Denny's Corp (DENN) 2014 Q1 法說會逐字稿

Good day and welcome to the Denny's Corporation first-quarter 2014 earnings conference call. Please note today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Whit Kincaid, Senior Director of Investor Relations. Please go ahead, sir.

Thank you, Joshua. Good afternoon and thank you for joining us for Denny's first-quarter 2014 earnings 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 commentary on Denny's full-year guidance for 2014. As a reminder, our 10-Q will be filed later today.

Before we begin, let me remind you that in accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the Company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements. Management urges caution in considering its current trends and any outlook on earnings provided on this call. Such statements are subject to risks, uncertainties, and other factors that may cause the actual performance of Denny's to be materially different from the performance indicated or implied by such statements. Such risks and factors are set forth in the Company's most recent annual report on Form 10-K for the year ended December 25, 2013, 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.

Well thank you, Whit, and good afternoon, everybody. We are pleased to start of the year with another quarter of system-wide, same-store sales growth, highlighted by our strongest quarter of same-store sales at Company restaurants in over seven years. This strong performance at our Company restaurants was driven by our newly launched Heritage remodel program, which helped our Company restaurants outperform the continuing momentum of our franchise locations.

The enhancements and investments we are making in our restaurant atmosphere reflect a more contemporary diner feel. This further reinforces our America's diner positioning, and strengthens the existing improvements we have made in our food and service.

We are focused on differentiating Denny's in a crowded marketplace, by successfully executing our key objectives to further strengthen our position as America's favorite diner in 2014 and beyond. Achieving consistent positive same-store sales performance through continued improvements in our food, service, and atmosphere is one of our key objectives. We have ongoing initiatives in place focused on improving all three of these critical elements.

Of the 47 remodels completed in this quarter, 29 restaurants incorporated the Heritage image, including all 16 Company restaurants. The great news is that we are achieving positive same-store guest traffic at Company locations; this is evidence of our success with the Heritage image upgrades. While it still early in the revitalization process, we look forward with optimism to the opportunities that remain in front of us.

Our franchisees have a seven-year remodel requirement, which means approximately 70% of the system will be remodeled over the next five years. The Company will continue to lead the way by completing approximately 40 remodels this year, with the majority completed in the first half of the year.

We also continue to make improvements to our food, through both menu and promotional changes. At the beginning of this year, we launched redesigned menus, which further emphasize our diner heritage, while decreasing operational complexity and enhancing our breakfast all day and beyond breakfast offerings.

Our first-quarter limited-time-only menu featured the build-your-own skillet offering. In addition, the menu highlighted our Fit Fair build-your-own Grand Slam and the $2-$4-$6-$8 Everyday Value Menu. Guests responded well to our skillet offering, and we were especially pleased to see our guests taking advantage of a high number of our add-on opportunities.

In early April, we refreshed the limited-time-only menu with a build-your-own French toast offering. This menu also highlights the $4-dollar Baja Quesadilla Burger on the $2-$4-$6-$8 Everyday Value Menu and a selection of avocado favorites.

Like the first-quarter's menu, there were numerous add-on opportunities, in addition to showcasing our new coffee and milkshake flavors. These changes helped increase our guest-check average in the first quarter.

We continue to balance compelling, limited-time-only product offerings with our highly effective $2-$4-$6-$8 Value Menu, which mixes in the 19% to 21% range. Over 20% of our guests say they visit Denny's specifically because of the $2-$4-$6-$8 Value Menu, and we have an even higher percentage for this menu from our Hispanic guests.

It is an advantage that we are proud to have as we fight for share in this highly competitive industry. This proven platform will continue to be a critical part of our strategy to increase guest counts, visit frequency, and drive profitable traffic into our restaurants. We have worked closely with our franchisees to explore ways to leverage the high brand awareness of our $2-$4-$6-$8 Value Menu, balancing its traffic-driving appeal with the desire to grow profitability.

As a result of our initial efforts, we made some modifications to the $2-$4-$6-$8 lineup, with the clear objective of maximizing unit-level profitability. In April, we primarily focused on the $8 products by removing the free beverages, with the exception of the Grand Slam Slugger. We also replaced the $6 endless soup and salad with the eggs in a basket, which is one of the successful products from our Hobbit movie promotions.

We expect these changes to improve the food-cost percentage of the $2-$4-$6-$8 Value Menu. We will continue to work closely with our franchisees in identifying opportunities to reinforce the traffic and frequency-driving aspects of the $2-$4-$6-$8 Value Menu, while continuing to look for ways to improve food cost, margins, flow-through, and ultimately, store-level profits.

