Denny's - Earnings Call - Q2 2021
August 3, 2021
Transcript
Speaker 0
Good day, and welcome to the Denny's Corporation Q2 twenty twenty one Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Curt Nichols, Vice President of Investor Relations and Financial Planning and Analysis. Please go ahead.
Speaker 1
Thank you, and good afternoon, everyone. We appreciate you joining us for Denny's second quarter twenty twenty one earnings conference call. With me today from management are John Miller, Denny's Chief Executive Officer Mark Wolfinger, Denny's President and Robert Gerostic, Denny's Executive Vice President and Chief Financial Officer. Please refer to our website at investor.dennys.com
Speaker 2
to find our second quarter earnings press release
Speaker 1
along with a 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. John will begin today's call with a business update. Mark will then provide some comments around restaurant capacities, our franchisees and development. And Robert will provide a recap of our second quarter financial results and current trends.
After that, we will open it up for questions. Before we begin, let me remind you that in accordance with the Safe Harbor provisions
Speaker 0
of
Speaker 1
the Private Securities Litigation Reform Act of 1995, The company knows that certain matters to be discussed by members of management during this call may constitute forward looking statements. Management urges caution in considering its current trends and any outlook on earnings provided 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 ks for the year ended 12/30/2020, and in any subsequent Forms eight ks and quarterly reports on Form 10 Q. With that, I will now turn the call over to John Miller, Denny's Chief Executive Officer.
Speaker 3
Thank you, Curt, and good afternoon, everyone. I do hope that each of you have remained safe and healthy since we last shared an update on Denny's. And we are very encouraged by our second quarter system wide same store sales results, which achieved approximately 99% of 2019 levels despite staffing challenges that have hindered our ability to return to 20 fourseven operations across our system. This performance included same store sales of 1.9% above twenty nineteen levels at our company restaurants for the second quarter as tourism and travel are gaining momentum. I'm even more encouraged by the stickiness of our Denny's based brand off premise business, which has grown from its pre pandemic trend of 12% to over 20% during the second quarter.
Additionally, we are seeing an incremental 3% of average weekly sales through our two new virtual brands, the Burgers Inn and the Meltdown. We're very pleased the positive sales momentum continued in July with preliminary domestic system wide same store sales 2.7% above 2019 levels, including 2.4% at domestic franchise locations and 6% at company locations. Furthermore, approximately half of the domestic system generated positive sales in the month of July and each of our top four states were positive as well. These results are a testament to the hard work and dedication of our teams, safely welcoming guests back into our dining rooms while remaining focused on growing our off premise business. Our teams have accomplished this while enduring industry wide staffing challenges that have impacted our ability to execute at our highest potential, especially during our late night daypart.
However, we are excited and encouraged by our recent America's Dining hiring tour. We deployed our mobile relief diner that typically supports people during hardships such as natural disasters to bring awareness to our hiring efforts. This week long tour with our new career website that includes open positions for all company and franchise restaurants in one centralized location supported our efforts to recruit applicants for over 20,000 open positions in our restaurants. We remain focused on our four key guest centric themes. These are reassurance, value, comfort, and convenience.
And I'll now touch briefly on each of these. As guests return to our restaurants, it is more important than ever that we ensure the health and safety of our teams and guests. So we are committed to reassuring our guests that Denny's provides a safe dining experience by consistently executing our enhanced cleanliness and sanitation procedures at all consumer touch points, a point of great importance in light of recent surges in COVID cases across the country. And our second area of focus is value. We understand that value comes in different forms and has a different meaning for each type of guest.
We consider our value approach to be a comprehensive balance between price, abundance, convenience, and bundled value. And our third focus is comfort. We strive to ensure that Denny's is a place where our guests feel welcomed and valued. Whether dining with a large family or as a party of one, we believe our guests view the Denny's experience as a time to build connections in an environment that is both inviting and comfortable with consistent and reliable service. Our final area of consumer focus is convenience.
We believe guests will continue to expect technology to bring enhanced value to their dining experience, whether in our restaurants or through off premise options like our well established Denny's on Demand platform of our two, and that of our two new virtual brands. Our first virtual brand, The Burger Den is live in over 1,100 locations and allows us to focus on one of our strengths, great burgers, with new varieties using ingredients that are already in the pantry. Our second virtual brand called the Meltdown is a DoorDash exclusive brand that features handcrafted sandwich melts with fresh ingredients and unique flavor combinations. While this brand can utilize approximately 70% of the items currently in our pantry, our innovative culinary teams have crafted new craveable products with the addition of some new premium ingredients. We started the rollout of the meltdown in April to approximately half of our domestic system and expect to be substantially complete during the third quarter.
Robert will give more specifics on the performance of these brands. However, we believe these transactions are highly incremental and leverage underutilized labor to maximize kitchen efficiency. Furthermore, these brands provide opportunities not only at dinner and late night to leverage underutilized labor and kitchen space, but we're also seeing a meaningful number of transactions during the week versus the weekend. In closing, it's amazing how far we have come since the beginning of the pandemic. Many things have changed in the restaurant industry, but one thing remains the same.
We're still the place where people come in, sit down and connect with one another over great food. And despite near term labor challenges that will subside in due course, our sales have now surpassed pre pandemic levels. We have launched two new virtual brands driving incremental traffic during underutilized dayparts, and we still believe there are market share opportunities on the horizon. We have an extraordinary group of dedicated franchisees and an exceptional Denny's team, which makes me very optimistic about the future of this brand. With that, I'd like to turn the call over now to Mark Wolfinger, Denny's President, to discuss more about our franchisees and development.
