Denny's Corp (DENN) 2012 Q2 法說會逐字稿

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. 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)

I would now like to turn the call over to Mr. Whit Kincaid, Senior Director of Investor Relations. Please go ahead, sir.

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 the10-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 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 the form 10-K for the year ended December 28, 2011, and any subsequent quarterly reports on form 10-Q.

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

Good afternoon, everyone.

We are pleased with our second quarter results as we continue down the path of re-energizing 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 a challenging economic environment.

We are most appreciative to our loyal guests for their guidance and their response in re-energizing Denny's. 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. We remain focused on executing against our three 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, [predictable] cooking of family favorites, and indulgent items served in a come-as-you-are, friendly and inviting atmosphere. We now have six, now going on seven quarters under our belt with our America's Diner brand positioning efforts. With this as 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 up-sale opportunities. The module performed well as we saw higher than expected numbers of customers ordering our signature pancake creations rather than build their own creation. We were also pleased to see that our Breakfast day part traffic increased sequentially and was the strongest performing day part in the quarter.

As we entered the summer season, we brought back our successful Tour of America module, which will run into mid-August. Back by popular demand are the classic diner items like the Philly Cheese Steak Omelette and the Midwestern Meat & Potatoes Sandwich, with new additions to the line-up like the Red, White & Blue Pancake Breakfast, Malibu Fish Tacos, Brooklyn Spaghetti & Meatballs, our Southern Slam and the Florida Sunshine Salad.

For check-driving add on sales, we brought back the popular Strawberry Pancake Puppies and introduced a new Red Raspberry Smoothie, along with a new and innovative dessert, the Apple Crisp Milkshake Parfait. Most importantly, we are pleased to report that 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 dinerisms, 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 expeditor counters in all restaurants to add a little home-grown attitude to the Denny's experience.

We are 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, built 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 2468 menu by highlighting the specific items like the $4 Everyday Value Slam and the $4 Build Your Own Chicken Wraps through both national and local media.

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

We continue to execute our marketing strategies to help re-establish Denny's as a dining destination. Although we are disappointed that our system-wide same store sales declined sequentially, we're quite pleased to achieve the highest quarterly two-year same-store sales in almost five years. We believe we have the right brand building strategy 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 nine franchise units in the second quarter, including two international units in Canada and the Dominican Republic. Our first unit in the Dominican Republic is with one of our newest partners and represents 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's 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, and success we've had with recent openings in Canada, Honduras, Puerto Rico, Costa Rica and the Dominican Republic.

We have been placing more time and resources towards building our development pipeline outside the US, which led to signing the brand's largest international development agreement to date. We are participating with Great China International Group to develop 50 new Denny's restaurants in six 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 our scale in the US 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 talent and 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 head winds, 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 for debt repayment and returning value to the shareholders through our share repurchase program.

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

Thank you, John and good afternoon, everyone.

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 re-energized brand with a franchise-focused business model which provides stability to our profitability-can 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.

The second quarter system-wide same-store sales increased to 0.8%. Same store sales at franchise restaurants increased 0.9%, and same store sales of company restaurants were flat compared to the prior-year quarter. This is the fifth consecutive quarter that system-wide sales have been positive, and the strongest two-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 for 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 is driven by the honeymoon period, 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 open 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 counts 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 on-going re-franchising strategy we call FGI. In the second quarter, Denny's opened nine new franchise units, closed five franchise and company units, and sold 17 company-owned units to franchisees, leading to an increase of four net system units in 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 reported in the prior-year quarter.

Other operating costs decreased 1.3 percentage points to 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 six 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 the 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 was 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 contributes 62% of the total operating margin of 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 to $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 to 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 reflect restructuring charges, exit costs, impairment changes and gains and 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, while 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 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. This resulted in a charge of $7.9 million for the unamortized portion of deferred financing costs and original issued 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 one-time 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 pretax income.

Through the use of net operating loss carry-forwards, we only paid $1.2 million in cash taxes this quarter. We will continue to utilize additional net operating losses and income tax credit carry-forwards 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. 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 2.5 times. As a result of achieving a total debt ratio of below 2.5 times, our interest rates 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 2.0 times, 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 a total share repurchases and dividends, which will be eliminated with a total debt ratio below 2 to 1, or two times. At that point, the only restrictions will be the $19 million annual debt amortization and having the minimum of $20 million of availability on a revolver.

Since November 2010, we have been returning value to shareholders through share repurchases in addition to repaying debt. 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 a stronger franchiser and return value to our shareholders. That wraps up my review of the first quarter results, second quarter results, and I'll turn the call over to Whit who will comment on 2012 guidance.

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, changes I just noted, Denny's is reiterating its guidance ranges for the full year. That wraps up our guidance commentary.

I will turn the call over to the operator to begin the Q&A portion of our call.

(Operator Instructions)

Will Slabaugh, Stephens.

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

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 the operating net gains and losses, that's probably another, what $0.03 in terms of if you want to back that out, those are the two biggest items.

