Dine Brands Global Inc (DIN) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Applebee's International third quarter 2006 earnings release conference call. At this time, all participants are in a listen-only mode. Later we'll conduct a question and answer session and instructions will be given at that time. We ask that you please limit yourself to one question and one follow-up so that everyone may have a chance to ask. [OPERATOR INSTRUCTIONS] And as a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Carol DiRaimo, Vice President of Investor Relations. Ms. DiRaimo, you may begin the conference.

Good morning and thank you for joining us today. Just a reminder, this call is being broadcast simultaneously over the internet. A couple of calendar items to note. Comparable sales for our November fiscal period, which ends on November the 19th will be released after market close on Monday, November the 27th due to the Thanksgiving holiday. And our fourth quarter earnings are preliminarily scheduled to be released on Wednesday, February 14th after the market close with our conference call to be held on Thursday morning, February 15th, at 10:00 a.m. Central.

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 costs and inflation. You should review our Form 10-K for 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 Dave Goebel, our Chief Executive Officer, and Steve Lumpkin, our Chief Financial Officer. And with that, I'll turn it over to Dave.

Thank you, Carol, and good morning, everyone. In my remarks this morning, I will review recent sales trends. I'm going to talk about our food and marketing strategies, provide some color on what happened to margins during the quarter and lastly I'd like to address a few questions we've been hearing from the investment community over the past few months.

Now in the just under two months since becoming CEO, we've been particularly focused on crystallizing the brand positioning, the menu strategy and our consumer messaging, and all that is to ensure that our long-term strategies to drive results are aligned. I'm pleased with the progress but we're a long way from where we need to be still. As I reflect on the sales trends, we're encouraged by the improvement in traffic we've seen in the last 90 days. And specifically, that's down from the 5 to 6 range February through July so the down to 2 to 3 range in August, September and October. Now, while the macro environment has provided some consumer relief, we believe that these new food and marketing strategies have driven some improvement as well.

We also believe the October period provides a cleaner read of our performance. As you remember, August results were aided by an FFI drop and September results benefited from the lapping of weak results last year in the aftermath of Hurricane Katrina.

Starting in the October period, we began our new promotion featuring food developed in partnership with celebrity chef Tyler Florence. We believe that this affiliation and this partnership with Tyler can assist us in broadening the appeal of the brand over the long term and attracting the guests that quite frankly may not have been to see us for a while. Guest feedback has been very positive, and we've seen some pretty interesting trends. Response to the new food has been strongest in New England, D.C. and California, and this is perhaps an indication that the food is more relevant to those on the coasts. And also we've seen a substantial uptick in our Weight Watchers sales since the advertising started for this promotion with Tyler. We're looking a little bit more thoroughly into this right now but it certainly could be that this approach and this food is attracting a consumer that's more health conscious, perhaps hasn't been to see us for a while and is driven or attracted by our Weight Watcher lineup once they get inside the menu. We're so pleased with the initial reaction to the new food and under this campaign you can expect to see some Tyler work in our final promotion of the year which will begin in the December period.

Our consumer panel tracking results for Q3 have also shown steady improvement in food perception scores, and this is even pre-Tyler. Specifically, we've seen improvement on the attributes of better tasting food, Applebee's' being my first choice for a certain type of food, and higher quality food. So we feel like we're getting some traction, and I'll remind us again this is pre-Tyler. We knew when we launched this quality food promotion here in C6 that we'd likely be going head to head with many others in the category that were going to be screaming value. We felt it was the right move to make and as we sit here today, we're pleased with that decision. Four weeks into the high part of our high-low strategy, we believe Tyler's created a buzz in the minds of the consumer, and our restaurant staff are also pretty proud of this campaign.

However, these strategies have resulted in some pain to our margins during the quarter as Steve will quantify for you in just a moment. We've been working on infusing an improved culinary culture at the restaurant level. We've incurred some significant additional training costs to do so. Also, as a reminder, we pushed back the launch of the Tyler promotion by one week as a result of the nationwide spinach recall so these training costs hit in our September period. In addition, waste was higher. We studied our research in core menu set and guest order incidents and we made a decision to remove some items and to make room for the Tyler food to reduce complexity in our kitchens and to set us up for success at executing this new food.

In addition to our higher training costs, our labor costs were negatively impacted in the quarter by our decision to modify our restaurant manager bonus program. We did this to acknowledge and reward our managers and our multi-unit operators who were doing a great job with the metrics they can control, but were hurt financially through their bonus program by the macro economic environment. We're committed to retaining our best managers and associates to execute our strategies and to take care of the guests that are still coming to see us. Our turnover remains low but we continue to be mindful that good people always have options. Our total management turnover of 22%, and when I say total, that includes our managers in training, our assistants, our kitchen managers, our GMs. At 22%, it's about 25% lower than the industry average, and our hourly turnover at 88% is about 20% less than the industry average. Of note here, as we sit here today, management turnover in the CDR industry is currently at a six-year high. As long term managers of the business, we know how important it is to retain our best people and we're going to continue to do that.

Bottom line, however, we're not pleased with our margin performance during the quarter and we've taken steps to address these issues. Now, most of you will probably recall when we rolled out Carside and Weight Watchers that we experienced some initial labor inefficiencies. As we suggested, that dissipated relatively quickly. We would expect the same thing to happen again as we periodically make investments in things that will drive long-term results.

