Denny's Corp (DENN) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Denny's Corporation's second-quarter 2015 earnings conference call. 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, Katherine. Good afternoon. Thank you for joining us for Denny's second quarter 2015 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 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. As a reminder, we will be filing our 10-Q today.

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 will 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 risks and factors are set forth in the Company's most recent annual report on Form 10-K for the year ended December 31, 2014, 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 to achieve another quarter of a strong same-store sales growth for both Company and franchised restaurants. The execution of our brand revitalization strategy focused on improving the food, service and atmosphere at our restaurants, has positioned Denny's to benefit from the improving consumer economic environment. Our efforts to meet our customers' expectations through better menu offerings, execution of service standards, and an enhanced atmosphere are contributing to the growth of our revenue, cash flow and earnings per share. The results of our efforts are steady gains in same-store sales and traffic with comparable sales growth in 16 of the last 17 quarters.

I am pleased to share that our system-wide same store guest traffic has increased each of the last three quarters, while traffic at our Company restaurants has grown each of the last six quarters. The growth in guest traffic demonstrates how we are truly benefiting from our strategies to deliver a differentiated experience along with solid execution by our franchised and Company operators. We believe the foundation is in place to build on these results and sustain momentum as we move ahead.

Once again the higher same-store sales resulted in continued growth in revenues, margin expansion at Company restaurants, and meaningful increases in adjusted EBITDA and adjusted net income per share. Similar to the first quarter, we benefited from a rise in guest traffic and favorable market shifts from guest trading into higher-priced offerings due to our proactive efforts in menu innovations and merchandising.

We continue to generate favorable product mix shifts which accounted for approximately 300 basis points of the increase in guest check average at our Company restaurants. The product mix improvements are coming from guests moving away from value as evidenced by a decrease in the incidence rate of our 2, 4, 6, 8 everyday value menu. Most importantly, guests are ordering more of our more premium offerings found in both our core and limited-time-only menus.

We continue to work to optimize our core menu through a combination of additions, deletions, and revisions with the goal of enhancing product quality, consistent delivery, and check or margin benefit. In June, we rolled out an updated core menu incorporating five new menu item additions, nine menu item deletions and seven new recipe or process improvements.

This menu includes a few new sandwiches, including a new Cali Club, the Chicken Philly melt, and the Spicy Siracha Burger. We are now showing calories on our menus nationally as we align our consumers' expectations for information and transparency. In addition, we now highlight the gluten-free items in our menu and have added a gluten-free English Muffin to our offering for customers seeking gluten-free products.

Our limited-time-only menu strategy remains focused on showcasing fewer, but harder-working options in conjunction with highlights around our improving core menu. During the second quarter, we showcased a limited-time-only menu, Denny's With a Twist, which put a spin on a few of our traditional diner favorites. The current limited-time-only menu is in exclusive partnership with the upcoming Fantastic Four movie.

The limited-time Slamtastic Four menu features a selection of iconic Denny's dishes inspired by Marvel Super Heroes like the Invisible Woman Slam, the Thing Burger, the Human Torch Skillet and the Fantastic Four Cheese Omelette. While the movie -- with the movie hitting theaters later this week, we will replace this menu with the limited-time-only menu for the month of September.

Our Big Burger Bash menu will showcase five premium burgers along with three of our new sandwiches found in the core menu. Like always, guests will always be able to order off the 2, 4, 6, 8 value menu. With each and every quarter, we are getting better at delivering high-quality products with more consistent service standards supported by our field training and coaching initiatives.

These efforts are supported by the Heritage Remodel Program which continues to perform very well, further reinforcing improvements investments being made in our food and service. With nearly 25% of the system reflecting the enhanced atmosphere, we believe we are still in the early stages of our brand revitalization. This year we expect 180 to190 remodels to be completed, including approximately 50 remodels at Company restaurants and by the end of next year all of our Company restaurants will be remodeled. Approximately 50% of the franchise base is due a remodel in the 2016 to 2018 timeframe. We expect this program to continue to be a sales and traffic growth driver for our brand, allowing our menu, service, and media improvements to all work together.

