Denny's Corp (DENN) 2014 Q3 法說會逐字稿

Good day, and welcome to the Denny's Corporation third-quarter 2014 earnings conference call. Today's conference is being recorded. At this time I'd like to the conference over to Mr. Whit Kincaid, senior director of investor relations. Please go ahead, Sir.

Thank you, Melissa. Good afternoon, and thank you for joining us for Denny's third-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 investor.dennys.com to find our third-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 third-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 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 risk 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 chief executive officer.

Thank you Whit, and good afternoon everybody. We are pleased with our quarterly results, highlighted by our strongest quarter of system wide same-store sales in the last 2 1/2 years. Our Company restaurants achieved the highest quarterly same-store sales increase in the last eight years.

Given the strength of our results and our solid start to the fourth quarter, we are positioned to achieve the highest annual same-store sales growth for the brand in the last eight years. We're also on track to achieve the highest annual same-store sales growth for our Company restaurants in the last 10 years.

In addition to the same-store sales growth this quarter, we grew both adjusted EBITDA and adjusted net income per share while generating strong free cash flow. Due to our performance, we are raising our annual financial guidance again for company same-store sales and adjusted EBITDA.

Achieving these results, despite the ongoing challenging economic environment for many of our customers, is a testament to the progress we have made in our brand revitalization thus far. We are pleased with the start of our heritage remodel program, which was rolled out late last year.

Enhancements in the atmosphere at our restaurant is one of the drivers to our growing sales. Foundational to our America's diner positioning, these enhancements reinforce the improvements we have made to date in our food and service.

For the first three quarters, we have completed 129 remodels. Results have been positive with increases in same-store guest traffic coming at all-day parts, with dinner seeing the strongest lift. We have remodeled 38 of our Company restaurants through the first three quarters of this year with the goal of completing approximately 45 by the end of the year.

This, along with the 26 completed late in 2013, means nearly 50% of our Company restaurants will be showcasing the heritage image. Due to the strong performance, we will continue to accelerate remodels at the Company restaurants with a target of completing 45 to 50 remodels in 2015.

The results we have seen to date at both remodeled company and franchise locations provide a blueprint for franchisees as they continue to remodel their restaurants over the next several years. We continue to look to our guests to guide us in our ongoing efforts to improve our menus and to meet the needs of an ever-changing marketplace.

While we are looking to elevate our product offerings in certain areas, we are just as focused on finding ways to enhance margins and improve operational execution. At the start of the third quarter, we rolled out a new core menu, which included two new premium sandwich entrees with new high-quality, seven grain bread in addition to over 20 other menu changes for simplification and for margin improvement.

Our Greatest Hits Remix limited time only menu leveraged existing entrees like the Super Bird, Moons Over My Hammy, and Red, White, and Blue Slam, which greatly simplified our station prep and line build complexity to enhance operational execution.

In the fourth quarter, our limited time only menu introduces seasonal and holiday flavors into our Build Your Own Grand Slam with check building, premium options like Pumpkin Pancakes and Gingerbread French Toast, in addition to a new holiday premium Red Velvet shake, which is available, as well as the all-new turkey and dressing sandwich with dippable turkey gravy.

Additionally, we have updated our $2, $4, $6, $8 value menu with a number of market-tested changes designed to keep the traffic-driving capabilities of the platform very strong, but also balancing the need to improve margins. New items at the $2 and $4 price points are expected to generate favorable trades, improving margins and to reduce these value menu incidence rates.

Recently, Denny's was featured in the second episode of TNT's On The Menu cooking show, starring Ty Pennington and celebrity chef, Emeril Lagasse. The debut season features eight brands in eight episodes, and we are pleased to have secured the only family dining position on the show, providing Denny's a great opportunity to showcase our revitalized brand.

The winning dish, which was an Apple Danish French Toast with Chorizo Hash, demonstrates our growing confidence in our ability to provide our guests with more relevant and more premium products to meet their needs. In summary, we believe that we are still early in our brand revitalization process and pleased with our momentum.

We remain focused on differentiating Denny's in the crowded marketplace by successfully executing on our key objectives to further strengthen our position as America's favorite diner in 2014 and beyond. When it comes to restaurant growth, we continue to make progress in increasing our footprint, both in the US and abroad, through traditional and nontraditional formats.

