Denny's Corp (DENN) 2017 Q2 法說會逐字稿

Good day, and welcome to the Denny's Corporation Second Quarter 2017 Earnings Conference Call. Today's conference is being recorded. And at this time, I'd like to turn the call over to Mr. Curt Nichols, Senior Director of Investor Relations. Please go ahead, sir.

Thank you, Tom, and good afternoon, everyone. Thank you for joining us for Denny's Second 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 second quarter earnings press release, along with any reconciliation of non-GAAP financial measures mentioned on the call today. 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 second 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 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 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. The restaurant industry's choppy performance continued into the second quarter of 2017 following a soft first quarter that was influenced by intense promotional activity. The continued gap between grocery and restaurant pricing, the influence of a retail slowdown on dining-out occasions, holiday shifts and federal income tax refunds delays all weighed on performance. Denny's second quarter domestic system same-store sales overcame some of the broad pressures, as sales increased 2.6% due in part to improving guest traffic patterns, the launch of Denny's on Demand and a stronger-than-expected benefit from the Easter and spring break shift, which represented approximately 120 to 140 basis points on the quarter. Once again, we outperformed key industry benchmarks. This consistent performance versus our category reflects the positive impact of our brand revitalization initiatives, which support our commitment to achieving our vision of being the world's largest, most-admired and beloved family of local restaurants. To that point, we will continue to execute against the following 4 strategic pillars to achieve our vision: First is delivering a differentiated and relevant brand in order to achieve consistent same-store sales growth; second is consistently operate great restaurants with the primary goal of being in the upper quartile of satisfaction scores for all full-service brands; and third, growing the global franchise by expanding Denny's geographic reach throughout the U.S. and international markets; and finally, driving profitable growth, with a disciplined focus on cost and capital allocation, thereby benefiting franchisees, employees and shareholders.

During the second quarter, we continued to evolve our menu in order to meet guest expectations for better, more craveable products. Our latest LTO menu highlights fresh-picked flavors like the Strawberries & Cream Pancake Breakfast, the Chopped Kale & Grilled Chicken Salad, a Berry Blue Lemonade and a Lemon Berry Smoothie. At the same time we introduced these great-tasting summertime products, we also launched Denny's on Demand to meet guest expectations for greater convenience. Denny's on Demand includes the ability to order and pay for to-go items on the web or through new mobile apps that were built in partnership with Olo. This new platform also includes enhanced to-go packaging from -- made from sustainable materials that will better ensure Denny's to-go meals will be served hot, fresh and delicious.

Where available, we also launched delivery via Olo's Dispatch delivery network, and a number of restaurants have signed separate additional third-party delivery agreements. While we are in the early stages of executing on this new platform initiative, we have been encouraged by a nearly 1 percentage point increase in off-premise sales following the national launch. These new to-go transactions are highly incremental and over-indexed at late-night and the dinner dayparts. With 28% of domestic system activity engaged with one or more delivery service provider, we anticipate continued long-term growth in our off-premise sales from the Denny's on Demand platform as more restaurants sign delivery agreements.

Our remodel program continues to receive favorable guest feedback and generates a mid-single-digit range sales lift. Our franchisees completed an additional 52 remodels during the second quarter, bringing the Heritage image to over 58% of the system. Remodels will continue to be a significant tailwind for the brand over the next few years, and we expect over 75% of the system to 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 running great restaurants. Overall, we continue to make progress toward improving our food, service and atmosphere, as evidenced by our guest satisfaction and Pride review scores, which once again reached new highs during the second quarter. And while we are encouraged by the substantial progress our team has made, opportunities remain in order to reach our full potential. Therefore, we continue to invest in our talent and systems in order to further elevate the guest experience.

Turning to development. Our growth initiatives have led to over 470 new restaurant openings since 2009, representing over 27% of the current system and one of the highest totals of all full-service brands. Our current international footprint of 125 restaurants has grown by more than 60% since 2009, and we look forward to gaining further momentum beyond North America. As we noted 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 adjusted free cash flow in the form of share buybacks.

