Q3 2021 Denny's Corp Earnings Call
[music].
Good day, ladies and gentlemen, and welcome to the Denny's Corporation Q3, 2021 earnings call. Today's conference is being recorded at this time I'd like to turn the conference over to Curt Nichols, Vice President of Investor Relations and financial planning and analysis. Please go ahead.
Thank you Keith and good afternoon, everyone. We appreciate you joining us.
Today for <unk> third quarter 2021 earnings conference call.
With me from management are John Miller, Denny's, Chief Executive Officer, Mark Wolfinger, Dennys, President and Robert <unk> Denny's.
As executive Vice President and Chief Financial Officer.
Please refer to our website at Investor Denny Dot com.
Our third quarter earnings press release, along with a reconciliation of any non-GAAP financial measures that I mentioned on the call today.
This call is being webcast.
Archive of the webcast will be available on our website later today.
John will begin today's call with a business update Mark will then provide some comments around restaurant capacities, our franchisees and development.
Robert will provide a recap of our third quarter financial results and current trends after that we will open it up for questions.
Before we begin today, let me remind you that in accordance with the Safe Harbor provisions of the private Securities Litigation Reform Act of 1095, the company noticed 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 30, <unk> 2020, and in any subsequent forms 8-K and quarterly reports on Form 10-Q.
With that I will now turn the call over to John Miller, Denny's, Chief Executive Officer. Thank you Curt and good afternoon, everyone. Our third quarter domestic system wide same store sales started out very strong as consumer confidence was on the rise and families were enjoying similar vacations. Some for the first time in two years, However average daily kill.
With 19 case counts across the country accelerated throughout the quarter and case counts remained elevated with average daily cases at their highest level. Since January the result was pressure on consumer confidence as well as dine in transactions throughout the industry in August and September Thankfully the improvement in case counts in October yielded a return.
Dine in transactions to their highest level since the pandemic began with same store sales once again, surpassing the 2019 levels. Furthermore, approximately half of the domestic.
System generated positive sales in the month of October.
Approximately half of the domestic system generated positive sales in the month of October and each of our top four states were positive as well and I am even more encouraged by the stickiness of our Denny's based brand off premise business, which has remained strong at approximately 20% of sales compared to its pre pandemic trends of 12 per.
Additionally, during the third quarter, we substantially completed the rollout of our second virtual brand the melt down to approximately half of our domestic system virtual brand sales for both the Burger Dan and the meltdown remain highly incremental at approximately 3% of sales. These brands provide opportunities not only at dinner and late night.
To leverage underutilized labor, but we continue to see a meaningful number of transactions during the week versus the weekend. Our teams have accomplished this while navigating persistent industry wide staffing challenges that have impacted our ability to execute at our highest potential despite the exploration of enhanced unemployment benefits.
Personal savings rates remain above pre pandemic levels. Therefore, we have not experienced a significant increase in staffing levels, which impacts our effective operating hours. We still view this as a near term challenge that we are combating with extensive hiring efforts. However, we expect it will take a few more quarters to return to pre pandemic.
<unk> levels and effective operating hours I will now touch briefly on our four key guest centric themes and some of the new and exciting investments we are making in these areas first areas focus is reassurance, we do remain committed to reassuring our guests that didn't need to provide the safe dining experience by consistently executing.
<unk>, our enhanced cleanliness and sanitation procedures at all customer touch points. Our second area of focus is value. We understand the value comes in different forms and has a different meaning for each type of guests. We consider our value approach to be a comprehensive balance between price abundance convenience and bundled value. Our third area of focus is can.
<unk>, we believe guests will continue to expect technology to enhance their dining experience whether in our restaurants or through off premise options like our well established denny's on demand platform or are two new virtual brands. We are committed to optimizing the digital experience for our guests as evidenced by our recent launch of the next phase of our technology.
Transformation. This phase included a revamped denny's dot com website, a new easy to use digital app with frictionless ordering and checkout smart upsell and cross sell capabilities as well as personalized profiles and digital wallets for rewards in fact since our digital relaunch there have been approximately <unk> <unk>.
30000, net new App downloads and approximately 100000 net new rewards members. Additionally, our updated mobile App receives very high star ratings on both Apple and Android devices further enhancing our focus on convenience. We're excited about the next phase of our technology transformation, we will begin the rollout.
Our new cloud based restaurant technology platform. During the first half of 2022 that will include enhancements, such as waitlist and table management as well as lay the groundwork for future enhancements as we continue to build towards next generation customer experiences with even more innovation and functionality. This rollout is expected to be.
We completed by the end of 2023 and our final focus area is comfort we have already established a history of providing a comfortable dining experience to our successful heritage remodel program and look forward to re launching our heritage two pointed out program next year. Furthermore, we are very excited to announce our latest investment in the <unk>.
Brand in our revitalization strategy, which is the rollout of our kitchen modernization project. The majority of our company restaurants, along with a group of franchise restaurants have been testing the equipment package throughout 2021 based on the positive guest feedback we're expanding this initiative to the entire domestic system the new equipment allows us to.
Accomplish three main goals first the new equipment package will reduce complexity in the kitchen, both improving efficiency and reducing waste. This simplifies execution for our cooks and results in more consistency for our guest second the oven delivers improvements to our current core items impacting over $4 5 million.
And place every week and allows for improved quality and consistency for our breakfast proteins are bacon as Chris beer sausage is more evenly ground and third investing in this new equipment.
<unk> provides the ability to enhance our menu offerings across all day parts, but especially further elevating the dinner day part with new comforting entre sides and baked desserts. The rollout is expected to begin during the first quarter of 2020 to be substantially completed by the end of 2022, the total domestic franchise system.
