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

Will Slabaugh - Stephens Inc Michael Gallo - CL King Nick Setyan - Wedbush Securities Alton Stump - Longbow Research.

Good day, and welcome to the Denny's Corporation First Quarter 2018 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..

Thank you, Kevin, and good afternoon, everyone. Thank you for joining us for Denny's first quarter 2018 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 this 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 first quarter results, along with brief commentary on our annual guidance for 2018. After that, we'll 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 27, 2017, 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..

A Star Wars Story, including a Blaster Fire Burger and Co-Reactor Pancakes. Through our partnership with the Star Wars franchise, we are also selling exclusive trading cards to raising money for No Kid Hungry in support of the mission to eradicate childhood hunger.

Our Denny's on Demand platform continues to resonate with guests, who are seeking the convenience of online ordering and payment options from pickup or delivery. We continue to be encouraged by the growth at our off-premise sales through this platform.

In March of 2018, off-premise sales represented 9.8% of total sales, reflecting an increase of 110 basis points from 8.7% of total sales in December. Since launching Denny's on Demand in June of last year, off-premise sales have grown approximately 300 basis points as a percentage of total sales.

The expansion in our off-premise business during the quarter was primarily driven by growth in third-party delivery. We have mastered delivery partnership agreements with multiple vendors, enabling individual restaurants to quickly and easily sign on with one or more of these partners.

Just over 50% of the domestic system is actively engaged with at least one delivery partner, and we sell a number of units as an additional delivery option at the end of 2017.

Approximately 52% of our company restaurants portfolio is actively engaged with multiple delivery options compared to approximately 22% of domestic franchise restaurants that are live with more than one delivery partner.

We believe this difference contributed to the higher same-store sales results of positive 3.2% at company restaurants during the first quarter compared with positive 1.2% at domestic franchise restaurants. As a reminder, these to-go transactions continue to be highly incremental.

They over-index to the late-night dinner date part and are skewed toward the younger 18 to 34 year old demographic. Despite the additional delivery fee, the total margin rate of these third-party delivery transactions ranges from the low teens to upper 20%.

We anticipate continued long-term growth in off-premise sales from the Denny's on Demand platform as more restaurants expand their delivery channels. Our Heritage remodel program continues to perform well, consistently receiving favorable guest feedback and generating a mid-single digit range sales lift.

During the first quarter, franchisees completed 52 remodels, and we completed one company remodel.

Approximately 71% of the system is currently on the Heritage image, but we believe we are just entering 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.

These 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 world, but also to better enable our operators - 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 opportunities remain in order to reach our full potential. Accordingly, we continue to invest in our talent and systems to further elevate the guest experience. Turning to development.

Our growth initiatives have led to over 500 new restaurant openings since 2009, representing over 29% of the current system and one of the highest totals of all full service brands.

In the first quarter, we opened three new international restaurants, including two additional openings in Canada, and our sixth restaurant in the Philippines, leading to a current international footprint of 130 restaurants.

The ongoing revitalization of our brand and our expanding global footprint continue to attract new interest for international expansion, and we look forward to gaining further momentum.

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 beginning our share repurchase program in the late 2010, we've allocated approximately $372 million to share repurchases.

We remain focused on continuing the transformation of the Denny's brand to grow around the world.

With just over 70% of the system on the new Heritage image, we still have a meaningful opportunity to capture additional sales and traffic through ongoing updates, brand enhancing strategies like our Denny's on Demand platform to deal incremental benefits for years to come.

Our expanding global footprint reflects growing interest from a number of franchisees, and we remain committed to our highly franchised business model. These collective efforts are allowing us to grow our profitability, generate strong cash flows and support our efforts in returning capital to our shareholders.

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

Thank you, John, and good afternoon, everyone. Our first quarter highlights include growing domestic system wide same-store sales by 1.5%, adjusted EBITDA by 10.2%, adjusted net income per share by 21.2%, and delivering adjusted free cash flow of $5 million.

