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Denny’s Corporation (NASDAQ:DENN)

Q3 2012 Earnings Call

October 30, 2012 5:00 PM ET

Executives

Whit Kincaid – Senior Director, IR

John Miller – President and CEO

Mark Wolfinger – EVP, Chief Administrative Officer and CFO

Analysts

JR – Stephens

Mark Smith – Feltl & Co

Conrad Lyon – B Riley & Co

Tony Brenner – ROTH Capital Partners

Michael Gallo – CL King

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Denny’s Third Quarter 2012 Earnings Release. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn today’s presentation over to Mr. Whit Kincaid, Senior Director of Investor Relations. Please go ahead.

Whit Kincaid

Thank you, Susan. Good afternoon, and thank you for joining us for Denny’s third 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 third quarter results. I will conclude the call with a commentary on Denny’s 2012 full-year guidance and initial thoughts on 2013. As a reminder, we will be filing the 10-Q by the due date of November 5, 2012.

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 knows 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 Miller

Thank you, Whit. Good afternoon, everyone. In the third quarter our adjusted income before taxes increased 9% and we generated almost $13 million of free cash flow. It is a testament to the resilience of our almost 60-year-old brand that we have been able to achieve these results despite the ongoing challenging consumer economic environment. Our franchise-focused business model provides financial stability and flexibility while enabling us to generate significant free cash flow that can be used to further strengthen our brand and increase long-term shareholder value.

While we achieved our sixth consecutive quarter of system-wide same-store sales – positive system-wide same-store sales, we’re not pleased with the sequential decline in same-store traffic. We are confident that we have the right brand-building strategies in place to enable us to continue to revitalize and grow the Denny’s brand. We see evidence that we are moving in the right direction with our positive sales performance relative to key industry benchmarks and the positive results we are seeing in key states like California and Texas, where we have nearly 600 locations and are seeing improvements in employment.

We continue to focus on evolving to better meet the needs of our guest at our franchisees. Next week we’ll have the Denny’s Annual Franchise Convention hosted by the Denny’s Franchisee Association. Our partnership is as strong as ever and we are eager to continue to move the brand forward despite the headwinds. We remain focused on executing against our three key objectives implemented to help Denny’s grow our position as 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 family favorites and indulgent items served in a come-as-you-are friendly and inviting atmosphere. With our America’s Diner brand positioning as our compass, we are in the early stages of effectively broadening our approach from the more narrowly focused breakfast-all-day platform.

Contributing to our third quarter results was our continued focus on our tiered pricing strategy designed to deliver both compelling new product offerings and everyday affordability, as well as drive sales beyond breakfast. Everyday affordability is regaining its prominence with our guest, who continue to seek value to meet their own economic challenges.

In response, we have been moving towards a more targeted everyday value strategy, leveraging the attractive pricing tiers in our popular $2 $4 $6 $8 Value Menu. As part of this effort we refreshed a few of these products, placed more pictures on the menu, and increased our media support for our value messaging. These efforts have helped increase the mix of our $2 $4 $6 $8 Value Menu from under 16% in the second quarter to over 18% by the end of the third quarter.

We will continue to work closely with our franchisees to leverage one of the most recognizable everyday value platforms in full-service dining. Our tiered pricing strategy helps balance the impact from our increased focus on everyday affordability by driving trades at the higher-priced limited-time-only products such as the “Build Your Own Burger”.

Favorable product mix added 80 basis points to our guest check average compared to the prior year quarter, affirming that can we have – that we can have success with our multi-tiered approach. We believe that the key to our collective success will be the balance of everyday affordability and limited-time-only products. Our limited-time-only offerings leverage Denny’s core strength as a diner and drive consumer interest, while delivering an enhanced dining experience for our guest. We launched our Build Your Own Burger and Milk Shake limited-time-only module towards the end of the summer and we will conclude the program at the end of next week.

Our guest have had great things to say about Denny’s burgers and milk shakes and have consistently said that they want the ability to customize and personalize their meals. Our Build Your Own Burger module provides an opportunity to spotlight great, beyond breakfast items at Denny’s, while the Build Your Own Milk Shake provided great upsell opportunities.

