Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Denny's (NASDAQ:DENN)

Q2 2012 Earnings Call

July 31, 2012 5:00 pm ET

Executives

Whit Kincaid

John C. Miller - Chief Executive Officer, President and Director

F. Mark Wolfinger - Chief Financial Officer, Chief Administrative Officer, Executive Vice President and Director

Analysts

Will Slabaugh - Stephens Inc., Research Division

Michael W. Gallo - CL King & Associates, Inc.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Mark E. Smith - Feltl and Company, Inc., Research Division

Michael Halen - Sidoti & Company, LLC

Conrad Lyon - B. Riley & Co., LLC, Research Division

Operator

Good afternoon. My name is Lacy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Denny's Second Quarter 2012 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Whit Kincaid, Senior Director of Investor Relations. Please go ahead, sir.

Whit Kincaid

Thank you, Lacy. Good afternoon, and thank you for joining us for Denny's Second Quarter 2012 Investor Call. This call is being broadcast simultaneously over the Internet. With me today from management are John Miller, Denny's President and Chief Executive Officer; and Mark Wolfinger, Denny's Executive Vice President, Chief Administrative Officer and Chief Financial Officer. John will begin today's call with his introductory comments. After that, Mark will provide a financial review of our second quarter results. I will conclude the call with commentary on Denny's 2012 full year guidance. As a reminder, we will be filing the 10-Q by the due date of August 6.

Before we begin, let me remind you that in accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the company notes that certain matters to be discussed by members of management during this call may constitute forward-looking statements. Management urges caution in considering its current trends and any outlook on earnings provided on this call.

Such statements are subject to risks, uncertainties and other factors that may cause the actual performance of Denny's to be materially different from the performance indicated or implied by such statements.

Such risks and factors are set forth in the company's most recent annual report on Form 10-K for the year ended December 28, 2011, and in any subsequent quarterly reports on Form 10-Q.

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

John C. Miller

Thank you, Whit. Good afternoon, everyone. We are pleased with our second quarter results as we continue down the path of reenergizing Denny's. We achieved our fifth consecutive quarter of system-wide same-store sales increasing while growing our adjusted income before taxes 35% and generating $15 million of free cash flow. It is a testament to the resilience of our 59-year-old brand that we have been able to achieve these results in this challenging economic environment. We are most appreciative to our loyal guests and their guidance and their response in reenergizing Denny's. Our franchise-focused business model provides financial stability and flexibility, while enabling us to generate significant free cash flow that could be used to further strengthen our brand and increase long-term shareholder value. We remain focused on executing against our 3 key objectives implemented to help Denny's become one of the largest American full service restaurant brands in the world.

Our first key objective is the revitalization of Denny's heritage as America's Diner, which provides the promise of everyday value, crave-able cooking of family favorites and indulgent items served in a come-as-you-are friendly and inviting atmosphere. We now have 6, going on 7, quarters under our belt with our America's Diner brand positioning efforts. But this is our compass. We are at the beginning stages of effectively broadening our approach from the more narrowly focused breakfast-all-day platform.

Contributing to our second quarter results was our Build Your Own Pancakes Limited Time Only module, which played off the strength of our Build Your Own Grand Slam platform. It delivered upon our guests' desire for customization, while also offering add-on and upsell opportunities. The module performed well, as we saw higher-than-expected number of customers ordering our signature pancake creation rather than build their own creation. We were also pleased to see that our breakfast daypart traffic increased sequentially and was the strongest performing daypart in the quarter.

As we entered the summer season, we brought back our successful Tour of America module, which will run until mid-August. Back by popular demand our the classic diner items like the Philly Cheesesteak Omelette and the Midwestern Meat & Potatoes Sandwich with new additions to the lineup like the Red, White and Blue Pancake Breakfast, Malibu Fish Tacos, Brooklyn Spaghetti & Meatballs, our Southern Slam and the Florida Sunshine Salad. Per check driving add-on sales, we brought back the popular Strawberry Pancake Puppies and introduced the new Red Raspberry Smoothie along with the new and innovative dessert, the Apple Crisp Milk Shake Parfait. Most importantly, we are pleased to report this sequel mixes at a higher level than last year's module.

In conjunction with the launch of our Tour of America Limited Time Only menu, we launched a new core menu during the quarter, which leverages our successful America's Diner positioning. The menu introduces clever references to our heritage as your local diner with what we call diner-ism, along with appropriate iconography bridging days gone by to today. One of these is the use of the classic diner bell you hear when your order is up. This iconic symbol is used to identify Denny's guest favorites: items such as Moons Over My Hammy, the Super Bird and the All-American Slam on the menu.