Our first restaurant in New York City was opened in lower Manhattan in early September by Rahul Marwah, a second generation franchisee from California. Rahul is taking advantage of our new emerging markets incentive program to penetrate areas where we do not have top market share.

This location represents the range of adaptability of our brand with an atmosphere scaling to its surroundings, a full bar and a franchisee with a great commitment to Denny's. We believe it provides an opportunity to showcase a revitalized and more relevant family brand appropriate for the times.

Two international locations were opened during the quarter, including our second in Dominican Republic and our first in downtown Toronto. We now have 65 restaurants in Canada, which has grown 33% over the past five years.

We also opened our newest nontraditional university restaurant at the University of Alabama at Birmingham. We have worked hard to evolve the branding for our fast casual, on-campus format. And UAB's The Den is a much more millennial friendly design.

Although the menu is much smaller than Denny's traditional menu, we do offer breakfast all day, hand smashed gourmet burgers, burritos, sandwiches, and salads, along with other craveable items like fried green beans. We believe that Denny's can compete successfully in the nontraditional market and look forward to opening more university locations utilizing this format starting later this year.

With a franchise-focused business that generates strong free cash flow, we will continue to balance our capital allocation between making investments to growth and strengthen the Denny's brand and returning cash to shareholders. While our investments in our base of company restaurants will continue, we remain committed to returning value to our shareholders through our share repurchase program.

Since our share repurchase program was launched in November 2010, we have allocated $104 million to repurchase a total of 20.7 million shares. We are focused on growing earnings per share through our franchise-focused business, which provides financial stability and flexibility. Our brand revitalization continues to gain momentum with our guest, with our franchisees, and the Denny's team energized and committed to future performance 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 third-quarter results were highlighted by growing franchise and Company same-store sales, growing adjusted net income per share by 29.2% and generating $12.8 million of free cash flow after capital expenditures.

During the quarter, Denny's opened nine and closed 13 franchise restaurants. As a result, we ended the quarter with 160 company restaurants and 1,529 franchise restaurants. Denny's total operating revenue, including Company restaurant sales and franchise and license revenue, decreased $200,000 to $117 million due to fewer company restaurants and lower occupancy revenue, partially offset by higher same-store sales at Company and franchise restaurants.

Same-store sales at domestic franchise restaurants increased 2.1%, 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 $34.2 million increased $300,000 primarily due to a $900,000 increase in royalty revenue, resulting from the increase in same-store sales in 12 additional equivalent franchise restaurants.

This increase was partially offset by a $600,000 decrease in occupancy revenue. Franchise operating margin of $22.9 million increased $600,000 partially due to the increase in royalty revenue that was offset by a decrease in occupancy margin.

Franchise operating margin, as a percentage of franchise and license revenue, increased 1.1 percentage points to 66.9% compared with the prior-year quarter. This improvement was primarily due to the increase in royalties.

Same-store sales at Company restaurants grew 4.1% due to both an increase in same-store guest check average and an increase in same-store guest traffic. The improvement in same-store guest check average was driven by both higher menu pricing and favorable product mix.

Sales at Company restaurants decreased $500,000 primarily due to four 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 temporary closure of our Las Vegas restaurant and permanent closure of one of our Honolulu restaurants in beginning of this year.

In addition, sales were unfavorably impacted by the refranchising of two restaurants in the third quarter of last year. Company restaurant operating margin of $11 million, or 13.3% of company restaurant sales increased by $700,000 or one percentage point compared to the prior-year quarter.

As a reminder, the company margin was negatively impacted by the temporary closure of our Las Vegas Casino Royale restaurant, which generated $700,000 of pretax operating income on $2.1 million of sales in the third 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 and product costs, partially offset by higher utilities and legal expenses.

The improvement in payroll and benefits costs was primarily due to a $1.1 million decrease and unfavorable worker's compensational accrual adjustments compared to the prior-year quarter. The improvement in product cost at 25.8% was primarily due to the leveraging effect of higher sales.

Other operating costs increased slightly due to a $300,000 increase in legal settlement costs during the quarter. Total general and administrative expenses improved $300,000 from the prior-year quarter primarily due to a reduction in share-based compensation expense.

Interest expense of $2.3 million decreased $200,000 primarily due to the expiration of capital leases. As we approach 2015, we would like to remind everyone that we entered into a 30-day LIBOR rate swap contract when we refinanced our credit facility in April 2013.

