Denny's Corp (DENN) 2007 Q1 法說會逐字稿

Good afternoon. My name's [Tashana] and I will be your conference operator today. At this time I would like to welcome everyone to the Denny's first quarter 2007 earnings release conference call. (operator instructions). After the speakers' remarks there will be a question and answer session. (operator instructions).

Mr. Lewis, you may begin your conference.

Thank you, Tashana. Good afternoon and thank you for joining us for Denny's first quarter 2007 investor conference call. This call is being broadcast simultaneously over the internet. With me today from management are Nelson Marchioli, President and Chief Executive Officer; and Mark Wolfinger, Denny's Executive Vice President Growth Initiatives and Chief Financial Officer.

Mark will begin today's call with financial review of our first quarter results. Nelson will then provide an overview of the business. After that, management will be available to answer questions.

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 annual report on form 10-K for the year ended December 27, 2006 and in any subsequent quarterly reports on form 10-Q. We expect to file our 10-Q for the first quarter this evening so you will have that available for review along with the earnings release.

With that I will now turn the call over to Mark Wolfinger, Denny's CFO.

Thank you Alex, and good afternoon. I will start my comments with a quick review of our first quarter sales performance. Company same store sales decreased 1.8% compared with a 4.6% increase in the prior year period. The sales decrease in this year's first quarter was comprised of a 2.7% increase in average check and a 4.3% decrease in guest counts.

The persistent soft guest traffic environment we noted on our last call continued through the first quarter. While our sales guidance for the year included soft traffic assumptions, we are committed to increasing guest counts in a profitable manner and have recently launched several value oriented promotions that we expect will have a positive impact. Nelson will talk more about these promotions in his remarks.

Denny's franchise restaurants reported a 0.7% decrease in same store sales in the first quarter. This decrease, combined with a company performance, resulted in a 1.1% decrease in same store sales across the Denny's system. This broke a streak of positive sales for the system that had reached 13 consecutive quarters. While we are disappointed to see the streak end, we are proud of the success achieved by our company and franchise operators over the last three and a half years.

Turning to our income statement, first quarter sales at Denny's company owned restaurants decreased $9.2 million, or 4.1% from the prior year, due primarily to 17 fewer equivalent units, combined with a 1.8% decrease in same store sales. No company restaurants were closed in the first quarter of this year. The equivalent unit decline occurred primarily through the close of 16 underperforming restaurants in the fourth quarter of 2006. While our revenue has been impacted by the closure of those underperforming restaurants, they contributed little income and produced negative cash flow after meeting their capital requirements.

Turning now to the quarterly operating margin table in our press release, our company restaurant operating margin in the first quarter decreased $5.3 million, or 1.9 percentage points, to 11.3% of sales from 13.2% in the prior year period. Product costs increased by 0.8% percentage points due to unfavorable shifts in menu mix along with modest increases in commodity costs.

The strong sales of our $5.99 Mega Breakfast had a negative impact on menu mix as these promotional items had a lower food cost margin than many of our other breakfast entrees. On the commodity front, we were impacted most severely by higher costs for orange juice and shell eggs.

Payroll and benefits costs increased 1.3 percentage points in the quarter due primarily to wage rate increases combined with the unfavorable impact of lower same store sales on our fixed management costs. Given the challenging sales environment and the certainty of minimum wage impacts, we expect wage pressures to remain our biggest cost challenge throughout the year.

Moving down the P&L to occupancy costs, these semi-fixed costs were also negatively impacted by lower same store sales in the first quarter. In aggregate, our other operating costs improved by 0.4 percentage points, or approximately $2 million in the first quarter, though there were some offsetting impacts. Utility and maintenance expenses decreased in the quarter while a prior year benefit to legal settlement expense negatively impacted the current quarter comparison. In addition, other operating expenses benefited from $900,000 of insurance and other lost income recoveries.

On the franchise side of our business, our franchise operating margin decreased $1.3 million, but improved by 0.5 percentage points to 69.1% of revenues from 68.6 percent in the prior year period. Our franchise and license revenue declined $2 million due to a $2.2 million decrease in franchise rental income attributable primarily to the 2006 sale of real estate previously leased to franchisees. The lost rental income was partially offset by a $300,000 increase in initial franchise fees. Costs of franchise and license revenue decreased by $700,000 primarily due to lower occupancy costs resulting from the sale of real estate previously leased to franchisees.