In summary, we are very pleased with the improvements we have achieved so far as that it is clear to us that our brand revitalization efforts are gaining momentum with franchisees and with our guests. Our commitment continues as we execute our brand revitalization strategies enabling us to unlock the full potential of the Denny's brand. Our continued growth and profitability will be driven by generating consistent gains in sales, improvements in customer return scores, margin growth and increased unit growth both domestically and abroad.

Through our highly franchised business, we expect continued growth in our earnings per share and to generate significant free cash flow. Going forward, we will continue to balance our cash allocation between reinvesting in growing and strengthening the Denny's brand and returning to shareholders.

And I'm pleased to announce, as Mark will discuss in further detail, we are increasing our growth expectations for this year as we are now targeted to produce our strongest year of same-store sales growth in a decade.

With that, I will call 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 domestic system-wide same-store sales by 7.3%, growing adjusted net income per share by 21% and generating $9.6 million of free cash flow after capital expenditures. During the quarter, Denny's opened 13 system restaurants, including four international locations and closed 11 system restaurants including one Company-operated revenue.

Denny's total operating revenue, including Company restaurant sales and franchise and licensed revenue, increased by $8.7 million or 7.6%, to $123.3 million, primarily due to the increase in same-store sales. Domestic system-wide same-store sales increased by 7.3%, due to increases in both same-store guest traffic and same-store guest check average. The improvement in same-store guest check average was driven by both favorable product mix and higher menu pricing.

Domestic franchise same-store sales increased by 7.2%, leading to a 3.6% increase in franchise and license revenue, primarily due to an increase in royalty revenue. This increase was offset by an $800,000 decrease in occupancy revenue which was driven by lease terminations. Franchise operating margin of $23.5 million improved by $600,000, primarily due to the increase in royalty revenue partially offset by an additional $1.1 million in direct costs.

Franchise operating margin as a percentage of franchise and license revenue was 67.7%, compared to 68.2% in the prior-year quarter. This was primarily due to the increase in direct costs, namely higher payroll expenses, advertising fund contributions, and incentive compensation. Same-store sales at Company restaurants grew by 7.9%, driving a 9.2% increase in sales at Company restaurants to $88.6 million. Company restaurant operating margin was 18.4% of Company restaurant sales, an increase of 4.2 percentage points, primarily driven by the leveraging effect from higher same-store sales and the reopening of the Las Vegas Casino Royale restaurant.

Total general and administrative expenses were $16.8 million compared to $14.1 million in the prior-year quarter, primarily due to additional incentive and share-based compensation, along with higher payroll and benefits costs. Free cash flow after capital expenditures was $9.6 million, compared to $11.6 million in the prior-year quarter, due to higher capital expenditures and cash taxes paid. We invested $9 million in capital expenditures during the quarter, which included remodeling 17 Company restaurants. In addition, we acquired a parcel of real estate for $1.6 million which is leased to a franchisee.

Also during the quarter we repurchased 1.5 million shares for $16.1 million. And through the first two quarters, we've allocated $21.2 million to repurchase 1.9 million shares. We have approximately 10.5 million shares authorized for ongoing repurchase programs based on Friday's closing price.

Now I would like to take a few minutes to expand on the business outlook section of our earnings press release. Based on second-quarter results and Management's current expectations, we are raising 2015 annual guidance expectations for same-store sales and adjusted EBITDA. We are increasing same-store sales expectations to be between 5.5% and 6.5% at Company restaurants and to be between 5% and 6% at franchise restaurants.

We now anticipate the Company margin rate will be between 16.5% and 17%, primarily supported by leveraging higher same-store sales. We continue to expect the franchise margin rate to be between 67% and 68%, including approximately $10 million in franchise occupancy margin.

Total G&A expense is now expected to be between $64 million and $67 million, primarily due to higher incentive and share-based compensation levels. Despite this increase, we anticipate adjusted EBITDA will be higher than previously estimated, ranging between $86 million and $88 million.

Cash capital expenditures are expected to be between $26 million and $28 million, which is approximately $2 million higher than previous guidance, primarily due to a scrape and rebuild of one Company restaurant. Despite the increase in our expectations for adjusted EBITDA, our free cash flow guidance is now between $44 million and $46 million, due to higher cash capital expenditures. Going forward we will continue to allocate our excess cash towards supporting reinvestment of the brand and our Company restaurants as well as returning value to our shareholders.

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)

Michael Gallo, CL King.

