Curt Nichols - Senior Director, IR John Miller - President and CEO Mark Wolfinger - EVP, CAO and CFO.

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

Good day, and welcome to the Denny's Corporation Fourth Quarter 2017 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, Investor Relations. Please go ahead, sir..

Thank you, Glen, and good afternoon, everyone. Thank you for joining us for Denny's fourth quarter and full year 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 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 a brief commentary on our annual guidance for 2018. 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 turn the call over to John Miller, Denny's President and Chief Executive Officer..

Well, thank you, Curt and good afternoon, everyone. Denny's achieved positive system-wide same store sales growth for the seventh consecutive year, and once again demonstrated relative strength against key industry benchmarks. This reflects the momentum generated by our revitalization strategies.

And I'm proud of the efforts of our team to consistently execute these revitalization strategies, which support our commitment to achieving our vision of being the world's largest most admired and beloved family of local restaurants.

That said, we accomplished these positive sales results during what proved to be another choppy year for the restaurant industry.

The continued gap between grocery and restaurant pricing, thorough income tax recent delays, holiday shifts, hurricanes and lackluster traffic are a few of the reasons often sighted us contributing to the challenges in this full service dining category.

However, we continue to execute against our four strategic pillars to achieve our vision and overcome these challenges.

These pillars include, first delivering a differentiated and relevant brand in order to achieve consistent same store sales growth; second, consistently operating great restaurants with the primary goal of being in the upper quartile satisfaction scores for all full service brands; third, growing our global franchise by expanding Denny's geographical reach throughout the U.S.

and international markets; and fourth, driving profitable growth with disciplined focus on costs and capital allocation for the benefit of our franchisees, employees and shareholders. We also continue to evolve our menu to meet guest expectations for better more favorable products.

Our latest, LTO menu builds on the success of our recent Buttermilk Pancake relaunch by introducing premium craft pancake. But we are also featuring fresh ingredients in both flavors in three sizzling skillet dinners like the Crazy Spicy Skillet and the Smoky Gouda Chicken & Broccoli Skillet.

We are making good progress addressing guest expectation for greater convenience through our new Denny's On Demand platform, which offers web and mobile ordering and payment options for pickup and or delivery.

And while still in the early stages of executing on this new platform, we are encouraged by an increase in off-premise sales of 2 percentage points. In December of 2016, off-premise sales represented 6.6% of total sales, but grew 210 basis points to 8.7% of total sales in December of 2017.

Holidays continue to exceptionally strong business days for off-premise sales and Christmas Day set a new record at 12.8% of total sales. These to go transactions continue to be highly incremental, they over indexed at late night and dinner day parts and skew towards the younger 18 to 34 year old demographic.

In terms of product mix pancake plates, burgers, milkshakes and build your own entrée options continue to over index for To Go transactions compared to the dine-in transactions. And approximately 50% of the domestic system is actively engaged with a one or more delivery service option.

And we continue to add master partnership agreements with third party delivery providers where available. These master partnership agreements enable individual restaurants to quickly and easily sign on for additional delivery options.

We anticipate continued long-term growth in off-premise sales from the Denny's On Demand platform as more restaurants sign these individual delivery agreements or add a second delivery option in their locations.

In January we featured a commercial promoting both value and the Denny's On Demand platform by offering a free Build Your Own Grand Slam after your next online order. And our heritage remodel program continues to perform well consistently receiving favorable guest feedback and generating a mid-single digit range sales lift.

During 2017, franchisees completed 247 remodels and we completed three company remodels.

For the approximately 67% of the system currently on the heritage image we believe we are just crossing into the middle stages of our revitalization with many brand enhancing strategies remaining and an expectation that approximately 80% of the system will have the new image by the end of 2018.

We believe remodels will continue to be a significant tailwind toward our brand revitalization over the next few years.

We remain focused on progressively evolving our field training and coaching initiatives to not only serve our franchise system as a model franchise or but also to better enable our operations teams to achieve their goal of delivering higher quality products with a more consistent service experience.

While we are encouraged by the substantial progress our team has made, we believe opportunity remain in order to reach our full potential. And accordingly we will continue to invest in our talent and systems to further elevate the guest experience.

Turning to development, our growth initiatives have led to nearly 500 new restaurant opening since 2009, representing over 28% of the current system and one of the highest totals of all full-service brands. The ongoing revitalization of our brand and our expanding global footprint continue to attract new interest for international expansion.

In 2017 we opened seven new international restaurants, including three additional openings in the Philippine and our first Denny's restaurant in both Guatemala and the United Kingdom, which was also our first in Europe.