Although we saw a sequential decline in same-store guest traffic, we were pleased with the favorable trades positively impacting our guest check average and positive feedback we received from our customers. We built further credibility with our traditional breakfast users and enhanced our beyond breakfast appeal. Based on this success, we are adding the new Build Your Own Burger platform to our new core menu to be launched in January.

And we are excited about our final marketing module for 2012 to be launched next week. We are partnering with Warner Bros. as the exclusive restaurant brand for the movie, The Hobbit, which will release globally on December 14. This is the long-awaited prequel to the Lord of the Rings trilogy, which grossed nearly $3 billion and has over 10 million Facebook fans. The Hobbit has an equally broad following in its own right as the fourth bestselling novel of all time.

Inspired by Hobbit’s love of comfort food and their extra-dining occasions, the limited-time menu will feature a host of familiar holiday favorites along with new, inventive taste. Some of the new Hobbit-inspired additions are our new Sausage Skillet, Seed Cake French Toast, Hobbit Hole Breakfast and a Pot Roast Skillet. Additionally, our guest would be treated to an enhanced in-store experience, complete with limited edition trading cards and digital content exclusive to Denny’s.

The combination of crave-able new products for all day-parts and exclusive only at Denny’s content represents yet another way Denny stands out in this all-for-competitive-environment with the goal of course of driving additional frequency into our restaurants during the holiday season.

These and other strategies are designed to reestablish Denny’s as a dining destination, not only for breakfast but beyond. Our goal is to generate sequential improvements in system-wide same-store traffic and sales. We believe we have the right brand-building strategies in place to drive the improvements that we seek and we are working closely with our franchisees to continue to revitalize the Denny’s brand.

Our second key objective is to continue the growth of the Denny’s brand through traditional and non-traditional venues, both domestically and internationally. We opened 12 franchise units in the third quarter, including the first international university unit located in Canada at the Southern Alberta Institute of Technology.

This is the fifth unit opened by the Compass Group, who will leverage our fast casual format and the Denny’s All Nighter branding. We continue to make significant progress expanding the Denny’s brand internationally with the right franchise partners, and our newest partner in South America is further evidence of our momentum.

Our development agreement with the Musiet Group to open 10 units in Chile marks Denny’s first expansion in South America. The Musiet Group is a family-operated company with diversified holdings throughout Chile, which include both the master franchise for Ruby Tuesday.

We expect Musiet Group to leverage Denny’s full-service format as a local diner with its strong breakfast heritage and anticipate their first restaurant to open late next year or early 2014. The partnership for Chile takes our international development pipeline to around 90 unopened units, primarily in China, Canada and Central America. We are aggressively looking for well-capitalized experienced partners throughout Southeast Asia, South America, the Middle East and other parts of the globe.

We have global ambitions and are moving aggressively to grow Denny’s existing 97 international locations to a much larger global footprint. We believe there is a significant untapped potential for the Denny’s brand outside of the US as evidenced by our large US exposure in international tourist areas like Las Vegas, Orlando, Miami, and Southern California. In addition, our current international units average almost $2 million in annual sales, which is significantly higher than the system-wide average in the US.

Our third key objective is to grow profitability and free cash flow through our franchise-focused business model. Though the first three quarters of this year – or through the first three quarters of this year, our adjusted income before taxes has grown 30% and we have generated around $42 million of free cash flow. Denny’s continues to demonstrate its ability to steadily grow sales and profitability, while generating significant free cash flow. This enables us to continue making investments in the brand, while also strengthening our balance sheet through debt repayments and returning value to 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.

Mark Wolfinger

Thank you, John and good afternoon everyone. Our positive third quarter and year-to-date same-store sales performance in the face of an ongoing challenging economic environment reflects the strength of our franchise-focused business model. In the third quarter, system-wide same-store sales increased 0.4%. This is the sixth consecutive quarter that system-wide same-store sales have been positive.

Same-store sales at company restaurants decreased 0.5% compared to the prior year quarter. The decrease was driven by a 2.2% decrease in same-store guest counts, which was offset by a 1.8% increase in the guest check average. The higher guest check average included a 1% increase from menu pricing. Same-store sales at franchise restaurants increased 0.6% and was primarily driven by around a 1.5% increase from menu pricing, offset by lower same-store guest counts.

