Denny's Corporation
Q4 2013 Earnings Call Transcript

Published: 20 Feb 2014

[Operator:]

Good day, and welcome to the Denny's Corporation Fourth Quarter and Full Year 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Whit Kincaid, Senior Director of Investor Relations. Please go ahead, sir.

[Whit Kincaid:]

Thank you, Angela. Good afternoon, and thank you for joining us for Denny's fourth quarter and full year 2013 investor conference call. This call is being broadcast simultaneously over the Internet. 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. John will begin today's call with his introductory comments. After that, Mark will provide a financial review of our fourth quarter results. I will conclude the call with commentary on Denny's full year guidance for 2013. As a reminder, we will be filing the 10-K by the due date of March 10, 2014. 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 26, 2012, 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 CEO.

[John Miller:]

Thank you, Whit, and good afternoon, everybody. We are pleased to finish 2013 with another solid quarter of performance marked by an additional quarter of positive same-store sales. We also grew adjusted earning per share by 21% this past year. We did this in the face of an ongoing challenging economic environment for our consumers. Most importantly, we have demonstrated that our franchise-focused business provides financial stability and flexibility while enabling us to generate earnings growth and significant free cash flow. Building confidence and momentum, we remain committed to executing against our key objectives to increase shareholder returns through the revitalization of the Denny's brand. Our first key objective is to achieve consistent positive same-store sales performance through continued improvements in our food, service and atmosphere. The foundation of Denny's revitalization is our competitively distinct and uniquely ownable America's Diner positioning. We see evidence that we are moving in the right direction with our positive sales performance relative to key industry benchmarks. In addition, we continue to see better performance in key geographies for Denny's like California, Texas, Arizona and Nevada where we have over 700 restaurants. In fact, same-store guest traffic was positive throughout 2013 in California, which represents 24% of our system. According to recent surveys, our guest at Denny's had a lower visit frequency than the guest visit frequency of our competition. Our guests have told us very clearly what needs to improve to get them to come back

[Mark Wolfinger:]

