Denny’s Corporation (NASDAQ:DENN) Q3 2023 Earnings Call Transcript

Denny’s Corporation (NASDAQ:DENN) Q3 2023 Earnings Call Transcript October 30, 2023

Denny’s Corporation beats earnings expectations. Reported EPS is $0.17, expectations were $0.15.

Operator: Greetings, and welcome to the Denny’s Corporation Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Curt Nichols, VP, Investor Relations and Financial. Thank you, Mr. Nichols. You may begin.

Curt Nichols: Good afternoon. Thank you for joining us for Denny’s third quarter 2023 earnings conference call. With me today from management are Kelli Valade, Denny’s President and Chief Executive Officer; and Robert Verostek, Denny’s Executive Vice President and Chief Financial Officer. Please refer to our website at investor.dennys.com to find our third quarter earnings press release, along with the reconciliation of any non-GAAP financial measures mentioned on the call today. This call is being webcast and an archive of the webcast will be available on our website later today. Kelli will begin today’s call with a business update and then Robert will provide a development update and recap of our third quarter financial results before commenting on our guidance.

A family enjoying their meal at a restaurant from the company’s franchise operations.

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 notes 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 during 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, 2022 and in any subsequent Forms 8-K and quarterly reports on Form 10-Q.

With that, I will now turn the call over to Kelli Valade, Denny’s President and Chief Executive Officer.

Kelli Valade: Thank you, Curt and good afternoon, everyone. Thank you for joining us. Today’s discussion will focus on our third quarter results, the continued progress made towards our CRAVE strategies and the growth and expansion of Keke’s Breakfast Cafe. After that, we’ll provide updates to our full year 2023 guidance. After the market close, we reported Denny’s systems same restaurant sales growth of 1.8%, while we maintain positive same restaurant sales throughout the quarter. Same restaurant traffic levels softened as the quarter progressed. This was similar to the trend experienced across the industry. Consumer confidence declined in August and September, driven by concerns around rising interest rates and the potential economic impacts of recent geopolitical events, and we anticipate consumer uncertainty and discretionary spending pressure to persist at least in the near-term.

While the operating environment remains challenging, we are laser-focused on making strategic choices in places we know we can win and where our guests count on us to deliver such as best-in-class breakfast and unbeatable value proposition and convenience in the form of off-premise options. During the quarter, we wrapped up our Baconalia promotion, which delivered quality craveable menu options relevant to our guests. Our Baconalia platform outperformed our last Baconalia LTO and exceeded all of our projections. Following Baconalia, we leaned into seasonal flavors, launching our relevant and craveable pumpkin pecan pancakes promotion, which just ended last week. Now, as we head into the holiday season, we’ve introduced our turkey and dressing dinner and seasonal pies, and we’re bringing back our salted caramel banana pancakes, which are seasonably relevant and a guest favorite.

And next week we’ll be launching our new fall core menu, which will incorporate many of the learnings from our comprehensive research to better understand our core guests as well as help enable operational efficiencies and improve margins. The menu architecture and design amplify what we’ve learned is most important to our guests and business, while not decreasing the overall number of menu items. For example, we simplify the menu layout by decreasing the number of customizations and build your own categories that currently occupy large areas of the menu. Those areas will now be utilized to highlight breakfast items and craveable value, while also leveraging and reigniting our equity in such areas as our slam platform, including our new strawberry stuffed French toast slam.

This new core menu item has four slices of brioche French toast, stuffed with sweet cream cheese filling and topped with strawberries, strawberry sauce, and powdered sugar. It can be enjoyed as a slam or a la carte. In addition, we’re leaning into guest feedback and their desired for varied beverage options such as cold brew coffee. The fall core menu also incorporates a new pricing model that will help protect our value leadership, while also better enabling franchisees to make smart pricing decisions that are aligned with regional factors and more localized competitive benchmarking. Lastly, in addition to the food and menu work happening within our four walls, our marketing team is continually optimizing our targeted messaging, delivering across effective channels to drive engagement and awareness.

