Denny’s Corporation (NASDAQ:DENN) Q4 2022 Earnings Call Transcript

Denny’s Corporation (NASDAQ:DENN) Q4 2022 Earnings Call Transcript February 13, 2023

Operator: Greetings and welcome to the Denny’s Corporation Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Curt Nichols, Vice President, Investor Relations and Financial Planning. Thank you, Curt, you may begin.

Curt Nichols: Good afternoon. Thank you for joining us for Denny’s fourth quarter 2022 earnings conference call. With me today from management are Kelli Valade, Denny’s 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 fourth 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. Then Robert will provide development update and recap of our fourth quarter financial results before commenting on guidance.

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 29th, 2021 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 Chief Executive Officer.

Kelli Valade: Thank you, Curt and good afternoon everyone. 2022 marked a year of many positive changes in our business and I’m excited to reflect on that today before turning to this quarter’s results. For starters, our Board of Directors oversaw a very thoughtful and significant leadership transition. We thanked both John Miller and Mark Wolfinger for their many years of service and impact, congratulated them on their retirements, and we now benefit from their experience and wisdom as continuing Board members. I was thrilled to join as CEO and I could not be more energized by the opportunity to build upon the great foundation already in place. We also completed the acquisition of Kiki’s Breakfast Cafe, which transformed our business into a portfolio company operating two complementary concepts now.

To ensure each brand maintains its unique identity and differentiated position in the market, we evolved our organizational structure with the appointments of John Dillon to serve as President of Denny’s and David Schmidt to serve as President of Kiki’s. Denny’s and Kiki’s now operate with independent leadership teams, each driving their own strategies, products, marketing, operations, and development initiatives with support from our shared services teams. Importantly, we’ll maintain our ongoing collaboration and best practices on all major initiatives with our franchise partners in both brands to ensure we’re set up for success. And finally, our seasoned and talented senior leadership team leverage the perspective of our franchise partners, operators, and leaders from both brands along with insightful data about our guests and teams to refine and refocus our strategic priorities.

I’ll now spend a moment on each of these. Our first strategic priority is develop best-in-class people and teams through culture, tools, and systems. I believe a positive enduring culture characterized by shared values leads to winning teams. The restaurant General Manager is clearly the most critical position for any restaurant. We’ll ensure we have the best programs in place to attract, retain, and develop these important leaders. In a broad sense, this involves offering transformative experiences and benefits that foster a sense of inclusion, wellness, and belonging and we’ve been recognized for our efforts here. Most recently, being recognized by Newsweek is one of America’s Greatest Workplaces for Diversity in 2023. We also understand our guests and our employees increasingly expect businesses to deliver quality goods and services, while also serving a higher calling.

We are a company grounded in strong values at our core and we’re a purpose-driven culture as well. We’re proud of the $12.5 million we’ve donated to No Kid Hungry over the last 12 years, the over $1 million donated to St. Jude Children’s Research Hospital since 2020, and over $1.3 million awarded in scholarships through our Hungry for Education program, including awards to students attending historically black colleges and universities. Giving is clearly a part of our heritage and fuels us every day. Finally, we continue to evaluate, develop, and offer programs to assist our employees’ mental and financial health, so they can be their best selves at work and at home. Our second strategic priority is to drive profitable traffic through relevant and outstanding guest experiences.

Our net sentiment scores have been trending up over the last year and most recently, we experienced a dramatic 600 basis point net sentiment increase just this last month with improvements noted across all major metrics. We’re thrilled our franchisees continuing to take such great care of our guests, and that the guests are giving us credit. To make further gains, we’re learning more about our core guests to ensure we provide that outstanding experience they speak every day. In fact, you may be surprised to learn that Denny’s is skewing towards younger generations with millennials and Gen Z currently representing about 45% of our customer base. Over half of our total guests base is also ethnically diverse, and our breakfast and late night day part skew younger and more diverse all the time.

So, Denny’s is a place that is enjoyed by different generations in different backgrounds for a variety of dining occasions across all dayparts. We are diverse in every sense, in our guests base, in our supplier network, in our franchise network, and in our workforce. We truly are America’s Diner for today’s America, and that diner positioning has been and will continue to be a unique competitive advantage for us. And Denny’s is 70 years young this year and will soon launch an exciting campaign highlighting our diner equity in a way that only weekend. With our Kitchen Modernization Initiative also currently nearing completion, we have less than 25 to-go at 98%, will feature some amazing new craveable products prepared with the new equipment starting with our upcoming core menu rollout just next month.