Speaker 4
Thank you, John. Our outstanding team and franchise system are driving a lot of exciting momentum for this iconic brand. I'm very pleased to say that beginning in May, all of our operating domestic restaurants had opened dining rooms and we currently have an effective capacity of approximately 99%. We are eager to return to our historical position as America's twenty four hour diner and have seen a 5% increase in effective operating hours since the beginning of the year to our current level of nineteen hours per day. We have worked with our franchise system, franchisee by franchisee, unit by unit to map out a plan to increase our effective operating hours per day, assuming staffing challenges subside after the enhanced federal unemployment benefits end in September.
Turning to development, franchisees opened three restaurants during the quarter, including one international location in Canada. Additionally, franchisees closed seven restaurants during the quarter, yielding a net decline of four restaurants during the quarter and five net closures year to date. This does represent the lowest year to date closures we've had we've seen in over a decade. I'd now like to take a few moments to update you on the health of our franchise system. With off premise sales remaining strong even as our dining rooms have reopened, we are very pleased to see franchisee profitability in July continue to improve as nearly 90% of our franchise restaurants exceeded the 70% of 2019 sales threshold required to cover both fixed and variable costs.
Additionally, franchisees represent approximately 98% of the domestic franchise restaurants have applied for the second round of PPP and approximately 90% of those restaurants have received funding to date. Improving sales, additional federal stimulus available to franchisees and the net decline of only five restaurants through June gives us confidence in our franchise system's ability to prevail and emerge on the other side of the pandemic more focused and driven than ever. We look forward to seeing this historic recovery unfold and returning to net restaurant growth in the future backed by our existing domestic and international development commitments, including approximately 75 remaining commitments from our recently completed refranchising strategy. Additionally, we believe there will be market share opportunities as the industry recovers. However, with multiple rounds of federal stimulus that have assisted our franchisees in remaining open, we believe these programs have also allowed other competitors to remain open.
Therefore, the opportunities may not be as robust as once thought at the beginning of the pandemic. Nevertheless, our development team is focused and has a proven record of converting existing spaces both inside and outside the restaurant industry into successful Denny's locations. In fact, in the last ten 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 Vorostik, Denny's Chief Financial Officer, to discuss the quarterly performance.
Robert?
Speaker 2
Thank you, Mark, and good afternoon, everyone. I would now like to share a brief review of our second quarter results and current trends as well as our expectations for the third quarter. As a reminder, I will be comparing our 2021 domestic system wide same store sales to 2019 as we believe this comparison will provide 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 second quarter declined 1.2% compared to 2019.
Sales results benefited primarily from reduced dine in restrictions related to the COVID-nineteen pandemic. While closed dining rooms and capacity restrictions are no longer the leading factors weighing on our business, industry wide staffing challenges remain. As John mentioned, the availability of labor continues to challenge our full return to twenty four hour operations, with approximately 40 of our domestic restaurants currently open 20 fourseven. Domestic restaurants, which were opened twenty four hours in the second quarter, delivered a same store sales increase of approximately 12% versus 2019 compared to a decrease of approximately 10% at domestic restaurants operating with limited hours. We believe this performance differential presents an ongoing opportunity as a growing portion of our system extends its operating hours.
With that being said, we are encouraged that preliminary domestic system wide same store sales results for July increased 2.7% with approximately 60% of our domestic restaurants still operating with limited hours. Now I want to spend a few moments providing more detail on our virtual brands. As John mentioned, we believe these transactions are highly incremental and leverage underutilized labor to maximize kitchen efficiency. In fact, approximately 70% of transactions from the Burger Den and approximately 60% of the transactions from the meltdown occurred during the dinner and late night dayparts compared to approximately 35% of transactions for the Denny's based brand. Not only are we leveraging underutilized dayparts, but both virtual brands over indexed during the weekdays compared to the Denny's based brand, providing additional opportunities to leverage underutilized labor.
Approximately 75% of transactions from our virtual brands occurred during the weekdays compared to approximately 65% for the Denny's based brand. The Burger Den is live at over 1,100 locations with an average check similar to a Denny's off premise transaction. As dining rooms have reopened and initial priority given to new brands on third party platforms has moderated, these locations are generating average weekly sales per restaurant of approximately $600 Nearly 700 locations are live with the meltdown and are generating approximately $1,200 in average weekly sales per restaurant with an average check similar to a Denny's off premise transaction. The actions being highly incremental and over indexing at dinner and late night compared to Denny's base brand off premise sales, margins range from the mid-20s to the low 30 percent after considering product cost, delivery fees and labor efficiencies. Turning to our second quarter results.
Franchise and license revenue increased 134.1% to $58,600,000 primarily due to improving sales from reduced dine in restrictions. Franchise operating margin was $29,900,000 or 51% of franchise and license revenue compared to $9,800,000 or 39.1% in the prior year quarter. This margin increase was primarily due to the improvement in sales performance at franchised restaurants, partially offset by fewer equivalent units. Company restaurant sales of $47,600,000 were up 214.5%, primarily due to the improvement in sales from reduced dine in restrictions. Company restaurant operating margin was $9,800,000 or 20.5 compared to a loss of $4,500,000 or negative 29.6% in the prior year quarter.