To complete the effort, diner bells have been added to expedite our counters in all restaurants, to add a little homegrown attitude to the Denny's experience. We're focused on bringing product innovation to the core menu, but only after thorough consumer and operational testing. The newest items, which include a Blueberry Pancake Breakfast, Chicken Avocado Caesar Salad, Loaded Chorizo Burrito and a Smashed Meatball Sub, build on the successful additions to the core menu launched in January. Our guests continue to look for value as evidenced by the mix of the $2/$4/$6/$8 Value Menu increasing during the second quarter and into the third quarter. We continue to emphasize the $2/$4/$6/$8 menu by highlighting specific items like the $4 Everyday Value Slam and the $4 Build Your Own Chicken Wraps through both national and local media.

About 1 in 5 of our guests come from our beloved Hispanic-American population. We followed up our successful Skillet Whisperer video that featured Cesar Millan with a Spanish-language commercial and music rap video focused on the $4 Chicken Wraps. The rap video has been creating quite a buzz with this important audience.

We continue to execute our marketing strategies to help reestablish Denny's as a dining destination. Although we are disappointed that our system-wide same-store sales declined sequentially, we are quite pleased to achieve the highest quarterly 2-year same-store sales in almost 5 years. We believe that we have the right brand building strategies in place to drive consistent improvement.

Our second key objective is to continue the growth of the Denny's brand through traditional and nontraditional venues, both domestically and internationally. We opened 9 franchise units in the second quarter, including 2 international units in Canada and the Dominican Republic. Our first unit in the Dominican Republic is with one of our newest partners and represented Denny's first airport location. It is located outside of the security gate attracting travelers, as well as local customers not traveling that want to experience their local diner.

Building on this success, we do have global ambitions and are moving aggressively to grow Denny's existing 96 units to a much larger international footprint. We believe there is a significant untapped potential for the Denny's brand outside of the U.S., as evidenced by our large U.S. exposure in international tourist areas like Las Vegas, Orlando, Miami and Southern California and success we have had with recent openings in Canada, Honduras, Puerto Rico, Costa Rica and the Dominican Republic.

We've been placing more time and resources towards building our development pipeline outside the U.S., which led to signing the brand's largest international development agreement today. We are participating with Great China International Group to develop 50 new Denny's restaurants in 6 provinces in Southern China. We are working closely with Great China to adapt Denny's to the local real estate, cultural norms and culinary demands. Great China will utilize Denny's full service format as a local diner and expect the first restaurant to open in 2013.

Due to our scale in the U.S. and our existing international presence of more than 90 units, we have many of the key people and processes in place to support international openings, including product development, marketing, supply chain logistics, training and operations.

As we gain scale in Asia and other regions, we look to make investments in our team as appropriate to ensure the success of these restaurants and partners around the world. The partnership for Southern China takes our international development pipeline to 80 unopened units, primarily in China, Canada and Central America. We are aggressively looking for well-capitalized, experienced partners throughout the balance of China and the world.

Our third key objective is to grow profitability and free cash flow through our franchise-focused business model. The restaurant industry is facing persistent and challenging headwinds, as well as a difficult consumer economic environment, inflationary pressures and intense value competition. However, this has not kept Denny's from demonstrating its ability to grow sales, profitability and free cash flow.

Through the first half of this year, our adjusted income before taxes has grown 45%, and free cash flow has grown 39%. This enables us to continue making investments in the brand, while strengthening our balance sheet through debt repayments and returning value to the shareholders through our share repurchase program.

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

F. Mark Wolfinger

Thank you, John, and good afternoon, everyone. Our second quarter performance was highlighted by positive system-wide same-store sales, a 35% increase in adjusted income before taxes and a 15% increase in free cash flow compared to the prior year period. Denny's is a reenergized brand with a franchise-focused business model, which provides stability to our profitability and cash flows, while generating excess cash that we're using to further strengthen our balance sheet and return value to our shareholders through share repurchases.

In the second quarter, system-wide same-store sales increased 0.8%, same-store sales at franchise restaurants increased 0.9% and same-store sales at company restaurants were flat compared to the prior year quarter. This is the fifth consecutive quarter that system-wide same-store sales have been positive and the strongest 2-year quarterly same-store sales we've seen since the third quarter of 2007.

