Good day. And welcome to the Denny's Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded..

Thank you, Trishaw, and good afternoon, everyone. Thank you for joining us for Denny's second 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 Web site at investor.dennys.com to find our second 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 Web site later today.

John will begin today's call with his introductory comments. Mark will provide a recap of our second quarter results, discuss the progress of our refranchising and development strategy and briefly comment on our annual guidance for 2019. After that, we'll open it up for some 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. I am pleased to report Denny's delivered another quarter of solid domestic system wide same-store sales growth, and we are adjusting our annual guidance accordingly.

I'm also delighted to report our refranchising transactions are ahead of schedule and we now expect to be materially complete with the sale of restaurants by the end of this year.

In the midst of our transaction -- transition to a more highly franchise brand, I'm especially proud of our team for their steadfast focus on high quality operations and for consistently executing against our strategic pillars.

These pillars include; first, delivering a depreciated and relevant brand with the 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 cost 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 franchises on virtually all brand initiatives. We continue to evolve our menu to meet guest expectations for higher quality and more cravable product.

Our newest LTO menu features premium hand pressed burgers, while also continuing to feature our recently introduced array of craves. We have also been featuring the Meat Lovers Slam starting at $5.99 as part of our everyday value offering.

Furthermore, our expanding off premise strategies enabled us to reach younger guests and increase our brand awareness. These off premise sales represented over 11% of total sales at company and franchise restaurants during the second 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. The number restaurants actively engaged with at least one delivery partner grew from approximately 79% of the domestic system at the beginning of the quarter to approximately 88% of the system by the end of the quarter.

These transactions continue to be incremental and deliver total margin rates from the low teens to upper 20% after considering product costs, labor costs and the delivery fee. Our Heritage remodel program continues to perform well and consistently receives favorable guest feedback.

And during the second quarter, franchisees completed 40 remodels and we completed one company remodel, resulting in approximately 84% of the system currently featuring the updated 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 Ignite e-learning system along with our latest Delight and Make it Right service programs have been well received. And our learning and development team continues to develop and deploy progressive curriculum to the 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 process -- progress thus far, we acknowledge opportunities remain in order to achieve our full potential and therefore, are focused on closing these gaps to our expectations. Moving to development.

Our growth initiatives have led to approximately 360 new restaurant openings since the beginning of our revitalization efforts, representing over 20% of the current system.

Franchisees opened six restaurants in the second quarter, including five international openings in the United Arab Emirates, the Philippines, Guatemala and our first ever Denny's restaurant, in Indonesia. Turning to our refranchising and development strategy.

The same team that successfully led our transition from 66% franchise business to 90% franchise a decade ago has made great progress on our current refranchising efforts.

We have been very pleased with the franchise communities' interest and pace of transactions, which have been ahead of schedule and at higher multiples than we had originally anticipated.

Specifically, we closed on the sale of 37 restaurants in the second quarter, and have closed on an additional 22 restaurants so far in the third quarter, resulting in a total of 70 restaurants sold since the announcement of our strategy last October.

Additionally, sales transactions are pending for 27 restaurants that were classified as held for sale at the end of the quarter. So at this point, we have either sold or have pending sales transactions on a total of 97 restaurants. As a result, we expect the refranchising strategy to be substantially completed by the end of 2019.

Mark will provide more details on our revised expectations for the re-franchising strategy in just a moment. But I wanted to share a few additional comments on our progress. Demand for the sale of company restaurants has been strong, particularly in West Coast markets.

We're excited to get loyal, high performing and well capitalized franchise partners and the opportunity to quickly grow their business. These franchisees appreciate how the sale of an established operating restaurant is a catalyst for further growth. As a result, we have secured more development agreements than originally anticipated.

Perhaps most important, we are excited to enable a newer generation of Denny's franchisees to breath new energy into this great brand through their emerging leadership and influence as we collaborate together on future initiatives.

And while the sale of restaurants is ahead of schedule, the concurrent effort to upgrade the quality of our real estate portfolio through a series of like-kind exchanges is still expected to extend on into 2020.