Thank you, John, and good afternoon everyone. Our fourth quarter results were highlighted by increasing domestic system-wide same-store sales by 0.9%, expanding Denny's restaurant count by 14 locations, growing adjusted net income per share by 195 and generating $8.9 million of free cash flow after capital expenditures. During the quarter, Denny's opened 19 franchise restaurants and closed five system-wide restaurants comprised of four franchise restaurants and one company restaurant. As a result, we ended the quarter with 163 company restaurants and 1537 franchise restaurants bring the total restaurant count to 1700. Denny's total operating revenue including company restaurants sales and franchise and license revenue decreased $1.7 million to $114.3 million driven by decreases in both company restaurants and franchise and license revenue. Same-store sales at domestic franchised restaurants increased 0.8% primarily due to an increase in same-store guest check average driven by higher menu pricing. Franchise and license revenue at $33.2 million decrease $1.1 million due to decrease in both occupancy revenue and initial fees which were partially offset by a $300,000 increase in royalty revenue resulting from seven additional equivalent franchise restaurants. Franchise operating margin of $21.6 million decreased $700,000 primarily due to decrease in occupancy margin and initial fee revenue. Franchise operating margin as a percentage of franchise and license revenue increased 0.1 percentage points to 65.3% compared with the prior year quarter. This increase was primarily due to decrease in occupancy margin. Same-store sales of company restaurants increased 1.5% primarily due to an increase in same-store guest check average driven by higher menu pricing. Sales at company restaurants decreased $600,000 to $81.1 million primarily due to six fewer equivalent company restaurants which reflects the impact of our re-franchising strategy that was completed at the end of 2012. Company restaurant operating margin of $11.2 million or 13.8% of company restaurant sales increased $200,000 or 0.3 percentage points compared to the prior year quarter. Product costs increased 0.8 percentage points due to the unfavorable impact of product mix and higher commodity cost compared to the prior year quarter. Payroll and benefits cost increased 0.6 percentage points. The increase included $400,000 or 0.5 percentage points of unfavorable workers compensation claims expense compared to the prior year quarter. Occupancy expense decreased 0.5 percentage points due to favorable general liability accrual adjustments compared to the prior year quarter. Occupancy was also favorably impacted by more leases when classified as capital leases during the year. The 1.3 percentage point decrease in other operating cost was primarily driven by lower margin expense compared to the prior year quarter. Total general and administrative expenses decreased $1.3 million from the prior year quarter, primarily due to decreases in incentive compensation and professional fees partially offset by $700,000 increase in share-based compensation. The fourth quarter adjusted EBITDA of $19.4 million or 17.0% of total operating revenue increased $1.7 million or 1.7 percentage points, primarily driven by the decrease in G&A expenses. Depreciation and amortization expense increased by $600,000 compared with the prior-year quarter, primarily resulting from the remodeling of 26 company restaurants in 2013. Net operating gains, losses and other charges which include restructuring charges, exit costs, impairment charges and gains or losses on the sale of assets increased $4 million in the quarter. The increase was primarily the result of a $4.2 million increase in impairment expense compared with a prior year. This increase was related with the partial impairment of the company restaurant located in Downtown Las Vegas. Our policy is to test for impairment if the restaurant has been opened for full year. This restaurant was open in November, 2012 and is adjacent to the Fremont Street Experience and part of the Neonopolis Shopping and Entertainment Development. Denny's long track record of success in the Las Vegas strip helped support the case to build another high volume location which showcased the brand with a more contemporary atmosphere. Due to investments in a number of unique design elements and equipment we spent more than $6 million constructing this location. This is about $2 million more than we would have spent without these additional design investments. In addition, sales at the Neonopolis restaurant had been below expectations as the retail complex has not been fully developed and the customer mix at this location has not responded as anticipated. We have made changes resulting in improvements in top line and bottom line performance. Regardless, given the above-average level of investment and lower than expected sales we determined it appropriate to write the asset resulting in /44.8 million non-cash impairment charge in the fourth quarter. Interest expenses for the fourth quarter decreased by $400,000 to $2.5 million resulting from a $17.1 million reduction in total debt over the last 12 months and lower interest rates under our refinance credit facility. In the fourth quarter or provision for incomes taxes was $1.1 million reflecting a 20.6% effective income tax rate and a 31.9% annual income tax rate. Due to the use of net operating loss and income tax credit carry-forwards we only paid $2.8 million in cash taxes during 2013. At the end of the fourth quarter, the deferred tax asset on our balance sheet was $51.6 million. We will continue to utilize additional net operating loss and income tax credit carry-forwards to eliminate the majority of our cash taxes for the next several years. Cash capital expenditures were $7.4 million in the fourth quarter and $20.8 million for the full year. The company completed 16 heritage remodels in the fourth quarter and 26 heritage remodels during the full year. Free cash flow was $8.9 million in the fourth quarter, an increase of $1.6 million compared with a prior year quarter, primarily due to the increase in adjusted EBITDA. In the fourth quarter, we repurchased $459,000 shares for $3.1 million bringing our full year total as to 4.2 million shares for $24.7 million. As of February 14th, we had a total of $8.6 million shares authorized and remaining in our ongoing share repurchase program. We ended the fourth quarter with $173.1 million in total debt outstanding with a total debt to adjusted EBITDA ratio of $2.22 times. We will continue to use our free cash flow after capital expenditures towards both share repurchases and to a lesser extent debt repayment, while also making investments to grow and strengthen the brand. That wraps up my review of our fourth quarter and full year results. I'll now turn the call over to Whit who will comment on our annual guidance for 2014.

