Dine Brands Global Inc (DIN) 2005 Q3 法說會逐字稿

Good day ladies and gentleman and welcome to the Applebee's International third quarter 2005 earnings call. I would like to introduce your host Miss Carol DiRaimo.

Thanks, Patty, and good morning. This call is broadcast simultaneously over the internet. A couple of calendar items to note. Comparable sales for our November fiscal period which ends on November 20 will be released after market close Monday November 28. We are giving you a break and you can all leave early to enjoy the Thanksgiving holiday. Fourth quarter 2005 earnings are tentatively scheduled to be released on Wednesday February 8, after the market closes and our year end conference call will follow on Thursday February 9, at 10:00 A.M. central time. In response to a few questions I received, I'll remind everyone that our fiscal year 2006 will contain 53 weeks. Many of the statements that were about to make with respect to our business outlook including comparable sales increases, costs, earnings per share growth in new restaurant development are forward-looking and based on current expectations. There are several risk and uncertainties that could cause actual results to differ materially from those described. Including but not limited to the ability of the Company and our franchises to open and operate additional restaurants profitable, the ability of our franchises to obtain financing, the continued growth of our franchises and ability to attract and retain qualified franchises. The impact of intense competition that of each segment of the restaurant industry, the impact on economic factors on consumer spending and our ability to control restaurant operating costs which are impacted by market changes, minium wage and other employment laws through costs and inflation. You should review our form 8-K filed with the SEC on February 9, for important information about factor that is could cause actual result or events to be materially different. With me are Lloyd Hill our Chief Executive Officer, Dave Goebel our Chief Operating Officer, Steve Lumpkin our Chief Financial Officer and John Cywinsky our Chief Marketing Officer. With that I'll turn it over to Lloyd.

Thanks, Carol and good morning, everyone. I'd like to share a couple of thoughts with you. I'll call it from the 50,000-foot level as we start the call this morning. First, since our last call the competitive and consumer environments have changed, well pretty dramatically. We've obviously disappointed ourselves with our sales trends in the last couple of months, particularly in company markets. I want to make it clear these results are not acceptable to me, not acceptable to this management team and I'll tell you this management team is not just sitting around waiting for things to change. We are not thinking things will get better. We are adjusting our plans and that's important.

In a few moments you'll hear John Cywinsky talk about our recent segmentation study. This is the most in-depth steady we've ever under taken and taking very, very measured steps based on careful analysis and very specific research as a result of that study. Another thing I'd like to say to you is there will be no knee-jerk reaction from this management team. And as a reminder and I know you're going to understand this, as a reminder don't expect us now to be as specific as we've been in the past relative to our tactics and initiatives for driving sales until they become clearly visible in the marketplace and I know the reason for that is obvious.

And regardless of the direction of our economy or the competitive landscape, I want to say you can trust that this management team is in action and has their arms around the issues that we can control. On a different note all together our Board of Directors approved substantial increases in both our annual dividend and stock repurchase authorization. You should note that both of these have been discussed, contemplated for several years and I think our actions speak to our confidence in the long-term growth model and annuity like and stability of our cash flow and certainly our commitment to shareholder value.

Lastly before I turn it over to Dave, although he's not with us, he's travelling, I'd like to welcome Stan Sword. Stan's our new Chief People Officer. Stan has some real big shoes to fill with Louis Kaucic retirement and we are thrilled to have him on board. Stan comes from an industry leading organization. A very successful healthcare technology company. Oddly enough it's right here in Kansas City. I'll say the very center of our strategic plan is noticeably better people and exactly why Stans here. With that, Dave, I'll turn it over to you.

Thank you, Lloyd. Good morning, everyone. In my remarks this morning I'm going to get additional insight around the sales softness. I'd like to provide color as to how we are viewing our operating performance and update progress on the development front. Insight as to what's going on with company comp-sales.

First lets take this apart by geography. By region California, Nevada, New Mexico and Texas have been the bright spots with Texas as our shining star. The midwest regions, you know them Kansas City, St. Louis, Minnesota and Michigan continue to under perform, although Kansas City has shown improvement in Q3 versus the year-to-date trends. New England has shown accelerated sales declines in recent months and that's compared to the year-to-date. That's consistent with what the industry has been experiencing in New England.