This margin increase was primarily due to improving sales performance at company restaurants in addition to lower payroll and benefit costs due to staffing challenges. Additionally, we recorded approximately $600,000 in favorable reserve adjustments and tax credits related to the CARES Act, which benefited the company restaurant operating margin by approximately 1.3 percentage points. Total general and administrative expenses were $17,500,000 compared to $13,200,000 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 as well as approximately $500,000 in tax credits related to the CARES Act. 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 $25,300,000 The benefit from income taxes was $1,200,000 with an ultimate effective income tax rate of 59.3%. Adjusted net income per share was $0.18 compared to adjusted net loss per share of $0.25 in the prior year quarter. During the second quarter, we generated adjusted free cash flow of $17,800,000 after cash capital expenditures, which included maintenance capital of $1,500,000 compared to $1,700,000 in the prior year quarter. We ended the quarter with approximately $195,000,000 of total debt outstanding, including $180,000,000 borrowed under our credit facility.
After considering cash on hand, the remaining capacity under our credit facility and current liquidity covenants, we had approximately $120,000,000 of total available liquidity at the end of the second quarter, and we have continued to make progress. Subsequent to the end of the second quarter, we paid down an additional $5,000,000 on our revolving credit facility, bringing our current outstanding balance to $175,000,000 The pandemic affirms for us the value of a conservative leverage philosophy. As such, we are currently more comfortable with a range of between 2x and 3x adjusted EBITDA, whereas prior to the pandemic, we would have targeted longer term leverage somewhere between 3x and 4x. Our quarter end total debt to adjusted EBITDA leverage ratio was 2.1x. This ratio was calculated using annualized adjusted EBITDA as defined in our prior year debt amendment.
Our traditional LTM total debt to adjusted EBITDA ratio is 3.7 times, which is actually in compliance with our unamended credit facility we had in place prior to the pandemic. As a reminder, on 12/15/2020, we entered into the third amendment to our existing credit facility. This reduced the revolver commitment to $375,000,000 and an additional step down to $350,000,000 took place on the first day of the third quarter of twenty twenty one. Financial maintenance covenants were waived through the 2021 followed by the introduction of more favorable covenant levels in the second and third quarters of twenty twenty one. Under the amendment, capital expenditures are restricted to $12,000,000 from mid May twenty twenty through the third quarter of twenty twenty one.
We have utilized approximately $6,000,000 through the second quarter, leaving an additional $6,000,000 available. Additionally, we are prohibited from paying dividends, making stock repurchases and other general investments until we deliver our third quarter results. However, we look forward to emerging from these constraints and continuing our long standing practice of returning capital to shareholders while also investing in the business. Turning to our business outlook, expectations for our fiscal third quarter ending 09/29/2021 reflect management's expectations that the current economic environment will not materially change. We anticipate domestic system wide same store sales will be between 24% compared to the equivalent period in 2019.
We are encouraged by the lower number of net unit closings year to date. However, due to labor availability challenges that are impacting the pace of openings as well as the requirement for franchisees to remain open for a certain period of time to recognize the full benefit of PPP forgiveness, we believe it is a touch early to provide guidance on net unit expectations at this time. Additionally, while efficiency of our highly franchised model, the exact timing and pace of restaffing and training new team members at company restaurants yields a less precise view into near term company margin changes. However, pre pandemic, we guided to 18% to 19% company margins, and we believe that target is still appropriate in a more stable environment. Our expectations for total general and administrative expenses are between $1,718,000,000 dollars including approximately $3,500,000 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 $22,000,000 and $24,000,000 In closing, as we work to overcome staffing challenges and move from our current 19 effective operating hours to our historic 20 fourseven operations, we remain optimistic about our ongoing sales trends. 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 continuously managing the business needs through this post pandemic recovery. That wraps up our prepared remarks. I will now turn the call over to the operator to begin the Q and A portion of our call.
Speaker 0
Thank you. Okay. So we will now take our first question from Nick Setney at Wedbush Securities. Please go ahead.
Speaker 5
Thank you, and congrats on on some incredible numbers. Guess, first off, just just given, you know, just given the the comparability versus 2019 is is a little difficult due to the refranchising that took place in 2019, would you mind just telling us what the 6% comp in July on the company online translates to in terms of average weekly sales?
Speaker 2
Hey, Nick. We're happy to get to that. If you look at the volumes, it's probably in the range of $18,000 on the year sorry, 180,000 on the year. But let us work on that and we'll get back to you on that. We don't want to give you the wrong number on that.
Speaker 6
Okay, sure.
Speaker 5
And then in terms of the 18% to 19% unit level margin commentary, is that applicable to the second half of this year? Or are we talking like longer term 2022?
Speaker 2
I think it's fair, Nick, to say it's probably a little longer term. If you look into the back half of the year, we still some volatility with regard to that. If you look, we're really looking to get staffed up, frankly, and that will come both with additional labor expense as training comes back online. But as we staff up, we'll also have the benefits of more of these units coming online 20 fourseven. So there's some volatility that will likely occur in the back half margins.
But again, once we get into a little bit more stable environment, I I think those 18% to 19%, should hold pretty pretty well.
Speaker 5
And just last question, just to follow-up on on that. On the labor line, you know, I guess maybe just give us some context in terms of, you know, how fast you are on the company on-site, you know, relative to where where you need to be. And then just, you know, inflation expectations for the second half in terms of food costs versus, let's say, q two.
Speaker 3
Nick, it's John. On the staffing side, just to follow-up on that tour, we did get about 13,000 applications from that hiring tour. We were seeking to hire about 20,000 people. And so while you won't hire everybody out of all those applicants, it was a very promising tour. We were able to sort of put a single website out there, careers.dignities.com, that really helped our franchisees.