Since beginning our share repurchase program in late 2010, we have allocated approximately $321 million to share repurchases. 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. We are still in the early stages of our brand revitalization through which we are growing same-store sales. Just over 58% of the system is currently on the new Heritage image, and we expect 75% of the system to be remodeled by the end of 2018. We have an expanding global footprint with the interest -- with new interest in the brand from a number of franchisees and an active pipeline with a healthy number of planned future openings. We remain committed to our 90% franchise business model and are growing our profitability. Our blended royalty rate is currently 4.14% and growing towards 4.5%.

Our current annual guidance for both adjusted EBITDA and adjusted free cash flow is the highest in a decade. And our ability to generate strong cash flow allows us to consistently return cash to shareholders.

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 highlights include growing domestic systemwide same-store sales by 2.6% and adjusted EBITDA by 2.5% to $26.7 million, while generating $12.7 million in adjusted free cash flow and allocating $24.4 million towards share repurchases.

We ended the quarter with 1,724 total restaurants, as franchisees opened 7 restaurants and we, the company, opened 1 company restaurant. These openings were offset by 15 restaurant closings, including the unanticipated closing of 8 franchised restaurants in Colorado. In addition, we acquired 3 franchise restaurants in New England and refranchised 4 Kwik Trip Travel Center restaurants.

Denny's total operating revenue, which includes company restaurant sales and franchise and licensing revenue, increased by 7.3% to $133.4 million, primarily due to higher company restaurant sales. Company restaurant sales grew by 10.3% to $98.4 million due to an increase in the number of company restaurants from the reacquisition of franchise restaurants over the last 12 months and a 2.7% increase in same-store sales.

Company restaurant operating margin of 16.9% was impacted by increases in product costs, workers' compensation expense and minimum wages, partially offset by higher sales. The increase in product cost was primarily due to rising commodities and enhanced packaging costs associated with the launch of Denny's on Demand. Workers' compensation expense was up due to favorable claim development of $800,000 in the prior year quarter compared with $100,000 in the current quarter.

Moving to our franchise restaurants. Franchise and licensing revenue was $35 million, as a 2.6% increase in same-store sales, a greater number of equivalent franchise restaurants and a higher average royalty rate were offset by decreases in both occupancy and revenue and initial fees compared to the prior year quarter. Franchise operating margin of 70.7% improved by 130 basis points due to higher royalty revenue and an improved occupancy margin.

Total general and administrative expenses of $16.6 million were up about 2.3% or $400,000 compared to the prior year quarter, as lower incentive compensation was offset by higher payroll and benefits expenses and a market valuation change in our non-qualified deferred compensation plan liabilities. As a reminder, a corresponding gain on plan assets is reflected in other non-operating income, and as a result, these deferred compensation plan valuation changes have no impact on net income.

Adjusted EBITDA grew 2.5% to $26.7 million compared to $26.1 million in the prior year quarter. Depreciation and amortization expense was $5.8 million compared to $5.1 million in the prior year quarter, primarily due to capital expenditures associated with company remodels and new and acquired company restaurants, operating gains, losses and other charges net of $2 million, including cost of $1.5 million associated with the implementation of our new ERP solution. We have recorded $3.7 million in these software implementation costs year-to-date and expect to incur approximately $1.3 million of additional software implementation costs throughout the balance of the year.

Interest expense increased by $700,000 to $3.7 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 $4.9 million, reflecting an effective income tax rate of 36%. Adjusted net income per share was $0.14 per share compared to $0.13 in the prior year quarter. Adjusted free cash flow, after capital expenditures, cash taxes and cash interest, was $12.7 million compared to $18.5 million in the prior year quarter due to higher capital expenditures, cash taxes and cash interest.

Cash capital expenditures of $8.3 million included the acquisition of 3 franchise restaurants and construction costs associated with the opening of a new company restaurant and relocating a high-performing company unit due to impending loss of property control.

