Denny’s Corporation (NASDAQ:DENN) Q4 2023 Earnings Call Transcript

Denny’s Corporation (NASDAQ:DENN) Q4 2023 Earnings Call Transcript February 13, 2024

Denny’s Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to the Denny’s Corporation Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now turn the conference over to your host Curt Nichols, VP, Investor Relations and Financial. You may begin.

Curt Nichols: Good afternoon. Thank you for joining us for Denny’s fourth 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 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 a 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 risk, 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. We were pleased to closeout 2023 with solid domestic system-wide same restaurant sales of 1.3% in the fourth quarter reflecting sequential improvement throughout the quarter. And because of that improvement and momentum, we deliver system-wide same restaurant sales growth a positive 3.6% for the full year, which was above the high end of our previously guided range, a satisfying achievement given the operational challenges the industry observed again in 2023. In fact, Denny’s same restaurant sales outperformed the full service industry benchmark for both the fourth quarter and for the full year, an impressive statistic for sure. Looking ahead to 2024, we entered the new year with a clear focus of what we know is resonating with our consumers and a laser-like focus on our three strategic areas of focus.

These are a best-in-class breakfast with craveable items, an unbeatable value proposition and convenience in the form of unique off-premise options. We spent last summer cascading these new strategies to our franchisees culminating with a comprehensive unveiling of our new playbook and our annual convention in October. By November, we put these strategies in play with bold moves with a new menu, new food innovation and unbeatable value proposition The playbook is now working and it’s providing momentum in this new year. First let’s talk about our craveable breakfast items and new menu. According to recent data there were nearly 6,000 new restaurant openings with the breakfast and brunch category in 2023. Clearly, there’s an enormous demand for breakfast coupled with consumers wanting breakfast items whenever it suits them.

This is obviously our sweet spot. We are American Diner after all and we own breakfast. Our November menu launch showcased our breakfast leadership in a big way as we leaned into our unique ownable equities with our slam platforms, including our new strawberry stuffed French toast slam, now made with our delicious premium Brioche French Toast and guests are clearly loving it given their reaction to this launch as we are selling over 150 total French toast plates per week per restaurant. Additionally, this menu launch was a key activation point in our new playbook and that we revamped the look and the feel of the menu also and leaned into what’s most important to our guests while being focused on ease of execution for operators. Specifically, along with new product innovation, we simplified the menu layout while minimizing customizations and the Build Your Own categories on the menu.

This not only allowed us to highlight our more popular and most craveable items, but it simplified operations without any impact on the guests or to guests preferences. This new menu also led to margin improvements, given our strategic approach to highlighting our most profitable items and ones we know to be guest favorites. Finally, the recent menu also incorporated a new pricing model that will help protect our value leadership while better enabling franchisees to make smart pricing decisions that are aligned with regional factors and more localized competitive benchmarking. The new pricing structure and approach will help us minimize traffic erosion when we do take price as we now have a heightened focus on the elasticity of certain menu categories and items.

At a time when the guest is still extremely sensitive to price increases at the grocery store and in restaurants, this strategy and focus is well timed and will continue to help us with our goal of smart menu smart pricing. Importantly, this improved approach will also be critically important in California as we work to offset the potential impact of AB 12:28 formerly known as the Fast Act. This quarter’s results were also aided by our approach to leading with value and leveraging our increasingly successful barbell strategy. Our original grand slam starting at the unbeatable price of $5.99 was feature nationwide starting in late November with positive results. We believe we brought this compelling offer to the guests at the perfect moment helping them balance holiday travel and shopping knowing they could count on Denny’s for the best breakfasts out there at an incredibly compelling price.