The swap protects us for three years and goes into effect in the beginning of April of next year. The swap fixes the 30-day LIBOR rate at 1.1% on $150 million of debt through April 2017, and on $140 million of debt through March 30, 2018. Based on our current LIBOR spread of 200 basis points, this would translate into a fixed interest rate of 3.1% during this three-year period.

Based on current interest rates, our interest rate would increase around 100 basis points, leading to an additional $1.5 million of interest expense on an annualized basis. With the interest rate swap starting next April, we anticipate that our net interest expense will increase by approximately $1 million.

In the third quarter our provision for income taxes was $4.1 million, reflecting a 33.0% effective income tax rate. Due to the use of net operating loss and income tax credit carry forwards, we paid $1.1 million in cash taxes during the quarter. At the end of the third quarter the deferred tax asset on our balance sheet was $43.6 million.

We will continue to utilize additional and net operating loss and income tax credit carry forwards to eliminate the majority of our cash taxes for the next few years. In the third quarter free cash flow, after capital expending, increased $1.2 million to $12.8 million. We spent $4.4 million on capital expenditures in the quarter, which included completing five heritage remodels at Company restaurants.

During the third quarter, we allocated $8.0 million to repurchase 1.2 million shares. Through the first three quarters of this year, we've allocated $32 million to repurchase 4.9 million shares, which is approximately 30% more than we allocated towards share repurchases during all of 2013.

We are pleased with the ability to grow our earnings per share as we overcame the temporary closure of our highest volume restaurant. After another quarter of growing same-store sales and adjusted net income per share, we are raising the Company's financial guidance for full-year 2014.

The Company is increasing expectations for Company same-store sales and adjusted EBITDA in addition to updating expectations for other selected components. We look forward to continuing to accelerate remodels in our Company restaurants, as well as reopening our highest volume restaurant on the Las Vegas strip.

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?

Thank you.

(Operator Instructions)

Michael Gallo, CL King

Hi, good afternoon. Congratulations on another good quarter.

Thanks, Mike.

Just wanted to drill in a little bit, third straight quarter Company comps now above 3.5%. Obviously, it would seem like the spread between Company and franchise stores, the main difference would be the remodels. I was wondering if you are still seeing the same kind of mid-single digit lift? Or is it somewhat greater than that, given the overall Company base seems to be getting close to that area?

And then, if you can comment at all about whether there's any accelerated interest from franchisees in the program, given that they now have a few quarters together and what you're seeing in accelerated same-store sales? Thanks.

Mike, this is John. Great questions. Yes, we do believe that that's playing a pretty important role, the separation between the Company and franchisee performance as a higher percentage of our base has obviously been remodeled. That's clearly playing a role.

It could also be that the Company restaurants -- you know, more than a third of our base is in California and though the unemployment rate is still 7.3% out there, that as a state is representative of a significant part of the overall job recovery of the United States. In fact our restaurants -- we have over 800 restaurants in California, Arizona, and New Mexico, Texas, Florida -- and most of the job creation is right there.

Our other strong performing state would be Illinois where we have a smaller percent Company base. But given that we have 36 in California has also helped with the separation. And then we have five big volume stores on the Vegas strip. One that's closed right now. Vegas is way up with tourism, so that's helped also with the Company separation from the franchisee performance.

Accelerated interest, we think that there will be some acceleration going into next year. We plan 45 to 50. Obviously, we're not guiding on 2015 just yet. But you heard in my comments that we think on the performance so far, the 26 we did last year and the 38 we've done year-to-date this year, we expect to do another 8 to 10 this year and then 40 to 45 Company stores next year.

We think the franchisee will also step up with some, call it 140 or so, into next year. And those continue to, then, bring the performance between the two back together again. But it's nice to see people respond to the changes in environment.

Okay, great. Thanks very much

Will Slabaugh, Stephens.

Thanks guys, congrats again on the quarter. Just wanted to ask you what you're seeing in terms of guest behavior. It seems like we've seen a little bit of a pickup in the industry overall. You're clearly capturing more than your share.

So, just wondering what you're feeling is in terms of the willingness to spend of your core guest? And then what you saw this quarter in particular that allowed you guys to gain more share than the rest of those out in family or casual dining?