Denny’s total operating revenue, including company restaurant sales and franchise revenue, decreased $15.7 million compared to the prior-year quarter, primarily driven by a decline in company restaurant sales in the quarter.

Sales of company-owned units decreased $18.1 million, primarily due to 49 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 re-franchising strategy we call FGI. In the third quarter, Denny’s opened 12 new franchise units, closed 9 franchise and company units and sold five company-owned units to franchisees leading to an increase of three net system units this quarter.

I’ll now review the quarterly operating margin table provided in our press release. The third quarter company restaurant operating margin of 14.7% represents a 0.6 percentage point increase compared to the prior-year quarter and was primarily impacted by the following items: Product cost increased 0.1 percentage point to 24.8% of sales, primarily due to the impact of increased commodity costs. Payroll and benefit costs increased 0.3 percentage points to 39.7% of sales, primarily due to a $1.3 million or 1.5 percentage point increase from unfavorable workers’ compensation claims development in this quarter, partially offset by improved labor efficiency.

Other operating cost decreased 1.0 percentage point to 14.1% of sales, primarily driven by a higher new store opening expense in the prior-year period. In addition, utilities decreased 0.3 percentage points compared to the prior year period, primarily due to lower natural gas rates.

In summary, the gross profit from our company operations decreased $2 million to $12.8 million, a sales decline of $18.1 million. For the third quarter of 2012, Denny’s franchise and license revenue increased 7.3% to $34.4 million. The $2.3 million increase in franchise revenue was primarily driven by a $1.2 million increase in occupancy revenue, which is primarily the result of selling company-owned units to franchisees where we are now collecting rent on these properties.

In addition, there was a $900,000 increase in royalties from 60 additional franchise equivalent units and the effects of higher same-store sales in the current year quarter. Franchise operating margin increased $1 million to $22.3 million in the third quarter. This increase was primarily driven by the items previously mentioned, but was offset by a $700,000 increase in occupancy cost and a $700,000 increase in direct franchise cost.

Franchise operating margin as a percentage of franchise and license revenue decreased 1.5 percentage points to 64.9% compared to the prior-year quarter. The franchise side of our business contributed 64% of the total operating margin in the third quarter, which was $9.5 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 16.3%, a decrease of 0.2 percentage points compared to the prior year quarter.

Total general and administrative expenses for the third quarter increased $1.4 million from the prior-year quarter, primarily due to an increase in performance-based compensation accruals relative to the prior-year period. Depreciation and amortization expense declined by $1.7 million compared with the prior-year quarter, primarily as a result of the sale of company-owned restaurants over the past two years.

Net operating gains, losses, and other charges, which include restructuring charges, exit costs, impairment charges, and gains or losses on the sale of assets, decreased $1.6 million compared to the prior-year quarter. This decrease was primarily driven by lower gains on the sale of company-owned units to franchisees and higher restructuring cost. Interest expense for the third quarter decreased $1.7 million to $3.1 million as a result of a $37.4 million reduction in total gross debt over the last 12 months and lower interest rates under our new credit facility.

Our effective income tax rate was 37.4% in the third quarter which was substantially higher than the effective tax rate of 4.8% in the prior-year quarter. The change in the 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 $500,000 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.

Denny’s is a reenergized brand with a franchise-focused business model which provides stability to our profitability and cash flows, while generated excess cash that we’re using to further strengthen our balance sheet and return value to our shareholders through share repurchases.

In the third quarter, adjusted income before taxes increased 9% to $13.1 million. We generated $12.9 million of free cash flow in the quarter and have generated $41.5 million of free cash flow through the first three quarters of this year. The free cash flow has allowed us to continue to strengthen our balance sheet, as we have repaid $7 million in term loan debt in the third quarter, bringing our total term loan debt repayment to $64 million since the beginning of 2011.

We have reduced total debt by over $350 million since early 2006 and now have less than $200 million of total debt, including outstanding term loan debt of $176 million. Our total debt to adjusted EBITDA ratio is now around 2.4 times. As a reminder, the next total debt ratio threshold in our new credit agreement is 2 times, which we anticipate achieving sometime in 2014.