Looking at the details for company same-store sales performance, the guest check average increased by 1.7%. The higher guest check average included a 1.5% increase from menu pricing taken in January of this year and June of last year. In the second quarter, company same-store guest counts decreased 1.6%. Around 20 basis points of this decrease was driven by the honeymoon period -- the honeymoon impact of the new company-owned units we opened in 2010 and 2011, as new units become part of our same-store calculations after being opened for 12 months.

Franchise same-store sales increased 0.9% in the second quarter, primarily driven by a 2% increase from menu pricing, offset by lower same-store guest counts.

I would like to remind everyone that we will cease reporting same-store company guest count and guest check average at the end of this year. Since our franchise units account for 89% of the system, we believe that franchise and system-wide same-store sales metrics better reflect changes in unit level performance throughout our system.

Denny's total operating revenue, including company restaurant sales and franchise revenue, decreased $11.1 million compared to the prior year quarter, primarily driven by a decline in company restaurant sales in the quarter. Sales at company-owned units decreased $12.8 million, primarily due to 36 fewer equivalent company restaurants compared with the same period last year, reflecting the continuing impact of selling company-owned units to franchisees as part of our ongoing refranchising strategy we call FGI.

In the second quarter, Denny's opened 9 new franchise units, closed 5 franchise and company units and sold 17 company-owned units to franchisees, leading to an increase of 4 net system units this quarter.

I'll now review the quarterly operating margin table provided in our press release. The second quarter company restaurant operating margin of 14.8% represents a 1.5 percentage point increase compared to the prior year quarter and was primarily impacted by the following items: product costs increased 0.3 percentage points to 24.9% of sales, primarily due to the impact of increased commodity costs. Payroll and benefit costs decreased 0.7 percentage points to 40.1% of sales, primarily due to improved labor efficiency. Occupancy costs increased 0.3 percentage points to 6.8% of sales, primarily due to favorable general liability claims development recorded in the prior year quarter. Other operating costs decreased 1.3 percentage points, 13.4% of sales, primarily driven by a 0.8 percentage point decrease in other operating expenses, which were higher in the prior year period due to the new store opening expenses for 6 company-owned units in the first half of 2011.

In summary, the gross profit from our company operations decreased $0.4 million or $400,000 to $13.5 million on a sales decline of $12.8 million. For the second quarter of 2012, Denny's reported franchise and license revenue of $33.5 million compared with $31.8 million in the prior year quarter. The $1.7 million increase in franchise revenue was primarily driven by a $900,000 increase in royalties from 51 additional franchise equivalent units and the effects of higher same-store sales in the current quarter. The $400,000 increase in occupancy revenue was primarily driven by selling company-owned units to franchisees where we are now collecting rent on these properties. The $300,000 increase in initial and other fee revenue was primarily driven by selling 16 more company-owned units to franchisees compared to the prior year quarter. Franchise operating margin increased $1.4 million to $22.1 million in the second quarter. This increase was primarily driven by the items previously mentioned, but were somewhat offset by a $300,000 increase in direct franchise cost that was primarily driven by higher performance-based compensation accruals relative to the prior year quarter. Franchise operating margin as a percentage of franchise and license revenue of 66% represents a 0.8% percentage point increase compared to the prior year quarter.

The franchise side of our business contributed 62% of the total operating margin in the second quarter, which is $8.6 million more than our company restaurants. As we have emphasized in past quarters, the income shift to a franchise-focused business model gives us much greater stability and predictability in our earnings. In addition, it enables us to generate above-average EBITDA margins for a restaurant company.

For the quarter, adjusted EBITDA margin as a percentage of total operating revenue was 17.0%, an increase of 1.7 percentage points compared to the prior year quarter. Total general and administrative expenses for the second quarter increased $700,000 from the prior year quarter. General and administrative expenses, excluding share-based compensation, increased $1 million, primarily due to an increase in performance-based compensation accruals relative to the prior year period. Depreciation and amortization expense declined by $1.4 million compared with the prior year quarter, primarily as a result of the sale of company-owned restaurants over the past 2 years.

Net operating gains, losses and other charges, which reflect restructuring charges, exit costs, impairment charges and gains or losses on the sale of assets, increased $3.6 million compared to the prior year quarter. This increase was primarily driven by the sale of more company-owned units to franchisees and was primarily offset by higher restructuring and exit costs. Operating income for the second quarter increased $5.3 million from the prior year quarter to $19 million, primarily due to the increases in operating gains, losses and other charges and franchise operating margin and lower depreciation and amortization.

