Curt Nichols - Senior Director of Investor Relations & Financial Analysis John Miller - President, Chief Executive Officer, Director Mark Wolfinger - Chief Financial Officer, Executive Vice President, Chief Administrative Officer, Director.

Michael Gallo - C.L. King Drew Stevenson - Stephens Alton Stump - Longbow Research Mark Smith - Feltl and Company Colin Radke - Wedbush Securities.

Good day and welcome to the Denny's Corporation fourth quarter and full year 2016 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Curt Nichols, Senior Director of Investor Relations. Please go ahead..

Thank you Camille. Good afternoon everyone. Thank you for joining us for Denny's fourth quarter and full year 2016 earnings conference call. With me today from management are John Miller, Denny's President and Chief Executive Officer and Mark Wolfinger, Denny's Executive Vice President, Chief Administrative Officer and Chief Financial Officer.

Please refer to our website at investor.dennys.com to find our fourth quarter earnings press release along with any reconciliation of non-GAAP financial measures mentioned on the call. 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 his introductory comments.

Mark will then provide a recap of our fourth quarter results, along with brief commentary on our annual guidance for 2017. After that, we will open it up for questions.

Before we begin, let me remind you that in accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the company 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 on 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, 2015 and in any subsequent quarterly reports on Form 10-Q. With that, I will now turn the call over to John Miller, Denny's President and Chief Executive Officer..

Thank you Curt and good afternoon everybody. Denny's celebrated the sixth consecutive year of positive system-wide same-store sales growth in 2016 while once outperforming casual dining category benchmark. This success was impressive, given we overcame a number of challenges often cited as contributing to the industry's softer performance.

These include an increasingly choppy consumer economic environment, lackluster traffic, a particularly contentious election cycle and the widening spread between restaurant and grocery prices, to name a few.

Our revenue growth in 2016 coupled with our disciplined focus on cost drove significant improvements in our company and franchise operating margins and led to approximately 12% growth in adjusted EBITDA and approximately 27% growth in adjusted net income per share on the full year.

This consistent performance reflects the ongoing momentum generated by our brand revitalization initiatives, which at the end of 2016 still represents just over 50% of our system modernized to our new successful heritage image.

We remain committed to executing against the following four key strategic areas in order to accomplish our vision of becoming the world's largest, most admired and beloved family of local restaurants serving classic American comfort food at a good price around the clock.

The first is to lever a differentiated and relevant brand in order to achieve consistent same-store sales growth supported by profitable gains in guest traffic. Delivering systems same-store sales growth in 14 of the last 15 quarters is evidence of the success of these strategies.

Continually evolving our menu to meet guest expectations for better quality and more cravable products is an important component of our strategy to maintain relevance. One of our most important initiatives in 2016 was the launch of our new and improved pancake recipe featuring fresh buttermilk, real eggs and a hint of vanilla.

The consumer response remains very positive as we maintained a strong 35% incidence rates for pancakes through the fourth quarter, compared to 29% of our guests who were purchasing pancakes before we made the change.

And building on this success, our latest LTO menu continues the celebration of our new buttermilk pancakes, including the new banana berry pancake breakfast while also featuring fresh ingredients in bold flavors and three sizzling skillets like the crazy spicy skillet and the smoky gouda chicken and broccoli skillet.

We also continued to leverage our $2 $4 $6 $8 platform by highlighting a variety of these value items on the menu. We are currently featuring eight products for $4 on our value menu and in commercials which provides a balance to our limited time only premium offers.

We have replaced or improved more than a third of our core menu items over the past year alone. The improvements we have made to-date in our food and service are further reinforced by the enhanced atmosphere delivered through our heritage remodel program that I discussed earlier.

The program continues to receive a very positive consumer response and generates a middle single-digit range of same-store sales lift. Remodels will continue to be a significant tailwind for the brand over the next few years as we expect 75% of the system to have the new image by the end of 2018.

Our second key strategic area is to consistently operate great restaurants with the primary goal of being in the upper quartile of satisfaction scores of full-service brands. Throughout the year, our operations team continued to make progress toward achieving our goal of delivering higher-quality products with a more consistent service experience.