So spirits are lifting up the stabbing challenges that we can close the gap on that. It did not materially change so far in terms of the number of twenty four hour locations. But we are on our way. We expect that as we work throughout August that that continues to improve. And in September, we expect in October, we expect to fully close the gap.
As far as to the other parts of your question, Robert, did you have those down?
Speaker 2
Yes, John. So we're talking in the room here. We're Nick, we're working on that AUV, the 6%, what that looks like. So hopefully, prior to this call being over, we'll get it to you here shortly. Then with regard to the commodities on the back half of the year, so what we had seen with regard to commodities is typically we're in that 1% to 3% range, Nick.
I will tell you that we were slightly above that range in Q2. And frankly, we expect to be in that kind of above that range for the back half of the year. But the reality is we're not overly concerned with that overall. We think it's temporary, frankly, and we do believe that we'll have another pricing opportunity as we head into Q4. So that's it's not our biggest area of concern right now.
Speaker 7
Great. Thank you very much.
Speaker 0
Thank you. We will now take our next question from Michael Thomas of Oppenheimer and Company. Go ahead.
Speaker 6
Thanks. Hope everyone is doing well. Great to see the business back above twenty nineteen levels, and it's obviously continuing to build in July. So the question is really on the sales guidance. I mean you're already at 3% above, I think, in July, and the guidance is for 2% to four for the third quarter.
But I think you have some additional catalysts coming through, particularly as you continue to roll out. I believe the is going to finish rolling out in this quarter. So I'm just wondering how are you thinking about this third quarter, the rest of the quarter here? And if you've factored any of the California stimulus payments into that guidance as well?
Speaker 2
Hey, Michael. This is Robert. So so, yeah, with with regard to that, I think what what you'll see within that two to 4% number is a a somewhat of a continuation of what we know today. Again, one of the things that we we've learned over the course of this pandemic is things can change pretty rapidly. But the the reality is is, we'll kind of point to this, see the 2.7.
And frankly, have seen that remain fairly strong given the current environment and given some of the talk about the volatility. So within that, I think you would see us include everything that we've talked about, frankly. You would see that the 700 meltdown units, the 1,100 Burger Den units contained within there. And then that gradual build back towards the twenty fourseven. If you notice what we've seen when we since we spoke to the year last from q one to q two is we've made some progress with regard to the additional operating hours and we have a very developed plan with our franchisees how to continue to move that forward.
But I don't think it's going to be a step function forward. We're going to work through that very deliberately and build those sales, and we just don't want to get ahead of ourselves.
Speaker 8
That makes sense. Thanks.
Speaker 6
And then just on those twenty four seven units, can you just first maybe clarify, when you're comparing with the table in the press release against the pre COVID levels and those units are only down 7%, that's like for like, meaning those units had 20 fourseven servers before, now they don't, if you could just clarify that. And if that's the case, it doesn't seem that bad, all things considered. And so what I'm wondering franchisees that either don't have to? Or would you be open to the option of them not going back to 20 fourseven service using these virtual brands and having sales volumes that are very similar today to where they were pre COVID when they were running with those 24x7 units? And then how does that compare from like a cash flow side of things?
I'd imagine it's almost better from a cash flow perspective if they were to just go on the virtual side of things and not be open 24x7 and potentially have like margin or a better process, excuse me, with the twenty four seven service. So just any thoughts there?
Speaker 2
Yeah. Let me let me start there, and then I'll turn it over to John. I'll I'll take the more technical piece of that. Yes. With regard to calculation with regard to those comps, those are like for like.
So you're looking at units that would have been 20 fourseven previously and down north, and that's really the catalyst for them being down. But correspondingly, and the thing that really bolsters us with regard to that daypart is, it is a 20 fourseven to 20 fourseven comparison to the ones that are up 15% also. So that's the biggest move in late night upward in the last decade. We were looking into that at least, and we can't find a larger catalyst for late night. But with regard to the second part, I'll pass
Speaker 9
that over to John Miller.
Speaker 3
Well, just simply to say that margins can be calculated in a lot of different ways. Percent margin, you could be right. I'm not sure you are that there's a higher margin. The highest margin would be if you were just open Saturday from ten to one. But the point of it is, these overnight sales, we're talking about 8% -ish, 8% to 10% difference in what the brand would be comping if all stores were open twenty four hours versus not.
There's a fairly significant flow through of those dollars being open those hours. And remember, we're an all day menu place. America's Diner always open. That's been sort of our market positioning for many years. And then finally, if you're going be open for 05:00 for breakfast and you are wrapping up around midnight, the night before, the benefit to closing is not as powerful as you might think.
So it's really a staffing challenge when we're fully staffed our franchisees and our systems committed to being a 20 fourseven brand. I would also say that we're getting high trial among Gen Z, a little bit more of that late night dinner and late night daypart and more reluctant to get trial during the traditional breakfast and lunch daypart, the historical usage of family dining. We don't want to miss the opportunity to have a high capture rate of these younger consumers through the late night daypart.
Speaker 6
Perfect. Thank you.
Speaker 1
Thanks, Michael.
Speaker 0
Thank you. And then we'll take our next question from Jake Berglis at Truist Securities. Please go ahead.
Speaker 10
Hey, guys. This is actually Jack on for Jake. Thanks for taking the questions. First, I wanted to ask about, you know, your trend in off premise sales. It seems like the absolute level of off premise sales is coming down here in June and July.
