Good day, and welcome to the Denny’s Corporation Q1 2019 Earnings 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, Vicky, and good afternoon, everyone. Thank you for joining us for Denny’s first quarter 2019 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 during 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, briefly comment on our annual guidance for 2019 and provide an update on our refranchising and development strategy. 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 26, 2018, 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, everyone. Denny’s once again achieved positive domestic system-wide same-store sales growth and delivered enhanced operating margins, thanks to our team’s unwavering commitment to our brand revitalization strategy.

In the midst of our transition to a more highly franchised brand, I’m proud of our team for their continued focus on our vision of becoming the world’s largest, most admired and beloved family of local restaurants while consistently executing against our strategic pillars.

These pillars include, first, delivering a differentiated and relevant brand with a goal of perpetuating consistent same-store sales growth; second, operating great restaurants with consistent reliable service; third, expanding Denny’s footprint throughout the U.S.

and international markets; and fourth, driving profitable growth with a disciplined focus on costs and capital allocation for the benefit of our franchisees, employees and shareholders.

These pillars are supported by our continued investments in technology and training along with close collaboration with our franchisees on virtually all brand initiatives. We continue to evolve our menu to meet guest expectations for higher-quality and more craveable products.

Our latest core menu enhancements include new and improved premium chicken tenders with our signature Den sauce and a wild-caught haddock fillet with a buttery herb glaze. Our newest LTO menu features an array of new crepes, a Southwest Chorizo Burger and our Strawberry Pancake Puppies.

We also continue to evolve our value platform with the latest addition of the Meat Lovers Slam, starting at $5.99. Our expanding off-premise strategy enables us to reach younger guests and increase our brand awareness.

These off-premise sales represented approximately 12% of total sales at company and franchised restaurants during the first quarter, which is up from approximately 7% at the launch of Denny’s On Demand in mid-2017. Delivery continues to drive the expansion of our off-premise business.

We have observed a steady progression of company and franchised restaurants adding delivery channels over the last few quarters. The number of restaurants actively engaged with at least one delivery partner grew from approximately 71% of domestic system at the beginning of the quarter to approximately 79% by the end of the quarter.

At the same time, the number of restaurants eligible for delivery grew from approximately 77% at the beginning of the quarter to approximately 89% by the end of the quarter. This means we have an opportunity to further grow our off-premise business as more restaurants eligible for delivery sign on to actively participate with delivery partners.

These transactions continue to be incremental and deliver total margin rates from the low teens to upper 20s percents inclusive of the delivery fee. Our Heritage remodel program continues to perform well, consistently receiving favorable guest feedback and generating mid-single-digit range sales lifts.

During the first quarter, franchisees completed 44 remodels, and we completed one company remodel, resulting in approximately 83% of the system currently featuring the new Heritage image. This enhanced diner environment will continue to provide a significant tailwind for our brand revitalization strategy over the next several years.

And our new Ignite e-learning system along with our latest Delight and Make it Right service programs have been well received and are now rolling out to Denny’s system.

We remain focused on our franchisee collaboration as we work together to enhance our field training and coaching initiatives to better enable our operations teams to achieve their goals. These initiatives are primarily focused on delivering higher-quality menu offerings with a more consistent service experience.

While we have made substantial progress thus far, we acknowledge opportunities remain in order to achieve our full potential. We are focused on closing the gaps to those expectations. Moving to development.

Our growth initiatives have led to over 350 new restaurant openings since the beginning of our revitalization efforts, representing approximately 20% of the current system. And franchisees opened two restaurants in the first quarter, including our first restaurant in Aruba.

With regards to our refranchising and development strategy, we closed on the sale of three restaurants in the first quarter and have closed on an additional three restaurants so far in the second quarter, resulting in a total 14 restaurants sold since the announcement of our strategy last October.

Additionally, we have moved 48 restaurants to assets held-for-sale, including the three restaurants we sold in April. Mark will provide more details on held-for-sale treatment in just a moment. We are very pleased with the interest from our franchise community and excited by the ultimate value this strategy will create.

We will continue to provide more information on the details of these additional transactions in the coming quarters. We also closed on our first like-kind exchange real estate transaction during the first quarter for approximately $5 million.