[indiscernible] operating income, interest expense for the second quarter decreased $1.9 million to $3 million as a result of a $39.2 million reduction in total gross debt over the last 12 months and the lower interest rate under our new credit facility. Other nonoperating expense increased $7.9 million to $8.2 million in the second quarter due to the closing of the new credit facility, which resulted in a charge of $7.9 million for the unamortized portion of deferred financing costs and original issue discount related to the prior facility and a portion of the fees related to the new facility.

Our effective income tax rate was 41.1% in the second quarter, which was substantially higher than the effective tax rate of 4.8% in the prior year quarter, primarily due to a onetime adjustment from the prior year. The change in effective tax rate compared to the prior year resulted from the release of a substantial portion of the valuation allowance on certain deferred tax assets based on our improved historical and projected pre-tax income.

Due to the use of net operating loss carryforwards, we only paid $1.2 million in cash taxes this quarter. We will continue to utilize additional net operating losses and income tax credit carryforwards to eliminate the majority of our cash taxes for the next several years.

The transition to a franchise-focused business model and improved operating performance has allowed us to generate a significant improvement in profitability and free cash flow. In the second quarter, adjusted income before taxes increased 35% to $12.9 million. We generated $15 million of free cash flow in the second quarter, which is an increase of $1.9 million compared to the prior year. The free cash flow has allowed us to continue to strengthen our balance sheet as we repaid $7 million in term loan debt in the second quarter, bringing our total term loan debt repayment to $57 million since the end of 2010.

We have reduced total debt by $347 million or 63% since early 2006 and now have outstanding term loan debt of $183 million. Our total debt to adjusted EBITDA ratio is now below 2.5x. As a result of achieving a total debt ratio of below 2.5x, our interest rate spread will decrease by 25 basis points from 300 basis points to 275 basis points, resulting in a cost of debt of approximately 3% based on the current 30-day LIBOR rate.

As a reminder, the next total debt ratio threshold in our new credit agreement is 2.0x, which we anticipate achieving sometime in the next 18 to 24 months. Achieving this will lower our interest rate by another 25 basis points and enable us to maximize our availability for returning cash to shareholders.

We currently have an annual spending cap of $34.8 million for total share repurchases and dividends, which will be eliminated with a total debt ratio below 2:1 or 2x. At that point, the only restrictions will be the $19 million annual debt amortization and having the minimum of $20 million of availability on our revolver.

Since November 2010, we have been returning value to shareholders through share repurchases, in addition to repaying debt. In the second quarter of this year, we purchased 1.4 million shares, bringing our total to 8.1 million shares since initiating the share repurchase strategy. We have 6.9 million shares remaining in our authorized share repurchase initiative, which includes the new 6 million shares authorized by the Board of Directors in May of this year. We will continue to balance the use of our free cash flow for both debt repayment and share repurchases as we seek to both make us a stronger franchisor and return value to our shareholders.

That wraps up my review of our first quarter results -- second quarter results, and I'll turn the call over to Whit, who will comment on 2012 guidance.

Whit Kincaid

Thank you, Mark, and good afternoon, everyone. I would like to take a few minutes to address a few topics related to the full year 2012 guidance described in the business outlook section of today's press release. Our current thinking is that commodity cost pressures will be in the 2% to 3% range for 2012. We are currently locked into around 60% of our needs for the remainder of 2012 and hopeful that we will see the lower end of the range.

In the first half of this year, we sold 23 company-owned units to franchisees and anticipate selling an additional 7 to 12 units in the second half of the year, which translates into 30 or 35 units for the entire year. Our goal remains to complete the FGI program by the end of 2012. As a reminder, the FGI program helps adjusted income before taxes but places downward pressure on our adjusted EBITDA.

Although our year-to-date capital spending was $4.3 million, our annual guidance for capital spending remains $15 million to $16 million. This is primarily driven by the timing of the openings of the company-owned unit in downtown Las Vegas and remodels of the company-owned units. Based on year-to-date results, management's expectations at this time and changes I just noted, Denny's is reiterating its guidance ranges for the full year.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Will Slabaugh with Stephens.