Our focused on field training and coaching initiatives is critical to delivering our mission and to be a model franchisor which includes assessment and coaching to run great restaurants.

Our guest satisfaction surveys continue to trend positively and the results during 2016 represented an all time high performance since we first started measuring the system in 2011. While we are encouraged by the substantial progress our teams have made, opportunities remain in order to reach our full potential.

Therefore, we will continue to invest in our talent and in systems in order to further elevate the guest experience. This focus drives us to partner, listen, share, refine and invite participation from our franchisees and virtually all brand strategies and initiatives.

We have accomplished this through Denny's Franchisee Association and Brand Advisory Council which are led by Denny's executives with leadership participation from Denny's Franchisee Association board members and at-large member volunteers.

Our third key strategic area is to grow the global franchise in order to expand Denny's geographic reach of domestic and international locations. Our growth initiatives have led to over 450 new restaurant openings since 2009, representing over 25% of the current system and one of the highest totals of all full-service brands.

With 50 new restaurants, 2016 was best year of unit expansion in the past five years. Further, with 23 net openings 2016 marked the eighth consecutive year of positive net system growth. Our international expansion was also the strongest in over a decade, including 14 new restaurant openings outside the United States.

Two of these restaurants opened in the Philippines, representing an exciting introduction to Asia with plans to open an additional eight restaurants over the next several years. Our international footprint of 123 restaurants has grown by 60% since 2009.

With our current pipeline of approximately 80 planned openings, we look forward to gaining further momentum beyond North America. Our strong performance continues to drive interest in the brand attracting new franchisees, building the real estate pipeline and adding new development agreements.

In the U.S., we have over 1,600 restaurants, including 169 company operated locations with geographic concentrations along the West Coast and the Southwest, Texas and Florida. In 2016, our strongest markets for new development were Texas, Utah and California.

Our fourth key strategic area is to drive profitable growth for all stakeholders with the goal to grow margins and profits with a disciplined focus on cost and capital allocation benefiting franchisees, employees and shareholders.

Consistent profit growth will be driven by growing our highly franchised business which provides a lower risk profile with upside from operating a meaningful base of high volume company restaurants.

Since completing our refranchising program in 2012, we have grown adjusted net income per share at a compounded annual rate of 21% and adjusted EBITDA at a compounded annual rate of 6%.

Our continued growth and profitability will be driven by a combination of investments in our brand and our company restaurants along with shareholder friendly allocation of free cash flow.

We completed the acquisition of 10 high-volume franchise restaurants during the year and remain confident in our strategy to own and operate a base of company units, representing approximately 10% of the system.

Our strong free cash flow generation creates significant flexibility to support brand investments, including these opportunistic and accretive acquisitions of a lot of high-volume franchise restaurants and we will continue to review similar opportunities as they become available.

Since beginning our share repurchase program in late 2010, we have allocated more than $270 million to share repurchases including approximately $56 million in 2016. With over $79 million remaining in our purchase authority by year-end, we will continue to return capital to our shareholders through our share repurchase program going forward.

In closing, while the current challenges facing the full-service restaurant environment will most likely persist for the foreseeable future, we are committed to profitable system sales growth and market share gains.

We remain focused on continuing the transformation of the Denny's brand through the ongoing evolution of our food, service and atmosphere while building a sustainable foundation to grow around the world.

Denny's relative strength and performance is a testament to the success of our revitalization strategies and the improvements we have achieved to-date give us the confidence that we can continue to grow the Denny's brand benefiting franchisees, employees and shareholders.

With that, I will turn the call over to Mark Wolfinger, Denny's Chief Financial Officer and Chief Administrative Officer..

Thank you John and good afternoon everyone. Our fourth quarter highlights include growing domestic system-wide same-store sales by 0.5%, adjusted EBITDA by 17.8% to $25.8 million and adjusted net income per share by 52.9% to $0.17 while generating $14.4 million of free cash flow.

During the quarter, franchisees opened 12 restaurants including eight locations in the U.S. and four international locations. In addition, we acquired one franchise restaurant. Our system restaurant count increased by five to 1,733 restaurants as seven franchise restaurants were closed during the fourth quarter.