As we look ahead, we remain committed to profitable system sales growth, market share gains, generating compelling returns on invested capital and maintaining our shareholder-friendly allocation of adjusted free cash flow towards share repurchases.

Since the beginning of our share repurchase program in late 2010, we have allocated approximately $445 million towards share repurchases.

In closing, we remain committed to our brand-enhancing strategies, including continued quality enhancements to our menu and Everyday Value focus and convenience of Denny’s On Demand, investments in training to elevate the guest experience and our Heritage remodel program to drive consistent, profitable same-store sales growth for years to come.

And at the same time, we are pleased with the start of our refranchising and real estate strategy. We will sell restaurants to develop focused franchisees, upgrade the quality of our real estate portfolio and rationalize business costs as we transition to a more asset-light business model and create additional stakeholder value.

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 first quarter highlights include growing domestic system-wide same-store sales by 1.3% and adjusted free cash flow by 44.7% to $7.2 million. Adjusted EBITDA was $20.6 million, and adjusted net income per share was $0.13.

We ended the quarter with 1,705 total restaurants as Denny’s franchisees opened two restaurants. These openings were offset by six franchised restaurant closings. Additionally, three company restaurants were sold to franchisees.

Franchise and license revenue declined 2.2% to $52.9 million primarily due to lower occupancy revenue due to scheduled lease terminations and lower advertising revenue due to changes in certain international restaurants contribution arrangements.

Franchise operating margin was 48.8% compared to 47.2% in the prior year quarter primarily due to a reduction in other direct costs, which is associated with our refranchising and development strategy and an improved occupancy margin. Moving to our company restaurants.

Sales were impacted by our refranchising and development strategy that resulted in a lower number of equivalent company restaurants. Consequently, sales were $98.5 million for the quarter or down approximately 2.6%.

Company restaurant operating margin was 14.6% compared to 14.2% in the prior year quarter primarily due to pricing and an enhanced restaurant portfolio related to our refranchising and development strategy, partially offset by increases in minimum wages and third-party delivery costs.

Total general and administrative expenses of $18.8 million were impacted by market valuation changes in our deferred compensation plan liabilities and share-based compensation expense. As we have noted before, corresponding valuation adjustments in deferred compensation plan assets is reflected in other non-operating income.

And as a result, these deferred compensation plan valuation changes have no impact on either net income or adjusted EBITDA. These results contributed to adjusted EBITDA of $20.6 million.

Depreciation and amortization expense was approximately $300,000 lower at $6.2 million, primarily resulting from a lower number of equivalent company restaurants due to our refranchising and development strategy.

Interest expense rose by approximately $800,000 to $5.4 million primarily due to rising interest rates and a higher average credit facility balance. Provision for income taxes was $4.7 million, reflecting an effective income tax rate of 23.1%. Adjusted net income per share was $0.13 compared to $0.15 in the prior year quarter.

Adjusted free cash flow after cash interests, cash taxes and cash capital expenditures was $7.2 million compared to $5 million in the prior year quarter primarily due to decreases in cash capital expenditures, partially offset by increase in cash interests.

Cash capital expenditures of $7.8 million included approximately $4.7 million related to our first like-kind real estate transaction in addition to expenditures for new construction and facilities maintenance.

This compares to $12.6 million in the prior year quarter, which included approximately $7.9 million, which was used to acquire five franchised restaurants. Our quarter end debt-to-adjusted EBITDA leverage ratio was 3.02 times.

And at the end of the quarter, we had approximately $312 million in total debt outstanding, including $283.5 million under our revolving credit facility. During the quarter, we allocated $8.9 million towards share repurchases.

Additionally, in the quarter, the remaining shares from a $25 million accelerated share repurchase agreement initiated during the fourth quarter of 2018 were received. As a result, basic shares outstanding at the end of the quarter totaled 61 million shares.

Subsequent to the completion of the ASR at the end of the first quarter and April 29, 2019, the company allocated an additional $12.9 million to share repurchases, resulting in $21.8 million allocated towards share repurchases year-to-date.

And as of April 29, 2019, the company had approximately $107 million remaining in the authorized share repurchases under existing $200 million share repurchase authorization.

Since the beginning of our share repurchase program in late 2010, we have allocated approximately $445 million to repurchase approximately 49 million shares at an average price of $9.15 per share, leading to a net reduction in our share count of approximately 39%.