Will Slabaugh - Stephens Inc., Research Division

I just had a quick housekeeping question to start off, to double check I'm getting to the right adjusted EPS number. When I look at your pre-tax income number of $12.9 million adjusted, I'm getting to an EPS number around $0.08. So I'm just wondering, I know it's a tough number to get to considering EPS as it has been sort of moving around with you guys in the past year or 2. But wondering if that's -- if you think I'm looking at that correctly?

Whit Kincaid

Yes, I guess it depends on what you want to exclude, Will. So the refinancing, the $7.9 million, that's about $0.05. And then kind of the operating net gains and losses, that's probably another, what, $0.03 in terms of -- if you wanted to back that out. Those are the 2 biggest items.

Will Slabaugh - Stephens Inc., Research Division

Okay, makes sense. And then just broadly speaking, I wonder if you could -- you guys could speak to traffic and sales dynamics throughout the quarter, how they may be played out month-to-month and then just general views about how your consumers are doing this environment?

John C. Miller

It's John Miller. Thanks for the questions. And the quarter was -- let's see, price was -- we're carrying about 1.5x price and that'll be -- so we took a little bit of price mid-year last year then first of the year this year and none in the recent menu print, so it'll be 1.5x that's carrying through the quarter. So obviously -- and then I think you asked month-to-month. I think the best way to answer it is we saw reasonably consistent sales. We led mid-scale throughout the quarter. We're tracking very consistent with the KNAPP-TRACK family numbers, if that helps you answer how we perform.

Will Slabaugh - Stephens Inc., Research Division

Great. And then just last thing for me. I wonder if you could talk to the broader diner positioning that you mentioned a minute ago. You guys have been focusing on it for a while now and just sort of your assessment of how's that resonating, how it's playing out with guests versus some of your peers that have chosen more recently to go to a bit more narrowly market and focus the menu on one daypart or another.

John C. Miller

Well, that's -- it's interesting. In fact, Restaurant News' cover page about 2 weeks ago focused on that. There are narrow menu brands just doing great, and there are really broad strategies that are doing great. So each brand has to decide what's best for its positioning and its consumer. For us, big picture -- and I'll let Whit speak to dayparts a little bit -- but we've seen overall dinner improved. It means the diner positioning is resonating. We think we're just now at the early stages of getting traction for these initiatives. Even though we're quite a number of quarters behind us now, these are modest investments compared to our continued strong investment in the breakfast daypart, and we have a long history many, many, many years of being famous for grand slams in the breakfast daypart. So this is a long, slow building the heritage of the diners, is a long, slow transition -- but we are getting traction from consumer scores around new product introductions, affection for those products and just overall mix has been strong, and that's without the compromise to breakfast. As you know, the pancake promotion we did in Q2 gave us really, really strong breakfast and sequential breakfast numbers year-over-year, quarter-to-quarter. So I'd say in general, big picture, it's faring as we hoped.

Operator

Your next question comes from Michael Gallo with CL King.

Michael W. Gallo - CL King & Associates, Inc.

John, it seemed like the commentary in the release was a little more forthcoming about the opportunities in international. Can you frame a little bit more about what areas you see opportunity? How big can this brand be internationally? Obviously the company has had a presence -- or the Denny's system, I should say, has had a presence in Japan for -- I don't know, since 1984, although clearly you don't get any benefit from it. So I was just wondering if you could just frame for us what the opportunity is. Obviously, the China deal was exciting, but it seemed to me that there's a lot of places around the world that certainly Denny's would have recognition that you don't find a Denny's today.

John C. Miller

Sure, Mike. Thanks for the question. I think the world's getting smaller, actually, and the best way I can frame it is brands that are growing and Denny's is certainly one of those. And we're pleased to be able to say that in this environment -- would just quite naturally, especially with 59 years behind us -- want to explore. And with good reception we've had in the international markets where we currently operate, we just quite naturally want to continue to explore and exploit that with high-quality developers that we've been seeking and lately securing. So as you can imagine, our ambition is to continue along those lines. And when I say the world's getting smaller, I don't think that Asia, the rest of China, Central and South America, Middle East, that's basically where the riper or larger development opportunities exist, certainly as pioneered by QSR, and other American brands that are bigger in their global footprint than we are. So we saw no reason -- especially in light of signing our first China agreement -- not to be forthright with our comments. But we want to do more. We've stepped up our investment to chase it, and we're hopeful that, that will continue to get more results.

Michael W. Gallo - CL King & Associates, Inc.

Okay. John, and then just a follow up on that. Any update on domestic development? How you build the pipeline there?