<unk> for the new cloud based technology platform and kitchen equipment package is approximately $65 million to assist franchisees, we will be allocating approximately $10 million toward the cost and installation and have also negotiated favorable financing terms on their behalf, where the remaining cost in closing we have a law.
Lot of energy in this iconic brand we are very encouraged to see our October sales results. Once again surpassed 2019 levels. We're also excited to be Kickstarting, our revitalization strategies again, our new technology transformation.
Transformation, including our revamped website and mobile App, the new restaurant technology package that will greatly enhance our operations and guest experience the new kitchen equipment package, which will propel menu innovation and the impending relaunch of our heritage two <unk> remodel program and all of this together should ultimately drive incremental traffic.
<unk> was bolstered by our extraordinary group of dedicated franchisees and their confidence in the long term vision of the brand their excitement around these initiatives and the investments. We are making gives me great confidence about the future of this brand with that I'll turn the call over to Mark Wolfinger, Denny's President to discuss more about our franchisees and <unk>.
<unk>.
Thank you John I want to Echo your comments about the confidence and optimism we have for this iconic brand and the exciting initiatives ahead.
Also want to add that the enthusiasm and energy our franchisees had during our recent annual Denny's Franchisee Association convention was undeniable.
Having the opportunity to see our franchisees in person for the first time in nearly two years was a great experience. So many express their positive outlook for the brand.
We are eager to return to our historical position as America's 24 hour diner and have made steady progress over the last few months.
We currently have approximately 70% of our domestic system operating on average at least 18 hours per day.
This is a 15 percentage point increase from July resulting in 'twenty effective operating hours across the system.
Approximately 45% of our domestic system is currently operating 24 hours a day seven days, a week and an additional 8% of our restaurants.
Operating 24 hours during the weekend.
We continue to work with our franchise system franchisee by franchisee unit by unit to map out a plan to extend our effective operating hours per day, assuming staffing challenges subside over the next few quarters.
We're also being very proactive with our hiring efforts as we launched our second national hiring tour, which leverage our long standing relationships with historical historically black colleges and universities, the National Urban League and the National Society of aesthetic Mbas.
Turning to development, we are very pleased to deliver net positive unit growth in the third quarter.
This growth was supported by the opening of seven franchise restaurants, including four international locations in Canada, partially offset by five closures.
I would now like to take a few in a few minutes to update you on our franchise system.
With dining sales at the highest level since January and the stickiness of our off premise business. We are very pleased to see nearly 90% of our franchise restaurants in October exceeding the 70% of 2019 sales threshold required to cover both fixed and variable costs.
With sales above pre pandemic levels multiple rounds of federal stimulus and a year to date net decline of only three restaurants through September our franchise system continues to be strong.
Our development pipeline remains intact, including approximately 75 remaining commitments from our recently completed Refranchising strategy.
Additionally, our development team is focused on securing market share and has a proven record of converting existing spaces, both inside and outside the restaurant industry into successful biddings locations. In fact in the last 10 years, approximately 60% of our openings have been conversions.
These less capital intensive opportunities provide enhanced rois for franchisees and our experienced development team is already assessing the landscape for future Denny's locations.
I'll now turn the call over to Robert <unk>, Denny's, Chief Financial Officer to discuss our quarterly performance Robert.
Thank you Mark and good afternoon, everyone.
I would now like to share a brief review of our third quarter results and current trends as well as our expectations for full year 2021.
Okay.
As a reminder, I will be comparing our 2021 domestic system wide same store sales to 2019 as we believe this comparison still provides a more consistent and informative representation of our recovery.
Additionally, we will continue our standard practice of comparing to the 2020 prior year in our press release.
Domestic system wide same store sales during the third quarter declined <unk>, 1% compared to 2019.
After highlighting positive preliminary same store sales for July during the second quarter earnings call in August and September softened as new COVID-19 cases increased.
In addition, the quarter was impacted by the availability of flavor that continues to challenge our return to 24 hour operations.
Approximately 45% of our domestic restaurants are currently opened 24, 7%.
Domestic restaurants, which were opened 24 hours in the third quarter delivered a same store sales increase of approximately 11% versus 2019 compared to a decline of approximately 9% at domestic restaurants operating with limited hours.
We still believe this performance differential presents an ongoing opportunity as our system looks to extend its operating hours.
With that being said we are encouraged that preliminary domestic system wide same store sales results for October increased 0.8% with approximately 55% of our domestic restaurants still operating with limited hours.
Now I want to spend a few moments providing an update on the performance of our virtual brands.
The Burger Dan is currently live at over 100 locations, while the meltdown in slides at nearly 800 locations.
<unk> Rollouts are now substantially complete and as John mentioned earlier. These virtual concepts continued to deliver approximately 3% of highly incremental sales, while leveraging labor during the underutilized dinner and late night day parts.
They are also over indexing during the week days compared to the Denny's based brand.
Now turning to our third quarter results.
Franchise and license revenue increased 39% to $57 $3 million.
Primarily due to improving sales from dine in restrictions in the prior year quarter.
Franchise operating margin was $29 9 million or 52, 1% of franchise and license revenue compared to $19 7 million or <unk> 45 zero percent in the prior year quarter.
This margin increase was primarily due to the improvement in sales performance at franchise restaurants, partially offset by fewer equivalent units.
Company restaurant sales of $46 $5 million were up 45, 9%, primarily due to the improvement in sales from reduced dine in restrictions in the prior year quarter.
Company restaurant operating margin was $7 9 million.
