Denny's Corp (DENN) 2017 Q3 法說會逐字稿

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

Thank you, Vickie, and good afternoon, everyone. Thank you for joining us for Denny's Third 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 third 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 third quarter results, along with a brief commentary on our annual guidance for 2017. 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 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, everyone. Let me start by providing a sense of the positive energy and enthusiasm that was generated at the Annual Denny's Franchisee Association Convention in October. The growth and progress of this brand is resonating as franchisee attendance of this year's convention was one of the largest ever. So many franchisees expressed their support for the returns on quality investments we are making to continually improve our food, our service and atmosphere.

We're thrilled to be working with such a talented and passionate group of franchisees, vendors and employees. In addition to the excitement from the convention, this collective team and our company's efforts to effectively execute against our strategic initiatives yielded positive same-store sales during the third quarter as we performed well against -- again versus key industry benchmarks. We accomplished this in spite of the choppy industry environment, that was further impacted by recent hurricanes Harvey, Irma and Maria. These hurricanes impacted approximately 220 Denny's restaurants in Texas, Florida, Georgia, South Carolina and Puerto Rico, including 25 company restaurants. But the good news is we had a large number of restaurants reopen within the 1st week following landfall, though many were operating on limited hours due to imposed curfews and staffing availability.

Today, all domestic locations are currently opened with the exception of 1 company restaurant in Houston that remains temporarily closed. Due to this -- due to the significant damage sustained by the 13 franchise restaurant in Puerto Rico, only 8 of those restaurants are currently operating with limited hours. And we do not expect that situation to change much throughout the balance of the year.

Despite the temporary closings, these storms had a slightly positive impact on overall same-store sales results during the quarter. We're truly grateful for the dedication of our company and franchise restaurant operating teams to reopen so quickly and for their passion to serve all of our guests. Despite the ongoing challenges in the full-service dining category, our consistent performance 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 our 4 strategic pillars to achieve our vision: first, to deliver a differentiated and relevant brand in order to achieve consistent same-store sales growth; second, to consistently operate great restaurants with the primary goal of being in the upper quartile of satisfaction scores for all full-service brands; third, to grow the global franchise by expanding Denny's geographic reach throughout the U.S. and international markets; and fourth, to drive profitable growth with a disciplined focus on cost and capital allocation, thereby benefiting franchisees, employees and shareholders.

We continue to evolve our menu in order to meet guest expectations for better, more craveable products. Our latest limited-time-only menu features flavors of the season including a Turkey & Dressing Dinner and New! Pumpkin Cream Pancake Breakfast and new White Chocolate Raspberry Pancake Breakfast and our Build Your Own Holiday Slam. We recently launched our latest core menu which now includes several new craveable pancake and burger options. We're making good progress toward meeting guest expectations for greater convenience through our Denny's on-demand platform, which offers web and mobile order and payment options for to-go items.

We're still in the early stages of executing on the Denny's on-demand platform initiative. But we're encouraged by an increase in off-premise sales of over 1 percentage points where off-premise sales currently represent about 8% of total sales. Transactions through our new mobile online ordering platforms, which were built in partnership with dispatch network company Olo, have contributed approximately $12 million in sales to-date towards the growth in our off-premise business. These to-go transactions continue to be highly incremental. Over-indexed at the late-night and dinner dayparts and skewed towards the younger 18 to 34-year-old demographic.

In terms of product mix, pancake plates, burgers, milkshakes and Build Your Own entree options, over-indexed with to-go transactions compared to dine-in transactions.

In addition to the delivery capabilities through Olo, we have third-party master partnership agreements in place with Postmates, GrubHub, DoorDash and most recently UberEATS. These agreements enable individual restaurants to quickly and easily sign on for additional delivery options where available. While delivery options are currently available for over 47% of our domestic system, approximately 34% of the domestic system is actively engaged with one or more of these delivery service providers. We anticipate continued long-term growth in off-premise sales from the Denny's on-demand platform as more restaurants sign these individual delivery agreements. Our Heritage Remodel Program continues to perform well, consistently receiving favorable guest feedback and generating a mid-single-digit range of sales lift.

Franchisees completed 57 remodels. And we completed 1 company remodel during the third quarter. With 61% of the system currently on the Heritage image and an expectation of 75% of the system will have the new image by the end of 2018. Remodels will continue to be a significant tailwind for the brand over the next few years. We remain focused on progressively evolving our field training and coaching initiatives to not only serve our franchise system as a model franchisor, but also to better enable our operations team to achieve their goal of delivering higher-quality products with a more consistent service experience.

While we're encouraged by the substantial progress our team has made, we will continue to invest in our talent systems to further elevate the guest experience as opportunities remain in order to reach our full potential.

