Dine Brands Global Inc (DIN) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your first-quarter 2006 earnings release conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Carol DiRaimo.

Good morning and thank you for joining us this morning. I would like to note that this call is being broadcast simultaneously over the Internet. A couple of calendar items to note. Due to the Memorial Day holiday comparable sales for our May fiscal period are going to be released on May 31st. And second-quarter 2006 earnings are scheduled to be released on Wednesday, July 26th after the market close with our quarterly conference call on Thursday morning, July 27th at 11 AM Eastern Time. June and July comparable sales results will be included in our second-quarter earnings release.

Many of the statements we're about to make with respect to our business outlook, including comparable sales increases, costs, earnings per share growth and new restaurant development, are forward-looking and based on current expectations. There are several risks 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 franchisees to open and operate additional restaurants profitably; the ability of our franchisees to obtain financing; the continued growth of our franchisees; and our ability to attract and retain qualified franchisees.

The impact of intense competition in the casual dining segment of the restaurant industry and our ability to control restaurant operating costs which are impacted by market changes, minimum wage and other employment laws, food cost and inflation. You should refer review our Form 10-K for the fiscal year ended December 25, 2005 for important information about factors that could cause actual results or events to be materially different.

With me today are Lloyd Hill, our CEO; Dave Goebel, our President and COO; Steve Lumpkin, our CFO; John Cywinski, our Chief Marketing Officer; and Stan Sword, our Chief People Officer. And with that I'm going to turn it over to Lloyd.

Thanks, Carol. Good morning, everyone. We appreciate joining us this morning. A couple of very brief comments on my part as we start the call this morning. First, I've got to tell you that I am really excited with the progress that we're making against our strategies and our initiatives, specifically our food initiatives. And you're going to hear more about that from Dave and John in just a moment.

But then I'll tell you, I'd be less than candid if I did not add that -- and for all of the macro factors that you've already heard -- if I did not add the consumer behavior right now and its predictability is -- well, at best it's a little more difficult to read. Having said that, I will also say that this team stands accountable for figuring it out and for delivering on our commitment.

Lastly, my succession plan is on track and I anticipate recommending to the Board sometime this summer that Dave Goebel succeed me as CEO as I move to the nonexecutive chairman's role. Dave, over to you.

Thanks, Lloyd. Good morning, everybody. In my remarks this morning I'm going to add some color to the issues surrounding the current sales softness, elaborate a little bit on our current initiatives that are designed to drive top line, and address our balance of the year expectations. We intend to be brief here so we can get to Q&A so we can address the questions and the issues that are on your minds.

Following a tough fourth quarter with Company traffic in the down 4.5 to 5 range and system comps around a plus 1, we were encouraged to see the weather-adjusted traffic in January and February improve slightly to down 3 and system comps in the plus 3 to 4 range. Now Easter adjusted March/April traffic returned, as you see, to the 5 to 5.5 down range with system comps back to the plus 1 range. As we've signaled previously, we really weren't looking for a lot of traction from our food and advertising initiative until early to mid Q2. However, we hoped we'd hold on to some of that moderate improvement we saw in Q1 and in March and April we did not.

And our intuition is that once again we got some lift from our three course combo value campaign in January and in early February, but we were unable to sustain that momentum with Shrimp Sensation in our new creative in March. We also began, as you've seen, to see gas prices and other macroeconomic conditions rear their ugly heads as we, again, got to about mid-March. And although we had a lot of preference and good feedback from our guests around Shrimp Sensations and the quality of that food, it wasn't successful in driving traffic to the levels that we had anticipated.

Let's take this apart a little bit on a regional basis. Regionally our strongest company markets for the quarter and now year-to-date through April are Texas, California, Washington D.C., New Mexico and Nevada where comp sales range from up 2.5 to up 6.5%. Our weakest company markets are Michigan and New England in the down 2 to 2.5 range year-to-date worsening to down 5 to 7 range in April. Virginia has surfaced here in '06 as a troubled market, down approximately 2% year-to-date and approximately 4.5 in April.

To take it apart by daypart, by daypart our bright spot is late-night as we see good guest response and traction from our beverage and value initiative and it's driving positive traffic comps at that daypart. Lunch and dinner traffic are both down in the dining room and at Car Side, and a note that lunch seems to be holding up a little better in April than dinner did.

There's no question that our lower to middle income guest is getting pinched again and either reducing visit frequency or temporarily stepping back out of casual dining. Our own proprietary metrics -- and let me refer to those. We've talked about our segmentation study of last year where we were following 20,000 consumers. We continue now to follow 10,000 of those guests several times this year as a follow-up to that segmentation. And our most recent snapshot tells us that 5% of the casual dining guests have simply left the casual dining space recently.

Now with that said, let's move to the positive front. As Lloyd said, we're very excited about the progress and news that's coming out of our culinary center. Our team has been very hard at work on the other side of these learnings from that '05 segmentation study and the first of this higher quality, higher flavor profile food is coming out of the pipeline with this current campaign that began this week, Steakhouse Inspirations.