Traffic is negative across all of our day parts accept late night. Year-to-date lunch remains the weakest day part in comps and traffic with week day softer than the weekend. Despite this tough environment and as Lloyd said; "Disappointing performance throughout Q3", there is a little silver lining and that's about some very modest sequential improvement we saw on the company side in October. But the caution flags are still out. As we analyze our macro guests graphic declines there's a specific demographic that stands out for us. We've seen falloff from the guests whose household incomes on in the 35,000 range and down. These guests represent 19% of our heavy users. The highest percent in the grill and bar space. Just a reminder our heavy users are people who have visited Applebee's previously better than six times per month.

In this macro economic environment it's forced a large number of these guests to alter their dining out routine and that's seems to be characterized by fewer visits and different spending habits. We don't believe there's any question whether they'll return more frequently to casual dining. The issue is we don't expect that to happen overnight. In the meantime, we're working hard at mining near term opportunities.

First of all, it goes without saying we'll stay the course on optimizing efforts on car size, speed and convenience, weight watchers and continued food improvement. In my remarks last quarter, I suggested we have increased focus around more overt relevant value propositions. That work was underway when we addressed you and continues with a number of tests in the marketplace. A quarter later as we sit here today we know it's a tougher environment than we forecasted last July. Once again our guests in the 35,000 house hold income range and down have been hit hard.

We're mindful of that as we ride this storm and address the value issues but the insurance we can give you is that as we go to market with propositions we'll be tested, validated and all that will be to ensure that they add value to the shareholder, the franchises as well as the guests. And I'll repeat what Lloyd said, we won't do any knee-jerking in this environment. The solution may be value based but rest assured it will be profitably value based. Our initiative will make sense to the topline and the bottom line and continue to fine tune initiatives with this in mind and more to share with you after the first of the year.

Now let's move to the operations front. Car side sales mix and company restaurants was 9.8 versus 8.9 a year ago and averaged about $4500 a week which was a 10% improvement over the same quarter last year. Slightly lower mix from Q2 is consistent with historical seasonal softness in the summer and October bounce back to the 10.5% range. Timing and franchise restaurants like company roll-out as you recall by about a year, franchise car side mix continues to grow on a similar track. We have not waiver around our intent to own-to-go in casual dining and we continue to explore wades to maximize this off premise business. In Q3 our customer service measure for car side reached a new high and with over 25% of our restaurants now north of 12% mix we do not subscribe to the notion that there's some kind of artificial ceiling around 10%. In the dining room, our guest and operations metrics continue to validate that we are taking care of business inside the four walls. With over 200,000 surveys in Q3 on our dining room CSI or our Customer Satisfaction Index, our operating teams both on the company and franchise side broke another threshold in guest satisfaction to produce our best score card yet.

Technology and operations procedures have been the foundation for these solid table turn times we have been producing and customer convenience. In the midst of declining comp sales our company operators have done a solid job controlling usage and labor costs. However, given all these data points we are not losing sight of the fact that great operations lead to better sustained traffic performance and all of our operations are not great. Our best performers in CSI, the best of the best continue to have the strongest comp sales despite the external environment so we're going to continue to drive for better execution.

Let's move over to the development front. On that front we remain committed to 2005 as a year of significant investment. Continued evidence it's important we remain aggressive around taking market share for the long-term health of our earnings. In the first three quarters of '50, we've opened 39 company restaurants including the seven in the Memphis , at 18 more restaurants than we did for the comparable three quarters last year and we'll open at least 11 additional restaurants in the fourth quarter. Our franchises have opened 52 restaurants through three quarters and open at least 33 more in Q4.

And just this week we opened our 100th new Applebee's restaurant this year in Mansfield, Texas which gives us our 13th consecutive year of 100 or more. We are still projecting 135 total company and franchise openings for the full year. In closing let me just say this, we're going to continue to stay all over taking care of the guests that we've got and while we do that we're going to continue to press hard to bring forward profitable sales driving initiative. But forever remaining committed to our long-term strategy. With that I'm going to give it to you, John.

Thank you, Dave. Good morning, everyone. I'd like to focus my remarks on our near term activity as well as directional view to the future. As much as we'd like to talk to you about specific action plans moving forward we're going to resist doing so at this time for obvious competitive reasons even though you're going to probe as we get to Q&A. As you heard we are promoting Applebee's Italian style which will continue for a couple more weeks until early November.