We ended the quarter with 1,724 total restaurants as Denny's franchisees opened 10 restaurants. These openings were offset by 20 restaurant - 20 franchise restaurant closings and one company restaurant closing. In addition, we acquired five franchise restaurants. So let me take a moment to level set our financial results.

Starting in the first quarter of 2018, our results include the impact of adapting new revenue recognition standards in accordance with Topic 606, which clarifies the principles used to recognize revenue. The adoption of these new standards did not impact the recognition of company restaurant sales or royalties from franchise restaurants.

However, the adoption did impact advertising arrangements with franchisees, initial fees, gift card breakage and other franchise services fees. Fees received from franchisees for advertising programs were previously recorded net of the related advertising expense.

Upon adoption of Topic 606, the revenue and expenditures are now recorded on a gross basis within the consolidated statement of income. Similarly, other franchise service fees are now recorded on a gross basis whereas under previous guidance, they were netted against the related expenses.

Initial fees, which we previously recognized upon the opening of a franchise restaurant are now deferred and recognized over the term of the underlying franchise agreement. In the event of franchise agreement is terminated, any remaining deferred fees are recognized in the period of termination.

Upon adoption, we recorded deferred franchise revenue of $21 million, an increases of $15.6 million to opening deficit and $5.4 million to deferred tax assets.

Because we adopted these new standards on a modified retrospective basis, prior year quarterly results are not adjusted and continue to be reported in accordance with our historical accounting.

Denny's total operating revenue, which includes company restaurant sales and franchise and license revenue grew 21.4% to $155.3 million primarily due to recognizing franchise advertising revenue on a gross basis and an increase in company restaurant sales.

Franchise and license revenue grew 58.4% to $54.1 million primarily due to recognizing $19.3 million of advertising revenue. Additionally, increases in initial fees, which were also impacted by revenue recognition changes and royalty revenue were partially offset by lower occupancy revenue due to scheduled lease terminations.

Franchise operating margin was 47.2% compared to 71.4% in the prior year quarter primarily due to recording advertising revenue and related costs on a gross basis. Absent revenue recognition changes, franchise operating margin would have been 74.0%, which represents an improvement of 250 basis points over the prior year quarter.

Additionally, increases in our initial fees and royalty revenue were partially offset by an increase in other direct costs and a reduction in occupancy margin. The increase in other direct costs was associated with the gross of other franchise service fees and related expenses. Moving to our company restaurants.

Sales grew by 7.9% to $101.2 million due to an increase in the number of company restaurants over the past 12 months and a 3.2% growth in the same-store sales.

Company restaurant operating margin of 14.2% was impacted by an increase in third-party delivery costs as John mentioned earlier, along with prior year general liability benefit and an expected rise in product costs and minimum wages, partially offset by higher sales.

Total general and administrative expenses of $16.6 million improved by 5.4% or approximately $900,000 primarily due to market valuation changes associated with our deferred compensation plan and reductions in share-based compensation and professional fees, partially offset by investments in personnel.

Adjusted EBITDA improved by $2.1 million or 10.2% to $22.3 million. Depreciation and amortization expense was approximately $800,000 higher at $6.5 million primarily due to the acquisition of franchised restaurants during the past year.

Operating gains, losses and other charges on a net basis improved by $400,000 to $360,000 primarily due to amounts in the prior year quarter related to the implementation of our cloud-based enterprise resource planning system, which was partially offset by our prior year gain on the sale of real estate to a franchisee.

Interest expense rose by $1.1 million to $4.6 million primarily due to higher - due to a higher revolver balance, an approximate 75 basis point increase in our weighted average interest rate on outstanding revolver loans and a greater number of capital leases compared to the prior year quarter.

The provision for income taxes was $1.8 million, reflecting an effective income tax rate of 15.8% driven by the new 21% federal statutory income tax rate and a $400,000 benefit associated with the settlement of share-based compensation. Adjusted net income per share grew 21.2% to $0.15 per share compared to $0.12 per share in the prior year quarter.

