Denny's Corp (DENN) 2017 Q1 法說會逐字稿

Good day, and welcome to the Denny's Corporation First Quarter 2017 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Curt Nichols, Senior Director, Investor Relations. Please go ahead, sir.

Thank you, Johnny, and good afternoon, everyone. Thank you for joining us for Denny's' First Quarter 2017 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 first quarter earnings press release along with any reconciliation of non-GAAP financial measures mentioned on this call. This call is being webcast, and an archive of the webcast will be available on our website later today.

John will begin today's call with his introductory comments. Mark will then provide a recap of our first quarter results along with brief commentary on our annual guidance for 2017. 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 and 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 28, 2016, 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, Curt, and good afternoon, everybody. Following a challenging wrap up to 2016, the first quarter of 2017 proved to be another volatile one for the restaurant industry. We believe this reflected a number of forces at play, including intense promotional activity within the industry as commodity deflation persisted, the continued gap between grocery and restaurant pricing, the influence of the retail slowdown on dining out occasions and federal income tax refund delays among others. While we anticipated some relative softness, our same-store sales performance was even weaker than we anticipated.

First quarter domestic same-store sales saw a slight benefit from the new year shift to January, but we're particularly challenged by federal income tax refund delays in February, followed by the Easter and spring break holiday mismatch in March. These events collectively weighed on first quarter system same-store sales by approximately 90 to 100 basis points. Despite this choppy environment, we fared well on a relative basis once again outperforming key industry benchmarks. Our consistent outperformance versus our category reflects the momentum generated by our brand revitalization initiatives, and we remain committed to achieving our vision of being the world's largest, most admired and beloved family of local restaurants.

As a reminder, we will continue to execute against the 4 following strategic pillars: First, delivering a differentiated and relevant brand in order to reinvigorate same-store sales growth; second, consistently operating great restaurants with the primary goal of being in the upper quartile of satisfaction scores for all service brands; third, growing the global franchise by expanding Denny's geographic reach throughout the U.S. and international markets; and fourth, driving profitable growth with a disciplined focus on cost and capital allocation, thereby benefiting franchisees, employees and shareholders.

During the first quarter, we continued to evolve our menu in order to meet guest expectations for better, more craveable products. Our latest LTO menu features a new signature burger lineup, including the Bacon Gouda Burger and the Honey Jalapeño Bacon Sriracha Burger, along with the new Cake Batter Milk Shake. Our media messaging is currently focused on our quality burgers with our hand-pressed 100% pure beef, fresh toppings and bold flavors that are made to order and start at a compelling price of $6.99.

Burgers represent an opportunity for growth within our dinner daypart along with our dinner-focused skillet entrees, which are highlighted in our latest core menu. Denny's $2 $4 $6 $8 Menu continues to resonate strongly with our guests, with 1 in 5 citing it as a reason for their visit. We continue to evolve our value menu offerings in order to provide a variety of products to our guests while maximizing margins.

As I mentioned during our last earnings call, one of our most important initiatives during 2016 was the launch of our new improved pancake recipe. Throughout the first quarter, the guest response remains very positive. In fact, Denny's traffic has outperformed casual dining and family dining benchmarks since our new pancake launch in December of last year, which we believe represents a guest preference for fresh ingredients. This puts Denny's as one of the largest users of fresh buttermilk in the nation.

Our remodel program continues to receive favorable guest feedback and generates a mid-single-digit range sales lift. Franchisees remodeled 71 restaurants during the first quarter, which was ahead of schedule, and we continue to expect more than 75% of the system will have the new image by the end of 2018.

During the quarter, our operations team continued to make progress toward achieving their goal of delivering higher quality products with a more consistent service experience. Our focus on progressively evolving our field training and coaching initiatives is critical to delivering our mission and to serve our franchise system as a model franchisor. Our new breakthrough training approach includes assessment and coaching to run great restaurants.