Now, let’s talk about value. We are pleased to see a steady increase in our total value mix. Total value mix in the third quarter was approximately 17% up from the 16% mix in the second quarter and 15% mix in the first quarter. With growing concerns around consumer spending, delivering on our promise of everyday value for our guests is even more relevant than before. Understanding this need, we are choosing to double down on value to improve traffic trends. We’ve always been known for our strong value positioning and we’re able to drive profitable sales and traffic through our value propositions. In addition to our signature Super Slam starting at $7.99, most recently, we began testing our original Grand Slam at the unbeatable price of $5.99 in several markets with test results showing a profitable traffic lift and little impact to check compared to system trends.

As a result, we will be extending the offer to several other markets in the coming weeks. Next, let’s talk about the convenience of our off-premise business. Off-premise sales were approximately 19% of total sales for the third quarter flat with quarter two. We feel good about this, especially considering that many in our industry are experiencing actual sales declines in this channel. Even better, most recently, we’ve started to see an uptick in our off-premise sales, hitting above 20% by the end of quarter three, further showing that off-premise channels are consistently strong for us and a way to leverage operating capacity at dinner and late night to a new consumer. Whether delivering convenience through our Denny’s app or our Burger Den and the Meltdown virtual concepts, families rely on us for great off-premise experiences with craveable food options.

That’s why we remain focused on capturing further off-premise opportunities, including current testing of a new virtual burrito brand concept we call Banda Burrito. We’ve been in alpha testing of Banda Burrito in 10 locations, and based on positive results, we’ll be expanding it to an additional 80 locations next month. We are primarily focusing this concept in California and believe it has potential to efficiently expand our off-premise business with popular regional flavors while leveraging many existing SKUs in our pantry. In addition, last week at our annual franchisee convention, we unveiled our first complete remodel and new prototype under Modern American Diner. Not only does the new prototype feature an improved overall look and embraces off-premise with a dedicated pickup area staffed by a dedicated to go specialist.

So while we’re focused on these three areas, food value and convenience, we have not lost sight of our other strategic priorities captured in our CRAVE framework. At Denny’s, CRAVE stands for creating leading edge solutions with technology and innovation, robust new restaurant growth as a franchisor of choice, assembling best-in-class people and teams through culture, tools and systems, validating and optimizing the business model to maximize restaurant margins and elevating profitable traffic through the guest experience and uniquely craveable food. I’ll touch on creating leading edge solutions with technology and innovation and assembling best-in-class people in teams. First, I’ll start with technology and innovation. Technology touches everyone and everything in our business, which is why technology and innovation are part of our plan to win.

Our new ovens continue to unlock menu opportunities and efficiencies for us. Currently, about 50 plates on our menu, our prepared, at least in part, using our new ovens, including our proteins and our oven baked entrees and desserts. The culinary and operation teams are continuing to learn and explore opportunities to leverage our kitchen equipment further driving menu innovation and kitchen efficiencies. We believe the pursuit of additional efficiencies through our ongoing kitchen optimization programs will be critical as we anticipate further wage impacts, especially related to the FAST Act in California. We look forward to sharing more about these kitchen optimization strategies on future calls. In addition, we remain focused on implementing new solutions that not only solve points of friction, but also introduce relevant tools to streamline processes and deliver efficiencies such as QR pay.

We’re also still testing a new cloud-based POS platform from which we’re learning and enhancing ahead of a broader rollout. Going forward, this will be driven under the leadership of our new Chief Digital and Technology Officer, Pankaj Patra. We are excited to welcome Pankaj who can help us build on the solid foundation already in place, while leading us in identifying new, relevant and innovative solutions to serve our guests and employees and franchisees in the future. And of course, we have to talk about our people. We are a restaurant company, but also a people business, which is why it’s important that we put people first in everything we do. We officially launched our new Denny’s gain program in August, creating opportunities that may have been otherwise out of reach for our team members.