Ultimately, our guests will guide us in our ongoing efforts to improve our menus to meet the needs of an ever-changing marketplace. In summary, our revitalization efforts to improve our food, service, and atmosphere put us further down the path to achieving consistent, positive same-store guest traffic and the recovery of lost transactions over recent years.

Another key objective is to increase the growth of the Denny's brand, both domestically and internationally, through traditional and nontraditional locations. In the first quarter, our franchisees opened four new restaurants, including one international location. We expect to open between 45 and 50 franchise restaurants this year.

Our newest international restaurant is located in Eastern Canada, and opened by our largest international franchisee, Dencan Restaurants, who is based in Vancouver, Canada. Dencan currently has over 50 Denny's restaurants, primarily in Western Canada, with plans underway to continue their expansion. We continue to focus our efforts on finding the right well-capitalized franchisees to build our international pipeline and increase our global share.

Our goal is to build on our momentum, resulting in a growing net number of openings each year. Our development pipeline currently stands at around 170 unopened restaurants, including almost 70 international locations. Interest in Denny's from new franchisees continues to grow; Denny's is ranked eighth in Entrepreneurial 35th Annual Franchise 500 this year, marking the fourth year in a row we have been ranked in the top 10.

In addition to growing same-store sales and Denny's net locations, we remain focused on our objective to grow profitability and free cash flow, with a disciplined approach to operating cost, corporate G&A, expenses, and capital allocation. During the first quarter, we generated almost $7 million in free cash flow after our investment in Company remodels.

With a franchise-focused business that generates significant free cash flow, we will balance our capital allocation between making investments to grow and to strengthen the Denny's brand and returning cash to our shareholders. Given that we have a meaningful base of Company restaurants, we will reinvest in those restaurants through our Heritage remodel program, with a goal of having over 40% of the Company restaurants remodeled by the end of the year. While these investments continue, we remain committed to growing earnings per share through our franchise-focused business, which provides financial stability and flexibility.

With the success of our America's Diner revitalization resonating with our guests, both our franchisees and our team continue to be energized and excited about the future of Denny's.

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

Thank you, John, and good afternoon, everyone. Our first-quarter results were highlighted by increasing domestic system-wide, same-store sales by 1.8%, with Company same-store sales growing by 3.2%; completing an additional 16 Heritage remodels at the Company restaurants; and generating $6.7 million of free cash flow after capital expenditures.

During the quarter, Denny's opened 4 franchise restaurants and closed 8 system-wide restaurants, including 2 Company restaurants. One is a temporary closure of our Las Vegas Casino Royale location, and the other is the permanent closure of one of our restaurants located in Honolulu. As a result, we ended the quarter with 161 Company restaurants and 1,535 franchise restaurants, leading to total restaurant count of 1,696.

Denny's total operating revenue, including Company restaurant sales and franchise and license revenue, decreased $2.6 million to $111.9 million, driven by decreases in both Company restaurant sales and franchise and license revenue. Same-store sales of domestic franchise restaurants increased 1.5%, primarily due to an increase in same-store guest-check average, given by both higher menu pricing and favorable product mix.

Franchise and license revenue of $32.6 million decreased $844,000, primarily due to a $1.1-million decrease in occupancy revenue, which was partially offset by A $454,000 increase in royalty revenue, resulting from 10 additional equivalent franchise restaurants. Franchise operating margin of $21.9 million decreased $139,000, primarily due to a $550,000 decrease in occupancy margin, offset by the increase in royalties.

Franchise operating margin as a percentage of franchise and license revenue increased 1.3 percentage points to 67.2%, compared with the prior-year quarter. This increase was due to both the increase in royalties and the decrease in occupancy dollar margin.

Same-store sales at Company restaurants increased 3.2% due to both an increase in same-store guest-check average and an increase in same-store guest traffic. The increase in same-store guest-check average was driven by both higher menu pricing and favorable product mix. Sales at Company restaurants decreased $1.7 million, primarily due to five fewer equivalent Company restaurants, which was partially offset by the increase in same-store sales.

First-quarter sales were unfavorably impacted by a combined $2.7 million from the temporary closure of our Las Vegas restaurant and permanent closure of our Honolulu restaurant. In addition, sales were unfavorably impacted by the refranchising of two restaurants in the third quarter of last year and the number of Heritage remodels completed during the quarter. As a reminder, our remodeled restaurants typically close for 5 to 7 days, during which additional training takes place.