Overall, we continue to make progress toward improving our food, service and atmosphere as evidenced by our guest satisfaction scores, which once again reached new heights during the first quarter. And while we are encouraged by the substantial progress that our team has made, opportunities remain in order to reach our full potential. We will continue to invest in our talent and systems in order to further elevate the guest experience.

Switching to development. We opened 8 restaurants during the quarter, including 3 international locations in Canada, Mexico and the Philippines. Our current international footprint of 126 restaurants has grown by more than 60% since 2009. And with a pipeline of approximately 80 planned openings, we look forward to gaining further momentum beyond North America. During the quarter, we also acquired 3 restaurants located in close proximity to our corporate headquarters. We plan to revitalize and improve the overall economics of these restaurants as well as utilize them for purposes of alpha testing potential improvements to food, service and atmosphere.

As we articulated during our last earnings call, we expect the challenges currently facing the restaurant industry to persist for the foreseeable future. However, we are committed to profitable system sales growth and market share gains. Our continued growth and profitability will be driven by a combination of investments in our brand and our company restaurants along with our shareholder-friendly allocation of free cash flow in the form of share buybacks. It is our intention to continue our buyback program and return capital to our shareholders as we move forward.

In closing, we remain focused on continuing the transformation of the Denny's brand through the ongoing evolution of our food, service and atmosphere, while building a sustainable foundation to grow around the world.

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

Thank you, John, and good afternoon, everyone.

As John mentioned in his remarks, the first quarter was a challenging and noisy one for the restaurant industry overall and for Denny's. Our systemwide same-store sales were down 1.1%, including decreases of 1.6% at company restaurants and 1.1% at domestic franchise restaurants.

We ended the quarter with 1,731 total restaurants as franchisees opened 8 restaurants and closed 10 restaurants.

Denny's total operating revenue, which includes company restaurant sales and franchise and licensing revenue increased by 2.6% to $127.9 million, primarily due to higher company restaurant sales. Company restaurant sales grew by 3.8% to $93.8 million due to an increase in the number of company restaurants from the reacquisition of franchise restaurants in 2016, partially offset by softer same-store sales. Company restaurant operating margin of 17% was impacted by minimum wage increases and higher workers' compensation expense, partially offset by higher sales and lower product costs.

Moving to our franchise restaurants. Franchise and licensing revenue was $34.1 million as lower same-store sales and occupancy revenue were partially offset by our greater number of equivalent franchise restaurants and the higher average royalty rate compared to the prior year quarter. Franchise operating margin of 71.4% improved by 60 basis points due to high royalty revenue and an improved occupancy margin.

Total general and administrative expenses of $17.5 million increased by $600,000 compared to the prior year quarter. Lower incentive compensation was offset by higher payroll and benefits expenses, higher software service fees related to cloud-based ERP systems, and a market valuation change in our nonqualified deferred compensation planned liabilities. As a reminder, a corresponding gain on plan assets is reflected in other nonoperating income. As a result, these deferred compensation planned valuation changes have no impact on net income. In light of our challenged sales and consistent with past practice, we are taking a close look at our annual G&A costs and are committed to pursuing savings opportunities.

Adjusted EBITDA was $19.8 million compared to $22.6 million in the prior year quarter. Depreciation and amortization expense was $200,000 higher at $5.7 million primarily due to capital expenditures associated with company remodels in new and acquired company restaurants. Operating losses and other charges of $800,000 including costs of $2.1 million associated with the implementation of our new ERP system I mentioned earlier, and a gain of approximately $1.4 million related to the sale of real property to a franchisee. Additional software implementation costs of approximately $2.4 million are expected to be incurred throughout the balance of the year.

Interest expense increased by $800,000 to $3.5 million due to a higher revolver balance and a greater number of capital leases compared to the prior year quarter.

The provision for income taxes was $4.7 million, reflecting an effective income tax rate of 36.2%. Adjusted net income per share was $0.12 per share in both the current and prior year quarters.

Free cash flow after capital expenditures, cash taxes and cash interest was $9.4 million compared to $14.4 million in the prior year quarter, primarily due to lower adjusted EBITDA along with higher capital expenditures and cash interest.