Our culinary team, training team, company and franchise operators are focused and they're ready to demonstrate to our guests that something very different is going on in the kitchen at Applebee's. Roasted garlic and asiago chicken with fresh tomatoes and basil, sirloin steak and lump crab cakes with a tangy remoulade sauce, and our bistro sirloin sandwich on rosemary chiabata bread and grilled red onion and roasted garlic cheese sauce. These are just some of the items that you see on our menu this week.

And it gets better from here in our subsequent campaigns this year. We're going to give these heavy users and equally, if not more importantly, the previously light and median user of Applebee's -- those that are looking for higher quality, flavor profile and better taste -- many reasons to increase the frequency of their visits to Applebee's. And in a moment John will share our plans to drive them to our restaurant with better advertising that breaks through the media clutter in a positive way.

On the people front, we're fresh off our annual GM conference and just last week a full franchise business meeting where we shared the balance of the year food news and conducted some great hard-hitting workshops focusing on the training and execution of delivering new food at the restaurant level. In company restaurants for Q1, both our general managers and associate manager turnover have continued the steady improvement we saw in '05, but we're mindful in this tough environment that good people always have options. So we're dialed in to keeping our people close, communicating well and often with them, and accelerating their development through greater capacity at our Applebee's Leadership Institute.

As far as our business outlook for the remainder of 2006, we're reiterating our expectation to open approximately 120 new restaurants, that's made up of 40 company and 80 franchise. We believe our current initiatives, particularly around food and advertising, will support systemwide comp sales in the 2 to 3% range for the full year.

Finally, in a moment Steve will address a number of items including the P&L and balance sheet, but overall we expect margins to be similar to 2005, dependent of course on comp sales at company restaurants. EPS is expected to be in the range of $1.26 to $1.30, that's excluding the impairment charges which include the impact of about $0.17 on the stock-based compensation expense. So with that I'm going to turn it over to you, John.

Thanks, Dave, and good morning, everyone. I'd like to share some thoughts on why this team remains optimistic in this tough environment. Let's start with our food strategy where our goal is to become more relevant among all CDR users. This strategy will unfold throughout year as we fixate on favorable new products within each promotional campaign. Specifically we plan to elevate taste and quality perceptions of Applebee's food and to differentiate on food versus our direct competitors.

We'll no longer be satisfied with simply being as good as the others on these key attributes. We really need to win on food taste and quality and that certainly won't happen overnight. We'll tackle this mission methodically, one product at a time. We'll focus on products that have a unique credibility factor and might even be a little unexpected at Applebee's. And we'll work hard to maximize trial of these higher quality products. And most importantly, we'll immediately move these new items to our core menu. In effect this will eliminate the old paradigm that we've had of a predictable twice-a-year menu change in favor of a continuous pipeline of new product news throughout the year.

As Dave mentioned, we started this week with our new Steakhouse Inspirations. It's an event designed to leverage those special family occasions where we celebrate moms, dads and grads at Applebee's. In addition to this advertised campaign we have also added several new products to the menu. These products include three of our absolute guest favorites from some earlier promotions -- the Three Cheese Chicken Penne, the Grilled Shrimp and Spinach Salad, and the Raspberry Cheesecake Rapture.

You'll also find several other homerun items such as our Sizzling Ribeye, the new Quesadilla Burger, the new Fire Roasted Shrimp Skillet, our new Pecan Crusted Chicken Salad, Weight Watchers' new Southwest Cobb Salad and Cajun Lime Tilapia and, last but certainly not least, Applebee's new Dreamsicle Cake dessert.

So along with Steakhouse, these products are going to start us down the road to significantly better taste and quality at Applebee's. And following Steakhouse you'll see us become progressively more ambitious with an accelerated pipeline of product news within each promotional window.

Now let's shift gears and talk about advertising. In the summer of '05 it became clear to us that the CDR space had become cluttered, blurred and undifferentiated in many, many respects, especially the bar and grill category. We decided it was time to change not only our food strategy but our advertising approach as well. Along with our franchise partners we established very clear strategic parameters to guide our development.

Our top priority is to be different with a really compelling and proprietary idea, to bust through all that restaurant clutter, not just CDR clutter, and to engage the audience in a unique and memorable way. Our number two priority is to instill a youthful spirit in our brand while maintaining maximum appeal across our wide-ranging demographics. We also set out to create advertising that makes people smile, to be likable and to have fun and, frankly, not to take ourselves too seriously which, after all is consistent with the personality of the Applebee's brand.

And finally, we clearly expect our new advertising campaign to drive incremental growth on a sustained basis. With these parameters in place we developed the Applebee's Guys concept and decided to launch on March 6th behind shrimp sensations. Now we know that the combination of the Shrimp and the Guys did not change our negative traffic trend, but we also know from extensive consumer work that we have a terrific idea on our hands that is extremely well received by our guests. As with any new ad campaign, it will evolve and it will get better with each execution just as our food and music campaign did when we launched it about four years ago in '02.