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 spinning cap of $34.8 million for share repurchases and dividends, which will be eliminated with a total debt ratio below 2 times. At that point, the only restrictions will be the $19 million annual debt amortization and having a 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 retaining debt. In the third quarter of this year we used $4.8 million of cash to purchase 1 million shares, which completed the 6 million share repurchase program authorized in April of 2011.

As of October 26 we have repurchased approximately 10 million shares since initiating the share repurchase strategy. We now have 5 million shares remaining in our authorized share repurchase initiative. 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 third quarter results. I’ll now turn the call over to Whit, who will comment on our updated guidance for 2012 and initial thoughts on 2013.

Whit Kincaid

Thank you, Mark, and good afternoon everyone. Based on year-to-date results and management expectation at this time, Denny’s is updating its full year 2012 financial guidance to reflect the third quarter same-store sales results, the $1.3 million of unfavorable workers’ compensation claims development in the third quarter, and our current expectations for the fourth quarter. There remains a great deal of volatility around same-store sales, given the ongoing challenging consumer economic environment.

In addition, the month of December was one of the strongest same-store traffic months we saw in 2011 which included positive impacts from weather and around a 100 refreshes and remodels completed at franchise units in the fourth quarter of last year. We now expect annual franchise same-store sales to range from positive 1% to positive 1.5%, and annual company same-store sales to range from flat to positive 0.5%. Our current thinking is that commodity inflation for 2012 will end up around 2%. We are currently locked in to more than 90% of our needs for this year.

Based on our current thinking, we believe that commodity cost pressures in 2013 will provide a headwind for us in the 3% to 5% range. We are currently locked into around 25% of our needs for next year. Although we achieved our target of being 90% franchised in the third quarter, our goal remains to complete the FGI program by the end of 2012. We anticipate selling an additional five to 10 units in the fourth quarter.

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 7.8%, our annual guidance for capital spending remains $15 million to $16 million. As a reminder, the fourth quarter timing of our capital spending is primarily driven by the timing of the opening of the company-owned unit in downtown Las Vegas, and remodels at company-owned units.

We currently expect to open 46 to 48 new units this year including the company-owned unit in downtown Las Vegas which is scheduled to open mid to late November. We anticipate achieving net system unit growth of 10 to 15 units this year, which would deliver our strongest year of net system growth since 2000 if you exclude the Flying J conversions opened in 2010 and 2011.

Although our updated adjusted EBITDA guidance of $77 million to $80 million is lower than 2011, our adjusted income before taxes guidance of $45 million to $48 million represents more than a 20% annual increase compared to 2011. This reflects the benefits of our shift to a franchise-focused business model.

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 the line of Will Slabaugh with Stephens.

JR – Stephens

Hey guys, this is JR here on the call for Will. I was just wondering if you could speak to the traffic and sales dynamic throughout the quarter and maybe how it played out month-to-month. And as a follow-up, maybe if you could talk to trends in September and October and kind of talk to trends going into 4Q.

John Miller

Sure. This is John. Thanks for the question. We saw the softest part of the quarter in and around the Olympics basically. So July and September were actually positive, and then we had a tough August. And then coming into this quarter, we’ve seen more of a reversal of trend back in favor. So, from a – to answer your question directly, we see an improving fourth quarter, but at the same time we see some tough headwinds. December was very good weather last year, and our overall fourth quarter last year was a strong quarter at up 16 you remember. So, I think that basically give you a direct answer to that question.

JR – Stephens

Great. And kind of on the same lines, similar to the Olympics, I was wondering if you could speak to, were the debates a headwind for you as well?

John Miller

It was hard to – I would say, no, they were not.

JR – Stephens

Okay. Thanks, guys.

Operator

Your next question comes from the line of Mark Smith with Feltl and Co.

Mark Smith – Feltl & Co

Hey, look Whit, can you give us an update on remodels, where we are and sort of left coming from the remodel program?

John Miller

Sure. This is John again. The remodel program, you recall we went – coming out of the recession, went through a two-year period where we had to buy. We had a little north of 300 units signed out for a remodel program we called New Day, which is a little bit of a lighter scope than the normal full remodel scope you might expect in a full service establishment – gave our franchisees a break to get through a tough period. And we started, beginning of this fiscal year, at – back in January a full remodel scope. So again, our remodel cycles are about every seven years and we have a portion of those on a five-year cycle.