And while some have noted declines in off-premise, our off-premise business and our virtual brands remain consistently strong at approximately 21% of total sales. We believe this will remain a strength, particularly with our growing mix of younger guests, and an overweighting of our transaction from our virtual brands occurring at dinner and late night. Our third strategic priority is to optimize the business model to maximize restaurant margins. Given the persistent challenging inflationary environment, our teams are focused on identifying margin improvement opportunities, including opportunities to drive profitable traffic growth. As we increasingly focused on our core guests, we will thoughtfully consider ways to reach those guests with key marketing messages, optimize existing pricing strategies, and address key customer pain points.

Our fourth strategic priority is to lead with technology and innovation. With kitchen equipment installations functionally complete, we’ll begin rolling restaurant technology updates to this system soon, including a new cloud-based POS system. We anticipate this technology deployment will enable an improved overall guest experience, greater operational excellence, anticipated labor efficiencies, and improve payment experience, and serve as a platform for future innovation. Our fifth strategic priority is to grow new restaurants as a franchisor of choice. Based on some recent consumer research, we’re taking a close look at our restaurant reimage and our remodel elements to ensure we are delivering an environment that meets guests expectations for the modern American diner at a compelling return on investment for our franchise partners.

Our current Denny’s development pipeline remains strong with over 200 global commitments and we believe successful execution against these other strategies will yield greater franchisee interest going forward. We’re also excited about the opportunity to support and acceleration in the long-term development opportunity for Kiki’s. Turning now to our fourth quarter results, Denny’s domestic system-wide same-restaurant sales grew 2% in the fourth quarter and 6.3% for full year 2022 compared to 2021. Our 24/7 restaurants continue to outperform the Black Box Intelligence Family Dining Index by approximately 550 basis points during the quarter compared to 2019. We remain focused in the near-term on our big three initiatives, staffing, 24/7, operations, and value.

The progress we’re seeing with staffing and reduced turnover rates at Denny’s and across the industry, gives us reason to be optimistic going forward. In fact, Denny’s rolling 12-month management turnover during the fourth quarter was better than the Family Dining Index by approximately 750 basis points. We continue to support our franchisees with virtual hiring events and over 1,400 interviews have been conducted through this platform to-date. We’re also making headway in our return to 24/7 operations. I’m pleased to say the modest incentive we offer to motivate our franchisees to accelerate their path back to 24/7 is indeed working. Currently, approximately 67% of the domestic system is open 24/7, which represents a 14 percentage point improvement since mid-year 2022.

This also includes approximately four percentage points or roughly 12 to 15 restaurants per week opening it late night in just the last four weeks. Our third area of focus is value. As a reminder, we launched our All Day Diner Deals platform in the third quarter, we experienced notable improvements in guests sentiment scores around value generally and affordability in particular. Total value mix in the fourth quarter was just over 14%, which was comparable to the mix we saw in the third quarter. We will continue to evolve this platform including our upcoming menu refreshed next month, reaffirming our everyday value promise for our guests. Our barbell strategy is working as guest check average has remained strong. We believe those looking for a deal at Denny’s can find it on our All Day Diner Deals menu, but most choose our more premium LTO and core menu products.

Moving now to an update on Kiki’s. I’m pleased to report that we have completed technical system integration so far. In doing so, we’ve uncovered some opportunities for future optimization in areas like technology, supply chain, facility management, and site selection for development opportunities. We look forward to bringing those opportunities to fruition in due course. We anticipate 2023 will be a foundational year at Kiki’s as we continue to leverage the support of our shared services function, round out a leadership team position for growth, and begin accelerating the development of Kiki’s as a franchisor of choice. We remain impressed by the sophistication of the existing 18 Kiki’s franchisees and their desire to grow, particularly given the opportunities to expand within Florida.