Denny's total operating revenue, which includes company restaurant sales and franchise and licensing revenue increased by 4.5% to $129.6 million due to higher company restaurant sales and franchise royalties.

Franchise and licensing revenue grew 0.5% to $35 million due to a 0.6% increase in same-store sales, a greater number of franchise restaurants and a higher average royalty rate compared to the prior-year quarter, partially offset by lower occupancy revenue.

Franchise operating margin of 72.1% improved by 220 basis points due to higher royalties and improved occupancy margin. Moving to our company restaurant. Sales grew by 6.1% to $94.6 million due to an increase in the number of company restaurants over the past 12 months and a 0.1% increase in same-store sales.

Company restaurant operating margin of 17.5% improved by 230 basis points compared to the prior-year quarter. This was largely driven by higher sales and lower product costs partially offset by higher payroll and benefits expenses. Total general and administrative expenses of $17.3 million increased by $400,000 compared to the prior-year quarter.

Lower incentive compensation was offset by higher stock-based compensation. Adjusted EBITDA improved by $3.9 million, or 17.8% to $25.8 million. Depreciation and amortization expense was $300,000 higher at $6 million, primarily due to planned capital expenditures associated with company remodels and new and acquired company restaurants.

Interest expense increased by $700,000 to $3.3 million due to higher revolver balance and a greater number of capital leases compared to the prior-year quarter. The provision for income taxes was $1.9 million, reflecting an effective income tax rate of 14.4%.

During the quarter, we filed amended federal tax returns for prior years in order to claim foreign tax credits in lieu of foreign tax deductions. These returns generated $1.7 million in additional tax credits and $900,000 in federal income tax refunds.

Adjusted net income per share grew 52.9% to $0.17 per share, including $0.04 per share, resulting from our amended tax return filings. Free cash flow after capital expenditures, cash taxes and cash interest was $14.4 million compared to $7.1 million in the prior-year quarter, due primarily to lower capital expenditures.

Cash capital expenditures of $6.5 million included the remodel of 10 company restaurants and the acquisition of one franchise restaurant. During the quarter, we allocated $39 million towards share repurchases, including a $25 million accelerated share repurchase agreement that we entered into in November and completed in February 2017.

As a result of this agreement, we received a total of two million shares at a volume weighted average price of $12.56 per share. In addition, we repurchased 1.2 million shares in the open market during the fourth quarter.

At the end of the year, basic shares outstanding totaled 71.4 million shares compared to 76.9 million shares at the end of the prior year for a total reduction of 5.5 million shares.

Since beginning our share repurchase program in late 2010, we have repurchased nearly $36 million shares excluding delivery of the final 500,000 shares from the settlement of the $25 million ASR in February 2017 and reduced our share count by approximately 30%.

We ended the quarter with approximately $79 million in remaining share repurchase authorization. Our quarter-end leverage ratio was 2.45 times. And at the end of the quarter, we had $245.6 million of total debt outstanding, including $218.5 million under our revolving credit facility.

Let me now take a few minutes to review the business outlook section of our earnings release. For fiscal year 2017, we anticipate same-store sales growth at company restaurants and domestic franchise restaurants to range from flat to 2%.

While we typically do not provide quarterly insight into our annual guidance, the magnitude of the Easter spring break holiday shift is worth mentioning.

Historically, when the Easter spring break holiday shifts from Q1 of the prior year to Q2 of the current year, we have observed a 60 to 80 basis point weight on Q1 same-store sales, which has been offset with a bounce back in early Q2. We anticipate 2017 will follow similar historical patterns.

We expect open between 45 and 50 new restaurants globally with net unit growth between 10 and 20 restaurants. We currently expect total operating revenue of $523 million to $532 million, including franchise and licensing revenue of $140 million to $142 million.

Our company restaurant margin expectation is between 17.5% and 18%, which is similar to our 2016 margin of 17.8%. Our franchise operating margin estimate is currently between 71% and 71.5%, which represents an improvement over our 2016 margin of 70.8%.

General and administrative expenses are anticipated to range from $68 million to $71 million and our effective income tax rate is expected to be between 35% and 37%. Adjusted EBITDA is estimated to be between $101 million and $103 million.

