Denny's Corp (DENN) 2011 Q1 法說會逐字稿

Good afternoon. My name is Melissa. I will be your conference operator today. At this time, I would like to welcome everyone to the Denny's Corporation first quarter 2011 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 session. (Operator Instructions).

Thank you. I would now like to turn the conference over to Whit Kincaid, Director of Financial Planning and Analysis and Investor Relations. Please go ahead.

Thank you, Melissa. Good afternoon. And thank you for joining us for Denny's first quarter 2011 investor conference 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 first quarter results. I will conclude the call with an update to Denny's guidance. The 10-Q will be filed today.

Before we begin, let me remind you that in accordance with the Safe Harbor Provisions of thePrivate 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 risk, uncertainties, and other factors that may cause the actual performance of Denny's to be materially different than the performance indicated or implied by such statements. Such risk factors are set forth in the Company's Annual Report on Form 10-K, for the year ended December 29th, 2010, and in any subsequent quarterly reports on Form 10-Q.

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

Thank you, Whit. In the first quarter of 2011, we continued to build on the positive achievements realized in the second half of 2010, we had improving sales trends, strong unit development, and a furtherer strengthening of our balance sheet, despite the challenging economic environment and the inflationary pressures impacting our business and our customers for that matter, we remain very optimistic about our performance and our strategies. When we developed our 2011 annual same store sales guidance of negative 2% to positive 1%, we anticipated that our first quarter sales would have its own unique set of challenges.

As previously communicated, we expected first quarter sales to be impacted by a number of factors. The year-over-year impact of the 2-4-6-8 value menu which we tested you will recall, in the first quarter of 2010, then launched nationally in the beginning of the second quarter. The Easter spring break shift, the severe weather in January and early February, and the impact of not repeating the Super Bowl promotional event of 2010. As we execute our marketing strategy and emphasize every day affordability, combined with attractive limited-time products, same store guest trends continued to improve relative to our performance relative prior to the launch of the 2-4-6-8 value menu. So when you exclude the 2 percentage point negative impact on guest traffic from not repeating the 2010 Super Bowl promotional event of 2011, same store guest counts would have been positive.

In the first quarter of 2011, we focused our marketing efforts on our 2-4-6-8 Value Menu, along with a few Breakfast Lovers limited-time only products, which featured three items priced between $5.99 and $7.99. With post-holiday time being a value-sensitive time of year, we wanted to stick with Denny's every day affordability using the 2-4-6-8 Value Menu. The successful focus on our value menu during the first quarter increased the mix above 20%, as compared to less than 20% in the fourth quarter.

Most importantly, now that we have reached the anniversary of the national launch of our value menu, we are no longer seeing a decline in comparable guest chest average. We also launched our new America's Diner brand positioning with our America's Diner is always open campaign. Our campaign looks to capture the soul of the diner, that which is very approachable, very warm and open to all types of guests and occasions. Our strategy is less about the look, and more about the feel where one of could say time out to their title or station in life, and just be a member of the community seeking a diner. Our guests see our brand as America's Diner, with great hospitality and great comfort food at a great price.

As we move into the second quarter, we will continue with our America's Diner is always open campaign, and focus on our three primary marketing strategies, delivering every day affordability, creating compelling limited-time only products, and driving sales beyond breakfast. Strategically, we remained focused on increasing the relative price/value gap between ourselves and our competitors. The key to our collective success in 2011 will be the balance of every day affordability, and limited-time only products. Our focus has shifted to our LTO new products, which provide margin friendly premium offerings, with higher starting price points leveraged to balance the impact on our guest check averages from the value of our every day affordability platform from earlier in the year.

In late March, we launched our newest module called Baconalia featuring a variety of cravable unique bacon product offers. In addition, we launched our real fruit Smoothies nationwide, which provide an attractive guest check add-on opportunity for our restaurants. These offers leveraged Denny's core strengths as a diner, drive consumer interest, and deliver and outstanding dining experience for our guests. They are all very, very good.

Turning to unit growth, we opened 18 new units in the first quarter after opening 136 new units in 2010, which was the highest number of domestic openings in the Company's history. Denny's has opened 154 new units in the last five quarters, and 137 units in the last three quarters. We continued to execute the Flying J program as we opened 12 additional Flying J conversions, which brings the total Flying J program to 112 openings. Of the 12 sites converted in the first quarter, seven were converted by franchisees and five were converted by the Company, bringing the program to date total to 86 franchise and 26 company Flying J locations.