Based on first quarter results and current expectations for 2019, we are reiterating our business outlook. As we have done in the past, we will revise our guidance expectations in connection with future quarterly earnings updates if needed.

Now I would like to spend a few moments updating everyone on the status of our previously announced refranchising and development strategy. Further information can be found in the current investor presentation on our website.

In October 2018, we announced a plan to migrate from 90% franchised business model to one that is between 95% and 97% franchised over a period of 18 months by selling between 90 and 125 total company restaurants with attached development agreements.

While this transition to a lower-risk business model initially will have a dilutive impact on adjusted EBITDA, we anticipate an accretive impact on adjusted earnings per share and enhanced adjusted free cash flow.

These accretive actions combined with refranchising proceeds are expected to enable us to generate more compelling returns for our shareholders. John mentioned in his comments that we have sold a total of 14 restaurants under this strategy.

This total includes eight restaurants sold in the fourth quarter of last year, three restaurants sold during the first quarter of 2019 and another three restaurants sold thus far in the second quarter.

In anticipation of additional refranchising transactions, we moved 48 company restaurants to the held-for-sale category in our balance sheet as of the end of the first quarter, including the three restaurants sold in April.

As a reminder, our practice is to move assets to the held-for-sale category when we have a signed letter of intent and a high degree of confidence that the sale of specifically identified restaurants will occur in the near term.

The pace of transactions is on schedule with our expectations, and we continue to be encouraged by the interest from the franchise community. Our 2019 adjusted EBITDA guidance of $95 million to $100 million versus just over $105 million in 2018 contemplates our anticipated volume and pace of transactions during the year.

The EBITDA contribution of the restaurants we expect to sell, which will be partially offset by royalty revenue and some rental income, is also incorporated in our guidance.

Further, we are beginning to rationalize approximately $10 million to $12 million of business costs, ultimately yielding to an adjusted EBITDA level that is similar to the results we delivered in 2018.

Approximately 75% of the total cost rationalization will be captured in general and administrative expenses, a majority of which will trail our refranchising efforts.

We expect to receive multiples in the range of four to five times EBITDA on these transactions, leading to a total pretax refranchising proceeds in excess of $100 million over the full refranchising process. We are just getting started, but the initial refranchising transactions do support our multiple expectations.

While we will continue – while we continue operating a portfolio of company restaurants in our highest volume trade areas such as the Las Vegas Strip, our transition to a more asset-light business model is expected to reduce annual cash capital expenditures associated with maintenance and remodel costs by between $7 million and $10 million.

The reduction in ongoing maintenance and remodel capital, coupled with refranchising proceeds and future royalty revenue on the associated development commitments, will further support our commitment to shareholder-friendly investments and returns, including a return of capital to our shareholders.

We also anticipate moderately increasing our leverage from the current level of 3.02 times. We are excited to use this refranchising strategy to stimulate additional growth for our franchise partners and to attract new franchisees to the Denny’s brand.

We will also upgrade the quality of our real estate portfolio to a series of like-kind exchanges, anticipate generating approximately $30 million in proceeds from the sale of between 25% and 30% of the approximately 95 properties we currently own.

Proceeds from the sale of real estate under lower-volume restaurants will be redeployed to acquire higher-quality real estate. Our 2019 cash capital expenditure guidance includes between $20 million and $25 million related to anticipated real estate acquisitions.

We have a high degree of confidence in our ability to successfully execute this refranchising development strategy because the team that led our transition from a 60% franchised business to 90% franchised is still in place and actively leading our current transition to a more asset-light model.

And again, as a reminder, following our refranchising efforts, we expect to generate similar adjusted EBITDA to 2018 through a rationalization of business costs while also enjoying the ongoing benefits of this new asset-light model. That wraps up our prepared remarks. I will now turn the call over to the operator to begin the Q&A portion of the call.

Operator?.

Thank you. [Operator Instructions] And now we’ll go first to Will Slabaugh with Stephens..

Hey, Will..

Hey, guys. Thanks for taking my question. Just a quick housekeeping one first and perhaps on the first quarter. Wondering if you guys had much impact from the weather that we saw in California. We’ve been hearing a number of your peers say that the rains in middle part of the quarter impacted them a little bit, so curious on that.

And any other impact that we may not be able to see, countershifts, et cetera, during the period?.

