Denny's Corp (DENN) 2017 Q4 法說會逐字稿

Good day, and welcome to the Denny's Corporation Fourth 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, Gwen, and good afternoon, everyone. Thank you for joining us for Denny's Fourth Quarter and Full Year 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 fourth quarter earnings press release along with any reconciliation of net -- excuse me, of non-GAAP financial measures mentioned on the 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 fourth quarter results, along with brief commentary on our annual guidance for 2018. 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 turn the call over to John Miller, Denny's President and Chief Executive Officer.

Well, thank you, Curt, and good afternoon, everyone. Denny's achieved positive systemwide same-store sales growth for the seventh consecutive year and once again, demonstrated relative strength against key industry benchmarks. This reflects the momentum generated by our revitalization strategies. And I'm proud of the efforts of our team to consistently execute these revitalization strategies, which support our commitment to achieving our vision of being the world's largest, most-admired and beloved family of local restaurants. With that said, we accomplished these positive sales results during what proved to be another choppy year for the restaurant industry.

The continued gap between grocery and restaurant pricing, federal income tax refund delays, holiday shifts, hurricanes and lackluster traffic are a few of the reasons often cited as contributing to the challenges in this full-service dining category. However, we continue to execute against our 4 strategic pillars to achieve our vision and overcome these challenges. These pillars include: first, delivering a differentiated and relevant brand in order to achieve consistent same-store sales growth; second, consistently operating great restaurants with a primary goal of being in the upper quartile of satisfaction scores for all full-service brands; third, growing our global franchise by expanding Denny's geographical reach throughout the U.S. and international markets; and fourth, driving profitable growth with a disciplined focus on cost and capital allocation for the benefit of our franchisees, employees and shareholders.

We also continue to evolve our menu to meet guest expectations for better, more craveable products. Our latest LTO menu builds on the success of our recent buttermilk pancake relaunch by introducing premium craft pancakes. We also -- we are also featuring fresh ingredients and bold flavors in 3 sizzling skillet dinners, like the Crazy Spicy Skillet and the Smoky Gouda Chicken & Broccoli Skillet. We are making good progress addressing guest expectations for greater convenience through our new Denny's on Demand platform, which offers web and mobile ordering and payment options for pickups or delivery. And while still in the early age -- early stages of executing on this new platform, we are encouraged by an increase in off-premise sales of 2 percentage points. In December of 2016, off-premise sales represented 6.6% of total sales, but grew 210 basis points to 8.7% of total sales in December of 2017. Holidays continue to be exceptionally strong business days for off-premise sales, and Christmas Day set a new record at 12.8% of total sales. These to-go transactions continue to be highly incremental. They overindex at late-night and dinner dayparts and skew towards the younger 18- to 34-year-old demographic.

In terms of product mix, pancake plates, burgers, milkshakes and Build Your Own entrees options continue to overindex for to-go transactions compared to the dine-in transactions. And approximately 50% of the domestic system is actively engaged with one or more delivery service option, and we continue to add master partnership agreements with third-party delivery providers where available. These master partnership agreements enable individual restaurants to quickly and easily sign on for additional delivery options. 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 or add a second delivery option in their locations.

In January, we featured a commercial promoting both value and the Denny's on Demand platform by offering a free Build Your Own Grand Slam after your next online order. And our Heritage remodel program continues to perform well, consistently receiving favorable guest feedback and generating a mid-single-digit range sales lift.

During 2017, franchisees completed 247 remodels, and we completed 3 company remodels. With approximately 67% of the system currently on Heritage -- the Heritage image, we believe we are just crossing into the middle stages of our revitalization with many brand-enhancing strategies remaining and an expectation that approximately 80% of the system will have the new image by the end of 2018. We believe remodels will continue to be a significant tailwind toward our brand revitalization 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 teams to achieve their goal of delivering higher-quality products with a more consistent service experience.

While we are encouraged by the substantial progress our team has made, we believe opportunities remain in order to reach our full potential. And accordingly, we will continue to invest in our talent and systems to further elevate the guest experience.

Turning to development. Our growth initiatives have led to nearly 500 new restaurant openings since 2009, representing over 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 continue to attract new interest for international expansion. In 2017, we opened 7 new international restaurants, including 3 additional openings in the Philippines, and our first Denny's restaurant in both Guatemala and the United Kingdom, which was also our first in Europe. We have opened more than 60 international locations in 9 new countries since 2009, leading to a current international footprint of 128 restaurants. And with our current pipeline of approximately 80 planned international openings, we look forward to gaining further momentum beyond North America.