In the fourth quarter of 2011, we completed around 100, 132 so far in 2012, and about 150 refreshes completed during the same period. So, all in all, this year you see us wrapping up the New Day program and backing the full remodel cycle. So we expect that obviously to continue into next year and beyond.

Mark Smith – Feltl & Co

Any commentary on any sort of left or positive results (inaudible)?

John Miller

I’d say it’s sort of industry norm. We are pleased with the lift, and it does – it does have an adequate industry sort of normal ROI.

Mark Smith – Feltl & Co

And then can you talk about, as we look at menu pricing, traffic being down in the quarter, what’s your availability on taking price, especially with commentary on 3% to 5% kind of headwinds next year on commodities?

John Miller

We’ve been watching price carefully as you know. We think we’ll finish this year in and around the 2% range, which is a whole lot better than where we started. The first quarter was the toughest. It got a little easier as the year went on. I think our highest overall commodity inflation was in the first quarter in that 4% to 5% range and this just softened as the year went on. So looking out for next year, we think we are facing, some say as high as another 4% to 5%, and obviously we’ll do our best to mitigate that and how we cover them by. We do plan to take a small price increase in the early part of the year and want to keep that as nominal as possible, but understand in light of the commodity headwinds that our franchise community will expect some relief. And so that’s what our plan is at this point.

Mark Smith – Feltl & Co

First one for Mark. Any insight you can give us on tax rate, maybe the best way to look at that?

Mark Wolfinger

I mean I think as I mentioned in my comments, on tax rate, we’ve continued to see sort of a more normalized tax rate, obviously up to the deferred tax asset change at the end of last fiscals. I think from a directional standpoint, I think our year-to-date rate is in sort of I’ll call it around 39.5%. But I think as we mentioned, because of the number or dollar amount of operating losses that we have, we don’t anticipate paying any kind of significant cash taxes for the next several years. So, again a more normalized rate sort of in that 40ish range I’ll say, but as far as cash taxes, pretty limited over the next several years.

Mark Smith – Feltl & Co

Great. Thanks guys.

Operator

Your next question comes from the line of Conrad Lyon with B. Riley & Co.

Conrad Lyon – B Riley & Co

Thanks, guys. First of all, congratulations on showing some positive stockholder equity. It’s been a long time. Let’s see.

Mark Wolfinger

Morning. We commented on as well.

Conrad Lyon – B Riley & Co

Yes.

John Miller

That’s good. You looked at the balance sheet. That’s really good.

Conrad Lyon – B Riley & Co

Thanks. All right, question on the guidance. Okay, that – this, the same-store sales guidance, low end has kept intact. As it relates to the EBITDA guidance coming down, is there some other cost not directed towards sales or aligned with sales that’s coming in there? I know you talked about the workers’ comp, but perhaps can you point us to something else that’s influencing...

Mark Wolfinger

Yes, Conrad I think it’s probably – so G&A, we originally guided to be $3 million to $6 million higher than the prior year. Kind of our updated thinking is towards the high end of that range; it’s around $60 million to $61 million for the annual number, and that’s total G&A...

Conrad Lyon – B Riley & Co

Okay.

Mark Wolfinger

That we report. So that might be the – one of the items that you are speaking about.

Conrad Lyon – B Riley & Co

Gotcha. Okay, fair enough. Question on The Hobbit program, is that intended to attract a whole new demo to the company or is it to enhance perhaps existing traffic, or both?

Whit Kincaid

Yes. That’s a great question. I think this is – think of it as an opportunity; this is the blockbuster. It’s predicted to be – certainly, we have a lot of confidence, that’s true. The producers thought Denny’s as an appropriate fit for the family audience, and we do – one of our primary audience is families out with their kids. We have other audiences that are important to us, no question; Hispanics, Boomers, Millennials that don’t cook tend to score Denny’s pretty highly. But The Hobbit will feel the families. The trading cards we think is the nice benefit; it’s unique to Denny’s. It’s an opportunity for us to sell skillets and platters and breakfast items that cover lots of day-parts with a very popular movie, with Hobbit’s that eats selling on today. So what could be better than that?