At that time, we'll introduce a new higher end campaign called, Steak and Shrimp Double Features. As well as up to 10 new menu items, as part of our second menu evolution of the year. Depending on which market you happen to be in you'll, see several new entree such as the truly exceptional, 12-ounce Sizzling Rib-Eye Steak, the very popular Grilled Shrimp and Spinach Salad, from our recent irresistables campaign, two delicious Penni Sandwiches and a true Weight Watchers Wow, for only seven points that were calling our new Confetti Chicken. For those not counting points, were introducing Applebee's Crispy Bread Pudding, one of the most decadent desserts you'll ever taste. As we approach the holidays we are confident we'll be providing our guests with a terrific range of new tastes. Additionally importantly we are investing significantly in our menu team, menu innovation as a primary growth engine for the brand. To that end, we filled positions in the menu strategy, culinary and kitchen technology arena.

All three will have an immediate impact on our '06 menu pipeline. However, with all that said our traffic performance suggests menu news alone is not enough to reverse our trend in this challenging environment. What has been wonderfully successful for us in four years will not necessarily result in future success. What this means for us is very simple. The landscape has changed. For us to gain momentum our paradigm must change as well. We must become more relevant and attractive to all of our guests. We must earn our loyalty and preference in a cluttered and frankly incentive laden landscape. We must innovate, execute and compete at a higher level and for us to win this battle on a sustained basis it's essential that we have a strategic plan for right growth opportunities in the right way.

We are confident we have that road map in our hands today. As Lloyd references it comes in the form of the insight we now have from the CDR segmentation study that we initiated in Q1 and completed this past July. We haven't fielded a study like this which was the foundation for our past 3-4-year business strategy. In this new segmentation we spoke in depth with 20,000 casual dining guests, geographically dispersed and captured 48,000 recent visits or dining occasions.

The result is an assessment of the good, the bad and the ugly from a guest perspective. How they perceive us today. How they perceive us as competitors, how they make dining decisions and why they choose one brand over the other. We have visibility to eight distinct eating occasions that are most revelant to us here at Applebee's's. As well as [needstake] , motivations, demographics and relative strengths and weaknesses. From a revenue standpoint, we know the size of each occasion, our share of each occasion, as well as our incremental growth potential by occasion. Most importantly we understand with great clarity what we need to do as a guest perspective to capture that incremental growth.

This new insight will help us focus, prioritize and sequence our future business initiatives as well as overall resource allocation. As we look to the future our objective is to reestablish this traffic momentum. Our strategy will fixate on differentiation in an industry ripe with category and competitive learning. In particular we will focus this strategy on three components of our core business -- menu, service and value. And our tactical marketing approach without question will necessitate change.

Now you've heard the expression to continue to do the something and to expect different results, that's the often referred to definition of insanity. We want you to understand we do indeed expect different results and we most certainly are not insane. Chuckle, chuckle on this. We think that should give you some indication how we are thinking about this business moving forward without revealing too much. Program development, testing and action plans are under way for '06 implementation.

We are driven by consumer insight, sound business strategy and long-term health and, as always, we will work closely with our franchise partners to leverage the best thinking and to ensure alignment before we move forward. We hope to share more with you on this subject on our next call. To walk us through the intricacies of up front media planning and complexities of advertising copy testing, I'd like to turn it over to Steve Lumpkin.

Good morning everybody and thank you for your interest in the Company. I'm going to run the numbers for the quarter and talk about how we think about the road ahead at least for the balance of the year. Company sales up 10.3% and $273 million. That's capacity increase of 14% because we opened 50 company restaurants in the last 2 months. Excluding the seven Memphis restaurants we reopened in 2005, that's on organic growth rate of 10%. Taken together the Memphis and Ozark acquisitions contributed about 4% to this capacity growth. These increases were offset by a 3.3% decline in average weekly sales as compared to a comp decline of 1.6 during the quarter. This gap is due to company openings in the midwest and New England the same markets currently under broad economic pressure. It's important to note there's no GAAP in comp versus the franchise community.

Franchise royalties and fees up 5.1% to 31.6 million that's an increase of 1.7% and 89 openings during the last 12 months. This is normalized capacity growth of 7%. That excludes the impact of our franchise acquisitions. Other franchise income came in about 1 million. This is a decline of 2.8 million as related to the decrease in the insurance income as fewer franchise participate as quite frankly we look at this business and evaluate whether we need to be in it. The difference between other franchise income versus expense of 274,000 relates to revenue from IT, products and services we provide to the franchises. Total revenues came in at 305 million that was up 8.6% during the quarter.

System wide sales increased 7.1% driven by [ A ] growth of 3/10 and a net capacity growth of just under 7%. Net income excluding impairment was 24.6 million versus 28.6 last year.

