Denny's Corp (DENN) 2018 Q2 法說會逐字稿

Good day, and welcome to the Denny's Corporation Second Quarter 2018 Earnings Call. Today's conference is being recorded. 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, Carina. Good afternoon, everyone. Thank you for joining us for Denny's Second Quarter 2018 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 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 second quarter results, along with brief commentary on our annual guidance for 2018. 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 27, 2017, and in any subsequent quarterly reports on Form 10-Q.

With that, I will turn the call over now to John Miller, Denny's President and Chief Executive Officer.

Thank you, Curt, and good afternoon, everyone. Our revenue growth, coupled with a disciplined focus on cost, resulted in strong cash flow generation and growth in adjusted net income per share. The consistency of our highly franchised business model, coupled with the momentum generated by our revitalization strategies, contributed to the relative strength of our results, and we are reiterating our annual guidance for company and domestic franchised restaurant same-store sales growth, adjusted EBITDA and adjusted free cash flow.

We delivered total operating revenue growth as we navigated through a challenging, value-focused, competitive environment while also rolling over our strongest sales quarter last year. Second quarter domestic system-wide same-store sales declined 0.7%, impacted by negative holiday and marketing shifts in light of the highly competitive value-focused environment, although our 2-year same-store sales improved sequentially to positive 1.9%.

The Easter spring break shift at the beginning of the quarter weighed on same-store sales by an estimated 60 basis points. Adjusting for this impact, our domestic same-store sales would have been nearly flat for the quarter.

To address some of the competitive value concerns, we launched a new limited time $5.99 value offer called the Super Slam. The guest response has been very positive with the Super Slam, garnering an incident rate of over 10% and contributing to a sequential improvement in same-store sales trends as we moved through the second quarter. We have been pleased to see the positive guest response to this product and media messaging continue into July.

I'm also proud of our team's execution against our 4 strategic pillars which support our vision of being the world's largest, most admired and beloved family of local restaurants. These pillars include: first, delivering a differentiated and relevant brand experience in order to achieve consistent same-store sales growth; second, consistently operating great restaurants with the primary goal of being in the upper quartile of satisfaction scores for a full-service brand; third, growing our global franchise by expanding Denny's geographic reach throughout the U.S. and international markets; and fourth, growing -- driving profitable growth with a disciplined focus on cost and capital allocation for the benefit of our franchisees, employees and shareholders.

We continue to evolve our menu to meet guest expectations for higher-quality and more craveable products. Our latest LTO menu features our hand-pressed 100% beef burgers, including a Bacon Avocado Burger, a Spicy Sriracha Burger and a classic burger starting at $6.99. We've also enhanced our premium craft pancake lineup to include a mouthwatering selection of new pancake breakfast items.

Our Denny's on Demand platform continues to resonate with guests who are seeking the convenience of online ordering and payment options for pickup or delivery. Off-premise sales represented over 10% of total sales at company restaurants during the second quarter of 2018 and about 9.5% of franchised restaurants.

Since launching Denny's on Demand last year, off-premise sales have grown over 300 basis points as a percentage of total sales, and delivery continues to drive the expansion in our off-premise business. And we have observed a steady progression of company and franchise stores, adding delivery channels over the last couple of quarters.

Approximately 60% of the domestic system is now actively engaged with at least one delivery partner. And these to-go transactions continue to be highly incremental, overindexed to the late-night and dinner dayparts and skewed toward the younger 18- to 34-year-old demographic.

While the additional delivery fee, the total margin -- with additional delivery fee, the total margin rate on third-party delivery transactions ranged from the low teens to upper 20%. We anticipate continued long-term growth in the off-premise sales from the Denny's on Demand platform as more restaurants expand their delivery channels.

Our Heritage remodel program continues to perform well, consistently receiving favorable guest feedback and generating a mid-single-digit sales lift. During the second quarter, franchisees completed 48 remodels, and we completed 3 company remodels, resulting in approximately 74% of the system currently featuring the new Heritage image. With many brand-enhancing strategies remaining and an expectation that approximately 80% of the systems will have the new image by the end of 2018, these remodels will continue to be a significant tailwind for 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 that our team has made, we believe opportunities remain in order to reach our full potential. Accordingly, we continue to invest in our talent and systems to further elevate the guest experience.

Turning to development, our growth initiatives have led to over 500 new restaurant openings since 2009, representing approximately 30% of the current system and one of the highest totals of all full-service brands. Franchisees opened 7 domestic restaurants in the second quarter. An additional international restaurant opening in Canada contributed to our current international footprint of 128 restaurants.