Turning to development. Our growth initiatives have led to over 480 new restaurant openings since 2009, representing approximately 28% of the current system and one of the highest totals of all full service brands. The ongoing revitalization of our brand and our expanding global footprint has attracted new interest for international expansion. We were delighted to recently announce our first ever development agreement for the United Kingdom, based on his experience, operating franchise locations for other leading global brands, we are confident, our new franchisee and his team are the right partners to introduce the Denny's experience for the first time to the United Kingdom and more broadly Europe. This agreement will bring 10 locations to the United Kingdom over the next several years, with the first expected to open in Wales towards the end of 2017.

Our current international footprint of 125 restaurants has grown by more than 60% since 2009 with our current pipeline of approximately 80 planned openings. We look forward to gaining further momentum beyond North America.

And as we look ahead, we remain committed to profitable system sales growth and market share gain 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've allocated over $344 million to share repurchases.

Our intent to return capital to shareholders through our ongoing buyback program was further supported by our recently announced credit facility refinancing a new share repurchase authorization, which Mark will cover in more detail.

In closing, we remain focused on continuing the transformation of the Denny's brand to grow around the world. Our brand revitalization, through which we're growing same-store sales, is still in the early stages. And with only 61% of the system the new Heritage image, we have great opportunity to benefit from this successful investment for years to come. Our expanding global footprint with growing interest from a number of franchisees supports an active future openings pipeline.

And finally, we remain committed to our 90% franchise business model and are growing our profitability with our blended royalty rate increasing towards 4.5%, allowing us to continue generating strong cash flows and to support our efforts in returning capital to our shareholders.

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. Our third quarter highlights include growing domestic systemwide same-store sales by 0.6% or adjusted EBITDA by 9.6% to $27.3 million and growing adjusted net income per share to 11.2% to $0.14 per share.

Initially we generated $12.6 million in adjusted free cash flow and allocated $29.7 million to share repurchases during the quarter.

We ended the quarter with 1,725 total restaurants as Denny's franchisees opened 8 restaurants and we opened 1 company restaurant. These openings were offset by 8 franchise restaurant closings. We also acquired 1 franchise restaurant in Texas.

Denny's total operating revenue, which includes company restaurant sales and franchise and licensing revenue, increased by 3.1% to $132.4 million, primarily due to higher company restaurant sales. Company restaurant sales grew by 5.1% to $97.9 million due to an increase in the number of company restaurants from the acquisition of franchise restaurants over the past 4 months and a 0.6% increase in same-store sales.

Company restaurant operating margin of 16.9% was impacted by anticipated rise in product costs, specifically commodities, along with minimum wages, partially offset by higher sales and lower workers' compensation expense. The reduction in workers' compensation expense was due to $1.3 million of favorable experience in the current year quarter compared to $300,000 of favorable experience in the prior year quarter.

On a year-to-date basis, reversals from favorable workers' compensation experience were $1.6 million compared to $1.9 million for the first 3 quarters of the prior year.

Moving to our franchise restaurants. Franchise and licensing revenue was $34.5 million, supported by a 0.6% growth in same-store sales and a higher average royalty rate, which were offset by a reduction in the number of equivalent franchise restaurants, a decrease in occupancy revenue due to scheduled lease terminations and lower initial fees from fewer restaurant openings compared to the prior year quarter. Franchise operating margin expanded by 160 basis points to 72.5%, due to higher royalty revenue and improved occupancy margin.

The scheduled lease terminations I just mentioned drove a reduction of both occupancy revenue and costs.

As we exit these leases, the contraction of this lower margin occupancy business has a positive effect on total franchise operating margin rate.

Total general and administrative expenses of $16.4 million improved 6.3% or $1.1 million as additional stock-based compensation was offset by a reduction of professional fees, lower incentive compensation and a market valuation change in our nonqualified deferred compensation plan liabilities.

As a reminder, a corresponding valuation adjustment to plan assets is reflected in other nonoperating income, and as a result, these deferred compensation plan valuation changes have no impact on net income.

Adjusted EBITDA grew 9.6% to $27.3 million compared to $24.9 million in the prior year quarter. Depreciation and amortization expense was $6 million compared to the $5.6 million in the prior year quarter, primarily due to the increase in reacquired franchise rights related to the acquisition of franchise restaurants during the current and prior year.

Operating gains and losses and other charges on a net basis totaling $600,000 included cost of $1 million associated with the implementation of our new ERP solution. We have recorded $4.7 million in software implementation costs year-to-date and expect to incur approximately $500,000 of additional costs during the fourth quarter to complete the implementation.