Quick note here on the impairment charge, impairment charge came in at 3.9 million before tax or 2.5 million after and that reflects the write down of the value of property and equipment of three restaurants that are not performing as expected. One restaurant that will be closed and relocated and one of the long lived assets. Diluted EPS exclude the $0.03 of impairment was $0.31 versus $0.34 last year or $0.28 on a GAAP basis. A higher tax rate accounted for a decrease of about $0.02 versus our most recent guidance for the quarter. A quick note here on our tax rate. We just completed our tax returns for fiscal '04 and we've increased our taxable income in higher rate states. Really a state tax issue. We adjusted our year-to-date tax rate to 35.7 from our previous expectation of 34.6. As a result of this catch up adjustment the tax rate for the quarter came in at 38.5.

Now let's hit highlights on the P&L. Overall margin 13.3 down 330 basis points from the prior year. Food costs came in at 26.2 down 10 basis points. Higher commodity costs offset by menu price increases of 1%. We took last November and a 1.5 this May. Labor 33.1 up 105 basis points in total. Hourly labor was up 45 [[bps]] , due to nearly 2% increase in hourly wage rates, as well as lower volumes.

Management labor up 25 [[bps]], due to 2.3% increase in managed wage rates as well as lower store volumes. Of course, this is offset by decrease in store level bonuses. Higher group insurance accounted for 35 [bps] of pressure on payroll related front. D&O -- was up 235 [bps] to 27.4 with the largest variance attributed to unfavorable shift in advertising of 55 [bps], higher utilities of 50 basis higher depreciation of 50 basis points, higher packaging cost of 25 basis points , the remaining increase of 55 [bps] was deleveraging on these lower volumes, around deleveraging on R&M property taxes and rent.

Moving to G&A came in at 8.6, that's a pretty low number for us, that's down 90[bps]. This decrease is due primarily a reduction in corporate bonus, that basically accounts for all the difference. Interest was the only other item of note up, that was up 30[bps] as we did increase borrowings and during our credit facility to fund essential stock repurchase.

Quick look at the balance sheet here. Inventory down 14.4 million as we reduced some of our protein around baby back ribs, riblet, and shrimp. Debt up over 100 million from year end 2004, behind franchise acquisitions and share repurchase. Debt to cap came in at 22.2 at quarter end and that's the highest it's been in several years. We have shown we're not diverse to leveraging up a bit. While we've not publicly stated the top end of our debt to cap we are comfortable with leverage beyond these levels going forward. We think we've got a lot of capacity. Actual shares outstanding at quarter end were 77.4 million. Share repurchase we are activity in the quarter bought back over 2.2 million shares, an average price of 23.3. We spent 53 million.

Year-to-date we repurchase in excess of 4.9 million shares on average price of 24.58 for a total of 121 million so at the end of the quarter we had about 29 million left on our previous authorization from last year. Now on stock buy break at our October board meeting we did approve additional repurchase for you will to 175 million as we continue to believe the intrinsic value at these levels are substantially higher than where the stock is currently running. In addition, based on confidence as Lloyd talked about and really our long-term model, visible cash flow, we approved a 233% increase in the annual dividend to $0.20 a share and that represents a new dividend we foresee increasing as future cast flows grow.

Let's take a moment here to kind of reflect on guidance for the rest of the year. First of all as energy, as everybody is aware energy costs will have a negative impact on margins including higher utilities, surcharge and packaging costs. We anticipate this impact to be greater than the 75[bps] combined we experienced here in the third quarter. To give you context year to date through September, gas and electricity combined account for between 2.5 to 3% of sales, with electricity being the larger component. Within our company markets where we can and where utility regulations will allow we have negotiated contracts gas and utilities, I'm sorry, gas and electric but it's in a minority of our stores. Effective tax rate for the quarter, expected to be 35 to 35.2 as a result of higher state income taxes and as a result we expect full year EPS to be in the range of 1.28 to 1.32. That includes impairment, $0.03 impairment charge we had this quarter.