F. Mark Wolfinger

Mike, it's Mark. On the domestic side here, clearly, as we talked about our guidance, the annual number for openings, obviously, it's still -- most of our openings will be in the domestic U.S. and we haven't moved to offer any new guidance for the year, which is in that 45 to 50 range for openings. Now the first half of the year was a bit light, but -- so the other question might be it looks a little bit back-end loaded on openings, it is. We're watching it very closely, but again maintain our guidance for the year. We continue to see development agreements across the board that takes us probably well over 100 as far as new store openings, as far as in develop agreements. And in fact, the refranchising activity in the second quarter where we talked about some of the markets we sold during the second quarter, both those FGI transactions included new store development agreements with them. So we continue to see an interest there and very excited about that. I think the other comment I'd make on unit openings in the U.S. is we continue to see some very strong opportunities in conversions. So yes, we continue to build greenfield sites, but one of the opportunities that comes out of a tough economic environment from a recessionary standpoint is opportunities to use existing structures, existing buildings out there. And we have seen conversion opportunities certainly in the QSR space and certainly in the video retail space, et cetera. So obviously, maintain our guidance for the year as far as openings.

Operator

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

Anton Brenner - Roth Capital Partners, LLC, Research Division

I have 2 questions. First, Mark, what would be an appropriate tax rate going forward?

F. Mark Wolfinger

Yes, Tony, our guidance for the year is 35% to 40%. This quarter, I know, was a little bit higher than that range. We had a onetime item from the prior year that impacted that. So yes, we're still comfortable with that annual guidance range.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. And then, second, while you are still reporting guest counts and price check averages, I'm kind of concerned with the ongoing decline in customer traffic 3 quarters in succession despite an awful lot of effort devoted to the $2/$4/$6/$8 Value Menu. And just looking back, there's been only one quarter since 2005 with as much as a 2% year-over-year increase. With a commodity outlook for next year troublesome to say the least, and probably some price increases next year being required, it seems like that's going to put even more pressure on that customer count. So you've tried a lot of things and there just doesn't seem to be a lot of traction generating increased traffic. I'm wondering what your thoughts might be.

John C. Miller

Tony, this is John. I believe our strategies are the right strategies. I think it's a very difficult consumer environment and then we continue to track along the lines of casual players where the customer is clearly focused on value right now, and we're working closely with our franchisees to further leverage our Value Menu. Certainly, first half of the year and find ways to more strategically target how that -- those ads and how that messaging takes place now throughout the balance of the year. I think it is, I guess, important to note and certainly not as an excuse by any means as we're very focused on this. But the '05 and '06 period was a period where people were sort of making hay in the industry and taking price and margin, at the expense of traffic, so to some degree, the sin [ph] of full service, and we certainly participated in those days. And then as you know from April of '07 forward, things started to decline, starting at dinner and then all dayparts followed. We went into the recession. And coming out, full service has been a struggle. However, Denny's is closing the gap on it. And we believe that quarter-after-quarter we get closer and closer and expect to ultimately prevail over that particular metric. We're confident we'll get there. We do think it's a tough environment right now. I might also add that the 5 states that hold better than 60% of our units -- California and Texas, in particular -- have shown that they found the bottom some time ago and were quite strong over Q1 and Q2 sequentially. And so these are good signs for our brand. But to your point, we're not there yet.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Quite strong means what exactly, John? There were up in traffic or close to up?

John C. Miller

Yes, Texas and California, were positive in both metrics, comps and track.

Operator

Your next question comes from Mark Smith with Feltl and Company.

Mark E. Smith - Feltl and Company, Inc., Research Division

First question. I know Whit in his commentary talked a little bit about how many FGI transactions you can still have here through the second half. Is 90% still the long-term goal? Is there an opportunity to go higher than that as far as franchise mix? And then secondly, what's your goal in growth for company units? And what type of units do you want these to be?