As we look ahead, we remain committed to profitable system sales growth and market share gains, 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 over $384 million to share repurchases.

In closing, we remain committed to expanding our global footprint through the ongoing revitalization of the Denny's brand. Our brand-enhancing strategies like the Denny's on Demand platform should yield incremental benefits for years to come. We believe our ongoing initiatives to enhance our food, service and atmosphere will continue to generate profitable sales growth.

Our expanding global footprint reflects growing interest from a number of franchisees, and we remain committed to our highly franchised business model. These collective efforts are allowing us to grow our profitability, generate strong cash flows and 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.

Thank you, John, and good afternoon, everyone.

Our second quarter highlights include growing adjusted EBITDA by 0.2% to $27.2 million and adjusted net income per share by 28.2% to $0.18 a share, while generating $13.7 million of adjusted free cash flow.

We ended the quarter with the 1,720 total restaurants as Denny's franchisees opened 8 restaurants. These openings were offset by 9 franchised restaurant closings and 3 company restaurant closings. In addition, we acquired one franchised restaurant.

As a reminder, our 2018 financial results include the impacts of adopting new revenue recognition standards in accordance with Topic 606, which clarifies the principles used to recognize revenue. A more detailed explanation of these revenue recognition changes can be found in our second-quarter 2018 earnings release and on our quarterly report on Form 10-Q. Because we adopted these new standards on a modified retrospective basis, prior year quarterly results were not adjusted and continue to be reported in accordance with our historical accounting.

Denny's total operating revenue, which includes company restaurant sales and franchise and license revenue, grew 18% to $157.3 million, primarily due to recognizing franchise advertising revenue on a gross basis in accordance with Topic 606, and an increase in company restaurant sales.

Franchise and license revenue grew 55.9% to $54.6 million, primarily due to recognizing $19.5 million of advertising revenue in accordance with Topic 606 and an increase in initial fees that benefited from revenue recognition changes, partially offset by lower occupancy revenue due to scheduled lease terminations.

Franchise operating margin was 46.8% compared to 70.7% in the prior year quarter, primarily due to recorded advertising revenue and related costs on a gross basis. Absent revenue recognition changes, franchise operating margin would have been 74.7%, which represents an improvement of approximately 400 basis points over the prior year quarter.

Additionally, an increase in initial fees and an improving occupancy margin were partially offset by an increase in other direct costs. The increase in other direct costs was associated with the gross-up of other franchise service fees and related expenses in accordance with Topic 606.

Moving to our company restaurants, sales grew by 4.5% to $102.7 million due to an increase in the number of company restaurants over the past 12 months. Company restaurant operating margin of 15.7% was impacted by increases in minimum wages and third-party delivery costs, partially offset by higher sales. We are encouraged by the 150 basis point improvement in company restaurant operating margin from our first quarter results driven by pricing in the range of 1% to 1.5% at the start of the quarter, a modest easing of commodity inflation and generally good controls around the other cost lines.

Total general and administrative expenses of $15.6 million improved by 5.9% or approximately $1 million, primarily due to a reduction in share-based compensation and market valuation changes in our deferred compensation plan and liabilities.

Adjusted EBITDA improved by $100,000 or $0.1 million or 0.2% to $27.2 million. Depreciation and amortization expense was approximately $900,000 higher at $6.7 million, primarily due to the acquisition of franchised restaurants during the past year.

Operating gains, losses and other charges on a net basis improved by $1.6 million to approximately $500,000, primarily due to software implementation costs in the prior year quarter. Interest expense rose by $1.6 million to $5.4 million, primarily due to increases in the balance of our credit facility and related interest rates. The provision for income taxes was $2.6 million, reflecting an effective income tax rate of 18.1%, driven by the new 21% federal statutory income tax rate and a $700,000 benefit associated with the settlement of share-based compensation.

Adjusted net income per share grew by 28.2% to $0.18 per share compared to $0.14 per share in the prior year quarter. Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $13.7 million compared to $13.1 million in the prior year quarter, primarily due to decreases in cash taxes and cash capital expenditures, partially offset by the increase in cash interest.

Cash capital expenditures of $7.4 million included approximately $2 million invested to acquire real estate and one franchised restaurant. This compares with $3.1 million used to acquire 3 franchised restaurants in the prior year quarter.

Our quarter end debt-to-adjusted EBITDA leverage ratio was 2.98x. And at the end of the quarter, we had $313 million of total debt outstanding, including $282 million under our revolving credit facility.

