Denny's Corp (DENN) 2003 Q1 法說會逐字稿

Good morning. My name is Tramaica [ph] and I will be your conference facilitator. At this time I would like to welcome everyone to the Denny's first quarter 2003 earnings 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 period. If you would like to ask a question during this time, simply press star then the number one on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you.

I would now like to turn the call over to Mr. Ken Jones, VP and treasurer of Denny's Corporation. Mr. Jones, please go ahead, sir.

Good morning and thank you for joining us today. Speaking first will be Andrew Green, Denny's Chief Financial Officer, who will give you a financial review of our first quarter's results. I will then provide a liquidity update followed by a few words from Nelson Marchioli, our President and Chief Executive Officer. After Nelson's remarks we will open it up for a Q&A period. A replay of this call will be available later today on Denny's Web site or by calling the replay number. If you do not have the number already feel free to the call me and I will provide that to you.

Before we begin, here is the Safe Harbor disclosure. In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, during this call may constitute forward-looking statements. Such statements are subjects to risks and 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 annual report on Form 10(K) for the year ended December 25, 2002.

With that, I will now turn it over to Denny's CFO, Andrew Green.

Good morning. This is Andrew Green. Thank you for joining us for the first quarter 2003 conference call. Let me start by reviewing our sales results for the first quarter which we previously reported in our March sales release. Same store sales were down .4% during the quarter, as we experienced an increase in our average guest check of 2½% offset by a 2.8% decline in guest counts. Our sales performance was particularly difficult to assess this quarter given the many external factors that impacted the retail and restaurant sectors. The sluggish economy combined with harsh winter weather and the war with Iraq certainly contributed to reduced consumer spending.

Countering the negative impact of these macro factors was the positive impact from the new national media campaign that aired January and March. And I think helped stabilize our sales. This past Tuesday, we released our same store sales results for April. As this report showed, our sales were down 1.7%. As an increase in average check of 3.2% was more than offset by a 4.9% decline in customer accounts. The war with Iraq was at its peak during the first two weeks of our fiscal April at which time our sales were down very significantly. During these past two weeks of April, our sales rebounded to solidly positive territory. Also contributing to the overall sales decline in April was a media mismatch as we were on-air last year during the month but not this year.

Now that the winter weather and the war are behind us, we are optimistic that our marketing programs along with our operational initiatives will begin to build sales momentum through the summer months.

Let me turn now to an update on the Denny's restaurant portfolio. Our company-owned unit account at quarter end was 563, compared with 602 units at the same time last year. The reduction over the last 12 months is due primarily to the closure of 30 restaurants during this period as well as to the re-franchising of an additional 11 units. During the first quarter we slowed the pace of the company store closures, with only four units closing during the period.

As I've stated in previous quarters, I believe most of our company store closing are behind us. However, we continue to evaluate our portfolio. And we will close those stores that don't meet our profitability or capital investment criteria. I estimate the company restaurant closures for the year will total between 10 to 20 units.

With regard to re-franchising transactions, I expect these to continue to be very limited. Perhaps five units or so this year. We re-franchised no units in the first quarter.

Now let's turn to the P&L. Sales at Denny's company-owned restaurants declined $13m to $199m in the first quarter. The sales decline resulted primarily from the restaurant closures as I mentioned and to a smaller degree to the same store sales decline. As the number of company units level off so, too, should the revenue drop experienced over the last year or so.

Operating income in the first quarter declined compared to the same period last year. Due in part to the decrease in company restaurant sales as well as the higher operating cost in our restaurants. Especially labor costs which I will talk about in a little more detail in a minute. Operating income in the first quarter benefited from a scheduled $6m decrease in depreciation and amortization expense. This decrease resulted from the five-year anniversary of the company's reorganization in January of 1998. This comparison will continue to be favorable for the remainder of the year and into next year.