From a regional perspective, the good news is that we've seen some significant improvement in traffic over the last quarter in New England, Michigan and the midwest. But eastern Virginia continues to be the most challenging Company market.

By day part, our bright spot continues to be late night. That's our 9:00 P.M. to close time period as we see good guest response and traction from the beverage initiative we've talked to you about before.

Q3 overall comps as we said were down 1.7, but bar was up 2.8, and that is again some sequential improvement in bar over Q2. In terms of the impact on the portfolio, note that late night is comparable to Carside in percent of sales at around 10%. And as forecasted, the rollout of the new bar initiative was completed throughout the system in late June so we had pretty much a full quarter benefit from this program.

Lunch and dinner traffic were both down in the dining room and at Carside with dinner being weaker than lunch in the quarter and accounting for almost all of the comp sales decline. Weekends have also been softer than early week and both of these trends are similar to what we saw in Q2. Now of note, we saw some nice improvement in our dinner trends in October and we believe it's driven by the Tyler promotion which clearly spoke primarily to a dinner guest.

As to our advertising, we're pleased with the improvement in our consumer messaging over the last couple of campaigns, and particularly with the multimedia strategy we used with the Tyler promotion. For those of you who haven't done so, I encourage you, take a peek at the website and you'll see an example of what I'm talking about. The media landscape continues to change and we intend to change with it.

We continue to work closely with our franchise partners. We've just come off meetings last week with our marketing and our kitchen councils. They are very supportive of our current strategies. They are hard-hitting sessions as always and they're also always a powerful, powerful reminder that we're all in this for the long haul together.

Finally, let me address a couple of the issues we've heard questions about from the investment community over the last few months. First, it's the future unit growth. We've been indicating since early summer that we expected 2007 Company growth to be less than 2006 and we've significantly reduced Company unit growth from approximately 35 restaurants this year to 10 to 15 next year. As we continue to apply this very tough filter to the site selection process, it's accurate to say that only the strong sites are surviving. And this short list remaining represents strategically sound decisions in these markets and trade areas [we] will open in '07.

We're also focused on driving improved performance in our existing restaurants and we may step up the amount of capital we allocate to remodels in the next few years so we can provide a more relevant total experience to the guest. As a franchiser, we know it's very important to lead our system by our example and remodels are a perfect example of that.

Secondly, as to the question of refranchising some of our Company stores, we firmly believe that having significant skin in the game is paramount to being a credible franchiser. In terms of our portfolio, we already have the highest franchise ownership in the casual dining segment and we're going to continue to evaluate our portfolio and Company market. And just as we've done historically, when we find a franchisee that can operate a market better than we have, we've sold markets like Long Island, Philadelphia and Atlanta. You are not going to hear us publicly state we intend to refranchise any market unless it's in the context of a specific deal. In any transaction, our primary concern is our people and retention of our associates is of utmost importance to our long-term results. Continuity of performance is also critical to the buyer. It's critical to the seller and obviously it's expected by our guests and by our associates.

To close my comments, I want you to know that we're very intent on driving improved performance in our existing restaurants with less emphasis on new development, as evidenced by the significant reduction in Company unit growth plans next year. We remain committed to having a disciplined approach to capital allocation and of focusing on relevant long-term strategies to drive shareholder value including increasing our free cash flow generation. So with that, Steve, I give it to you.

Great, Dave. Thank you, and thanks everyone again for your continued interest in the Company. I'm going to take a brief spin through the numbers here in the quarter, then talk a little about some of the outlook we gave you for the rest of the year.

Now, as we look at Company sales, Company sales were up 5.2% to $287 million. That was driven by a capacity increase of nearly 9% as we opened 38 Company restaurants in the last 12 months. That's organic growth rate of about 8%. We also acquired four stores in Houston earlier this year. That brought in another 1% to capacity. These increases were offset by a 3.3% decline in average weekly sales with a comp decline of 1.7 during the quarter. Now that gap between Company (indiscernible) and comps has remained fairly consistent from what we've seen in the last several quarters.

Franchise royalties and fees were up 5.5% to $33.3 million driven by a capacity increase of approximately 8% as 107 franchise restaurants have opened in the last 12 months. This increase was partially offset by a decrease in domestic franchise A-lists of 2.4%. It's important to know we saw virtually no gap in comp versus A-lists on the franchise side again this quarter. Other franchise income totaled $400,000. This is lower than the $1.1 million we had in Q3 of last year due to getting out of the captive insurance business. We did have some additional claims coming here of about $300,000 that are reflected in the corresponding cost of other franchise income line.

Total revenues were at $320.6 million. That's up 5% during the quarter. System-wide sale during the quarter increased 5.1% and that's a net capacity growth of nearly 8% with 145 new restaurants opened in the last 12 months. Capacity growth was partially offset by decline in domestic A-lists of 2.7% for the quarter.

Net income came in at 14.8 versus 22.1 last year excluding impairment and other restaurant closure costs. Legal expenses related to the pending settlement of a California wage in hour lawsuit and stock-based comp. Net income was $20.4 million in the quarter.