Cash capital expenditures of $6.8 million included the purchase of real estate associated with relocating a high-performing company unit due to the impending loss of property control as well as the acquisition of 3 franchise restaurants, which John mentioned in his comments.

During the quarter, we allocated $12.3 million towards share repurchases. And as a reminder, we also completed the $25 million accelerated share repurchase agreement in February, which we previously disclosed.

At the end of the quarter, basic shares outstanding totaled 70.2 million shares, which is 6.7 million shares below last year. That would be last year Q1 2016. Since beginning of share repurchase program in late 2010, we have repurchased over 37 million shares and reduced our share count by 30%. We ended the quarter with approximately $67 million in remaining share repurchase authorization.

At the end of the quarter, we had $257.8 million of total debt outstanding, including $230 million under our revolving credit facility. Our quarter-end leverage ratio was 2.6x, and we remain committed to our target leverage ratio range of 2 to 3x.

In summary, the first quarter was volatile, but we have been encouraged by our sales performance in April. Accordingly, we are not making any changes to our business outlook at this point. As we have done in the past, we will revise our guidance expectations in connection with future quarterly earnings updates, if needed.

That wraps up our prepared comments. I'll now turn the call over to the operator to begin the Q&A portion of our call.

Operator?

(Operator Instructions) And we'll take our first question from Michael Gallo with CL King.

I just want to drill in, John, to what you're seeing out there in terms of the consumer and how they are approaching value. Obviously, there was a lot of volatility in the quarter with holiday shifts and the tax refunds. But did you see a big uptick in how the consumer used $2 $4 $6 $8? And I guess, you're starting to see the -- perhaps as the refunds catch up and the holiday shifts work their way through that the trends are kind of returning to normal? And along those lines, I guess, Q2, you have a little bit of a promotional mismatch because, if I recall, you ran the burger promotion in Q3. So I was wondering if you can sort of dovetail those in terms of once we sort of parse through the noise, what you're seeing in terms of trends and how the consumers are using Denny's?

I think those are the great questions, Mike. And I think they are the questions on everybody's hearts and minds. I'm happy to take a shot addressing all that. I think how you wrapped up the question is really well put, as usual, on your part. It's noisy. So it's helpful, I think, sometimes to sort of lay things out in the logical order. So we'll start with the wrap up of 2016. Everybody remembers that December was especially difficult for full-service eat out and really maybe even across the full spectrum. This was the broader industry-wide phenomenon I'd say softer holiday sales, retail not out to shops and not out to dine, the persistent discrepancy of pricing of food at home being a little lower, which could create headwinds for a little bit longer than Q1 of this year, but we don't think it persists forever. But these are some things that create some noise in the near-term environment. And then you get into our January -- our fiscal calendar had the benefit of New Year's. It wasn't as strong as the headwind to the closeout of the quarter, March, which had the headwind of the Easter holiday shift, which favors April obviously. And then in the middle of that, Mike, you had the really challenging environment from the some 60 -- I -- do I have the right number -- billion dollars of dollars that shifted into March or later in the refund checks from fraud protection and other programs that we implemented during the period that were not comparable to the same time a year ago. So when you roll all that together, what we like to say about Denny's is it was a quarter that, as I said earlier, is a little softer than we earlier anticipated when we drafted our plan. We were down 1.1% in the quarter but we had 90 to 100 basis points of headwinds in the quarter. So all in all, we would say that we were optimistic about what we saw in April. And I don't know that I'd go so far as to call it a return to normalcy, but it was enough to roll all that together along with the strong response to our current burger promotion, and reaffirm our guidance of flat to 2% for the year.

Just on $2 $4 $6 $8, did you see a big jump up kind of in February when the tax refunds or [change in] mix was?

We saw a jump up, but remember, our promotional calendar is already set. So we were at 15.6% at the end of the fourth quarter -- I'm sorry, at the first quarter, and we are coming off of a 13% and some change in the fourth quarter. So it did jump up 150, 160 basis points during the quarter.