We have opened more than 60 international locations in nine new countries since 2009 leading to a current international footprint of 128 restaurants. And with our current pipeline of approximately 80 planned international openings, we look forward to gaining further momentum beyond North America.

As we look ahead, we remain committed to profitable system sales growth and market share gains along with our shareholder friendly allocation of adjusted free cash flow in the form of share buyback. Since the beginning our share repurchase program in late 2010, we have allocated approximately 356 million share repurchases.

Our intent to return capital to shareholders through our ongoing buyback program was further supported by our credit facility refinancing and new share repurchase authorization announced in October. In addition to the favorable impact of the recent tax reform, which Mark will cover in more detail.

So in closing, we remain focused on continuing the transformation of the Denny's brand to grow around the world, with two-thirds of the system on the new heritage image, our brand revitalization through which we are growing same store sales is just entering the middle stages.

We have continued progress with remodels coupled with our brand enhancing strategies is expected to yield benefits for years to come. And our expanding global footprint with growing interest from a number of franchisees supports an active pipeline for future openings.

Finally we remain committed to our 90% franchise business model and are growing our profitability with our blended royalty rate increasing towards 4.5% allowing us to continue generating strong cash flows and to support our efforts in returning capital to our shareholders.

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

Mark?.

Thank you, John and good afternoon, everyone. Our fourth quarter highlights include growing domestic system-wide same store sales by 2.2%, adjusted EBITDA by 7.6% to $27.8 million and adjusted net income per share by 5.9% to $0.18 per share, we generated $15.3 million of adjusted free cash flow.

We ended the quarter with 1,735 total restaurants, as Denny's franchisees opened 13 restaurants and we opened one company restaurant. These openings were offset by four franchise restaurant closings. In addition, we acquired three franchise restaurants.

Denny's total operating revenue, which includes company restaurant sales and franchise and license revenue increased by 4.5% to $135.5 million, primarily due to higher company restaurant sales and franchise royalties.

Franchise and license revenue grew 0.5% to $35.2 million, primarily due to 2.2% growth in same store sales, a higher average royalty rate and higher initial fees compared to the prior year quarter, partially offset by lower occupancy revenue.

Franchise operating margin of 72.1% was flat to prior year, as growth in royalty revenue and initial fees was offset by an increase in other direct costs and a reduction in occupancy margin. The increase in other direct costs was associated with enhanced support for new restaurant openings in non-traditional locations.

Moving to our company restaurants, sales grew by 6% to $100.3 million due to an increase in the number of company restaurants over the past 12 months and a 2.1% growth in same-store sales.

Company restaurant operating margin of 16.4% was impacted by an expected rise in product costs and minimum wages, partially offset by higher sales and lower workers compensation expense.

The reduction in workers compensation expense was due to approximately$600,000 in favorable experience in the current year quarter compared to approximately $600,000 of unfavorable experience in the prior year quarter.

On a full year basis, reversals from favorable workers' compensation experience were $2.2 million compared to $1.4 million in the prior year. Total general and administrative expenses of $15.9 million decreased by 8% or $1.4 million, primarily due to our reduction in professional fees and lower incentive compensation.

Adjusted EBITDA improved by $2 million or 7.6% to $27.8 million. Depreciation and amortization expense was $300,000 higher at $6.2 million, primarily due to the acquisition of franchise restaurants during the current year.

Operating gains, losses and other charges on a net basis improved by $1.7 million to $900,000 primarily due to a reduction in both impairment charges and restructuring and exit costs compared to the prior year quarter.

Interest expense was up by $1 million to $4.3 million, primarily due to higher revolver balance and approximately 50 basis points increase in our weighted average interest rate announced in the revolver loans and the greater number of capital leases compared to the prior year quarter.

The provision for income taxes was $2.1 million reflect an effective income tax rate of 13.8%. The enactment of the Tax Cuts and Jobs Act of 2017, during the fourth quarter required us to revalue our deferred tax assets and liabilities using the 21% federal statutory income tax rate.

As a result, we recorded a one-time non-cash benefit of $1.6 million to provision for income taxes. Excluding this tax reform impact and a $1.8 million benefit associated with the settlement of stock based compensation, the effective income tax rate for the fourth quarter would have been approximately 35.6%.

Adjusted net income per share grew 5.9% to $0.18 per share compared to $0.17 per share in the prior year quarter.