I just wanted to drill a little bit on the SG&A, a little higher in the quarter. I know you have the stock-based comp. But just to take a step back, it looks like core SG&A was up about $2 million. And when I look from the start of the year, I think you started at $58 million to $61 million of SG&A in the guidance. And now we are talking about $64 million to $67 million, which I guess back of the envelope, that's $0.04 or $0.05 variance from where your individual guidance was in February.

So walk me through the SG&A. How much of what is kind of embedded in year is stock-based comp? Is there any front loading, given just how strong the year has been? And then also, what is going on with the core SG&A number? It looks like it was up again fairly meaningfully year over year. Thanks.

Hello, Mike. It's Mark. How are you?

I'm good. How are you?

Doing well.

So let's start first with 2014 annual G&A last year; and actual 2014, it was right around $59 million. And to set the numbers for 2015, as outlined in the guidance comments, were in the $64 million to $67 million range at this point in time. In the second quarter, we were up about $2.8 million in G&A. And I would say probably about, let's call it around 70% of that change, that increase, was a combination of annual incentive accruals as well as stock base comp. And the majority of that was the annual incentive accrual.

To reference that, if you go back and take a look at our proxy statement from last year, the plan that is outlined from an annual incentive standpoint is primarily focused around top-line sales as well is profitability. The plan on the stock base comp is basically it's a total shareholder return focus primarily. But what it really does is it takes a look at Denny's share price change on an absolute basis and also on a relative basis to peer group. And again, all that is outlined in the proxy statement.

Back on the core G&A piece, I would tell you that excluding stock base comp and excluding the annual incentive piece, which I mentioned in the second quarter probably was almost three-fourths of that differential from prior year. Within the sort of core G&A thereafter, which is really payroll and benefits costs, there are some headcount changes, some folks we're adding. We are focused on investing in the right G&A pockets, I would say, to drive the business forward.

And I think that is relatively consistent with what we've said in the past. When we clarified historically about investing in the brand, part of that investment was really on the G&A side. And that is sort of the other piece of that there as well. But again, when you look at the overall picture, a large portion of the change is a combination of the annual incentive piece as well stock-based comp.

As I mentioned in Q2, in our second quarter, that was probably call it somewhere be between two-thirds and three-fourths of that change on a year-over-year basis for second quarter. ( multiple speakers ). Go ahead.

Presumably now you've factored in -- at least from where you sit year to date, I would presume that you contemplate probably hitting the high ends on the annual at this point? In terms of ( multiple speakers ).

Well, I would go back to the range that we quoted, which was the $64 million to $67 million number for the year. And, again, that compares against $59 million from 2014 actual. So we did provide a range. And right now, obviously, we'll update or not update. We will refresh that accordingly when we get to the end of the third quarter. But right now, the range of $64 million to $67 million.

And as I mentioned, when you look at the second quarter and the first half of the year, a large part of that change, that delta, is a combination of the annual incentive accrual as well as the stock-based comp, the two combined.

I guess just coming back to, again, that $64 million to $67 million range, that assumes just looking at the numbers at least fairly significant leveling off of the year-over-year changes in the back half. Because I think last year you did $30 million, $31 million, $30.7 million, I think, in the back half. So that would imply it's going to level off. Is that fair?

Right. So without answering your question specifically, the guidance would suggest we're going to be up somewhere between $5 million and $8 million on a year-over-year basis. And I think in the first half, we are up probably about $5.5 million year over year

Okay. Perfect. Thank you.

Alton Stump, Longbow Research.

Brittany Whitman on for Alton today.

I was wondering if you could give us any color on the nature of the competitive environment? We are just trying to gauge if 2Q was any better or worse than 1Q?

Hi, Brittany. This is John Miller.

Of course, our Q2 was slightly stronger than Q1. That has been the trend of the top performers in the industry and sort of the reverse of the average of full service. So it looks like there is starting to be a little separation between the lead performers and the average. And other than that, I do not know specifically what else to --

All right, no, any color is good.

And then just a quick follow-up on the Heritage remodel. I know you said the program is doing pretty well, and you are moving along with some of the remodeled stores, I was wondering if you had an updated comp lift figure from the remodeled stores?