Company restaurant operating margin of $9.1 million, or 11.5% of Company restaurant sales, decreased $2.8 million, or 3.2 percentage points, compared to the prior-year quarter. The decrease in Company margin included a $700,000, or 0.6 percentage-point, impact from the temporary closure of our Las Vegas Casino Royale restaurant. Excluding this impact, the decrease was primarily driven by increases in payroll and benefits costs and other operating costs.

The increase in payroll and benefits costs as a percentage of restaurant sales was primarily driven by a 1.4 percentage-point increase in workers' compensation costs, and increasing group insurance benefits costs and higher incentive compensation. The increase in workers' compensation was due to $400,000 in unfavorable claims development during the current year period, compared to $500,000 in favorable claims development in the prior-year quarter. The increase in other operating costs was primarily driven by higher utilities and repair and maintenance costs compared to the prior-year quarter.

Total general and administrative expenses decreased $1 million from the prior-year quarter, primarily due to reductions in payroll and benefits costs and incentive and deferred compensation expense. Interest expense for the fourth quarter decreased by $478,000 to $2.3 million, resulting from an $11.4 million reduction in total debt over the last 12 months and lower interest rates under our refinanced credit facility.

In the first quarter, our provision for income taxes was $2.6 million, reflecting a 28.9% effective income tax rate. This is lower than our guidance range of 34% to 38%, due to an $800,000 income tax benefit, resulting from certain state jobs tax credits and other income tax adjustments relating to prior years.

Due to the use of net operating loss and income tax credit carry-forwards, we paid $820,000 in cash taxes during the quarter. At the end of the first quarter, the deferred tax asset on our balance sheet was $49.5 million. We will continue to utilize additional net operating loss and income tax credit carry-forwards to eliminate the majority of our cash taxes for the next few years.

In the first quarter, free cash flow after capital spending of $6.7 million decreased $5.9 million compared to the prior-year quarter, primarily due to a $3.9 million increase in cash capital expenditures. We spent $6.9 million on capital expenditures in the first quarter, which included completing 16 Heritage remodels at Company restaurants.

In the first quarter, we allocated $9.1 million to repurchase 1.4 million shares. As of April 25, we had repurchased a total of 18.1 million shares since we started our share repurchases program in November 2010. As a result, we have a total of 6.9 million shares authorized and remaining in our ongoing share repurchase program.

We ended the first quarter with $174.7 million in total debt outstanding, with a total debt to adjusted EBITDA ratio of 2.3 times. As John mentioned, we will continue to use our free cash flow after capital expenditures, primarily towards share repurchases, while also making investments to grow and strengthen the brand.

That wraps up my review of our first-quarter results. I will now turn the call over to Whit who will comment on our annual guidance for 2014.

Thank you, Mark, and good afternoon, everyone. I would like to take just a few minutes to expand upon the business outlook section in today's press release. [Recalling] estimates for full-year 2014 are based on first-quarter results and management's expectations at this time. We now expect full-year Company same-store sales to increase between 2% and 3%, compared to our initial guidance range of 1.5% to 2.5%. We continue to anticipate that franchise same-store sales will increase between 1% and 2% for the year.

We currently anticipate that commodity cost inflation will be between 1% and 2% this year, which is slightly higher than our previous expectations of flat to 1%. We are currently locked in to approximately 70% of our needs for the year.

We continue to expect our full-year Company margin percentage to range between 13.5% and 14%. We expect the second half of the year to be stronger than the first half of the year, primarily due to the timing of our remodeling at Company restaurants.

We continue to expect our franchise margin percentage to be between 66% and 67%. In addition, we expect our occupancy dollar margin to be approximately $1 million lower than 2013. The decrease is driven by both a decrease in the number of sublease locations in 2013 and 2014 and a decrease in the number of subleases identified as capital leases.

We continue to expect our annual effective income tax rate to be between 34% and 38%, with cash taxes to be between $3.5 million and $4.5 million in 2014. This is slightly higher than our previous guidance of $3 million to $4 million.

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.

(Operator Instructions)

Will Slabaugh, Stephens.

Congratulations on the quarter. I wanted to ask you a little bit more about the cost side of the Company. Obviously, the sales came in really strong there. Typically, is there any reason to believe that we will see a continuation of some of these higher insurance costs through other claims that we saw?