EBITDA, which excludes the benefit of this decrease in depreciation and amortization, declined approximately $8m to $25m in the first quarter. This was due primarily to a 3.9 percentage point reduction in our company restaurant operating margin as you probably noted in our press release. The largest contributors to this margin decline were payroll and benefit costs which were up 2.8 percentage points through a combination of increased restaurant labor and higher benefit costs.

Our labor costs have been rising over the last two years as we continue to invest in additional crew labor as well as managers in order to improve service and hospitality in the restaurants. This is a conscious investment in people resources. And is being validated by our consumer research scores for service, cleanliness and overall experience, which are showing improvement.

The primary contributor to increased benefit costs is medical insurance. Like most businesses across the country, we have experienced a considerable rise in medical costs over the last year. Overall our payroll and benefit costs for the first quarter were 44% of company sales. And I expect that it will run in that kind of a range over the balance of the year.

In addition to the higher payroll and benefit costs, we experienced moderate increases in other restaurant costs as well. Product costs increased .2 percentage points to 24.6% of sales. Due to a $900,000 reduction in deferred gain amortization, which is a credit to product costs. This is non-cash amortization. It totaled $1m in the first quarter and is expected to total $2.6m for the year before expiring in September. Occupancy expenses, utilities and repairs and maintenance all experienced slight increases as well.

Our first quarter G&A expenses dropped $1m from last year as we continue to reduce our corporate overhead in connection with the reduction in Denny's restaurant base. For the remainder of 2003, I would expect G&A expense to be approximately $13m to $15m per quarter.

Turning to franchise. Franchising licensing revenue in the first quarter decreased by 800,000 to 21.4m as the number of franchise restaurants declined by a net 17 units versus the same period last year. Franchise operating income was basically flat as lower bad debt experience. And other franchise costs contributed to an improvement in franchise operating margin.

Commenting on the recent activity in Denny's franchise restaurant portfolio. In the last 12 months, our franchisees have closed 61 stores while opening 33 new stores and purchasing 11 of our company units. With regard to franchise unit closures, we expect franchisees to continue to evaluate their portfolios in a manner similar to the decisions we have made on company-owned units, which may lead to continued closures in 2003. During the first quarter our franchisees closed eight units while opening four new units.

For the first quarter we reported a net loss of $9m compared with a net loss of approximately $5m last year. Last year's net loss benefited from a $2.7m reduction in income tax expense related to recently enacted Job Creation and Worker Assistance Act. We subsequently received a tax refund for this amount in the latter part of 2002.

A quick note with regard to capital expenditures. Our cash CAPEX spending for the first quarter was a little over $5m. The spending rate is expected to increase through the summer due to improved weather. And I would expect the full year total for cash capital to be approximately $35m to $40m. General facilities upgrades will consume the bulk of this investment with our ongoing remodeling efforts making up the remainder. As we continue to look to remodel approximately 10% of our company units each year over the next several years.

In conclusion. Although in the first quarter we experienced reduced operating margins, over the last two years we have bolstered our profitability by closing underperforming restaurants, reducing G&A expenses and lowering product costs while improving food quality. We have reinvested much of these savings back into store-level labor in order to improve service and hospitality. Now our focus shifts to attracting new and lapsed customers so that they may experience the improvements firsthand. With macro economic factors working against us this first quarter, we were unable to capitalize on a strong new advertising program in order to grow customer traffic. However, we are optimistic that our summer promotion and supporting media, which Nelson will talk about later, will provide a much needed boost to our customer counts.

Let me turn the telephone back to Ken Jones, our treasurer, for a liquidity update.

Thank you, Andrew, and before we get to Nelson's remarks, just a quick look at our revolver position. At the end of the first quarter we had borrowings under the new $125,000,000m credit facility of just over $60m compared with $47m at year end 2002. In addition, we had letters of credit of $48m leaving available credit at quarter end of about $17m. Contributing to the increase in the revolver advances plus the $21m semi-annual interest payment we made in January on our 11 1/4% senior notes. As of yesterday our outstanding revolver borrowings had declined slightly to just under $60m after making the $8m semi-annual interest payment on our new 12 3/4% senior notes. And we made that payment on March 31, which was after the quarter end. Our letters of credit remain at $48m, leaving current net availability of $17m heading into our stronger summer months.