During the quarter, we allocated $24.4 million towards share repurchases. This enabled us to acquire an additional 2.1 million shares, representing approximately 3% of our public float. At the end of the quarter, basic shares outstanding totaled 68.2 million shares, which represented a reduction of 8.4 million shares or approximately 11% over the last 12 months. Since beginning our share repurchase program in late 2010, we repurchased over 39 million shares and reduced our share count by approximately 32%. And between the end of the quarter and July 31, 2017, we allocated $11.7 million to repurchase approximately 1 million additional shares, and we currently have approximately $31 million in remaining share repurchase authorization.

At the end of the quarter, we had $264.7 million of total debt outstanding, including $235 million under our revolving credit facility. Our quarter-end leverage ratio was 2.66x, and we do remain committed to our target leverage range of 2x to 3x.

Now let me take a few minutes to expand on the business outlook section of our earnings press release. Based on second quarter results and current expectations, we have updated our annual guidance expectations for 2017. We continue to expect same-store sales growth at company and domestic franchise restaurants of between flat and positive 2% for full year 2017. As a result of the unanticipated closing of 8 franchise restaurants during the second quarter, we now expect a net restaurant growth of 5 to 15 restaurants during 2017.

Due in part to recent accelerated commodity inflation, coupled with slightly higher cost of to-go packaging, we are lowering our company restaurant operating margin expectations to between 17% and 17.5%. This range would still represent our second-highest company margin in well over a decade. We expect our total general and administrative expenses to range between $67 million and $70 million, primarily due to lower incentive compensation.

We have increased our debt leverage to purchase a significant number of shares year-to-date. As a result, we now expect our net interest expense to be between $14.5 million and $15 million. We expect cash taxes to range between $6 million and $8 million. Cash capital spending is now expected to be between $25 million and $27 million due to the acquisition of 3 franchise restaurants during the quarter. Our expectations for adjusted EBITDA remain between $101 million and $103 million. Our updated guidance for adjusted free cash flow is $55 million to $57 million due to the increase in capital expenditures for the acquisitions mentioned previously.

That wraps up our prepared remarks. I will 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 Will Slabaugh with Stephens.

I had a question on the sales front. You guys bounced back pretty quickly this quarter after the softness you saw last quarter. So can you walk us through what you saw as you exited 1Q and worked your way through 2Q? And I'm assuming this implies to you that the 1Q softness was heavily macro-weighted, and that's fairly through. Or is there something else out there that maybe kept you from being more optimistic on the comp guide looking forward?

Thanks, Will. It's John. I would say that there's really no big change, all in all. We anticipated Q2 to benefit from the headwinds of Q1 based on holiday shifts, one to the other. Q1 is really noisy. We can replay it, if you like, but I think we've lived through that by now, with federal tax returns a slight benefit early in the quarter and negative at the end. But that negative at the end then benefited Q3. So obviously, that benefit would have slightly favored the earlier part of the quarter. And as I mentioned in my notes, 120 to 140 basis points may be a little bit more favorable than we thought. So it has some benefit that's not embedded in all quarters throughout the year.

Got you. And if I can follow up on the delivery commentary, you mentioned it was highly incremental. I'm curious on if you have any data behind that, on how we know it's incremental and how incremental, if you're willing to share? And then what types of food are they ordering versus the typical product mix and what that means to the P&L?

Yes, so obviously, to-go is a little bit of a different business model. It's very similar, but it's a little bit different. We're very pleased with the consumer response. The near 100% of the system signed up for the Olo program software, so guests can sign up online or order online, mobile, tablet or through their computer for pickup in near the entire Denny's system. And we already have, in the early going, about 28% of the system signed up for at least one third-party delivery company, and we think that will continue to grow. So that's one of the sources for our optimism. We do have, from the pre- and post-testing data, some incrementality checking tools. No one can know with perfect precision, but I'd say there's a high degree of confidence, of a high degree of incrementality associated with it. During tests, we would have modeled, Will, a number of scenarios as conservative as 50% incrementality, to make sure that it sort of passed all the tests for launch, and we got well past that during test. So it gave us confidence for the roll, and we're pleased with how it's going. And as we said, it's about $2.5 million, near 1%, in a very short period of time.