These implementation costs are onetime charges that will be replaced by annual software service fees of approximately $1 million recorded in general and administrative expenses. Interest expense was up $1 million to $4.1 million due to higher revolver balance and a greater number of capital leases compared to the prior year quarter. Provision for income taxes was $5.4 million, reflecting an effective income tax rate of 36.8%. Adjusted net income per share grew 11.2% to $0.14 per share compared to the $0.13 in the prior year quarter. Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $12.6 million compared to $3.7 million in the prior year quarter due to a lower capital expenditures partially offset by higher cash taxes and cash interest. Cash capital expenditures of $8.5 million include the acquisition of 1 franchise restaurant and construction costs associated with the opening of a new company restaurant and relocating a separate high-performing company restaurant. Cash capital expenditures also include general facilities maintenance and remodel costs at 1 company restaurant.

At the end of the quarter, we had $291 million of total debt outstanding, including $262 million under our revolving credit facility.

Now let me discuss the recent refinancing of our credit facility. On October 26, 2017, we entered into a new 5-year $400 million revolving credit facility, which includes an accordion feature that would allow us to increase the size of the revolver to $450 million. This new credit facility replaces our previous $325 million revolver. The interest rate under the new facility was initially set at LIBOR plus 200 basis points, which is consistent with the credit spread under our previous facility. Our interest rate swap contracts were not impacted by this refinancing and remain in effect. Taking into consideration our LIBOR interest rate swaps, the weighted average interest rate on the revolver loans as of the refinanced date was 3.2%, which is also consistent with the effective rate under our previous facility.

The refinancing is a reflection of the progress we've made in our brand revitalization strategy and demonstrates the confidence the financial community has in our strategic plan. Our quarter-end leverage ratio was 2.87x. And we're also increasing our targeted leverage range from 2x to 3x up to a new range of 2.5x to 3.5x as we intend to utilize the additional flexibility from the new credit facility to further support our strategy of returning capital to shareholders through our share repurchase program and to continue the accretive practice of selectively acquiring high-performing franchise restaurants. We also announced the approval of new multiyear share repurchase authorization to repurchase an additional $200 million of common stock, which is equivalent of nearly 25% of our market cap.

We currently have less than $8 million remaining under our existing $100 million authorization. Since beginning our share repurchase program in late 2010, we have allocated over $344 million to repurchase approximately 42 million shares and reduced our share count by approximately 34%. At the end of the quarter, basic shares outstanding totaled 65.7 million shares, which represented a reduction of 8.3 million shares or approximately 11% over the last 12 months.

Now let me take a few minutes to expand on the business outlook section of our earnings press release. Based on third 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.

Due to slower than anticipated openings year-to-date, we are revising our guidance for new restaurant openings to 40 to 45 openings while also adjusting our guidance for net restaurant growth to a range of 5 to 10 restaurants during 2017.

We are maintaining our current restaurant -- our current company restaurant operating margin guidance of 17% to 17.5%. And as a reminder, this range represents our second-highest company margin in well over a decade. We continue to expect our total general and administrative expenses to range between $67 million and $70 million, primarily due to lower incentive compensation.

We continue to expect our net interest expense to be between $14.5 million and $15 million. And we continue to expect cash taxes to range between $6 million and $8 million. Cash capital spending is now expected to be between $32 million and $34 million due to the acquisition of 1 franchise restaurant and real estate associated with the location of a high-performing company restaurant during the quarter, as well as additional acquisition of franchise restaurants anticipated to close during the fourth quarter.

We're committed to our strategy of selectively acquiring high-performing franchise restaurants that can be officially managed through our company operated field infrastructure and are accretive to earnings per share. During 2016 and through the first 3 quarters of 2017, we have invested over $19 million to acquire 17 franchise restaurants. We target a purchase price multiple of between 4.5x and 5.5x after excluding lost royalties. The average multiple we paid across all 17 restaurants during this period is well within our targeted range.

We are also committed to a 90% franchise, 10% company operated system. It is important to note that while we acquired 17 franchise restaurants during 2016 and through the first 3 quarters of 2017, we also sold 10 restaurants to franchisees during that same period of time.

As a result of these collective transactions, the company restaurant portfolio continues to represent 10% of the Denny's system at the end of the third quarter.

Our expectations for adjusted EBITDA remain between $101 million and $103 million. Our updated guidance for adjusted free cash flow is $48 million to $50 million due to the increase in capital expenditures 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 will take our first question today from William Slabaugh with Stephens.

This is actually Drew on for Will. I have got 2 quick ones if you don't mind. First, so just from a general industry perspective, we've heard from a number of peers along with industry data points there has been some improvement throughout the space, I guess, in the quarter-to-date period. So could you give us your updated thoughts on what you all are seeing quarter-to-date? And then how you're feeling as we go into the holiday season?

I think it's a great question. I think we'd be as true to form, typically cautious about commenting on the quarter. But I would say that our guidance sort of reps indicates the $200 million share authorization we have reaffirmed our guidance, and I think that should suggest that the consumers are in a good spot and we're confident about the year wrapping up inside the guidance.

