Denny's Corporation (NASDAQ:DENN) Q3 2017 Earnings Conference Call November 1, 2017 4:30 PM ET
Curt Nichols - Senior Director, Investor Relations
John Miller - President and Chief Executive Officer
Mark Wolfinger - Executive Vice President, Chief Administrative Officer and Chief Financial Officer
Will Slabaugh - Stephens Inc
Michael Gallo - C.L. King and Associates
Alton Stump - Longbow Research
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, Investor Relations. Please go ahead, sir.
Thank you, Vicky, 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 Web site 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 Web site 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 or that’s 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 we generated at the Annual Denny’s Franchise Association Convention in October. The growth and progress of this brand is resonating as franchisee attendance at 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 are thrilled to be working with such a talented and passionate group of franchisees, vendors and employees.
In addition to be excited 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’re performing well again versus key industry benchmarks. We accomplished this despite of the choppy industry environment that was further impacted by recent hurricanes, Harvey, Irma and Lidia. 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 reopened within the first 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 one company restaurant in Houston that remains temporarily closed. Due to the significant damage sustained by the thirteen franchise restaurants in Puerto Rico, only eight 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 temporary closings, these storms had a slightly positive impact on overall same store sales results during the quarter.
We are truly grateful for the dedication of our Company and franchise restaurant operating teams to reopen so quickly and for the 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 four 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 cravable products. Our latest limited time only menu features flavors of the season, including a Turkey & Dressing Dinner, a new Pumpkin Cream Pancake Breakfast, a 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 cravable pancake and burger options. We are 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 are still in the early stages of executing on the Denny’s On Demand platform initiative. But we are encouraged by an increase in off-premise sales of over one percentage points where off premise sales currently represent about 8% of total sales. Transactions through our new mobile online ordering platforms, which we’ll build in partnership with Dispatched Delivery Network company Olo, have contributed approximately $12 million sales to-date towards the growth in our off premise business. These To Go transactions continue to be highly incremental. Over index at the late night and dinner dayparts is skewed toward the younger 18 to 34 year old demographic.
In terms of product mix, pancake price, burgers, milkshakes and build your own entrée options over index for 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 post 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 one company remodel during the third quarter. With 61% of the system currently on the heritage image and an expectation to 75% of 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 franchise or but also to better enable our operations team to achieve their goal delivering higher quality products with a more consistent service experience. While we are 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 opening since 2009, representing approximately 28% of the current system and one of the highest totals of all four 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 level brands, we’re confident our new franchisee and his team are the right partner 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 toward the end of the 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. Now, 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 buyback. Since the beginning of our share repurchase program in late 2010, we have 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 and 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 are growing same-store sales is still in the early stages with only 61% of the system on the new heritage image. We have great opportunities 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’ll 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 highlight include growing domestic system-wide same-store sales by 0.6%, growing adjusted EBITDA by 9.6% to $27.3 million and growing adjusted net income per share of 11.2% to $0.14 per share. Additionally, we generated $12.6 million in adjusted free cash flow and allocated $29.7 million towards share repurchases during the quarter. We ended the quarter with 1,725 restaurants as Denny’s franchisees opened eight restaurants and we open one company restaurant. These openings were offset by eight franchise restaurant closings.
We also acquired one 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 12 months, and 0.6% increase in same-store sales.
Company restaurant operating margin of 16.9% was impacted by an anticipated rise in product costs, applicable commodities, and minimum wages, partially offset by higher sales and lower workers’ compensation expense. The reduction in worker’s compensation expense was due to $1.3 million in 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 three quarters of the prior year.
Moving to our franchise restaurants, franchise and licensee revenue was $34.5 million, supported by 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 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 termination I just mentioned drove the reduction in both occupancy revenue and cost. 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 in professional fees, the lower incentive compensation and a market valuation change in our non-qualified deferred compensation plan liabilities. As a reminder, a corresponding valuation adjustment to planned assets is reflected in other non-operating income. And as a result, these deferred compensation planned 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 $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, 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 cost during the fourth quarter to complete the implementation. These implementation costs are one-time 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. The 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 $0.13 in the prior year quarter. Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $12.6 million compared $3.7 million in the prior year quarter due to lower capital expenditures, partially offset by higher cash taxes and cash interest.
Cash capital expenditures of $8.5 million included the acquisition of one 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 one 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 five 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 a 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 refinance date was 3.2%, which is also consistent with the effective rate under our previous facility. The refinancing is reflection of the progress we have made in our brand revitalization strategy and demonstrates the confidence the financial community has in our strategic plan.
Our quarter end leverage ratio was 2.87 times and we are also increasing our targeted leverage range from 2 to 3 times up to a new range of 2.5 times to 3.5 times, 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, a new multi-year 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 optimization.