The guest responded well and quickly as we saw traffic in sales trends increased and we immediately noticed share gains against both family dining and casual dining. Mix on our value platform remained consistent and 17% but we grew check with premium offerings merchandize in restaurant, which is proof positive of our successful barbell strategy where some guests indeed are coming in for our rallied equity, but others are ordering more premium options. In addition, we remain focused on providing convenience through our off-premise business and we saw pick up here on a year-over-year basis also. Specifically off-premise sales were approximately 20% of total sales, up from 19% in the third quarter. We feel good about this sales mix considering that many in our industry are actually experiencing sales declines in this channel.

For us these channels provide a unique opportunity to leverage operating capacity at dinner and late-night to a distinctly new consumer. For these reasons, this will continue to be a part of our strategies which is why we’re leaning into testing our third virtual brand with Banda Burrito and why we’re leaning into a test with Franklin Junction, a global leader in branded virtual restaurants. We should be able to speak to both of these tests in more depth at our upcoming calls. But we continue to be hopeful and encouraged by the results we’re seeing so far. Now I’d like to provide updates to some of our other priorities captured in our crave framework. Here we will focus on technology and innovation first. We’re pleased with our recent progress on our new cloud-based POS platform, as we are now moving forward with installations and all company restaurants expected to be completed by the second quarter of this year with franchise restaurants to follow.

This foundation will enable improved kitchen visual systems or KVS, server handheld and QR pay resulting in more consistent operation execution, labor efficiencies and enhanced guest experiences. In addition our culinary and operations teams are continuing to lean in and explore opportunities to further leverage our ovens and other kitchen equipment to drive menu innovation and kitchen efficiencies. In fact, next quarter you will see new exciting products which will leverage our new ovens at the primary cooking platform. Importantly, we’ve also seen improvement in our food quality scores year-over-year and a high percentage of this improvement can be attributed to our new kitchen equipment. And of course we have to talk about our people and our guests.

We’re extremely proud of the progress we have made with our people programs including the launch of our game program this last year. We’re impacting lives and careers by offering education entertainment for all. As a result, we continue to see improvements in staffing and reduced turnover rates at Denny’s. In fact, management turnover for 2023 improved 400 basis points compared to ‘22 and was approximately 400 basis points lower than guest expand family dining index formerly Breakfast Intelligence. As for the guest experience, our overall 2023 net sentiment score was 41% compared to 32% for the family dining segment and 23% for the overall restaurant industry and our Google ratings continue to improve as we recently reached a 4.3 rating. I can’t say enough about the progress of both our teams and our guests as we have our company and franchise operators to thank for taking such great care of our guests always.

Their continued commitment to delighting every guest is appreciated and apparent. We also continue to remodel restaurants with our Heritage 2.0 program, while testing the next evolution of our prototype which will lean into our unique diner image with a modern updated and fresh look. Early results for the modern diner tests are strong with positive marks for unique, brighter yet warm approach to a modern diner. Sales and traffic results are also promising, while full results from this test to share soon and we’ll begin incorporating the modern diner remodel program into the mix in the back of the year. Finally, I want to pivot and talk about the growth and expansion of Keke Breakfast Cafe. We are thrilled to have opened our first Keke location outside the state of Florida a couple weeks ago in Hendersonville, Tennessee, just outside of Nashville.

Despite opening during a snowstorm, sales were strong for the first week and continue to be impressive. We also recently held an official grand opening ceremony for the new cafe receiving a warm welcome as we were joined by the Hendersonville Community including the mayor the city Chamber and local businesses. With this new location, we debut a new Cafe design an updated look and feel that was developed through our learnings from last year’s brand echos work. It’s a beautiful design highlighting the things unique to Keke’s that we know our guests love mornings from scratch as a prominent tagline and our unique positioning which serves to highlight a core differentiatorsm, a fresh from scratch cooking daily made with highest quality ingredients offered in great abundance.