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

Will, it's John Miller, thanks for the questions, and the -- quarter was let's see, price was -- we're carrying about 1.5 price, mid year last year, then first this year and none in the recent menu print. So it will be about 1.5 carrying through the quarter, so obviously -- and then I asked you asked month-to-month. I think the best way to answer it, we saw reasonably consistent sales. We led mid-scales throughout the quarter. We're tracking very consistent with the Knapp Track Family numbers if that helps you answer how we performed.

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

That's interesting. In fact, the Restaurant News cover page about two weeks ago focused on that, there were narrow menu brands just doing great, and their really broad strategies are doing great, so each brand has to decide what's best for its positioning and its consumer. For us, big picture in all that, Whit speaks to day parts a little bit, but we've seen overall dinner improve, which 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 cared to our continued strong investment in the breakfast day part, and we have long history, many years of being famous for Grand Slams and the breakfast day part.

This is a long, slow -- building the heritage of the diner is a long, slow transition, but we are getting traction from consumer scores around new product introductions, affection for those products and then just overall mix has been strong. That's without the compromise to breakfast -- as you know the pancake promotion we did in Q2 gave us strong breakfast and sequential breakfast numbers year-over-year, quarter-over-quarter. I'd say in general, big picture, it's faring as we hoped.

Great, thank you.

Michael Gallo, CL King.

Hi, good afternoon. Congratulations on good results. 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? The Denny's system has had a presence in Japan since 1984. Although clearly you don't get any benefit, so wondering if you could frame for us what the opportunity is. Obviously the China deal was exciting, but seemed to me that there's a lot of places around the world and certainly Denny's would have recognition that you don't find at Denny's today.

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 and with good reception we've had in the international markets where we currently operate, we just quite naturally, we 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 this Asia, the rest of China, Central and South America, Middle East, that's where the riper, larger development opportunities exist. Certainly as pioneered by QSR and other American brands that are bigger in their global footprint than we are. We saw no reason, especially in light of the signing of our first China agreement not to be forthright with our comments. We want to do more. We've stepped up our investment to chase it, and we're hopeful that, that will continue to give more results.

John, then just a follow-up on that, you know, any update on domestic development? How you build the pipeline there?

Mike, it's Mark, how are you? On the domestic side, 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 US and we haven't moved off our annual guidance for the year, which is in the 45 to 50 range for opening. The first half of the year was a bit light, so the other question might be it looks a little back end loaded on openings, it is, we're watching it very closely but again maintained 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 development agreements. In fact, a 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. Continue to see an interest there and very excited about that. I think the other comment I'd make on unit openings in the US 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. 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.

Okay, great. Thanks, Mark.

Tony Brenner, ROTH Capital Partners.

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

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

Okay. And then second, while you're still reporting discounts and price check averages, I'm concerned with the ongoing decline in customer traffic, three quarters in succession despite an awful lot of effort devoted to the 2-4-6-8 Value Menu. Looking back, there's only been one quarter since 2005 with as much as 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?

Tony, this is John. I believe our strategies are the right strategies. It's a very difficult consumer environment and 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, we found ways to more strategically target how those ads and how that messaging takes place between and now throughout the balance of the year.

I think it is I guess, important to note an certainly not an excuse by any means is we're very focused on this, but the '05 and '06 period was a period where people were making hay in the industry and taking price in margin at the expense of traffic. So, to some degree the sin of full service, we certainly participated in those days, and then as you know from April of '07 forward, things started to decline starting at dinner. Then all day parts followed, we went into the recession, and coming out, full service has been a struggle. However, Denny's is closing the gap on it. 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 five states that hold better than 60% of our units, California and Texas in particular, have shown they have found the bottom some time ago and were quite strong over Q1 and Q2 sequentially. So, these are good signs for our brand, but to your point, we're not there yet.

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

Yes Texas and California, we're positive in both metrics. Comps and traffic.

Thank you very much.

Mark Smith, Feltl & Company.

First question, I know Whit, in his commentary, talked a little bit about how many FGI transactions you can still have here in 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 secondly, what's your goal in growth for Company units and what type of units do you want these to be?

Hi, Mark, it's Mark Wolfinger. How are you?

Doing well, thanks.

So I guess we'll start with the refranchising FGI side as Whit commented, we probably have call it ten or a few more here that we anticipate the second half. We're 89% franchised today. That will pretty much finish out the refranchising activity or the FGI as the program was called. It will put us right around 90%. Per our guidance this year, obviously virtually all the new store openings are going to be franchised. Just stepping back for a minute, we anticipate we'll continue to do from a Company perspective a flagship or prototype opening, those things along those lines. As an example is our Company opening 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 on the franchise, that number could shift, but the target number is simply to get to 90% simply through the refranchising activity. Hopefully that's he 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 that 50% range. Clearly as we viewed that, that's going to take the combination of successes obviously going to be continue our traditional opening. We talked about the development pipeline there.