[Whit Kincaid:]

Thank you, Mark, and good afternoon, everyone. I would like to take a few minutes to expand upon the business outlook section in today's press release. 2014 will include 53 operating weeks with the extra week following in the fourth quarter of the year. We estimate that the 53rd week will contribute between $3 million and $3.50 million of pretax income. We anticipate that between 35 and 40 system restaurants will close in 2014, which is consistent with the 2% annual closure rate we have seen over the last seven years. We anticipate that two or three of the closures will be company restaurants. At the end of January, one of our company operated restaurants located in Honolulu, Hawaii permanently close due to loss of property control. This was a high volume location generating over $4 million of sales last year. At the beginning of the year, we announced that our Las Vegas Casino Royale location, the highest volume company operative restaurant has been closed for reconstruction and is currently not expected to reopen until early 2015. The landlord is redeveloping the location to include a completely rebuilt Denny's restaurant funded by the landlord. In 2013, this restaurant contributed $7.9 million of sales and $2.9 million of pretax operating income. We expect our company percent margin to range between 13.5% and 14% as we face a number of headwinds including minimum wage increases, most notably in the state of California, and the rollout of the Affordable Care Act. We anticipate that commodity cost inflation will be flat to 1% this year, which is the lowest that has been in the number of years. We are currently locked in to approximately 60% of our need for the year. The temporary closure of our Las Vegas Casino Royale location creates a 60 basis point headwind to the company percent margin in 2014. We anticipate that our company sales as well as our payroll and other operating costs will be impacted in the first half of the year by the remodeling of the company restaurants. Remodeled restaurants typically close around one week during which additional training takes places. As a result of inflationary pressures impacting our industry we did take around a 1% price increase with our new January core menu and plan on an additional modest price increase at our California restaurants in July when the minimum wage increases to $9 per hour. We expect our franchise per cent margin to do between 66% and 67% with total franchise revenues to be between $136 million and $138 million. We expect a favorable impact from the 53rd week new restaurant growth and same-store sales increases to be partially offset our lower occupancy margin resulting from a decrease in the number of subleased location in 2013 and 2014. We currently expect our annual effective income tax rate to be between 34% and 38% with cash taxes to be between $3 million and $4 million in 2014. Cash capital expenditures, annual guidance of $20 million to $22 million include remodeling of approximately 40 company restaurants, the majority of these remodels will be completed in the first half of the year. 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 Michael Gallo with CLK Investments.

[Michael Gallo:]

Just a question on the change in the way you are marketing this year with the monthly module and the chalk (inaudible) specials and little more seems like LPO urgency that gets created as opposed to the two or three month modules that you were running before. So wondering what kind of impact that you have seen from that, what kind of mix you see on whatever the monthly module you're running in and then also how you could help use that respond to changing consumer trend perhaps more rapidly than you could have under the old ways that you were running the modules? Thank you.

[John Miller:]

Mike, this is John. Those were some great questions. I would say that's 50,000 feet a little too early to tell with great position where the change leads us or take it in general, it's simpler on our operators and gives us more flexibility that has generally the same sort of from a consumer side, I think it feels a lot like it's always felt. So we are able to divide what used to be five approximate, 10-week modules into four modules with about the same number of media messages and production pieces but to the server and to the operators it feels like 12 different distinct focus points. Over the course of module 1 product Q1 that used to be module 1 and then parts of module 2 leading over into that same period of time. There might have been about the same number of overall media messages, the value message or a couple of LPO premium products maybe some value launch price point, LPOs and some 2468 messaging that kind of all blur together. So these are a little bit more distinct and they go at the end of one, but it flows into the next, the Melanesia is over, it rolls into the next. It allows us to get a little bit more focus on the line, focus on training, higher quality execution, one less training roll out for the year and but about the same overall broadcast time and so forth. So it's too early to answer it like we'll be able to answer at the end of the year, but I guess the important part is the mix is holding up well, consumers are responding. We came out of the gates with a Value sandwich promotion, we end the quarter with a built around Slam with a focus on Fit Fare and we think to build equity is in the brand on these platforms is better whenever the whole month you can talk about skit and build your own versus scattered out throughout a whole 10-week module. So we feel good about it. It is more frequency like and less casual life, I guess when you look at the historical perspective, but it's not a new approach, its one incident in the industry for a number of years.

