Denny's Corp (DENN) 2004 Q3 法說會逐字稿

Good afternoon. My name is Shayla, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Denny's third-quarter 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 period. (OPERATOR INSTRUCTIONS). Please limit your questions to one question and one follow-up question. For further questions, please return to the queue. I would now like to turn the conference over to Ken Jones, Vice President and Treasurer. Please go ahead, sir.

Good afternoon, and thank you for joining us. Today, we have with us the management as usual -- Nelson Marchioli, Denny's' President and CEO, and Andrew Green, Denny's' CFO. Nelson will provide an update of the business and a overview of the quarter. Andrew will then provide a financial review of our third-quarter results. We will follow that up with our standard Q&A period.

But before we begin, let me remind you that, in accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the company notes that certain matters to be discussed by members of management during this call may constitute forward-looking statements. 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 annual report on Form 10-K for the year ended December 31, 2003, and in any subsequent quarterly reports on Form 10-Q.

Before I turn the call over to Nelson and Andrew, I'd like to begin with a few words about our recent capital structure initiatives. As many of you may know, earlier this month, we completed a comprehensive recapitalization that places the company in its strongest financial position in over a decade. The recap was jumpstarted back in July, when we raised 92 million through the sale of common stock which provided the catalyst for a full balance sheet recapitalization. We completed Phase II of the recap in September 1 when we closed a new 420 million bank credit facility and refinanced our old facility at significantly better terms and lower interest rates.

As the final component of our new capital structure, earlier this month, we completed Phase III of the recap when we sold 175 million of new senior notes. With the excess proceeds from the new bank loan as well as the new senior notes proceed, we were able to repurchase the remainder of our higher-cost old notes.

Compared with the old capital structure, we estimate that our annual interest expense will be lower by approximately 25 million. In addition, we have significantly extended our debt maturities, providing us ample flexibility to focus on building sales and profit.

All in all, we're very pleased with where we ended up, and we would like to thank all of the investors that participated in our transaction and those who supported us during the process.

With that, I will now turn it over to Nelson Marchioli, Denny's President and CEO.

Thank you, Ken, and good afternoon, everyone. And thank you for joining us today. I am particular pleased today to report that both Company restaurant sales and Company restaurant margin have increased year-over-year for 4 straight quarters. We began to build this positive momentum in the third quarter of 2003, with the introduction of our 4.99 value breakfasts.

Over the last few months, we've heard about some concerns about our same-store sales slowing down once we began to rollover positive sales from last year. Well, I'm pleased to report that September was the first month of that rollover, and we were successful in maintaining our momentum, as our same-store sales increased by 7 percent. We remain optimistic about our sales potential in the fourth quarter and our September results certainly support that position.

We have a few marketing initiatives this order that we feel will help drive traffic. We excited about our new 4.99 promotion, Fabulous Fruit-filled Pancakes, which is a new addition to our menu, and initially extremely well received by our customers. This promotion will be offered through the end of the year in addition to new menu items. We are planning to run media in December which has not traditionally been a month we are on air. We feel Denny's has a terrific opportunity to go after holiday shoppers and travelers during this busy time of the year. We also hope to build on our strong Thanksgiving and Christmas Day business, when we are one of the few chains open for business. Customers have come to rely on Denny's for these occasions. And we expect our positive momentum to continue at these times, as well.

In addition to our sales growth, we are pleased to see our margins continue to improve in a challenging cost environment. Given that rising commodity costs have certainly hit our industry hard over the last year, it's particularly gratifying to me that we were able to maintain a stable product cost margin. Though our total Company restaurant margin improved in the third quarter, we are experiencing some cost increases, most notably in workmen's compensation and utilities expense.

We have reduced workers' comp claims over the last few years as a result of our aggressive safety initiatives. However, higher healthcare costs are increasing the ultimate cost of each claim. As for utilities, I really don't foresee a significant decrease in natural gas and other utility costs over the next year, given the current record energy prices.