Let me now turn the program over to Nelson Marchioli, the president and CEO of Denny's.

Good morning and thank you, Ken. As I am sure you all know the first quarter of 2003 was a difficult period for the restaurant industry and retail in general. I read this morning that this was the third consecutive quarter of decline in customer accounts for the industry, which has not occurred since the late '70s.

Given this environment, I look at Denny's results for the first quarter at one of mixed results. Same store sales of company units were modestly down .4%. In January, we launched our first media campaign of the year featuring lunch with a focus on classic sandwiches and soup. We came back in March with our new hoagie melt sandwiches as well as some great new dessert items. I believe that successful promotion of these new food offerings helped blunt the impact of severe weather, a weak economy, and the war. Our guest check average increased 2.5%, helping to compensate for soft traffic as our focus on lunch items caused customers to trade up from lower-priced breakfast. We did take a modest 1% price increase in February.

We continue to make improvements in store operations with a significant focus during 2003 on hospitality and customer service. We are staffing our restaurants better than we ever have. In particular, we've added managers to the floor as well as more hostesses and servers. The investment in labor hurt our margins in the first quarter, but I strongly believe it's the right investment for the future of the Denny's brand.

We need to do a better job of capitalizing on our position as a 24-hour restaurant company. Having a distinct competitive advantage as a four day-part operation in breakfast, lunch, dinner and late night. I don't think people have thought of have thought of us much in the past for lunch and dinner and our job going forward is to remind people that we are a great place, not just for breakfast but for lunch and dinner as well.

Last week we launched our Denny's Barbecue Days promotion which will run through the summer. We also have plans to promote our late night business. Obviously, we will be closely watching and will need to react to the economic picture and consumer confidence as the year progresses.

Finally, last year was about getting the systems and infrastructure in place to position the company for customer count growth. We are going to continue to focus on hospitality and service with great-tasting food. For the balance of the year, you'll see more quality products introduced. And it's going to be about the food and providing that comfortable environment and great hospitalities so our customer will come back to Denny's again and again. Thank you for your continued interest in Denny's. Ken?

Okay. We will now begin the Q&A portion of our program. Tramaica?

At this time I would like to remind everyone if you would like to ask a question please press star then the number one on your telephone key pad. You have been asked by management to please limit your questions to one with one follow up. Should you have additional questions you may reenter the queue. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Mary Gilbert with Imperial Capital.

I wanted to find out if the company would consider doing another exchange offer under a separate indenture, to exchange some of the 11 1/4s into some equivalent 12 3/4s? And how much of a basket do you have left to do that?

Mary, it's Ken. We do not have any additional basket as I think you know in the new indenture to tack on to that indenture. We really don't want to speculate on type of transaction we may do in the future. We are going to consider a transaction that will help the company. But at this point we don't have anything structured, so it doesn't make sense for us to speculate.

Okay. Great. Thanks.

Your next question comes from Karen Altridge with Goldman Sachs.

Can you give us a sense of what kind of franchise activity you are seeing in terms of pipeline for new units and remodeling?

As Andrew mentioned a little earlier, we do have -- we expect about 33 new franchise units this year. We are seeing some closures based on performance. We are in fact putting together a team in our franchise development group that will actually begin actively selling the Denny's brand as a franchise. And as you probably know, it takes awhile for those kinds of things to get going. We have a nice flow of that kind of business from our existing franchisees and from a few outsiders. But we really haven't had a marketing plan that really addressed new franchisees, particularly those that understand the business, are either involved in the business now, or were in the business before and already have an infrastructure in place. So that will be a focus and I would expect it to be quite active and quite good over the next couple of years.