Adjusted free cash flow after capital expenditures cash taxes and cash interest was $15.3 million compared to $14.4 million in the prior year quarter, primarily due to higher adjusted EBITDA and lower cash taxes partially offset by increased capital expenditures and cash interest.

Cash capital expenditures of $7.6 million included the acquisition of three franchise restaurants and the remodel of two of our company restaurants. Our quarter end leverage ratio was 2.79 times, at the end of the quarter we had $289 million of total debt outstanding including $259 million under our revolving credit facility.

During the quarter we allocated over $16 million to our share repurchases. At the end of the year basic shares outstanding totaled 64.6 million shares compared to 71.4 million shares at the end of the prior year for a total reduction of 6.8 million shares.

Since the beginning of our share repurchase program in late 2010, we've allocated approximately $356 million to repurchase more than 43 million shares and reduced our share count by over 43%. We ended the quarter with approximately $196 million remaining on our share repurchase authorization.

Now, let me take a few minutes to review the business outlook section of our earnings release. For fiscal year 2018, we anticipate same-store sales growth at company restaurants and domestic franchise restaurants to range from flat to positive 2%.

We expect to open between 40 and 50 new restaurants globally with approximately flat net restaurant growth. Due to changes in revenue recognition standards which became effective in January, we will begin separating advertising proceeds received from franchise restaurants from the related expenditures.

These items were previously netted together in our income statement, but will appear separate components of both our franchise and license revenue and costs of franchise and license revenue.

Further, we will began recognize initial franchise fees ratably over the franchise agreement term compared to the previous practice of recognizing that revenue at the beginning of the term.

Upon adoption, we expect to record deferred revenue of approximately $21 million related to previously recognized initial franchise fees, which will be amortized over the remaining term of the related franchise agreements.

While these revenue recognition changes are not expected to have a material impact on franchise margin dollars, adjusted EBITDA or adjusted free cash flow they will impact our guidance for total operating revenue, franchise and license revenue and franchise operating margin rate.

We currently expect total operating revenue of $634 million to $642 million, including franchise and license revenue of $222 million to $225 million.

Had we applied the revenue recognition changes to our fiscal 2017 results, we would have reported total operating revenue of approximately $612.7 million and franchise and license revenue of approximately $222.3 million. Moving further on, our company restaurant margin expectation is between 16.0% and 16.5%.

Our franchise operating margin estimate is between 46% and 46.5%. By comparison, we would have reported franchise operating margin of approximately 44.9% for fiscal 2017 had we applied the new revenue recognition standards.

General and administrative expenses are anticipated to range from $71 million to $73 million and include higher assumed incentive compensation and investments in our training and technology functions to further support our brand revitalization strategies.

Our effective income tax rate is expected to be between 22% and 24% with cash taxes of between $4 million and $6 million. Adjusted EBITDA is estimated to be between $105 million to $107 million. Cash capital expenditures are expected to range from $33 million to $35 million.

This range encompasses approximately $10 million to $11 million of growth capital including the acquisition of five high volume franchise restaurants in Texas last month, in addition to a planned company restaurant opening later in the year.

This range also includes approximately $7 million to $8 million associated with remodels from recent franchise restaurant acquisitions and restaurant offsets. The balance of this CapEx range relates to ongoing maintenance capital. Adjusted free cash flow is anticipated to be between $48 million and $50 million.

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

Operator?.

Thank you. [Operator Instructions] And we'll take our first question from Will Slabaugh with Stephens..

Hey, thanks guys.

Want to ask on the same-store sales guide of 0% to 2% for 2018, should we think about that as a typical goalpost you're setting out there for the year or is there any sort of additional competitive pressure that you're either expecting or maybe already seeing out there as the year has begun?.

That's great question, Will. I think for us if you look over the history and then forward-looking we guide the year at a time. I think this 0% to 2% range is consistent the narrative of just where the industry has been, where full service has been.

Denny's on the bright side of guidance as we continue to outperform our peers and that sort of grew in our separation throughout 2017 finishing sort of fourth quarter stronger than the first quarter in terms of outperforming family dining peers rather casual peers.

So the performance of our brand in the competitive set continues to be solid, but at the same time there is challenges with - there is traffic challenges in the category. And so we just want to make sure that we're guiding according to what we expect to deliver..

Understood. And traditionally we haven't seen quick service impact you guys in any significant ways.

But I'm curious what the recent aggressiveness of around price points within quick service if you've seen any impact there or planning anything that to combat if that pressure to show up?.