So in closing, we remain confident in our strategies and we will do whatever is necessary to regain our momentum in this tough environment. With that I'll turn it to Steve.

Great, John, thank you. Thanks, everybody, this morning. We know this is a very busy week and especially compressed day for all of you. So we're going to quickly go through some numbers here and then get to Q&A.

First, as to company sales, company sales were up 13.8% to $308 million. That was the capacity growth of 14% as we opened 48 company restaurants in the last 12 months. Now when you take away the seven stores we opened -- reopened in Memphis, that represents an organic unit growth rate of about 9%. In addition, the Memphis, Ozark and Houston acquisitions contributed approximately 5% to this capacity growth. These increases in capacity were offset by a 2/10 decline in average weekly sales or A-list as compared to a comp increase of 1.2% during the quarter. This gap is essentially equal to what we saw in Q4, slightly improved however and is due primarily to company openings in the Midwest and New England, the same markets that continue to see some broad economic pressure. It's important to note that we saw no gap in comp versus A-List on franchise front.

Now franchise royalties and fees, those were up 8.9% to nearly $36 million driven by an increase in franchise A-lists of 3.2% with 99 openings in the last 12 months. That's normalized capacity growth of about 8% of course excluding the impact of the franchise acquisitions we've made. Other franchise income totaled $400,000. This was lower than the $1.1 million in Q1 of last year as we got out of the insurance captive business in the fourth quarter of last year. The difference between other franchise income versus expense of 312,000 is due to an additional $0.5 million we recorded in the quarter to increase our reserves for estimated insurance losses incurred by franchise participants in our prior captive. We believe we're adequately reserved for the exposures that carry forward from our terminated captive, but the tail on these franchise claims is just a little more uncertain. I think we're in good shape now.

Total revenues were $344.3 million, that's up 13% during the quarter. Systemwide sales up nearly 10% driven by A-List growth of 2.1 and net capacity growth of approximately 8% with 147 new restaurants opened in the last 12 months, that's a lot of openings. Net income was $27.2 million this quarter versus $31.7 million last year. Now when you exclude the impairment charge and other restaurant closure charges and then add bag the stock-based compensation net income was $32.2 million here in the quarter. Diluted EPS came in at $0.36 versus $0.38 last year. And excluding those same items, impairment and stock comp, diluted EPS came in at $0.43 here in the quarter.

Now quickly some highlights on the P&L. Restaurant margin came then at 14.8, that was down 130 basis points. That's less of a decline we've seen in the last couple of quarters, I think we're happy with that. Drilling down into it, food costs came in at 26.7, a slight increase of 20 basis points from last year. Menu price increases were essentially offset by some higher costs associated with our beverage initiative which includes our late-night value strategy. The roll out of this initiative continues into the second quarter here.

Labor came in flat at 32.8, no real change. Hourly labor was up about 20 basis points due to minimum wage increases in the state of Minnesota where we've got a big footprint. Overall hourly wage rates were up 2.3%. Management and labor was down 35 basis points due to a decrease in store level bonus which was offset by a 2.9% increase in management wage rates. Payroll-related costs accounted for the remaining 15 basis points due largely to taxes on higher tip reporting.

Now D&O -- D&O came in overall at 25.6, that was up 110 basis points, the biggest mover there has been consistently, again, utilities. Utilities were up 60 basis points -- a little bit lower rate than we've been experiencing, nonetheless still in our numbers. Higher depreciation expense of 40 basis points and higher packaging costs of 10. So advertising was flat year-over-year there on the D&O line.

G&A came in at 10.3, now of course that's up 150 basis points from prior year because we booked a lot of the stock-based compensation on that line -- essentially all of it, had a little bit that hit the field, not really anything to talk about however. Excluding the stock-based comp G&A was down 10 basis points quarter over quarter.

Impairment charge -- we did take an impairment charge here of $1.6 million pretax during the quarter and other -- this results in impairment of two new stores as well as closures, closure cost to reflect the write-down of the carrying value of property from two restaurants we impaired last year. These are primarily related to lease obligations. This resulted in an after-tax EPS hit of over a penny.

Interest expense was up 60 basis points due to increased borrowings on our facility from stock repurchase, the Houston acquisition, our increased divi and routine CapEx in the quarter. As we said in our release, we've got about $30 million capacity remaining on our revolver which isn't a huge number. The tax rate came in at 33.6 for the quarter. This first-quarter tax rate was lower than expected due to the resolution -- a favorable resolution of a tax state matter and higher hourly employment tax credits as we mentioned.

Quickly, a couple things here on the balance sheet. Debt was up $19.4 million from year end '05 due to stock repurchase, the Houston acquisition, our divi and reaching CapEx. Debt to cap came in at 31.7 at the quarter as we continue to show we're not adverse to putting a little more leverage on the sheet. We're comfortable with more leverage beyond this level.

