guys, just wanted to clarify one thing and sorry if I missed this, but did you discuss the real estate acquisitions in the quarter and what those are for?

I'm sorry, Mark, it's Mark. Can you repeat that just one more time please?

Oh, the real estate acquisitions here in the quarter.

We had -- sorry, if I understand your question, we had -- we talked about two properties during the quarter, one company location and one franchise location. And obviously, we are on the head lease on a few hundred properties out there and some of those have an option to purchase. And obviously, in running those numbers and looking at the kind of metrics that we need, we purchased two of those parcels during the quarter.

And in our view, this is the kind of investment we can make with our cash, with our free cash flow metrics and I think you might recall that in the fourth quarter of 2012 we repurchased an operating franchise restaurant out in California and that fit well into our company-operated structure there out in Southern California.

And how many real estate properties do you guys own today?

We own around 90 pieces of real estate and around a third of those are under company operated stores and the other two-thirds are under franchise. That's a rough split and I think you've heard us say this before, we also own the headquarters that we are in, in Spartanburg, South Carolina. But the majority of those properties obviously are restaurant properties. And again, you probably also recall in the history that we sold a lot of real estate back in 2006 timeframe, which was really the beginning of our deleveraging process. And we did sell certain piece of real estate as we went through the refranchising process as well. But again, as we look at the use of our cash, if these type of transactions make sense then we will step forward and do these transactions of which there were two I think we mentioned, and actually in the second quarter.

Then second, can you guys just talk about the -- your commodity outlook and what you're looking for in your basket and any particular items that maybe we're seeing a bigger shift in?

Hey, Mark it's Whit. So our update for the commodities, initially when we kind of gave guidance for this year it was 3% to 5% and now it's 2% to 3%. So we're locked into two-thirds. The biggest driver is kind of the inflation that has come from pork, and eggs, and dairy and the remaining areas of variability for this year are going to be things, really ground beef and precooked bacon. And so what we've seen kind of the recent favorability has been more focused on kind of chicken, eggs, and cooking oil, and that's really a function of kind of some of the changes in the grain market putting less pressure on commodities.

So just a reminder, we do all of the purchasing, the contracting for the system and so yes, we'll look to continue to try to bring scale, guidance that we can bring scale to.

And one last one on the outlook here as we look out maybe even beyond 2013, your appetite for opening new restaurants, company operated restaurants.

This is John and between Mark and I we'll do our best to answer the question. We are -- we have a lot more flexibility under 2.5 levered with this newer pedigree and the lower amortization schedule. So much like this real estate acquisitions, I would say that where it complements our portfolio, where do we have supervisory efficiency we would be of the mind to be opportunistic to acquire and/or grow one to two units a year. And this year we've not guided to a Company unit opening, but last year we did open one and I would say that in that range of one to two year, if it's the right arrangement it would be part of our overall strategy.

This is Mark and I agree totally with John's comments, and again our current guidance for the current fiscal year 2013, all of the openings, store opening are franchise openings, and to John's point last year, we opened obviously a flagship store in Las Vegas, Neonopolis opening off the Freemont Street area. So again, the focus of our capital, if it's the right investment, last year was Neonopolis. This year we have no Company openings as part of our current guidance.

Perfect, thanks guys.

And we'll take our next question from Nick Setyan from Wedbush Securities.

Thanks, guys. I was very pleasantly surprised with the franchise margin, particularly since we were working the lack of additional franchisees to maybe be a much bigger headwind. So I just wanted to kind of think about it going forward. Can we see the continued leverage going forward for the rest of the year or are there some moving parts in Q1 that particularly benefited this quarter and we shouldn't think of it that way going forward?

Hey Nick, this is Whit. Yes, I think kind of we gave our annual -- gave kind of an annual guidance for franchise margins between 65% and 66%. So I think yes, I think you could expect to see a bit more leverage certainly than you saw last year, and part of it is performance-based compensation. And then another piece would be based on kind of just the occupancy kind of cost going through there. And then there was also some investments, kind of brand investments we've made last year that hit the franchise cost side as well that we do not anticipate having this year.

Got it. And then kind of a more bigger picture kind of question, could you guys maybe talk about what the margin, the unit of margin structure for your top 20% of stores versus your bottom 20% of stores, your current company owned store basis?