In closing, as we transition to a more asset light business model, we remain focused on our brand enhancing strategies, including quality enhancements to our menu, everyday value focus, the convenience of Denny's on-demand, investments in training to elevate the guest experience and our heritage remodel program.

These strategies will continue to support our commitment to profitable system sales growth, market share gains, generating compelling returns on invested capital and highly accretive and shareholder friendly allocations of adjusted free cash flow.

With that, I'll turn the call over 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 system wide same-store sales by 3.8%, and generate an adjusted EBITDA of $27.2 million, which is flat compared to the prior year quarter despite a lower number of company restaurants.

Adjusted free cash flow was $6.8 million and adjusted net income per share increased by 30.8% to $0.23 per share from $0.18 per share in the prior year quarter. We ended the quarter with 1,702 total restaurants as Denny's franchisees opened six restaurants, including our first international restaurant in Indonesia.

These openings were offset by nine franchise restaurant closings. Franchise and license revenue increased 3.4% to $56.4 million, primarily due to domestic franchise same-store sales growth of 3.7% and the impact of our refranchising and development strategy.

Franchise operating margin was 48.8% compared to 46.8% in the prior year quarter, primarily due to an increase in royalty revenue, a reduction in other direct costs, which was associated with our refranchising and development strategy and an improved occupancy margin. Moving to our company restaurant sales.

We're impacted our franchise and development strategy that resulted in a lower number of equivalent company restaurants, partially offset by 4.4% increase in same-store sales. Consequently, sales were $95.4 million for the quarter, or down approximately 7.1%.

Company restaurant operating margin was 16.4% compared to 15.7% in the prior year quarter, primarily due to pricing, menu mix and an enhanced restaurant portfolio related to our refranchising and development strategy, partially offset by increases in minimum wages and commodities.

Total general and administrative expenses of $18.5 million were impacted by higher performance-based incentives and share based compensation expenses, partially offset by $600,000 reduction in personnel costs. These results contributed to adjusted EBITDA of $27.2 million.

Depreciation and amortization expense was approximately $1.6 million lower at $5 million, primarily resulting from a lower number of equivalent company restaurants due to refranchise and development strategy, and classifying restaurants as held for sale. Interest expense was approximately $5.4 million in the current and prior year quarter.

The provision for income tax was $6.8 million, reflecting an effective income tax rate of 16.5%. During the quarter, the company recognized the net [Technical Difficulty] approximately $3.4 million related to the completion of an internal revenue service audit and the settlement of share based compensation.

Adjusted net income per share was $0.23 compared to $0.18 in the prior year quarter, primarily due to tax provision benefits.

Adjusted free cash flow after cash interest, cash taxes and cash capital expenditures was $6.8 million compared to $13.7 million in the prior year quarter, primarily due to increases in cash taxes related to the gains on the sale of company restaurants, partially offset by lower cash capital expenditures.

Absent the cash taxes related to gains on the sale of company restaurants, adjusted free cash flow would have been flat to the prior year quarter. Cash capital expenditures of $3.7 million included facilities maintenance, new construction and remodels compared to $7.4 million in the prior year quarter.

Our quarter and debt to adjusted EBITDA leverage ratio was 2.85 times. At the end of the quarter, we had approximately $294 million of total debt outstanding, including $271 million under our revolving credit facility. We allocated $29.1 million towards share repurchases during the quarter.

Between the end of the quarter and July 29, 2019, we allocated an additional $9.4 million to share repurchases, resulting in $47.4 million allocated to share repurchases as year-to-date.

As of July 29, 2019, the company had approximately $81 million remaining in its authorized share repurchases under its existing $200 million share repurchase authorization.

Since beginning our share repurchase program in late 2010, we've allocated approximately $471 million to repurchase approximately 50 million shares at an average price of $9.43 per share, leading to a net reduction in our share count of approximately 40%.

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 Web site. John mentioned in his comments that we have sold a total of 70 restaurants under the strategy.

This total includes eight restaurants sold in the fourth quarter of last year, three restaurants sold during the first quarter, 37 restaurants sold in the second quarter and another 22 restaurants sold thus far in the third quarter.