[Operator:]

And we will now go to Will Slabaugh with Stephens

[J.R. Bizzell:]

Yes, JR here asking question for Will. Thanks for my call and congrats on the quarter.

[John Miller:]

Hey JR.

[J.R. Bizzell:]

Yes, thanks. On sales for geography I know a lot of them in your space had been in referencing whether or across different geographies in California in addition to what you are seeing in California. Have you experienced any negative year-over-year weather impact throughout other regions?

[John Miller:]

Sure. This is John. There is no question that the Mid-West and northeast has been hit harder whether it'd be early last year beginning of 2013 or the beginning of 2014. So what affects other brands and what you see would Denny's in the same way. The fact that we are more weight of minutes in our whole portfolio of 700 between states I have mentioned earlier 24% of our units in California, 36% of the company units in California place to it got loads of volatility of weather for us overall. Our guidance for the year, however, includes the impact of that the guidance we took you through just a moment ago.

[J.R. Bizzell:]

Thanks. And kind of a longer menu, I know you added us some new coffee in there and I'm wondering if you are seeing any impact from that it is a platform similar to the coffee or there other platforms that you can expand with the day part menu and items you think can add on to the check in different day parts.

[John Miller:]

Yes, there are. The first was to have some credibility around our coffee program. We talked about our heritage quite a bit as a diner and leading coffee shops or diners obviously renowned for coffee, and the world has changed since those days where now in hotel lobbies to convenience stores you expect to have choice and more than one blend. So at first was to get a high quality coffee with Arabica beans that was roasted like miles and have those option available also to have a respectable decafe coffee that moved from just having one that delighted people. So the first and an important goal was to reduce the number of comments or complaints associated with our coffee program and we are delighted to report that that goal has been accomplished. And then to your point, then we can build on that. So we have added ice coffee since then and we've also built on other platforms that create significant add on opportunities for us whether it would be build your own programs, build your own shakes, which is now our number one selling desert item, and other ways to continue to add on and build the check.

[Operator:]

We will now go to Mark Smith with Feltl and Company.

[Mark Smith:]

Hi guys, just a real quick one to confirm. Your occupancy revenue is down due to fewer subleases and that's expected to continue in the last year, if I look from that direction.

[Whit Kincaid:]

Yes, I'm afraid, Mark. This is Whit. That's correct. So when you look at you saw really tell the impact in the fourth quarter this past year kind of overall for 2103 our occupancy margin dollars were pretty much flat, down $12.5 million. So the reason is we've had subleases and that's where we're on the head lease and then perhaps we're subleasing to franchises. So we've had some franchisee when the option become available, they have stepped down and taken over, renegotiated the lease.

[Mark Smith:]

Oh that's out of the middle.

[Whit Kincaid:]

And so you see a headwind to occupancy revenue, you won't see a decrease in the expense fees in terms of occupancy. How much in terms of a margin kind of a net EBITDA margin impact really depends on the REIT. And there is also for some of these leases that are defined as capital leases you would also have a corresponding decrease and depreciation of interest expense as well. So kind of a net margin impact on EBITDA when we take into account the lower depreciation of interest, it is smaller than what we saw on the fourth quarter, so the $300,000 impact would be closer -- on a cash basis be closer to $100,000. And then this translates for 2014 guidance, yes, so if it comes a headwind and one way to think about it to our -- in terms of the franchise margin dollars, it is certainly from a rate basis though it helps you because this is a low margin business and it is not a growing business for us. You know the history well in terms of it is really reflection of a re-franchising efforts that went on and selling leased restaurants to franchisees. And so we don't anticipate this margin growing with a re-franchising efforts having come to an end at the end of 2012. And so some of these leases will continue to low off as the franchisees step in but on a net basis if, when you will figure out the whole pool of dollars it is about a $6 million pool of sublease EBITDA margin and it is about a $4 million pool when you include the depreciation of interest expense on a capital leases that's not included in EBITDA. So over time, it is over a long course period of time if becomes a headwind.