During the quarter, we allocated $12.7 million towards share repurchases. And at the end of the quarter, basic shares outstanding totaled 63.5 million shares, which represents a reduction of 4.7 million shares or approximately 7% from 1 year ago.

Since beginning our share repurchase program in late 2010, we've allocated approximately $384 million to repurchase more than 45 million shares at an average price of $8.54 per share, leading to a 36% net reduction in our share count. We ended the quarter with approximately $167 million remaining in our share repurchase authorization.

Now let me take a few minutes to expand on the business outlook section of our earnings release. We are reaffirming our annual guidance for several key financial metrics, including company and domestic franchise same-store sales growth of 0 to 2%, adjusted EBITDA expectations in the range of $105 million to $107 million and adjusted free cash flow of $48 million to $50 million.

This includes revising expected new restaurant openings to between 35 and 45 restaurants from our previous guidance of 40 to 50 new restaurants, with an expected net restaurant reduction of 5 to 10 restaurants compared with our previous expectations of approximately flat net restaurant growth.

With these updated expectations for unit count changes, we are also revising our guidance for total operating revenue to between $626 million and $634 million from our previous guidance of between $634 million and $642 million. We are also revising our expectation for franchise and license revenue to between $216 million and $219 million from our previous guidance of between $222 million and $225 million. We are raising our guidance for franchise operating margin to between 47% and 48% compared with our previous guidance of 46% to 47% based on the year-to-date results.

Consistent with our past practice, we continually take a close look at our G&A costs and are committed to pursuing cost savings opportunities while also investing in our technology and training support teams to further elevate the guest experience. Accordingly, we are revising our expectations for general and administrative expenses to range from $67 million to $69 million from our previous guidance of between $68 million and $70 million. This change primarily reflects anticipated reductions in incentive compensation, professional fees and other discretionary expenses.

With the increase in the balance of our credit facility and related interest rates, we are adjusting our guidance for net interest expense to between $19.5 million and $20.5 million from our previous range of $18.5 million to $19.5 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 will now turn the call over to the operator to begin the Q&A portion of our call. Operator?

(Operator Instructions) We'll take our first question from Nick Setyan with Wedbush Securities.

Appreciate the commentary about the sequential improvement in the comp. But any way to be able to quantify the banks with that improvement?

Yes, a little commentary, Nick. Thanks for the question. We -- yes, our media calendar at the start of the quarter was out of cycle with where the rest of the industry was, as you might have noted by now. And what we were building, working on longer term, image -- brand image equities, and the rest of the industry was really doing casual, in particular, was focused on value messaging. So by the -- by June, we did, of course, correction. We launched the $5.99 Super Slam, and we were negative in both April and May and slightly positive in June; as we mentioned in the transcript a moment ago, that continued into July.

Perfect. And then in terms of the 1 to 1.5-some incremental pricing at the beginning of the quarter, what does that -- where does that take total pricing currently? And what was mix in the quarter?

Yes. Mix was a little softer in the quarter, down about 1 point. I think we had about 1.5 points of pricing that we added during the quarter, and there was some carryover pricing, so in that 2 to 3 range.

Got it, that's helpful. And then just kind of turning on the margin side, I guess, relative to your expectations going into the quarter, what changed on the franchise margin side that allowed you to increase the margin guidance while lowering the license and franchise revenue number?

Yes, Nick. It's Mark. It's really -- I mean, as far as the franchise margin piece, it continues to be, I think, a theme that's probably come out the last several quarters. It's really a combination of -- we continue to see the changes with the franchise royalty rate. And so clearly, that has continued to enhance the margins on the franchise side.

Right now, probably in the quarter the average royalty rate picked up again; we're probably about 4.17% or 4.18%. So that was up just a bit from the prior quarter. I think prior quarter was 4.15%. Also at the end of the quarter, the second quarter of 2018, we had close to 750 domestic locations on the 4.5% royalty. So that continues to trickle up. And again, that's one piece.

I think the other piece that we've talked about and probably didn't place as much emphasis on it this time around, but this occupancy margin piece that comes through, which, again is -- we're on the primary lease with the landlord, and we're subleasing those properties onto franchisees. Many of those locations are not high margins on a percentage basis. It's pretty much an in and out, almost a pass-through. And obviously, as those leases fall off of our books and the franchisee either goes directly to the landlord and store closes; obviously, we're losing what I would term to be low-margin business and then also enhances the franchise margin as well.

(Operator Instructions) We'll hear next from Will Slabaugh with Stephens Inc.