Program to date, we received over $80 million in pre-tax proceeds front end fees some of the transaction fees, resulting in EBITDA multiple of approximately 5.2 times, as well as over 45 development commitments.

In anticipation of additional refranchising transactions, we have classified 49 company restaurants and one piece of real estate is held for sale on our balance sheet as of the end of the second quarter, including the 22 restaurants sold in July.

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

We continue to be encouraged by the interest from the franchise community, and look forward to continuing this transition together. Based on management's current expectations for refranchising transactions, the company now anticipates selling between 115 and 125 total company restaurants with between 70 and 80 attached development commitments.

The vast majority of these transactions are expected to be completed by the end of 2019. While this transition to a lower risk more asset light business model initially will have a dilutive effect on the adjusted EBITDA, we anticipate an accretive impact from adjusted earnings per share and enhance adjusted free cash flow.

These accretive actions, combined with refranchising proceeds, are expected to enable us to generate more compelling returns for our shareholders. The EBITDA contribution of the restaurants we expect to sell will be partially offset by royalty revenue, rental income and cost rationalization.

Based on our updated range of total company restaurants to be refranchised, we are beginning to rationalize approximately $11 billion to $13 billion of business costs compared to the previous range of $10 million to $12 million.

With the process underway, we are refining how we expect these cost savings relationalize; approximately 40% of the savings will come from reductions in field support functions, currently captured in operating margins; approximately 35% of the savings will come from adjustments in our corporate G&A support structure; and the remaining 25% will come from gradually migrating certain support costs from Denny's G&A to shared costs with franchisees over the next couple of years.

Following the conclusion of our refranchising efforts and the trailing rationalization of business costs, we expect to yield an adjusted EBITDA level that is similar to the results we delivered in 2018, excluding inflationary pressures.

We expect to receive multiples on the range of 4.5 to 5.5 times restaurant level EBITDA on these transactions compared to the previous guidance of 4 to 5 times.

These multiples are expected to yield total pretax refranchising proceeds of between $125 million and $135 million compared to the previous estimate of over $100 million across the four refranchising processes.

While we will continue to operate in 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 of between $9 million and $10 million compared to the previous guidance of $7 million to $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 the return of capital to our shareholders.

We continually assess our capital allocation strategy with the goal of balancing shareholder friendly returns with an optimal leverage profile that supports Denny's broader strategic initiatives. As a result, we also anticipate increasing our leverage from the current level of 2.85 times.

The second part of our strategy includes upgrading the quality of our real estate portfolio through a series of like-kind exchanges. We anticipate generate approximately $30 million in proceeds from the sale of between 25% and 30% of the approximately 95 properties that we owned at the start of the strategy.

Proceeds from the sale of real estate under lower volume restaurants will be redeployed to acquire higher quality real estate. During the quarter, we sold three properties for approximately $3.9 million, and plan to redeploy these proceeds to the like-kind exchange transactions in the near term.

We are very proud of the team that has worked so diligently to make this strategy a success. Based our second quarter results and the updated expectations for our refranchising and development strategy, we have updated our business outlook for 2019.

We are increasing our same-store sales expectations for company and domestic franchise restaurants to between 1% and 3% from our previous guidance of 0% to 2%. We are tightening our range for new restaurant openings to 35 to 40 from 35 to 45, while reaffirming our current guidance of approximately flat net restaurant growth.

We are increasing our guidance for franchise operating margin to between 47% to 48.5% from our previous guidance of between 46.5% to 48%.

Primarily due to increases in share based compensation and deferred compensation planned valuation adjustments, we are adjusting our expectations for total general and administrative expenses to between $71 million and $74 million from between $66 million and $69 million.

Due to the faster than expected pace of refranchising transactions, coupled with the other guidance updates I just described, we are revising adjusted EBITDA expectations to between $93 million and $96 from our previous guidance of between $95 million and $100 million.

Cash taxes are now expected to be between $23 million and $26 million versus between $13 million and $16 million. Included in this estimate is between $19 million and $22 million related to taxes on anticipated gains from refranchising transactions, which is an increase from the previously guided $9 million to $12 million.