A couple of quick updates here. A bright spot as we look ahead. We believe maybe on the commodities front although near term it looks like some of those improvements may be offset by higher packaging costs and fuel surcharge. Our beef buy is half done here with some year-over-year reductions in beef. We're just staging right now our chicken buy. The chicken market will look favorable looking ahead. Now as most of you heard lease accounting rules have been shall we say reversed by the versus our position and our successful position with the SEC last year. FSP 13-1, takes effect next year. We expect this change will have at most a $0.01 impact as we record higher preopening expenses during the construction period versus capitalizing these costs. As the impact of option expensing, we note that many of you are putting those in your model. On that front we're doing the work and I think you need to take a look at our guidance we've given you historically and putting in our Q here to give you indication on option expensing. Certainly more to come at the start of the year on our next public data point, the work will be done and we'll talk about that.

Hurricane Wilma, a quick update. Currently, 12 restaurants closed, unfortunately, for our franchise partners in Florida. Florida Apple has six restaurants closed they have successfully reopened three of the nine that were originally closed. Apple Sauce, our other franchise in south Florida , has got six closed. We expect the impact RP&L will insignificant but certainly significant to our franchise partners, however.. As you think about these recent hurricanes, it's clearly not a positive for construction costs, development costs, construction costs increased 10% this year and we expect there's going to be further pressure as demand for labor and materials go up, following the wake of these recent hurricanes. We are currently evaluating the impact of rising construction costs on our near term pipeline future openings as we maintain a focus on capital discipline. So that's the end of my remarks and operator, let's open it up for Q&A. Thank you.

Our first question comes from John Glass from CIBC Boston.

Good morning. Competitors namely Chilis have begun to use price point advertising and effectively and you said the franchise base hasn't allowed you to. Do you think price point advertising is a good idea and how do you convince franchises it is an okay strategy.

John, this is John Cywinsky. A couple points on that. A complicated question. We know we get great credit as a brand for delivering superior value. That's generally speaking. In this competitive environment we know there are many brands out there reinforcing price on err. That's a tactic that we may choose to consider at some point in the future as Dave referenced it, if we do go there we would go there in a smart sustainable profitable way but we are prepared to comment beyond that at this point. We think there are other avenues to deliver value and we look at the entire value which -- occasion which price is a very important component but other components as well. How's that for a nonanswer, John?

That's fine.

John, it's Steve. I don't think there's any resistance par say however our franchise community and our company operators expect anything we do would be smart. Given the fact that we've got a large variety of how we price markets, we think, to answer your question, do we think it's healthy? We think there's many, many examples in our industry where leading with a price point has not created value ultimately for shareholders or brands. We are thoughtful about this. In the short run here there's no doubt that price pointing is going to appeal to a certain customer and perhaps create a strong call to action. We are looking at that with keen interest. We're not sure within the short run that's the Ruth call for us, though.

And following your comments about unit development costs, any sense of magnitude how much you might consider reducing the opening plans in '06 given the cost price pressures?

Hey, John. Dave Goebel. First of all back to this development issue with this whole arena is one of our core competencies. As we've talked in previous calls we've had a robust pipeline over the course of -9 months. How does all that translate to the issue of rising costs? What it really means is every sight that comes into the pipeline we're going to assure it's meeting the hurdles and be disciplined about what comes out the other side. Particularly sensitive to the markets where we are seeing pressure but certainly we intend to keep the course on the penetration strategy and it's too early for us to give any sort of view to '06.

Thank you.

Our next question comes from David Palmer of UBS New York.

Hi, guys. Good morning. Just looking at Nap Tracks September same-store sales up 1.6% and two-year growth of about 1.5%. That's only a point worse than we had in 2Q on a two-year sales trend basis and two points worse than 1Q. I figured that was good considering we had Katrina in the month. Applebee's didn't have the luck in September better in September and October, I was wondering to what degree do you believe Applebee's sales trends have been more than economics even when considering the regional differences and more of a brand your advertising campaign remained similar for a while now. Thanks.

To John the Nap Track numbers, that's the comps, not the traffic numbers. They were lapping hurricanes from a year ago that helped to boost the September numbers arguable in a very soft economic environment. With that back drop I'll turn it over to John.

David, we think the content that we choose to market is as important as the advertising. We have been on this approach which we think is best in class not on judgment based upon what consumers tell us going back to our emphasis on differentiation. If we feel it's appropriate for this business to evolve whether that's menu, marketing content or advertising we will doing so we'll be guided by the consumer and we have a high standard there which is best in class.

We want our advertising to be consistent with brand character, likable and broad in its appeal and memorable and break through the clutter and we contend that in this environment in particular over six months there has been more clutter that at any point in recent memory so we are very serious about differentiation and I won't comment beyond that.