Gain includes four key areas, GED accreditation, college credits and certifications, life skills and career pathways for high school students. We’re really pleased with how the program has been received so far and are optimistic about the positive impact the program may have on attracting new talent and staffing and turnover rates. Since the launch of the program, 17 members have already earned their GED while 102 are currently enrolled in the program. Finally, I want to pivot and talk about growth and the expansion of Keke’s. Now that we have a playbook built on Keke’s that articulates what makes this brand so special, we’re leaning into that Keke special sauce to ensure that as we grow, we continue to demonstrate a differentiated offering to all of our guests through the new tagline, mornings from scratch.

This quarter, we rolled out a new menu design incorporating learnings from the brand ethos work that was concluded earlier this year. The new menu has fewer items, which reduces kitchen complexity, while also providing a cleaner look that allows Keke’s to better showcase the high quality ingredients and made from scratch philosophy it’s known for. The menu redesign has already led to check growth, and we’re still testing alcohol in several cafes also with promising results. We also continue making brand decisions and leveraging our learnings to support accelerated long-term cafe growth within and outside of the State of Florida. We have opened three cafes already this year, including one that opened after quarter end. In addition, we have signed development agreements with current Keke’s franchisees to open four more.

While we have faced construction challenges and needed to adjust the timelines for several openings, we are extremely pleased with the progress we’ve made. We’re also excited to bring the Keke’s concept to the Denny’s franchise system. Interesting Keke’s remains high among Denny’s franchisees, and we’re excited to announce securing several development agreements. Keke’s has also garnered interest from new franchisees, having held several meetings over the past couple of months with potential new operating partners. Lastly, we have a new cafe prototype ready to go as we look to bring the winning Keke’s experience to a new set of consumers soon. So as you can see, the foundational work we’ve been doing at Keke’s is starting to drive potential momentum, and we’re excited for what’s to come.

In conclusion, we just wrapped up our annual Denny’s Franchise Association Convention and Trade show, which is an incredible opportunity for us to gather with our franchisees, talk about our business today and rally together for our future. We used our time together to share our plans to continue to strengthen and revitalize the brand through new and relevant strategies all under the CRAVE umbrella, and we showcase new leadership and bold thinking. While not avoiding the realities and challenges of the current operating environment, our franchisees walked away with a clear understanding and alignment of the strategies and initiatives that will strengthen both top and bottom line results and continue to grow our brand, and they were pleased with our bold thinking.

Next time, we’ll share further progress against those strategies for both Denny’s and Keke’s. With that, I’ll now turn the call over to Robert.

Robert Verostek: Thank you, Kelli and good afternoon, everyone. Today I will provide a development update and a review of our third quarter results before discussing our annual guidance. Starting with development highlights. Franchisees opened eight new restaurants during the quarter, including two international locations, while Keke’s opened one franchise cafe during the quarter. We also opened an additional Keke’s franchise cafe in October. While several Keke’s openings expected this year will likely push out to earlier 2024 due to permitting and construction delays outside of our control, the development pipeline for this growth concept continues to take shape. Property control has already been secured for 10 future franchised and company operated Keke’s locations, in addition to signed development agreements from current Keke’s franchisees and continued discussions with Denny’s franchisees.

Moving forward to our third quarter results. Denny’s domestic system-wide, same restaurant sales grew 1.8% in the third quarter compared to 2022 consisting of a 2.1% increase at domestic franchised restaurants. Denny’s domestic system-wide same restaurant sales growth was primarily driven by pricing of approximately 8.4%, net of changes in discounts and product mix. Denny’s domestic average weekly sales for Q3 were approximately $37,000, including off-premises sales of approximately $7,000 or 19% of total sales. This translates to average unit volumes of approximately $1.9 million. Franchise and license revenue was $61.0 million compared to $65.2 million in the prior year quarter. This change was primarily driven by a $4.4 million decrease in initial and other fees associated with the sale of kitchen equipment in the prior year quarter.