Right, of course we always try to prepare our marketing calendar with a great deal of planning and flexibility. We like the fact that we have value leverage we can pull in or guide guest toward value oriented quality investments we've made in the brand.

Our consumers have self-selected toward check builders rather than value, you see our 2468 continues to hold in that mid-teen area rather than just seem to have a lot of pressure. And that's in spite of the fact that there is all you can eat, pancake promotions everyday value slims been offered.

So the response to our category seems to be counter to the value trend that's growing the attention to QSRs. So it's hard to know yet traffic is under pressure. So well I think Will is that there all of these categories in the mature industry have some impact.

We still continue to believe anecdotally as groceries in the home that's got the greater impact. And there is different ways that you can point to evidence of that that sort of hard to articulate in a short answer, but the Denny's on demand is a one strong indication.

I think you see little midyear loss and even though we've put some amortizing behind it this is not an overweight long-term equity builder for the brand in terms of advertising investment nevertheless despite customer demand has grown a little over 200 basis points since the finish of 2016.

So you know we think that there is pressures other than just value or QSR drive to pressures that are impacting the industry..

Got it. And one more question on the margins if I could or on the guidance rather. So if you look at the store level margin guide of 16% to 17% for fiscal 2018, the fairly wide range.

So outside of comps, I was curious what the other variables might be to take that to the high or low end of that range?.

Yes, let me just - I just want to confirm obviously our guidance range..

I think the guidance is 16% to 16.5%..

Sorry about that..

So just along those lines, I guess what we're seeing Will obviously is you've got - so let me step back a second. So from a company restaurant standpoint just as a reminder about 35% of our company operated restaurants are in California.

So that's about 65 stores we have in California and obviously California has taken another $0.50 per hour wage increase on minimum wage. So that moved from $10.50 to $11 on January 1. Additionally there - so you've got wage inflation coming from I will say the state wage out there, so that's going to impact obviously cost of labor.

And then we have got some carryover from labor inflation that occurred sort of late in the year in certain jurisdictions in California. So we think probably what we're seeing their again within that comp range of 0% to 2% there's probably call it 50, 60 basis points of inflation, that's going to basically run to the labor line.

So that's the first comment. On the commodity side, which I haven't had a question on, so I'll just go ahead and speak to that, commodity inflation we're seeing probably 1.5% to 2.5% inflation in commodity that's what we're viewing for 2018 at this point in time.

To put that in perspective that number was just slightly above 2% in 2017 and of course 2016 was the highly deflationary year. So when you put it altogether, we are sort of in that that 2016 range for fiscal 2018 for the company restaurant operating margin. And hopefully that gives you sort of a feel for how inflations rolling through the P&L..

Great, thanks guys..

We'll go next to Michael Gallo with C.L. King..

Hey, Mike..

Can you hear me..

We can now..

Mike, are you there?.

Yes, I am here.

Just a couple quick questions, Mark I think the guidance on franchise restaurant margin on a pro-forma basis implies some meaningful step up in percentage I know you have had the royalty rate that's escalating if some old contract roll off, is there a larger number that rolls off in 2018 or is there is something else going in terms of that line item?.

Yes, Mike, there is a couple things rolling through that and just sort of to set the stage because I know there's a lot of numbers moving around because of the rev rec change.

But again if you go back and look at fiscal 2017 and you would apply the new rev rec rules that franchise margin was call it around 45%, I think it was 44.9% and we're guiding in that 46% to 46.5%. So we are up call it somewhere between 110 and 160 basis points or 100 to 150 basis points.

Part of that is the fact that we continue to see - to your point we continue to see franchise stores roll-on to this 4.5% royalty rate.

And so at the end of 2017 - let me put it this way, at the end of 2016 we had about 600 franchise stores at the 4.5% rate at the end of 2017 so the fiscal year we just ended that was up about 100 stores call it around 700 with the 4.5%. And we anticipate there will be another 50 to 75 that will probably roll with 4.5% during fiscal 2018.

So that is definitely rolling through the P&L that's obviously benefiting margins and there is the other piece, if you recall that with that 4.5% royalty change there was a certain portion of it that we contributed back to the brand building fund and that all - that does go away at the end of 2017.

So there is a little bit of extra benefit there that the other way to put it would be a lower franchise P&L expense that has been rolling throughout the fiscal 2017. So hopefully haven't completely confused you but bottom-line is we're up somewhere between 110 to 160 basis points in our franchise operating margin based on guidance for 2018..

Okay. And I think that make sense. Question for John, obviously tax reform, so sort of three pronged, your own tax rate which obviously is dropping, but then also the significant potential benefit to your franchisees that where I would think a lot of them are pass through entities.