David, this is Dave. I just answer that comment that we are fresh off a couple of great days in Chicago with our franchise marketing and menu where we took a deep dive not just in terms of some of the approaches to '06 around campaign but in general asking that same question.

Thank you.

Our next question comes from Joe Buckley of Bear Stearns New York.

Thank you. I have a couple of questions as well. First, Steve, a question on near term development pipeline. What kind of flexibility do you have in terms of adjusting that if you want to choose to go that route. Are you locked in for '06 is what I'm asking?

When you think about our pipeline there's any time you skew with your mix to more lease sites you have flexibility. If you look ahead we have a pretty good rash of lease sites next year. That being said I think any time you don't, we have conditions on a number of sites we are taking a look at all of them as Dave said. We have some flexibility. On our deals with have more flexibility. In our small town development we have more flexibility. We have some flexibility. I would say, though, for '06, the good news is a nice part of our pipeline is committed. We feel very good about the returns we are getting even as we are seeing updates to our investments come in.

Steve, how do you balance that versus the share repurchase? Your balance sheet as you've leveraged up a bit is still under leveraged. I know you say you haven't shared how high you're willing to go. Some parameters to think about and how Cap Ex plays well versus share repurchase?

How we think about it is we like to be spending our capital in pursuit of growing EBITDA versus share repurchase. I mean, the management team against our own view of the intrinsic value of the stock, given where it's trading now. We continue to be big supporters of the stock at this level. If you look at the peer group and if you look at leverage with capping the leases, the peer group probably an average of 47% debt to cap and we're trailing substantially below that.

And I think we think we've got a strong cash flow to fund all our CapEx, acquisitions and to implement a new share repurchase plan within the capacity we have. I don't want to peg it too finely what the upper end would be. Board and management are willing, absolutely, to go beyond the levels we're at right now.

A question for Dave. Sounds like more change as you attempt to address the current environment. We talked before about the amount of change you've implemented over the last year or two and what the franchise system can tolerate or execute in terms of more change. To share your thoughts on that. If you change too much can the franchise base can handle it?

Yes, it's a very good way to ham it, Joe. If you look at the calendar and see where the real infusion on the company side of our business has been heading a change as we introduced car side and KDS and Weight Watchers. We went through a very intense period not long ago. Some of that franchises paralleled our timing and as you know car side, they lagged a year. As we sit here today, the franchise community has done a masterful job of digesting all of the elements of car side. As I said earlier we see them on a similar track at this point.

The short answer to your question would be to a large extent the system puckered up to take on exchanges in '06 and we've done a nice job to this point and I'm confident we can come forward with some good stuff. We're only going to do it when we are motivated to do it.

And one last question for John. Talk about your ability to differentiate. Certainly the amount of advertising you do is one way and that didn't quit deliver the results hoped for this year but talk about some of the things that you see as areas where you can differentiate Applebee's.

The insight we referenced, Joe, provides us some parameters around occasions and without telling you which occasions. There are some clear, very, very clear equities we have relative to competitors. Some of that is demographic based and we can leverage that in a very distinct way and differentiate. We think menu, marketing content, advertising, people are all opportunities and it's challenging. It's difficult. It is not easy but we are confident we can do that. We did it back in '01 effectively and we're at a point here where we think an evolution is warranted and we are confident.

Okay. Thank you.

Thanks, Joe.

Our next question comes from John Ivankoe of JPMorgan New York.

Two questions if I may. The first is on the development pipeline for '06. How many units in ''05, or what percentage of your '05 development was in the markets of the midwest and New England and are those committed to in '06 and '07?

I don't want to give you an off the top of my head answer. Let's follow-up this afternoon and I'll be glad to give you a specific one on that. What you're going to hear is a pretty substantial portion of our new store openings in ' 05 in midwest markets in Minnesota and St. Louis and some in Kansas City. One or two openings in Michigan this year. I'll give you a more precise number on that.

It certainly is interesting given the macro comments you're making and the fact those are coming in lower volumes. The question I'll ask more directly. Are the returns still good for units to be opening in the markets?

I think it's a good question. One we are contemplating. It's somewhat dangerous and we would think if we think about it this way to try to make a call on an entire market in a period where there's pretty unprecedented low end customer pressure. We think about when we make the commitments we want to be there for 20 years. These markets especially New England where we are un penetrated I think we are making sure we are doing good deals but it does not dissuade us from the full potential of these markets. I think in the short run it makes you look harder at deals that come in to make sure the economic terms and the investment is right for the times. Our head doesn't get turned on an individual market at all.