Great. And one more thing, if I could, on the commodity basket. Curious what you saw on the period, with cost of goods pressuring most in the industry. And then any expectations you may have for the rest of the year?

Yes, Will, it's Mark. And I would say that when we did our first quarter call, I think we talked about expected commodity inflation in that 1% to 3% for the fiscal year '17. And again, coming off of fiscal '16, when we had about a 5% deflationary situation in our commodity basket, that commodity inflation today, we feel, is probably more in that 2% to 3% range. So bring that range up towards the higher end. We've certainly seen an increase in pork prices, pork belly has moved that. But clearly, it's a commodity number that we would prefer it to be lower, but right now, we're thinking it's probably going to be in the 2% to 3% range.

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

Just on the labor front, obviously, we saw the 90 basis points of deleverage there. And then we know, in July, we've got the uptick in L.A. minimum wage rate. And so how should we think about sort of that deleverage? I mean, are we going right back up to well above 100 basis points in the second half? I mean, how should we think about the directionality there?

Nick, it's Mark. I think, well, I think you've started outlining, obviously, some of the concerns we have. Obviously, California, the state minimum wage, as well as L.A. County, which you mentioned, which I think that was a July 1 increase, if I recall, which I think was $1.50 an hour, we know that we came into the year with a series of wage increases in other states as well and in some cases, significant increases in minimum wage. And it's obviously difficult to price through that entirely, so certainly, part of our adjustment in our annual guidance on margins. And again, that adjustment is moving the annual guidance for company margins from between 17.5% to 18% down to the 17.0%, 17% to 17.5%, and last year, we ran 17.8%, I believe, was fiscal '16. So labor's a part of that. And I think the other thing that I mentioned here is that we've got -- in the second quarter, we had this workers' comp rollover. So it was about a $700,000 differential in workers' comp, meaning the fact that it was $700,000 less favorable this second quarter than it was last year. And last year, it was about an $800,000 pickup. This year, it was about a $100,000 pickup. So that's part of what played into this as well. And then I think back to the previous question on commodity inflation, again, it's -- in our -- our cost of goods runs around 25% of our P&L, but I think bringing that range up to that 2% to 3% commodity range, specifically in the pork belly side, is probably the biggest item that we've seen move. You put all that together and obviously, we've changed our expectations for guidance in margins about 50 basis points.

Got it. And then commercially, on the other operating side, we actually did see some decent leverage there, even with the delivery fees going presumably into that line item. Is that correct? I mean, what -- how should we think about the delivery fees, and how are we recording those?

Are you talking about the third-party delivery fees, Nick?

Correct, yes.

Yes, I mean, I think what we'd say is that I'd probably go back to John's comment, is that based on all the analytics we've done, that a large portion of the sales incremental, I think John mentioned that -- I think, John, you said at least 50% -- from a margin standpoint, we're sort of still working through that, but obviously, there's incremental margin dollars associated with those transactions as well. So I can't give you specific guidance except to say that, obviously, moving our takeout sales by almost a full percentage point, John talked about that $2.5 million number, I think, in the first month, et cetera, that we certainly are very encouraged. The margin piece is still analytically to be put together, but we really don't have that information at this point in time to talk about on the phone.

I would add to that though, Nick, that as you -- well, people are picking up from the stores, that will be the overwhelming majority of our to-go orders. 28% of the system signed up for a third-party delivery that would have a delivery fee associated with that sale, and near 75% of the system doesn't have a third-party delivery at this point. But again, we welcome those add-ons for their incrementality in spite of the delivery fee. It's still got a nice margin associated with it.

I think the other thing that John mentioned that is a powerful statement for us is the fact that the dayparts also that are certainly experiencing the benefit is the late-night and the dinner dayparts, which, again, we're certainly quite positive to see that as well.