Not updated. I think it has been fairly consistent. What I could tell you we've had some questions about what happens when they start to comp over. And we're pleased to report they continue to perform very well and not honeymoon off. So they continually perform in that mid-single-digit range across all of the averages, and then they continue to hold it and build

Okay. Thanks.

Will Slabaugh, Stephens.

You mentioned last quarter, and then again this quarter, that the guests are ordering more of the high-priced premium items. I'm wondering if you are seeing this across the board, across your system; or if it's notably stronger or weaker in certain parts of the country where employment growth or some other factor may be stronger or weaker?

That's a great question, Will. It's has been fairly consistent. We see a little bit of difference in comp based on housing and sort of employment; but we don't see much difference in total check, GCA.

So there is a little bit of a difference between company and franchise. Franchisees have a little bit more price they're carrying. And so we have a little bit smaller $2-4-6-8 incidents and more trade-ins of the premium items as a result of slightly lower pricing. So there is a little bit of a benefit there. In other words, with less pricing we actually have higher guest check shift, odd to report. But other than that, it is fairly consistent, Will

Got it. That's helpful.

And on the $2-4-6-8 -- I may have missed this -- I know you mentioned last quarter that was down 300 bps year over year, and probably in conjunction with what you just mentioned a minute ago. Was that number similar in 2Q?

That's right, real similar to Q1; however the Company continued to slide a bit. So the Company incident rate is about 15% now; the system is about 17% in Q2. Q1 was about 18%. So it's real similar. So 17% versus 21%, about 300 to 400 basis point difference.

Got it. Okay, and the last thing for me. Update on any sort of pricing changes that you may have had during the quarter or are looking forward, just given any sort of movement you've seen with eggs or anything else in your commodity basket?

Sure. As you may or may not be aware, our commodities are pretty well spread; that's the benefit of our larger menu. Pork and beef are the two highest and make up about a little more than 30% of our total market basket, with beef being slightly higher and pork being slightly lower of that. Eggs only makes up about 10%.

So in the first half of the year, it was fairly nominal what the avian flu impact was. In the back half of the year, it will be more significant. So full-year guidance is about 2% to 2.5% total market basket change, including the impact of the avian flu

Perfect. Thanks, John

Thank you.

Tony Brenner, ROTH Capital Partners.

I wanted to ask a little more about the shift in the value menu. It makes sense, I think, that your customers -- certainly your existing customers -- are coming more often, given what economic improvement there is. But one of the motivations of putting in the value menu in the first place was to attract new guests, new customers, who are not currently patrons of Denny's.

And the fact that the value menu is running down 300 or 400 basis points as a percentage of the mix, I wonder if that implies anything with respect to whether the increased sales, or how much of the increased sales, are coming from new customers that were not previously going to Denny's Or whether the value menu really makes a difference in that respect at all?

I think those are great questions, Tony.

Obviously, we pride ourselves on taking care in consumer insight work and market intelligence on where our traffic is coming from: breakfast, lunch, dinner, late-night, value menu, premium options, LTOs. And then the great work our marketing team does on segmentation and demographic information, and how they are responding to different initiatives.

Obviously, way too much to put into a short answer. But they all seem to be moving in a positive direction. And so we look at $2-4-6-8 and say this is primarily a traffic driver, not just for new customers but for any of those categories. And we were very comfortable with its impact on check, up to a certain level. And above the 21% level or so, or maybe for easy talking points above 20%, we start to view that as a migration into too successful.

So somewhere in that 15% range to 18% range, we are very comfortable that it is doing what it is designed to do and maintaining frequency for guests that might not have been there without a value program. It's a great lever that we have and a tool in our toolkit to pull when we to need to accelerate it or pull off the gas a little. But we are pleased to see the work in raising the quality. And other drivers for that other 80% of the guests and their reasons to come is taking root as well.

All in all, I would say we're fairly comfortable with where we are, as well is our franchisees. The tool is not expected to go away. But we made the election not to reprice it, but to keep it with the equity in the name $2-4-6-8. So it did require some engineering, and it was a bit too successful by some measures. And it's very appropriate where it is right now.

Are you seeing, John, any particular strength in a day part? For example, is the big growth reflecting more families coming at dinner, or is it spread out?

Yes. That's a great question.