I guess how much of that do you attribute to changing consumer habits as restrictions are easing versus, you know, some seasonality as maybe July is usually a lower, off premise months? And I guess I guess, where do you see the off premise sales leveling out long term? Or or do you have a goal of where you want it to level out?
Speaker 3
Well, of course, we'd like to continue to build business in all four dayparts, breakfast, lunch, dinner, late night, dine in, and take out. We don't have a limit per se. We'd like to grow profitable transactions wherever the consumer is going. And we think that is not as mysterious as it used to be. There is a summer softness that's usually expected, particularly you might have noted Burger Den softened up a little bit.
We are told by our third party delivery experts that that was to be expected to some degree. They're used to seeing that seasonality where people are out and about more. They are dining out a little bit more, but but the the the third party delivery burgers softens a little bit, so they do expect some recovery of that a little later. And then and then in part of this is, I think just people getting out and more and more restaurants opening and dining in a little bit more, so there's some softening. But remember, we've gone from 12% over 20 in our takeout business 2019 to 2021.
It is very sticky. We expect, you know, a good portion of that is incremental with different younger audiences coming during the week versus the weekend. And we expect that a considerable amount of that continues to persist as sort of part of the new normal of how people trade their meals from takeout, delivery and dine out away from home. So the summer softness does not you know, we expected some of this as people, dine in a little bit more, but we do expect it to be really sticky. I mean, it's a great question.
I think time will tell what the more precise answer is. But we're ahead of where we expected and pleased to be retaining this amount of to go business.
Speaker 10
Okay. Great. That's helpful. And then, I guess, there any sales trends you're seeing differently geographically still? California still trailing the rest of your system or that come back very strong as that's reopened?
Speaker 3
California sort of trailed and dine in for a while. But remember, we were pretty, during the pandemic, it was tough. But remember, leading up to the pandemic, California, we had nine consecutive years, 2011 through 2019, of of positive comps above the system. And '20 I believe 2012 through '17, positive traffic out there still out forming the system. And California is back to being our number one state in performance over these past few weeks.
And then other strong states for us have been Nevada, Colorado, Texas, Florida, Hawaii. Those are some of our stronger performing states right now. But we've had, I think we reported in the script that over half were positive during, the quarter. So so it it does it does vary regionally. But, but California is certainly been a benefit and not a burden to the overall comp performance of the brand.
Speaker 10
Great. Thank you.
Speaker 0
Thank you. We will now take our next question from Jon Tower at Wells Fargo. Please go ahead.
Speaker 8
Great. Thanks. Hopefully, you can hear me. I am curious just to hear your response on I believe California, in particular, might be imposing some new rules around animal welfare, particularly that may impact pork based products in that market. And I'm curious to get your perspective on how you think this might impact your business.
Do you actually proposition as being something that might get passed, or sorry, enforced in the state? Or do you think it's something that the federal government might step in and, prevent that from happening anytime soon?
Speaker 3
Sure I'll give a point of view. Robert, you might want to jump in here. I know we've had conversations with our supply chain team about this. Question. I don't know that I can say with certainty what the outcome will be long term.
I'd say the near term based on how we process and and source pork, it's not it's not a challenge for us short term like you might think. And that that could be explained in some fine points of detail perhaps later. But I'm not sure exactly all the specifics that set us apart on on being less concerned about that impact near term. So I don't wanna speak out of turn here. Robert, is there any other anything else to add to that?
Speaker 2
Hey, John. Just in general, not specifically related to the PERC, I think you answered that. But I think the reality is we pay very close attention to all of those and we move in concert with what the markets can conveyor. For instance, with the egg issue and our commitment to get them to the cage free eggs by 2026. So Prop 12 is for the raw product.
All of our product is cooked, so it won't impact us unless they change the law. So that's I with regard to the going back to the pork specifically, but we do pay very close attention to all of that.
Speaker 8
Got it. I appreciate that distinction at the end of raw versus the cooked product. Thank you. Just just going into the the real estate opportunity, Rob, I think you mentioned on the call the idea that that you weren't seeing the real estate opportunities you had expected, I think, even just a few months ago opening up. And would you say that's more restaurant specific sites?
Or are you seeing this across retail, potential locations that you thought might come up as conversions for franchisees down the line? And even that level of closures haven't necessarily shown up the way that you had once anticipated?
Speaker 4
Yes. So it's Mark. I'll try to address your question, maybe Rob or John may want to jump in here. But so in my script, when I talked about that, I primarily referring to the restaurant sector. I'm glad you asked this question, the broader question about retail.
I would tell you, and we've talked about this in the past, is that from our standpoint, if the trade area works, the demand point works, what we convert doesn't necessarily have to be a pre existing restaurant. We've done retail conversions that have been very successful for our brand. So we're primarily focused on the demand point. And again, to answer your question, I was primarily talking about the restaurant closures piece, but clearly retail has also been heavily impacted as a result of the pandemic. So that does continue to create an opportunity for our brand.
Speaker 8
Great. And just two more for me. On the twenty four hour stores, 20 fourseven, in the 2Q, I believe they ran plus 12% versus twenty nineteen, and stores that didn't have it were down pretty nicely. Aside from these stores being open 20 fourseven, is there anything else to call out about these stores in terms of their ability to staff? Maybe there's geographies that are better than others.
Perhaps these stores have both of the virtual brands in. Anything you can comment about those stores just outperforming? Or is it solely just the fact that they're 20 fourseven?