Diluted EPS as reported came in at $0.20 versus $0.28 last year not excluding the impairment and other restaurant closure costs of approximately $0.02, legal expenses of $0.01, and the incremental stock comp of approximately $0.04. Diluted EPS came in at $0.27 this quarter as compared to $0.31 last year excluding those same charges. On a year-to-date basis, excluding these same items, diluted EPS is $1.05, flat with last year.

Now, let's do take a focus here on the cost side of the P&L. Overall restaurant margins before pre-opening came in at 10.9%. That's down 240 basis points from the prior year. Now, obviously nobody on this end of the phone is happy with this level of margins Dave talked about. Now I'll balance that thought by saying that we have not been an aggressive taker of price as compared to some of our competitors which have hurt our margins and we are also making important investments in food, training, in our people for winning the marathon that we find ourselves in.

Now, let's drill down and look at some of the pieces. Food costs came in at 26.7 for the quarter. That's up 45 basis points from the prior year. Menu price increases of approximately 2.5% were offset by an increase in food spoilage and waste due to a reduction in the number of menu items, our new bar initiative and the new fall menu. In addition, we experienced an unfavorable shift in menu mix and higher alcoholic beverages costs partially offset by our late night value strategy, partially related, I'm sorry, to our late night value strategy. Commodity costs were slightly favorable in the quarter.

Labor came in at 34.5. That's up 145 basis points. Now breaking it down, hourly labor was up 85 basis points. Increase in hourly wage rates of about 2.6% accounted for 50 basis points of this total with the remainder being due primarily to high impact training and additional prep labor related to the rollout of the Tyler promotion. We'll talk later about more high-impact training we see coming here in Q4. Manager labor was up about 80 basis points with about half of this total reflecting a 3.6% increase in management pay rates. About 30 basis points of the increase was due to higher incentive comp as a result of modification to our bonus plan designed to retain our best managers as Dave talked about. The remainder was due to the impact of lower sales volumes. Payroll-related was down 20 basis points as higher payroll taxes were partially offset by lower workers' compensation and health insurance expense.

D&O. D&O came in at 27.9. That was up 50 bps with several ins and outs on this line. First, pressure from higher utilities continued. That was about 45 basis points. Unfavorable year-over-year comparisons for depreciation came in at about 55 and rent expense at about 30. This was offset somewhat by the favorable impact of the change in accounting for small wares. The net impact of the small wares change was 30 basis points favorable to the D&O line, with small wares favorable at 55 basis points and depreciation unfavorable by 25. That unfavorable 25 is contained in the overall 55 unfavorable in depreciation we discussed.

Third quarter was also favorably impacted by lower advertising expense, approximately 40 basis points due to the timing of our food promotion so a lot of in and out there at the D&O line.

G&A now. G&A came in at 11.1. That was up 250 basis points due in large part to the impact of stock-based comp. Excluding stock-based comp, G&A was up 120 basis points from last year. This is due to higher compensation expense due to staffing levels and legal expenses of $1.5 million related to the pending settlement and related costs of a California wage and hour lawsuit.

Impairment. Impairment and other restaurant closure costs reflect the writedown of the carrying value of the property and equipment at two restaurants as well as corporate aircraft. This resulted in an after-tax hit to EPS of about $0.02.

Interest expense was up 50 bps due to higher interest rates and increased borrowing on our credit facility resulting from stock repurchase. The Houston acquisition increased divvy and CapEx. We've got about 45 million in capacity remaining on our current revolver.

Tax rate came in at 35.3 and a little higher than we thought as Congress did not extend the lot fee credit before they adjourned.

Now quickly, a few things here on the balance sheet. Debt was up almost $6 million from year end '05 due to stock repurchase, Houston acquisition of CapEx and our divvy. Debt to cap came in at nearly 29% at quarter end.

Now importantly, we continue to be comfortable with additional leverage beyond these levels going forward. As a point of reference, our current debt is less than one times EBITDA and we would be more than willing to go well above that level in the future without the need to resort to a high-cost financing structure such as a sale leaseback. We just don't think a large scale sale leaseback transaction makes sense for an operator trying to control costs and preserve flexibility.

Shares outstanding came in at 73.9 million at the end of the quarter. Share repurchases. During the quarter, we bought back nearly 600,000 shares of stock at an average price of 19.03 for a total of $11.4 million. Now year-to-date, we've purchased almost 1.3 million shares at an average price of 21.41 for a total cost of $27.5 million. At the end of the quarter, we had approximately 101 million remaining under our current board authorization on share repurchase. We want to reinforce our commitment to enhancing shareholder value through increases in our dividend as well as the use of stock buyback on an opportunistic basis.

Now I'm going to close here with a little bit of our talk about guidance for the remainder of '06 and for the sake of time, I'm just going to hit some topics that's probably most important to you. We continue to expect to open about 35 stores this year so no change. However, as Dave talked about, as a result of rising development costs, slower industry trends and I think our more disciplined approach to capital allocation, as well as the underperformance of several of our new restaurants, we're expecting to open approximately 10 to 15 Company restaurants next year. This should come as no surprise as we've been letting you know this was in the works since early June. We've been very willing to kill deals this year with over 500,000 in dead deal costs hitting our G&A year-to-date.

Based on recent trends, we now expect system-wide same-store sales for the remainder of the year to be in the range from down one to down three. Please keep in mind we're not taking any pricing action for the balance of the year.