In addition to the Flying J openings, our franchisee and licensees opened four traditional units, two university locations at Auburn University and Kansas State University, both in partnership with Compass Group's Chartwells division, we have opened a total of eight university locations since January of 2010, demonstrating the attractiveness of the Denny's brand in new distribution points. We are excited about completing the Flying J conversions and working closely with our franchisees and licensing partners, to grow the Denny's brand from traditional and non-traditional venues, both domestically and internationally. Our probability remains on track despite commodity pressures that are providing headwinds for us and others in the restaurant industry. Our growing free cash flow has enabled us to continue strengthening our balance sheet, and return cash to shareholders.

Along these lines, we repaid $10 million of our term loan in the quarter, and repurchased 2 million shares, completing the 3 million share repurchase program announced by our Board of Directors last November. In addition, the Board of Directors authorized a $6 million stock repurchase program at the beginning of the second quarter. Since our refinancing at the beginning of the fourth quarter of 2010 we have allocated over $30 million, to pay $20 million in debt, and repurchased 3 million shares, in addition to opening 16 company-owned Flying J restaurants.

Although Denny's achieved a number of successes in the past 12 months, I believe there is tremendous opportunity with the Denny's brand. It is an exciting time for our Company, and I want to thank our customers, team members, franchisees, suppliers, and of course our shareholders, for supporting us as we build upon the foundation, currently in place at Denny's. We are committed to making Denny's a much more competitive player in the mid-scale segment and in the industry. Our leadership team is working to further develop a growth plan to drive shareholder value over the long-term. We are committed to executing successful strategies that further strengthen our position as America's favorite diner in 2011 and beyond.

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

Thank you, John. Good afternoon everyone. Our first quarter performance continued the momentum we experienced in the fourth quarter, as we continue to execute on Denny's sales and guest driving initiatives, continued our strong unit development, re-priced the Company's debts, repaid $10 million of our term loan, and completed our 3 million share repurchase program announced last November.

Denny's had new system growth of positive seven units in the quarter, after opening 18 units and closing nine franchise units and two Company units. In addition, we sold nine Company restaurants to franchise operators. In the first quarter, system-wide same store sales decreased to 1.7%, which was 0.3 of a percentage point lower than the fourth quarter of 2010. Same store sales at company restaurants decreased 1.3% and same store sales at franchise restaurants decreased to 1.7%.

Looking at the details for Company sales performance, we saw a same store guest count decrease of 1.1% in the quarter. We estimate that our same store guest count would have been positive in the first quarter without the estimated negative 2 percentage point impact from not repeating the 2010 Super Bowl promotional event, an estimated 0.5 percentage point impact from the Easter spring break shift, and severe weather in January and early parts of February. In the first quarter average guest check decreased by only a 0.1 of a point. This represents an improvement relative to the fourth quarter when our guest check decreased by 1.4%. This improvement is primarily attributable to the estimated 2 percentage increase in average guest check from not repeating the 2010 Super Bowl promotional event.

In addition, our 2-4-6-8 value menu wasn't launched nationally until the beginning of the second quarter of 2010. So there was a negative year-over-year impact from the investment in our every day affordability strategy. Now that we have reached the anniversary of the national launch of 2-4-6-8, we are not seeing a negative same store guest check average. The decline in total Company restaurant sales in the first quarter largely reflects the continued impact of our franchise growth initiative or FGI, as Company sales decreased $3.2 million or 3%, primarily due to four fewer equivalent Company restaurants compared to the same period last year, and the decrease in same store sales for the quarter.

I will now turn to the quarterly operating margin which decreased 1.5 percentage points in the first quarter, and was primarily impacted by the following items which I will discuss in more detail. Payroll and benefits costs increased 1.3 percentage points to 42.3% of sales. Primarily due to higher restaurant manager incentive compensation, and $500,000 from an unfavorable Worker's Compensation claims development. Product costs increased 0.7 of a point to 24.5% of sales, primarily due to the impact of increased commodity costs, and a higher mix of value priced items.

Other operating costs increased by 0.4 of a point primarily due to higher new store opening expense associated with the opening of 16 Company-owned Flying J units in the last two quarters. Offsetting these items were lower occupancy expense which decreased 0.3 of a point, to 6.6% primarily due to favorable developments and general liability claims. In addition, marketing expenses decreased by 0.3 of a point to 3.7% of sales primarily due to 2010 media spending related to the Super Bowl, and the testing of the 2-4-6-8 value menu in the prior year quarter. In summary, the gross profit from our Company operations decreased $2 million on a sales decline of $3.2 million.

The first quarter of 2011, Denny's reported franchise and license revenue of $31.3 million compared with $29.8 million in the prior year quarter. The $1.5 million increase in franchise revenue was driven by a $1.3 million increase in royalties, and $0.5 million increase in franchise fees, offset by a $300,000 decrease in occupancy revenue. The higher royalty revenue was due to 110 additional franchisee equivalent restaurants.