Shares at the end of the quarter, 74.5 million. Share repurchase now -- in the quarter we bought back $5.2 million of stock at an average price of $23.70. We had approximately $124 million remaining under our current Board authorization. As I've said before, you really shouldn't expect us to repeat our '05 stock repurchase performance here in '06. We want to reinforce our commitment to enhancing shareholder value through increases in the divi as well as use of stock buyback.

Now I'm going to hit a little bit of guidance here for the remainder of the year for sake of your time. I won't repeat everything, I'll hit a couple things that you've likely got questions on. Commodities now continue to be favorable, although we expect some of the improvement may be offset somewhat by higher packaging and fuel surcharges, we'll have to see what happens with diesel fuel. It's not encouraging what's happening and we'll see what happens here in the coming quarter.

We also have the potential to see some pressure on food cost as we get deeper into our food and value strategy depending on pricing decisions and mix. This should become more visible in latter parts of the next quarter. Labor, continued increases in minimum wages in several states -- Michigan is next on the list with minimum wages and we could see pressure at this line.

Pricing, we took a modest price increase of 1.5% here with our new menu as we rolled off last year's price increase. We now have got 2.5% pricing in our numbers on a go forward basis. We think that's modest given the environment and against what other people in the space are doing. Lastly, despite a lower tax rate and our strong Q1 EPS performance, we did not increase full-year EPS guidance as we prefer to remain cautious given the weak consumer environment. That's the end of our prepared remarks. Operator, let's open it up for Q&A.

(OPERATOR INSTRUCTIONS). Jeff Omohundro.

I wonder if you could talk to us a little bit more about the new media campaign. Any learnings from the first round going into the second round supporting the Stake Sensations. And then also, I think you said that your lunch is holding up. That's a little bit different from what we're hearing from some companies. Maybe you can elaborate on what you might be doing around that.

Jeff, this is Dave. I'll take the second half of that first and then turn it back to John to address the question around the new campaign. In my remarks lunch held up a little bit better than dinner. I want to be clear, when I say 'holding up' it doesn't mean we're in a positive trend there. I also would reiterate that we've seen traffic down at lunch. It simply was a little more favorable than we saw during the dinner meal period. So that's basically --

it's a relative comment on lunch versus dinner.

Absolutely.

Okay.

Jeff, this is John. Was your question regarding the food itself of the advertising?

I guess a little bit of both. It seems like the Steak Sensations campaign, at least to me, is a little bit more food focused in the media?

I think that's safe to say. We did learn some things certainly on the advertising front with our first execution. Steak is also a -- it's a more newsworthy program for us. Frankly the shrimp program didn't have a great deal of news. This is the start of our new strategy and from an advertising standpoint we had a lot of consumer insight around that first execution in shrimp and we applied that with -- actually we have two executions out there behind Steak, one that's on the website; we have another on that has a Car Side reference that has a completely different set of lyrics and an equal amount of food romance in it. So we look forward to getting your thoughts on that one as well.

Jeff, it's Steve. Just quickly, the Shrimp Sensations campaign was never really designed to be a look-alike liked steak is. And we made a decision to implement the Guys in that campaign and we could have easily done it just with steak. We wanted to get some consumer learning around it. So I'd say, A, the shrimp wasn't designed under the new food manner. It did have the new media approach and we know we have a lot of weight over the NCAA. There's good learning there and I think what you see here in steak is a nice evolution and it's going to continue.

Great, thanks. It's good to see the food more the focus.

We would agree. Thanks, Jeff.

Joe Buckley.

Just a question on some of the new menu items. I know that you've been trying to speed up the food development process, how have these items been tested in markets versus what you might have done previously?

Joe, this is John. We have a pretty thorough validation process and it's a little bit of art, it's a little bit of science, but certainly concept screeners with initial concepts. We then move to focus groups where people actually eat these products with a lot of repetition and geographically dispersed markets. And then depending on how overwhelming that response is we go to market and put these in several restaurants. So it's those three steps and we have attempted to take out some of that process timeline along the way. And we're certainly using that integrated menu as well that you've been seeing in test markets.

Joe, this is Dave. To John's point, there are certain parts of this process that we'll never compromise. John mentioned concept screener, focus groups, some in market work where we get [option] shakedown. The acceleration of timing, to John's point, will come -- if intuitively and based on responses coming out of those three pieces we could potentially have less breadth or potentially shortened cycle time in market, but there are certain hurdles that we're never going to give up on. We're certainly always going to ensure that those pieces of that process remain in place.

And then just a question -- I guess consumer environment is a big question on everybody's mind. But your April versus March numbers actually looked very comparable adjusting for the holidays, despite gasoline prices going up pretty significantly. Any read into that, is that somewhat reassuring or too short of a time frame to make a judgment on or just your thoughts?