Restaurant level margins will largely depend on Company comp sales. We expect them to be lower than last year.

Here's some things you might want to focus on. First, our improved menu offerings in our final campaign of the year are expected to result in higher food costs in the fourth quarter.

Secondly, labor costs will have continued pressure due to hourly wage rate increases and incremental hourly training to support two new food campaigns, one benefiting this year, excuse me, and one benefiting in '07. So just the way the calendar falls here, you all need to know that we'll have an incremental high impact training that will benefit '07 that will occur late in the year. Management pay rate increases to remain competitive and higher incentive comp as well as our retention bonus plan will continue in our numbers.

Finally, these increases will be partially offset by the change in accounting for small wares as well as the impact of the 53rd week of operations.

Now excluding the cost of franchise acquisitions, we now expect CapEx for this year to be between $115 and $125 million, including costs related to the construction of our new corporate headquarters that will open in the latter half of 2007. This $20 million decrease from prior guidance is due to a reduction in '07 restaurant openings and a delay in the timing of CapEx related to the new corporate headquarters. As Dave said, you can see we're focused on free cash flow generation.

With regard to full-year 2007 guidance, it's our historical practice to give full-year guidance in January. We realize the reduction in new store openings for 2007 discussed today probably raises a host of questions about next year which we will answer in due course.

Lastly, our revised full-year EPS guidance for '06, including stock-based compensation, is in the range of $1.10 to $1.13. This range excludes impairment and reflects about $0.05 benefit from the 53rd week. Operator, that's the end of our prepared remarks. Let's go to QandA.

Thank you. [OPERATOR INSTRUCTIONS] Again, we ask that you please limit yourself to one question and one follow-up. Our first question comes from David Palmer of UBS. Your question, please?

Hi. Just a quick one to start. Have you seen any improvement in the overall industry environment since gasoline prices are lower? Is there any appreciable difference in terms of the two-year trend rate in the industry growth?

David, good morning. I think we'll, the tale of the tape is going to be heard here in the coming weeks as other names report. We certainly have access to weekly industry data which we don't talk about. And I think when Malcolm gets around to publishing his data, I think that will become evident what the industry's doing here in October.

Okay. Perhaps just one big picture question. In terms of, sometimes you've gotten into an evaluation process lately and lately meaning in the last year, and with these insights, you may start to even somewhat kick yourself about things that you maybe should have done in recent years. It sounds like you are in the process of reinvesting more in the food. You're likely going to reimage the restaurants or invest in the restaurants. You're going to slow down unit growth. Sounds like you are recommitting just in general to that in-restaurant dinner experience and perhaps putting in the background a little bit, some of these other new peripheral initiatives, the Carside and the Weight Watchers and those things, which perhaps even hurt your folks a little bit. Perhaps you can kind of give us a feeling as to is there a general feeling that you slipped? Maybe you should have been doing more of these things with regard to the in-restaurant experience and do you feel like slowing down the unit growth in and of itself is going to help with you that focus? Thanks very much.

Hi, David. This is Dave. That's a mouthful. Let me take that apart and touch a few pieces. As we look back, let's talk first of all about the food piece. You've heard us refer to the large segmentation we did in early '05. That painted for us a very clear map on the wall in terms of our opportunities going forward with food and we got underway with it immediately. And earlier, in my remarks, you heard me say that as we continue now to track 10,000 of those people every quarter, it's become very clear that some traction from that early food work in '05 and early '06, we're seeing attribute scores come up. So I don't know in retrospect, hindsight's a beautiful thing. Could we have gone more quickly? I think pulling the trigger at the time that we read segmentation was right about the right time.

Relative to some of the initiatives that we brought forward, as we sit here today, no regrets on Carside. It's an important part of our business. The consumer demand for that is very clear. It remains at about 9.5 to 10% of our business. And I guess I'd say that we're excited about what lies ahead as we look now back into the dining room and we pull a bunch of pieces together. One piece is food, one piece is messaging to the consumer. We've always been diligent in this look at our facilities with our six-year remodel program. But I think in this particular environment as we've see the space get crowded, we're looking even more carefully at how can we have a very, very relevant facility. And that work's been underway for quite some time. So I think what you're seeing is a culmination of a lot of pieces that at the end of the day, they translate to a better guest experience. It just doesn't happen overnight.

Maybe just a few quick comments on that and then we'll go to the next question, Operator. There's no doubt we've had to spend a lot of time and focus on creating new revenue platforms for the Company. Weight Watchers, Carside To Go, bar and late night, and we think that those are strategic investments that we've made. Now we're turning our attention to the dining room experience, the dinner day part with better entree food and we think that is going to have a positive impact on all of our revenue platforms. We started to see that here in this quarter with Weight Watchers and I think over time, as we become more relevant dine in, that's also going to create opportunities for us to drive existing revenue platforms. So let's do take the next question, please. Thank you.

Our next question is from John Glass of CIBC. Your question, please.

Thanks. Good morning. You spoke about lowering growth, but you didn't really talk about the other side of the equation with lower CapEx in '07 and beyond. So could you talk about what maybe you could do that piece dividend if you will and perhaps if you could in answering that talk about what role remodeling's play. What's the order of magnitude you might expect next year?