We’re also thrilled with the cult-like following this brand enjoys in that state where Kiki’s was just voted Florida’s Best Pancake House. We’re currently conducting brand ethos work to ensure we appropriately capture the secret sauce that has made Kiki so special as we develop plans to expand into other states. We anticipate the first step out of Florida will be with a small number of company restaurants to demonstrate the brand’s potential. With an updated disclosure document in the spring, we’ll have the ability to begin signing development agreements in other states for openings that will likely occur in 2024. At the same time, we’ll continue to support development within Florida, with both Kiki’s and Denny’s franchisees. In closing, the positive changes we’ve experienced in 2022, including the acquisition of Kiki’s, provide momentum for continued success for many years to come.

We have the right leadership structure at Denny’s and Kiki’s, each supported by our shared services teams, we have focused and refined strategic priorities, we are leveraging an even greater understanding of our evolving customer base and their expectations to better inform our strategic initiatives with a new campaign and new products on the horizon. And finally, we have great franchise partners in both brands who remain steadfast and focused on the future. We’re very excited about the opportunity to propel Denny’s and Kiki’s into 2023 and well beyond. With that, I’ll turn our call over to Robert Verostek, Denny’s Chief Financial Officer.

Piotr Rzeszutek/Shutterstock.com

Robert Verostek: Thank you, Kelli and good afternoon everyone. Not only was 2022 a year of positive change for our organization, it was also another year of resiliency, during which our dedicated franchisees, operators, and support teams remain focused on serving our guests in a persistently challenging environment. We were therefore pleased to close out the year delivering fourth quarter results in line with or better than the guidance we provided on our previous earnings call. Today, I will provide a development update and review of our fourth quarter results, before sharing our guidance for fiscal 2023. Starting with our development highlights, Denny’s franchisees continue to grow, opening 12 new restaurants during the quarter, including five international locations.

This resulted in 28 Denny’s restaurant openings for the full year, consistent with pre-pandemic opening rates. A Kiki’s franchisee opened one location during the quarter, resulting in three new Kiki’s franchised restaurants for the full year, including one opening prior to the acquisition. However, the persistent inflationary environment has continued to weigh on lower volume restaurants and we experienced a higher than average number of Denny’s franchise closures in the back half of the year. As inflationary headwinds continue to moderate, we anticipate returning to our longer term historical trend of consistently opening 2% or more of the system annually, while closing 2% or less of the system through normal attrition. Denny’s franchisees completed six Heritage 2.0 remodels and we completed one company remodeled during the quarter.

This brought the brand total to 49 remodels for the year, including 38 at franchise restaurants. Our successful Heritage remodel program has consistently delivered a warm and welcoming environment for our guests, and mid-single-digit sales lift for our franchise partners. We want to ensure our remodels deliver the same compelling returns we have come to expect, while also meeting the expectations for a modern diner among a growing base of younger multicultural guests. Therefore, considering the higher cost of remodels due to inflationary pressures, we are taking an opportunity to make certain we have the most appropriate remodel elements. With this consideration in mind, we plan to execute lower scope restaurant upgrades at targeted restaurants in 2023, before returning to a full remodel cycle in 2024.

Moving to our fourth quarter results, as Kelli mentioned Denny’s domestic system-wide same-restaurant sales grew 2% in the fourth quarter compared to 2021 or 3.3%. compared to 2019. Off-premise sales have remained strong at approximately 21% of total sales compared to the pre-pandemic trends of 12%. This reflects both our speed-to-market as the first family dining brands large online ordering and the strength of our off-premise technology and infrastructure. Additionally, the performance of our virtual brands has remained remarkably consistent and highly incremental, representing about 3% of domestic average weekly sales. Denny’s these domestic system-wide same-restaurant sales growth came from an approximately 8.5% increase a guest check average, which was comprised of approximately 7.5% percent pricing and approximately 1% of product mix benefits.

As highlighted in our Q4 earnings investor presentation, domestic average weekly sales for Q4 were nearly $37,000 compared to $34,000 in the pre-pandemic fourth quarter of 2019. This represents a 7.1% increase in average weekly sales compared to 2019, whereas same-restaurant sales increased 3.3% relative to 2019. The variance between these two metrics demonstrates that while our system portfolio is smaller than it was three years ago, it is healthier and generating higher average weekly sales as lower volume restaurants exit the system. Franchise and license revenue was $66.5 million compared to $60.2 million in the prior year quarter. This increase was primarily driven by $5.6 million related to the kitchen modernization rollout and $1.5 million of Kiki’s Breakfast Cafe franchise revenue in the current quarter.