Often times when we see comp weakness and weak unit volumes canalballization is the reason. Is it not canalization?

In terms of what's happening to A was that is not a principle factor. I mean, in some markets we're seeing perhaps a little more of that but it is not on a broad , the issue -- basis, the issue.

Okay. Let me switch gears and ask on advertising. We've seen price point advertising, consumers have been given an opportunity to trade up. Often times there are higher price products that are featured. With that, of course, telling us your secrets, is that your thought in terms of what you can do in '06 protecting the check average and allowing per check average increase that's the first question and secondly do you think the brand has continued pricing and that's it for me. Thanks.

John, this is John on the subject of what many industries rely upon is this what people end up purchasing is something different. That has a role as you move lower on the income demographic sale and something our competitors have utilized. With respect to the second question we know we have pricing flexibility relative to the past few years and where our competitors are and where our guests are telling us. We are reluctant to go deep on either one of those subjects at this point.

Okay.

Our next question comes from Andrew Barish of Banc of America.

Hey, guys. A question on pricing. You mentioned you're about to lap a 1% price increase coming up here and actually check average the last few months looks like it's moved up more to average 3 points of increase which kind of seems inkongerous with the trends managing expenditures a little bit more closely. Is that just a function of losing that low end consumer or emotional mix?

No. You hit it right on the head. I think we're experiencing and we've heard other operators in the category talk about this. The people now that are coming in are spending. While we continue to see the dynamics we talked about, those kind of things, that's the primary reason.

Thoughts of pricing here with the next as you lap up the points?

I don't think we'll go there right now. I'll reiterate, we have flexibility. We do split apart what's happening in the cost structure versus our pricing. We'll let the consumer tell us on individual items how far pricing can go. We've got flexability here, management still has to make.

You heard John say earlier that our go forward mentality is to make sure we have something out there for all of our customers and this whole issue of making sure we are taking care not just for the folks who have temporarily backed away and we believe will come back some of the approaches we are taking with this sizzling rib eye skillet where we bring this to the guest and sure we'll geographically from the higher end guest.

Thanks.

Our next question comes from Jason Whitmer of FTN Midwest Cleveland.

Good morning. A quick question on your CSI scores. Is this something you look at as a leading indicator or lagging indicator one of your competitors looking at, brand recall is something that was strong but not directly tied with comp movements. You give any thoughts on that?

I would say, Jay, I think CSI is one element of many that we look at. We don't rely solely on that. We continue to slice our CSI results and when we take the best of the best as I said earlier there's a high corelation between gad traffic and good comps in the scores that have the highest CSIs. That's combined with other measurements as we do Applebee's operations assessment. External audits as well as information we get through brand tracker and other guest measures. CSI has a piece of it and a lot we are learning as well. It continues to say to us, invalidates that great CSI scores for the guests coming in the door translate to higher satisfaction and return business.

On your value side of things within your menu do you think you're shifting more to an very late mode or qualify your spending on advertising to be more defensive or offensive at this point or do you see that shifting going forward over the last 12 months.

Not planning on investing more on the P&L than right now. A shift from local to national so I want to make sure we're clear on that.

Right. And lastly briefly obviously you want to get your hands around the core business at this point. Any future thoughts bringing forward a second concept or bringing forward for that over the near time?

We've been clear that we're focussed on Applebee's. The only thing we own. It drives us every day and we like that. There's such tremendous on tap potential of this brand both domestically and internationally that we're sticking to our knitting. Our franchises are happy we are sticking to our knitting and shows management on board.

Thanks.

Our next question comes from Robert Derrington of Morgan Keegan.

A lot of my questions have been answered. One of the things I'm curious about looking at sales, average unit sales and same store sales. How much of that is affected by many or any of the new smaller prototypes the company is opening?

That's a good question. Without too much of that 170[bps], about 50 of it is really can go to what we are doing in small towns and what.

What's the company's view of that development? Is the proto type still valid. You appear moving to or away from?

Our small town restaurants have the best comps and the best returns. We are very pleased with the proto type and we're in market, enhancements to that prototype.

As a percent of development going forward, can you ballpark what it might be?

Boy, we'll probably talk about that later. I think we're thoughtful of that and we're trying to balance metro and small town development.

If you look at the slide we put up of terms of star markets and small markets, it's not necessarily the building side, it's the market side. I believe the star market we identify 250 out of the domestic potential and that could be many sizes of proto type ye type.