Or 17.0% compared to zero point $5 million or one 7% in the prior year quarter.
This margin increase was primarily due to improvements in sales performance and the leveraging benefit of lower staffing at company restaurants.
Additionally, we recorded approximately $400000 in favorable reserve adjustments during the third quarter, which benefited the company restaurant margin operating margin by approximately 0.8 percentage points.
We experienced commodity inflation of approximately 10% during the quarter, which was primarily offset by favorable mix shifts driven by lower value incidents along with pricing.
This resulted in a 90 basis point improvement in our product cost line.
We expect similar commodity inflation during the fourth quarter as inflationary pressures are likely to remain in the near term.
Total general and administrative expenses were $16 5 million compared to $13 7 million in the prior year quarter.
This change was primarily due to increases in both performance based incentive compensation and share based compensation expense. In addition to temporary cost reductions during the prior year quarter.
These increases were partially offset by market valuation changes in our deferred compensation plan liabilities.
As a reminder share based compensation expense and market valuation changes are noncash items and do not impact adjusted EBITDA.
These results collectively contributed to adjusted EBITDA of $24 $4 million.
The provision for income taxes was $4 1 million, reflecting an effective income tax rate of 25 zero percent.
Adjusted net income per share was 16.
Compared to <unk> in the prior year quarter.
During the third quarter, we generated significant relative adjusted free cash flow of $14 $3 million.
After cash capital expenditures, which included capital maintenance of $2 2 million.
Our quarter end total debt to adjusted EBITDA leverage ratio was two seven times and we had approximately $185 million of total debt outstanding including $170 million borrowed.
Borrowed under our credit facility.
As we have stated in the last few earnings call. The pandemic affirmed for us the value of our conservative leverage philosophy.
As such we are currently more comfortable with the range between two and three times adjusted EBITDA in the near term, whereas prior to the pandemic, we would have targeted longer term leverage somewhere between three times and four times.
During the quarter, we announced the refinancing of our amended and restated restated $350 million revolving credit facility to a new five year $400 million revolving credit facility.
With the enhanced flexibility provided by this new credit facility. We were excited to relaunch, our multiyear share repurchase program and we allocated $6 $6 million to share repurchases during the quarter.
Between the end of the third quarter and October 29, 2021, we allocated an additional $6 8 million.
To share repurchases, resulting in approximately $235 million remaining under the existing purchase repurchase authorization.
Since beginning our share repurchase program in late 2010, we have allocated approximately $567 million to share repurchases.
Repurchases approximately 55 million shares at an average price of $10 34 per share leading to a net reduction in our share count of approximately 36%.
In addition to share repurchases. This long term financial flexibility allows for other brand investments such as the technology transformation and kitchen modernization initiatives that John mentioned earlier.
These initiatives are backed by a company contribution of approximately $10 million towards the cost and installation at domestic franchise restaurants.
We have also negotiated favorable financing terms and a loan pool with a portion backstopped by the company to support our franchisees for the remaining cost.
Let me now take a few minutes to expand on business outlook section of our earnings release.
The following estimates for our full year 2021 reflect management's expectations that the current economic environment will not change materially.
We anticipate a domestic system wide same store sales decline of approximately 5% compared to 2019.
Our expectations for total general and administrative expenses are between 67 and $69 million, including approximately $13 $5 million related to share based compensation, which does not impact adjusted EBITDA.
Based on the guidance I. Just described we are expecting adjusted EBITDA of between 84 and $86 million.
In closing as we work to overcome near term commodity inflation and staffing challenges that impact our effective operating hours, we remain optimistic about our potential for additional sales growth.
Finally, and most importantly, I want to mention how proud I am of our franchisees and the entire Denny's team who have remained focused on serving our guests while positioning this iconic brand for continued success.
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.
Thank you, ladies and gentlemen, if you'd like to ask a question. Please taking by pressing star one on your telephone keypad, if you're using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment.
Again, Please press star one to ask a question, we'll pause a moment to give everyone an opportunity to signal for questions.
We will take our first question from Michael come off with Oppenheimer <unk> Company. Please go ahead.
Thanks, Good afternoon, everyone.
Hey, Michael.
Hey, guys I was wondering if you could just sort of.
Tell us what the full year guidance implies for your fourth quarter same store sales relative to 2019 levels. Just so we're all on the same page.
Yes, Michael Happy we're happy to do so so that implies that down 5% on the full year would imply a range somewhere between flat and up 3% to still hit that down five on the full year.
That's perfect thanks for that.
And then you mentioned.
The third quarter was helped by lower staffing levels.
Can you maybe talk about how much do you think that helped this quarter. So we can sort of understand what your core margins might look like going forward as you sort of get back to better staffing levels.
And then related to that you mentioned less value purchases by consumers and more pricing helped to offset 10% inflation and youre talking about similar inflation in the fourth quarter. So do you think the pricing and value dynamics are also the same in the fourth quarter.
So Michael this is Robert I'll start with that margin question, and then pass it over to John So I think the best way to think about margins again, its pretty volatile right now.
Lack of $24 seven and more than half the units 55% of the units.
So I think the best way to frame that is to kind of point you back to where we were prior to the pandemic with the with our latest Refranchising strategy, where we said that we would target 18% to 19% corporate company store margin.
<unk> think that that holds true.
Ultimately longer term, we do have some near term inflation benefits from the lower staffing that will ultimately get filled but we will move back to the to all of the units ultimately being $24. Seven so you throw that altogether and ultimately we do believe longer term, we get back to those Atms.
The 19% margins.
On the company side so.