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 buyback. Since the beginning our share repurchase program in late 2010, we have allocated approximately $356 million to share repurchases. Our intent to return capital to shareholders through our ongoing buyback program was further supported by our credit facility, refinancing a new share repurchase authorization announced in October, in addition to the favorable impact of the recent tax reform, which Mark will cover in more detail.

So in closing, we remain focused on continuing the transformation of the Denny's brand to grow around the world. With 2/3 of the system on the new Heritage image, our brand revitalization, through which we are growing same-store sales, is just entering the middle stages. We have continued progress with remodels, coupled with our brand-enhancing strategies is expected to yield benefits for years to come. And our expanding global footprint with growing interest from a number of franchisees supports an active pipeline for future openings.

Finally, we remain committed to our 90% franchise business model and are growing our profitability with our blended royalty rate increasing towards 4.5% and 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 fourth quarter highlights include growing domestic systemwide same-store sales by 2.2%, adjusted EBITDA by 7.6% to $27.8 million, and adjusted net income per share by 5.9% to $0.18 per share while generating $15.3 million of adjusted free cash flow. We ended the quarter with 1,735 total restaurants as Denny's franchisees opened 13 restaurants, and we opened 1 company restaurant. These openings were offset by 4 franchise restaurant closings.

In addition, we acquired 3 franchise restaurants. Denny's total operating revenue, which includes company restaurant sales and franchise and license revenue increased by 4.5% to $135.5 million, primarily due to higher company restaurant sales and franchise royalties. Franchise and license revenue grew 0.5% to $35.2 million, primarily due to 2.2% growth in same-store sales, a higher average royalty rate and higher initial fees compared to the prior year quarter, partially offset by lower occupancy revenue. Franchise operating margin of 72.1% was flat to prior year as growth in royalty revenue and initial fees was offset by an increase in other direct costs and a reduction in occupancy margin. The increase in other direct costs was associated with enhanced support from new restaurant openings and nontraditional locations.

Moving to our company restaurants. Sales grew by 6% to $100.3 million due to an increase in the number of company restaurants over the past 12 months and a 2.1% growth in same-store sales. Company restaurant operating margin of 16.4% was impacted by an expected rise in product costs and minimum wages, partially offset by higher sales and lower workers' compensation expense.

The reduction of workers' compensation expense was due to approximately $600,000 in favorable experience in the current year quarter compared to approximately $600,000 of unfavorable experience in the prior year quarter. On a full-year basis, reversals from favorable workers' compensation experience was $2.2 million compared to $1.4 million in the prior year.

Total general and administrative expenses of $15.9 million decreased by 8%, or $1.4 million, primarily due to a reduction in professional fees and lower incentive compensation. Adjusted EBITDA improved by $2 million or 7.6% to $27.8 million. Depreciation and amortization expense was $300,000 higher at $6.2 million, primarily due to the acquisition of franchise restaurants during the current year.

Operating gains, losses and other charges on a net basis improved by $1.7 million to $900,000, primarily due to a reduction in both impairment charges and restructuring and exit costs compared to the prior year quarter.

Interest expense was up by $1 million to $4.3 million, primarily due to a higher revolver balance and an approximate 50 basis point increase in our weighted average interest rate on outstanding revolver loans and a greater number of capital leases compared to the prior year quarter. The provision for income taxes was $2.1 million reflecting an effective income tax rate of 13.8%.

The enactment of the Tax Cuts and Jobs Act of 2017 during the fourth quarter required us to revalue our deferred tax assets and liability -- liabilities using the 21% federal statutory income tax rate. As a result, we recorded a onetime noncash benefit of $1.6 million to provision for income taxes. Excluding this tax reform impact and a $1.8 million benefit associated with the settlement of stock-based compensation, the effective income tax rate for the fourth quarter would have been approximately 35.6%.

Adjusted net income per share grew 5.9% to $0.18 per share compared to $0.17 per share in the prior year quarter. Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $15.3 million compared to $14.4 million in the prior year quarter, primarily due to higher adjusted EBITDA and lower cash taxes, partially offset by increased capital expenditures and cash interest. Cash capital expenditures of $7.6 million included the acquisition of 3 franchise restaurants and the remodel of 2 of our company restaurants.