The revenue related to the sale of kitchen equipment has an equal and offsetting expense recorded in other direct costs. Franchise operating margin was $31.6 million or 47.6% of franchise and licensed revenue compared to $31.1 million or 51.6% in the prior year quarter. I would like to note that while franchise margin dollars were not impacted by the kitchen equipment rollout, the franchise margin rate was impacted by approximately 450 basis points through this accounting requirement. With the kitchen equipment rollout 98% complete, the margin rate impact will lessen, while still having no impact on franchise margin dollars. More information can be found in our recent 10-Q and forthcoming 10-K. Company restaurant sales of $54.4 million were up 14.8%.

This increase is primarily due to strong same-restaurant sales growth of 6% and $3.5 million at Kiki’s Breakfast Cafe company restaurant sales in the current quarter. Company restaurant operating margin was $6.8 million or 12.6% compared to $7 million or 14.8% in the prior year quarter. This margin rate change was primarily due to commodity and labor inflation, partially offset by the improvement in sales performance at company restaurants. Commodity inflation moderated sequentially from 18% in Q3 to 13% in Q4 and we anticipate continued moderation. Additionally, labor inflation continues to moderate as we experienced 5% inflation during the fourth quarter. G&A expenses for Q4 totaled $17 million compared to $17.7 million in the prior year quarter.

This change was primarily due to decreases in share-based compensation expense and performance-based incentive compensation, partially offset by an increase in corporate administration expenses compared to the prior year quarter. These results collectively contributed to adjusted EBITDA of $23.4 million, which was above the high end of our previous guidance. The provision for income taxes was $3.3 million, reflecting an effective income tax rate of 20.7% for the quarter compared to an annual effective tax rate of 24.9%. Adjusted net income per share was $0.18. We generated adjusted free cash flow of $14.6 million. Our quarter end total debt to adjusted EBITDA leverage ratio was 3.4 times, within our target leverage range of between 2.5 times and 3.5 times of adjusted EBITDA.

We had approximately $273 million of total debt outstanding, including $262 million borrowed under our credit facility. As a reminder, we utilize swaps to mitigate interest rate risk associated with our revolving credit facility, essentially pegging our interest at a favorable rate of approximately 5%. During the quarter, we allocated $7.8 million to share repurchases, continuing our commitment of returning capital to our shareholders. For the full year, we allocated $64.9 million to repurchase approximately 6.3 million shares at an average share price of $10.33. As a result, at the end of the quarter, we had approximately 153 million remaining under our existing repurchase authorization, Let me now take a few minutes to expand on the business outlook section of our earnings release, where we are providing the following estimates for our fiscal year 2023.

We anticipate Denny’s domestic system-wide same-restaurant sales will be between 3% and 6% compared to 2022. As we start 2023, we are rolling over the impact of the Omicron variant, which will magnify our sales comparisons, particularly in the first quarter. Consistent with our existing reporting policy, we will begin sharing same-restaurant sales results for Kiki’s in the third quarter once we have a full year of comparable sales activity following the acquisition. We anticipate opening 35 to 45 restaurants on a consolidated basis, inclusive of eight to 12 Kiki’s openings, with a consolidated net decline of 15 to 25 restaurants, as the residual impacts of inflationary pressures persist throughout 2023, before achieving a more anticipated steady state in 2024.

We are projecting commodity inflation for 2023 to be between 4% and 6%. With roughly 50% of our market basket currently locked. We expect labor inflation of approximately 5% for the year. We took approximately 2% of pricing at the start of 2023 and we will remain thoughtful about our pricing strategies within our customary two to three annual pricing windows. Our expectations for consolidated total general and administrative expenses are between $79 million and $82 million, including approximately $14 million related to share-based compensation expense, which does not impact adjusted EBITDA. This consolidated range contemplates a full year of Kiki’s G&A and assumes fully reloaded incentive plans. As a result, we anticipate consolidated adjusted EBITDA of between $86 million and $90 million.

In closing, I am very excited about our strategies and where our dedicated franchise partners, restaurant operators, and support teams will take both the Denny’s and Kiki’s brands in the many years to come. 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. Thank you. Our first question is from Nick Setyan with Wedbush Securities. Please proceed with your question.

Nick Setyan: Thank you and congrats on a great quarter. Just given the Q1 is still more or less an impacted quarter and the run rate numbers Q2 to Q4 may be very different from Q1, anyway to maybe bracket the comp, the inflation — commodity inflation in Q1 comp and Q1, and also pricing — expected pricing in Q1?