Joe, it's Steve. Good morning. Thanks for making the call, Joe. I know you're busy. I think on the consumer environment, we think it's so early and it looks like there's going to be some volatility here with gas prices certainly on the upside, saw $4.00 gas on the East Coast this week. And I think the case has got to bake a little bit on what's going to happen.

I know some management teams have talked about several dueling forces here -- interest rates, gas prices. I think that has yet to be baked in the cake. There's reason to be cautious. I think when we look at sequentially and we kind of wash the two months together, considering that we didn't really have our new food news and we really have the one initiative we had running and working successfully which was our late-night and beverage value initiative which we're very pleased with, we feel like we kind of held our own here.

But I think we've got that the proof's going to be in the pudding. Especially in the next three to four months it's going to be important. When you look at New England, I think we'll start to be a little more optimistic when New England starts to perhaps comp a little more positively. I think Malcolm's own numbers would suggest New England continues to be weak. And we've got a pretty big footprint there.

So I think, Joe, not trying to talk out of both sides of my mouth, I think the proof is in the pudding, we see how Steakhouse works -- our next promotion, which all the food we've eaten is in our view going to be even more exciting, it's going to have some nice stuff in it. We're excited about when we eat this food we have to see how the consumer reacts to it though.

Just one more. The late-night and beverage value initiative, is that half priced appetizers after a certain hour or is there -- I've seen that in a number of markets or is it something more substantial than that?

Joe, this is Dave. It's really a combination of things. In a number of markets you will find the half price appetizers after 9:00 PM along with some discounted draft and beer. But if you recall from our earlier conversations, when we talked about the food side of our business and we talked about strategy going forward where we said that new food at potentially higher price points could live side-by-side with our traditional value approach in food, pretty much the same thing applies here on beverage.

So where we see some late-night value initiative brought by late half price apps, some perhaps discounted beer, simultaneously with the beverage initiative we've introduced a new level of quality around glassware, selection of drinks, the introduction of smoothies, the introduction of energy drinks -- so we're taking very much the same strategy where you have attractive value price point living side by side at late-night with some improvement in the beverage initiative as well. It's a nice combination.

Okay, thank you.

John Glass.

At the risk of being a little bit politically incorrect, I do want to go back and challenge your comments about the recent environment. Your traffic has been negative since the third quarter of '04 and others have as well in this category. So I'm wondering, does this cause or at what point does this cause more introspection about the industry rather than the macroenvironment?

Maybe it's supply growth, maybe it's some other elements -- competitive elements in the industry. And I guess if you look at industry data that you probably have better than I do, how long have you seen the traffic -- the negative in the category? And if you have total sales volume numbers for casual dining, what have those trended for in the last few quarters?

John, it's Steve. We like a good politically incorrect question, okay? I don't think this management team -- please don't take in our comments from our last question as saying well gee, we're happy with down 5 on traffic. Nobody is happy with down 5 on traffic. I think what it signals, though, we've had a persistent down 4 to down 5 and you're absolutely correct. I think the point we're trying to make is in that period we really had none of our initiatives working other than late-night value. And if anything when we look forward our hope is that by some of our own hard work here we can start to pull that up.

I think it's hard to look at people's numbers that are reporting here -- I mean just go down the list. Aside from a few names in casual dining, people aren't reporting healthy traffic numbers. So John, I'm going to be more in agreement with you that I think our own research, as Dave said, our own panel tracker has shown 5% of the people that were in casual dining have left the space. And that down 5 on traffic is a pretty consistent number across many names in the category.

So I think while we're not trying to make an industry call here -- because we've got our own research, we can only look at our own numbers -- I think it's looking more like the consumer has a persistent inability to react favorably to what's happening in casual dining and certainly the quick service guys are as good or better than they've ever been. There's a lot of promotional activity with quick service and a lot of trading down. So I don't disagree violently with what you had to say.

Okay. I guess just maybe a more topical then. When you look at your current campaign, how do you make sure you can continue to connect with value customers as you push the food upscale and use things like Asiago and words that maybe they haven't typically heard or eaten before? Do you need a couple of separate messages at once to appeal to those core customers while bringing in new or can you do it all in just one campaign?

John, this is John. We want to make sure that we've got a multitude of products at different price points. So you will see this as we move forward. You'll see some high-end new products, you'll see some low-end new products. It's very important to us to pay attention to that lower end income guest. And we've also, as Dave mentioned -- we've looked at some value initiatives specifically designed for that guest in a number of test markets. As to whether we pull the trigger on those -- don't know -- but we can accommodate both the high- and the low-end guest with kind of a dual strategy on the menu front moving forward.

And many of these ingredients I think our own research would suggest that the "low-end guest" is very familiar with many of these ingredients. So we wouldn't be -- from an ingredients standpoint, we wouldn't be pushing the edge because we think things like Asiago are well-known much like balsamic vinaigrette and has become much more well-known.

Thank you.

John Ivankoe.