Since beginning our share repurchase program in late 2010, we’ve 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 five to 10 restaurants during 2017. We are maintaining 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 over [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 one franchise restaurant and real estate associated with the relocation 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 are committed to our strategy of selectively acquiring high performing franchise restaurants that could be efficiently managed through our company operated field infrastructure and are accretive to earnings per share. During 2016 and through the first three quarter of 2017, we have invested over $19 million to acquire 17 franchise restaurants. We target a purchase price multiple of between 4.5 times and 5.5 times 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 three 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’ll now turn the call over to the operator to begin the Q&A portion of our call. Operator?
Thank you [Operator Instructions]. And we will take our first question today from Will Slabaugh with Stephens. Please go ahead.
This is actually Drew on for Will. I’ve got two 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 that there’s been some improvement through 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 through to form typically cautious about commenting on the quarter. But I would say that our guidance wraps -- indicates we have 200 million share authorization and we have reaffirmed our guidance. And I think that suggests that the consumers are in the good spot, and we’re confident about the year wrapping up into our guidance.
And then just one quick housekeep, what was the 2, 4, 6, 8 mix in the quarter?
14.8% up from 14.6% the same quarter a year ago.
All right guys. Thank you very much.
Up from 14.4% same quarter a year ago.
And we’ll now take our next question from Michael Gallo with C.L. King. Please go ahead.
John, just a quick question, when we look at the menu construct and we think about delivery, we think about all of the various complexities to get broad and obviously we 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 menu, 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? Thanks.
Yes, that’s a great question. I think we’ve been rationalizing the menu for certainly the entire time I’ve been here and that work would have started prior to my arrival, I think the year just prior to my arrival, there’s tremendous progress that we’ve made in burger and shake categories, that’s been further enhanced since I’ve been here over past six years.
The menu net smaller than six years ago and we continue to think about the way we optimize the menu, whether it’d be for to go whether it be for delivery, whether it be more simplicity on the line but also turf and what customers want, what a multi cultural consumers looking for with our broad audiences and four day parts that we serve. So while menus are simpler, they’re more complex in other ways with breakfast all day. And a diner environment, we have a larger menu with lower frequency than QSR fast casuals. So parts of that needs also remain. So we are students of their since there just on a regular basis.
We have said that I think since just not in the script this quarter, but we did talk about in last quarter the number of improvements we’ve made over the last three years, so better than 50% of the menu been touched in some way. So with every quarter that passes and certainly twice a year, we’re going to have our ads and to reaching rationalizations on a fairly regular basis.
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 can update us on average, what percentage of the store had it in the quarter and how you see that building as you get delivering in more restaurants?
Well, virtually 100% of the stores have to go or online ordering near 100%. And then delivery, we said in the script, it is now 47% is eligible that have one of our delivery contracts available in their local market and about 30% of the system has signed a contract for the quarter and about 34%, I believe, 34% of the 47%, or 34% at the systems, 47% eligible. So we expect more stores to sign contracts overtime and we could get up to close to 50% of the system in the current footprint. And then overtime that will also expand and then our franchisee sign ups would expand as well.
And we’ll now go to Alton Stump with Longbow Research. Please go ahead.
I guess just question on the competitive environment, of course there’s lot of -- of course new slow still in the QSR category, the hamburger guys had. Of course you guys have done a very good job over the last 12-15 months to overcome that. Are you seeing anything difference though, I would say, 3Q versus 2Q as far as the competitive landscape?
Well, between Q2 and Q3 competitive landscape, I think when you’re seeing is the same thing that’s out there. And 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 or software related or digital related platforms. And I think, I guess, the other big analysis is there’s been a number, quite a few, anywhere from 300 to 1,000 depending on some of the numbers announcements for closings between now and over the next two to three years. So I think I don’t know that that wasn’t there in the second quarter, Alton. But I think in the third quarter, those were a little bit more visible changes.
Thanks, John. And then just a quick housekeeping thing to ask, if I missed it. But did you guys breakout what the hurricane impact was on cost in the quarter?
About 0.1% or just positive, so it is basically immaterial.
And then if I can just ask one last, and then I’ll hop back in the queue. But I guess this is to Mark. As you raise the debt EBITDA guidance, which if I recall wasn’t too long ago that you raised it to 18 to 24 months ago here. I mean, is there any reason why that couldn’t continue to keep higher in coming years, given obviously what’s every stable business, how your franchise model? I mean, is it out there to think that 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’ll answer the latter part of the question first. It’s obviously too early to indicate anything beyond that. Obviously, the history of the brand, 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 that 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 are 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 in that nature.
[Operator Instructions] It appears there are no questions. So I would like to turn the clock back to Curt Nichols for any additional or closing remarks.
Thank you, Vicky. 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 everybody.
Thank you very much. And that does conclude our conference for today. I’d like to thank everyone for your participation. And you may now disconnect.