We’ve also now launched a new menu in this location and in all existing Keke’s restaurants. This menu offers a simplified approach with less items and a focus on what we know Keke’s does best. In addition the alcohol program test was a success and a system-wide rollout now is underway. This program will become a brand standard and a requirement for all new cafe openings. For us, this has been a critical year building a strong foundation for the brand and integrating the KeKe’s brand into the portfolio at Denny’s. We’re incredibly pleased with the progress President Dave Schmidt has made as he has built a strong team cemented a unique position in the A.M. Breakfast segment and a competitive differentiated path that will allow us to win in new markets this year and beyond.

As a reminder, we have a franchise disclosure document in place and 14 signed development agreements for over 100 KeKe’s cafes across multiple states, 11 of those were Denny’s franchisees and three with KeKe’s existing franchises. We expect this number to grow and will soon be talking about many more. Our approach to KeKe’s and our early results are in line with our expectations. Our strategic intent and purchasing KeKe’s was to compete in this highly fractured yet steadily growing day time eatery segment. We have the unique opportunity to leverage our model franchisor approach and our strong network of franchisees in both brands to grow exponentially and capture market share. We are well on our way with the work we have done so far. Finally, we have laser-like in our focused approach to understanding what the guest love about KeKe’s and the results here are also phenomenal.

The KeKe’s brand 2023 overall net sentiment of 54% significantly outperformed the family dining index 31% in addition to significantly outperforming the the segment or service in scores per service on beyond an attempt to return. This tells us we have a winning formula in a brand that gets absolutely loved. The future is bright for a small but mighty KeKe’s brand. In closing, 2023 marked another year of resilience for our dedicated franchisees, our operators, and support team and we look to build on our achievements in 2024. This past year, we honored our past celebrating our 70 years in the business at Denny’s and we chartered a clear path to winning for the next 70 years. We couldn’t do this without the strong partnership and collaborative approach with our incredible franchisees and owners.

They are the reason we push to deliver our best every day they deserve it and our guests deserve it. It’s clear we have the right approach to win in today’s environment with committed leaders and partners and a game plan for our two unique incredible brands prime for growth and continued momentum for 2024 and beyond. With that, I’ll turn the call over to Robert.

Robert Verostek: Thank you, Kelly and good afternoon, everyone. Today I will provide a development update and a review of our fourth quarter results before discussing our 2020 annual guidance. Starting with development highlights, our brands opened 32 combined restaurants in 2023 marking the highest number of openings since 2017. Within the quarter, Denny’s franchisees opened seven new restaurants, including one international location. This resulted in 28 Denny’s restaurant openings for the year flat with 2022 and consistent with pre-pandemic opening rates. KeKe’s opened two franchise cafes during the quarter resulting in a total of four cafes for the full year. As Kelly noted, we also opened an additional KeKe’s company cafe in late January in Hendersonville, Tennessee marking the first cafe outside of Florida.

This marks the first of several company cafes as we plan to utilize company capital to develop oversight efficiency in various markets within and outside of Florida. In addition KeKe’s currently has four cafes under construction with several others in permitting and site approval phases. Moving to our fourth quarter results, Denny’s domestic system-wide same restaurant sales grew 1.3% in the fourth quarter compared to 2022 anchored by a 1.5% percent increase at domestic franchised restaurants. Denny’s domestic system-wide same restaurant sales were 3.6% for the full year 2023 exceeding the performance for eight of the nine years prior to the pandemic. Denny’s domestic system-wide same restaurant sales growth was primarily driven by pricing of approximately 7.5%, along with a product mix benefit of approximately 0.3%.

Denny’s domestic average weekly sales for Q4 were approximately $38,000 including off-premises sales of approximately $8,000 or 20% of total sales. As a result, average unit volumes for 2023 were approximately $1.9 million. Franchise and license revenue was $61.3 million compared to $66.5 million in the prior year quarter. This change was primarily driven by a $5.3 million decrease in initial and other fees associated with the sale of kitchen equipment in the prior year quarter. Franchise operating margin was $31.5 million or 51.4% of franchise and license revenue compared to $31.6 million or 47.6% in the prior year quarter. Approximately 430 basis points of this favorable change in margin rate resulted from the completion of our kitchen modernization roll out during 2023.

