While most analysts are focused on Denny's efforts to navigate the choppy waters of a potentially recessionary economy, a hidden gem lies buried in their recent Q1 2024 earnings call transcript. Denny's is quietly deploying a secret weapon against California's Fast Act (AB 1228): the expansion of their virtual brand, Banda Burrito. This strategic move, largely overlooked by Wall Street, reveals a savvy understanding of market dynamics and a commitment to supporting their California franchisees.

The Fast Act, signed in September 2023, raised concerns about potential labor cost increases and employee turnover in California's full-service restaurant industry. Surprisingly, Denny's reported a positive development: both management and crew turnover have actually improved in their California company restaurants since the Act's implementation. This likely stems from Denny's proactive investments in employee programs, like their "GAIN" program, which fosters career development and provides educational opportunities.

However, the potential for wage pressure remains, and Denny's acknowledges they've factored increased labor inflation into their guidance. This is where Banda Burrito enters the picture.

Denny's has been quietly testing Banda Burrito, their third virtual brand, and it has been a resounding success, with performance rivaling their popular "The Meltdown" virtual brand. Now, they're strategically expanding Banda Burrito to over 200 locations in California – a move directly tied to mitigating the Fast Act's impact.

Why is this so significant?

Virtual brands, operating exclusively through delivery platforms, offer a key advantage: they sidestep the Fast Act's wage requirements, which primarily affect in-person, dine-in employees. By strategically expanding Banda Burrito in California, Denny's is providing their franchisees with a new revenue stream that is immune to the potential wage pressures of the Act.

This expansion is particularly timely, coinciding with the Act's implementation. Denny's California franchisees have enthusiastically embraced Banda Burrito, recognizing its potential to offset any negative financial impact from AB 1228.

Let's delve into the numbers. Denny's virtual brands have already demonstrated their ability to drive incremental sales, generating 2-3% additional sales transactions through a unique customer base that skews younger than their dine-in clientele. Notably, 70% of their Gen Z and millennial guests utilize off-premise channels, highlighting the incremental nature of this business.

While virtual brands operate at a lower margin than dine-in, their strategic significance lies in their incrementality and ability to capture new markets. Denny's bullishness on this approach is evident in their national rollout plans for Banda Burrito in Q4 2024, following the California expansion.

Denny's Multi-Faceted Approach

This calculated strategy reveals a multi-faceted approach to combating the Fast Act's potential impact. Denny's is simultaneously:

Minimizing wage pressures through employee programs and leveraging the virtual brand's exemption from the Act's wage requirements. Generating new revenue streams for their California franchisees, potentially offsetting any cost increases. Expanding their market reach to a younger, delivery-focused customer base. It's a masterstroke of strategic planning that underscores Denny's commitment to both their franchisees and their long-term growth.

Hypothetical Impact of Banda Burrito Expansion

Hypothesis:

Increased Revenue: We can expect to see a noticeable increase in Denny's California revenue in Q2 and Q3, driven by the expanded Banda Burrito rollout. Assuming a conservative 2% increase in sales transactions from virtual brands, applied to California's roughly 200 participating restaurants, we could see an additional $400,000 to $600,000 in revenue per week. Improved Franchisee Profitability: Banda Burrito's immunity to the Fast Act's wage requirements should translate to improved profitability for Denny's California franchisees. This could potentially offset the projected 4-5% labor inflation included in Denny's overall guidance.

Denny's quiet deployment of Banda Burrito as a strategic countermeasure against California's Fast Act is a testament to their adaptability and proactive approach. While the macroeconomic environment remains uncertain, this under-the-radar maneuver reveals a strategic depth that positions Denny's for continued success in the years to come.

"Fun Fact: Denny's, founded in 1953 as Danny's Donuts, originally served donuts and coffee before evolving into the 24/7 diner we know today."