Adjusted free cash flow after capital expenditures, cash taxes and cash interest was $5 million compared to $9.8 million in the prior year quarter primarily due to increased capital expenditures and cash interests, partially offset by higher adjusted EBITDA.

Cash capital expenditures of $12.6 million included approximately $8 million invested to acquire five franchise restaurants. This compares with $3.8 million used to acquire three franchise restaurants and a real estate - and a piece - and a real estate associated with relocating a high-performing company restaurant in the prior year quarter.

Our quarter-end leverage ratio was 3.01, and at the end of the quarter, we had $314 million of total debt outstanding, including $282 million under our revolving credit facility. During the quarter, we allocated over $16 million towards share repurchases.

And at the end of the quarter, basic shares outstanding totaled 64 million shares, which represents a reduction of 6.2 million shares or approximately 9% from one year ago.

Since beginning our share repurchase program in late 2010, we've allocated approximately $372 million to repurchase more than 44 million shares at an average price of $8.41 per share, bringing to a 36% net reduction in our share count. We ended the quarter with approximately $180 million remaining in our share repurchase authorization.

Now let me take a few minutes to expand on the business outlook section of our earnings release. With the exception of three adjustments, we are reiterating each component of our initial annual guidance.

We are reaffirming adjusted EBITDA expectations in the range of $105 million to $107 million, which represents an increase of over 4% at the midpoint and adjusted free cash flow of $48 million to $50 million, which is a similar range to our 2017 adjusted free cash flow performance.

This includes revising our company restaurant operating margin expectation to between 15% and 16% from our previous guidance of between 16% and 17%.

This change is influenced by the softer than expected margin performance in the first quarter, as I previously discussed, coupled with more conversative expectation for general liability and workers' compensation expenses, along with higher costs associated with the faster-than-expected growth in our off-premise delivery business.

Consistent with our past practice, we continually take a close look at our G&A costs and are committed to pursuing cost savings opportunities, while also investing in our technology and training support teams to further elevate the guest experience.

Accordingly, we are revising our expectation for general and administrative expenses to range from $68 million to $70 million from our previous guidance range of between $72 million and $74 million. This change primarily reflects anticipated reductions in incentive compensation, professional fees and other discretionary expenses.

Finally, we are updating our expectations related to taxes. Given the results from the quarter and the tax benefit from the settlement of share-based compensation, we're revising our effective tax rate expectations to range from 16% to 19% from our previous guidance of 22% to 24%.

Similarly, we're revising our expectations for cash taxes to be between $3 million and $5 million, which is a slight decrease from our previous guidance of $4 million and $6 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. We will now turn the call over to the operator to begin the Q&A portion of our call.

Operator?.

Thank you. [Operator Instructions] We'll take our first question from Will Slabaugh with Stephens Incorporated. Please go ahead..

Thanks, guys. I wanted to ask about the company outperformance versus the franchise stores. And I believe you mentioned much of that was due to delivery at company-owned stores being adopted a little bit more quickly.

Can you talk about any learning's you've had with regard to either incrementality or profitability of delivery at your company stores and [indiscernible] a switch to flip your franchisees? But roughly how far away do you think we are from having franchisees adopt delivery to the extent that the company has?.

Yeah, that really is the learning wheel that the pace at which we can go or willing to go and are organized to go versus herding up 268 digital owners and whatever else they have on their agenda. They can move as fast as we move on.

Many rollouts and strategies, but when it comes to sort of new implementations, it tends to be - it tends to trail a little bit. I think, the good news here or the best we can guide is that we think this will continue to grow as we comment in our script that we think this is a tailwind for the brand that will continue to see this expand.

We think that more of these companies will be available in a higher percentage of the country and more franchisees will add in due time. The - you know, regarding margin, I think it's just a little bit early to get into the deep details.

But we are pleased with the incrementality, both of the sales, traffic, the business, the late night component and the younger crowd. And we believe this is a very strong benefit to the Denny's position. Remember, we're still under 10% total to go even at the end of this quarter..