But I think another way to look at it is, it’s another very well orchestrated limited-time offer that touches all the key points where Denny’s – where we’re trying to take our brand. One other interesting point is that the collaborative work between our operation’s Brand Advisory Council with our franchisees and the operations – or the Marketing Brand Advisory Council with our franchisees participating has been extraordinary to come up with this module. And we think the work is very good, from pricing, to an array of pricing, to tiered pricing, to value offerings, to consumer appeal, and the food is really good; it’s really good. So we’re excited about it and we’ll see what happens.

Conrad Lyon – B Riley & Co

Yes, same here. In terms of – from a financing standpoint, was there any of costs that were supported by Warner Bros, or is it predominately Denny’s?

Whit Kincaid

No. So we have access – so we – we’re – our investment in this module is about the same as the white – five modules up and it’s about what it is. And then – but we get the tag-on benefit. So part of that investment, from banner ads to social media to different ways in which we engage and let the public know that we have a Hobbit tie-in would be inside us – our normal module investment. And I think the – I think that’s – I think that covers it.

Conrad Lyon – B Riley & Co

Got you. Got you, fair enough. All right. Different question here is just on units, your next job, replenishing franchise stores. Question just about company stores, is more a refresher. Understand the decision to go to the franchise-loaded model, but is there a absolute number of company-owned stores you’d like to settle in at some point in the future, even with – taking the account store closures and that type of thing?

Whit Kincaid

Well, you always idealize – we want to build a lot more Denny’s. The – so from the company standpoint, we really look at optimizing efficiency; marketing, supervisory efficiency, and then optimizing that, which franchisees be motivated or incented to build out a market. So, our FGI program as we’ve said a number of times really materially comes to a close at the end of this year. So that puts us right at the 90/10 number.

And then as we grow from here, we’re looking at one to two units of growth a year. And so obviously with that 90 number, we’ll slowly fade off of that. And so what’s optimal would be a different question for each year’s cycle. It will come off of the 90/10, but we like having a good base of company units; we like having a material numbers towards 150 or north of that. We like the everyday weight on our shoulders of P&L management and commodity pressures. We like to be able to relate to our franchise community with P&L burden and not just franchise relationship burden. So we think that makes us a better franchisor.

Conrad Lyon – B Riley & Co

All right. That’s helpful. Thank you very much.

Operator

Your next question comes from the line of Tony Brenner with ROTH Capital Partners.

John Miller

Hi, Tony.

Tony Brenner – ROTH Capital Partners

Thank you. Good afternoon.

Mark Wolfinger

Good afternoon.

Tony Brenner – ROTH Capital Partners

You mentioned that the macroeconomic drought area is getting better in California and Texas, where there are – I believe there are a large number of company-operated restaurants. And you also mentioned that there are – the $2 $4 $6 $8 Value Menu is increasing as a portion of the sales mix, yet your guest counts continue to decline four quarters in a row, which is depressing company same-store sales. I wonder if you can elaborate on some of the reasons for that.

John Miller

Yes, we’ve been able to grow check pretty dramatically. We had a nice check bump in the Build Your Own Burger and the Adam Shakes sales. They got actually high value scores and intense returns and customers like what was going on. As I mentioned earlier, July and September were actually positive months, although the traffic was negative. We had a tough August on the Olympics. We also think that the environment is just that choppy right now. With August, with difficult times staying in the normal rhythm of your marketing buy we pulled off. Normally we’ve been on air during August at the Olympics. Costs are a little high.

We think that disruption of rhythm may be playing a role in that. It’s hard to say. What I would say is, we see the momentum reversing. It is interesting that we are learning to get pretty good at this, that when we feel like the traffic stimulator of $2 $4 $6 $8 needs revved up we can also have the non $2 $4 $6 $8 buyer bill their check. So while check expanded, call it just nearly 2%, we were able to grow check even though the instance of $2 $4 $6 $8 went up. So ultimately, we believe these strategies resulted in sequential traffic and – positive traffic and positive comp performance. It’s just not appearing yet, as you pointed out.

Tony Brenner – ROTH Capital Partners

Well, I mean it’s – the gap of four consecutive quarters, it’s hard to bring that on the Olympics modules. Do you...?