Before I turn the call over to Andrew, I would like to emphasize Ken's early remarks regarding the recapitalization and reiterate our gratitude to all of you who invested, lent money, or provided us support along the way. Your faith in Denny's and your support for management are certainly appreciated.

While 2004 has been a milestone year for Denny's, we look forward to building on our current momentum and putting this great brand back in a position of growth and posterity. As always, thank you for your interest in Denny's.

I'll now turn the phone over to Andrew Green, our CFO, who will take you through the third-quarter numbers.

Thank you, Nelson. Good afternoon. This is Andrew Green. Let me start by detailing our third-quarter same-store sales results which Nelson mentioned in his remarks. I am pleased to report that our strong sales momentum continued through the second quarter, the third quarter, as our Company restaurant same-store sales were up 6.8 percent. This increase was comprised of a 3.8 percent increase in guest check average combined with a 2.9 percent increase in guest count. We closed the quarter with September sales up 7 percent, which marked our 13th consecutive month of positive sales. Importantly, our franchisees have experienced similar sales increases, posting a 6.6 percent increase in the third quarter.

Now, turning to the P&L. Sales at Denny's company-owned restaurants increased 9 million to 224 million in the third quarter as the result of our strong same-store sales. I will note that the hurricanes in August and September did not materially impact our same-store sales because our systems exclude, for purposes of calculating same-store sales, any day in which a restaurant is closed for a full 24-hour period.

However, our revenues for the quarter were impacted by the 4 hurricanes. We estimate the sales impact at approximately $2 million in lost revenue, based on 407 closed-store days. The most significant impact was from Hurricane Frances, which hit Labor Day weekend.

Our sales increase in the quarter contributed heavily to a 2.1 percentage point improvement in our Company operating margin, compared with last year's third quarter. This improvement is summarized in the margin analysis table in our press release.

The largest contributed to our margin improvement was a 1.3 percentage point decline in payroll and benefits cost. As we have mentioned on earlier calls, the 2 primary contributors to our labor and benefit savings have been more efficient labor scheduling, which contributed to a 1.3 percentage point decline in restaurant payroll for the quarter, and a redesign of our medical benefits plan which resulted in a 1.0 percentage point decline in group insurance cost for the quarter. Now, partially offsetting these cost savings were a 0.5 percentage point increase in incentive compensation for restaurant managers and a 0.4 percentage point increase in workers' compensation expenses.

Product cost as a percent of sales for the third quarter were nearly flat with the prior year, as higher commodity costs were mitigated by proactive menu management as well as selective price increases. In addition, product cost in last year's third quarter benefited from approximately $700,000 in deferred gain amortization compared to no deferred gain amortization this year.

We are pleased with our efforts to hold food cost margins steady, given an extremely difficult year for commodity costs. As we noted earlier in the year, we took a 2 percent price increase in April to cover rising food costs. In addition, just recently in mid-October, we issued a new menu with another, smaller price increase of approximately 1 percent.

Franchise and licensing revenue in the third quarter was flat year-over-year at $23 million. A 6.6 percent increase in franchise same-store sales offset a 28-unit decline in franchise restaurants. Franchise costs, and consequently franchise operating margins, were flat year-over-year, as well.

Our third-quarter G&A expenses increased approximately (ph) 4.7 million from last year. This was due primarily to a $2.8 million higher incentive compensation in this year's third quarter, which brings the year-to-date increase to $7 million in incentive comp. For the full year, we expect our incentive compensation will be 10 to $11 million higher in 2004 than in 2003, when we paid minimal bonuses. In addition, in this year's third quarter, we expensed 1.4 million of recapitalization-related expenses, bringing the year-to-date total to 3.9 million.

Operating income in the third quarter increased $2.7 million compared with the same period last year, reflecting our higher sales and improved margins. Regarding bottom-line net income, we reported a net loss of 11.8 million for the third quarter compared with a net loss of 6.3 million in the same period last year. This year's net loss did include $9.7 million of nonoperating expenses resulting from debt repurchase premiums and other costs attributable to the recapitalization.

