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

Will Slabaugh - Stephens Inc. Nick Setyan - Wedbush Securities Michael Gallo - C.L. King.

Good day and welcome to the Denny’s Corporation Second Quarter 2017 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the call over to Mr. Curt Nichols, Senior Director of Investor Relations. Please go ahead, sir..

Thank you, Tom, and good afternoon, everyone. Thank you for joining us for Denny’s second quarter 2017 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 first quarter earnings press release along with any reconciliation of 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 his introductory comments.

Mark will then provide a recap of our second 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 28, 2016 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. The restaurant industry's choppy performance continued into the second quarter of 2017 following a soft first quarter that was influenced by intense promotional activity.

The continued gap between grocery and restaurant pricing, the influence of a retail slowdown on dining out occasions, holiday shifts and federal income tax refunds delays all weighed on performance.

Denny's second quarter domestic systems same-store sales overcame some of the broad pressures as sales increased 2.6% due in part to improving guest traffic patterns, the launch of Denny's on Demand and a stronger than expected benefit from the Easter and spring break shift which represented approximately 120 to 140 basis points on the quarter.

Once again we outperformed key industry benchmarks. This consistent outperformance versus our category reflects the positive impact of our brand revitalization initiatives which support our commitment to achieving our vision of being the world’s largest, most admired and beloved family of local restaurants.

To that point we will continue to execute against the following four strategic pillars to achieve our vision.

First is delivering a differentiated and relevant brand in order to achieve consistent same-store sales growth; second is consistently operate great restaurants with the primary goal of being in the upper quartile of satisfaction scores for all full-service brands; third, growing the global franchise by expanding Denny’s geographic reach throughout the U.S.

and international markets; and finally, driving profitable growth with a disciplined focus on cost and capital allocation, thereby benefiting franchisees, employees and shareholders. During the second quarter we continued to evolve our menu in order to meet guest expectations for better and more cravable products.

Our latest LTO menu highlights fresh thick flavors like the Strawberries & Cream Pancake breakfast, the Chopped Kale & Grilled Chicken Salad, a Berry Blue Lemonade and a Lemon Berry smoothie. At the same time we introduced these great tasting summertime products, we also launched Denny's On Demand to meet guest expectations for greater convenience.

Denny's On Demand includes the ability to order and pay for To Go items on the web or through new mobile apps that were built in partnership with Olo. This new platform also includes enhanced to go packaging made from sustainable materials that will better ensure Denny's To Go Meals will be served hot, fresh and delicious.

Where available we also launched delivery via Olo's Dispatched Delivery Network and a number of restaurants have signed separate additional third party delivery agreements.

While we are in the early stages of executing on this new platform initiative we have been encouraged by nearly one percentage point increase in off premise sales following the national launch. These new To Go transactions are highly incremental and over indexed at late night in the dinner dayparts.

With 28% of domestic system activity engaged with one or more delivery service provider we anticipate continued long long-term growth in our off premise sales from the Denny's On Demand platform as more restaurants sign delivery agreements.

Our remodel program continues to receive favorable guest feedback and generated mid-single-digit range sales lift. Our franchisees completed an additional 52 remodels during the second quarter bringing the heritage image to over 58% of the system.

Remodels will continue to be a significant tailwind for the brand over the next few years we expect over 75% of the system to have the new image by the end of 2018. During the quarter our operations team continued to make progress toward achieving their goal of delivering higher-quality products with a more consistent service experience.

Our focus on progressively evolving our field training and coaching initiatives is critical to delivering our mission and to serve our franchise system as a model franchisor. Our new breakthrough training approach includes assessment and coaching to run great restaurants.

Overall we continue to make progress toward improving our food service and atmosphere as evidenced by our guest satisfaction and pride review scores which once again reached new highs during the second quarter. And while we are encouraged by this substantial progress our team has made, opportunities remain in order to reach our full potential.

Therefore we continue to invest in our talent and systems in order to further elevate the guest experience. Turning to development, our growth initiatives have led to over 470 new restaurant openings since 2009 representing over 27% of the current system and one of the highest totals of all full-service brands.