Hey, John. Good morning. I think no question the, as we think about opening fewer stores in '07 and beyond, there is going to be additional free cash flow generation. We're thoughtful right now on how we're going to use that free cash flow. There's no doubt that a focus on the inside of the restaurant and the outside of the restaurant and the guest experience will take some of our capital in the future but I think we're going to be pretty judicious on how that's allocated. Our franchisees and our Company operators would expect to see traction as well as a return depending on the amount of the investment, and we've actually been doing a lot of work in that and haven't talked about it publicly and we'll talk about it on this call today but we've got good alignment with our franchise partners on what that needs to look like and I think good alignment with our Company operators.

Great. Thank you.

Yes.

Our next question's from Steven Kron of Goldman Sachs. Your question, please.

Great, thanks. If I could just start off with a follow-up to that. If we talk about remodels, I know you've started that process, and Steve, I think you just indicated you are not going to get into a tremendous amount of specifics but is there any color you can kind of put around some of the customer scores or anything that you're getting in some of the remodels that you've already started, and I guess back to John's initial question there, which is what should we expect from a CapEx standpoint, if any, in the near term?

Hi, Steve. This is Dave. How are you? Let me take the first part and maybe relative to any CapEx look forward. I'll let Steve handle that. Think of our remodels this way. Historically, we've been on a continued disciplined path as I said of remodeling every six years, six to seven years. Remodels historically have really been about ensuring the building stays fresh, a lot about refurbishment, a lot about good, clean look and really has been, I would say, more of a defensive strategy. Think about the progress we're, the things that we're working on now, I would classify as more of an offensive strategy on remodel as we've seen the space get crowded, as we've seen some penetration in trade areas and that offensive strategy is going to bring with it, I think, a little bit different posture in terms of how we think about design and relevancy and quite frankly bring with it a pretty disciplined approach to return on what could be some incremental capital spent for remodel. Now we will have the different levels of investment depending on trade area and restaurant. We'll sit and we'll put the business case forward for our franchisees as we go out first and lead by example here. But I think the headline, the headline, Steve, would be think about what lies ahead here as a lot more offensive than we've done historically on remodel, and that's I think as much as I should say.

Steven, just one kind of quick follow-up there. With regard to '07, I think we've been getting a fair number of questions about '07 and I think we kind of apologize for giving just a piece of next year's guidance because I know it doesn't help you guys. Realistically, though, we are right now pulling together our '07 capital plan. There is a potential big swing in our number next year for capital which is what we ultimately do at our corporate headquarters. We are going to do a sale leaseback of that as we said. The timing of that is a little unknown. I mean, we think we're going to move into our new building October/November. We want to do the right kind of smart transaction. That transaction actually could fall into early '08. If it falls into '07, you've got a big influx of cash into the Company. So that's why I just don't want to get too far ahead of ourselves. The things that are known, though, is the 10 to 15 stores next year. I think as Dave's discussed, our remodels. We'll have more on that in the coming months. Operator, let's take the next call.

Your next question is from Joe Buckley of Bear Stearns. Your question, please?

Thank you. Quick question on franchisee expansion. As you scale back the Company expansion, are the franchisees likely to follow suit? Maybe you could address that from both an '07 perspective and maybe a longer term perspective in terms of the ultimate unit potential of the concept.

Hi, Joe. This is Dave. Relative to expectations on franchise development going forward, I don't think we will expect to see the kind of change in reduction in units on a percent basis that we just described on the Company side. We don't expect to see that in '07 on the franchise side. That has a lot to do with a lot of robust trade areas and blue sky our franchisees have identified. Now, as we've said to our franchisees, we don't talk out of both sides of our mouth. Those things that it's been proven for us to discuss relative to new restaurant development, we'll be having those same conversations with our franchisees to be sure that the new restaurants that go in the ground are good restaurants. But I wouldn't look for the same falloff that we described here on the Company side.

Hey, Joe, I think one of the most important things that we're focused on for our franchise partners is making sure that we are providing, and the system has adequate access to capital to grow new stores and to do remodels. There's going to be a balance point here between growth and then reinvestment. We're going to make sure that we work with our franchise partners to get to the right, balanced answer for the good long-term health of the system.

Great. So it sounds like we wouldn't be off assuming there will be some decline in franchisee expansion, but nothing near the percentage decline in the Company?

I wouldn't disagree with that.

Okay. Thank you.

Yes.

Our next question's from Jeff Omohundro of Wachovia Securities. Your question, please?

Thanks. Just looking for a little more color on how you see the Tyler Florence campaign evolving both on the longer term? Also, what kind of tweaks you might be making in the shorter term as we move into Q4? Thanks.

Jeff, this is Dave. Relative to the Tyler campaign and it's still forward evolution, I step back for just a moment and remind us all that as we read segmentation and said our opportunity looked like an opportunity to get greater preference when somebody was looking for higher quality food, better tasting food, signature items they could come to eat at Applebee's, we said what Tyler does with borrowed equity is accelerates, if you will, in the marketplace for those who may have left us. It accelerates the notion there's something new going on here. And the early buzz in the marketplace, and as I said earlier in my remarks, the improvement in dinner traffic we've seen here in October is an indication that it's tracking the way we'd like it to. Now, our partnership with Tyler and our culinary team here has been outstanding. And also, as I said in my remarks, as you look forward to C-7, you can look forward to seeing some continued Tyler work in the campaign although in all likelihood, the entire campaign would not be just a Tyler product but we bring forward the equity that we're beginning to see in attracting a guest that hasn't been with us for quite a while and again, I just reiterate we're only four weeks into this so there's a lot of learning occurring each week here.