That's that piece and I'll pass the pricing question over to John.
We did experience.
Sort of a combination of a series of events.
With staffing challenges as you can imagine filling the dining rooms.
Is is it's fair amount that we fill it with full price guests. So the focus on value sort of disappeared across the industry and.
In general.
Not just full service, but just pretty much across the entire industry. So that's given some buoyancy to check so that along with pricing is a little bit higher than normal pricing to cover wage and commodity inflations creates a little bit of.
Check that's higher than the normal run rate as well. So when you put all those together you have a flow through from that missing the value part of the normal part of the process is to stimulate some of your sales through a value components of the value part of our equation that is down and I think youll see that consistent trend across.
Industry at the moment.
Thanks, guys I'll hop back in.
Thank you.
We will take our next question from James Rutherford with Stephens incorporated. Please go ahead.
Thanks, very much and for all the information here I'm just curious on the kitchen modernization effort that $65 million price tag indicates I think about 40000 per store correct me, if I'm wrong, there, but with all the costs that operators are dealing with now I'm kind of curious what the reception has been for that investment.
Why now kind of question and then also if you're able to quantify some of those food or labor savings that you referenced.
Sure. So surprisingly our franchisees have been very enthusiastic about the project. This is this is not something that we just tested in 'twenty one although our prepared remarks talk about the fact that it's been in test throughout this year preparing to rollout, but this is this has gone on for some time.
We've been on this long journey of.
The revitalization of Denny's as America's diner, and we focus for many years on the breakfast and lunch component. The part of preparing for dinner has been the launch of these ovens.
But to do to do dinner items that you don't Cook to order, which would be a big change for normal breakfast or grill Cook.
You have to have hot holding equipment with that you have to have different refrigeration on the line you have to have a training program that supports it. So our franchisees had been saying where this takes us back to the heritage of our brand way back when and they've been enthusiastic for the day that we could finally get to this stage in our company the why now.
Say that there was very little discussion around the timing or that there is high wage inflation or commodity inflation or tough time staffing coming out of the pandemic. Most franchisees are looking past that to the longer term, which has been a really nice place to be for us our franchise convention there was tremendous enthusiasm.
Around that.
Workshops were filled with people.
Learning more about where product could go and some of our vendors along with our product team actually demonstrated some of the things that will be available several quarters down the road, so that sort of takes care of the answer around the kitchen.
As far as the technology Likewise, when we see this much of our business going to both virtual brands, which has been seen as highly incrementals as well as our denny's on demand. The enthusiastic reception of our guests is given this new platform of the Denny's Dot com website really high scores.
From folks say, how much easier it is how much more frictionless. It is to be able to order online to navigate the menus to add to lead plus or minus their own customization. There build your own capabilities. It's been such a positive experience for our guests and the notable comments from our guests that are.
Disease have been enthusiastically embraced this time to move to a cloud based system to move to a system that had more capabilities and even though that rollout takes a little bit longer period of time. There is enthusiasm to see that kicked off so that as we get to the end of the pandemic and transactions continue to improve we will have those capable.
As in the system, it's a long journey due to the completion of that and so no one wanted to see that delayed.
We can let Robert speak to sort of the mix between those two investments, but that amount of money is.
Both kitchen modernization and tech.
Transformation.
That's right James It is both the $10 million is the aggregate for both of those I think the way that that is about.
<unk>.
Bye.
Yes, so about 60 40 between the kitchen.
And the technology, but again, it's wrapped up in a in total between those two.
We with regard in total the $65 million for the franchise piece, we did put together the financing for that and that will come out over time.
The interesting pieces with regard to that about 25% of our franchisees.
Have said that they gave their given their financial position they're going to.
They're going to.
<unk> in cash.
So again speaks to some of the health of the franchisees, 75% of the company and it's by the way already have.
Kitchen equipment. So we will include the balance of that will likely run through.
Q4 capital, so that won't necessarily be and it wasn't it wouldn't be a big number considering we have 75% already installed.
But it will impact the balance will impact Q4, not extending into 2022.
Okay.
Thanks for all that information and then yes.
That's really helpful. The second question is just on the staffing situation as well, but I wasn't sure if.
There was a comment made earlier that staffing has not materially improved I'm not sure. If that was a comment in regards to company or franchise, but I'm curious if you know.
If that's the case, how there has been growth in the number of units running 24, 7% each month not huge growth, but gradually improved how is that happening. If labor is also not improving in lock step. Thanks very much that's a great. That's a great question as you can see we're trying to be consistent with our comments you might have asked it a different way.
Staffing has got momentum then why havent more stores moved $20 seven so we wanted to make sure that our comments were tempered in our prepared remarks, we have moved up about 90 units from July until now that our 2007.
We do see momentum in staffing, but we do see this playing out over.
A few more quarters, rather than something happening just overnight in the next few weeks. So remember when you put when you put these employees on there is a little bit of a wedding periods in a testing period in a training period before you actually extend the hours and so we just wanted to be tempered there is enthusiasm for getting there a lot of support from a franchisee Association.
From Board through Committee members.
But just also.
Our request for.
For us to be mindful of the fact that we don't want to we don't want to open up those hours and have a miserable experience for our guests with somebody new and not capable yet. So this is going to take a little while but there is momentum is improving and so I think I.
I think thats, a good call out that our remarks.
Our prepared remarks, maybe you Didnt tell the whole story. There is there is positive momentum in staffing.
Love that approach thanks, very much for the help.
Thanks, Jamie.
We'll take our next question from Nick <unk> with Wedbush Securities. Please go ahead.
Thank you.
Just going back to the pricing question I know historically.