Sure. Well, there's a number of things. Every brand has its cycle, and, obviously, because of our changes in environment that plays a role. And as I mentioned earlier, the performance -- our [weight] or distribution of units, along with the stronger performance dates, certainly plays a role.

I also think that as the job markets improve that it's finally come around to where it favors our category to a degree. You think about a brand with anywhere from $8.90 in some areas to $9.10 check all day, there's something about that that when you're reentering the job market, that's a little more favorable than maybe brands that are priced higher than that. I think that entry point may favor our positioning.

And I think we've done a really nice job with revitalization, both in the environment, but also with food and hospitality and ticket times, cleaner restaurants, and, I'd say, better advertising. So when you get all those together, it creates some momentum that's favored us for the time being. I do believe employment plays a very important role in all boats rising right now. And even though we've never really seen a strong correlation, it doesn't hurt the gas prices are in favor at the moment as well.

Makes sense. One quick clarification if I could. I don't know if you mentioned what the traffic check and pricing was in the quarter?

We didn't. Our GCA company is up 3.1, price about 1.7, and so the difference is the mix-shift changes.

Perfect.

And then franchisees are going to be a little lower than that, so their pricing will be a little higher. And the mix shift is going to be real low 0.1, 0.2, so GCA and pricing are going to be about the same. They took, obviously, higher pricing.

And just last thing for me, if you could talk about pricing plans going forward? Do you expect to maintain that mid-1's type range?

Yes, we do have a headwind of ACA more full adoption rate is expected or a fuller adoption rate beginning next year. And then you have the carryover of California wage impact plus that, among a number of other wage-initiative states.

So we think it's going to require -- and then the commodity outlook is in that 2 to 3 range at the early look at it. So we're going to kick off the year with a sub one and then leave room in July. That's the way we're thinking about it right now. And we'll have some carryover from the pricing that we just took last July.

Thank you.

Tony Brenner, Roth Capital Partners.

Thank you. Could you remind me what the average cost of the remodels is per store?

Hi Tony, it's Mark. How are you?

I am well. Thank you.

On average cost, what we've said on that is that on the company side, the average cost is probably up in the high 2s, so call it 275 range. On our company remodels, Tony, we are completely redoing the restrooms, so that's an added cost.

When we looked at the higher volume Company locations, we have a traffic and while we were in the store and closing the store down for a certain number of days, we've gone ahead and done those restrooms. Even if under a full inspection perhaps it wasn't required, but we thought that was the right thing to do.

On the franchise side, given the scope of their remodels and the fact that again on the Company side we're completely doing restrooms, the franchise spend is probably around 2, call it high 1's around 2, depending upon, again, the scopes that they're choosing to do on their remodels.

Is any of that spend occurring in the back of the house in terms of equipment changes or anything of the sort?

There's a little bit Tony, but I would say that a very, very high percentage majority of it's the front of the house, inside the four walls and then obviously some spend on the exterior between repaint on the exterior, awnings, things like that. But it is primarily what I would say customer focused at this point.

Okay. Your footprint is a moving target because you've regularly got a number of closures, which tend to sometimes be less than, sometimes more than, the number of store openings. I know it's an old system, and you've got a lot of franchisees out there with old stores.

But is there a point at which those closures should recede? Or are we just going to regularly see maybe half a dozen to a dozen closures per quarter on average?

This is just a terrific brand, but it's a brand that obviously has 60-plus years of history. I think when we've gone back, Tony, and looked at the average closing rate over the last several years, it's in that mid-30 number, call it 32, 33, 34 units per year.

And when you look at our tightened guidance range that was in the press release, it obviously suggests that same type of closing level. We really don't anticipate that's going to change for the next few years.

When you talk about an increasing footprint, there really isn't one, is there? Except that you are expanding internationally? So your international footprint is expanding, but certainly domestically it's not.

So a couple comments there. Last year -- I think because we can speak to actuals -- the last year we opened 46 locations. Most of those were domestic locations, but we opened 46 and closed 34, so the net opening number was 12. And this year, obviously, the tightened guidance range would suggest a net number in that, I'll call it at the lower end of the 5 to 10, 5 to 15 type of net number. We, obviously, continue to see that closing number.

I don't want to give a specific net number for the US. We really haven't gone that way. But I think to your question, again, most of those closings I mentioned and the average number throughout the last few years are all in the US, basically.

Right, got it. Thank you.

You're welcome

(Operator Instructions)

Nick Setyan, Wedbush Securities.