Nick, this is Whit. So it's really a wide range. So obviously the midpoint is right there around, where guided two last year was kind of a little bit south of 15%. So certainly the higher volume units and then this is -- part of it, if you look back in history, our high volume units that we have really units that do well over the $2 million average. We also have units more kind of towards would be the system average, which is $1.5 million, some of our Flying J units. Those units average $1.4 million. And so yes, our margins tend to correlate I think probably much similar to other franchise restaurant concepts, to sales volumes. And so yes, you certainly would expect to see our upper quintile restaurants performing well above kind of the average. And then the lower quintile below the average that we report.

So this is one of the areas we continue to put focus on and so yes, so in terms of the new kind of bringing on the operations team, we've really made investments there on the company side as well as the franchise side. And certainly, we think this is one of the areas that of opportunity for us is really continue to improve the operations at our restaurants.

Got it. The reason why I ask that is because I want to really understand why you guys feel like the current sort of company owned store mix is the right mix versus the franchise mix. Is it kind of just like an arbitrary 10% is the right number or could we possibly see kind of as you guys go through the next couple of years maybe you guys could call a little bit more and then perhaps we can keep some of the better performing stores and sell off some of the more underperforming stores.

Nick, this is John. I wasn't here during the entire FGI program, so coming into it fresh I had a lot of the similar questions and those are very good questions. There's nothing magical about 10%. I'd say that we like it being somewhat significant of a portfolio that it matters that we maintain our ability to be strong restaurateurs, strong restaurant operators. We think that makes for a better franchise or franchisee relationship. We have skin in the game (inaudible) strategic decision that's being made.

We also like its ability to sort of move EBITDA in a more powerful way as comps move in a straight 100% franchise model. We think there's an advantage to that. And then the base has been really picked over and analyzed, and looked at a number of different ways from supervisory efficiency to short plights, location of supervisory, strong supervision, and where they reside and can travel from, and any number of ways you can look at it. And at the end of the day, the portfolio that remains the company portfolio because it's beneficial in earnings, for it to be beneficial to our shareholders to sell them they get to be a risk adjusted price to the franchise community, but prefer to go do something cheaper.

So we'd have to charge a price that sort of gets in the way of their risk. They'd rather go put that same money in a location somewhere else and take the risk of opening up a sales that gives them a better return than having to pay a higher multiple of something we would reluctantly sell. We certainly wouldn't turn it over for less than an accretive sale price. So that balance was sort of self-adjusting looking at shareholders' point of view and then our ability to operate it over the court of the FGI program.

Got it. Thank you very much.

We'll take our next question from Conrad Lyon with B Riley and Company.

Hey, guys. A question about the credit facility. I think an intriguing aspect, I think Mark you talked about this, is the ability to lend and backs up some of your franchisees. Maybe you could just remind us how significant can that be? I mean is that something that potentially could accelerate growth or is it just a matter of simply giving them better rates perhaps? Any color would be appreciated?

Yes, Conrad, I would say it could be pretty significant. We had I believe an [L] facility under the current leverage issue. We had up to $10 million that we could direct lend. That number is up to $20 million now. So it increased by about $10 million under the current leverage ratio that we have. But you look at it, and I know we've talked about this in the past, once was the coffee program. So we have the national rollout and the change in coffee equipment brand-wide, total reintroduction of coffee, including adding -- upgrading a (inaudible) of the coffee product that we had in our restaurants. And to facilitate that rollout with our balance sheet flexibility, and this was under the old credit facility, we were able to direct lend to the franchise community over a 12-month timeframe and charge no interest. And you probably heard us talk about this. We have obviously a very strong credit card program, credit card relationship, which allows us to obviously collect that loan back through our financial resources.

But I look at that, we've also done a similar program with our point of sale equipment. We don't have one point of sale product throughout the system. So again, to encourage franchisees to convert their platform, we also have direct lent money as it relates to the point of sale conversion. So again, using the strength of our balance sheet, the credit card program we have in place, obviously our continuing lower cost of debt or cost of capital.

But I think probably the other part of your question would be would we consider doing something like that for remodel programs or equipment package changes. I think that's always a possibility. Again, if it makes sense that that's the kind of investment we should make in the brand. The great news is we had that kind of flexibility with our balance sheet and with our cash flow metrics. And as I mentioned, this facility that we put in place just tremendous backing from the bank group on this facility. A lot of positive feedback from the bank group and a lot of demand out there in the marketplace for the Denny's brand.

That flexibility is fantastic. Question about marketing. How's the calendar looking in general for the year? And what I mean is, is there going to be anything drastically different? Might you go after different demos, maybe focus more on Hispanic younger groups, anything of that nature?