General and administrative expenses decreased approximately $1.3 million from the prior year period, due primarily to a $1.2 million decrease in share based compensation. Core G&A was basically flat, though decreases in incentive compensation offset increases in other G&A costs primarily related to additional staffing.

Depreciation and amortization decreased $1.2 million from the prior year quarter due primarily to the sale of real estate assets last year. The last line impact in operating income is operating gains, losses, and other charges, which decreased $1.8 million over the prior year period. The increase was due primarily to asset sale gains of $3.3 million resulting from the divestiture of three real estate assets, along with the sale of six company restaurants to franchisees during the first quarter. All of these factors combined to lower operating income in the first quarter by $2.3 million to $12.7 million.

Below operating income, interest expense decreased by $3.3 million to $11.3 million in the first quarter. This included a $2.6 million increase in cash interest expense compared with the prior year period as a result of lower debt balances and improved borrowing costs.

Our decision last year to sell nine core real estate assets, primarily properties leased to franchisee operatives, resulted in lower operating income due to loss of rental income, but higher net income due to the greater reductions in cash interest expense.

In addition, non-cash interest expense decreased by $700,000 in this year's first quarter due to the write off of considerable deferred financing costs in the fourth quarter of 2006.

Now to the bottom line. We reported net income in the first quarter of $1.2 million, or $0.01 per share per diluted common share, an increase of $500,000 compared in the prior year. Our internal profitability measure adjusted income or loss before taxes. This excludes re-structuring charges, exit costs, and pyramid charges. Asset sale gains, share based compensation, other non-operating expenses and income taxes, decreased by $2.1 million to a loss of approximately $100,000 in the first quarter. The decrease in this core business income metric is due primarily to lower same store sales and the resulting negative impact on our company restaurant operating margins.

Regarding restaurant portfolio activity in the first quarter, we saw no net change in the total system restaurant count from year end 2006. The company portfolio declined by four restaurants in the first quarter. One new company restaurant was opened and one restaurant was acquired from a franchisee. No company restaurants were closed in the quarter but we did sell six company restaurants to franchisee operators. We opened our newest company restaurant inside the Tahiti Village Resort, a large condominium complex on the south side of Las Vegas Blvd.

Our franchise restaurant portfolio increased by a net of four restaurants in the first quarter as franchisees opened three new restaurants and purchased six company restaurants. They also closed four restaurants and sold one back to the company.

Moving on to capital expenditures, our cash capital spending for the first quarter was approximately $7 million, including the purchase of one franchise restaurant operation. We expect our capital spending will increase as the year progresses. Most of our new company restaurants are expected to open in the second half of the year and our remodel schedule is currently heavier in the back end of the year.

Turning to our balance sheet, we continue to make progress on our initiatives to sell non-core assets and use the proceeds to reduce our outstanding debt. Our net proceeds in the first quarter were $5.17 million from the sale of three real estate assets and six company restaurant operations. Consequently, we reduced our debt balances by $6 million in the quarter. In addition, our cash balance increased by $9 million in the quarter, though much of that went out to pay the $8.8 million semi-annual interest payment on our senior notes just after the quarter ended.

In addition, we have initiated a $10 million voluntary pre-payment of our credit facility term loan which will lower that debt balance to $231 million later this week. This represents a $29 million reduction in this loan in the five months since it was originated. In fact, since the beginning of 2006 we have reduced our total debt outstanding by over $116 million, or 21%.

In March we completed an amendment to our credit facility which allowed for a 25 basis point reduction in our borrowing rate from LIBOR plus 225 to LIBOR plus 200. Our consistent focus on cash flow generation and our proven commitment to debt reduction were essential to gaining consent from our lenders for this rate improvement.

Also in March we entered into an interest rate swap on $150 million of our floating rate term loan. At that time we were able to lock in a 3-year fixed LIBOR rate of just under 4.9%, which lowered the cost on that portion of our credit facility to below 7%. It also represented a savings of approximately 35 basis points, compared with our current floating rate borrowing. Based on balances and rates at that time we could save as much as $1 million in annual interest expense from this interest rate swap in the March loan re-pricing.

Our liquidity remains strong at the end of the first quarter with $35 million in cash and $48 million in availability under our revolver. Our cash balance today is approximately $10 million after making a coupon payment on our senior notes and the volunteer reprieve payments on our term loan. We expect our cash balance will build through our seasonably stronger summer months. We will continue to apply assets sales proceeds and cash flow from operations towards reducing our debt balances.