Speaker 3
I think those are some great questions. With anything, circumstances and the timing of those play a role in where people are today and the trajectory of staffing, hiring, We're on the averages, it's always true one hundred years ago, one hundred years from now, those stores that have really top quality general managers do a really good job taking care of their crew. And where they were newer or in transition, then those stores had a tougher time, right? They weren't as deeply established with a crew where there was continuity of leadership there for a long period of time. So the stores that had stable management and stronger, more tenured tended to have outperformed, I'd say there's some correlation there.
There's some correlation to the franchisees that sort of read into the pandemic a little bit more trouble, weren't certain of PPP loans early on and were more aggressive in furloughs or laying off, then that sent a cultural signal in their ranks. And so they struggled a little bit more than those that took the bet. But all would be fine in protected management and key positions in their restaurants and on their rosters. And so there is some correlation there, not just with our brand Denny's, but across the industry, depending on some of the staffing challenges. I think the strongest correlation, though, is just the neighborhood the store happens to be in.
Where are some areas are richer with staffing opportunities and others are tougher. And that would be, I think, the strongest correlator. We do again believe these are temporary, and they're all solved through time.
Speaker 8
Got it. And and then just last one for me. Can you remind us how, you're you're marketing the two virtual brands? And if there are any plans on the horizon horizon to alter it, if, say, today, you're only doing it in digital channels, if perhaps you start tagging it on to Denny's specific commercials?
Speaker 3
All those things are in discussion all the time, sort of testing and weighing the pros and cons. We do believe there's benefit in having some of the product lines that have been especially popular on the core base brand in due time. We did update some of the melt sandwiches on our core menu last quarter. As a result, they performed really well for us. And so we're studying those things all the time.
More to come on that. The advertising channels are really mostly through social media and or the social pages associated with third party delivery.
Speaker 8
Awesome. Thank you very much.
Speaker 0
Thank you. We will now take our next question from James Rutherford at Stephens. Please go ahead.
Speaker 11
Hey, thanks very much and congrats on the improvement here. I just wanted to narrow down in on those units open 20 fourseven that are comping up 15% versus twenty nineteen levels. Can you give some detail about the components of that 15% growth? Perhaps even directionally, if you can speak to traffic versus check or new customers versus existing or dayparts or days of the week. Just trying to get as much detail as possible on the components of that growth.
And the goal is to try to understand maybe how sustainable that mid teens lift might be over time. Sure,
Speaker 3
James. It's a great question. As to sustainability, it's a bit early to comment on that. We're highly confident these are brands that will endure a while, and they're not just a flash to sell some burgers and melts for the short period of time. They're quite popular.
We get high marks from our third party delivery vendors saying this is the kind of product line they're looking for. And we've even heard discussion about how they're dialing back the number of automatic takers that they just put on their platforms without evidence that the product will stand up over time. So we're pleased with how they've been launched and confident of their enduring value. In terms of the rest of the answers, I wish I could give you some specifics. Think basically the twenty four seven stores with both Burger Den and meltdown outperform everybody.
So there's a strong correlation to the number of hours open and being fully staffed and having quality management on staff and having the capacity take on these new these new efforts. So they're gonna do a little bit better on check. Obviously discounting is out of favor in full service right now until brands are fully staffed. Said another way. We can't handle all the transactions.
We aren't we don't have the dining rooms fully open. We're not twenty four seven, so there's no particular reason to, to move transaction building, you know, to to know that we don't have the servers to to cover more shifts at the moment. But but the but all the way around weekday breakfast, lunch dinner late night. I'd say that the good news is especially strong midweek and, for, the meltdown and the burger den in terms of just outperforming normal dining business and being both younger and a different time of the week. And then late night has been very, very strong.
As a result of, you know, one being open with fewer options open out there in the marketplace and then also having these virtual brands. That on just about every metric across the board, it's sort of run of the board that the twenty four hours stores are, you know, just categorically better.
Speaker 9
Thank you for Not located
Speaker 3
located better necessarily, but just performing better.
Speaker 11
Okay. Perfect. One more. It's a question that that we're starting to get, probably hard to answer, but just as the cases have started to rise in certain parts of the country, have you seen much impact yet? Or do you think it's a situation where consumers have learned to live with it and are kind of working around in some of the isolated restrictions and mask mandates and that type of thing?
Speaker 3
Well, I think true to form, you know, we we carp and harp and you you hear the people talking about the way they wish the world was or the way the world ought to be, but it isn't right now. It's a it's a challenging time for people. I think people are trying to sort out, you know, what will come next. There it introduces a certain level of uncertainty. And so it's the conversation of pretty much every business every day to mask or not to mask.
I think what you're seeing so far, because we are talking about it a lot and watching it very closely, is we're not really seeing any change whatsoever, or if any, certainly immaterial in any consumer behavior at this point. That's not to say they aren't concerned or thinking about it. But rather, I think they're optimistic that they may go through some social distancing, some plexiglass. Put up between cash registers and consumers, some more tape on the floor to keep people far enough away and mask mandates and the like. But I think people are generally not expecting there to be shutdowns per se.
And so we're going about our business. I think people have more and more confidence that wherever these rises and spikes came from, they came from large events and 100,000 people gathering or beach parties and the like, and not likely coming from responsible, socially distanced restaurants with servers and masks. I think, you know, my sense of it is whether it be discussion and concern and people be watching carefully what happens over the next several weeks that the consumer behavior so far, in particular in areas like California and other areas that maybe have a higher vaccination rate, the consumer confidence remains high to go out to eat and our and the support for Denny's continues to be strong in in in spite of the delta version and mask mandates.
Speaker 11
Thank you. Always appreciate your perspective.