And maybe to add a little more color while we're on that topic, so let's just -- let's sort of -- let's talk about that burger promotion. They are some craveable products. We have the gouda burger and honey jalapeño sriracha burger, which is sort of stepping out for family dining to do something that's a little bit more, I'd say, daring, and you see a patty melt and a cheeseburger in family dining. But Denny's now is becoming known for these quality signature burgers. We have a Slamburger that's done really well. We're building on top of a bourbon barbecue burger that's rolled out a couple of years ago in LTO and now made a permanent spot on the menu. So we have an array of things now that -- an avocado bacon burger, a Build Your Own Burger category. And then we have the Double Cheeseburger, which is quite popular at Denny's. So 7 to 8 burgers on a regular basis that show up in our menu, and this promotion is just to reinforce how far we've come in that category. I think we also said in our call notes that we outperformed our categories. So if you look at the closeout of 2016, that's about 140 basis points in Q4. And then that spread narrowed a little in Q1 but we continue to outperform peers, which again we believe represents momentum from our brand revitalization initiatives. And then on a 2-year basis still pretty healthy, company same-store sales 1.9% on a 2-year franchise 1.2%. And I can talk about regional if you care to know, but I'll turn the call back over to those that have questions.

And we'll take our next question from Will Slabaugh with Stephens.

Yes. John, I was curious about regional.

All right. So I didn't mean to lead the witness, but -- so let's just -- we'll start with California. It was a special bright spot to us. It was yet again positive in the quarter, up about 17 to 280 basis points and system-wide positive versus the overall system performance. The other bright spot was Washington, which has also outperformed California in positive sales, about 400 basis points above. Arizona was also positive during the quarter. So those are really nice bright spots for us. There were other bright spots, but those are states that have a little bigger percentage: California with 23% of the system footprint and then Arizona at about 5%. And the tough spots for us persist in Texas, about 11% of our footprint, and Florida about 8%, they were down. Texas, a good 200 basis points behind in traffic. And Florida about 140 basis points behind on traffic versus the system. So we -- those also sequentially improved, but they are still a challenge for us at this point.

Got you. And you mentioned the volatility during the quarter, and we've heard that from a number of people. And I know you've seen some quarters that moved up and down in the past. So I'm curious if you could talk a little bit more about the volatility you saw intra-quarter now versus what you've seen historically. Were the refund check delays just that much more impactful maybe because of where your demographic sits in the economic spectrum? And was it a little bit more than maybe you think most were anticipating?

I think it's more than most anticipated. That's a guess. I don't know how people wrote their plans. It's a little more than we anticipated. We have to go back to 2013 when there was a delay. The FICA tax dilemma during that quarter, it created a negative quarter for Denny's. So we anticipated, to the extent that we can get our head around this issue, we thought there might be some softness associated with it. And it's a little bit like lost sleep, Will, you don't get back everything you lost inside the quarter. So while those refunds eventually hit, you're missing a normal cycle in February. And then on your higher heavier users, that visit cycle repeats in March. So you don't get the lift. You don't get the offset within the quarter. It's sort of gone forever. So we're looking for the time where there is more comparable periods. But yes, I do believe, to answer your question, the middle of the quarter was the toughest because February was most affected by this change. And I don't think you will see this again. And I don't think we had a comparable point in history we could relate to.

And one last one I had, I wondered if there were any other bits of color you could give on the G&A opportunities that, Mark, you mentioned earlier.

Yes. What I'd start out by saying is that we left the guidance the same. The first quarter also was noisy, and I think Mark will -- his notes did sort of attempted to answer some of the trade-offs, pluses and minuses but . . .

Yes, I would agree with that what John commented on. I think more than anything it recognizes, obviously, we continue to look at our cost structure. Our G&A at this point in time, as John referenced, we've left all of our annual guidance elements the same, including G&A.

And we'll take our next question from Nick Setyan with Wedbush Securities.