Thank you. Fabulous quarter guys. I want to focus on the franchise comp a little bit, because we saw not only a sequential acceleration, we also saw a pretty impressive, on a two-year stack it was a pretty impressive acceleration.

Just to even back out, obviously, they don't have as much of a remodel benefit, so I'm just wondering the cadence in the quarter of that? Did you see perhaps an acceleration of the comp as gas prices went down? Do think that maybe the minimum wage actually going up helps in terms of spending power for your demographic? Just any commentary would be helpful.

Yes. This is John. I think that there's so much noise, it's hard to ferret all that out. We've asked all the same questions as you can imagine. And we have a pretty good, robust machine here for post-ad analysis, post-initiative analysis. Whether it's discounts, digital media, broadcast, local store, or co-op initiatives, we take a very hard look at all of those.

We can't point to any one thing associated with wage or gas prices particularly, and usually they don't correlate certainly in the near term. Disposable income, obviously, does correlate over the long term. And the number of meals eaten away from home and employment are the strongest correlators. That said, July was the toughest month in the quarter. And then things picked up from there.

Perfect. And on the labor front, even if you back out the benefit from the work comp, you pretty much stayed flat on the labor line even with the minimum wage headwind in July.

I know obviously your company-owned comp was very strong. But is there anything else going on? Are there some cost focus or anything else you're doing at the restaurants to be able to control some of those labor headwinds?

We do have -- like anybody in the restaurant business there's a constant battle around wage and cost containment. And our progress along those lines is never as strong as we'd like. We'd like to have the margins of days gone by or decades gone by.

That said, we saw an improvement in the labor line. I believe it was about 30 basis points, part of that we had a favorable workers comp. So we're about [1.5] last year to [400,000] this year, I believe, so about [one/one] pick up there, and then some overall better controls.

I'm sorry, cost of sales was 30 basis points improvement. That's really just pricing over commodity. So we saw the tail end of the year come under control a little bit better. We recovered on all the big commodities, so we saw some pick up there. So between food and labor, you're right, labor about flat and then a little bit of leverage over cost of sales.

Are we pretty much covered for the food cost through Q4 now?

For this year, yes.

Okay. And then just last question, any updates on the royalty transition?

Yes, the transition's gone well I think. As you can imagine, this is, as we've said before, this takes place over the long haul. It'll take a good decade for it to fully mature.

I think we've shared that by the end of this year we're around, or right now and through the end of the year, about 150 restaurants are affected by that, so they would be at the higher rate. And then that grows every year, I think, to about 40% of the system over the next four years and then trickles in over 10 years.

Thank you very much.

Mark Smith, Feltl and Company.

Yes, this is Shannon Richter on for Mark Smith. Just one quick question here. What was traffic versus ticket in the comp?

Let me just give Company. So Company GCA was up 3.1 about 1.7 of that price. Traffic would be about 1 on the company stores, positive in the quarter. And our guidance for the year would be 0 to 1, so updated guidance.

Perfect, thank you.

(Operator Instructions)

Michael Gallo, CL King.

Hi, good afternoon. Just a follow-up. I was wondering if you saw any GCA benefit from some of the changes you made on the $8 items? Maybe getting a higher incidence within $2, $4, $6, $8? Or whether you saw the mix within $2, $4, $6, $8 stay relatively skewed to the lower-priced items?

Yes, the $2, $4, $6, $8 changes have been good changes for the brand. We addressed our $2 and $4 items that might've been just a little bit too good of a deal. And we did a nice test to make sure there weren't negative consequences.

So it's consistent with what I said in my opening remarks. We've seen a nice balance working with our franchisees to protect margin or grow margin in that category, but at the same time still have some traffic driving consequences.

This has been mixing in that 19% to 21% and sometimes 22% range. We'd like to curb that back a little bit with these changes. So we're starting to see some nice adjustments accordingly. We think we'll get the biggest benefit in the fourth quarter, third and fourth quarter. And about a 1% cost of sales impact on that part of our menu.

Thanks very much.

That does conclude our question and answer session at this time. I'd like to turn the conference back over to Mr. Kincaid for any closing or additional remarks.

Thank you, Melissa. 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 fourth-quarter 2014 results and detailed annual guidance for 2015. Thank you, and have a great evening.

That does conclude our conference for today. Thank you for your participation.