Speaker 2
Thank you.
Speaker 0
Thank you. We're going take our next question from Eric Gonzalez at KeyBanc Capital Markets. Please go ahead.
Speaker 3
Hey. Hey. Thanks. And congrats on the return to pre pandemic trends.
Speaker 9
Just regarding the 20 fourseven units and the sustainability of those comps that we just discussed, I would imagine a lot of those businesses, particularly the independents that are in the same area might have more difficulty staffing than a large team like Denny's. So is it possible that these units are perhaps over earning a bit by virtue of the fact that, you know, you're the only game in town at those hours? I'm just trying to understand how those twenty four hour units might perform as additional competition opens up in those trade areas.
Speaker 3
Yeah. We're we're certainly not the only game in town. We are we were one of the very few full service games in town. But there there are quite a number of, options available, including third party delivery these days that did not exist before. So we think instead what's happening is there's been a considerable reintroduction of the brand, people in trade areas where they ordered through third party delivery and gave us a good old try for a burger, an omelet, or what have you.
They're less likely to be a dine out customer, you know, at the breakfast daypart at lunch. They might be working at home on Teams or on Zoom. And but at dinner and late night, they're going, hey, let's let's order out. And so I think we've been had, you know, the market opened up to us in a in a number of areas. And because we are open late, your point, but also not just because we're the only one open late, but because we've been a little bit rediscovered.
People have remember QSR went through the roof throughout the pandemic and full service is fairly compromised because of dining room shutdowns and the number of transactions. And so with that comes a little bit more of a, I don't know, a cabin fever or an interest to try some full service meals that are maybe different than a handheld drive thru type of meal. And so with that, I think we have some stickiness that remains post pandemic. Pandemic that's driving this transaction.
Speaker 9
Sure. That's fair. On the if I can squeeze another one in. On the third quarter guidance, you touched on this earlier, but just wondering, what are you assuming in terms of 20 fourseven units versus what you have today for that for the third quarter guidance? And then as you think about the fourth quarter, do you expect to see a big uptick in twenty four seven units, with the supplemental unemployment rolling off?
Speaker 3
We believe it will progressively improve. We're not guiding precisely on the number of units that will convert just
Speaker 0
yet. Okay.
Speaker 2
All
Speaker 9
right. That's fair. And then lastly for me, how much price did you have or did your franchisees have in the second quarter? And how are you advising them to price you know, going forward in the second half of the year? I think you mentioned the fourth quarter you were going to revisit it, but maybe if you can quantify that.
Speaker 2
So with regard to that hey, this is Robert again. We we had within within the traffic is still kind of breaking out the pieces. The traffic is below twenty nineteen levels. We haven't quoted a pricing number yet, but the pricing, we do have slight pricing within that number. But one of the material components is the mix change that we've benefited from throughout this year with additional lunches and such.
So really minimal pricing, a lot of mix traffic below twenty nineteen. And with regard to the, the second part of the question,
Speaker 9
maybe Just pricing the back half. Just the pricing. How do think about that?
Speaker 2
Yeah. We got another opportunity for menu pricing here coming up as we head into the to Q4, and and we're always balanced. We do take into account the commodity inflation, to ensure that we're covering that. But we do believe now is the appropriate time to leverage all various aspects of our value to ensure that we are capturing traffic. That is the opportunity now.
So we won't under price ourselves, but we know that the opportunity capture the traffic. And and just so we're all on
Speaker 9
the same page, when you say traffic, on an off premise order, do you count entrees or do you count one, you know, one order versus, you know, an on premise transaction that might have, you know, certain multiple guests for, you know, one guest who are on trip or guest?
Speaker 2
Yeah. That's a really good question to to be very specific. We count entrees as we as for a measurement of our guest traffic.
Speaker 9
Got it. Thank you.
Speaker 3
Thank you.
Speaker 0
Thank you.
Speaker 10
So we
Speaker 0
will now take our next question from Brett Levy of MKM Partners. Please go ahead.
Speaker 7
Great. Thanks for taking my call. You talked you spent a good amount of time talking about twenty fourseven, especially as it related to labor and your shortfall. And you talked about the success you had on your tour. What are you doing going forward?
How often do you think you need to go out and make the pushes for grand gesture tours or really push the agenda to make sure you're getting more than your fair share of labor because you're not the only ones who have gone out and tried to, you know, beat the bushes to scare up the snakes on labor. And what are you doing from an incentive standpoint, whether it's upfront incentives, ongoing, some kind of benefit for existing people?
Speaker 3
That's a great question. The questions are asked often about wage incentive, environment, culture, good place to work, stay bonus, hiring bonuses, upward mobility, education support. So just about everything you can imagine, you know, scaled organizations, you know, like like Denny's would have many of those kinds of programs in place. I should remind you that you've been building one of the best places to work in South Carolina on multiple occasions. And so, you know, we we guard sort of the all those mirror check type items all the time.
Is this a place I'd like to work as a starting place, as a restart, as a career builder, as a jumping off place, and all the kinds that are important to attract quality workforce? All of those things are very challenging right now in this environment, which is which is, you know, a curious place to be again. We think they're overall temporary, but it's important that we continue. You know any good company and good companies we compete with are going to continue to be vigilant about holding and building and developing. There's their staff and the career opportunities within the organization right now are, company historically and like many franchise owners worry about joint employer challenges, and so we've had really hard lines between our HR policy and what a franchisee might do.