Franchise operating margin was $31.2 million or 51.2% of franchise and license revenue compared to $30.7 million or 47.0% in the prior year quarter. Approximately 330 basis points of this favorable change in margin rate resulted from a lower kitchen modernization rollout impact in the current year quarter. Company restaurant sales of $53.2 million were up 1.8%. This growth was primarily due to an increase of $0.8 million at Keke’s Breakfast Cafe company restaurant sales in the current quarter. Company restaurant operating margin was $7.3 million or 13.7% compared to $3.8 million or 7.2% in the prior year quarter. This margin change was primarily due to lower legal settlement expense, improvements in product cost, and more equivalent units compared to the prior year quarter.

Commodities continued to improve moderating sequentially from 1% inflation in Q2, 2023 to 1% deflation in Q3, 2023. Additionally, we saw a slight improvement in labor during the quarter moderating sequentially from 4% in Q2, 2023 to 3% in Q3, 2023. G&A expenses for Q3 totaled $18.2 million compared to $16.6 million in the prior year quarter. This change was primarily due to increases in share-based compensation expense and corporate administration expenses, partially offset by a reduction in performance-based incentive compensation. These results collectively contributed to adjusted EBITDA of $22.2 million. The provision for income taxes was $1.7 million, reflecting an effective income tax rate of 17.6% for the quarter compared to 24.3% in the prior year quarter.

Adjusted net income per share was $0.17. We generated adjusted free cash flow of $12.0 million, which represents 54% of our adjusted EBITDA. Our quarter end total debt to adjusted EBITDA leverage ratio was 2.99 times. We had approximately $259 million of total debt outstanding, including $248 million borrowed under our credit facility. During the quarter, we allocated $16.5 million to share repurchases, continuing our commitment of returning capital to shareholders. At the end of the quarter, we had approximately $117 million remaining under our existing repurchase authorization. Since beginning our share repurchase program in late 2010, we have allocated over $685 million to repurchase approximately 66 million shares at an average share price of $10.43.

Let me now take a few minutes to expand on the business outlook section of our earnings release. We anticipate Denny’s domestic system-wide same restaurant sales will be between 2.75% and 3.5% compared to 2022. We anticipate opening 35 to 45 restaurants on a consolidated basis, inclusive of four to six Keke’s openings, which amounts to a consolidated net decline of 10 to 20 restaurants. We are projecting commodity inflation for 2023 to be between 1% and 2%. We expect labor inflation of approximately 4% for the year. Our expectation for consolidated total general and administrative expenses are between $75 million and $77 million, including approximately $11 million related to share-based compensation expense, which does not impact adjusted EBITDA.

This consolidated range contemplates a full year of Keke’s G&A. As a result, we anticipate consolidated adjusted EBITDA of between $85 million and $87 million. Finally, I want to mention how proud I am of our franchisees and the entire Denny’s and Keke’s teams who have remained focused on serving our guests and driving our CRAVE strategic priorities, especially during a period of consumer uncertainty and other macroeconomic headwinds. In closing, we remain confident in the strength of our highly franchised asset-light business model, which generates meaningful cash flow. We have a disciplined financial framework, which allows us to appropriately support the transformation of Denny’s and the growth of Keke’s while consistently returning capital to our shareholders.

That wraps up our prepared remarks. I will now turn the call over to the operator to begin the Q&A portion of our call.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question comes from the line of Michael Tamas with Oppenheimer. Please go ahead.

Michael Tamas: Hi. Thanks. Good afternoon. You touched on this briefly in your prepared remarks, but can you walk through what sort of changed on the same-store sales front relative to your expectations? Was it just the traffic shift that you mentioned across the industry, or were you seeing anything else on the average check side relative to what you thought you were going to see? And then Robert, if you could just kind of square us all away here, what, what is the implied fourth quarter same-store sales range. I know things kind of get wonky sometimes with waiting, but is it down two and a half, top one? Is it around that range? Or if you could just clarify, that’d be helpful. Thank you.