How about in terms of remodeling activities?

We are seeing remodeling. I can't speak to a specific number. I believe it's going to be somewhere around, something over 100.

On the franchise side.

On franchise side.

Our franchisees are really just catching up with what the company has been doing for several years now. And there really is an escalated remodeling going on on the franchise side. So we are real pleased about that. So I think we are going to see a lot of remodeled franchise units this year.

There are a lot of franchisees making commitments literally as we speak during this quarter. Our franchise agreements do require remodels and they are beginning to comply with that agreement.

Great. And one last question. As you look to build a lunch and dinner, is there any plus to trying to build a take out business?

It's something we have talked about. Obviously many people in the industry are focusing on that. Ultimately we will be there. We already have a nice take out business. It probably isn't as publicized and as well known as some of the other folks, particularly in casual dining where they've been focusing on it.

However, I would tell you we want to focus on inside the four walls, if you will. To make sure we get the breakfast lunch and dinner and late night day parts fully implemented and taken advantage of. We currently have 3% of sales now in take out and we do think we can build on that but we want to make sure that we've really taken advantage of what we already have in the, within the four walls. And, candidly, I don't think we have. I would hope in about a year or so we can begin to focus on that.

Great. Thank you very much.

Thank you.

Your next question comes from Larry DeMage [ph] with SG Cowen.

Good morning. First quick question relates to a statement that Andrew made about labor costs. Do you expect labor costs to continue to run at about 44% of sales even if you have comp store sales growth at the Denny's company-owned restaurants?

Yes, particularly as we go into the summer and we have higher volumes. And that's our peak period just because of the growth in sales. And if we have positive comps, which we hope, it will be a bit below 44 during the summer but maybe 42, 43. But when you get into the softer quarters of the year, just in terms of sales volume on a percentage basis it tends to go up. So I guess, Larry, in answer to your question, it may moderate a point or two lower than that but I wouldn't go much lower than that.

I would add to that, Larry, that one of the things that much of us don't talk about and we don't take into consideration. At Denny's I've been advised that the number one reason we have restaurant management turnover is because of inadequate staffing of the past. So we believe we will actually see not only improved hospitality and customer service, but make Denny's a better place to work. And hopefully become an employer of choice in this industry over the next several years by staffing appropriately, training appropriately and retaining quality talent which ultimately will save us millions of dollars literally.

Okay. Along those lines in modeling that through for the rest of the year and where you are in terms of your revolver, and I know you don't want to talk about a potential transaction. But where does that leave you liquidity wise at the end of the year? The reason I bring that up is because your coupon payment comes due in January and July.

As I mentioned -- this is Ken -- we've already gone through the softest quarter for the company, which is the first quarter. And heading into the summer months we should build liquidity. And so that should not be an issue.

But if you are going to do, say, $40m of CAPEX. Do you think year over year you would be in the same position you'd be at last year at the end of last year?

We are not going to give a cash forecast.

I understand that. I am just talking about liquidity versus where you are today versus where you were a year ago.

We believe we have adequate liquidity.

Your next question comes from Jeff Cobilar [ph] with Solomon Brothers.

I wanted to ask again about the labor. How quickly will we see a return on investment from investing in this labor?

One thing just to make sure everyone understands. On that line, payroll and benefits, this would include all the accrued hourly labor in the restaurants, all the manager level in the restaurants as well as all of the taxes and fringe. So that's what makes up the 44% just so everyone understands it. I will let Nelson answer the question of return on that investment.

Well, we are driving customer counts. We are seeing that return now. Obviously the soft economy and that the other issues we already talked about that has affected our sales performance in the first quarter have contributed to, unfortunately, not widespread increase in customer counts. But where we have been able to invest the labor and have been able to drive positive guest counts, and we have, that return is almost immediate.