Great. And then a number of your peers have talked about a consumer inflection, at least it seems that way into March and April.

Have you seen anything similar that you would classify that way in your business? And I guess, if so, if that sort of manifesting through either traffic or check?.

Yes. So what we really see in the family category is sort of the same story. We see good news from a strong consumer from jobs, wage growth in the sort of normal strong indicators. We see a little bit of headwind from QSR value environment persisting in this environment that you would normally think is a tailwind.

But I could point out that this is the first quarter in a number where Denny's actually outperformed the QSR sandwich category for the first time in a while, we continue to outperform the mid-scale category as well. So I think it is a good consumer environment as to the comparisons that the casual players have reported.

I think with holidays and how they're mixing in big days compared to mid-scale, I think, it's so non-comparable. Other than to say, it's a good strong environment overall..

Got it. Thanks, John..

Thank you. We will take our next question from Michael Gallo with CL King. Please go ahead..

Hi, good afternoon. I was wondering if I could just drill in a little bit on the company store margins. Obviously, there was some pressure in the quarter from delivery, which you kind of had alongside the higher same-store sales growth.

I was wondering as you kind of get further along some of the learning's on managing some of the labor and some of the other issues associated with delivery, some of those orders and the like will come at different times of the day and whether you think that margin headwind lessens over time or whether you think this is just a permanent structural margin headwind, which will just get bigger as delivery gets bigger? Thanks..

Mike, its Mark. So I'll give you some of the more specific answers, some of the margin movement and then I don't know, John wants to provide some commentary as well. But first, I guess, I'll talk about the quarter and that was the 14.2% company margin in the quarter.

And really, there were a number of pieces that moved through that to bring us to the 14.2% margin. Part of that certainly was the third-party delivery costs and some of the packaging costs that are involved obviously with off-premise.

Part of it was the fact that last year, in 2017, we had a benefit in general liability, and we did not have that this year. So that was a bit of that movement as well. And these aren't necessarily ranked in the size of order, but just to give you a little bit of the background here.

We had obviously another minimum wage increase out in California, $0.50 an hour. I think, as we mentioned before in our company base, about 1/3 of our company stores are in California. So we obviously have faced that headwind consistently over the last few years, but just wanted to mention that as well.

And there was a bit of commodity movement, but quite candidly, there were just a number of movements within the P&L, other items that did not move in our favor.

So that basically produced the 14.2%, which, then as I mentioned in my commentary on guidance, we looked at the annual company margin and that range was 16% to 17% for original guidance that we gave back in February.

We took into account the 14.2% for the first quarter, looked at the overall situation of the business and guided down approximately 100 basis points in that 15% to 16% range. So obviously from a mathematical standpoint, we're in 14.2% in Q1. If you take the midpoint of the new guidance, that will be 15% to 16%.

That midpoint is 15.5-ish, let's say and that obviously would suggest that our view right now, mathematically, is something margins will improve from the first quarter 14.2% as we go - during the balance of the year. That's the math side, and I know John wants to provide some additional commentary to your question..

Well, I don't know what else to add other than there is a headwind near term with the higher wage states, and we have an overweight portion of the company portfolio in those states that Mark covered that.

We are now at $12, let's see where are we, $10 in Arizona now, $12 in California, I don't know - that the numbers continue to grow, and I think California will grow another dollar from the west, rest the way out all the way until '22 when it hits $15.

So the ability to take enough price to cover that near term, so take a little longer period of time to smooth that, and so that is the headwind..

And I think as we mentioned and just to come back on that is that when you look at the geography because we need to get a caution about geography and strengthen geography in the U.S.

that - as we talk about minimum wage increases in California, clearly California, which is about 25% of our domestic system has been a very strong performer for us from a comp standpoint, as is several other of the western states as well. So clearly, the economy continues to move forward in a positive way out there at west at this point in time..