Can you talk to one what you're seeing in terms of franchisees willingness to invest and or will say in remodels or accelerating remodels, particularly given the depreciation benefit and or new stores?.

Sure. I was waiting for the other two prongs. That's the….

Well, the next part was on the consumer side as well if you've seen any change in behavior as a result..

Yes, well I'll do the consumer first. I think it's a little too early well. Will alluded a moment ago to a lot of noise in value or discounting going on among QSR and then casual with a number for 2 for 20 or different kind of stimulus out there.

So I'd say the market is noisy enough not to really know, so you've got a strong economy, a reasonably near full employment normally with a high correlation to eating out and yet this value environment to persist.

So there is I think explanations for all of those when somebody starts there is a chain reaction then you know when you can kind of work yourself out of it.

But I think that those because of all that noise, it's hard to say where the consumers is whether or not they're feeling a bigger pay check and changing their dine out habits, whether it be the selection of brands or categories.

QSR, fast casual, family or casual and whether it be - or in another words are they being driven by a strong stimulus so that being driven by a fatter check. It's just really too early to know. I do believe that longer term, just pure conjecture is that overall this plays a role in more capital investment and in growth in general.

And whether or not that plays through the more mature industries or restaurant retailer big boxes is yet to be seen, but overall for our economy it has to be good news for dining out ultimately it's a bit too early to know.

On our franchise system, we said for some time and throughout this heritage remodel program, we've run these things in seven year cycle. So we're going to be what pushing towards the 80% mark with this remodel scheme.

And so we think that it's late enough in this scheme the seven year cycle that you wouldn't see at this point people moving ahead of their due dates. It's much more likely that this money would be allocated differently. So will this be applied toward kitchen investments or new builds or accelerated development, those are great questions.

And I think once again it's too early to know, but as we work with our franchise community throughout the year we too, have a great deal of interest in answering those questions for you..

Okay, great. And then just a clarification from what Mark has said. I think you said 16% to 16.5% restaurant operating profit margin. I thought the guidance was 16% to 17%. So if you can you just clarify..

Yes, sorry Mike, that's right. I misspoke, it's 16% to 17% sorry. That's correct..

Thank you..

[Operator Instructions] We'll go next to Nick Setyan with Wedbush Securities..

Hi, Nick..

Hi, guys. Thanks for taking the question. Your G&A actually came in below guidance for I think it was $67 million to $70 million for 2017. And I guess the 2018 G&A guidance calls for a step up we haven't seen in a while.

So I guess maybe just kind of give us some color on what sort of step up - what some of the step up entails?.

Sure, Nick, I'd be happy to, it's Mark. Yes, so let me - I'll just go back do a little bit history here just to sort to set the stage. So 2016 actual G&A was around $68 million. 2017 came in around $66.5 million, $66.4 million. And right now our guidance for 2018 is a $71 million to $73 million.

And so looking at the components, I mean, I think, as mentioned in my script it's really the change or the increase is really driven by the change sort of reloading our incentive accruals.

And I think as we've spoken to in the past the incentive accruals on cash incentive this will be our annual incentive accruals, can move around back and forth based on performance in this particular year 2017, we reduced those accruals as the year came together in 2018 we are taking that backup basically a full accruals.

So that's a primary driver, the rest of it is really to a bit of investment and training and technology function. So again focused on some headcount additions and both our training function again driving the ops revitalization and then on the technology side. But that's a piece of it, but I would say the larger piece is the incentive accrual..

Just to clarify on the press release the guidance is $72 million to $74 million.

So is it $71 million to $73 million or $72 million to $74 million?.

$72 million to $74 million, sorry..

Okay.

And then in terms of just moving parts on the top-line, could you guys just kind of break out what the advertising dollars are there, so we can back into it but that would just help?.

You want the revenue rec change?.

Yes..

In total, it's probably in the range of about $80 million of advertising that sort of goes and then out..

Okay.

And then just last clarification, in terms of the price and mix and guests count for the quarter?.

On the fourth quarter alone?.

Yes..

Yes, fourth quarter mix was slightly positive point - quarter of a point or so, on the quarter end traffic slightly negative..

Got it, thank you very much..

And that concludes our question-and-answer session. I would like turn things back to our speakers for any closing remarks..

Thank you, Glen. I'd 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 2018 results. Thank you and have a great evening..

Thank you, everyone. That does conclude today's conference. We thank you for your participation. You may now disconnect..