Our quarter-end leverage ratio was 2.79x. At the end of the quarter, we had $289 million of total debt outstanding, including $259 million under our revolving credit facility. During the quarter, we allocated over $16 million towards share repurchases. At the end of the year, basic shares outstanding totaled 64.6 million shares compared to 71.4 million shares at the end of the prior year, for a total reduction of 6.8 million shares.

Since the beginning of our share repurchase program in late 2010, we have allocated approximately $356 million to repurchase more than 43 million shares and reduced our share count by over 43%. We ended the quarter with approximately $196 million remaining in our share repurchase authorization.

Now let me take a few minutes to review the business outlook section of our earnings release. For fiscal year 2018, we anticipate same-store sales growth at company restaurants and domestic franchise restaurants to range from flat to positive 2%. We expect to open between 40 and 50 new restaurants globally, with approximately flat net restaurant growth.

Due to changes in revenue recognition standards, which became effective in January, we will begin separating advertising proceeds received from franchise restaurants from the related expenditures. These items were previously netted together in our income statement, will appear as separate components of both our franchise and license revenue and cost of franchise and license revenue.

Further, we will begin recognizing initial franchise fees ratably over the franchise agreement term compared to the previous practice of recognizing that revenue at the beginning of the term. Upon adoption, we expect to record deferred revenue of approximately $21 million related to previously recognized initial franchise fees, which will be amortized over the remaining term of the related franchise agreements. While these revenue recognition changes are not expected to have a material impact on franchise margin dollars, adjusted EBITDA or adjusted free cash flow, they will impact our guidance for total operating revenue, franchise and license revenue, and franchise operating margin rate.

We currently expect total operating revenue of $634 million to $642 million, including franchise and license revenue of $222 million to $225 million. Had we applied the revenue recognition changes to our fiscal 2017 results, we would have reported total operating revenue of approximately $612.7 million, and franchise and license revenue of approximately $222.3 million.

Moving further on, our company restaurant margin expectation is between 16.0% and 16.5%. Our franchise operating margin estimate is between 46.0% and 46.5%. By comparison, we would have reported franchise operating margin of approximately 44.9% for fiscal 2017 had we applied the new revenue recognition standards.

General and administrative expenses are anticipated to range from $71 million to $73 million and include higher assumed incentive compensation and investments in our training and technology functions to further support our brand revitalization strategies.

Our effective income tax rate is expected to be between 22% and 24% with cash taxes that are between $4 million and $6 million.

Adjusted EBIDTA is estimated to between $105 million to $107 million. Cash capital expenditures are expected to range from $33 million to $35 million. This range encompasses approximately $10 million to $11 million of growth capital, including the acquisition of 5 high-volume franchise restaurants in Texas last month, in addition to a planned company restaurant opening later in the year. This range also includes approximately $7 million to $8 million associated with remodels from recent franchise restaurant acquisitions and restaurant offsets. The balance of this CapEx range relates to ongoing maintenance capital.

Adjusted free cash flow is anticipated to be between $48 million and $50 million. We will continue to allocate capital towards investments in our brand and company restaurants, while also returning capital to our shareholders through our ongoing share repurchase program.

That wraps up our guidance commentary. I'd now like to 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.

Wanted to ask on the same-store sales guide of 0% to 2% for '18, should we think about that as a typical goalpost you're sitting out there for the year? Or is there any sort of additional competitive pressure that you're either expecting or maybe already seeing out there as the year has begun?

That's a great question, Will. I think for us, if you look over the history and then forward-looking guide a year at a time, I think this 0% to 2% range is consistent with the narrative of just where the industry's been, where full service has been. Denny's, on the bright side of guidance is that we continue to outperform our peers. And that sort of grew in our separation throughout '17 finishing sort of fourth quarter stronger than first quarter in terms of outperforming family dining peers or other casual peers. So the performance of our brand in the competitive set continues to be solid. But at the same time, there's challenges with -- there's traffic challenges in the category. And so we just want to make sure that we're guiding according to what we expect to deliver.

Understood. And traditionally, we haven't seen quick service impact you guys in any significant way. I'm curious, with the recent aggressiveness of -- around price points within quick service, if you've seen any impact there or planning anything to combat if that pressure does show up?