The franchise fee increase resulted from selling 9 Company units in the quarter compared to no units in the prior year quarter, and opening 13 franchise units in the first quarter of this year compared to six in the prior year quarter. The franchise openings this quarter included seven Flying J Travel Center conversions and two university locations. In addition to opening 13 franchise units during the first quarter, Denny's franchisees closed 9 restaurants. Franchise operating margin increased by $2.3 million to $19.7 million in the first quarter. This increase was primarily driven by the $1.3 million increase in royalties, a $700,000 decrease in direct franchise costs, and a $500,000 increase in franchise fees.

Franchise operating margin as a percentage of franchise and license revenue was 63%. An increase of 4.5 percentage points compared with the same quarter last year. The franchise margin increase was primarily due to the higher royalties and fee revenue, and lower direct franchise costs, offset by the lower occupancy margin. The $1.5 million benefit we saw from the 2010 Super Bowl expenses was partially offset by a $500,000 one-time franchisee encroachment settlement. The decrease in occupancy margins primarily driven by the impact of lease terminations and closures.

The franchise side of our business computed 61% of gross profit, which is $7.1 million more than our Company restaurants. This income shift allows us to reduce the risk and increase the predictability of our earnings. General and administrative expenses for the first quarter increased $1.1 million from the same period last year. This increase was primarily driven by higher incentive compensation accruals relative to the prior year. Depreciation and amortization expense declined by $200,000 compared with the prior year period, primarily as a result of the sale of Company owned restaurants over the past year, offset by the addition of 25 new units in the last 12 months.

Operating gains, losses and other charges on a net basis, which reflect restructuring charges, exit costs, impairment charges and gains or losses on the sale of assets, increased by $1 million in the quarter. This increase was primarily the result of an $800,000 increase in gains on the sale of Company restaurants, and real estate to franchisees, and a $200,000 decrease in closed store exit costs. Operating income for the first quarter increased $300,000 to $11.5 million, primarily due to a $2.3 million increase in franchise margin, partially offset by the $2 million decrease in the gross profit from our Company operations. The lower operating income interest expense for the first quarterdecreased $700,000 or 11%, to $5.7 million as a result of lower interest rates under the refinanced and repriced credit facility, and a $20.1 million reduction ingross debt from the prior year period. Other non-operating expense increased $1.5 million in the first quarter primarily due to $1.4 million in expenses associated with the pre-pricing of our debt.

Because of the significant impact to our P&L from non-operating, non-recurring, or non-cash items, we give earnings guidance based upon our internal profitability measure, adjusted income before taxes. We believe this measure best reflects the ongoing earnings of our business. Our adjusted income before taxes in the first quarter was $6.2 million, which was $400,000 below the prior year. Negatively impacted by the $0.5 million one-time franchise encroachment settlement, and $0.5 million from an unfavorable Worker's Compensation claims development.

Moving on to capital expenditures, our year-to-date cash capital spending was $5.8 million, a increase of $2.6 million compared with the prior year. The increase was driven by a $3 million increase in new construction expenditures, reflecting the impact of opening five Company owned Flying Js this year, and 14 new Company owned units in the fourth quarter of 2010, and the timing of payments related to 4 Flying J units we opened in the first quarter of the prior year.

The transition to a franchise focused business model, and our focus on cost containment, has allowed us to aggressively reduce debt by almost $300 million, or 54% since the middle of 2006, lowering interest expense by more than $32 million when comparing full year 2006 to the last 12 months. This placed us in a position to refinance our credit facility in the fourth quarter of 2010, and to take advantage of credit markets in February of 2011 by repricing the credit facilities, saving us additional interest costs. The cost of our debt is currently 5.25%, compared to 7.7% 12 months ago. In addition, after the repricing, we added an additional lending partner, which enabled us to increase the capacity of our bank revolver to $60 million from $50 million.

Our strong financial position allowed us in the first quarter to repay $10 million in debt. Additionally, the Board of Directors authorized a 6 million share stock repurchase program at the beginning of the second quarter, after completing the 3 million share stock repurchase program approved last November. Denny's Board of Directors and management are committed to continuing to improve Denny's balance sheet, to return cash to shareholders, and to invest in the Denny's brand. That wraps up my review of our first quarter results.

I will turn the call back over to Whit,who will speak to our full year 2011 guidance.