Cash capital expenditures are expected to range from $22 million to $24 million and include the relocation of three high performing company restaurants due to impending loss of property control. Free cash flow is anticipated be between $58 million and $60 million.

We will continue to allocate capital towards investments in our brand and company restaurants while also returning capital to shareholders through our ongoing share repurchase program. That wraps up our guidance commentary. I will now turn the call over to the operator to begin the Q&A portion of our call..

[Operator Instructions]. We do have our first question from Michael Gallo with C.L. King..

Good afternoon..

Hi Mike..

A couple of questions, if I may. John, the fourth quarter, obviously, trend in the industry got more challenges went on and I think the promotions you had were perhaps a little bit further away from value than you would have liked.

I was wondering, as you shift it back to the $4 pancake offers, what you have seen in terms of value incidents and whether you think you have that mix right today? And then just as a follow-up, I thought I heard you say that you now expect 75% of the stores to be reimaged by the end of 2018, which I think was 70% previously.

If you could just clarify that? Thanks..

Yes. Thanks Mike. I will start with the last question first. Late in the year, we clarified that was 75% by the end of 2018. So that is correct. That's been a revision up from 70%. I do not remember when we last said 70% earlier in the year. Regarding value promotions and getting it right.

I do think we have done a pretty good job of managing the annual calendar to be consistent with where the consumer is.

I think the launch of pancakes mid-year, which had a little bit more of a value mainstream comfort food appeal, sort of wear the mood of the country maybe the answer to what the country is looking for played a role in some separation between us and the field of competitors in the full-service and casual space.

We say that because the consumer response was pretty strong. But quarter-to-quarter, fourth-quarter-to-fourth-quarter, we are only 0.1 basis point off in the incident rate of our value menu 2015 to 2016 and the same is true in the first quarter of 2016 to 2015. So what we are doing in the first quarter of 2017 is still consistent.

I think we always use in the first quarter, we use value this time of year, it's sort of part of the annual rhythm..

Okay. Thank you..

Our next question comes from Will Slabaugh with Stephens..

Hi guys. Thanks. This is Drew, on for Will. Just one question real quick.

What was the $2 $4 $6 $8 mix during the quarter? And where are we in terms of opportunity to update the items in each category similar to what was done a few years ago? Or you feel like it's at a good balance as is?.

Okay. So the first quarter was on the mix of $2 $4 $6 $8 in the fourth quarter.

Was that right, Drew?.

Yes..

Yes. It was around 14%, in that range and that was actually pretty close, I think to prior year. The same number, we probably would have talked about in 2015 fourth quarter.

And then, I am sorry, the second part of the question?.

Yes.

So a couple of years ago, I think that you all had updated that, in terms of the mix of the items and I was just seeing if you all feel like it's still being received pretty well as is? Or you are maybe going to change it around?.

That's true. Certainly last year, we talked a lot about the roll that late 2014 and throughout the first three quarters of 2015 rolled in building our check and a good part of that was a mix benefit coming from deemphasizing the value menu.

Having strung together a number of years it has driven more by value and traffic driving type strategies including our strong partnership with AARP, our $2 $4 $6 $8, any number of other things that were more value-oriented.

And the farther we got from the recession and the stronger our performance was in consecutive years, I think the more both from a leadership team in terms of approaching strategy and then also our franchise community.

And then especially in light of a little bit stronger consumer, stronger employment numbers, we felt like we could start to deemphasize that. So it did have traffic consequences that were, sort of there is give back in traffic, but tremendous benefit in check over that four, five, six quarter period.

So you saw that from late 2014 through the end of 2015, $2 $4 $6 $8 incidence moving from nearly 23% incident rate down to below 15% for a short season and now rebalancing in that 15% range..

Great. Thanks guys..

Our next question comes from Alton Stump with Longbow Research..

Hi. Thank you and good afternoon..

Hi Alton..

It would appear that you have a pretty good customer response to your upgrades, the pancakes portion of your menu.

Not giving away all of your secrets, are there any other categories you see in the near or long term which could be in a similar mode of a potential for an upgrade as you see currently?.