Robert Verostek: Hey, Nick, this is Robert, good to hear your voice. Let me see if I can parse that apart a little bit for you. So, we’re trying to figure out how Q1 will be impacted with regard to the, kind of, topline sales and in the inflationary pressures if I think I’m hearing you correctly. So, I think the way to look at it is you are correct. It will be an impacted quarter. And I think we were calling out the in prior year a likely a double-digit impact from Omicron at the heart of it. So, when you look at our 3% to 6% sales range, it’s about that midpoint about 4.5%. So, if you factor in rolling over the that decline, I think you can see that we’re thinking about Q1 is a pretty, pretty robust quarter frankly in the terms of the cadence of the year.

I hazard to put out a specific number, but it is by — it is the most robust quarter in the year, the way we see it. When you look at the commodity inflation with that 4% to 6%, that clearly is the most impacted in Q1 also. So, the midpoint of that 4% to 6% would be five percentage points. I think if you look at the trending of the way we came down from 18% to 13%. If you kind of draw a line to it to get to an average of a 5% on the year, you could still see that Q1 will be highly impacted. Also, kind of, give you a — kind of, a guide to get there also without giving a specific number. So, you’re right to call out the fact that Q1 will look a little different than the balance of the quarters and the year. There was — just to reiterate what I said my script, there was 2% pricing in January that we will benefit from that, that will also benefit that Omicron rollover.

The next — the 2% to 3% window is beyond that. The next one, I think is in March, and then about six months later.

Nick Setyan: That’s very helpful. Thank you. And then in terms of G&A, what portion of G&A is related to the G&A guidance? What portion of that is related to Kiki’s?

Robert Verostek: Yes, so we really haven’t parse that out, Nick. It’s one of the reconciling items. If you look at where we — where our G&A came in this year to the guidance range, the $79 million to $82 million, there’s a couple of build back there. One is the differential in the stock-based compensation, we gave that as a whole number, you can see what it was in the current year. The other is the build back in short-term incentive compensation. I think in the release that we come across and it’s between $5 million to $6 million. And you — when you get back to a full pool, that’s another reconciling item. Kiki’s is another piece. We didn’t write that out. Kiki’s it’s an investment year for us. One of the key strategies clearly is to grow that brand much more quickly.

You can see already that in the current year with 8% to 12%, that midpoint of 10% is about double any other year prior to us acquiring it. And we know that we have to go well beyond that in the 2024 and out year. So, it does represent an investment into the Kiki’s G&A, although we have not called that out specifically.

Nick Setyan: Thank you. And just last question for me in Q1, are we — what’s the number for the cash portion of the stock comp?

Robert Verostek: I’m looking at Curt to see if we have that number. We do pay — we did pay out to the RSU portions of the couple of plans that were in place. I would suggest it’s probably in that 3% to 4% range is where I would peg that, Nick.

Nick Setyan: Thank you very much.

Robert Verostek: Thanks Nick.

Operator: Thank you. Our next question is from Eric Gonzalez with KeyBanc Capital Markets. Please proceed with your question.

Eric Gonzalez: Hey, thanks for taking the question. Maybe the first one just 24/7 locations, can you confirm that there’s still that mid-teens comp gap between those 24/7 and non-24/7? And if so, that’s still translates into the five to six point comp opportunity, depending on the timing? And maybe talk about how much you expect to capture this year of that opportunity?

Robert Verostek: Yes, that’s an excellent question, Eric. Thank you for that. So, we can confirm that we are seeing that mid-teens gap between the 24/7 and the non-24/7 units. So, yes, we can absolutely confirm that. With regard to that, that five to six percentage points, I think as I was speaking to that through about through the back half of last year, I think we’ve captured some of that. As you can see we’ve moved from 53% mid-year to 67% at this point with four points in the last four weeks here. So, I think we’ve captured some of that five to six points already. So, I would bring that down. I would temper that probably to four to five now. And if you look at the cadence, right, we’re adding about a point a year, that would translate to probably somewhere in that three percentage points range when you look, — yes, that four to five percentage points annualized.

So, when you look at it, the effect to the current year, it’s probably in that two to three points when you consider that we’re adding about a point a week at this stage.