Company restaurant sales were $54 million compared to $54.4 million in the prior your quarter. Company restaurant operating margin was $5.4 million or 10% compared to $6.8 million for 12.6% in the prior year quarter. This margin change was primarily due to $1.8 million in legal cost in the current quarter partially offset by improvements in product cost compared to the prior year quarter. The $1.8 million in legal cost had an unfavorable 340 basis impact on the company restaurant operating margin rate for the current quarter. Commodity inflation was in line with our internal expectations at approximately 2% in Q4 2023 compared to 1% deflation experienced in Q3 2023. Additionally, labor inflation for Q4 2023 was 3% flat with Q3 2023. G&A expenses for Q4 totaled $19.3 million compared to $17 million in the prior year quarter.

These results collectively contributed to adjusted EBITDA of $18.6 million. The provision for income taxes, was $1.7 million reflecting an effective income tax rate of 36.9% for the quarter, compared to 20.7% in the prior year quarter. Adjusted net income per share was $0.14. We generated adjusted free cash flow of $7.4 million. Our quarter end total debt to adjusted EBITDA leverage ratio was 3.26 x. We have approximately $266 million of total debt outstanding including $256 million far out under our credit facility. During the quarter we allocated $16.2 million to share repurchases continuing our commitment of returning capital to our shareholders. At the end of the quarter, we had approximately $100 million remaining under our existing repurchase authorization.

Since beginning our share repurchase program in late 2010, we have allocated over 700 million to repurchase approximately 67 million shares at an average share price of $10.39. 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 0% and 3%, compared to 2023. We anticipate opening 40 to 50 restaurants and cafes on a consolidated basis inclusive of 12 to 16 Keke’s openings and a consolidated net decline of 10 to 20 restaurants. We are projecting commodity inflation to be between 0% and 2% for 2024. We expect labor inflation between 4% and 5% for the year. This labor inflation guidance takes into account the anticipated impact from AB12 28 in California.

Our expectations for consolidated total general and administrative expenses are between $83 million and $86 million, including $12 million related to share-based compensation expense, which does not impact adjusted EBITDA. This consolidated range contemplate the full year of G&A for Keke’s new management team and a fully reloaded incentive plan, which is paid out at approximately 70% over the last four years. Additionally this range would suggest corporate administrative expenses have grown at a compounded annual rate of 2.5% to 3% from pre-pandemic 2019 before considering the investment in Keke’s management team, who will drive that brand’s growth. That compares to a compounded annual growth rate of 4.3% nationally for private Industry salaries and wages between 2019 and 2023.

As a result we anticipate consolidated adjusted EBITDA of between $85 million and $89 million. Finally, I would like to thank our engaged franchisees and results-driven brand team who have remained focused on serving our guest while supporting the transformation of the Denny’s brand and the growth of Keke’s. 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: [Operator Instructions] Thank you. [Operator Instructions] Our first question comes from the line of Michael Tamas with Oppenheimer & Company. Please proceed with your question.

Michael Tamas: Hi, thanks. Good afternoon. You provided same-store sales guidance of 0% to 3% for the year. So, can you first touch on maybe what level of menu pricing you are anticipating within that for 2024? And then can you talk about the cadence, should we see sales build throughout the year or how you are thinking about that trajectory? Thanks.

Robert Verostek: Yeah. Hey Michael. How are you? Hope you’re well. With regard to pricing for the year we are going to roll into some roll over pricing on the year of approximately 2% and there will be additional pricing. We have two pricing windows. We’re getting back to our normal cadence of the year, which is an April menu print and October menu print, which will have two additional menu opportunities for pricing within those menu prints. So we’ve roll over two – we have two additional pricing. The April pricing will allow us to contemplate AB1228 in California. So I would expect that window to probably have a more pricing than the October window. So I would think that the pricing will be in the range of the 5% to 6% with that build that I just described there.