Then also just a little clarification on the incentive comp. I assume that was attributed to store and regional managers or is that at the corporate level or where did that occurred?

Hello, Will it's Mark. How are you?

Doing well, thank you.

Very quickly on the worker's comp piece, as we've described before, obviously, part of that is an issue relating to the historical movement and outstanding claims in cases outstanding. I think the key overall focal point, from a margin standpoint on the Company side, should be back to Whit's comments on guidance and expectation for the second half of the year. I think that's absolutely critical and important from the standpoint of I think when you talked about improvement in the second half of the year on the margin side.

As it relates to the incentive comp, it would be basically at the store level. And so, yes, it would basically be at the RM and GM level at the store; within the four walls, as we would say.

Got you, and then also wanted to ask you about the $2-$4-$6-$8 menu, and I know that John, you mentioned a lot of -- or a few changes at least going on there in terms of re-jjiggering how that menu looks or feels. Can you go into a little more detail about that? And then you also mentioned a stat as far as the percentage of customers that come in just specifically for that $2-$4-$6-$8. Could you repeat that? I didn't get that down.

I sure can. I think in my opening comments, we were talking about 19%, with higher for Hispanic consumers who have a bit of a higher preference for that when they bring larger groups, there's a higher percentage that come for the value menu. So about 20%, it moves up and down, as you know. We report each quarter where it's been historically. So about over 20% are saying they come for it, and a little under 20% are actually buying it once they get inside the building.

Because it is not taking price since we rolled it out, and we continue to evolve it and tweak it, some of the costs have moved up. So we did some value engineering exercises, and we took about 100 basis points annualized out of that menu and made that introduction recently. ¶ And the biggest change is, I think I highlighted, one of those, just to repeat, there's an endless soup and salad that has been traded for one of the Hobbit specials that we had during the last holiday season. And that being a very popular dish and a little bit friendly on cost, it substitutes -- it keeps the viability of the $2-$4-$6-$8 really high. And in our $8 items, we weren't really getting credit for, but they included free beverage. And so we just eliminated that, except on the Grand Slam Slugger, which was one of the more popular of our $8 items. So we kept it there, again, just to keep the satisfied guests coming back.

Michael Gallo, CL King

Congratulations on a good quarter. My question is on the gap that has developed over the last couple of quarters between Company unit and franchise same-store sales. Obviously, probably the majority of that is attributable to the impact of the Heritage program.

I was wondering what you are seeing in terms of franchise interest, as franchisees started to see come of it significantly improve performance in Company store -- same-store sales in traffic as a result of the Heritage remodel. Obviously, you have a pretty old asset base there; there hasn't been a whole lot of significant refranchise -- remodeling activity over the last four or five years. And then also, whether you might provide any incentive plans to try to accelerate the potential re-imaging rollout in Heritage. Thank you.

Those are some great questions, and there's a number of things put in there. Let's just talk about the program itself.

We completed 47 remodels in the first quarter, 29 Heritage remodels, and all 16 -- I'm sorry all 16 Company and 31 franchise stores are remodeled. So because that 31, as a percentage of the total franchise base, compared to the 16, plus those we completed at the tail-end fourth quarter of last year. So combined, we have a higher percentage base, which creates a little bit of a separation. We also have 36% or a little bit more than one-third of our locations in California, where you've seen more of the growth in transactions and an economic recovery. So it's created a bit of a tailwind for the Company performance over franchise, but our franchisees are doing a great job adopting, implementing, and rolling out this program, as one would expect.

Overall, the whole system is about 25% older image, so the desire to move quickly through those is a priority for the Company, and then for our franchisees is what we've been focusing on. And we've been able to take that part of our portfolio, focus on the older one first, which also perhaps, in the range of performance, we're still mid-single digit reporting on our overall remodeling program, but it is a range. And so with the priority for Company on the older schemes, it creates a little bit of a separation in our performance there as well.

So I think that answers your question. We think, clearly, with about one-quarter of the restaurants being that older scheme, it's the priority to move our image forward. The Company is putting its best foot forward, and I would say our franchisees small and large are following suit, as they are due and as the opportunity presents itself.

John, a follow-up to that, I was wondering as you see the Heritage image is much more contemporary. I was wondering if that drives a higher incidence of lunch and dinner, and that's where see the biggest pick up? Or whether the pick-up in same-store sales is pretty even throughout the day? Thank you.

Most of the lift is traffic, which is pretty consistent with normal remodel impact, consumers are curious, and/or if they've been a frequent consumer and they create a little bit higher frequency. For us, the most dramatic change has been a dinner traffic, so your instincts are right on that, beyond the question.