Our current international footprint of 125 restaurants has grown by more than 60% since 2009 and we look forward to gaining further momentum beyond North America. As we noted during our last earnings call, we expect the challenges currently facing the restaurant industry to persist for the foreseeable future.

However we are committed to profitable system sales growth and market share gains. Our continued growth in profitability will be driven by a combination of investments in our brand in our company restaurants along with our shareholder friendly allocation of adjusted free cash flow in the form of share buyback.

Since beginning our share repurchase program in late 2010 we have allocated approximately 321 million to share repurchases. It is our intention to continue our buyback program and return capital to our shareholders as we move forward.

In closing 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. We are still in the early stages of our brand revitalization through which we are growing same-store sales.

Just over 58% of the system is currently on the new heritage image and we expect 75% of the system to be remodeled by the end of 2018. We have an expanding global footprint with new interest in the brand from a number of franchisees and an active pipeline with a healthy number of planned future openings.

We remain committed to our 90% franchised business model and are growing our profitability. Our blended royalty rate is currently 4.14% and growing toward 4.5%.

Our current annual guidance for both adjusted EBITDA and adjusted free cash flow is the highest in a decade and our ability to generate strong cash flow allows us to consistently return cash to shareholders. With that, I'll turn the call over to Mark Wolfinger, Denny's Chief Financial Officer and chief administrative officer.

Thank you, John and good afternoon everyone. Our second quarter highlights include growing domestic systemwide same-store sales by 2.6% and adjusted EBITDA by 2.5% to $26.7 million while generating $12.7 million in adjusted free cash flow and allocating $24.4 million towards share repurchases.

We ended the quarter with 1724 total restaurants as franchisees opened seven restaurants and we the company opened one company restaurant. These openings were offset by 15 restaurant closings including the unanticipated closing of eight franchise restaurants in Colorado.

In addition, we acquired three franchise restaurants in New England and refranchised four QuikTrip Travel Center restaurants. Denny's total operating revenue which includes company restaurant sales and franchise and licensing revenue increased by 7.3% to $133.4 million primarily due to higher company restaurant sales.

Company restaurant sales grew by 10.3% to $98.4 million due to an increase in the number of company restaurants from the reacquisition of franchised restaurants over the last 12 months and a 2.7% increase in same-store sales.

Company restaurant operating margin of 16.9% was impacted by increases in product costs, Workers Compensation expense and minimum wages partially offset by higher sales. The increase in product costs was primarily due to rising commodities and enhanced packaging costs associated with the launch of Denny's On-Demand.

Workers Compensation expense was up due to favorable claim development of $800,000 in the prior year quarter compared with $100,000 in the current quarter.

Moving to our franchise restaurants, franchise and licensing revenue was $35 million as a 2.6% increase in same-store sales, a greater number of equivalent franchise restaurants and a higher average royalty rate were offset by decreases, both occupancy and revenue and initial fees compared to the prior year quarter.

Franchise operating margin of 70.7% improved by 130 basis points due to higher royalty revenue and improved occupancy margin.

Total general and administrative expenses of $16.6 million were up about 2.3% or $400,000 compared to the prior year quarter as lower incentive compensation was offset by higher payroll and benefits expenses and a market valuation change in our nonqualified deferred compensation plan liabilities.

As a reminder, a corresponding gain on planned assets is reflected in other non-operating income and as a result these deferred compensation planned valuation changes have no impact on net income. Adjusted EBITDA grew 2.5% to $26.7 million compared to $26.1 million in the prior year quarter.

Depreciation and amortization expense was $5.8 million compared to $5.1 million in the prior year quarter primarily due to capital expenditures associated with company remodels in new and acquired company restaurants.

Operating gains, losses and other charges net of $2 million including cost of $1.5 million associated with the implementation of a new ERP solution. We have recorded $3.7 in the software implementation costs year-to-date and expect to incur approximately $1.3 million of additional software implementation costs throughout the balance of the year.

Interest expense increased by $700,000 to $3.7 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 $4.9 million reflecting an effective income tax rate of 36%. Adjusted net income per share was $0.14 per share compared to $0.13 in the prior year quarter.

Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $12.7 million compared $18.5 million in the prior year quarter due to higher capital expenditures, cash taxes and cash interest.

Cash capital expenditures of $8.3 million including the acquisition of three franchised restaurants and construction costs associated with the opening of a new company restaurant and relocating a high performing company unit due to impending loss of property control. During the quarter we allocated $24.4 million towards share repurchases.

This enabled us to acquire an additional 2.1 million shares representing approximately 3% of our public float. At the end of the quarter, basic shares outstanding totaled 68.2 million shares which represented a reduction of 8.4 million shares or approximately 11% over the last 12 months.

Since beginning our share repurchase program in late 2010 we have repurchased over 39 million shares and reduced our share count by approximately 32%.

And between the end of the quarter and July 31, 2017 we allocated $11.7 million to repurchase approximately 1 million additional shares and we currently have approximately $31 million in remaining share repurchase authorization.

At the end of the quarter we had $264.7 million of total debt outstanding including $235 million under our revolving credit facility. Our quarter end leverage ratio was 2.66 times and we do remain committed to our target leverage range of 2 times to 3 times.

Now let me take a few minutes to expand on the business outlook section of our earnings press release. Based on second quarter results and current expectations we have updated our annual guidance expectations for 2017.

We continue to expect same-store sales growth at company and domestic franchise restaurants of between flat and positive 2% for full year 2017. As a result of the unanticipated closing of eight franchise restaurants during the second quarter, we now expect a net restaurant growth of 5 to 15 restaurants during 2017.

Due in part to recent accelerated commodity inflation, coupled with slightly higher cost of the go packaging we are lowering our company restaurant operating margin expectations to between 17% and 17.5%. This range would still represent our second-highest company margin well over a decade.

We expect our total general and administrative expenses to range between $67 million and $70 million primarily due to lower incentive compensation. We have increased our debt leverage to purchase a significant number of shares year-to-date. As a result, we now expect our net interest expense to be between $14.5 million and $15 million.

We expect cash taxes to range between $6 million and $8 million. Cash capital spending is now expected to be between $25 million and $27 million due to the acquisition of three franchise restaurants during the quarter. Our expectations for adjusted EBITDA remained between $101 million and $103 million.

Our updated guidance for adjusted free cash flow is $55 million to $57 million due to the increase in capital expenditures for the acquisitions mentioned previously. That wraps up our prepared remarks. I will now turn the call over to the operator to begin the Q&A portion of our call.

Operator?.

Thank you, sir. [Operator Instructions] We will take our first question from Will Slabaugh with Stephens..

Thanks guys. I had a question on the sales front, you guys bounced back pretty quickly this quarter after the softness you saw last quarter.

So can you walk us through what you saw as you exited 1Q and worked your way through 2Q and I'm assuming this implies to you that the 1Q softness was heavily macro weighted and that's fairly through or is there something else out there that may be kept you from being more optimistic on the comp guide looking forward?.

Thanks Will, it's John. I would say that there is really no big change all in all. We anticipated Q2 to benefit from the headwinds of Q1 based on holiday shifts one to the other. Q1 is really noisy.

We could replay if you like, but I think we've lived through that by now with federal tax returns slight benefit early in the quarter and negative at the end and benefited Q3. So obviously that benefit would have slightly favored the earlier part of the quarter.

And as I mentioned in my notes, 120 to 140 basis points may be a little bit more favorable than we thought. So it has some benefit that's not imbedded in all quarters throughout the year..

Got you, and if I could draw up on the delivery comments here, you mentioned it was highly incremental, I'm curious on do you have any data behind that on how we know it is incremental and how incremental if you are willing to share? And then what types of food are they ordering versus a typical product mix and what that means to the P&L?.

Yes, so obviously To Go is a little bit of a different business model, it is very similar but it is a little bit different. We're very pleased with the consumer response.

The near 100% of the system signed up for the Olo program software, so guests can sign up on line, order online mobile, tablet or through their computer for pick up in the entire Denny's system and we already have in yearly going about 28% of the systems signed up for at least one third party delivery company and we think that will continue to grow.