That wraps up my comments on our results. While we expect a difficult sales environment in the first quarter, and frankly for much of this year, that doesn't less our disappointment or detract from our commitment to perform better. As we approach our seasonably higher volume summer months we are launching several marketing initiatives which provide our customers an incentive to dine out with Denny's.

As the sales weakness impacting the industry is not likely to improve in the short term, we must also be more efficient in our labor usage and more proactive in our food cost margins. We operate in a penny driven business that becomes particularly challenging in a soft sales environment. We are committed to meeting our free cash flow targets through operating cash flow, asset sale proceeds, and disciplined capital spending.

We expect further asset sales during the year to help supplement our operating cash flow. We have nine real estate properties, surplus and franchise, which we expect to sell within the next 12 months. This excludes any real estate that may be sold in connection with our franchise growth initiative, or FGI.

With regard to our FGI program, we sold six restaurants to franchisee operatives in the first quarter. Subsequent to the quarter end we closed sale of an additional four restaurants. While we are encouraged by the initial response to our program, we are still in the early phases of our marketing efforts. As we have discussed previously, we have divided our company restaurants into very specific geographic clusters across the country. The marketing and negotiation of these clusters will be a complex process. We will provide updates each quarter as we progress through our FGI program and gain a better understanding of the demand for our company restaurants, but more importantly the potential new franchise development that can be driven by this program.

That wraps up my comments. I will now turn the call over to Nelson Marchioli, Denny's President and CEO.

Thank you, Mark, and hello everyone. Our first quarter results were in line with our expectations, but were disappointing nonetheless. Same store sales across the Denny's system decreased 1.1%. While this was the first negative quarter for the system in the past three and a half years, we are not accepting our negative sales trends. We have refocused our marketing and operational efforts on activities that can best drive incremental guest traffic.

The persistent soft sales environment affecting our industry has been particularly challenging because of continued cost pressures, most recently the impact of higher minimum wage rates. The strong sales leverage restaurants can generate from a positive sales performance can be equally unfavorable when sales are declining.

In an effort to break out of our soft sales trends, we recently launched several marketing initiatives designed to give our customers an added incentive to dine at Denny's, one of which is a national coupon circular with offers similar to the coupons we distributed last year with notable success. In addition to the coupons, we are promoting a new $4.99 weekday breakfast offering and supporting it with additional television advertising.

While we always approach any discounting with caution, we have demonstrated success in driving traffic while maintaining our profitability. It is too early to judge the success of our current promotions, but we are encouraged by the initial response. Although the operating environment is challenging, we remain committed to delivering on our long term strategic initiatives.

We continue to focus on cash generation and debt reduction. The clear benefits of continued debt reduction are lower cash interest and higher free cash flow, but equally important are a strong balance sheet and a reduced risk profile, particularly in challenging economic times.

We are also making progress on our initiatives to reignite our restaurant development across the Denny's system. Our new franchise development programs are now being implemented and initial interest has been strong. Our franchise growth initiative, or as we refer to it FGI, where we offer to sell geographic clusters of company restaurants to franchisees in return for new unit development agreements, has moved from the development stage to a few early transactions.

As Mark mentioned, we have sold 10 company restaurants to franchise operators so far this year. As part of that, we also secured development agreements for six new units. While we are pleased with these initial transactions, the financial implications of this program and the potential demand for our restaurants are still under evaluation.

We're also committed to looking beyond our day-to-day management decisions in order to prepare Denny's for long-term success. Denny's is an American icon, and the brand carries immeasurable value. That said, the restaurant industry continues to evolve with changing consumer needs and preferences. The relative success of quick service restaurants during the current soft sales trends in our industry is a reflection of consumer desire for greater value, convenience, and innovation.

Consumers are still eating out, but their decision points for their dining choices have clearly changed. To reach our goals for the Denny's brand, we must meet the changing needs of our customers and achieve relevancy. We believe Denny's has an opportunity to materially enhance its operations with regards to value, speed, and convenience, as well as achieve additional strategic possibilities.

To lead our commitment to Denny's evolution we recently announced the appointment of Mark Chmiel to a new position of Senior Vice President Concept Innovation. Mark's responsibilities include identifying strategic business opportunities, as well as managing projects designed to drive sales growth and evolve the Denny's brand.