Great. Thank you.

Thanks, Bob.

Our next question comes from Peter Oakes of Piper Jaffrays.

Hi. We have a couple if I may. Curious if you update how much comp you think is necessary to stabilize the margins given the climate we're seeing out there?

Boy, that's, I'm going to say 2.5 to 3 in this environment and that may even need to go slightly higher depending on what happens to energy here in the next quarter or two which is anybody's guess.

That is going up.

I wish we had a crystal ball to find it. Diesel prices here are 3.50 and that's driving tremendous fuel surcharge here. I think we have to get through how bad is the winter. All those need to come in to play. Certainly a much better visibility here in a quarter or two.

That's good. You mentioned the segmentation study you did is the first major effort in four years without given up the secret you found. What would you characterize as the biggest eye opener as far as how it's served over four years.

How familiar casual dining guests are with these brands. Focus on grill and bar for the moment. How familiar with the brands, menus, price points and that's one insight. The other for us is significant changes in a four-year time frame. From ' 01 to '05 And what -- occasions happen to be relevant for Applebee's. Remarkable shifts as an example of perceived health was nowhere to be found on the radar screen back in '-- 01. So that's another significant insight. And a final one without revealing proprietary info, we probed not only on your last couple of visits and we spent 20 minutes with your guests online but we asked 65 different attributes we clearly have a sense for why they would choose one brand versus another and it is providing us great parameters for moving forward. Hard to go into more detail than that. And it's going to help us significantly in '06.

On that first point that you mentioned consumers more familiar than maybe you would have appreciated a few years ago. Is that suggesting there's more differentiation than maybe what we in the investment community perceive in the major brands?

Consumers without question have very clear perceptions around each brand. They can play back the signature equities of each brand. I'm Mott talking menu. One big step back talk about how they perceive brands and what they would associate with each brand and it is, yes, Peter. It would suggest exactly what you said.

Okay. And then lastly with nearly half of your units ten years old or older, are you folks taking another look as far as what role remodels will play as far as keeping the brand relevant to the consumer?

Peter, this is Dave. As you recall because I think you were with us when we were inside a couple of new prototypes. We went 18 months ago or so when we took a fresh look to remodel and prototype. We did allow our franchises and company operations to pause just a second as we got that right.

Since then we've come out the other side with accelerated pace with remodels on the remodel and franchise side. The most important point you're making here we are mindful of with an aging portfolio whether it's a full-blown remodel or prototype look or very disciplined approach around refreshing, we're going to continue to keep that way up top on the radar screen here. We've had really good system compliance around that.

Thanks a lot.

Operator, let's take two more questions.

Certainly. Our next question comes from Steven Kron of Goldman Sachs.

Thanks. I had a question on the expense side a bit and what you can do to manage costs over the next couple of quarters. You mentioned on the utility side trying to contract for energy. What the assumption you have baked in greater than 5 basis point increase in energy cost for you in the fourth quarter and secondly on the labor front. If traffic remains challenging over the couple of quarters anything you could do to manage that cost a little more efficiently?

On the energy front it's anybody's guess. I'll offer one and we'll both be wrong. When I said the combined more than 75 that's just looking at what's happening with the trends. Overblown at this point and that's not necessarily bad because ink we're all protecting the down side here but we don't know.

With regard to labor, labor is a slippery slope within the four walls especially if you send a signal to the GM's that you want to focus on cutting the floor. We want to take care of our guests coming into our restaurant. Have we got some opportunities at the margin of the business, we do, we're not going to do things like increase number of tables, change up our service model, decrease cooks on the line. Short staff restaurants. Put inexperienced managers and new openings, we're not going to go there. However on the G&A front on the corporate overhead front we are very serious about managing costs there. We've got opportunities and we'll continue to pursue those vigorously.

Thanks.

Our final question comes from Jeff Omohundro of Wachovia securities.

Thanks. Just one, just curious about Weight Watchers, where you stand on that now and how that might fit in with this digitation strategy since it is one of the unique things part of Applebee's now.

Hey, Jeff. That is absolutely one of our points of difference. It's exclusive. We talked about the occasion that is very prompt today in consumers minds which is health and we've talked to you before about the fact that candidly we believe it's undeleveraged. It will be a primary component of our strategy moving forward.

Very good. Thanks.

Thank you, Jeff.

Operator, thanks and thanks everyone for joining us and we look forward to speaking with you in February.

Thank you.

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.