I'll add one more thing, Nick. Trick questions you didn't ask, but not only late-night pickup but also a younger audience. Right now, the largest share of digital orders is coming from 25- to 34-year-olds, followed by the second largest group of orders, 18 to 24. So that's a really nice averaging down of the age of use of our brands. So we're very pleased to see the early results.

Got it. And so just to clarify, the online ordering, that's purely takeout, that doesn't allow delivery?

Well, there may be delivery with the Olo Dispatch feature, but that would be fairly nominal. It's the third-party where there is the larger fee, and that's only 28% of the system at this point. But as that grows, again, there's a really nice flow-through associated with those incremental sales.

(Operator Instructions) And we'll go next to Michael Gallo with CL King.

John, I just want to stick on delivery here for a second. I think I heard you say it was adding 100 basis points early on to same-store sales. Correct me if that was wrong. But is that what you've seen in stores that have it in test markets, or is that what you're seeing early on as a group? And how does that kind of ramp as we go through the year? How would you expect that will ramp, given that this is the kind of thing that it would seem like it will take time to build? So do you have some thoughts on that?

So certainly, the goal is for this to grow. Off-premise grew about 1%. So what it represents of comps is not really in the script, but we believe a good portion of that's incremental. And then obviously, we'd expect it to continue to grow. I don't know if that really answers fully your question, but the whole idea to launch this was to meet some long-term goals of a much higher to-go percentage than we're at today. Over time, Mike, we've grown just sort of from customer sentiment, staying home, online and shopping from home, not being out as much. It has gone from 4% to 6% or so in to-go sales just organically. And so through these initiatives, better packaging and the launch of software, and that's well past 7% now, and obviously, we expect that to continue to grow.

And do you expect additional stores to add it in the back half of the year?

We expect additional stores to add third-party delivery services, correct.

Okay. And then I was wondering with this also if you're collecting then any data from the customers and then whether you can use that as a way to actually market to them to get them back into the restaurant at other times as you -- obviously, you'll see what they're ordering, et cetera?

That's a great question. The -- it's a topic among a lot of brands, what to do with this rich amount of data that's available in different ways to collect your consumer data these days. We've even had people call and say, "Can you sell us some of your data that you collect from online?" So it's really been interesting questions associated with it. But just suffice to say, we expect to be among the sophisticated users of data over time to benefit our brand.

Great. And then just a follow-up for Mark. I think you mentioned, Mark, that there was, was it $1.3 million of additional software implementation fees, I think, in the back half? What was the total for 2017? And do you expect those to recur in 2018?

Yes, so first on the '18 question. No, right now, we're anticipating that there will be no additional expenses per se in '18. I think I talked about the fact that in the first couple of quarters, we're about $3.7 million, and we anticipate a little bit over $1 million, like $1.3 million, I think, for the balance of the year. So you're talking around $5 million for fiscal '17.

And just again to clarify, will the $5 million repeat and there won't be anything incremental, that will just be the new run rate? Or does the $5 million come off next year?

Basically, most of that is implementation cost, and then there will be some ongoing expense related to the system, I want to say, probably in the $1 million range that will run through G&A.

Okay. So net, and again, correct me if I'm not reading this right, but net, you should see a $3 million or $4 million reduction in baseline G&A from this next year?

No, because the $5 million is not going through G&A. It's going through the other op line that I mentioned. So you -- it sort of -- what I would say, Mike, is probably to follow up technically. It probably would be good to arrange a call with Curt and me to walk through it in more detail. But there's $5 million of implementation cost going through the fiscal '17 P&L at this point. And again, ongoing, that will not occur in '18, but in '18 and beyond, there will probably be about $1 million of G&A expense going through, as far as systems.

Okay. But net-net, it will be a positive, I got you. Yes, I'll talk to you offline on that.

And with no further questions left in the queue, Mr. Nichols, I'd like to turn the call back over to you for any closing remarks.

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

And ladies and gentlemen, this does conclude today's conference. We appreciate your participation.