We do. Obviously I can't talk about the specifics of those but if you look over the past several years, we have tackled these diner oriented categories. We have improved our shakes, our burgers, moving to 100% pure beef. We have added a few dinner entrees a number of years back. We have addressed vegetables going from frozen to fresh.

And so we continue to create either new value categories, new $2 $4 $6 $8 offers or new premium offers with the barbell strategy. And so obviously you would expect for us to continue to focus on those areas that have broad appeal, middle America feel, diner appeal..

That's helpful. Thanks. And then I guess just one other question on the pricing front. The idea is, obviously, sort of all-in ticket have been in the 2% to 2.5% range for most of the last couple years anyway.

Is there any change in your franchisees and what you are hearing from them? Obviously labor cost going up, particularly on the West Coast and elsewhere, but the commodities are pretty benign.

And so an outlook for 2017 as to how much price do you think the franchisees maybe taking on average?.

Yes. I will give you a little bit of perspective over the year. Full year, we benefited a little bit. Pricing was around 2.5% for system and franchisees were a little higher than company. So we were at 2.2% on the year and franchisees 2.6%.

Now, bear in mind, with 23% of our system in California and 90:10 franchise to company-owned, the concentration of where our states are and the burden of higher labor costs creates a little bit more of an aggressive pricing environment over of course of 2016 and then fourth quarter really exaggerated that because of where we took our menu pricing in the quarter moving it ahead of first quarter of 2017.

So fourth quarter, we were at 3% in the quarter, which brought the mix down about 0.1. So that positive 0.5 in the quarter, obviously, because we had negative traffic like a lot of people. Even though that performance being positive was about 140 days points ahead of most of our peers.

So it created a very interesting environment where earlier or the first two-thirds of the quarter continued to move along, it really is December where the challenge came. So what role pricing played in that with these cumulative 2015, 2016 industry-wide prices, call it 0.5 point above normal run rate based on wage inflation mostly.

[Indiscernible] percentage was what role does that play in traffic is sort of the persistent question. So Mark can speak to the guidance for 2017 on commodities and some other things that we are willing to talk about this early.

But I would say that if you look at our historical pattern, we are a little bit more comfortable strategically in that 2% range..

Okay. Thanks for all the color. I appreciate it, John. That's all I got..

Our next question comes from Mark Smith with Feltl and Company..

Hi. Good afternoon guys.

First, can you just walk us through those relocations? Where they are at? And how much those potentially cost in the CapEx?.

Mark, it's Mark.

You talking about the CapEx guidance on 2017?.

Yes..

Yes. So the guidance is $22 million to $24 million. And just as a reminder for everybody on the phone, the actual average of 2016 was about $34 million. So the way we look at this is, in the $34 million in 2016 there was about $14 million spent on acquisitions and about, call it, $6 million on remodel.

So about $20 million and we, at times, reference that as our growth capital. So you back off the $20 million, the core spend was, call it, around $14 million. So if you go about the same process through the guidance and the midpoint is $23 million, that's the $22 million to $24 million, same type of core capital, sort of mid-teens core capital.

We have talked about the fact that we have got, we call him offset or relocations of three company stores. The AUV on those company stores is north of what our current average in the company base. So it's, I will call it, mid-2s AUV, 2.5$, 2.6% range. And as far as locations, one is in California, Southern Cal. One is in Vegas.

And one is actually on the East Coast. So again, they are strong performing stores and what we are facing there is either no extended lease terms at all as far as property control or property control on the terms and conditions that we felt was just far too expensive terms that we thought an offset was appropriate.

And obviously that allows us to build something brand new as for our new store build..

And will we see lost operating weeks? Or are you able to get new ones opened before or at about the same time that you lose these ones?.

It's a great question, Mark. I will tell you, it's a mix and match. And in some cases, if you go store-by-store, there is probably going to be some downtime. But obviously we have included that in our entire 2017 guidance.

And probably Curt can give you a better feel specific to the store, but we hope to obviously keep the existing stores open as long as possible as we do the rebuild..

Okay.

And then last one for me, the opening guidance, how many of those are international?.