As you all look at the overall development picture, both for Applebee's and casual dining -- certainly I think you and a lot of other companies are considering '07 plans as you're presumably signing deals now for 2007. Maybe it's you, Steve, that could comment. Just in terms of what you're seeing out there in terms of deals that are getting done or aren't getting done, what you're seeing in terms of construction costs and what is the right way for a lot of us to think about supply growth across the overall industry going forward based on what your experiences may be in the market? Thanks.

A couple things. We said on the last call and I continue to believe that '07 is going to be an inflection point for a lot of the names in casual dining to be talking about doing less development. And I think it's just a natural byproduct of the lead time it takes to get projects done and how much costs have run. I'd say our team is being much more, if you will, stingy on approving sites in the '07 time frame than we've ever been just based on what's happening in the macroenvironment. I think you have to be.

And so, I won't make a comment on how that translates into an '07 expectation for us, but I think clearly we're going to see -- '07 I think you're going to see supply moderate for casual dining in a way that we haven't seen in a while. And that probably becomes more visible towards the end of the year. We haven't seen a situation where construction costs or land prices are coming down. I think the sale leaseback market remains somewhat frothy even though on the ten-year here we've taken almost 60 basis points on the ten-year which is compressing some returns, but the hard asset buyer is still out there, still driving prices.

So I don't think that's likely going to go the other way. With that being said, our franchisees continue to see opportunities. We continue to approve franchise sites at a pretty good clip and markets, especially on the coast. So I think we're cautiously optimistic for '07 in total for the system, international pipeline is very strong. We'll open at least 16 stores internationally this year and more next year. So I think, John, in total the picture for '07, cautiously optimistic but with the Company being much more thoughtful about how we approve things. Dave, I don't know if you've got a comment or not.

Yes. John, I would possibly add to that. I think in this environment it's probably helped us become better developers. Last year we made a conscious decision to undertake a mix shift in terms of geographic approach to where we would develop based on the environment that we saw across the United States. You heard in my comments earlier that our strongest market we're seeing 2.5 to 6% positive comps. And that mix shift strategy we're going to continue to employ, not only here through '06 but as we look to the pipeline in '07.

And I think the last piece to reiterate is to Steve's point -- we have become even more diligent in our approval through our site selection committee. So I think in an interesting sort of way it's made us better developers.

Okay, thanks. If I may on a slightly different topic or a completely different topic -- a number of your competitors that own their whole systems, that own their brand, had to use price point advertising with some being very effective, some not so effective. Could you comment on what the franchise community has told you in terms of using price point advertising to possibly communicate a consistent value message nationally?

John, this is John. We've certainly had those discussions; we're aware of the competitive landscape in terms of nationally advertised price points, price points that you see in print and locally advertised. And we have complete alignment around, where it's appropriate, to use that type of tactic and where it's not. And without revealing that from a competitive standpoint, we look at the value equation maybe in a broader sense.

We understand price break -- given demographic is important, but the entire experience is probably something that we're a bit more focused on. That's why you're seeing new food, a fixation on our service level, the execution of that food in the restaurants all at a fair price. And again, you can look at some of our test markets to see how we've applied price from a strategic standpoint behind some of our initiatives.

Okay, very good. Thank you.

Andrew Barish.

A quick question on the advertising layout for this year? It sounds like the weights were heavy in the first quarter and just kind of tying that in to ad spend. Any differences of note year-over-year as we move through the rest of the year?

Andy, this is John, good morning. We certainly had an investment in the Olympics in the first quarter. That is -- obviously is going to skew things. Other than that we have a pretty consistent approach on a quarterly basis.

Thanks.

Robert Derrington.

I'm not sure who to direct this question to; it's kind of a couple part question. Looking at -- let's start with you, Steve, we'll pick on you. Looking at the product plan as you've got new products rolling out. It seems as though there are a number of items that have a little bit higher price point than is traditional for your brand. And so I'm just trying to be thoughtful as we look at cost of sales and the relationship to those prices. Should we expect that cost of sales likely will drift up even though the penny profit on some of these items might be better than traditional items?

Bob, I think if you look -- if you pull out the Steakhouse Sensation menu, we're promoting a sizzling ribeye, in most markets that sizzling ribeye is going to be priced at $14.99. I don't think at that level we're not doing -- that's not causing us to have our food costs go up unless we have a tremendous mix to that. I think our Bistro Sirloin Sandwich is priced -- it's very effectively priced from a food cost perspective.

I think this menu doesn't necessarily worry us about food costs, Bob, but we've got a bunch of other stuff coming. And we might -- as I said in my remarks, we might have a situation depending on how we price it, depending on how we promote it, but we're not -- I think all that's in really our guidance for the year. We're not highlighting from a guidance standpoint that our constituents should expect big aberrations from us. Until you, however, get this in all your stores and put media behind it you don't know how it's going to mix.

I'm just trying to understand how the menu mix effect of your business will vary as we go forward? Should we expect that menu mix could add a little bit more to the overall same-store sales number based on the product profile going out?