With regard to the cadence, I think you probably captured it correctly. I think it does somewhat build over the course of the year. We are rolling over the prior year some pretty strong numbers from the first quarter of the prior year and we have seen some impacts from weather as we started off January here. So I do believe it will build over the course of the year based on some of those items I just mentioned along with our initiatives becoming even further baked as we move throughout the year with regard to menu innovation, value messaging off-prem off-prem with regard to the virtual brand. So I think all of those will continue to mature across the year. So, with regard to pricing, I think that 5% to 6% range and I do think that as you described it does build over the course of the year.

Michael Tamas: Thank you. And then and then, I think the unit growth guidance suggests you closed about 50 to 70 units this year. Can you talk about maybe what led to that decision? Any help on timing pacing of that throughout the year? And then, can you talk about maybe the financial impact and maybe EBITDA or how we should think about that? Thanks.

Robert Verostek: Yeah, so it is another really good question. So to your point that that the midpoint there would suggest about 60 closures, right. That 50 to 70 range that you described, the reality of that situation is having come through the inflation environment that we had although it did temper quite a bit in 2023, the profitability of restaurants that where it kind of a breakeven for a unit at Denny’s restaurant to remain open has really kind of elevated from about $1 million to about $1.2 million. And so we’re continuing that that used to be that level used to be that $1 million I just referenced that used to be the break point of a closure. So we are continuing to work through some additional closures that as a result of those inflationary pressures.

Our goal, as I’ve said previously is to get back to a more normalized rate, but we wanted to be as we started off the year to be somewhat conservative with regard to that. When you think of these restaurants to your point with regard to what the EBITDA impact would be these generally are about million-dollar units, million-dollar restaurants. So $40,000 to $50,000 in EBITDA that’s growing up. So as we build new higher Denny’s restaurant openings, so we guided 40 to 50 openings, 12 to 16 of those being Keke’s. You would expect us to open somewhere around 30 Deny’s. Those are almost double the volume nowadays of the closures. So the reality is that it’s somewhat net neutral on the EBITDA between those two. But the closings about half the number of openings as our closings but the volume of the openings are about double, double – double that of our closings.

And we are at that level of openings the guidance actually suggests the highest number of Denny’s openings since 2017. So we got we have that machine back open and with the 12 to 16 Keke’s, that’s three to four times the level of openings that we have seen out of that brand at any point in its history really. So we’re really excited about what that starting to produce for us.

Michael Tamas: Thank you.

Robert Verostek: Thanks, Michael.

Operator: Thank you. Our next question comes from the line of Jake Bartlett with Truist Securities. Please proceed with your question.

Jake Bartlett : Great. Thanks for taking the question. First, I just want to dig into kind of what drove the miss on EBITDA versus your expectations? It looks like, sales was a little bit above. So what was the surprise that drove that miss? I think versus the midpoint of guidance of 5% lower. So, any help there would be.

Robert Verostek: Yeah. That’s a really good question, Jake and hello. Good to hear your voice. Some of it really was there were in some of our prepared remarks really kind of revolving around $2.5 million to $3 million worth of reserve adjustments that we really didn’t have a good line of sight into, more than half of that came from some legal reserves that we had to book into late into the year. 2.5 that really sat in the company margin. And if you right size for that on the quarter, it would have been between 14.5% and 15% and that $2.5 million would have added basically another full point to the year and there was a about a $0.5 million of reserve adjustments related to our captive within the G&A section of our P&L also. So, again we really – it bothers us.

We put out guidance with the full intention of achieving it and the fact that we didn’t because of these kind of one-time events was truly bothersome to us. But when you adjust for those, right size for those, the margin particularly on the company side are much better. The other – some of the other pieces of those one-time charges is 2.5 part was legal. We also had some claims development into workers comp and GL, general liability and some minor medical that impacted that. So it’s just kind of pervasive across the board. Nothing really is going in our favor this fourth quarter.