Thanks, Jeff.

Our next question's from Andy Barish of Banc of America Securities. Your question, please?

Let me do two quick ones, I guess. On the development, what do you attribute the difference in sort of the relative success of franchise openings versus your Company average weekly sales numbers that have kind of diverged from same-store sales? Then secondly, on the, kind of on the investment back into the restaurants, food, people, et cetera, I don't expect to have a complete quantification but does that continue into the first half of '07 and then you sort of start lapping some of the real upgrades that you were doing kind of mid year, this year?

Yes. I'll take the first one and we can talk a little bit about how we think about the back half. I think, first of all, with regard to Company versus franchise new store A list, we've been on our base, we've been opening a pretty significant amount of smaller town units and grills this year. That is a contributor. There's also a contributor here is that we've been developing in some markets where we've got a lot of Applebee's and we have not seen the kind of opening sales that we had anticipated. I think our franchise partners are less penetrated than we are. So that's also a reason why they're opening better in certain markets. Now, I think with regard to continuing, word of this investment in quotes continue, we're committed to the total experience, service and food. I think we believe that this continues next year. Don't want to put too much of a fine point on how long it goes but certainly our focus on retaining our people, on training our people to being increasing capability within the four walls of the restaurant, to execute and develop and deliver great food is going to be there and our focus on the guest experience. So we're not trying to short change that. We really view ourselves in the part of a more long-term restaging of the guest experience inside the four walls.

Andy, it's Dave. I think I'd probably just add a couple of things to the first point on franchise development. As you look at where those restaurants have opened geographically and you look at where the macro economic strengths and weaknesses have been, there's certainly a preference to those stronger economic pockets than we've seen on the Company side. And I think the other thing that you might think about relative to the second part of that question, as Steve said, we refer back to what we did on the front end here with Carside and Weight Watchers, up front investment, time-out, let's get the troops together and get organized around kind of a new way of thinking and training and perhaps new procedure. We will have been through about three rounds of that as we turn the corner on the first of '07. As Steve said, we've got high impact training coming twice here in Q4. One's to support our C-7 campaign and one's to support our C-1 campaign. I think you might think in terms of seeing that begin to model down a bit as we turn the first of the year.

Thanks. That's helpful.

You bet.

Our next question's from Michael Smith of Oppenheimer. Your question, please?

Well, I had one kind of a detail question. When you said the guidance for this year was $1.10 to $1.15 and that excluded the charges, were those the charges you just took in the, impairment charges you just took in the third quarter?

Mike, our guidance is $1.10 to $1.13 and that excludes the impairment charges we've taken year-to-date. And if you look at the press release, there's a reconciliation of non-GAAP so the impairment charges are set out separately on there.

Okay. And kind of going back to the question that's been asked a couple of times. The remodels you're doing, would those cause you, if you did a major program, would those cause you any lost operating weeks?

Mike, we've never closed Applebee's for, to do remodels. We find a way, make a way. We don't like the idea of having days when we're not open. There -- we're looking at a couple different flavors of remodels. I would not plan that we would do that on any kind of widespread basis. Our franchise partners, I think, feel very strongly about losing sales days. I don't even want to talk about sales weeks. So we're going to find a way to do any kind of remodel such that it does not impact our ability to be open and operate.

Thanks, Mike.

Our next question is from John Ivankoe of JP Morgan. Your question, please?

Hi, thanks. A question for Dave and a question for Steve. Dave, in your prepared remarks, you talked about a high-low strategy. I know the Company in a variety of markets has been working on some specific price pointed lunch value. Could you give us an update with what your current thinking is there? And Steve, with hindsight being 20/20 here, how much of the comp declines or volatility in comps you've seen over the last two years might have been caused by yourselves, through cannibalization if you have a sense of that?

Got it.

John, Dave, regarding the first part on lunch. First of all, we are still in test in a number of markets with lunch. Our franchisees are also testing with us now on lunch. And we're gaining some enthusiasm and over what we've seen in early test results, we're going to be mindful of a couple of things here. We think there's clearly some day part opportunities there. But again, to the conversation we just had earlier, a lot of focus right now on the dinner meal period and the dinner guest and we'll continue to be in test with lunch until we've refined this from a standpoint of our expectations around both traffic and profit. But a lot of positive action there. We like where we are.

John, your second question on cannibalization over the last two years. We've got a good handle on that. That's not the big story in what's happening with our comps. There are certain markets, and I would single out like the Twin Cities market, where we have built seven or eight or nine new stores in the last two years on a base. We have clearly impacted ourselves there. But across the whole estate, it's less than a 0.5 point impact on cannibalization.

And then I'd just add some color on that Minnesota market for example. So you may take some short-term cannibalization there. That market has rebounded nicely this year as it laps kind of that cannibalization. So if you look at the fact that we won a great trade area and we will take some of that short-term pain in a market to maintain sometimes our market shares, especially in places where we are clearly dominant.

Thanks, John.