Just kind of on the labor line, last year we had, obviously, the inflation in California, and you guys weathered it relatively well in Q1. I guess it was a little bit of a surprise in terms of the 180 basis points of deleverage. Could you maybe talk -- I mean I think we had a little bit more pricing in Q1 that we're [not] going to have for the rest of the year, if I'm not mistaken. But I guess, maybe talk about the different components. Maybe there was a little bit more volatility on the non-wage items there in Q1 that we had previously expected? And how should we think about it for the rest of the year?

Nick, it's Mark. So little bit of the background of that. First of all, just opposite of the 2 key components on our P&L are cost of goods and cost of labor, and we'll probably get the question about commodity inflation. But -- and then I'll go to the labor line. On the commodities side, we continue to see probably an inflation range of 1% to 3%. In Q1, you actually saw an improvement in product cost or cost of goods sold. A little bit of deflation in that first quarter. We expected inflation will occur in commodities in our basket sort of throughout the balance of the year. So that sort of ties back to that 1% to 3% commodity inflation assumption at this point. On the labor line, you're right, 180 basis points, the wrong way. When we looked at sort of the breakdown there, there are couple of key components. One is obviously, there's a bit of a deleveraging effect, the wrong way in the P&L because of the negative sales comp. And that's probably something and call it I'll say the 30 to 40 basis point range of that 180 basis point overall. Another key component was probably minimum wage, and that's probably call it 50, 60, 70 basis point range, the impact of that. So obviously, it's minimum wage in California, but we've also seen a number of states take minimum wage up across the country, and so we're seeing the impact of that. And we've got I think something greater than 60 of our company stores sit in California. You heard us say that before as well. And the last piece that I referenced in my comments was on the workers' comp side. So the bottom line is that, that cost us probably 60, 70 basis points in that range, 60 to 70 basis points as well. So there were a number of components that went through the labor line that moved back and forth, but ended up in that 180 basis point, the wrong way, the negative side of it. Again, part of it was deleveraging on sales, part of it was minimum wage and part of it was workers' comp.

Got it. And then going forward, is the workers' comp going to be a little bit less of a headwind? Or should we think about kind of a similar headwind going forward?

No. It moves back and forth based on the overall movement, and I would say the claims themselves. And I think if you go back over the last 2 or 3 years, you've seen some, I'd say, minor volatility in that line item. But ultimately, when you look at it -- when we look at our guidance ranges, again, despite the pluses and minuses in Q1, we've obviously kept with our guidance ranges.

Okay. And then just a breakdown in terms of price mix and transactions in the quarter?

Sure. Let me make sure I grab the right data here. So we've got price basically 210 basis points. Traffic off about 250, along with some negative mix shifts of about 70 which give us 110 negative or 1.1% negative overall. And again, 90 to 100 basis points, that was just built in headwinds.

And in terms of the pricing going forward, if I'm not mistaken, I thought the 2% to 3% range you have made some comments previously, and again I may be mistaken, but that was maybe towards the higher end of that range. Was there something that you guys adjusted, in terms of your thinking mid-quarter?

Yes. So you're right. We talked about this on the fourth quarter call. We talked about we had gone to an extra pricing or menu cycle during the year, which will help layer in especially for the coast or high wage inflation, Phoenix, California. They will be ahead of the national pricing numbers, and they are now.

Okay. And in terms of the acquisition of the stores, obviously, it's a geography that historically hasn't been one of your highest volume markets. Is this maybe a little bit of change in the strategy? Or should we maybe think about that, hey, maybe this is just a one-off case, close to the [main] headquarters, strictly due to the ability to test some things, et cetera?

Yes, I think it was -- this is Mark, obviously a bit of a unique situation. When we take a look at this, our nearest company-owned units prior to this transaction was probably a couple of 100 miles away from the corporate headquarters. And I think, as John mentioned upfront, all of these stores are tightly within I'll call the Greenville Spartanburg market. We hope to use stores from an alpha test standpoint and really sort of leverage the fact that we've got stores that are nearby. So I don't want to say it was entirely unique, but it was somewhat unique. Obviously from the decision standpoint, it was probably more strategic. And I think, before the other question comes up, we continue to target franchise acquisitions. This is an element of our strategy as far as reinvesting our free cash flow, reinvesting in the brand, and we're continuing to focus on that 4.5 to 5.5 multiple range.