I don't know, Bob, that's a possibility. We've got a pretty healthy mix right now in our numbers given pricing. So if we get a higher income, light user of Applebee's heavy user of the category and they come in and try these products and a lot of people try them and they like them, you could see it. So I think that has yet to be seen, Bob.

And then the second -- last piece, if we look at what's going on with some of the key commodities -- particularly poultry, particularly beef, pork -- Steve, all those look awfully attractive I think versus what some of us had expected previously. Is there a chance that the Company could actually float down some of its contracts later in the year?

Bob, we redid our chicken deal in January, it's a two-year deal. And if you're spot market buyers it's a nice market to be in. We're not a spot market buyer on stuff. Our steak and our chicken is locked. And so I wouldn't anticipate a big opportunity for us on the down side just because our contracts are what they are. But we'll be opportunistic in taking advantage of when we could perhaps do some sourcing, look at different suppliers, shift mix, but I don't want to forecast too much of an upside there for you. I will say, however, it's favorable.

Last thing. How should we look at fuel surcharges possibly affecting cost of sales?

Given the best crystal ball that anybody has got on diesel fuel -- I mean diesel fuel never really came back down. And so I think, Bob, right now it's probably going to be more of a persistent part of our P&L going forward if these fuel charges -- diesel costs continue to go up. So I don't think it's something that gets better, it potentially could get worse from here. How's that for a definite answer?

We'll try and model it.

Peter Oakes.

Good morning. On the marketing front, John, you reminded us that you want to differentiate on taste and quality measures. And with the menu that you've just unveiled and obviously your enthusiasm going forward, it seems like the taste is being elevated and it's communicated to the consumer. I'm curious if there's anything that you're sharing either -- comes across in the marketing message or maybe more subliminally, trying to communicate to the consumer that indeed you are improving the quality of the ingredients going into the food equation there.

Good question, Peter. Certainly the copy we right or the lyrics that you hear will punctuate some of the quality ingredients. So there will be a bit of a fixation on that. You'll certainly pick that up in a 60 second radio spot where we've got more time to talk to it. You'll also see that as we embellish some of these unique products and ingredients on our menus directly. You'll see more photography, you'll see embellished copy.

And so I guess the final point there is as you go into a restaurant it's our expectation that our entire organization will be better at articulating what's new at Applebee's, what's great at Applebee's and our food culture, which has been terrific in the past, is going to accelerate in terms of our ability to engage in particular that light and medium user. So there are little things that we're going to do and it's not all about the television advertising. Much of that is about the menu and the in restaurant experience.

Peter, this is Dave. Related to that in restaurant experience we've certainly seen time and time again, as we reprint menus and we move around on the menu those things that we opt to photograph, that the guest always moves towards that. And clearly the guest eats with their eyes. So as we have the opportunity to bring these new items forward and highlight some of these ingredients through photography, that will certainly be another way to have them lean in that direction.

Operationally is the system emphasizing more upselling or showcasing the new items even more than you might have in the past?

Peter, we will direct -- we want people to try these new products. So we'll have a greater emphasis on directing folks to not only the promotional products but very specifically the couple of items that we'll migrate onto the core menu. In the initial seven to eight week trial period we want to maximize trial. We wanted to get those products in their mouths, then we'll move into the core menu. And as you know, perceptual change comes very slowly over time. So it's going to be easier for us to change and elevate those perceptions if people are trying the products.

Peter, this is Dave. I think potentially related to will there be some upsell -- emphasis on upsell. With this new food the training is awfully comprehensive. It begins with our regional food shows that we do in market, our preshift rollouts and now some ongoing really first-class DVD training. And this is really all about educating our servers. For instance, over the past couple of weeks, as we prepared for the rollout of Steakhouse Inspirations we wanted to be absolutely certain that when a guest would look to one of our servers to say it's either been a while or I've not had a crab cake, can you talk to me about that crab cake, that the server is in a position to do a wonderful job talking about that food. And that certainly could translate to some upsell.

Okay, good. The 5% commentary that you made about casual dining guests have left the space, that's not necessarily referencing -- or I should say is it referencing just the last few weeks or even the last month or so with the elevated consumer anxieties? Or is that something that relates to year-to-year type phenomenon?

In terms of the timing, we referred to this tracking panel, Peter, and the last read we got on that tracking panel is really within the last month to six weeks. So we'll do that panel three or four times a year and that reference to the 5% guests that left the casual dining space is very recent.

Okay, all right. And then lastly, again, in the context of the consumer environment where we are, does that prompt you to think about Applebee's anywhere maybe a little more aggressively given that that customer is probably price sensitive? Or is this just kind of more of a master plan that you're still evolving that really don't have the ability to step on the pedal that fast?