So eight to 10 would be in the guidance, a little lower than last year with a little step up of domestic..

Perfect. Thank you guys..

[Operator Instructions]. And our next question comes from Nick Setyan with Wedbush Securities..

Hi. This is Colin Radke, on for Nick. Obviously out here in California has been very wet weather recently, record rainfall.

I was just wondering, given year your base in California, to what extent that impacted Q4 and maybe Q1 to-date? And if that's incorporated in the 2017 comp guidance at all?.

Yes. So in Q4, California continued to be one of the stronger performers. It was our strongest performing state along with Illinois and Washington. Illinois did not have weather that was notable and nor did Washington, we don't believe in the fourth quarter. California has certainly reported their troubles with rain.

I think the rains actually persisted in the first quarter, but I can't talk about the quarter results at this point. But California has continued to hold up pretty well. There was obviously a deceleration in December across all 50 states, but California continued to outperform the rest of the system.

So those three states that performed strongly represent, call it, 29% of the system and they are sort of offsetting the four states that performed, that are more challenged, Texas, Florida, New York and Arizona..

Got it. Thank you. And just in terms of the remodels, just wanted to get an update now that you have had some of these in the base for a longer period of time now.

Are you still seeing the mid-single-digit lift carryover into year two and year three and beyond? Or are they starting to maybe drop off once they have been in the system for a while longer?.

So Colin, it's Mark. What we have seen obviously and the way that we have captured this is, we have articulated in saying that once a store has been remodeled with the heritage remodel image, we have seen sort of this mid-single-digit increase. Obviously, most of that is traffic increase.

And I think we have also mentioned that the stronger day-parts, as an example, dinner tends to the strongest day-part lift amidst the four day-parts, but all four do get a lift.

And then in year two what we have seen is that in general those stores that are now in the second year post remodel, they tend to hold to, I would say, the overall system average movement. So we don't see a fall off, I guess you could say, from year one. And so again, we view it as a pretty strong return on capital.

And obviously, the fact that we are half remodeled and John gave those stats of 2018, I think, 75% of the brand remodel by the end of 2018. So again, great endorsement by our franchise community and it obviously continues to perform well for us..

Got it. And then last one for me.

What's the commodity inflation and the wage inflation that's incorporated in that level margin outlook for 2017?.

On the commodity side, Colin, 2016, obviously a highly deflationary year, total annual deflation in 2016 for us here at Denny's was a deflation of around 5% and it really picked up as far as deflation in the second half. Primarily, we were rolling over obviously the bird flu and egg price increases from 2015.

So actually the fourth quarter deflationary number was probably around 8%. And this is again in 2016. What we are expecting in 2017 is, I would say, a more normal year at this point. Again, we are early .We are only six weeks in to the fiscal year. But we are thinking that commodity inflation will probably be plus 1% to plus 3%. So inflation of 1% to 3%.

Again, that's more in line with historical run rates.

If you were going to go back , let's say, over a 10-year timeframe and I know one of the question that you will probably ask as a follow-up is, okay, how much are we locked in on? And I would say, we are probably locked in around, call it, around 60% of our needs and we can probably max it up close to 70%. So we are 60% locked in.

And from a basket standpoint, overall commodity basket, we talked about this before as well, is that when you look at the primary items in there, beef and pork together represent about 30% of our commodity basket and eggs were about 10% of the commodity basket. So that sort of gives you the outline of what we are seeing in 2017.

And again, current inflation on commodities between 1% and 3%..

Okay.

And just in terms of the wage inflation? I mean I know there is another round of state-by-state minimum wages and also some specific cities have some minimum wage increases going into effect, what sort of labor inflation rate that you guys are anticipating for 2017?.

So California is going to run up another $0.50. That's $1 million to $2 million total, 30 to 50 basis points impact on the company portfolio. And then obviously price strategies are part of how you deal with it..

Thank you very much..

Thank you Colin..

That does conclude our question-and-answer session. I would like to turn the call back over to Curt Nichols for closing comments..

Thank you Camille. I would like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in early May to discuss our first quarter 2017 results. Thank you all and have a great evening..

And once again, that does conclude today's call. We appreciate your participation..