<unk> been hesitant to take.
Much more than say, 2% to 3% pricing.
Yes.
Just given the context of inflation today and into the first half of next year.
Are you comfortable taking a little bit more pricing than that what that pricing could be again in the context of just.
Lot of the peers, taking a lot more pricing than we've seen historically.
Nick that's a great question I'd say the simple answer is yes, we're comfortable something above our historical norms.
And we don't have quite the hesitation you would normally have there has been considerable wage and commodity inflation and.
And I think it's fair to say that our franchisees, who largely control that.
While disciplined we will be ahead of the historical average.
Is there a way to get away from the company owned side that you guys have visibility.
<unk>.
Maybe quantify the demand late night headwinds from staffing constraints in terms of sales.
I think it's largely staffing I don't know that there'll be much more than that to quantify the difference.
Youre asking reluctance on the franchisee to go to 24, 7%.
Noise is in.
The brand and has been here for probably 20 years plus I've been here for just slightly ahead of 10 years now and so you see a small group of folks who say gosh.
In my neighborhood, it's pretty sleepy, but thats, a pretty small contingent most understand the beneficial economics. The momentum we have in late night with third party and.
And I would say that the.
The conversations and our brand.
Around convention in most circles are more just give us time to staff properly. So I think it's really highly correlated to that single topic.
Got it and just im not sure if I got to the heart of your question or not.
What I interpreted your question to me.
That's okay I will follow up offline.
On the kitchen monetization cost next year is that all within G&A in terms of the $10 million.
Yes, that's an excellent question Nik no it actually won't come through G&A at all.
The way the way that will be recognized.
It is over the balance the average balance of the life of the franchise agreement so.
Somewhere likely let's say five years to seven years, so what youll see is.
Probably 1 million five $2 million thats going to run through the franchise margin for each of the next 567 years. So we won't have we won't take that hit all at one time, while the cash will come out the door as those are.
Those are put into the system. It will actually in a very technical center to answer that will be a contra revenue item is the way that will fall out so it won't actually be an expense it will be a contra revenue item, but thats, a very specific technical answer to that but it will not impact G&A. It will impact the franchise margin and it will extend over.
The average life of the remaining franchise agreements.
Got it and another to a classic clarification.
The October quarter to date number at least for the company owned side can you maybe tell us what the average weekly sales number for the company on site is perhaps sober.
So Nick.
What I know they were up <unk> eight and I can again reiterate the fact that likely the differential between the $24 seven and the non 24 seven.
He is still in that range of that 20 point differ differential.
It's about 1% for the system again that <unk> eight.
And the company is generally higher than the franchisees.
Okay. Thank you.
Thanks, Nick.
We'll take our next question from Jon Tower with Wells Fargo. Please go ahead.
Hey, great. Thanks for taking the questions.
First one.
John I think you had mentioned something earlier in the call about the new kitchen equipment, allowing.
Allowing you to kind of get into some new products, specifically kind of.
Geared towards the <unk>.
Dinner time period so.
I was wondering if you could expand upon that a little bit maybe where those products are in Perth today. If they are in test today and how we should think about those items versus the current menu.
Is it going to be new proteins are utilizing a lot of skus that you already have today.
In a different format because of the equipment that you have and.
Yeah, I'll pause on that.
Well, they could impact breakfast lunch dinner and late night, we called attention to the fact that there will be some enhancements at dinner one of those.
<unk>.
Our Red program was when I can call attention to right now we have a garlic toast and that's it so it will be an ability to have a breakfast finish.
<unk> finished biscuit or dinner roll that would be a capability, we would have in the future and I hesitate to mention too. Many others. We do have a pretty good testing protocol, we've exposed our franchisees to a number of the products and a series of cuttings and through the normal ways in which we communicate to our franchise system. There is some enthusiasm about it.
But at the same time the menu can only be so big at the same time. So I think the process here would be very focused and disciplined about rollouts.
And so.
As first things first as we improve the quality.
And the ability to manage our current shifts just with this equipment. So the ability to get through a busy shift is enhanced.
It does save waste it does save.
Some amount of later that labor that we think will be redeployed rather than save technically and so it just helps run the business better.
That business case alone got our franchisees very enthusiastic about it so within what comes at dinner will just be something that will come. Once these are fully installed in the full system and which is still a little ways down the road.
<unk>.
It will be the typical array of things to support our diner positioning.
Got it and I apologize if I missed this earlier, but did you say what percentage level youre at with respecting to.
Staffing levels versus 2019.
I don't think we gave that level.
But we but we it's sort of hard wired in the answer of 90 additional stores versus July that are 24, 7% and we.
We have an effective 20 hours now that's moved up from where we were in July. So we have the number of stores in the system as we move up in 24 hours. The number that are in restricted hours moves down but it doesn't tell the full story, but theyre also moving up in total hours or 18 hours plus so.
So both the 24, 7% in the 18 hours as plus we're now at 20 effective hours.
Per day across the whole system. When you when you average in the 46% that are are at 24, 7%.
And the rest of the system north.
But then you can correlate that back to the number of stores of staff.
It doesn't give the total head count missing I will say this our hiring as I said earlier it is showing promising signs of building momentum.
And do you think you'd need to staff back to 2019 levels across the system. Obviously, you try to drive our late night business. These virtual brands, but it sounds like this kitchen equipment will also allow you to manage hours a little bit better maybe redeploy to labor better in the stores, but I guess do you think these stores really need to be staffed at those levels again.
What I would say is that we ultimately hope so.
So staffing grids in our industry are pretty simple, they're tied to transactions. So you.