John Miller

That’s right. It’s – these efforts take time, and positive comps at the first step, positive traffic is what we’re all focused on at the moment.

Tony Brenner – ROTH Capital Partners

Thank you.

Operator

(Operator instructions) Your next question comes from the line of Michael Gallo with CL King.

John Miller

Mike?

Mark Wolfinger

Hey, Mike.

Operator

Michael, your line is open.

Michael Gallo – CL King

I think I had you muted. Can you hear me okay?

John Miller

Yes.

Mark Wolfinger

Yes, we can hear you.

Michael Gallo – CL King

Yes, okay. My question is on the marketing spend. I think you spent about $700,000 or so less in marketing this year. I know some of that’s from the FGI shift. But you alluded to spending less in August around the Olympics. I was wondering if some of those dollars end up being shifted into the fourth quarter, or do you expect marketing spend for this system year-over-year to be up in Q4? Thanks.

John Miller

Yes. So August was lighter, but overall each module is about the same. The net result, that was, the fourth quarter did get slightly more than last year.

Michael Gallo – CL King

Okay, great. And then just a follow-up question. A little pressure on the franchisee – on the franchise operating margins. What was that due? Was that due to some of the international initiatives, or I guess a little bit of pressure there in margins?

Whit Kincaid

Yes, Mike, this is Whit. So the primary drivers of the increase in the franchise G&A was there are a number of factors, but primarily was payroll and benefits, and that includes higher performance-based compensation and it also included a one-time accrual reversal. It was less than a couple 100,000, but was also another contributor to the year-over-year increase.

Michael Gallo – CL King

All right, great. Thanks very much.

Operator

Your next question comes from the line of (inaudible).

Unidentified Analyst

Hello, I would first like to congratulate all of you on a great quarter. And my question is, with you guys doing a $6 million buyback at least two times in a row, have you considered perhaps doing a $0.32 million or maybe $0.34 dividend?

Mark Wolfinger

Farhan, its Mark. How are you? And thank you for your comments, appreciate that. The – first, on the $6 million, those were – that was the share authorization, not the dollar amount but the share amount, and...

Unidentified Analyst

Oh yes; yes, that’s actually what I meant, the $6...

Mark Wolfinger

Right, right. So...

Unidentified Analyst

The $6 million share buyback.

Mark Wolfinger

Right. I think as I mentioned we basically had – you had sort of three tranches of authorizations, that was 3 million shares, 6 million shares, another 6 million. And in my comments I mentioned we’ve closed out the first 6 million authorization. We obviously had closed out the 3 million share authorization and we’re now sitting around 10 million shares in total buyback.

Your question about dividend, I think the good news here is obviously we’re very pleased with our continued free cash flow numbers that both John and I mentioned and Whit mentioned as well in his guidance. Right now, the focal point for us continues to be obviously our debt amortization, which is a fixed amount of 10% of the term loan debt and that was the new transaction we put in place in April of this year and then obviously continuing our share buyback.

We do have the flexibility to certainly pay dividends. That’s something that we, from time-to-time discuss internally between management and the board, but at this point our focus is a combination of the debt reduction. And I mentioned the fact that when we get under-toolevered there is benefits obviously to that lower leverage ratio, both in the cost of our debt as well as the use of excess free cash flow. And then obviously the other part of our focus is continued share repurchase. So that’s currently where we stand. Obviously changes could happen in the future, but right now it’s a combination of debt reduction and share buyback.

Unidentified Analyst

Okay. And I appreciate that. Just one last thing was, when you go to the website of dennys.com – this is just a suggestion of course, you guys could think about it is, maybe on the top left side you can have something, ‘investments’, so therefore when you get the tremendous amount of people that come on your website they know that not only they can eat there, they can actually invest in your company.

Whit Kincaid

Yes, now, thank you Farhan for the feedback. Yes, we’re looking at making some improvements to the website as well as a connection to the Investor Section. It’s just...

Unidentified Analyst

Okay, is – thank you, a appreciate that.

John Miller

Yes. Thank you for your support. We appreciate it.

Unidentified Analyst

Okay.

Operator

There are no further questions at this time. I would now like to turn the floor back over to Mr. Kincaid for any closing remarks.

Whit Kincaid

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

Operator

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

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