So that's one of the sources for our optimism. We do have from the pre and post testing data some incrementality checking tools, no one can know the perfect precision, but I'd say there is a high degree of confidence of a high degree of incrementality associated with it.

During tests we would have modeled Will a number of scenarios is conservative as 50% incrementality to make sure that it sort of passed all the tests for launch and we got well past that during tests.

So it gave us confidence for the role and we're pleased with how it's going and as we said it’s about $2.5 million and nearly 1% in a very short period of time..

Right, and one more thing if I could on the commodity basket, curious what you saw in the period with cost of goods pressuring most in the industry and then any expectations you may have for the rest of the year?.

Yes, well its Mark and I would say that when we did our first quarter call I think we talked about expected commodity inflation in that 1% to 3% for the fiscal year 2017.

And again coming off of fiscal 2016 when we had about a 5% deflationary situation our commodity basket, that commodity inflation today we feel is probably more in that 2% to 3% range, so bringing that range up towards the higher end. We've certainly seen increase in pork prices, pork bellies that has moved that.

But clearly it's you know it's a commodity number that we would prefer to be lower but right now we're thinking it's probably going to be in the 2% to 3% range..

Great. Thank you..

And we’ll take our next question from Nick Setyan with Wedbush Securities..

Thanks John and congrats on a great comp.

just on the labor front, obviously we saw the 90 basis points of deleverage there and then we know in July we’ve got uptick in LA minimum wage rate and so, how should we think about sort of that, that deleverage? I mean are we going right back up to well above 100 basis points in the second half and how should we think about the directionality there?.

Nick, it's Mark. I think, well I think you've started outline obviously some of the concerns we have obviously California State minimum wage as well as L.A. County which you mentioned which I think that was a July first increase if I recall I think it was a dollar half an hour.

We know that we came into the year with a series of wage increases in other states as well and in some cases significant increases in minimum wage and it's obviously difficult to price through that entirely.

So, certainly part of our adjustment in our annual guidance on margins and again that adjustment is moving the annual guidance for company margins from between 17.5% to 18% down to the 17.0, 17% to 17.5 and last year we ran 17.85 I believe in fiscal 2016. So labor is part of that.

And I think the other thing that I mentioned here is that we've got, in the second quarter we had this Worker's Comp rollover, so it was about a $700,000 differential in Workers’ Comp., meaning the fact that it was $700,000 less favorable this second quarter than it was last year.

Last year it was about $800,000 pickup, this year it was about a $100,000 pickup. So, that's part of what played into this as well. And then I think back to the previous question on commodity inflation, again it's you know our cost of goods runs around 25% of our P&L.

But I think bringing that range up to about 2% to 3% commodity range specifically in the pork belly side is probably the biggest item that we've seen move. And you put all that together and obviously we've changed our expectations for guidance and margins about 50 basis points..

Got it and then conversely on the other operating side we actually did see some decent leverage there.

Even with the delivery fees going presumably into that line item is that correct? I mean what were to, how should be think about the delivery fees and how are we recording those?.

Are you talking about the third party delivery fees Nick?.

Correct, yes..

Yes, I think what we'd say is that I'd probably go back to John's comment is that based on all the analytics we've done that a large portion of the sales incremental I think John mentioned that and I think John you said at least 50%.

From a margin standpoint we're sort of still working through that, but obviously there's incremental margin dollars associated with this transaction as well.

So, I can't give you specific guidance except to say that obviously moving our take out sales by almost a 4 percentage point, John talked about that $2.5 million number I think in the first month et cetera that we certainly are very encouraged.

The margin piece is still analytically that we put together, but we really don't have that information at this point in time to talk about on..

I would add to that that though Nick, that as you - well people are picking up from the stores that will be the overwhelming majority of our To Go orders.

28% of the system signed up for a third party delivery that would have a delivery fee associated with that sale and near 75% of the systems doesn't have a third party delivery at this point, but again we welcome those add-ons for their incrementality in spite of the delivery fee it's still got a nice margin associated with that..

I think the other thing that John mentioned that is a powerful statement for us is the fact that the day parts also that are certainly experienced in the benefit as late night and the dinner day parts which again we're certainly quite positive to see that as well..