We have some fixed variable costs at a pretty dynamic you'd get passed fixed level pretty fast with management in a few key positions and the rest is variable and so as transactions increase you had labor back in we would we see us we see ourselves as a brand that will ultimately get back there.
<unk>.
So we are hopeful of needing every single body that were missing from the roster right now.
Stay on the road got it and then just digging into the commodity inflation comments I think Robert you had mentioned that you expect similar levels in the fourth quarter as you saw in the third quarter, which would imply roughly 10% or so.
Yeah.
Wanted to get your take on your thoughts for 'twenty two.
And your ability to or the franchise the ability to start potentially locking in any sort of product for 'twenty, two and at what levels Theyre potentially seeing now.
Any thoughts there would be helpful.
Yeah. Thanks, John So with regard to 2022.
I think.
We really have described is that 10% in Q3, we've said that that will remain for the near term the implication that that's Q4 likely extending into 2022, we ultimately do see.
See it abating at some point in 2022, that's the vision that we have we will give that guidance as we get into February but we don't ultimately see this.
Existing permanently we do see some.
If peaking at some point likely in the first half we do keep our eyes open.
The opportunity to lock in the dilemma right now as you would suspect.
Everything is really.
Pretty high levels. So we are.
Are very opportunistic and to the extent that we saw something that we believed would be at.
Market low or below average looking out for the next 612 to 18 months, we would take that opportunity to lock it just really hasn't presented itself.
At this moment, but we are always looking for that opportunity.
Got it thanks for the color thanks for taking the questions. Thanks, John Yep.
We will take our next question from Jake Bartlett with Truth Securities. Please go ahead.
Great. Thanks for taking the question.
Wanted to start with just your expectations for the next two months of the year just to make sure.
I understand I know that sometimes when we take an average they are sticking to the weightings by by month and stuff, but you might math is that the November and December.
Given the range, you've talked about would be kind of flat to up 4% and I'm trying to think about the drivers to being on one or the other end of that range.
Could you talk about maybe your confidence.
Why you wouldn't expect to be at the high.
Higher end.
Staffing is improving if we're consistently adding hours if you have a new digital platform youre starting to get rolled out here.
<unk> contribution just maybe some of the moving pieces as to what would drive you to the to the top or the bottom end of the.
The range, if I'm right about flat to 4% for November December.
Right.
Great questions I think the headwinds and <unk> are pretty well stated out there.
The the <unk> stack and continues to improve and therefore, it's ours would continue to expand we are confident in our promotional calendar we have a very.
In spite of the all the things that are challenging in the environment of our franchisees.
<unk> have some pretty enthusiastic body language about the investments, we're making in the brand and the outlook for the future.
On the tailwind side commodities and wage inflation and consumer confidence have been sort of on a little bit of a roller coaster, although October really looks very much more promising.
Then with the Delta variant starting to subside.
Cooler weather comes on.
Volatility around the world always creates headwinds and so.
We have.
I think guided.
I think the simple answer is guiding with the same amount of precision and competence and creates a little bit more ranges and guidance. These days.
But we did say.
This would be positive flat to three.
And.
Yes, Jay in front, a little bit more technical answer right. So if you think about what we did with our Q3 guidance, we had a little bit higher of a sales range than what we ended up producing that we guided prior to the delta variant really grabbing hold.
One of the things I can tell you, though is that regardless of that if you recall, we provided the guidance range on adjusted EBITDA of 22% to $24 million.
And despite.
It really kind of coming in below the sales range. We topped the profit range. So again, just don't necessarily want to have that same issue again with sales so trying to be conservative.
And again, we have proven that we can still bring that to the bottom line and if you convert that adjusted EBITDA into free cash flow adjusted free cash flow.
Again approximates about 60 cents of every dollar.
<unk> brought down into into the adjusted free cash flow. So I think I get the math that you're doing for the zero to 4% range.
And again, we'd just as John mentioned there its just.
It's a little bit difficult to be overly specific but again, we'll focus on delivering that profit with what comes through the top line.
Great. That's helpful. And then one maybe this could help frame the impact of the staffing, but could you talk about your weekend brunch sales recovery versus 19 versus some of the other day parts weather weekday breakfast youre starting to see more of a normalization as we get back to work or.
<unk>.
I would imagine a.
Yes.
Great question weekends have been stronger than weekday.
Okay.
And then we will remember there in all likelihood ahead of the weekday.
Got it and that's despite.
Likely I would think that Thats, where you could have some some staffing issues being more of a constraint.
That's not happening.
Well, you'll you'll cover your business shifts first and.
For sure so it's.
I'm, not saying that we don't have staffing challenges.
At all day parts, but it's it's focused and concentrated on the hours, where you are not open.
So as we build staff and staffing momentum the best training environment for them would be on the weekends. When we're busier and then you turn them loose to open up other other day parts and ship. So we are seeing again more momentum on the weekends and I would expect that to continue through the fourth quarter.
Great and then.
In terms of the kitchen equipment and what you've seen in the in your company stores. It was.
It sounds like maybe what you experienced there was you were able to convince their franchisees to two.
To go forward with it so can you quantify any of the impacts on sales or any of the impacts on.
On cost savings just so we can understand how I guess, how big a deal as it could be longer term.
Okay, and just give you some general ideas when you're when you are able to.
Bob Cook.
Hi Tech new oven.
Then you free up space on the grill.
And when you free up space on the Grill, you. The Cook is not sort of waiting or running up and down the line to be as efficient. So you improve some ticket times and you're also improve some waste.
The hot holding from products prepared in a.
Much better quality and control environment like the oven.