Right. The -- of course, we always try to prepare our marketing calendar with a great deal of planning and flexibility. We like the fact that we have value levers we can pull and/or guide guests toward value-oriented quality investments we've made in the brand. Our consumers have self-selected toward check builders rather than value. You see our $2 $4 $6 $8 continues to hold in that mid-teen area rather than just seem to have a lot of pressure. And that's in spite of the fact that there's All You Can Eat Pancake promotions, Everyday Value Slams being offered. So the response to our category seems to be counter to the value trend that's drawing the attention of the QSRs. So it's hard to know. Yet, traffic is under pressure. So what I think, Will, is that there's -- there -- all of these categories, in a mature industry, have some impact. We still continue to believe, anecdotally, it's groceries in the home that's got the greater impact. And there's different ways you can point to evidence of that, that are sort of hard to articulate in a short answer. But the Denny's on Demand is one strong indication. I think, you see little midyear launch, and even though we put some advertising behind it, this is not an overweight, long-term equity builder for the brand in terms of advertising investment. Nevertheless, just by customer demand, it's grown a little over 200 basis points since the finish of 2016. So we think that there are pressures other than just value or QSR drive-through pressures that are impacting the industry.

Got it.. And one more question on margins, if I could -- or on the guidance rather. So if you look at the store level margin guide of 16% to 17% for fiscal '18, it's a fairly wide range. So outside of comps, I was curious what the other variables might be to take that to the high or low end of that range?

Let me just -- I just want to confirm, obviously, our guidance range.

I think, the guidance was 16% to 16.5%.

I just wanted -- sorry about that.

Yes. So just along those lines, I guess what we're seeing, well, obviously, is you've got -- so let me step back a second. So from a company restaurant standpoint, just as a reminder, about 35% of our company-operated restaurants are in California. So that's about 65 stores we have in California. And obviously, California has taken another $0.50 per hour wage increase on minimum wage. So that moved from $10.50 to $11 on January 1. Additionally, there is -- you've got wage inflation coming from, I'll say, the state wage out there. So that's going to impact, obviously, cost of labor. And then, we got some carryover from labor inflation that occurred sort of late in the year in certain jurisdictions in California. So we're -- we think probably what we're seeing there, again, within that comp range of 0% to 2%, there's probably call it 50, 60 basis points of inflation that's going to basically run through the labor line. So that's the first comment. On the commodity side, which I haven't had a question on, so I'll just go ahead and speak to that. Commodity inflation, we're seeing probably 1.5% to 2.5% inflation in commodity. That's what we're viewing for '18 at this point in time. To put that in perspective, that number was just slightly above 2% in 2017 and of course, '16 was the highly deflationary year. So when you put it all together, we're sort of in that 16% range for fiscal '18 for the company restaurant operating margin. And hopefully, that gives you sort of a feel for how inflation is rolling through the P&L.

We'll go next to Michael Gallo with CL King.

Just a couple quick questions. Mark, I think the guidance on franchise restaurant margin on a pro forma basis implies some meaningful step-up in the percentage. I know you've had the royalty rate that's escalating as some old contracts roll-off. Is there a larger number that rolled off -- rolls off in '18? Or is there something else going on in terms of that line item?

Well -- yes, Mike, there's a couple of things rolling through that. Just sort of to set the stage, because I know there's a lot of numbers moving around because of the rev rec change. But, again, if you go back and look at fiscal '17, and you would apply the new rev rec rules, that franchise margin was, call it, around 45%. I think, it was 44.9%. And we're guiding in that 46% to 46.5%. So we're up, call it, somewhere between 110 to 160 basis points or 100 to 150 basis points. Part of that is the fact that we continue to see -- to your point, we continue to see franchise stores roll on to this 4.5% royalty rate. And so at the end of '17 -- let me put it this way, at the end of '16, we had about 600 franchise stores at the 4.5% rate. At the end of '17, so the fiscal year we just ended, that was up about 100 stores. Call it around 700 with the 4.5%. And we anticipate there'll be another 50 to 75 that will probably roll into the 4.5% during fiscal '18. So that is definitely rolling through the P&L. That's, obviously, benefiting margins. And then there is the other piece, if you recall, with that 4.5% royalty change, there was a certain portion of it that we contributed back to the brand-building fund and that all -- that does go away at the end of '17. So there's a little bit of extra benefit there. The other way to put it would be a lower franchise P&L expense that has been rolling through up to fiscal '17. So, hopefully, I haven't completely confused you. But bottom line is we're up somewhere between 110 and 160 basis points in our franchise operating margin based on guidance for '18.

Okay. I think that makes sense. A question for John. Obviously, tax reform is sort of 3-pronged. Your own tax rate, which, obviously, is dropping. But then also the significant potential benefit to your franchisees, who I would think a lot of them are pass-through entities. Can you talk to, one, what you're seeing in terms of franchisee's willingness to invest and/or (inaudible) remodels or accelerating remodels, particularly given the depreciation benefit and/or new stores?