F. Mark Wolfinger

It's Mark Wolfinger. So I guess we'll start with the refranchising FGI side. I think as Whit commented we've got probably, call it 10 or a few more here that we anticipate in the second half. It'll -- we're at 89% franchised today, that'll pretty much finish out the refranchising activity, or FGI, as the program was called. It'll put us right around 90%. Now per our guidance this year, obviously, virtually all of the new store openings are going to be franchise. So just stepping back for a minute, we anticipate that we'll continue to do, from a company perspective, a flagship or prototype opening -- those things along those lines. As an example, obviously, our company opening plan this year is in Las Vegas where we have strong company operations along the Strip, et cetera. So I think from that standpoint, it's not going to be a perfect 90%-10%. But clearly, as more and more development takes place in the franchise side, that number could shift. But the target all along is at least we get to 90% simply through the refranchising activity. So hopefully, that's the first part of the question. I think the longer term, the aspirational target for our brand that we talked about historically is to get to a net opening number that's in sort of that 50 range. And clearly, as we view that, that's going to take the combination of successes -- that's obviously going to be to continue our traditional openings, we talked about the development pipeline there. John talked about the international spectrum, which has obviously been dramatically increased with the announcement around China. And then the other piece for us is the nontraditional piece, which speaks to the airport location in the Dominican Republic, our campus locations, et cetera. But that 50 net number is long term and we haven't put a specific time frame on that, but long term obviously implies something greater in the next couple of years.

Mark E. Smith - Feltl and Company, Inc., Research Division

If I look at -- you bring up nontraditional. I think John talked earlier a little bit about conversions as an opportunity. Does -- do you want to open some as corporate stores to kind of show best practices? And what kind of results you can get in nontraditional or in conversions and then maybe refranchise those units? Or do you want to focus primarily on bigger flagship-type units.

F. Mark Wolfinger

Yes, I think our focus from a company operation standpoint would be more towards the flagship side. A lot of that nontraditional marketplace sort of has a -- sort of a special type of licensee or franchisee. So as an example, we've obviously had good success on campus but a large part of that campus institutional feeding contract is held by some of our partners like Sodexo and Aramark and Compass. So they service our licensee on campus. Alternatively, we have license relationships with the food service division of the university if they choose to run their own food operations on campus. So again, back to your question, I would say the company development would be more towards the flagship side than the prototype side.

John C. Miller

One thing to add -- this is John -- just talking about company involvement in sort of the evolution of the brand which is not in your question but maybe inferred to some degree -- even in our traditional model, a brand continues to evolve with constant menu rollouts. And with that, there's equipment that modernizes today technology, different POS systems, ways in which you read and take orders. So add those kinds of things that the full service industry has access to those, we do a pretty good job of testing those in company operations, but also with our franchise community. And we found that that partnering with the franchise community is actually better, faster and quicker to get to the bottom line of a robust testing process then holding it at bay on just the company side and then sharing with franchisees later. Doing it together -- with warts and all -- is proving to be we think could be the better practice. And so not having a company operation per se to have your hands all over it to do that with company and franchisee personnel in a franchise restaurant is working really well for us.

Mark E. Smith - Feltl and Company, Inc., Research Division

Great. And then looking at the international pipeline that you've mentioned, I think, John, in your commentary, if we look at the next, let's call it, 12 to 18 months of those 80 unopened, what are we looking at if we call that near term?

John C. Miller

Well, in a room like this I get stares when I talk about anything but the second quarter so it's hard to look out 18 months, and I'm certainly not trying to punt the question. I think it is just a little too early for us to comment at this stage. We're very optimistic about more -- adding more international partners. But until we know the scale of each transaction, it's just too early to guide.

Operator

Your next question comes from Michael Halen with Denny's (sic) [Sidoti].

Michael Halen - Sidoti & Company, LLC

Can you expand a little bit more on the honeymoon period? It seems that your company-owned stores had a pretty nice jump in average unit volumes in the quarter. Can you talk to me -- give us a little bit more color on the honeymoon period for the company stores and also on the franchise stores, if possible?

Whit Kincaid

Yes. Mike, this is Whit. We do a 12-month calculation. So what we see in -- what we've seen with the Flying J units is there's about a 3- to 6-month honeymoon period for these units. So you have kind of a big -- and this is on average -- kind of a big opening, maybe the first couple of weeks, maybe the first month. And then as you comp over that, you might comp negatively over that. Some units might comp positively. We've seen more of an impact of that on the company side and part of this is just a fact -- kind of a law of the numbers. So because we have a smaller company-owned base of units and we've opened -- actually originally opened 29 company-owned Flying J units -- that's had a larger impact on the company comp than it has on the franchise comp on the traffic side. One of the things that's kind of offset that impact on the franchise side is the number of remodels that the franchisees did at the end of last year, kind of completing our refresh program, and which helped carry over kind of into the first and even the second quarter here as well. So that -- there's kind of a differential there between the company and the franchise traffic fees.

Michael Halen - Sidoti & Company, LLC

Great. And can you give us a little more color on how those remodels are going? What kind of returns franchisees might be looking at right now?