Okay. That's helpful. And then just one quick housekeeping. What was the $2, $4, $6, $8 mix in the quarter?

14.8% up from 14.6% in the same quarter a year ago. I'm sorry, up from 14.4% same quarter a year ago.

And we'll now take our next question from Michael Gallo with CL King.

John, just a question. When we look at the menu construct and we think about delivery, we think about all of the various complexities that get brought in, obviously, when you see a number of your peers in the space rationalizing the menu in order to speed up service times and improve efficiencies. I was wondering if you can comment at all on how you think about the Denny's menus. Your ability to continue to manage these various complexities, particularly as delivery grows as a percentage? And whether you think at some point rationalization would be something you would look at as well?

John, that's a great question. I think we've been rationalizing the menu for certainly the entire time I have been here and that work would have started prior to my arrival. I think the year just prior to my arrival there was tremendous progress that was made in burger and shake categories. That's been further enhanced since I've been here over the past 6 years. The menu is not smaller than 6 years ago and we continue to think about the way we optimize the menu. Whether it be for to-go, whether it to be for delivery, whether it be for simplicity on the line, but also turf and how -- what customers want, what a multicultural consumer is looking for with our broad audiences and 4 dayparts that we serve. So while menus are simpler, they are more complex in other ways. With Breakfast All Day in a diner environment, we have a larger menu with lower frequency than QSR fast-casual. So parts of that need to also remain. So we are students of this and stare at this on a regular basis. We have said that -- I think since, not in this script this quarter, but we did talk about in last quarter of the number of improvements we've made over the last 3 years. So better than 50% of the menu has been touched in some way. So with every quarter that passes and certainly twice a year we've going to have our adds, deletes and rationalizations on a fairly regular basis.

Okay, great. And then just a follow-up question on delivery. I think you noted it's adding about a point to overall takeout mix. I was wondering if you could update us on sort of on average at what percentage of the stores had it the quarter and how you kind of see that building as you get delivery in more restaurants.

Sure, virtually 100% of the stores have to-go or online ordering, near 100%. And then delivery, we've said in the script just now 47% is eligible. They have one of our delivery contracts available in their local market and about 30% of the system has signed a contract accordingly. And about 34%, I believe -- that is 34% of the 47% -- 34% of the system, 47% eligible. So we expect more stores to sign contracts over time and we could get up to close to 50% of the system in the current footprint. And then over time that will also expand and then our franchisee sign up would expand as well.

And we will now go to Alton Stump with Longbow Research.

I guess just a question on the competitive environment of course there's lot of -- new slow still in the QSR category. The hamburger guys have done a very good job over the last 12 to 18 months to overcome that. Are you seeing anything different though in 3Q versus 2Q as far as the competitive landscape.

Well, between Q2 and Q3 competitive landscape?

Yes.

I think what you've seen is the same thing that's out there. You see a little bit more dealing in full service, casual in particular. And now that's bled over into QSR, preparing for the holidays. I think you've also seen a number of other announcements around on-demand type programs of software-related or digital-related platforms. And I think -- I guess the other big announcement is there has been a number, quite a few, anywhere from 300 to 1,000 depending on how you've done the numbers, announcements for closings between now and over the next 2 to 3 years. So I think I don't know that wasn't there in the second quarter, Alton. But I think in the third quarter those were the little bit more visible changes.

Excellent. Just a quick housekeeping thing. If I missed it, I'm sorry, but did you guys break out what the hurricane impact was on constant quarter?

About 0.1%, just positive. So it is basically immaterial.

Got it. And then if I just ask one last one and hop back in queue. But I guess, this is for Mark. You raised the debt EBIDTA guidance which as I recall wasn't too long ago, that you raised it, I guess, 18 to 24 months ago here. I mean is there a reason why that couldn't continue to creep higher in coming years given obviously what's a very stable business high-franchise model, I mean, is it out there, to think it could be 3.5 to 4 or is it kind of too early at this point to think about that?

Alton, thanks for the question. So I will answer the latter part of the question first. It's obviously too early to indicate anything beyond that. Obviously we -- you know the history of the brand, the history of the leverage. We certainly were very pleased with this latest refinancing and the tremendous support we had from the financial community. For us moving to that 2.5 to 3.5 range is significant when you think about our deleveraging process that we went through for years and years. But we're certainly encouraged by that and obviously that combined with the large share authorization, the $200 million that John and I both mentioned, I think, are both really good signs and we're going to put obviously some of that leverage to work on that nature.

(Operator Instructions) It appears there are no other questions. So I'd like to turn the call back to Curt Nichols for any additional or closing remarks.

Thank you, Vickie. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in February where we will discuss our fourth quarter 2017 results. Thank you, have a great evening.

Thank you very much and that does conclude our conference for today. I would like to thank everyone for your participation and you may now disconnect.