Grounding, our sausages on all sides not routinely some products flipping hash Browns too early if theres any number of products that are better on the averages and and then therefore you don't have as many of those pieces that don't make the shift and get thrown away. So it improves waste and improves labor.
And improves quality.
But the material improvement is how much easier it is to manage getting through.
Challenging busy shift, especially when you are moving from <unk>.
Breakfast to lunch on a weekend and you have the menu start to dynamically changed from pancakes or burger bonds or burgers filling the grille.
To have that space to just navigate the product mix is materially easier on the cooks and the product quality has improved dramatically as a result, so it's around a lot of different categories.
Little pieces here and there.
<unk>.
And we will be able to we'll be able to share this a little bit more specifically in the future it's a bit early.
Great I appreciate the detail. Thank you.
Thanks, Craig.
We will take our next question from Brett Levy with MK and partners. Please go ahead.
Thanks for taking my questions.
When you say hey, Brad.
Hey, guys. When you think about all of the different pressures on the franchise system and all of the new investments that you are talking about now.
How are they thinking and obviously you still have the 75 unit commitments how are they thinking about development. How are you thinking about what the next 135 years looks like.
What's their appetite right now to take on.
Additional pressures from openings, while still trying to find enough labor to get the.
To get the current operations up to full speed.
No. That's a great question, our franchisees sort of answer it in two different ways. There is this.
Unbridled enthusiasm for the longer term not only for family dining before our positioning in that as America's diner at the same time the labor when we pull our franchisees and then speak to our franchise business coaches that have direct contact on a more of a daily basis with their franchisees in the trenches they will say that.
Staffing challenges there number one challenge.
So commodity and wage inflation runs right behind that and the rest of these challenges there are a lot less concerned about not that they're not concerned there is a lot of things they face, but whether it's a pandemic recurrence or lockdowns or mass or vaccine mandates or political environment are all the kinds of things as sort of show up.
On the radar over the last year to year and a half their way lower and it's really more about staffing. So the near term staffing challenges impact a little bit of the body language toward development.
Way too early for us to talk about one year, where next year's guidance or two to three impact on Remodels, where development, but I would say the franchisees very short term are are knowing they want to see the brand grow and develop they want to meet their development commitments and at the same time.
I would say because of staffing there a little bit more wary about the pace at which those things kick back in.
Okay.
And so as staffing abates confidence returns.
Net meant say staffing challenges abate confidence return.
I'm going to try to ask this a different way on the staffing levels.
What percentage of your system would you say if you had to.
Hartal rank.
Or if you could talk about like the bottom half of the bottom quartile.
How how challenged are they how long have they been.
Pressured where where you think they can get what they want to get back to staffing levels, but they just can't seem to get.
The personnel to either joint or stay.
Regardless of whatever the situations can you talk about that bottom quartile, a little bit more yes, yes.
Yes, I think we do think about it that same way. It's a great question, we think about the areas, where it's been more challenging than others or areas, where traction is not as prevalent as others.
Sort of focused on what's going on there how can we assist.
What can we do to get the staffing challenges to obey quicker.
Are there are you participating incentives take a good look at their scheduling their roster.
The number of experienced managers or cooks. It makes it harder to onboard new wounds or have a harder retention.
Bigger retention challenges for new ones and the fact of the matter is those that sort of went the farthest down have the farthest to come back because they will have maybe no.
Tribal knowledge no cultural knowledge on their staff.
Any experienced servers whatsoever, so they're the ones that are struggling the most and it does seem to be isolated to a few areas that are sort of trailing the momentum of the rest of the brand.
California was a concern for us early on.
Where it didn't get the traction or Florida, or Texas, or Arizona right at first but now it seems to really be picking up momentum. So that was a big relief for our franchisees that reside and operate their their sales.
Are coming back quicker and it's outperforming most of the others in fact, all other states in the country and so our franchisees' commitment to step up to wages and commitments to full time hours for certain positions in all of those things have sort of gone away. So there's a lot of positive momentum there and so there's just a few areas where that where that lags a couple of states in the Midwest, Pennsylvania.
And a little bit of a Pacific northwest, where it went down a little further and has little harder to come back it's coming but it is lagging the rest of the system, but the confidence of how we got through that in other areas seems to be a strong indicator of what's yet to come.
Yes.
In our core tile or quintile, it's probably one quintile at the present that represents the biggest headwind.
Brett This is the conference operator, you may have muted on your end.
Oh I'm sorry. Thanks.
And as a reminder to the audience star one for questions. We will take our next question from Eric Gonzalez with Keybanc capital markets. Please go ahead.
Hey, Thanks good question.
Given the store level profitability in the third quarter the company owned stores with costing about 90% 90 basis points favorable.
And very similar to 2018 levels are we assuming the franchisees are seeing a similar level of improvement and Thats the case.
That 10% inflation.
It's being offset with modest pricing and mix improvements is there a need to price above historical ranges in the near term or perhaps <unk>.
He is a little less urgent than it had been in the past.
So Eric this is Rob I'll start.
Then let Jon add on there so we do have a tool.
It's called a looming <unk> through which we capture about half of the franchise P&L on a monthly basis through that tool I would suggest that they are seeing similar effects with regard to the increased check whether that be the mix of the pricing that we have taken to date.
And the deleveraging effect that we're seeing through the product cost line.
Ultimately when you look across that P&L, let's just not isolated into there we are seeing.
Some similar wage inflation or wage wage inflation I don't want to imply that it's similar to commodities, but we are seeing wage inflation. So it's really best.
To look at those.
In tandem.