And we'll take our next question from Alton Stump with Longbow Research.

This is actually Brittany Whitman on for Alton this afternoon. Just sort of off the same question, the last question. The 3 franchise restaurants that you acquired, what was the cost of that acquisition?

Yes. I'd say probably a little bit north of $1 million for the 3, something like that. It will obviously be reflected in our documents, our filings.

Right. Okay. And then just moving forward throughout the year, do you have anything in terms of updates or changes to the $2 $4 $6 $8 Menu planned?

Yes, this is John. The $2 $4 $6 $8 Menu just in general continues to evolve and be refined. We have -- last year first quarter, we focused on the $8 end of the range. Today I'd say that the $4 and $6, in terms of future outlook, is more of the focus. We have deemphasized it considerably over the last 2 years and focused on the value trying to outrun an over-value or over-discount sort of sense about the brand. We relied on it little bit more heavily for traffic. But as the consumer confidence has improved, we've distanced ourselves a little, and it could be that in a value season like this, that we return to that little bit more. It's not unusual for back to school August, September and certainly coming out of the holidays January, February, for consumers naturally to be drawn to it a little bit more, as there's a little stress on credit cards or other pressures. And so then we just do our best to respond to the competitive environment and the consumer environment with our strategic approach to the menu.

(Operator Instructions) And we'll take our next question from Mark Smith with Feltl and Company.

First off, just we've kind of beat the topic to death, but sequential comp trends during the quarter primarily in March. Can you quantify anything or give us any insight into April or even -- and was it really the comp trends late in the quarter that gave you the confidence to maintain your guidance?

Yes. I just -- I think this will be true for most companies and so there's sort of the, what's going on at Denny's and maybe what's going on question. So January benefited from New Year's and March was affected negatively by Easter and holidays. And February was the tough period in the quarter. April will have benefited from Easter flips and holidays, and we were heartened by what we saw. So I think that's probably all the quantifying we can do at this stage. But it gives you some sense of how things unfolded.

Okay. And then your interest expense came in a little bit higher than expected and kind of the run rate is a bit above the guidance. Is there change in kind of balance sheet that we should expect through the year, in knocking some of that down or anything else that's going on in that line?

This is Mark. I would say that obviously in Q1, if you look at the components of free cash flow numbers, obviously it's slightly below prior year. I know certainly one of the things that if you look at the year-over-year comparison, our share repurchase number was up substantially on a year-over-year basis. I think we talked about a number that was north of $12 million for the quarter. And I think last year, first quarter '16 was probably slightly under $4 million. So there was some movement around -- and some movement in working capital is well, Mark. But I think again as we look at it, our leverage range is in that 2 to 3x. We were slightly under 2.5x lever, I think, at the end of the fourth quarter of '16, and we were right around 2.6 level at this time around. So I look at it and say, it's not a material change and obviously as part of our guidance elements that we've stayed with or held to, our free cash flow guidance for the current year is, I think, $58 million to $60 million, which is up from prior year. I think prior year was about $51 million and change. So again from our perspective, we look at this 90/10 model, and obviously it's a strong cash generator.

And then last question from me. Just -- do you have the number of percent of franchise restaurants that have had the remodel?

About 56% at this point. And again, we are reiterating about 75% by the end of 2018. So it will continue to grow. First quarter with 71 remodels, a little ahead of our projection for the quarter and about 200 projected for full year 2017.

And we have no further questions in the queue at this time. I'd like to turn the conference back over to our speakers for any closing remarks.

Thank you, Johnny. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in early August when we will discuss our second quarter results. Thank you, and have a great evening.

Ladies and gentlemen, that does conclude today's conference. We'd like to thank you all for your participation. You may now disconnect.