Whit Kincaid

Yes, we don't provide that information other than to say it certainly is -- it's on par with kind of the level of investment to make it worthwhile.

Michael Halen - Sidoti & Company, LLC

Okay. And can you -- one last question. Can you give us a little bit more color in terms of the operating gains? I understand that there was 17 company-owned units sold to franchisees. But just by comparison, there were also 17 sold in the fourth quarter of '11, but the operating gains were significantly less in that quarter. Can you give us a little bit more color on that one?

Whit Kincaid

Yes, so there's a couple of things -- so back in 2011, we sold -- I'm trying to get the number off the top of my head. I want to say maybe 5 Flying J units. So that was part of it. Jay [ph] is going to correct me, hopefully. No? So 5 Flying J, and this was in the fourth quarter of 2010 so that certainly -- those units had not been open for a very long period. And then -- so that's part of the driver. And the other piece is this year some of the units have been -- some places like California where we have -- often have a number franchisees who are interested in these units. And that was the case here in the second quarter where these units tend to get higher multiples because they have higher -- more than one bidder they can get a little bidding war going. So we've seen that historically, and we've seen that, I would say, phenomenon certainly in the first and second quarter of this year.

Operator

[Operator Instructions] Your next question comes from Conrad Lyon with B. Riley & Company.

Conrad Lyon - B. Riley & Co., LLC, Research Division

It's a kind of 2-part question on mix. First part is how -- is it more difficult to control mix nowadays in this consumer environment? And the second part is -- and it's really kind of philosophical, say, have a challenging commodity environment next year. Would you try to alter mix depending on how commodities shape up next year?

John C. Miller

So I'll start, Conrad, and there's, I guess, multiple ways to answer. But just the blessing and challenge of 4 dayparts. So we say, is it harder to control [indiscernible] you can move it, but sometimes moving it. So we, as you can tell, we had a little bit smaller mix-shift lift Q2-over-Q2 and Q2-over-Q1. And part of that was we've run with the diner theme for a while and it's time to return to pancakes. So Q2 had a very successful premier on Build Your Own Pancake program followed by the current Tour of America, which has obviously back to some really quality diner programs, but also it doesn't abandon breakfast. You have Philly Cheesesteak Omelette, the Red, White & Blue Pancakes and we have a Southern Slam for $5.99 value offering. So in a tough economic or value season, those start to pick back up again. So we had the pancake module which is a little lower than module 1 Skillets and we went into this one and $2/$4/$6/$8 kind of popped up a little bit plus the Southern Slam at only $6 on the LTO menu sort of stole a little bit of that mix lift. So we're actually getting pretty good at this but part of it is a mixed strategy and part of it's a price strategy. And so when transactions are soft, as Tony pointed out just a little while ago, we want to be careful here not to push the lid off. And it's a balancing act. But it's a very good question. And Whit, do you want to add to that?

Whit Kincaid

Yes, the only thing I think I would add to it, Conrad, as you probably heard us talk about this before, is we try to look at it as the whole entity. Like John said, all 4 dayparts, everything kind of playing together in concert. So that is kind of the way we think about it. So hopefully -- and certainly, commodities comes into play in some respects as well.

Conrad Lyon - B. Riley & Co., LLC, Research Division

Yes, got you. Okay. Last question. You may have talked about this in the past. As -- I'll use the term, I guess, recycle stores, new stores, some stores come off, is there a -- do you see a changing demo in your customer at all, where you might desire to go in a different trade area? Or are your trade areas that you desire to go into pretty much the same as before?

John C. Miller

Yes, I will just say that when we have a 59-year history with 1,700 units -- near 1,700 units and near 60th anniversary, and with that we have just about every kind of trade area you can imagine. So obviously, larger footprint brands get closer to the middle of America. So one might say you have a working-class consumer in Certainville, America, that's really the laws of averages. In an upscale neighborhood, we serve upscale consumers. So I would say that our strategy is to fill in places where we're not, and which by its very definition, we'll continue to redefine our customer list [ph] -- who need a family dining experience.

Operator

At this time, there are no further questions. I would now like to turn the call back over to management for any closing remarks.

Whit Kincaid

Thank you, Lacy. I'd like to thank everyone for joining us on our second quarter earnings call today. We look forward to our next earnings conference call to discuss our third quarter 2012 results. Thank you, and have a great evening.

Operator

Thank you for participating in today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Denny's Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts