Denny's Corp (DENN) 2014 Q2 法說會逐字稿

Good day and welcome to the Denny's Corporation second-quarter 2014 earnings conference call. Please note today's conference is being recorded.

At this time I would like to turn the call over to Mr. Whit Kincaid, Senior Director of Investor Relations. These go ahead, sir.

Thank you, Joshua.

Good afternoon and thank you for joining us for Denny's second-quarter 2014 earnings conference call. 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.

Please refer to our website at www.investor.dennys.com to find our second-quarter earnings press release along with any reconciliation of non-GAAP financial measures mentioned on the call with their corresponding GAAP measures. This call is being webcast and an archive of the webcast will be available on our website later today. Our 10-Q will be filed later today, as well.

John will begin today's call with his introductory comments. Mark will then provide a recap of our second-quarter results along with brief commentary on our annual guidance for this year. After that, we'll open it up for 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 risk, 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 P resident and Chief Executive Officer.

Thank you, Whit, and good afternoon, everybody.

We are pleased with our second-quarter performance which clearly demonstrates the success of our brand revitalization strategy. We generated yet another quarter of system wide same-store sales growth highlighted by a strong quarter of same-store sales at Company restaurants. In addition, we grew adjusted EBITDA and adjusted net income per share while generating strong free cash flow.

As a result of our performance through the first half of the year, we are pleased to be raising our annual financial guidance and are on track to achieve the highest annual same-store sales growth for our Company restaurants since 2005, primarily driven by our new launched Heritage remodel program. We have remodeled 33 of our Company restaurants through the first half of this year resulting in nearly 40% of our Company restaurants showcasing the new Heritage image.

We continue to work closely with our franchisees to develop remodel programs at an appropriate level of investment for our brands with an annual average sales of $1.5 million. Due to Denny's diverse portfolio of restaurants with a wide variety of schemes, ages, geographies and sale volumes, we have seen a range of results with the restaurants having the oldest schemes garnering the strongest results overall from remodels.

Today approximately 54% of the system is on the current pre-Heritage remodel scheme with a much more relevant image than our older schemes. These include the 330 new restaurants that have opened since the beginning of 2008. For these approximate 900 locations, either not due or yet to be revitalized, we continue to collaborate with our franchisees to finalize a more modest remodel investment. We expect to lower the cost program to generate a sales lift at the lower end of the middle single-digit range that we are seeing today.

The great news is that the increases in the same-store guest traffic we are seeing at Company locations are clear evidence of our success with the Heritage program, and further proof that our America's Diner positioning resonates very well with our consumers. Our guests continue to guide us in our ongoing efforts to improve our menus to meet the needs of an ever-changing marketplace. Our revitalization efforts to improve our food, service and atmosphere put us further down the path to consistently growing restaurant sales and margins.

Over the past year, we have made investments in our new restaurant opening and training teams to support our franchisees in their efforts to improve the overall guest experience. We recently launched our Denny's pride restaurant review program to improve restaurant operations and guest satisfaction. This is accomplished by assessing, measuring, coaching and continuously improving the consistency and the execution of both our current brand standards, as well as our new initiatives, every day, every shift and every guest.

Our Management team remains focused on finding ways to improve restaurant margins, including purchasing efficiencies, menu changes and other operational initiatives. Together through the close partnership with our dedicated franchisees, we have identified a unique opportunity in our franchise agreement to improve restaurant level margins.

Recently introduced a new franchise agreement with total royalty and marketing fees of 7.5% of gross sales, comprised of a 3% contribution to the brand building fund and a 4.5% royalty excluding any incentives. The old franchise agreement had total royalty and marketing fees of 8% of gross sales comprised of a 4% contribution to the brand building fund and 4% royalty excluding any incentives.

Due to various incentive programs, the brand building fund contribution rate currently averages 3% across the system, with most franchise agreements providing a step up to the 4% contribution rate. The new fee structure lowers total fees to franchisees by 0.5% of gross sales. The reduced total rates with the higher royalty rate will be offered to all franchisees that will move to the 4% brand building fund contribution rate over the next decade. The new fees are more beneficial for all stakeholders and most importantly for our franchisees.

The total amount which the Denny's system spends for advertising and promotion will increase as we grow our footprint and restaurant level sales. By retaining the current average contribution rate, the new fees eliminate a future step up in contributions to the brand building fund. To help the brand building fund in this transition, if organic growth falls short of expectations, we have agreed to make an additional contribution to the fund through 2017 representing half of the incremental royalty up to $2 million per year.

Although most of the eligible restaurants have switched to the new fee structure, today that represents only approximately 100 franchised restaurants. It is critical to understand that due to the long-term migration of the existing franchisees from older incentives and the brand building fund, we won't see the full benefit from the higher royalty rate for more than a decade. This a great opportunity to enhance our existing and future franchisee profitability at a time when we are looking to grow our footprints across America.

With a franchise-focused business that generates strong free cash flow, we will continue to balance our capital allocation between making investments to grow and strengthen the Denny's brand and returning cash to shareholders. During the second quarter we generated almost $12 million in free cash flow after our investment in Company remodels. And while these investments continue, we remain committed to returning value to our shareholders through our share repurchase program.

Through the first half of the year we allocated $24 million to repurchase 3.6 million shares, which is close to the $25 million we allocated for all of last year. We are focused on growing earnings per share through our franchise-focused business, which provides financial stability and flexibility. And although we are still early in the revitalization process, our America's Diner revitalization is gaining momentum with our guests and our franchisees and the Denny's team continues to be energized and excited about the future of the brand.

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

Thank you, John, and good afternoon, everyone.

Our second-quarter results were highlighted by growing franchise and Company same-store sales, completing an additional 17 Heritage remodels at Company restaurants, growing adjusted net income per share by 15.7% and generating $11.6 million of free cash flow after capital expenditures.

During the quarter, Denny's opened three franchised opens and closed six system wide restaurants including one Company restaurant. As a result, we ended the quarter with 160 Company restaurants and 1533 franchise restaurants leading to a total restaurant count of 1693.

Denny's total operating revenue, including Company restaurant sales and franchise and license revenue decreased $2 million to $114.6 million due to fewer Company restaurants and the lower occupancy revenue, partially offset by higher same-store sales at Company and franchise restaurants. Same-store sales at domestic franchise restaurants increased 1.7% primarily due to an increase in same-store guest check average driven by both higher menu pricing and favorable product mix.

Franchise and license revenue of $33.5 million decreased $254,000 primarily due to an $860,000 decrease in occupancy revenue. This decrease was partially offset by a $724,000 increase in royalty revenue resulting from nine additional equivalent franchise restaurants.

Franchise operating margin of $22.8 million increased $698,000 primarily due to a $1 million decrease in occupancy and other direct costs. Franchise operating margin as a percentage of franchise and license revenue increased 2.5 percentage points to 68.2% compared with the prior-year quarter. This improvement was primarily due to the increase in royalties.

Same-store sales at Company restaurants grew 3.7% 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 to $1.7 million primarily to five fewer equivalent Company restaurants, which was partially offset by the increase in same-store sales.

As a reminder, sales in this quarter were unfavorably impacted by the temporary closure of our Las Vegas restaurant and permanent closure of one of our Honolulu restaurants in the beginning of this year. In addition, sales were unfavorably impacted by the refranchising of two restaurants in the third quarter of last year and the temporary closures relating to completing 17 Heritage remodels during the quarter.

Company restaurant operating margin of $11.5 million, or 14.2% of Company sales increased by $101,000, or 0.5 percentage points compared to the prior-year quarter. The Company margin was negatively impacted by the temporary closure of our Las Vegas Casino Royale restaurant which generated $800,000 of pretax operating income on $2.1 million of sales in the second quarter of the prior year.

Excluding this impact, the increase in Company restaurant percentage margin was primarily driven by a reduction in payroll and benefits costs, as well as occupancy costs, which were partially offset by increases in product and utility costs. The increase in product cost is primarily due to the higher commodity costs and the impact of changes in the product mix in the quarter.

Interest expense for the second quarter decreased by $274,000 to $2.3 million, primarily resulting from lower interest rates under our refinanced credit facility. In the second quarter our provision for income taxes was $4.7 million reflecting a 36.4% effective income tax rate.

Due to the use of net operating loss and income tax carry forwards, we paid $820,000 in cash taxes during the quarter. At the end of the second quarter, the deferred tax asset on our balance sheet was $46.5 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 second quarter, free cash flow after capital spending increased $420,000 to $11.6 million. We spent $6.7 million on capital expenditures in the quarter, which included completing 17 Heritage remodels at Company restaurants.

During the second quarter, we allocated $14.9 million to repurchase 2.3 million shares. As of July 25 we had repurchased a total of 20.3 million shares since we started our share repurchase program in November 2010. As a result, we have a total of 4.7 million shares authorized and remaining in our ongoing share repurchase program.

As John mentioned, returning value to our shareholders remains a very important part of our strategic plan, as evidenced by the 3.6 million shares repurchased in the first half of this year. With our momentum growing through the first half of the year, we are well-positioned to raise the Company's financial guidance for full-year 2014. The Company is increasing expectations for Company same-store sales, adjusted EBITDA and free cash flow in addition to updating expectations for other selected components.

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

(Operator Instructions)

Will Slabaugh, Stephens.

Congrats on a great quarter. Can you tell me a little bit more about where you saw the strength here that we've seen a lot of softness throughout family dining and all full-service dining in 2Q and especially to end up the quarter. So I didn't know how much detail you'd be willing to get into in terms of geographic or progression throughout the quarter, where you saw the strength within your business.

Will, thank you, it's John. Happy to do so. 670 restaurants, we've shared this in the past. So we have well over 800, a little less than 900 in six states. And if you look at Nevada, California, Arizona, Florida, 670 restaurants in the strongest performing state. So that certainly is a benefit to where we're geographically distributed.

So we're softer in Midwest, up Midwest. There are some areas, middle Atlantic, which are still not responding like the stronger states. But I'd say that in general where you see the most employment, not necessarily in percent compared to pre recession, but in raw net numbers of new jobs created you see the most sense of prosperity, eating out again and the most recovery in full service dine out occasions.

I think also the progression through the quarter in our calendar, Easter represented a little bit of a flip to our benefits, so the earlier part of the quarter benefited from that the first month of the quarter. And then we had the World Cup that created a little bit of a headwind for us that coming into as soon as we jumped out of the July 4 weekend, it returned back to more of a normal pattern pre-World Cup. So there was softening during the best games.

That's pretty much the story of the quarter. Strong regional performance and especially Nevada and California and then improving -- stead fast improvements Florida, Arizona, and then benefit coming out of World Cup.

Got it, that's helpful. And then wanted to ask quickly as a follow up to the cost of that Mark walked through. So obviously labor came in nicely, 70 basis points below your year-over-year number. Can you talk about how you see that going forward? I know that largely sales driven. And then combine that with the pressures you may see from a cost of goods standpoint and what your pricing stamps may be going forward?

Well from a pricing standpoint, Will, I think we're looking at probably pricing for the year, I'll call it, in the 1.2, 2 range, depending on franchise or Company side. We really haven't talk specifically about all of the components from a Company margin standpoint. But clearly I think as we commented after our first-quarter call where our first-quarter Company margins were lower than previous year, that we thought the margin would start to claw back which they did.

Just as a reminder we had a workers comp charge that occurred in last year's same quarter so that was part of the benefit in that year-over-year basis also in the quarter. But overall, I think we were pretty satisfied with the Company margin side.

Great and last question if I could. Could you break out traffic and check in terms of your Company-owned stores?

Yes, Will, this is Whit. So traffic was up 0.9% and check would have been up 2.8% at the Company stores in the quarter.

Great. Thanks, guys.

Michael Gallo, CL King.

Hi, good afternoon, again congratulations. I think that's the best Company comp I can recall in a long, long time.

I want to delve in a couple questions. First for John, John, I noticed you made some changes around 2-4-6-8, particularly on the $6 and $8 items. It looked like you went more to some of the I would say more Denny's driven items. I saw you put the [hobbit hole] at $6 and you made some changes with the country fried steak and eggs skillet and some of the skillets at $8. My recollection was the $8 items historically didn't mix that well as a percentage.