Moving onto capital expenditures -- our cash capital spending for the third quarter was approximate $8 million, bringing the year-to-date total to 22 million. Our estimates for 2004 has been $40 million, although from a timing perspective, some of this may slip into the first quarter of next year. Of the $40 million total, approximately 30 million will be directed at basic facilities capital, while most of the remaining 10 million will be spent on restaurant remodels as well as 1 new company unit scheduled to open in early December on the Strip in Las Vegas.

That wraps up my review of our financials for the third quarter. As I said in my opening remarks, we are certainly pleased with our sales momentum, as well as our improved operating margins. Looking ahead we are optimistic that our results for the fourth quarter and 2005 will continue to show improvement.

With that, I will ask the operator to begin the Q&A.

(OPERATOR INSTRUCTIONS). Farook Baruhi (ph), Jefferies & Company.

Just a few questions here. Number one, the $2.8 million of higher incentive comp that you mentioned in the release -- just curious how much of this is going to be cash versus non-cash?

The primary portion of our 2004 incentive compensation plan will be paid in the first quarter of '05. There have been some smaller quarterly payments, Farook, and I don't actually recall how much the quarterly portion of it was. But the bulk of the is in the first quarter of '05.

Okay, and is that all cash?

Yes.

Okay. Next, on the G&A -- if we exclude the $1.4 million of the recap cost that were included, it trended higher versus the previous run rate. I'm just curious -- is that primarily because of all the reason you already stated -- hire workers' comps and utility costs, etc.? Actually, not utilities, but workers' comp? Or is there anything else in there?

Well, the workers' compensation is not in G&A. That's going to be up in the payroll and benefits line, because it's restaurant-level expense.

If you exclude the recap costs, Farook, that gets you in the low 15s, I think, which is not too different than, say, the first quarter of the year. So I would have to probably reconcile back.

We did see some additional G&A costs in the quarter, you're right. I know that our legal expenses were up a couple hundred thousand dollars. We had Sarbanes-Oxley costs that were about 100,000 in the quarter. So there were a few small items that contributed to that.

The more notable cost things really, because there was greater cost pressure in the quarter, probably were utilities and the workers' comp. In addition, repairs and maintenance, you may have noticed, ran higher this quarter than prior quarters. But that's more of a seasonal thing. It's pretty comparable to last year, because frankly, the weather is better and we do more repairs in the summer.

Okay. One final one was that -- how much cash do you have today? I'm just trying to figure out what the cash situation is after all the recapitalization moving pieces settled.

I can answer that. We have essentially post end of the quarter have completed the recap. We paid all the premiums regarding the repurchases of the note. We have a couple of items that are still looming -- it's in the legal costs; maybe 1 million or so that has not been paid related to the recap.

We are basically in cash about 4 or 5 million right now surplus cash. That is in addition to what we show on the balance sheet normally as operating cash, which ranges from 4 to 6 million or so.

By the end of the year, we think we will be flat to slightly in the revolver, given the seasonality of our business in the fourth quarter.

Jonathan Feldman (ph), SBB (ph) Investments.

I was just wondering if you could comment on the competitive landscape that you're seeing in the family dining segment. And was curious if you felt that you guys were taking share of some of your competitors.

I think it is too early to tell as to whether we are taking share from anyone or not. But we do track that. But it's early in our recovery.

I would add to that that we are doing well because I think we are relevant, and we are executing better in the restaurant. So we have enjoyed the uptick in sales.

I still don't believe that people decide to eat in fast food family, casual, or white tablecloth tonight. I think they go through a list in their mind as to where they want to dine. And wherever they had the best experience or the kind of experience they are looking for on a go-forward basis is where they choose tonight.

I think it's something the industry has done to put us into these segments. I don't think consumers think that way. I think they think -- what kind of an occasion do they want to have.

I guess the one follow-up would be -- what do you think the customers are looking for in the current environment? And are you seeing an impact in terms of higher gas prices and what seems to a relatively weak retail environment right now?

Well, we have been very fortunate. We do have restaurants that are on the freeways and interstates in the United States. And in those restaurant, we have a tendency to be a little softer than I'd like us to be, although we're still positive. It's the neighborhoods where we are in a shopping district, where we continue to do quite well.