Thank you, Mark. Based on year-to-date results and management's expectations at this time, Denny's is updating its financial guidance for full year 2011, adjusted income before taxes to reflect the positive impact from repricing our credit facility in the first quarter. The areas with updates are as follows. The 2011 cash interest expense is expected to decrease from $19 million to $17 million. Based on the lower interest expense, our 2011 adjusted income guidance is expected to be between $38 million and $42 million, compared to $36 million and $40 million, reflecting an approximate $2 million decrease in interest expense.

Based on the lower cash interest expense component of our guidance, our 2011 free cash flow is implied to be between $43 million and $48 million, compared to $41 million and $46 million. Although it is early in the year, our profitability remains on track. We remain cautiously optimistic due to the challenging economic environment and inflationary pressures impacting our customers and our business. Six months ago, we were expecting around 2% inflation for the year. And with our expectation increasing to 3% to 4% when we gave annual guidance in February.

Due to the upward trend in commodities, we are currently expecting a 4% to 4.5% increase in commodity costs for 2011. As a result of the commodity increases, we will be taking around a 1% price increase with our summer menu release. Strategically we remain focused on increasing the relative price/value gap between ourselves and our competitors, which is why the amount of pricing is relatively small. We believe that our focus on every day affordability, supplemented with limited compelling limited-time offers, and our positioning as America's diner, will enable Denny's to remain an attractive choice for our customers.

That wraps up our guidance commentary. I will now turn the call over to the operator to begin the Q&A portion of our call.

Thank you. (Operator Instructions). The first question is from Michael Gallo of CL King

Hi, good afternoon. Congratulations on a good result.

Thanks, Michael.

Question for you, as we cycle into the second quarter, you have lapped the 2-4-6-8 menu roll out, you have got some price rolling into the menu, you are promoting some higher price point promotions. So my question is, should we start to see comps trend positively that we won't have the guest check factor, assuming you can maintain some of the positive traffic trends that you had in the first quarter excluding some of the comparisons, and two, on the marketing spend, obviously you had less marketing spend in the first quarter this year versus last year. Should we expect that to be pretty evenly disbursed throughout the year, and based on the number of additional units you have, would you expect that the overall marketing budget should be pretty positive on a year-over-year basis, which would be good for the remaining three quarters? Thank you.

Hi, Michael. It is Mark. I will start at the beginning of your questions. I might have to ask you to repeat the tail end of it there. But first, on the comp sales question, just asWhit reiterated and our press release reiterated, our guidance, we provide annual guidance on comps, which is a minus 2 to plus 1 range. Obviously the first quarter, when you look at the results really fit into that range per se.

We mentioned obviously in our comments, the improvement in guest check average that we have seen as we have lapped 2-4-6-8, but obviously we continue to reiterate our current annual guidance on comps, and the best way I can position it obviously, is we provide annual guidance, not quarterly. We would have to give you an update obviously when we do our second quarter call. The second part your question, can you on the marketing--?

The second part was related to the marketing dollars. Obviously last year you had a lot of marketing dollars diverted or spent in the first quarter, that you didn't have later in the year. This year not to repeat the promotion plus just the overall growth you have had, and you should have in the marketing budget from the new unit openings, suggests you should have favorable comparisons on marketing dollars in the second through fourth quarter of this year. Can you comment at all on whether you expect it to be pretty even?

Right. On the marketing side, we have five key modules we run throughout the year. And so obviously, to your point, 2010 last year first quarter, there was obviously a heavy up marketing spend, advertising spend around Super Bowl. There was a little bit of difference between the cash outflow and the timing from an accounting standpoint, but you are right, obviously the first quarter spend last year was solidly wrapped around Super Bowl. I would I would tell you it is much more even flow this year, and clearly, to your point, we continue to see a pick-up in over all unit growth, so clearly there will be some incremental contributions that will come out of those new units as well.

Thank you.

Your next question comes from Mark Smith of Feltl & Company.

I might have missed it in the comments, but can you talk about the mix of 2-4-6-8?

Mark, we mentioned it briefly. The 2-4-6-8 menu mix is right above 20% during the quarter, which was higher than the fourth quarter when it was below 20%.

Okay. Perfect. And second, can you give us an update on where you are on your commodities contracts,and how much you have got locked currently, and when those start to roll off?

We were locked in for about 59% for the remaining portion of this year. So that really is from May to December. So when you look at it on annual basis, we are locked in for a little bit over 70% of the year. Primarily the areas where we still have exposure are some port products, going to be wheat, fresh produce, shell eggs, but we are locked for, primarily for bacon in the second and third quarter, kind of substantially locked for the second and third quarter, given that we are obviously with the Baconalia module going on right now.

Most of you think coffee which is still floating out there?

We are actually locked into OJ and coffee for the year.

Okay. Perfect. Thanks.