Thanks.

Our next question's from Bryan Elliott of Raymond James. Your question, please?

Good morning. I wanted to come back to the headquarters building. Can you refresh our memory on size? What the project size is from a square footage standpoint? Is it all you or do you plan to lease some of it? Do you own the land?

Bryan, good. Thank you. First of all, here's the overview of the project. We negotiated very substantial incentives from the State of Kansas in the range of $14 million net present value. With that, we've actually purchased the land. We currently own the land. It's 31 acres for $4 million and we're building a facility that allows for some growth in the future above our current needs, not much. We've been -- we've got a pretty refined footprint. Under our plan, when we do the sale leaseback, if you look at kind of net/net, we're going to be all in on that at anywhere from $13 to $15 a square foot on a sale leaseback. That's a below market rate. What we get with this is we get a building that meets our need for world class culinary, which is the main reason why we're doing this is to create a world class culinary center, and it allows to us have a landed -- a lower landed cost than we would if we would have turned it over to a developer. But it is our plan to flip it. I can't give you numbers here on would we flip the whole thing, would we carve out ten acres that we would own and keep for future expansion, would we only do building and keep the land? But we are going to get that money back in for our use to do other things.

Would you expect, given the incentives, et cetera, to possibly end up net cash positive?

Depends on how aggressive of a sale leaseback we do. We can do a pretty aggressive sale leaseback and get back more than we have in the project but it's, we're going to, like I said, I haven't even started to negotiate that transaction but you ought to think about and the way we think about it is getting our money back while capturing the very nice incentives for our own account.

Okay. And essentially, it's the incentives that make a sale leaseback of that property a different economic cost than sale leasebacks on restaurant properties?

Absolutely.

Very good. Thank you.

Our next question is from Jason Whitmer of Cleveland Research. Your question, please?

Hi, this is actually [Scott Bender] filling in for Jay. I was wondering, kind of getting back to the margin pinch from the launch of the Tyler Florence promotion. Wondering if you could comment on how much of the investment's in food and labor had been previously budgeted and how much has kind of been incremental since the launch and also whether food or labor saw more pressure as a result or if it was pretty evenly split between the two? Thanks.

Yes. We've got certainly more pressure at labor, as we talked about here on the call. We kind of went through the diagnostic on that. I think with regard to comparison to budget, I would say that we had anticipated most all of these costs. I think as we look at the change we made that we would have been considered, quote unquote out of budget. It would have been for the simplification of the menu as well as probably the incremental training that we're seeing, where we call high impact training in the back of the house. But again, those are things that under a pure investment approach that we're taking make sense to us.

I think, Scott, what's important probably to note there as Steve isolates on what some of those costs have been, there's a very, very small portion of that that's really related to the fabric of the promotion and the food. You see a little bit through mix change but the good news is these are not costs that are baked in forever.

Right.

Thanks, Scott.

Just one --

Our next question's from Rachael Rothman of Merrill Lynch. Your question, please?

Hi, good morning, guys. Can you talk a little bit about your thought process in terms of appropriate leverage levels given the successful leverage recap we've seen at the other companies and your slowdown in Company-operated unit growth? Have you thought about, I understand you don't want to do a sale leaseback and I agree with that, but have you thought of potentially securitizing your real estate in other ways or securitizing your franchise royalty stream and using the proceeds to buy back stocks?

Rachel, it's Steve. Good morning. I think you alluded there to two specific structures, and certainly when you look at the structure about securitization and royalty, that is really a structure that is really appropriate if you're looking at going north of five times leverage and you're able to really buy down your all-in cost of debt. We've actually studied that structure because it's gotten some play out there with some transactions. But that is one that's not for us attractive. We certainly don't even think about leverage at that kind of level five to six times EBITDA. Now with regard to other structures, collateralizing our real estate, doing some kind of mortgage-backed structure, we really don't have to do that. We've got great access to financing both in the bank debt market as well as the private placement market. Those markets are very active because of our stable cash flows. I think we're a reasonably attractive Company. We still think in this environment to be low investment grade is reasonably important. Some might challenge that but we tend to be a pretty conservative Company. So Rachael, we've certainly looked at a lot of markets. We've looked at our peer group. We've looked at other peer franchise players. And we've done a lot of looking at what could be possible for us.

So would you be comfortable just floating bonds or using a term loan or more aggressive stance on your revolver to -- ?

Yes. I think, with regard to public debt, we're not, we don't think we need to tap the public debt markets right now. It's -- you end up having to be rated. It's very expensive. We've got a lot of access to capital in more traditional bank -- the bank market as well as the private placement market which is active, very active for a name like ours. Thanks, Rachael.

Our next question is from Aimee Marcel of Jefferies & Company. Your question, please?

Thank you. I was wondering if you could quantify the spinach recall. I know that you delayed Tyler Florence for a week and I was wondering if there was any wastage with that.

Aimee, Carol. On the spinach, that was really negligible to our results. We just pushed back the promotion. Our training occurred in our September period and the promotion then did not start till our October period.

Right. We missed a week of sales though with Tyler that we would have had in the period. And that's something that we're mindful of.

Okay, thanks.

Thanks.

Our next question is from [Shawn Dodge] of Suntrust. Your question, please?