Robert Verostek: Hey, Michael. Yeah. Good to hear your voice. Happy to answer those questions. So when you look at the same-store sales trends, it really is that overall industry that we’re talking about, nothing really different. From our perspective, we saw that really kind of happen back-to-school timeframe, kind of the mid to the later part of August and really kind of stepped down from that point from the trends that we were seeing and kind of persisted that way. So with regard to that, nothing really unique. The reality is, is we were really kind of successful with our value driving strategies over the course of that timeframe. In fact, Kelli mentioned it in her remarks that we went out with a $5.99 test in Orlando. That’s proven to be really successful.

It — the check is holding in that, but we drove significant amount of traffic. To the point that at that — at our franchise convention that Kelli remarked about. We had many other of our marketing areas, different geographies, want to go in and further test out that $5.99 plate, potentially a little bit higher. But the reality is to part of that first question, Michael, that the check is holding even in that $5.99 test in Orlando, we’ve seen the majority of that check hold. So really good. It really kind of plays to our DNA, frankly, with the regard of our ability to drive sales traffic profitability through value. One of our key historic tenants is providing that for our consumer. With regard to the guidance that 275 to 350, the math that we do on that, Michael — and is really, we see it as functionally down, slightly down one-ish to up two.

So that’s the math that we’re getting to here in the guidance that we issued. So, again, majority on the upside to that in Q4, but again, if things got worse, we kind of really hedged our best there with that range. So that’s what we’re seeing there.

Michael Tamas: Okay. Thanks for clarifying that. And then, on the Keke’s development agreement for, or development agreements for a hundred units, I mean, really impressive considering there’s not even 60 units in the ground today. So can you just expand upon that a little bit more? What’s the timeframe on those units? Where do you expect them to open? And just anything else you can tell us about those agreements and what’s so exciting to you about them? Thank you.

Kelli Valade: Yeah. Absolutely, Michael. We’re encouraged as you heard and can hear our excitement too. So it’s 14 franchisees. So — and so that’s Keke’s franchisees, that’s a lot of Denny’s franchisees. We’ve been expanding and sharing the story about the potential, really great opportunities for growth. So we’re excited about that. You asked about the market, so we’ve already talked about kind of under construction in the Tennessee market that’s still happening as company. And then we’ve got others that have signed agreements for the East Coast as well as Texas and California. So we’re thrilled about the excitement around it. And as you point out, yeah, I have a hundred agreements, 14 different franchisees. We’re just incredibly optimistic about what this little concept can do, and really excited to see the support from franchisees, ready to talk about it and sign those agreements.

Robert Verostek: Yeah, Michael, and just the timeframe of those, likely, typically the agreements start with the — give you a year to get the first one in the ground or so. And then the majority of these agreements extend over five years — up to five years with that. So if they’re lighter — the bigger ones are up to five years, the lighter ones would be done in less time. So to Kelli’s point, we’re really, really excited, inclusive of the 14 agreements, 11 were Denny’s franchisees coming into — looking forward to coming into the Keke system.

Kelli Valade: We also finally had the opportunity at our franchisee convention that I spoke of to just literally from the general session stage talk broadly about the opportunities for Keke’s development will hold another virtual town hall for all interested Denny’s franchisees. At the same time, Dave Schmidt and his leadership team are presenting to the Keke’s franchisees this week. So we expect this just to continue this momentum. We absolutely believe will continue. So it’s exciting.

Michael Tamas: Awesome. Thank you very much.

Robert Verostek: Thanks Michael.

Kelli Valade: Thank you, Michael.

Operator: Thank you. Next question comes from the line of Jake Bartlett with Truist Securities. Please go ahead.

Jake Bartlett: Great. Thanks for taking the question. Mine is about the same-store of sales drivers that you see from here on out or the rest of the year into 2024. In 2023, there were some really big ones. You have a new menu launch 24×7 was expanding pretty rapidly. That was obviously partially offset by macro pressures, but what are the big sales drivers that you see that you’re excited about from here on out, kind of going forward for the next 12 months?