Yes. Well, there were a couple of countershifts, if you recall, from last year’s review. We had New Year’s and Easter flip. And they more or less washed each other out, which is a little different than how they would have impacted us last year between Q1 and Q2. But in Q1 of this year, there really are none of that.

And then I would say the same thing, we have about a quarter of the brand in California, we didn’t see any significant weather. There was a lot of rain, but we’re a 24-hour business, and I think our customers just treat it like another day in paradise..

Good to hear. And then a question on value. You mentioned part of your evolving value platform launching the Meat Lovers Slam at $5.99. It seems like you’ve stayed pretty close or on that price point since about this time last year.

Curious how that’s been mixing as these Slams are even launching, how you’re thinking about your value offer in general and what that’s meant for the mix of the $2, $4, $6, $8..

Yes. The $2, $4, $6, $8, if you look at its peak and sort of average over time through 2016, would have been in that high teens to low 20s range, it’s now below – right around just above 14% the first quarter of this year, down about a point over Q1 last year. And so it’s playing less of the lead role with the $5.99 Value Slam and Super Slam.

And there is a $6.99 version of that, by the way, on the West Coast that most franchisees take advantage of there. So it’s $5.99 national, but it’s $6.99 in higher-priced markets with no tip credit..

Got it. And just a follow-up on a comment that you made around delivery. I believe you said low teens to upper 20s margin inclusive of delivery fee..

That’s right..

I just want to clarify what – if that was a – is that a store-level margin that you’re getting on a delivery order?.

Sorry, Will, it’s Mark. Yes, that is basically at the store level. It does include delivery fees. And again, we’re taking sort of mid to high teens and the low 20s range. And that’s after COGs and labor..

Got it. That’s a better number than we’ve been hearing. So I just wanted to clarify that, and appreciate it. Congrats on the quarter, guys..

Thank you..

Thank you..

[Operator Instructions] And we’ll go next to Nick Setyan with Wedbush Securities..

Thank you. Congrats on a great comp.

Did you guys mentioned the price versus mix for these transactions? If not, would you mind disclosing that information?.

Sure. I don’t believe we mentioned it. So price is about 2.5% in Q1. The mix was positive, about 0.75 points or so. And then total comps came in at 1.3%. That implies a little negative traffic in the quarter..

I appreciate it. Maybe any kind of geographic commentary on the comp, if any regions stood out versus the others..

Yes. Sure. Great question, Nick. The strongest area was the Pacific Northwest, followed by California and then Texas and Arizona. So West and Southwest, and we had some softening in Florida. And then sort of, I’d say, the – we call the Mid-Atlantic, what do you call that, would be the toughest area..

Central..

Mid-Central. Ohio Valley..

Mark, the franchise margin, it was up more than I was anticipating. How should we think about that as the year progresses? I mean I know it depends a lot on the timing of sales.

But at least at this point, how should we think about the year in terms of franchise margin?.

Yes. I guess, Nick, I’d go – obviously, we’ve got a current guidance range out there. First, I’ll go to the annual guidance piece, and then I’ll come back and answer your question on the quarter if I could. The current franchise margin guidance is 46.5% to 48%. That’s our annual guidance.

And a little bit to set that against where we ended last year, the entire year fiscal 2018 was 47.6%. This particular quarter, there were a couple of things that affected it. One is obviously – and we talked about this a little bit in the past is the property margin piece is obviously leases fall off of our balance sheet and don’t get renewed.

In many cases, those are relatively low-margin type of property income that’s coming through. And so that obviously pushes the percentage margin up in a favorable fashion. The second piece in there is within the cost structure, we began to see some changes in the cost structure.

I would say a chunk of that was due to continued changes in the field organization as we go through this franchise development strategy. And just to put it in perspective, within the quarter itself, there were 24 leases, approximately 25 leases that peeled off that were in the prior year results.

So again, that’s a very low-margin business and it tends to push that margin up obviously on a percentage basis. But again, the current guidance range for the annual guidance is 46.5% to 48% on franchise margin..

Perfect. Thank you, Mark..

And we have no further questions at this time. I’ll turn the call back over to Curt Nichols for any additional or closing remarks..

Great. Thank you, Vicky. 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 2019 results. Thank you, and have a great evening..

That does conclude today’s conference. We thank you for your participation..