I'll add one more thing Nick, for questions you didn't ask, but not only late night pickup but also a younger audience. Right now the largest share of digital orders is coming from 25 to 34 year olds followed by the second largest group of orders 18 to 24.

So that's a really nice averaging down of the age of the use of our brand so we're very pleased to see the early results..

Got it.

And so just to clarify the online ordering that's purely take out, it doesn’t allow delivery?.

Well there may be delivery with the Olo dispatch feature, but that would be fairly nominal. It's the third party where there's the larger fee and that's only 28% of the system at this point. But as that grows again there's a really nice flow through associated with those incremental sales..

Got it. Thank you..

[Operator Instructions] We’ll go next to Michael Gallo with C.L. King..

Hi good afternoon. John, I just want to stick on delivery here for a second.

I think I heard you say it was adding a 100 basis points early on to same-store sales, correct me if that was wrong, but is that what you've seen in stores that had it in test markets or is that what you're seeing early on as a group? And how does that kind of ramp as we go through the year? How would you expect that to ramp given that, this is the kind of thing that it would seem like it will take time to build, so give some thoughts on it?.

Certainly the goal is for this to grow. Off premise grew about 1%, so what it represents of comps is not really in the script. But we believe a good portion of that’s incremental..

And then obviously we'd expect it to continue to grow. I don't know if that really answers fully your question, but the whole idea of the launches was to meet some long term goals much higher to go percentage than we're at today.

Over time Mike, we've grown just sort of from customer sentiment staying home online shopping from home, not being out as much has gone from 4% to 6% or so and To Go sales just organically and so through these initiatives the packaging and the launch of software you know that's well past 7% now and obviously we expect that to continue to grow..

And you expect additional stores to add it in the back half of the year?.

We expect additional stores to add third party delivery services, correct..

Okay.

And then I was wondering with this also if you're collecting then any data from the customers and then whether you can use that as a way to actually market to them to get them back into the restaurant and other times obvious you'll see, what they're ordering, et cetera?.

That's a great question you know, it's a topic among a lot of brands what to do with this rich amount of data that's available in different ways to collect your consumer data these days.

We've even had people call and say can you sell us some of your data you collect from online? So it's really been interesting questions associated with just suffice to say you know we expect to be among the sophisticated users of data over time to benefit our brand..

Great. And then just a followup for Mark. I think you mentioned mark that there was a $1.3 million of additional software implementation fees I think in the back half.

What was the total for 2017 and do you expect those to recur in 2018?.

Yes, so first on the 2018 question. No, right now we're anticipating that there will be no additional expenses per se in 2018.

I think I talked about the fact that in the first couple quarters we're about $3.7 million and we anticipate a little bit over million like $1.3 I think for the balance of the year, so you're talking around $5 million for fiscal 2017..

And just again to clarify the – will the $5 million repeat, there won't be anything incremental that will just be the new run rate or does the $5 million come off next year?.

It basically - most of that is implementation cost and then there will be some ongoing expense related to the system. I want to say probably in the million dollar range that will run through G&A..

Okay, so net and again correct me if I’m not reading this right, but net you should see a $3 million or $4 million reduction in baseline G&A from this next year?.

No because the $5 million is not going through G&A. It's going through the other op line that I mentioned. So you it's sort of - what I would say Mike is probably the follow up technically probably would be good to range of call may need to walk through it in more detail.

But there's $5 million implementation cost going to the fiscal 2017 P&L at this point and again ongoing that will not occur in 2018, but in 2018 and beyond there probably be about $1 million of G&A expense going through as far as systems..

Okay, but net-net it will be a positive, I got you, yes I'll talk to you offline on that thing..

Right, right fair enough..

And with no further questions left in the queue, Mr Nichols, I'd like to turn the call back over to you for any closing remarks..

Thank you, Tom. I’d like to thank everyone for joining us on today's call. We look forward to our next earnings conference call to be in early November to discuss our third quarter results. Thank you and have a great evening..

And ladies and gentlemen this does conclude today's conference. We appreciate your participation..