The dinner day part is the biggest beneficiary of the remodel program, which is -- call it 25% of the system at the moment. For the whole system, including stores we've remodeled, the averages are a little different than the remodel isolated. And that is that breakfast and lunch have been stronger performers year to date in non-remodeled stores. So it's an interesting comparison between the two. But, yes, we are seeing a stronger lift right now in breakfast and lunch from all non-remodel related initiatives

Okay. Thank you.

Nick Setyan, Wedbush Securities.

Colin Radke in for Nick.

I may have missed it, but what was the impact of pricing and traffic on the comp in Q2?

Pricing is roughly 2.5 year to date and also in Q2. Call it 50-60 basis points difference between company and franchise. Back half of the year is predicted to be in the 2.0 to 2.5 range, slightly lower than the first half

Okay. Got it.

And then how should we think about kind of lapping the changes to the $2-4-6-8 menu in the second half, along with the kind of rollout of the core menu update in June and kind of some of the shift in the incidents you've been seeing? How should we think about that as you start to lap some of the changes going into the second half?

Guest check impact will start to mitigate late Q3. And the toughest comparison will be Q4, where we have the full benefit of the reengineering. So we will have the toughest comparison late in the year

Okay. Got it.

And then just one more kind of in the context of the higher egg costs. Would you take any more pricing to kind of offset in the second half? Or how does that impact maybe how you think about the fuel pipeline or the marketing calendar? Or just if there is anything that you can do to offset some of that inflation?

We did, as you can imagine, take a careful look at our LTO strategy and where pricing options could be addressed inside between the announcement and the end of the year. So in this price, in this menu that was just rolled out, we took a little pricing related to omelettes. And then we did the same thing in our LTO menu that we have in place right now.

And then you will see that we have a Burger Bash following the Fantastic Four promotion, the movie promotion, which is markedly counter to an egg promotion. So there are some things to mitigate it. And again, we think without the eggs we would've had a fairly flattish commodity year. But we are guiding 2% to 2.5%. So it is having an impact, but the news is getting a little better every week

Got it. Thanks a lot

(Operator Instructions)

Mark Smith, Feltl and Company.

Hello, this is Shawn Bitzan sitting in for Mark.

Can you touch on the results that you are seeing from nontraditional restaurants, mainly college campuses?

Sure. This is John, and I will address The Den.

We have 14 of these nontraditional locations open. They are primarily with partners like Compass, Sodexo, ARAMARK. We have an AAFES relationship as well. And then we have a couple of college campuses that operate their own food service and have elected to put the Denny's fast-casual program on their campus. The Den concept is our latest version. It's at the University of Alabama, Birmingham; UNC Charlotte; and then San Diego State. It has a slightly higher average weekly sales than the average of all 14, so it represents progress.

But I would say the way we look at this division is it is more opportunistic driven. It is not in a position for scale at this point, but it has been great learning for the brand. It's a tremendous opportunity for us to appeal to a millennial crowd that has firsthand captive audience opportunities to share with us what they like about the image of it, the product development. And so it certainly has its benefits for our system. And we will continue to open a few a year at this point; the guidance for this year, I think, is three total.

Great. How about some of the Flying J's and the airports and international results from those nontraditionals.

Flying J, what we call our travel center, is quite scaled on the other hand. And since we did the transaction with Pilot when they acquired Flying J, we've added new travel centers every year since that transaction concluded. We are not adding them at the same pace, obviously. But every year, franchisees -- from mom and pop's with truck stops to new build travel centers and now franchisees that are non branded or are not Pilot or Flying J -- that are adding travel centers that include Denny's. So there are a few of those being added every year that are at or around the average of the brand franchise average and generally have some favorable economics.

The crowd is a little different, depending on how much is 4 wheel and how much is 18-wheel traffic. The most notable difference is the 18-wheel traffic tends to have a stronger Tuesday, Wednesday, Thursday mid-week evening day part, instead of a Saturday morning strong day part. So you tend to sell a few more T-bone steaks and sirloins and chicken-fried steaks than omelettes and pancakes. But it's a very good complement to our brand.

Thank you very much

With no additional questions in the queue, I would like to turn the floor back over to our speakers

Thank you, Katherine.

I would like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in early November to discuss our third quarter 2015 results. Thank you and have a great evening.

Thank you.

Ladies and gentlemen, again, that does conclude today's conference. Thank you all again for your participation.