Jake Bartlett : Got it. Got it. That all makes sense. My other question was about trafficking. Your expectations in ‘24 given that – given the guidance for same-store sales and the pricing that you talked about, you set pretty negative traffic. So I guess, I’m wondering what is driving that. Are you seeing trade out of the category? I know at some point you’re talking about some trade down. And trade out and kind of being maybe a net neutral on that. But what are you seeing with the consumer? Where do you think you’re seeing this pressure on traffic? And do you – what can you do about it? Is there is there – I know you’re working on some innovation on the lower end of the menu. What’s your confidence that you can kind of try to really move the needle here with the traffic?

Robert Verostek: Yeah, so another really good question, Jake. So when we look at it, and we pay attention to what’s happening in the general economy. We’re seeing as somebody there’s not a lot of confidence into what we’re doing into 2024. So we – our guidance to your point on the guest traffic side is really a reflection of that. As you are aware our consumer set is half of our consumer has an income base of less than $50,000. So, again, we’re just being conservative there. We are really bullish about everything that we have into the hopper. We have new – we constantly original grand slam that $5.99, $7.99 messaging that we launched into in mid-November really change trends in a very material way. We have concept new value concepts – new value concepts in various levels of testing.

We have the multiple virtual brands I various levels of testing. So, in large part, we being conservative because of the rhetoric in the environment is there, but bullish about the other things that we have going.

Kelli Valade : Yeah. Yeah, Jake I think – hi, it’s great to hear your voice, as well. Just to echo what Robert said and just piggyback it really is about just watching the prediction from economist just watching those that we track and those that are putting out those reports that just tell us whether it’s inflation in the recent reports that just came out. And just that lot went into thinking about it and being optimistic yet just realistic. I would also call out our value mix have been picking up and we’ve seen that just in January alone. So we feel like we’re probably projecting at the right way and looking at it the right way and yet we are still optimistic. Lastly, I would tell you in both in the fourth quarter of last year and in January, we can tell that we are stealing share both on sales and traffic against our competitive benchmarks, which are both benchmark for family dining and casual dining.

So, is there trade down from casual? Perhaps. Is there trade off from us? Perhaps. we also see evidence that people in fact are still anxious enough to maybe visit less often. But again, for us, we can see what we’re doing against the competitive set. The last thing I’ll say relative to this Jake, is that our value makes while picking up and an indicator perhaps of indeed where people are being cautious. Our GCA is still up and we continue to just be really excited about and encouraged by our barbell strategy in that those that Robert called out less than 50,000 maybe the ones definitely coming in sensing that we do have great value at this unbeatable price and great food are also though – there are also people coming in and then upgrading to our amazing new products like the strawberry French toast, stuffed French toast just continues to just sell incredibly well.

So I feel like we’re balanced. We thought a lot about it and we’re really still pretty optimistic about the things we have in the hopper as you heard from Robert.

Jake Bartlett : Great. I appreciate it all. Thank you so much.

Kelli Valade : Thanks, Jake.

Robert Verostek: Thank you.

Operator: Thank you. Our next question comes from the line of Nick Setyan with Wedbush. Please proceed with your question.

Nick Setyan : Thank you. I just want to first clarify the pricing commentary. That I understand correctly that Q1 pricing is 2%.

Robert Verostek: Yeah, sorry Nick. Now – sorry if I misled you. We have – we’re rolling off 2% in pricing in the quarter. The pricing that we will see throughout the year is in that 5% to 6% range and it will be – that will be fairly steady across the year. Maybe a little bit tick higher in April as we take into account pricing related to AB1228. I apologize if I misled with my remarks. But no, no, the pricing in Q1 will be more in line with the 5% to 6% that I referenced today.

Nick Setyan : Okay. Thank you. And Q4 sounds like it wasn’t in that mid 5% range just to kind of get that 7.5%, for the year is that correct?