I was wondering within 2-4-6-8 if you saw a push in the mix of more towards $6 and $8 from what you've seen historically than say $2 and $4 and whether that helped average check in the quarter and how we should think about that going forward?

Those are great questions. The $8 category has always been the slightest but nevertheless a solid category for us, it just doesn't compared to the $4 and the $6. So I think the strength of $6 is really more around getting full for $6 and then you add a beverage.

We started out the $8 category with beverage and then over a 3.5, 4 year period without taking price in 2-4-6-8, the effort to address margins that come under pressure through time with commodity shifts, the menu had to shift. So we made the election to eliminate the free beverage with the $8 menu all but one item. And so that puts more downward pressure on that mixing at the top of the four different priced options.

So our best-performing group is the $4 and the $6 range, we expect to continue. $2 is going to come under a little pressure near time because we moved that more into dessert add on strategy category than a full meal strategy. And that helps margin, but frankly it's still every bit as compelling as when we first launched it. A little bit slightly over the same quarter last year.

All right, okay. And then a question for Mark. I was wondering to get into the details of how we should think about the change in the royalty fee as franchisee royalties roll over. So should we think about that as a $1 million or so positive tailwind to royalties per year as that rolls over and they'll be some offsetting expense? Or how should we think about the financial impact of that?

So a little bit Mike back to John's comment on that to all of the listeners. We talked about this new franchise agreement, John commented on that includes total fees of 7.5%. So again, that's a 3% contribution to the brand building fund and a 4.5% royalty. John mentioned that, that excludes incentives. We've had a lot of different incentives out there affecting certainly our royalty and also our brand building contribution. So again, that's the standard agreement excluding those incentives.

So total fees of 7.5%. The old agreement was 8%, which was a 4 and 4. And again you had a series of migrations, so both those numbers exclude incentives. John also mentioned that there's I think around 100 units that basically are in that, I'll call that 7.5% range because of where they are timing wise. But also mentioned the fact, and this is really I think to some degree Mike your question is that modeling question, that'll probably be up to a decade before the full benefit will be realized.

So I've given you a series of numbers but without saying specifically what the short-term impact is because there 's so many different moving parts here. But overall I think what John's point was, that obviously from a fee standpoint, for our franchisees, that their overall fees long term have been lowered by 50 basis points or 0.5 point of margin improvement basically. So a lot of moving parts and pieces but clearly from a brand standpoint, I think we're certainly very, very positive on this change.

Okay. Great. Thanks very much.

Tony Brenner, ROTH Capital Partners.

I had a question on the remodel or the timing of the Company store remodels. I know that for this year your remodels have been first half loaded, I wonder if you could update us on what the number of stores that might be remodeled in the second half? And then if you've got an early read on the number for 2015 Company stores.

Yes, Tony, this is John. 17 were done in the quarter, I think that's 33 year to date. And we had said in our earlier guidance about 40 Company stores on the full year.

Okay. And then for next year, any thoughts?

Yes, so for next year, this is the -- the 40 this year on top of 26 we did last year, so that's 66 of 160. So we certainly would continue. And I don't think we've guided longer term, but again I think you look at our habit would be to make sure that they're done when they're due and about one-seventh are due every year. We'll be a little bit ahead of that going into next year.

Okay. And then what is the status now of your downtown Las Vegas store? I know a lot of people that I know have had to change their wedding plans. So wondering where that store is at?

Yes, it is fascinating to us as well, the number of people that make it a stop. I don't know the number of weddings we've done to date down there, but I'll have that for you here in just a second, 33 to date. So in 1.5 years or so, that's not too bad with no advertising other than the debut when the restaurant opened.

The store is doing well along with that whole markets really gone through some increased tourism. And then also the state of Nevada is our at leading state in comp performance year over year. Now part of that is tourism is up and no question, when you have store that's doing about $8 million a year closed temporarily, the redistribution of that plays a role as well.

So until we reopen at our flagship location, affectionately known as unit number 141, we -- at Casino Royale, we don't know the overall weight between the market being up and the redistribution of sales. But that downtown store is doing quite well.