We are optimistic that our current promotions will prove effective in reinforcing Denny's value proposition to a consumer making selective dining choices. We are also optimistic about the initial response to our franchise development programs and our potential to reach our goals with greater unit growth, tighter company geographic footprint, and enhanced restaurant profitability. We look forward to reporting progress on these strategic initiatives over the coming quarter.

As always, we thank you for your interest in Denny's. I'll now turn the call back to Alex.

Thank you Nelson. And at this time we'll turn the call over to Q&A if Tashana will get that ready for us.

(operator instructions) Your first question comes from Eric Wold of Merriman Curhan.

Hi Eric.

What detail can you provide on the re-franchising, specifically on the six done in Q1 and the four done in Q2? How many franchises were those two -- is it a commitment for six more units? Over what period is that? And any detail on the valuation or multiples for those 10 units?

Hi Eric, it's Mark. We figured that would probably be one of the first questions we'd receive, and again appreciate your interest in Denny's. I think as we said, we really want to be very cautious and conservative as we approach this program. So we don't really want to provide a great deal more detail at this point. What I would tell is it was obviously -- there were a few franchisees involved. It was more than one, obviously, in the 10 stores that were sold. And as far as the six new stores, the six new development stores that Nelson mentioned, those are obviously a pipeline type of situation that will stretch out over a few years.

And I think the last comment -- I know Alex probably wants to comment here as well -- we realize there's a great deal of interest from all of our stakeholders in the progress we're making here on FGI. And as we said, we'll unfold this thing on a quarterly basis as we go through each results conference call and give you a little bit more detail each time, very similar to what we did in the real estate activity last year. I realize that can be a bit frustrating at times, but obviously we want to approach this accordingly from our management team perspective. Alex?

Yes, I would just say -- go back to what we said on the last call, and that's that there is going to be a wide variety of these transactions. There's going to be units that have very little cash flow for sales; you're going to get very little if no multiple. There are going to be other units that have potentially a lot more cash flow. It's also going to depend a lot on the capital requirements for that unit. It's going to depend a lot on what that particular franchisee can sign up for from a new development agreement. All those things will go into these negotiations and at six units, or even at 10 units, that is not a valid sample size to have the community on the other end of this phone trying to work from. So again, as Mark said, as we move forward, as we build some confidence in the process and start getting more transactions behind us, I think we'll be able to give you more detail.

I completely understand. I was following up with one quick question on that, if -- obviously only 10 of them have been done but obviously you're probably going to talk to a fair amount more. How would you characterize the demand or the response from the franchisees to this program versus when you first thought about it last year?

I'll go back to a comment that Nelson made in his script and that is that management is optimistic about the progress we've made the progress we'll continue to make. This is Mark, by the way. And I would also say, Eric, that I think our last conference call was mid-February time frame, which was our year end 2006 conference call. I personally, and I think the management team in entirety here is very pleased with the amount of knowledge and learning that we've gathered from this process over this last two and a half months. And we continue to be cautiously optimistic we'll make progress here and continue to disclose that progress each quarter.

Sounds good. Thanks guys, appreciate it.

Thanks Eric.

Your next question comes from the line of Kevin Starke of Weeden & Company.

I think I'm probably paraphrasing you wrong, Nelson, and I apologize for that. But you said something about consolidating the company owned geographic footprint and I'm wondering if you could elaborate on that a little.

Well as we've talked about in other calls an in other investor conferences, we are looking at where we own our restaurants strategically, geographically. We own restaurants in some places in this great country of ours that frankly don't make a lot of sense that made a lot of sense to management years ago as we were expanding this brand across the country.

I often referred to in my conversations with investors a couple restaurants in New Mexico. They do very well but we have no business owning them. It takes us eight hours to get a human being there to supervise those restaurants. So we are in fact -- I don't have any franchisees currently that are interested in this two stores that I'm aware of, but I am interested in selling those restaurants to folks that are good operators and want to expand in those areas where we are not going to invest company capital. And we can reduce our G&A exposure by not being in these far-flung territories, and focus on those areas that we know we do extremely well in, the state of California, Hawaii, Texas, Florida, etc.

Another question, the $2 million cash payments for restructuring charges and exit costs, is that the actual cash payment on a restructuring charge taken previously or was some of that taken in this quarter?