But we have to convince people that have been disappointed by Denny's service facilities and food in the past that they can trust us again and they can come back. And that's why our advertising strategy is so critical. And we believe it's the right one, as we focus on quality food and just a great place to sit and eat. And we are beginning to see those benefits already. Unfortunately, it hasn't been widespread enough because of all those other things that are going on in the world for it to demonstrate itself in the first quarter.

Can you elaborate a little bit more about that? You said you are seeing a return --

When you are able to put servers on the floor, for example, at a greater number you can turn your tables far faster. And we are seeing a significant increase in our ability to serve potential customers on just Saturday and Sunday. Between Friday afternoon and Sunday afternoon, we will run about 60% of our business. And we, frankly, weren't staffed before. We are seeing much improved performance in those restaurants where we are able to do that. I can't quantify it much more than that at this point.

Are your comps up?

In some stores, very definitely. In certain sections of the country, we are quite pleased with the performance. But we still have weakness in other parts of the country that, for whatever reason, are having difficulty dealing with the current economy, the war, and heaven knows what else. But I would tell you, to be more specific, East Coast and the West Coast over probably the last three to four weeks are performing very, very nicely. And we are quite pleased with it. The issue we have right now is through the midsection of the country. And we have a special task force focused on that to understand it and, frankly, cure it.

The last question. Is the labor component the same in the mid-country as it is on the East Coast and the West Coast?

Your volumes -- our volumes, I should say, on the East Coast and West Coast are higher than they are in the midsections. So our labor costs are going to be higher on a dollar basis, but from a percentage standpoint should be similar.

Thank you.

Your next question comes from Evan Ratner with CSFB.

Just a quick follow up on the liquidity question. Could you give some general guidance regarding the use of cash related to other accrued liabilities and other noncurrent liabilities? The last couple years have been somewhere $25m, $30m of a use on the cash flow statement.

You are talking about on an actual basis, Evan, or projected?

If you could give us for this quarter maybe sort of general guidelines for how we should look at it in the future, again, very broad. I don't want you guys to really be projecting but is it going to be in similar context in terms of the numbers or lower?

The guidance I can give you, Evan, is the usage of working capital should be declining. And this year should be lower than last year. In terms of giving you absolute numbers, it's a really dangerous thing for us to try to talk about. But as the company has gotten a lot smaller, we had a lot of accrued liability related to the old holding company last year -- the year before that we paid our last year. And most of that should not be paid this year. And we still will have some working capital usage but it will not be nearly as significant.

Could you give us a broad number, $10m to $15m versus $25m, $30m, or is it you just don't want to go there?

We really don't want to go there.

Okay. Thank you.

You're welcome.

You have a follow-up question from Karen Aldridge with Goldman Sachs.

You state in your press release your need to increase dinner. What strategies are you going to be enacting for that? Is it going to be media driven, product driven?

Both. As I mentioned earlier, we will be doing the Denny's Barbecue Days which we put into our restaurants on May 5. And it will go national media on May 19. That will be followed by breakfast, which is our strongest day-part as far as our consumers are concerned. And you'll see us again in the fourth quarter with dinner at a value. We get very, very high value ratings from our consumers, so we'll continue to drive that check through value and great tasting food. So it's actually both product driven and media driven.

Great. And final question. With the 24 hours, have you given any thought to some markets where you can scale back on the hours? Is it a major cash strain to keep the doors open that long if you're not getting the traffic?

No, it's not. Actually we do quite well at night, particularly as you might imagine on Friday, Saturday and Sunday. That's where the majority of our all-night business occurs. But we have a nice business all week long. And we'll continue to -- you'll see initiatives here very soon that begin to address that particular clientele that travels at night, if you will.

Okay. Thank you.

Thank you.

At this time there are no further questions. I will now turn the call back over to Mr. Ken Jones.

Well, thank you very much for joining us today. See you next quarter.

Thank you for participating in today's teleconference. You may all now disconnect.