Okay. All these construction that was going on in that area is now complete, it's been a while since I've been downtown.

No, actually it's not. At our and of that little area, it's still a little messy frankly.

Okay. But the comps in that store are --

Yes.

Positive?

Yes. [Traffic's up], comp's up, good numbers.

Thank you.

Nick Setyan, Wedbush Securities.

Let me ask that royalty question a different way. Maybe number of franchise stores. I know you guys said 100 are currently on that new model. Let's say we're -- a year from now we're standing, next Q2 when you're talking about how many stores have gone on that number.

How should we think about that? Is it maybe 100 stores a year? Is it maybe a little bit less than that, maybe a little more than that?

Yes, I think -- Nick, hi, it's Mark. I think what we can say on that is that again -- so I'll mentioned what John mentioned which is the 100 that are currently on that. I think we're anticipating probably by the end of next fiscal, it'll probably be, I'll call it several hundred restaurants will probably be on that kind of structure.

Again, they qualify for that fee structure. They obviously have to amend their franchise agreement to sign up for this new arrangement. So again you've got this transformation that's taking place but I think probably by the end of 2015, there'll be call it several hundred, I'll call it 300 to 400 that are probably -- again if everything works normal fashion, would be at that type of arrangement, is that helpful?

Got it. Yes, it's very hopeful. And is there other -- anything else in terms of commitments that go into the restructure commitment there in terms of maybe development agreements, maybe up the number of units you have to build per year or anything like that?

Yes, there -- Nick, this is John, there's no development related tagalongs with this fee change.

Okay. And the other question I have is, it's around the 14th week of Q4, do you guys know how much in terms of EBITDA that 14 week is worth?

Yes, Nick, this is Whit. It's about $3 million, $3.5 million. And so most of that flow through is coming in on the franchise side on the royalty piece. And then -- but you do see an impact on the Company margin as well, call it around 30 basis points, maybe 40 basis points in the fourth quarter.

Okay, very helpful.

And that's a [tax] number, about $3 million to $3.5 million.

Got it. When's the next menu change coming? Are we going to see a little more pricing in Q3 with the minimum wage headwind in California?

Yes. So Q1 you remember we talked about slightly under 1%. And then we took a menu price increase in July, [to benefit] the second half of the year, slightly higher in California to cover call it 30 basis points hit from California wage inflation and call it 30 basis points on ACA. So the franchisees are in the call it the 2% range on the year is how we're guiding for price in Company -- about 1.6% on the year.

Okay. And you guys said the average check in the quarter was at 2.8%. What was the break out between menu price and mix?

About 1.5% price so far and about 1% mix for the total 2.5 total check change.

Got it. And then last question longer term, would you guys consider maybe buying a second brands as a growth vehicle, or are we just looking at continued share repurchases going forward and the use the cash?

I think the best way to answer that is we're committed to the current course. We want to optimize the value of Denny's. We think we have a right brand with tremendous global expansion potential. And so any of those kinds of conversations of course, like any good Management team, we consider all kinds of options for cash use, but our focus right now is share repurchase.

Thanks very much.

Mark Smith, Feltl and Company.

Hey guys, this is Shawn Bitzan sitting in for Mark Smith. One quick question, can you talk a little bit about how much the limited time offers drove comps in the quarter?

Sorry, can you repeat the question, please?

Can you talk just a little bit about how much limited time offers drove comps?

Yes, this is John. That's a great question because answering with precision is a little difficult. I can tell you that our LTOs run pretty consistently around 10% of product mix. Because that's consistent quarter in quarter out, what it's impact on comps is sometimes hard to tease out. And so we use traditional methodology and asking what consumers thought of the media of their favorability of the brand, but that doesn't necessarily translate to (inaudible). So it's -- I'd say that without it sales wouldn't be as strong and with it we have brand momentum. But to say precisely what advertising does is pretty tough to answer.

Thanks.

And that will conclude today's question-and-answer session. 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 call to discuss our third-quarter 2014 results in late October. Thank you and have a great evening.

And this concludes today's conference. We thank you for your participation.