[Mark Smith:]

Okay. And on the real estate front, has there been any change there on properties that you guys are on?

[Whit Kincaid:]

There has not. There is the same 56 with 35 owned by the under -- sitting under company restaurant -- or excuse me, I'm sorry. 56 are under franchise restaurants, 35 are under company restaurants. The total ownership would be 91 location plus the Spartanburg headquarters and then we have one excess property beyond that.

[Mark Smith:]

And then just looking at (inaudible) and sales slipped on remodels in there any real change as we look in 2014 on expectations you have on the remodels?

[John Miller:]

Yes, in 2014, we expect a similar number of restaurants due. We did 178 franchise, remodel -- franchisees completed 148 last year and then we stand to do 40 company remodels on top of 26 we did last year, however, that will be front loaded where you heard in my comments a moment ago that we completed on the company's side last year were late in the year. So we do expect the number of company units to be stepped up considerably. We are pleased with consumer response on this. We engage consumer's franchisees in an effort to make sure that we were developing according with their expectations for the Denny's brand-wise in terms of atmosphere. And I'm please to see as the franchisor to sort of model the right behavior in getting the space right for our consumer. So that will be 40 plus the 26 last year and a total of 66 of our 163 company operations. We are seeing a good lift mostly in traffic.

[Mark Smith:]

Mostly traffic is still kind of mid-single I think you guys headed fast.

[John Miller:]

That is right.

[Mark Smith:]

Okay. And then just looking at the franchise openings this year, can you quantify roughly how many will be international or nontraditional?

[John Miller:]

Sure. This coming year we are guiding another 45 to 50 total and how much of that is international and traditional the year will play out. We expect a portion of that also be nontraditional units building on top of the momentum from last year. So I would say low-single-digit in the international arena.

[Whit Kincaid:]

And that would be the same for nontraditional as well Mark?

[Mark Smith:]

(inaudible).

[John Miller:]

That is right.

[Operator:]

(Operator Instructions). We will take our next question Michael Halen with Sidoti.

[Michael Halen:]

Good afternoon. My first question is what was the incidence rate of the 2468 Value Menu in the fourth quarter?

[John Miller:]

Yes. This is John. We moved from about 19% to 19% quarter-over-quarter on the full year about 16.5 to 19, so 2012 to 2013 is up, but quarter-to-quarter pretty flat.

[Michael Halen:]

Okay, great. And can you breakout the company on comp between just guest check and mix in traffic?

[Whit Kincaid:]

Hey, Mike, it's Whit. Yes, in the fourth quarter the company guest check was positive 2.7% and the traffic was negative 1.2%.

[Michael Halen:]

Okay, thank you. And when do you expect to rollout the new royalty program?

[John Miller:]

We are all looking at each other. I think we have -- we have a test, so until we -- it's all we know at this point.

[Michael Halen:]

Okay, fair enough. And I guess just the last one. Are you willing to talk at all about the impact of icy weather on your restaurants in Texas in this first quarter?

[John Miller:]

Yes, we had state guide too much in the quarter other than say the annual guidance is we are confident of the guidance.

[Michael Halen:]

Okay, fair enough. Thanks very much.

[Operator:]

And there appears to be no further questions at this time. I will now turn the call back to Mr. Kincaid for any additional or closing remarks.

[Whit Kincaid:]

Thank you, Angela. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call to discuss our first quarter 2014 results in the late April. Thank you. And have a great evening.

[Operator:]

Ladies and gentlemen this concludes today's conference. And we thank you for your participation.