I would say, this is John, thanks for the question, nothing we want to talk about, tip our hand to. We feel like we have a good calendar. We do focus on boomers, as you know, millennials. We have good social media programs that we think will be gaining momentum and becoming more powerful every year and we have quite an extensive outreach to the Hispanic community and we think we're getting better and better at that. And beyond that, I think we'll let things unfold.

And then kind of a follow on kind from a marketing spend perspective, is this going to be consistent perhaps as percent of sales or from what you collect? Or any major fluctuations there do you think?

No major fluctuations.

Great. Thank you.

And we'll take a follow-up question from Michael Gallo with CL King.

Hi, this is Mike. Just a follow-up question, I was wondering if you were seeing any impact from the -- on any of the Flying J locations from some of the stuff that's been in the news there? Thank you.

Michael, it's John. No impact really at this point. We can't tell that anything is any different other than it's unfolding in the news every day. Jimmy Haslam, the Pilot CEO, and the entire time that I've known him or that our Company has been associated has been very forward about his view that the trucker is everything to them. And so our sense of it is that he will do everything in his power to win the trust of that community and he did go out and make a statement recently about a five-point plan to address the issues that have been covered in the organization. Beyond that, I'll leave it to them to speak for themselves.

But so far, we've seen no pattern that's been broken in our sales whatsoever in the Flying J operations. We have about 130 of those. Of the 600 Pilot locations, about 130 are Flying J's with Denny's.

Okay, thank you.

We'll take our next question from Michael Halen with Sidoti.

How are you doing guys? I just was wondering what the guest traffic looked like in the quarter and where the guest check came out at?

Are you talking about company?

Yes, for the company owned stores.

Mike, this is Whit. The company guest traffic was negative 0.1%, -- negative 2.1%. That's guest traffic. And then the guest check average was positive 0.6%. So that gets you to same store sales at company restaurants of negative 1.5%.

Great, thanks. And I know some other chains sometimes when they go through the remodel program that that's a time they make decisions whether we're going to keep some stores open versus -- and remodel them versus closing them. Are there any company owned stores maybe that you're looking to close this year?

Well, the first part of your question, clearly that's an ongoing process of a 60-year-old brand. So not necessarily, but sometimes associated when a remodel is due, but mostly when a lease is come to. A portion of our brand will continue to purge. We have 1% to 2% store closings a year has been fairly much to prediction or sort of the track record in recent years, we'd expect that would likely continue throughout this year.

Company locations, I don't believe we have a company location on the list.

I think, Mike, if you look to John's point, historically, and I'll just go back let's say over the last five to seven years, we've closed around 2% on average sort of low 30s type of number and that's unit count. Last year, 2012, we closed 37 locations. 29, I believe, those were franchise, and eight was company. Our view, I think, is that that closing rate, I think we've said, sort of is going to continue in that manner. When I say closing rate I don't mean specifically country, but overall sort of in that around that 2% range that both John and Whit have mentioned.

Part of the answer to your question, though, as well is there were a significant number of company operated closings back I want to say in 2006 timeframe and that was the year before FGI or the refranchising strategy started. So we went through the portfolio at that time, and at that time we had over 500 company locations. Today, we have 164, but we went through that entire company portfolio and there were a number of closings, substantial number of closings, higher than normal rate closings in the company portfolio in 2006.

And I don't think, Whit, we've given specific guidance on company closings and --

We have not other than to say last year we would certainly anticipate it being less than it was last year. So you might see a few company closures kind of depending on how the leases come up and if the they get renegotiated, things like that.

The interesting part is when you look at our portfolio and take out that 2006 era for us that I mentioned as we sort of geared up for the refranchising strategy is despite the recession, which was extremely difficult, and still there's pockets of that obviously in the US, but despite the recession in certain states that that recession environment hit, and so you look at the difficulties in 2007, 2008, 2009, you look where our geography penetration is, our closing rate really has not changed that dramatically in the last five to seven years. So I think that, again, speaks to the longevity and the viability of this brand despite incredibly tough economic times, especially in certain states like California, Arizona, Florida, places like that, which clearly went through some very difficult economic times. And we talked about the fact, I know Whit has mentioned and John mentioned in his comments that we've begun to see some recovery in places like California and Arizona, and we find that to be encouraging.

But again, closure rate has been relatively consistent over the last many years.

All right, that's helpful. Thanks a lot, guys.

There are no further questions in the phone queue. I'd like to turn the call back to Whit Kincaid for any additional or closing remarks.

Thank you, Anne. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings call in late July to discuss our second quarter 2013 results. Thank you and have a great evening.

This does conclude today's conference. We thank you for your participation.