Just a follow-up to that, Mark. I guess, are there - I look like it was up 140 basis points year-over-year. How much of that was the increase in third-party delivery costs? And obviously, as you go through the year, and you kind of lap the rollout of that, the headwind to that will be a little less.

But how much year-over-year was just that?.

I honestly like - I don't have the exact number in front of me, but it was - I want to say half, but it was certainly a good chunk, maybe 50 or 60 bps, something like that and I think Curt can follow up with you to get some more specific answer on that..

Even with the increase, it was less than half of the increase.

It sounds like?.

Right, as I mentioned, there were a number of other movements in the P&L that just didn't go on here and there. And so, again, I think that as I mentioned, it's a combination of events that went through the P&L..

Okay. Thank you..

Thank you. We go next to Nick Setyan with Wedbush Securities. Please go ahead..

Thanks, guys. I think somebody asked what the average check with [ph] transactions were earlier.

I'm not sure if I heard the answer?.

Yeah. Average check in the brand is somewhere 10-40, 10-38 [ph] something like that in Q1 of '18. And so on the company stores, that's up about 3-2 [ph] about the same as the comp lift, combination of mix and price..

Got it. Okay.

And in terms of the pricing expectation for 2018 that hasn't changed from about that 2% range?.

Yes. I'd say it'd be 2% range, but then when you factor in the west that'll probably skew higher than that, which will drag the brand and the company average out..

Got it. Okay. Specifically on commodities, what do guys seeing - what did you guys see in Q1 in terms of commodity inflation? And then what do you expect now for 2018? And I guess, you didn't really address too much to egg costs that we've seen in terms of the headwind a little bit.

Is that just because you are already contracted or is that some of that potentially could impact the margin as the year progresses?.

Yes. Nick, its Mark. I mean, we - I think, we originally guided this to the 1.5% to 2.5% range for commodity inflation. And I think as we look at it today, we still feel comfortable in that range, again 1.5% to 2.5% inflation in commodities. There has been some movement on the egg side.

Eggs are about probably 10% of our market basket when it comes to commodities. And we're probably a little bit under 60% locked in or probably high 50s with a maximum mark of around 70% just based on other movements within that. So again 1.5% to 2.5% I think right now, we're certainly comfortable with that range.

And that sort of fits in the range what we saw last year overall for the year as well..

Thank you..

You're welcome..

[Operator Instructions] We'll go next to Alton Stump with Longbow Research..

Good afternoon..

Good afternoon..

I'm sorry if I missed this in the presentation, but did you mention how much of an estimate impact that weather had on comps in the first quarter?.

We have not fairly negligible with mostly a southern and a western footprint, but there was some modest impact..

Got it. It makes sense. And then as you kind of look at the franchise comp number, obviously, it's your stack basis fell quite a bit versus what you put up in the fourth quarter.

If you had to kind of point two reasons whether it's increased competition or if there is something else out there that kind of drove that weakness in your view?.

I think there is the - again, for our category, there is - on the plus side, there is jobs, wage growth, consumer confidence and off-premise growth. On the headwind side, there's sort of the groceries winning and the desire to stay at home and then sort of QSR value environment persist to some degree.

We are down year-over-year in both company franchise and $2 $4 $6 $8 Value Menus. So those continue to skew down, which has pushed our check up a little bit. But it comes to be expense of - it could come with expensive robust traffic. So I think the idea to win that chair [ph] we'd like to see some of this value environment play out a little bit.

But we think there's an overall strong environment in general and that our initiatives and continued outperformance of our category group are strong indications of our, I think, our strategies about where they should be and which leads us to our guidance for a consecutive positive year..

Got it. Makes sense. Thanks for the help..

[Operator Instructions] At this time, there are no further questions. I'd like to turn the conference back to over to your presenters for any additional or closing comments..

Thank you, Kevin. I'd like to thank, everyone, for joining us on today's call. We look forward to our next earnings conference call in late July to discuss our second quarter 2018 results. Thank you, and have a great evening..

Ladies and gentlemen, this does conclude today's conference. Thank you, for your participation. You may now disconnect..