John talked about the international spectrum, which is obviously been dramatically increased with the announcement around China. Then the other piece for us is the nontraditional piece, which speaks to the airport location of the Dominican Republic, campus locations, et cetera, but that 50% nut number is long-term, and we haven't put a specific number on it, but long-term implies something greater than the next two years.

You bring up nontraditional, John talked about conversions as an opportunity. Do you want to open some as corporate stores to show best practices and what results you can get in nontraditional or in conversions, and maybe refranchise those units or do you want to focus primarily on bigger flagship type units?

I think our focus from a Company operations standpoint would be more toward the flagship side. A lot of that nontraditional marketplace has a special type of licensee or franchisee. So, as an example, we've obviously had good success on campus, but large part of that campus institutional feeding contract is, you know, held by some of our partners like Sodexo and Aramark and Compass, they serve as 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 is developing more toward the flagship side, prototype side.

One thing to add to that, this is John, just talking about Company involvement in the evolution of a brand which is not your question, but maybe inferred to some degree. The -- 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. As 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.

We found that partnering with the franchise community is actually better faster and quicker to get to a bottom line of a robust testing process than holding it bay on the Company's side and sharing with the franchisee later. Doing it together, [warts] and all, is proving to be, we think to be a better practice. So, not having a Company operation per se to have your hands all over it, to do that with Company and franchise personnel in a franchise restaurant, is working really well for us.

Great. 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?

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 to try to punt the question. It's just a little too early for us to comment at this stage. We're very optimistic about adding more international partners, but until we know the scale of each transaction, it's just too early to guide.

That's fair. Thanks.

Michael Halen, Denny's (sic - Sidoti & Company).

Congratulations on the quarter.

Thank you, Mike.

Can you expound a little 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 more color on the honeymoon period for the Company stores and also the franchise stores, if possible?

Yes, Mike, this is Whit. We do a 12-month comp calculation, so the what we see and what we've seen with the Flying J units is there's about a three- to six-month honeymoon period for these units. So, you have a big -- this is on average, a big opening, maybe the first couple 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 the fact of the lull of the numbers, because we have a smaller Company-owned base of units.

We opened actually originally opened 29 Company-owned Flying J units, that's had a larger impact on the Company comp than it had on the franchise comp on the traffic side. One of the things that offset that impact on the franchise side is the number of remodels that the franchisees did at the end of last year, completing our refresh program and which helped carry over into the first and even second quarter here as well. So, there's a differential there between the Company and franchise traffic piece.

Can you give us a little color on how the remodels are going, what kind of returns the franchisees might be looking at right now?

We don't provide that information other than to say -- certainly it's on par with the level of an investment to make it worth while.

Okay. Thanks. 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 a 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 more color on that one?

Yes. Back in 2011, we sold -- I'd have to get the number off the top of my head, I want to say maybe five Flying J units, so that was part of it. [Jay] is going to correct me hopefully. This was in the fourth quarter of 2010, so that certainly those units had not been opened for a very long period. And then -- so that's part of the driver.

The other piece is this year, some of the units have been --places like California, where we have, often have a number of franchisees who are interested in these units and that was a case here in the second quarter where these units tend to get higher multiples because we have higher -- more than one bidder, you can get a little bidding war going. So, we've seen that historically and we would see that phenomenon in the first and second quarter of this year.

Okay, great. Thank you very much.

(Operator Instructions)

Conrad Lyon with B. Riley & Co.

Good afternoon, everybody. Two 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 probably have a challenging commodity environment next year would you try to alter mix depending on how commodities shape up next year?

So I'll start, Conrad, and there's I guess multiple ways to answer, but just that the blessing and challenge of four day parts. So we say, is it harder to control because 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. Part of that was we run with the diner theme for a while and it's time to return to pancakes. So, Q2 had a very successful create your own, build your own pancake program followed by the current Tour of America, which has obviously back to some good quality diner programs, but also doesn't abandon breakfast.

You have a Philly Cheese Steak Omelette, Red, White & Blue Pancakes, and we have a Southern Slam for a $5.99 value offering. So, in a tough economic or value season, those start to pick up again. We had the Pancake Module, which is a little lower than Module 1 Skillets, we went into this one, and 2-4-6-8 popped up a little bit, plus the Southern Slam at only $6 on the LCL menu stole some of that mix. We're actually getting pretty good at this, but part of it is mix strategy and part of it's price strategy. When transactions are soft as Tony pointed out 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, you want to add to that?

The only think I would add to it, Conrad, we try to look at it as the whole entity, all four day parts, everything of playing together in concert, that's the way we think about it.

Got you.

Hopefully and certainly commodities comes into play in some respects as well.

Got you. Okay. Last question, all these term 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?

I would just say that when we have a 59-year history with 1,700 units -- near 1,700 units near our 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 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 will continue to redefine our customer base.

All things to all people. I like that.

Who need a family dining experience.

Got you. Okay.

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

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.

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