There wasn't much restructuring charge taken this quarter. And what was there, not a lot, reflected exit costs. What that is, is those are the cash payments for exit costs, as you said, that were charged to the P&L in years past. But what you saw really in the first quarter was a little bit higher than normal because we did buy out of a few leases and so that was reflected in those cash payments.

And finally from me, could you comment a little bit on the effect of the minimum wage increase in California?

This is Mark. I can tell you that we obviously were prepared and relatively knowledgeable about what was going to happen in California from a minimum wage standpoint, and we operate a large part of our system out there. We have about 400 of our restaurants, that's company and franchise combined, in California. In preparing and getting ready for 2007 we realized that we probably had to take pricing actions to offset those minimum wage increased. Obviously a lot of folks were in the same situation that are in the service industry, and we did that accordingly because, obviously, we did not want to look at some kind of significant impact on the margin line.

And, Mark, I want to jump in. One thing, Kevin, you asked about and I was just reminded of, in the 10-Q that should be filed later this evening, we break out what those cash payments, what we expect those cash payments to be for the rest of the year, and probably over the next several years. So you can get a good idea of that from the 10-Q. I think it's General Note 2 or 3, somewhere along that line.

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

Thank you.

Hi Tony.

Good afternoon. Nelson, in talking about new marketing initiatives you mentioned a national coupon circular and a price promotion on weekday breakfasts. Earlier my impression was that you had indicated that the emphasis in 2007 would be on new product introductions and on addressing issues such as portability, speed of service. Is that a change in tactics or are the other factors still to come?

No, it is not a change in tactics. We're still going to focus on those areas that you mentioned with great vigor, if you will. But recognizing the current economic environment, it was obvious that while we are in the development stages of those areas of focus, be it product portability, be it speed of service, be it convenience, etc., we needed to do something to make sure that our base business continued to flourish. And clearly in the first quarter it did not. So we know that Denny's is known for value and it was time for us to remind the customer again and I think you'll see us continue to focus on that the balance of this year because we must continue to grow the business while we work on these other initiatives. But by no means is there a change of tactics. This is just something that we have to do, realizing the economic environment that we operate in.

Thank you.

Thank you.

Thanks Tony.

Your next question comes from Brian Moore.

Good afternoon.

Hi Brian.

Some of your peers have been, I guess, gracious enough this quarter to provide some color on sequential comps over the quarter. I was wondering if you could talk about January, February, March, and in light of the $4.99 promotion, how that fits into acceleration or deceleration of comps over the quarter.

Brian, this is Alex, and we're not going to go into those details. I think that goes against the point we're trying to make with focusing on quarters and years of performance. But I will say we didn't see -- had it been some material difference we probably would have chosen to speak about it. The $4.99 is a relatively new promotion that was not available during the first quarter so that's not impacted in those numbers. As was the coupon drop; both of those were second quarter events, the $4.99 and the coupon.

Okay. I guess as we look out over the whole -- or the entire marketing calendar, perhaps, how does that $4.99 promotion fit in terms of either a dinner module or some other type of module. I forget the exact number --

Right. And that's one of the reasons we haven't talked on this specific call about new product introductions because we are not to our next product launch and we don't typically try and talk about that until we do. That'll happen I believe at the end of May, early June, and that will be our next module if you will. This $4.99 was a limited time offer so it will not impact our normal marketing calendar which I believe at the end of May. That will have new dinner entrees, new breakfast entrees. It will have new promotions for the breakfast as well.

Do you think if there's some media behind or advertising behind dinner this year, or you'll primarily focus on breakfast?

I think you'll see us being breakfast inspired for the balance of this year. That may change but I may tell you Denny's is known for breakfast and we'll continue to focus on our strengths.

Okay. And then last question would be, I think you hinted at some opportunity, perhaps, for labor scheduling. If you could maybe provide some color on that in terms of managing that line item.

The only thing I could tell you would be we are putting in some -- or have put in some labor scheduling similar to others in the industry. But I think the impact of what those could be have been impacted by the lower sales. And that -- we have to maintain minimum service levels in our restaurants, so I think any improvements that we might have seen or might be enjoying as a result of new labor scheduling, schedules and grids and the like, frankly has been masked by the lower sales performance.

There are no further questions at this time.

Okay, well thanks everyone for joining us. Again, we will be trying to file the Q here this evening so you'll have that for review as well. And we look forward to talking to you next quarter. Thank you.

This concludes today's Denny's call. You may now disconnect.