You mentioned in the release the heightened competitive activity around value in the quarter. Can you talk about that a little bit more, where you saw this coming from in particular, either that's in full service or quick service or both and maybe where the majority of that impact came from?

Well, it's hard to speak to the impact with precision and without conjecture. But it was across the board from I think the $1 quarter pounder Wendy's, persisted 2 for $5 McDonald's as evident in the quarter. Throughout casual, there are lot of 2 for $20 deals, some including steak. And then late in the quarter, there were bundled meals or buy dinner and then get your take-home dinner free with some casual competitors. So there is considerable activity. And we had, again, no food on air during April or May. So I don't know if that answers your question or if you'd like further commentary.

No, that's helpful. I appreciate it. And just a follow-up on the guidance change on revenue. It looked like the -- by my math, your guidance implies 1.5% to 2% comps in the back half of the year, kind of getting back to the improvement that you've talked about earlier. So it looked like, to me, the revenue guidance change is more backward looking. Would that be fair to say? Or is there something coming up that we should be reducing your number on as well?

Yes, this is Mark. Well, I wouldn't say it's backward looking. I think we're just fine-tuning the numbers at this point. Obviously, we're taking a hard look at the store closing number. We talked about that, I think, both in John and my script.

I think, obviously, we continue to guide in that 0 to 2% range for comps. It was a little bit other costs that roll through there on the revenue side from a franchise standpoint that have decreased slightly, so that decreases the revenue as well. But I'd say it's a combination of store closings, a little bit of the occupancy piece that I mentioned earlier because that also rolls through from a revenue standpoint. But ultimately, we're sticking with our annual guidance for comp of 0% to 2%.

And we'll hear next from Michael Gallo with CL King.

I guess just to delve in a little bit on the weakness in April and May, I was wondering if we could parse that a little bit further, whether you saw specific weakness around dinner as you saw some of the casual promotions, whether it was kind of more broad-based or whether you saw any regional differences.

I was also wondering if the kind of movie tie-in perhaps kind of underperformed your expectations with -- and obviously, the movie you tied in kind of broadly underperforming expectations. And how confident you are as you look through the rest of the year that you kind of have the marketing calendar more in sync with where the overall consumer is today.

Those are great questions. Let's just start with where I finished on the discussion of the marketing calendar and sales.

As I mentioned, we did pick up in June. That followed into July. We believe that this is more of the -- consistent with what's going on in the marketplace with the value message and also building off core equities of a Super Slam. That said, the biggest -- the strong consumer response we've had to that came at breakfast and lunch. And so your question leads right into dinner. That suggests that we were a little softer there, and indeed, that is accurate, Mike. The -- it stands to reason that if the value dealing in casual was more dinner, then we felt it there a little bit.

That said, we've been building -- this will be our eighth year of positive comp growth with nothing but breakfast and lunch initiatives. And we've been saying for some time, we believe we're in the middle innings of our revitalization strategy. We are 74% remodeled around a modern image, which means 26% of the system would not be very responsive to dinner initiatives right now. So we're particularly vulnerable there.

We have been building some dinner equities through our burger and other product development programs, but you'll not hear us broadcast those or really talk about those strategies as outward strategies at this stage. We believe those are yet to come as the years unfold. So -- but I do believe that our confidence in our brand positioning of breakfast and lunch equities is strong and that we have upside through -- continue to build dinner equities over time and that we were pleased to see the consumer respond to the initiatives where we've built equities through time.

I'd also say, regarding the direct question around April, May and the particular strategies we had unfolding, we are confident in that relationship we had, and we believe they do play a role in building quality long-term equities and that there is a return on that, they just get read over a longer period of time.

And then I'm not sure if you touched on the regional differences in there?

Sure, sure. Proud to say that for the third consecutive quarter in a row, Texas outperformed the averages across the brand. That's a good sign for us. Other really strong regions, Washington and California, continued to be strong for the quarter and year-to-date basis. You can throw Arizona into that as being one of the really positive stories for us, and then Florida being a little softer on a year-to-date basis and in the quarter than what we've had. And again, I think a high degree of population of retirees that are more value sensitive, so that stands to reason that we weren't speaking to them as quite directly until late in the quarter.

(Operator Instructions) And that does conclude today's question-and-answer session. I'd like to turn the call back over to Mr. Nichols for any additional or closing remarks.

Thank you, Carina. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call later in the fall to discuss our third quarter 2018 results. Thank you, and have a great evening.

Once again, that does conclude today's conference. Thank you for your participation. You may now disconnect.