Would you suggest a what.
What if.
If you look at the 10% commodity inflation as some of the some of the work that we've done with the franchisees, we take a lot of time to educate our franchisees on pricing.
Again, we do feel that remaining competitive with pricing is critical.
And to cover our commodity inflation of up 10% with.
Would require about a quarter of that in pricing so to two 5%.
To get there so much less than what you might otherwise anticipate and we take a lot of effort to educate our franchisees on that topic. It does vary though the required level of pricing because of the other.
Factor there that I mentioned labor inflation varies dramatically across states. So again individual pricing determinants are made by the franchisees in those various situations, but our our efforts have been with regard to education on pricing.
And the potential for not needing as much as one may otherwise think so.
Yes.
Add much to that.
Other than its.
It's very different the rare for a dynamic process.
Every time, we have a menu print to educate franchisees.
We do assist them with a review of the P&L on impacts of rent labor food sort of total whether or not they are trying to maintain some sort of a percent.
The achievement or whether they've got their cost covered.
And so it is a dynamic process. So in the same market, let's say.
Some franchisees that missed the last round and take a little more of this time and others kind of got it covered in the last round, we will skip this time so but.
But we do.
We hope sooner with our franchise community.
Two two walked in through quite a bit of detail and educate them on what's going on and we also use a company called RMS They provide insights and then.
We work with our franchisees one on one.
And quite a number of our franchisees you reach out to them to understand where they have pricing sensitivities and where they don't and a good portion of our franchisees are now in a discipline of at least hitting their advice to some to some degree.
And then.
Uh huh.
And then the whole thing just sort of rolls up to what our averages are.
Menu change to another.
It's a great question answer is some do not some recovered already some are not and we will need to take some price.
Got it and then maybe if I can ask about the marketing plan right. Now you are a franchise business that collects advertising fees.
You have to spend those those dollars.
And this is happening at the same time when some of your large competitors are generally turning off the advertising and maybe redeploying those funds into other areas.
So my question is with the funds that you collected versus and deployed.
Youre pivoting away from value added value advertising. So how are you maximizing the impact of what is likely an outsized level of mind share versus what you would have achieved in the past with a similar budget.
Yeah.
I do think that higher frequency.
Quick serve or fast casual brands.
Maintain a top of mind awareness from sort of proximity drive by and what have you I think family and casual require have an advantage when they are scaled and can buy media versus.
Labor neighborhood markets and sort of have a little bit more dependency on a.
A reminder.
How to use those brands and why do you use them as one of the things that builds our ability to scale and consciously cannibalized and sort of penetrate markets a little bit deeper.
And so I would I would not say that we've achieved any top of mind awareness unaided certainly.
But.
But in terms of influencing where I might have dinner Tonight, I'd say that that we would continue to spend our marketing dollars to drive awareness and trial and awareness and trial, but we have been using those dollars through a combination of.
Traditional platforms as well as shows the platforms, we think that we have.
A pretty good finger on the path of what's required to get the right reach and frequency of the audiences of our.
Core customer.
And our annual calendar is required.
Some.
Investments in introduction and awareness around off premise.
Because family Guy has historically been and lower off premise provider.
And where we are today, we've used some of that to talk about diner positioning and sort of are 24 hours open all day, we use some of that to talk about value during value seasons, particularly after the holidays back to school and we use some of that to do product promotions of either new introductions.
For reinforcement with some of the favorites on our menu. So so all of those tend to be in the mixed model and when we do.
The appropriate investments in NII.
I think that Thats required some brands have have said let's.
We got longer lines right now through the drive thru.
What do we do to hold onto that share.
But I think they are less concerned about whether that's going to run into.
Full service is more concerned than it is not a threat to to Mcdonald's, but the grocery store might be so I do think you see people gearing up for premium promotions, rather than value promotions, rather deep discounts and focusing on the premium quality sandwiches that they've loss and the like so you do you do see.
To see that cadence and quick serve and fast casual. These days I do think that will influence full service.
Promotions as well to some degree.
It's a little early to know for certain.
But I think that seems to be the direction, a little bit of a reluctance to run back to absolute discount type value promotions and a focus more on premium promotions quality for the money quantity for the money bundled meal qualities rather than just steep discount.
Great. Thanks.
Thank you.
Ladies and gentlemen. This concludes today's question and answer session. At this time I'll turn the conference back to Mr. John Miller for any additional or closing remarks.
Alright. Thank you all for joining us today on the call. We are very pleased with the progress we've made through the pandemic and we do continue to navigate through the recovery the demand for <unk> remains strong with same store sales training above.
Pandemic 2019 levels in October <unk>.
With only 46% of our domestic system operating at 24 seven.
As we safely welcome guests back into our dining rooms, our off premise business has remained sticky supported by the successful launch of two new virtual brands, which are delivering approximately 3% and the incremental sales for our system and we continue to actively address the temporary staffing challenges with.
Hiring and training efforts and we believe this situation will correct itself in due course as it does we see additional potential for our brand based on the performance of those restaurants already operating 24 hours a day seven days a week and we are encouraged by the level of adjusted EBITDA and adjusted free cash flow generated by our highly franchised business model.
Through the third quarter. We were also excited to begin returning capital to shareholders. During this quarter, while at the same time announcing meaningful investments in kitchen equipment and restaurant technology platforms that will advance long term brand revitalization strategies. So we look forward to our next earnings conference call in February when we will discuss our fourth quarter two.
'twenty one results. Thank you all have a great evening.
Ladies and gentlemen. This concludes today's conference. We appreciate your participation you may now disconnect.
Yeah.
[music].