Sure. I was waiting for the other 2 prongs. That's the -- so let me just...

No -- I mean, yes, the next part was on the consumer side as well, if you've seen any change in behavior as a result.

Yes, why don't we do the consumer first. I think it's a little too early to tell. Will alluded a moment ago to a lot of noise in value or discounting going on among QSR and then casual with a number of 2 for $20 or different kinds of stimulus out there. So I'd say the market is noisy enough not to really know. So you've got a strong economy, a reasonably full -- near-full employment, normally with a high correlation to eating out and yet this value environment that persists. So it's -- there's, I think, explanations for all those. When somebody starts, there's a chain reaction and when you can kind of work yourself out of it. But I think that those -- because of all that noise, it's hard to say where the consumer is, whether or not they are feeling a bigger paycheck and changing their dine-out habits, whether it'd be the selection of brands or categories, QSR, fast-casual, family or casual. And whether the -- or in other words, are they being driven by a strong stimulus or are they being driven by a fatter check. It's just really too early to know. I do believe that longer term, just pure conjecture, is that overall this plays a role in more capital investment and growth in general. And whether or not that plays through more mature industries of restaurant, retail or big boxes is yet to be seen. But overall for our economy, it has to be good news for dining out, ultimately. It's a bit too early to know. On our franchise system, we've said for some time and throughout this Heritage remodel program, we run these things in 7-year cycles. So we're going to be, what, pushing toward the 80% mark with this remodel scheme. And so we think that it's late enough in this scheme, this 7-year cycle, that you wouldn't see at this point people moving ahead of their due dates. It's much more likely that this money would be allocated differently. So will this be applied toward kitchen investments or new builds or accelerated development, those are great questions. And I think, once again, it's too early to know, but as we work with our franchise community throughout the year, we, too, have a great deal of interest in answering those questions for you.

Okay, great. And then just a clarification from what Mark has said. I think he said 16% to 16.5% restaurant operating profit margin. I thought the guidance was 16% to 17%. So if you can just clarify.

Sorry, Mike. That's right. I misspoke. It's 16% to 17%. Sorry. That's correct.

(Operator Instructions) We'll go next to Nick Setyan with Wedbush Securities.

Your G&A actually came in below guidance for, I think, it was $67 million to $70 million for 2017. And I guess the 2018 G&A guidance calls for a step-up we haven't seen in a while. So I guess maybe just kind of give us some color on what some of those step-up -- what some of that step-up entails?

Sure, Nick. I'd be happy to. It's Mark. Yes, so let me -- I'll just go back and do a little bit of history here just to sort of set the stage. So 2016 actual G&A was around $68 million. 2017 came in around $66.5 million -- $66.4 million. And right now, our guidance for '18 is the $71 million to $73 million. And so we're looking at the components, I mean, I think, as I mentioned in my script, it's really -- the change or the increase is really driven by the change -- sort of reloading our incentive accruals. And I think, as we've spoken to in the past, the incentive accruals and cash incentive, this will be our annual incentive accruals, can move around back and forth based on performance. And this particular year, '17, we reduced those accruals as the year came together, in '18, we're taking them back up, basically, a full accrual. So that's the primary driver. The rest of it is really a bit of investment and training and technology function. So again focused on some headcount additions in both our training function, again driving the (inaudible) revitalization and then on the technology side. But that's a piece of it. But I would say the larger piece is the incentive accrual.

Yes. Just to clarify, on the press release guidance is $72 million to $74 million. So is it $71 million to $73 million or $72 million to $74 million?

$72 million to $74 million. Sorry.

Okay. And then in terms of just the moving parts on the top line. Could you guys just kind of break out what the advertising dollars are there? I'm sure we can back into it, but that would just help.

The rev rec change?

Yes.

In total? It's probably in the range of about $80 million of advertising that sort of goes in and out.

Okay. And then just last clarification. In terms of the price and mix and guest counts for the quarter?

On the fourth quarter alone?

Yes.

Yes, fourth quarter mix was slightly positive 0.25 point or so on the quarter and traffic slightly negative.

And that concludes our question-and-answer session. I'd like to turn things back to our speakers for any closing remarks.

Thank you, Gwen. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in early May to discuss our first quarter 2018 results. Thank you, and have a great evening.

Thank you, everyone. That does conclude today's conference. We thank you for your participation. You may now disconnect.