Your next question comes from Will Slabaugh from Stephens.

John, I wondered after now being in the role for a full quarter if you could give us kind of your initial take-aways there and also, last quarter you referenced a growth plan. And I wonder if just broadly, if you could touch on any details there what that might include?

Sure. The learnings are a lot along the lines you might expect. There are four to five key things over the last 90 days that sort of come to mind. One is this incredible passion for the Denny's brand everywhere I go. I have become a walking research department of one, trying to get, to learn all I can about the mid-scale space and particularly Denny's, and what turns people on about the brand, and what would make us stronger,

Consumers, they want us to win. They all have their Denny's story, and so this passion of this what has come to become an iconic brand, has been pretty special to be part of. Along the learning also is we really have the right leaders in place, they are trying to get this right. Beginning last year, I would say mid-year, a tremendous effort was put forth by our entire Executive team, to slow down and ask the customer, what do you want from Denny's? What do you love about Denny's? What would you like to see at Denny's? What would make you come more often to Denny's? And so the platform that we have now, this positioning America's diner is always open that was launched late last year, and continues through this year, is just now getting some great traction, we are winning blog contests.

We have a lot of customers responding to our campaigns. It is the platform is resonating and the positioning seems to be dead-on, always open. The consumers want this approachable, unpretentious family place, that they come when they are not using the grill and bar, when they are not using best casual, or other places. And they want certain things from our category. Our value proposition, our beyond-breakfast proposition, and our LTOs are designed to meet the needs of our consumers. So asking them and allowing them to guide the brand has been a tremendous benefit.

And then finally, I would say that our pipeline is deeper than ever. In listing the consumer and what they are looking for, we have been able to prepare a pipeline of products to supply the barbell end of the LTO, the new news end of our strategies now, and throughout the coming year and beyond. And we are excited about these new products and how they are going to launch. We are excited about the Baconalia launch, as I mentioned in my opening comments, and how the guests have received that, and so I would say, you can expect to continue to see the same kind of things along those lines. We will continue with our value proposition, and we will continue with new news that strikes at the heart of the diner, and what consumers expect from them.

Okay. Thank you.

On the subject of growth, I apologize I didn't answer the growth question. I don't recall exactly how that might have been referenced last quarter, but I would just simply say that as you heard from a number of commenting last quarter in this, we have through the travel center program, through some news and international, through the continued opportunity in non-traditional development, there is a lot of interest in Denny's right now. And so obviously, we expect to continue to grow our footprint in a number of places across the United States and globally.

Okay. Thanks. And on the new share repurchase program, any color there on how aggressive you plan to be here going forward?

Will it is Mark. We obviously on the first one, which is the 3 million share, there was a timeframe of fiscal year 2011, and obviously we completed that during the first quarter. So obviously, more rapidly than the end of the year. On the 6 million share piece, we have not provided a timeframe on that. We will obviously continue to be opportunistic in nature along those lines, but obviously that 6 million share count is double what the previous one was.

Thank you, guys.

Thank you. (Operator Instructions). Your next question comes from Sam Yake of BGB Securities.

Hello. I am wondering, it seems to me like the college campus, the university campus is a real positive opportunity for Denny's. I am wondering if you could give us some guidance on how many units you see possible there over the longer term?

Sam it is Mark. We obviously were confident enough in the beginning of the year, for the current year, fiscal 2011. Obviously this is a relatively new program. We really put it in place and opened the first six locations in the program during 2010. We provided guidance of 10 during 2011, clearly we believe we are the leader on campus from a family dining standpoint, with a number of different operating models, and clearly over in Kansas State, the openings that John mentioned in his comments, were those openings.

To directly answer your question, I would have to step back and say look at the potential of how many universities and colleges there are in the States, the United States. And then, in addition to that it is all wrapped around obviously the food service contracts, and those relationships. But long story short. We are extremely excited about that opportunity for this brand.

Okay. And then one other question. It seems to me your relations with your franchisees have improved a lot in the recent past. I mean dramatic improvement from, you had some pretty tough, rocky relations there for a while. I am just wondering if you could offer a general comment, and how much franchisee relations have improved, and how that has helped your business?

Well it is Mark here again. My response is obviously it is always difficult to quantify something like that. It is based on those relationships, but you have heard me say this before, Sam. We have a terrific franchise community, of over 260 individual franchise groups that we work with on a daily basis, and from a relationship standpoint, I would say it is very positive at this point in time.

Okay. Thanks so much.

At this time, there are no further questions. I will now turn the call back to management for closing remarks.

Thank you Melissa, and thank you for joining us on our first quarter call today. If you have any questions, feel free to contact me directly.

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