So the somewhat tentative on the economy. It's been good for Denny's, because I think we are offering a value in quality and an abundance of food. And we're focused on what we can do and what we can do well. And it is all about the fundamentals. It's a pretty simple execution.

Karen Eltrich, Goldman Sachs.

A couple of questions. First, I would note on comps -- there is precedent for Nelson on the conference call commenting on the how the current month is going. So I want to check and see if you guys would give us an idea of how October is shaping up.

Karen, I think we are going to pass on that.

Okay. Second question on comps --

We're releasing earnings -- the sales next Thursday, Karen.

Okay. On comp (indiscernible) -- obviously, it's great to see the positive traffic. But what has actually been impressive is also the average check going up so much. I was curious to see what is driving that, because you have also obviously taken some selective menu increases, but that's not really it. Is it the 4.99 price point versus the Grand Slam? Or are you seeing people trade up to other items at lunch and dinner?

Hi. I'm going to let Margaret Jenkins, our Chief Marketing Officer, address that one.

We actually have been delighted with our average check. And it has been growing organically. The price increases that Andrew referred to have been layered in very systematically. We've not seen the impact of the one that he mentioned at the 1 percent level.

Our guest check really is a combination of the 4.99 price special, but also a lot of other activity in the restaurants, including successful promotions that entice guests to trade up because of the value inherent in something else on the menu, or because they want to participate in a premium or a gift-with-purchase special that we may have.

We also have done a great job of selling orange juice and soft drinks and desserts and all those other ancillary items that help to round out a typical, average check. So the check that you see really is as a result of menu shift and not price increases, exclusively.

I would add to that, Margaret -- I think you have been very successful with the rotation of our 4.99's. For those of you who have visited Denny's, what you will see happen is that our 4.99 product is on a freestanding menu. And then when the new one is introduced, the old one goes up typically to 5.99.

And for example, right now, our 3 complete breakfast, or our Meat Lover's breakfast from the summer, which has been hugely popular, has now gone up to 5.99 instead of 4.99. And we are realizing quite a bit of traffic with that product still, but we are getting an extra dollar. It's one of the ways that Margaret and the marketing team have really managed the menu mix very successfully.

I would add to that, Andrew, that Margaret talks about the ancillary items. I would tell you that overall, Denny's is becoming a better restaurant operator. And we are executing more consistently. We are doing what many of our competitors have done for a long time.

As I said before, there is headroom. There's an upside to what Denny's is doing. And I think we've got a ways to go before we really do hit the full, maximum opportunity here. But we are doing things more effectively by suggestive selling, by managing our menu more aggressively, by managing our margins, by being a lot closer to the restaurant business day to day than this company has probably been in 20 years.

Ken Bann, Jefferies & Company.

The sales compensation, how was the -- since it went from zero to 2.8 million in this quarter, how was that calculated? On what number is that based --?

Could you repeat your question? Are you on a cellphone or speakerphone, because we really can't hear you.

The incentive compensation -- since it went up 2.8 million from the prior year, can you give us specifics on what that was calculated on, and if it's going to be 3 to 4 million higher in the fourth quarter, what is that going to be based on in the fourth quarter?

Our incentive compensation programs are very similar to this year as they have been for several years. And like many companies, there are several components. In our case, same-store sales, same-store guest counts, system sales -- so we include the franchisees. So there are several sales components. And then there are profitability components related to EBITDA, as well. And there's a small portion that varies by department.

So it's pretty a traditional -- sales and profits. And the variance from last year, as I inferred in my comments, really comes about because, frankly, we paid virtually nothing last year. So you are going from next to zero to what has been an outstanding year for us, comparatively speaking.

So you do get a big variance. And I do think that probably -- I haven't looked at a fourth quarter forecast, but I would expect and reason that we would have the same impact in the fourth quarter.

Okay. As a follow-up, going forward, would you say that for further increases in the incentive compensation that you will need increases in EBITDA even after the increased payments in order to generate that kind of compensation?