We had mentioned in previous conversations that a lot of the catalysts for Applebee's anywhere was really meant to be a convenience and an improvement for the people who were doing bulk Car Side with numerous items to simplify packaging, make it easier for the pharmaceutical rep and so forth. It's out there as a convenience. There will be trade areas where general managers and multiunit will maximize that opportunity. But for focus purposes we're going to stay after being sure we execute this new food. And so we're not going to be putting additional attention right now on Applebee's anywhere other than to make it convenient for the people that need that convenience.

Okay, good.

Steven Kron.

Just a couple of follow-ups actually. In light of your comments on the development front, I just wanted to go back to that. To the extent that you or maybe your franchisees are opening new units in existing markets. Can you just talk maybe if there's been any recent change in the average weekly sales of the established restaurant in those regions. Are you seeing greater cannibalization in the context of your comments about supply growth in the industry?

We are not seeing greater cannibalization that we're reading that's significant. I think the Company estate is on a relative basis more penetrated than the franchise community is. On the franchise side you've been no gap in comp versus A-List so the non-comp base is performing well with franchisees. You've seen a little gap on the Company side, but that's actually sequentially gotten better. 140 basis point gap here in the quarter has improved over 170 basis points.

So I think Steve that's something we're looking at. We're -- I think it's the classic marketshare versus cannibalization. We've been a marketshare driven company, however, in an environment where your returns are getting compressed we're much more thoughtful when we've got a new store that's going to impact an existing store. And I think as compared to perhaps a couple years ago, our attitude is much less forgiving on cannibalization in the current environment.

Okay. And then the next question I have is just follow-ups on the late-night strategy. Can you talk -- I think you mentioned additional costs in the second quarter. I don't know if they're material or not. Can you just kind of quantify that? Maybe -- you seem to be getting traction there, maybe quantifying the sales list that you've been seeing from that initiative in the stores and remind us how many stores across the system are currently doing this?

A lot of questions there. Just, Steven -- the comment on cost was really more about a lot of new menu items depending on mix and pricing. We said potentially we could be an impact on cost. I think our late-night initiative has had an increase in bar costs because of some of the pricing action we've been taking. And I think in terms of that daypart, in terms of our beverage component, beverage is about 20% of our sales mix and late-night, which is a little bit less than 10% of our business, has been seeing double-digit comp increases in there really across all markets. We are not totally rolled out yet on our late-night beverage initiative; will be by the end of the second quarter here.

So we are pleased with that. It is a combination of an enhancement, better products and value. So we're really pleased with the [acts] we're getting there; view that as kind of permanent. Now our strategy is to take better food to the dinner daypart that you're seeing here with Steakhouse Inspirations and start to drive that.

Okay, thanks.

Bryan Elliott.

Good morning. Actually, most of them have been asked, but I'm wondering can you tell from your tracking study where those missing 5% are going? Are they eating at home, are they going QSR? Do you have any additional insight?

We do, and I think what we would like to do is probably keep comments today kind of global. I think we have got a lot of money we're spending on this research.

That's fair. How about, is there a wide geographic dispersion? In other words, you've referenced how wide the range of sales success versus less success has been recently. I would assume that that is similar, that you're seeing significantly greater percentage dropouts in the weak markets?

Yes, I think that's fair. Eastern Michigan really pops not surprisingly, recently, as a market where there is a lot of trading down. So yes, I think it is a good overlay to what we are seeing broadly in the industry, both in Malcom's data, other names that are talking about this, and our proprietary tracker. It is all very consistent.

How about within context of that and the earlier comments on development and longer-term, intermediate-term plans, does it make sense to continue to open stores in some of these markets, and/or are you seeing exit accelerate in those markets?

I think we have consciously shifted our mix here, and it's hard to really pull that and get short-term results just given lead time and stuff. I think we have seen some names exit some of these markets, closing stores; not in grill and bar, but in steak, especially one large market in the Upper Midwest.

So I think you'll probably see some of that, but there is still good trade areas with retail assemblages that are happening. You have got to make sure that you can do a good economic deal and get the sales in this environment.

Thank you.

Rachael Rothman.

Hi, this is Oshima. This question was more about pricing. In light of other competitors taking price cuts in certain regions or attributing taking (indiscernible) pricing as an issue, I just wanted to get your thoughts on how you view your pricing competitiveness and pricing strategy going forward, given the traffic trends?

Oshima, I think our pricing has been to kind of lag the category. We have 2.5 points in our pricing right now. That has been very consistent with below where the industry has been, which is north of 3. So I think we're -- we do a lot of research on what kind of pricing you can take. I take your point; I think in this environment given traffic trends, the dynamics in the industry, you have got to be very thoughtful about pricing.

Recently, if you look at some of the NPD (indiscernible) data around check average, you can see that this movement over the last year as we look across our segment, the least amount of check movement from most brands in our space has really come from us. And that suggests the exact point that you are making. We have been on that now for 6 to 12 months, been very thoughtful about how we take pricing and being opportunistic only.

Okay, thank you.

Thanks, everyone, for joining us, and we'll look forward to speaking to you on the road in the next few weeks or on our July conference call.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect and have a wonderful day.