Yes, good morning, guys. It's actually Chris O'Cull. Hey, Dave, you mentioned that you are seeing better scores with the new food and the research that you guys are conducting. Is this with the light user of the brand or with the core user?

Those scores, Chris, cut across all demographics of our guests so when we go back in with tracking panel once a quarter, we're talking to heavy users, we're talking to medium and light users as well as lapsed users. That's a consolidation of what we see across the landscape.

What specific aspects of the brand do the light users or the people who don't use you as frequently, what are they not -- what aspects of the brand are they not giving you credit for with the new food? Is it service, is it the atmosphere or the design of the restaurant? Can you talk a little more about that?

Well, I think, Chris, first of all we go back to that first round of segmentation, and that light and less user as we read this back in mid-2005 talked a lot about taste, talked a lot about palate, culinary experience, talked a lot about memorable food. Now contrary to what we read in the spring of '05, this most recent consumer tracking panel here for Q3 says that that light user is beginning to respond very well to some of the food we've been introducing. Again, I'd reemphasize that's pre any of the four items we just brought to the table here in [C-6] with Tyler. So the direct answer to the question is that light to medium user says give me something that's a little less traditional base bar and grill and give me something that's a little more exciting to the palate.

Thanks, Chris.

Our next question is from Joe Buckley of Bear Stearns. Your question, please?

The question on the consumer segmentation study, I know you are keeping up with that and I'm curious if you've done an analysis since gasoline prices have gone down and gotten any indication that some of those consumers who had left casual dining might be returning to casual dining or intend to return to casual dining. Anything recent that you could share with us?

Joe, we have not reprised our gasoline study. We actually did one, I'm looking at Dave, about six, seven months ago. We have not reprised that. I don't think -- we're not seeing any kind of hard data in from other people that would suggest that there's a "rebound effect." It probably needed to last a little bit longer here in the consumer's wallet, especially the low-end consumer's wallet's been under attack for awhile.

Yes, Joe, distantly related, it's kind of an indirect way of getting at what you've asked but one of the things we saw in this recent tracking panel, when we look at the percent of people who were out in the casual dining space and the frequency of visitors to Applebee's in the last 30 days, we saw that tick up a little bit here in this last quarter and that very well could be related to some of the core guests returning to casual dining, but I don't want to, I don't want to make that leap. But intuitively, it suggests that there may be a little bit of return to casual dining in terms of visit frequency.

Okay. Just one more if I could on the playing offense with the remodels. Are you trying to take the positioning of the brand up as you do that to try to attract that more affluent consumer?

No. Rather than say up, Joe, I think I'd say differentiate. If you think about things that have been our core equities in the marketplace, we're going to do all we can to be sure we bring those to life. And we're going to be very responsive to the consumer who's clearly said over the last couple of rounds of research, I have difficulty distinguishing one of you from the other. Square box, awnings, neon, and so I would characterize that less about taking it up and more about differentiating. That doesn't necessarily imply upscale.

Right.

Thanks, Joe.

Our next question's from David Palmer of UBS. Your question, please?

Quick one on unit growth. Obviously you're slowing yours down for '07. Is your development team perhaps giving you a sense of how much the industry supply growth might be slowing for '07? Thanks?

David, I don't think we've gotten much on that. We've got anecdotal within given trade areas. I think you're seeing other names in the industry now talk about doing less in the future. I think people are realizing that it's going to be important to be rational allocators of capital.

Okay, thank you.

Our next question's from Michael Smith of Oppenheimer. Your question?

You've talked about Tyler Florence and the introduction. You're going to use him, well, you're using him now. You're going to use him again in December. Is he going to become a spokesman for Applebee's and along with that, you talked about his items having a higher food cost as well as a higher labor content. Are those permanent changes?

Mike, relative to the duration of our affiliation with Tyler, we're going to continue to read that. It's been a great boost for us initially here in terms of accelerating the consumer that we wanted to have a different impression of our food. And we're not going to speak to what that looks like as we get into '07. That's an open item but the opportunity exists for us to continue. Again, relative to cost structure here, most of the cost structure we referred to had a lot more to do with rollout and finite costs around training, finite costs around some waste as we removed items from the menu, and a lot less about permanent structure. One of the things that's beautiful about having Tyler stand side by side with our culinary team and our Ops-Excellence team is we can product engineer food together that gets us where we need to be from a theoretical food concept.

And Mike, year to date, food cost is essentially flat with prior year. It's up slightly. So thanks. I think we're going to take one more question then, Operator. Thank you.

Our final question today is from Steven Kron of Goldman Sachs. Your question, sir?

Thanks. Just two quick follow-ups on margins. Steve, I think in your prepared remarks you mentioned that the beverage program was a positive lift to comps but negative mix shift. I would have thought beverages would be positive mix shift. Can you just clarify that? And then secondly, I was just curious did the $5 trial incentive program that played out in July, did that have any negative impact or notable impact on the food line? Thanks.

No negative there, Steven, on the last one. On the beverage side, we're seeing in our total usage about 10 basis points that crept in on higher bar costs. Some of that is driven by the price of beer especially and others of it is driven by some of the discounting we're doing at late night. So it's a combination of those two things.

Okay, thanks.

Okay. I think we want to thank everybody for joining us today for our Q3 call. Look forward to catching up with you live, okay? Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.