I think that I understand your question. I think the answer is yes. We will build a plan for 2005. And I fully expect that it's going to involve increases. And we won't pay bonus unless you hit that plan.

Tony Reiner (ph), Harburt (ph).

2 quick questions. The first one being, what is our latest status as far as your listing -- from an asset (ph)?

As we have talked about in the past, the listing requirement really is a minimum bid price issue, and that is $4 for NASDAQ small-cap.

Okay. And actually, my other question has already been answered.

David Hargrave (ph), KBC Financial (ph).

Wondering if you gentlemen could characterize the nature of the 28 reductions, 28 unit reductions on the franchise side. Was it all unprofitable or common ownerships or some sort of regional characteristics -- or any sort of common issues that they all had?

The 28-unit decline in franchise restaurants really is pretty geographically spread. So it's not one particular area of the country.

I don't know how long you been following the company, but back in '01 and '02, when Nelson and I really started into this turnaround, we closed over 100 company units, probably closer to 120. And frankly, because no -- very few Denny's had been closed over the last decade, even though trade areas shift, you have weaker stores.

And what we are seeing is that our franchisees are still rationalizing their portfolio. Now the Company is at a run right of, you know, 5 to 10 a year, which I consider pretty normal turnover with a portfolio.

But the franchisees are still going through that. So these are typically lower-volume stores, under $1 million that -- trade areas have shifted. The franchisees are not profitable. Perhaps they have a lease coming up for renewal that they don't want to renew. Frankly, there's a whole variety of reasons, more than one common theme -- other than I would say it's typically the lower-volume stores.

And while we hate to see that happen, and we hate to lose the royalty and advertising contributions, in the long run, if it is not a good store and it's not generating volume and it's not remodeled and looking good, it may be best for the brand to let the bottom part prune off, if you will.

I understand. I just recall from the roadshow -- I think you guys had mentioned that you had thought there was some low-hanging fruit in franchising. And I'm wondering if you had some sort of number in your head as to how low you think the number could go. Could we see another 25 close in the fourth quarter? Would that be reasonable?

I don't really have a number. It's very hard for us to project, to be honest with you, because we don't control those stores. The franchisees send in a request to close. And we respond to that. So it's more difficult for me to forecast than on the company unit site.

Sure. But you wouldn't be surprised by, say another 25 next quarter?

I could not hear your last comment. Say it again, please.

That's fair. But you wouldn't be surprised, let's say, if there was another 25 next quarter?

I don't want to speculate as to the numbers. But I expect to see some continued closure on the franchise side.

Jeff Kobolarz, Salomon Brothers.

Wondering if you can comment about your outlook for commodity costs over this fourth quarter and first quarter next year?

Hi, this is Nelson. I don't see a lot of movement. I see a stabilization on commodity prices now through '05. We are taking forward positions with suppliers that we have relationships with. We don't hedge.

As far as things that I continue to see pressure on, with not a lot of letup, is actually energy. Natural gas and oil, as I alluded to in my comments, are still unpredictable, just following the markets. I don't know where that's going to wind up. That's a risk, as it is with every retail business.

And some of the petroleum-based products -- you know, we use a lot of take-out products, petroleum-based stuff -- can liners, take-out materials. The non-ingredient side -- I think we've done really well, the industry has in general, and so have we -- have done really well on the non-ingredient, non-food items this past year.

I am skeptical about whether or not we are going to get another year. My belief is we are going to see increased costs there. But we will continue to manage them, and hopefully get some benefits on the food commodity side to offset it.

So I'm projecting maybe 1 percent, 1.5 percent up on our commodity costs next year.

Okay. So that's going to be more than offset by your menu price increase?

We will watch it carefully. We deal with this menu weekly here, and try and not only do damage control, but to be opportunistic, as to how we manage them menu, which is really an upside, too, to what Denny's has done in the past, which -- candidly, we didn't do that. So, I'm not concerned about the 1.5 or 1 percent that I'm predicting.