Tony Brenner, Roth Capital Partners

Can you break out for Company stores the increasing guest traffic versus average ticket? And related to that, I wonder if there was a short pick-up in March compared to January, February or was it even throughout the quarter?

Even throughout the quarter. So it's hard to answer, Tony, on that one because of the disparity between weather patterns across the country. So clearly, where the weather was toughest it was the toughest period for us, but that varied by what week it was and in what part of the country. So, and I'm sorry, back to the other question, a little bit about traffic

Wait a minute, assuming the worst weather was in January and February then, are you saying there was a bigger gain in March?

Clearly March outperformed the bad weather months, yes.

And then guest traffic?

Yes, so on traffic, the Company, positive in the quarter, was going over the easiest quarter of last year. So, but your question specifically about traffic, we were up about 0.4% in the quarter on Company traffic.

Okay, and then you eluded to this in the previous question, I wonder if you could quantify what sales lift you're getting in the remodeled stores? And why aren't all of the remodels Heritage stores, out of curiosity?

Yes, so if you had a long permitting process, then you've finally got your permit, we wouldn't change the scheme on you. But basically, everything going now, if it's of an older scheme, it's going to the latest scheme, which is the Heritage remodel. So effectively, it's headed that direction at this point.

And the lift from the remodeled stores versus the base in terms of same-store sales?

Yes, we continue to have a range of performance on these, depending on if they were older scheme, newer scheme and the average of the range is still mid single-digit.

Mid-single digit sales increase or the difference between what the base is doing and what the remodels are doing?

Mid-single-digit increase

Mark Smith, Feltl and Company.

Most things have been hit, but I did want to check on average ticket and any pushback in the January menu price increase that you took? I want to say was less than 1%

Yes, given the quarterly results, we haven't seen all the competitive numbers come in, but I would say that it was in that range -- expected range in that modest pricing range. And so the consumer, I think, responded more favorably to that than when you take aggressive pricing. We do have the California wage, ACA, other impacts, 14 states taking with wage initiatives, California being one of the more aggressive with the $1 increase in July. So we expect to take more price then as well. How the consumers responds to that, you can't know for sure, but again, we're trying to keep it in the most modest range possible, which is consistent with our strategy over the past few years.

And that was really my next question, was looking at commodity price increases, labor expense, the different issues that you face, how much opportunity you have to take above and beyond what you have historically done here in July or whenever this next menu rolls out

We engage -- we go through quite a process comparing competitive prices, price elasticity studies of sorts. So -- and we're highly sensitive to it, because if you take it too fast or there's no question of traffic consequence. That said, we are now breaking that positive traffic range; we have strong performance in California, Texas, Arizona, New Mexico. Florida has turned to the bright side, lots of sun shining on the state there in the Denny's performance in that state.

So we see, actually, the consumer behaving a little differently. We've got the $2-$4-$6-$8 Value Menu, thank you very much. But the add-on sales and how consumers are responding to our skillet promotion, it is giving a tale of a different story that if I want what I want, I'm willing to pay for if the value is there in how it's merchandise and how it's offered. So we are starting to see less reluctance. Absolute price (inaudible), although there's no question, value is still a big part of leading in the market place today.

Last question from me, can you just give us a little more of an update on international development? What you have signed to date, where you're seeing the opportunities, and how pleased you are with where you stand today on international?

Sure. Well we've got, as mentioned in our notes, about 170 locations in the pipeline,100-ish or so for domestic,70 in the international pipeline. Our international franchisees are growing at or ahead of their development agreement schedules, which is a good sign. They are pleased with returns and the brand they've chosen and confident in the direction of our concept.

Our largest franchisee has really stepped up for expansion recently, our Canadian franchisee, with more growth. And then Dominican Republic is new. The Central American franchises are --w ere not only off to a good start a few years ago, but already on their fourth restaurant, with continuing development plans. Our first restaurant in South America opened earlier in the year, performing quite well, so we think we will see more of that. And then, of course, we have the 30-unit deal we signed in the Middle East, those restaurants expected to open over the next 10 years. Not a location, there's not a restaurant announcement yet there, the first restaurant, but again, I think all of this represents momentum overall for international development for Denny's.

It appears there are no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you, Joshua. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call to discuss our second-quarter 2014 results in late July. Thank you and have a great evening.

This concludes today's conference. We appreciate your participation.