There might be shared services or we point people toward an outside counsel or guide, but we usually don't directly tell them what their employee support programs should look like, just what their outcomes should be and how they run a store according to Denny's policies. Today, we blur those lines a little more. We are more collaborative in our ability to say, here. Here's a website. Here's a Denny's website to help us all recruit, where we can we can share third party services through a link.
It's a return work really hard to make things easier and better from a technological standpoint to support our franchisees in the system to share best practices or give them sources to find or mine those best practices. So our Franchisee Association Board recently met you know, starting late last year, but all the way throughout this year, many of the meeting topics have been focused around, you know, market wide hiring bonuses, ways in which we can recruit, share best practices, share resumes if we aren't going to use this particular cook will share with another franchisee down the block. So a lot of those things are changing and becoming more institutionalized and formal inside our system compared to a little bit more, you know, casual in the past. It was a great question. And I think we're doing a pretty good job of assisting our franchisees to make sure they've evaluated their programs from starting wage to the rest of the programs and benefits they're offering.
And I think our franchisees are doing a nice job at retention. Just so you know, in 2019, and I'd say most years prior to that, when you looked at our roster, we had average tenure and turnover rates lower than most full service competitors. So we would have been one of the better performers in the industry, and we'd like to be able to maintain that status coming out of pandemic.
Speaker 7
And when you think about those areas that had been early in removing the enhanced unemployment benefits. Have you seen any change in their ability to hire? Or is it just more the expectation that as they roll off and as we get past September that they'll improve?
Speaker 4
Well, I think it's a
Speaker 3
lot of things. You know, some of this is, you know, the challenges aren't just because there's incentives out there. There's also maybe a concern about, you know, being confident about the environment or having an elderly parent at in home, and they're really nervous about being out. There's any number of things that abate through time, but not all at once. And so you know, we're confident things do continue to improve.
There's quite a number of people displaced and out of work. And working provides a better outcome than staying at home based on their historical personal household experience, so I would expect that those things will return in due time. But as it is today, you know, a number of people came through the pandemic cut their expenses. And found different ways to make it through. That environment and so, they're they're, maybe not quite as ready to go back towards just yet.
So, again, I I think all these things are abating time. I I don't think this is, too different than what you're hearing across restaurants and retail. The the answer is time will tell. We're confident it normalizes, but not as it it doesn't happen like snapping your fingers. It's it's not yet.
It's still a challenging hiring environment.
Speaker 7
And then one just one last question. When you think about the talk of different markets out there introducing a mandatory vaccination proof of mandatory vaccination to enter the restaurant, what do you think you'll need to do structurally? Is there going to be a dedicated position? How are you thinking about that from an operational standpoint?
Speaker 3
Yes. I I think we have in place the kinds of supervisory, controls and headcount. Remember, the restaurant industry is already full of, you know, multiple layers of compliance. So when it comes to health and sanitation, serve safe compliance, food safety handling. These aren't the kinds of things you do on the ride to work first day.
These are coursework that takes a while. It takes a considerable amount of headspace to pass. There's a lot of really smart people that fail those classes. So, you know, we're good at institutionalizing those kinds of areas. So it's certainly not that big of a challenge for us to say, show me evidence that you've been to a doctor or show me evidence that your hepatitis is gone or, in this case, me evidence that you've been vaccinated.
I think I think we have to treat these things with a great deal of respect and honor whatever the local jurisdictions are requiring. They do vary considerably across the country. We have both customers and employee bases that will look to different authorities than us as the experts. So we have we're managing that with great sensitivity, and and I think in our system, doing a pretty good job of it.
Speaker 6
Thank you.
Speaker 0
Thank you. As reminder, if you
Speaker 9
Go ahead, please.
Speaker 0
As a reminder, if you would like to ask a question, you may be still working. Seems terrible.
Speaker 2
Yeah. And and as we're waiting to queue additional questions, I just wanted to follow-up with that question from Niccetian earlier in the call with regard to how the 6% same store sales increase for company units in the month of July translated into average unit volumes. The comparison to 2019 to 2021, in 2019, those set of company units were running approximately $2,900,000 annual unit volumes or roughly $579,000 dollars per week, that would translate into our annual run rate of $3,100,000 or approximately $60,000 a week. So that is the how to convert that 6% comp into an AUV from a refranchised year to a non refranchised year.
Speaker 9
I just wanted to follow-up with that. Thank you.
Speaker 0
Thank you. And it looks like that is all the questions we have for today's call. So I would now like to turn the call back over to John Leonard for any additional or closing remarks.
Speaker 3
Thank you all for joining the call today. We are very pleased with the progress we've made through the pandemic, and we have started navigating the recovery, as you can tell. The demand for Denny's is strong with same store sales currently trending above pre pandemic twenty nineteen levels, even with only 40% of our domestic system operating 20 fourseven. And we safely welcome guests back into our dining rooms. Our off premise business has remained sticky and supported by the launch of two new virtual brands.
So we are actively working to address the temporary staffing challenges, which we believe will abate, as I've mentioned before, as we move through the balance of the year, and we see additional potential for our brand based on the performance of those restaurants already operating twenty four hours a day, seven days a week. We were encouraged by the level of adjusted EBITDA and adjusted free cash flow generated by our highly franchised business model during the second quarter. We look forward to the opportunity to begin returning capital to shareholders later this year while advancing our long term brand revitalization strategy. We look forward to our next earnings conference call in early November to discuss our third quarter twenty twenty one results. Thank you again for your time today, and all have a great evening.
Speaker 0
That concludes today's call. Thank you for your participation. You may now
Speaker 3
disconnect.