And then can you remind us what the 14th week of last year's fourth quarter -- what did that contribute to EBITDA?

Yes, last year, we did have an extra week. It was a 53-week year. And it hit in the fourth quarter. We announced last year that the revenue impact of that was 22.4 million, and the EBITDA impact was approximately 5 million.

Robert Goch, Miller Tabak Roberts.

On the cash -- did I hear you guys correctly that you are currently sitting with 4 to $5 million in excess cash, and cash needed at the registers is between 4 and 6 million?

Robert, you did hear me correctly. We have about 4 to 5 million of surplus cash right now. And we will likely eat into that for the balance of the quarter, as it is our seasonally toughest quarter from the cash standpoint.

Right. Although you guys commented on the incentives in the general and administrative expenses, did anything go on on the store level on manager incentives -- which is, I believe, in payroll and benefits this quarter -- third quarter?

Yes, it did. I'm looking back -- (multiple speakers) it was about 0.5 a percentage point -- the store level incentive. comp. And you're right; that hits in the payroll and benefits line.

And lastly, I guess with the 2 percent increase in April, is it too simple to think that if you have an average check up 3.8 percent, that 2 percent is due to price increase and 1.8 percent is due to menu mix?

No, that would be in the ballpark. You actually have to go back to the prior price increase, as well to do it perfectly, so that, for example -- if we took a price increase in November or October of 2003, in September of 2004, you're still having the benefit of that, as well.

So is it fair to say that that would even increase the price impact on the average check? Is that fair to say, that most of the increase in average check is basically due to pricing as opposed to mix?

Now. We're thinking it's in the low 2 range. So you weren't far off when you started at about 2 percent.

Tiz Pike (ph), UBS.

First, congratulations on a productive quarter. My first question relates to the year-over-year improvement in the payroll and benefits margin. You mentioned some of the reasons, but are we at a run rate now in the third quarter, or should we expect to see continued improvement in that margin in the next couple of quarters?

I think we are at a pretty good run rate. It ran -- let me see, it was 41 percent this quarter. It was 41 percent approximately last quarter. So I think we are at a pretty good run rate, I would say.

Okay. And then my follow question relates to your updated remodels in Chicago. Would you care to provide any update in terms of how well those stores are being received, and has there been any decision made in relation to rolling out something like that on a nationwide level?

Let me go back to your prior question, because I want to make sure -- I didn't really respond in terms of seasonality. And there probably is some. In the fourth quarter and the first quarter, which are our lowest sales volume quarters, there probably is a bump up as a percentage of sales of labor. So let me just put that one qualifier -- you might want to look back at sort of how the seasonality runs. So the 41, for example -- I'm looking at the fourth quarter last year now -- was a little over 42.

Okay, this question was about the remodels in the Chicago area.

Yes. The updated remodels -- you said there were about 7 stores or so that you guys are rolling out a new look for?

Yes, actually, there's 7 stores, plus we are probably going to do another 30 of that type for the balance of the year and into the first quarter.

But it is too early to tell. We've got some consumer research that we've had an opportunity to see that is very favorable. However, I would tell you -- perhaps on the next call, we'll talk about the results. And we'll have enough time with those first 7 stores to really provide you some quantitative information. Right now, it would be very speculative.

All remodels, as you probably have heard me say before, for all brands always generate increased sales. The question is, 6 months to 1 year later, did you hold onto them? And we want to wait a while to see ultimately what the financial benefit is going to be. But right now, the consumer is embracing the new approach.

Nelson, I would add to that -- and this is a question that Nelson and I were asked a lot on our recent roadshow, about the remodels and the new design. We do believe that remodels are a part of doing business in the restaurant industry. And the success of the Denny's turnaround -- it is only one component. So we hesitate, and you probably won't hear us tell you that remodel sales returns are a silver bullet. It is part of doing business. And you do get a nice bump. But there's a lot of other parts to increasing sales. So I don't like to overplay it.

Thank you. At this time, there are no further questions.

Okay.

Okay. With that, we will conclude the call.

Thank you. This concludes today's conference call. You may now disconnect.