Related to our real-estate strategy, we are increasing our cash capital expenditures to between $38 million and $43 million from $35 million to $40 million due to like-kind exchange transactions, increasing to between $23 million and $28 million from our previous guidance of between $20 million and $25 million.

Finally, we are revising our adjusted free cash flow guidance to between $7 million and $10 million from our previous expectations of $23 million to $26 million to reflect the accelerated timing of refranchising transactions and additional real-estate transactions.

And as a note, if the anticipated real-estate transactions were excluded along with the incremental cash taxes from anticipated gains on refranchising transactions, our expectations for adjusted free cash flow would be between $53 million and $56 million.

At the midpoint, this represents between 6% and 9% growth from the $51.2 million and $50 million in adjusted free cash flow delivered in 2017 and 2018 respectively. That wraps-up our prepared comments. I'll now turn the call over to the operator to begin the Q&A portion of our call.

Operator?.

Thank you [Operator instructions]. And we will take our first question from Will Slabaugh from Stephens Inc..

I had a question for some promotions and marketing. You received some good press on the viral digital marketing during the quarter, and your comps imply some nice acceleration on the two year basis there as well.

Can you talk about what you thought drove most of that improvement during the quarter? And if what worked this quarter drives your thinking about what your marketing message, or maybe the marketing media may include in the future?.

I would say the combination of the barbell strategy worked well for us. We had a combination of a great promotion, which is a new introduction and platform for Denny's, along with the Super Slam starting at $599 higher prices in premium priced markets.

But the combination of value with new news and interest in new product introductions was a good combination for us.

I wouldn't want to get too far ahead on predictions in the future other than to say that we are, as we mentioned in prior calls, attempting to go into every module with preparation from as much as 12 to 15 months of advanced planning with both value in core menu and/or premium LTO news, so that we have flexibility in our modules depending on the circumstances at the time..

And then a guidance question about quote around EBITDA and the change there. I was wondering, if Mark, can you give a little more color on the increase in G&A, as far as how much of that has to do with putting costs against stores that you're selling a little bit quicker than you had initially planned on, which obviously is a good thing.

And then, sorry if I missed this.

But what was behind the increase in the share based compensation that affected that number as well?.

So first on the EBITDA guidance. Well, one of the primary drivers there is the fact that obviously we are -- we move faster as far as selling, stores selling assets. And so as we looked at the assets that moved out based on some of our internal projections, we adjusted the EBITDA guidance accordingly.

So again, the soon you sell the store is obviously sooner you adjust for the EBITDA. That was really the biggest driver there. Again, just as reference as we've said. Obviously, our target is to get back to an EBITDA level in that 105-ish range that we achieved in 2018.

But obviously, the cost rationalization piece will trail that and I think we've talked about that in the past. Specifically on the G&A piece, we've actually included a table in our public documents. If you go to the P&L and back of the press release, but also obviously it will be in Q filing as well.

And what we try to show there -- I'm just kind of look at the year-to-date number, first two quarters, is that actually our general and administrative expenses have actually declined a bit as far as what I would call pure G&A.

And I think what you will see there is really what we try to point out as the [Technical Difficulty] the development or refranchising strategy. And obviously, today, we've closed above $21 a share. So that's about 50% change in share price in that nine month timeframe. So that's also the share based compensation fees.

Again, long-term incentive plans, these are three year plans for senior management. So that's that share based piece. The incentive compensation piece, which is the annual cash compensation piece, that's also shown an increase through the first two quarters this year of about $2.4 million.

Again, if you go back to our proxy statement and look at the actual payout of our annual incentive that cash incentive, that averaged around 60% over the last couple years. Clearly, we're off to a good start this year and our accrual effect there from an annual cash incentive standpoint is higher based on the current year performance.

So that's the other explanation. So the third piece -- and I apologize about the long winded response here. The third piece we've talked about historically, and that's the adjustment, I referred comp valuation, which again as the equity markets improve that shows up as a negative in our G&A. It gets backed out when we get to the bottom line.

So it's really a neutral effect. But the big drivers there, I will repeat it one more time, is share based comp and incentive comp. Share based is a long-term plan. Incentive comp is the annual cash plan. And year-over-year, for the first two quarters, that's almost $5 million..

Will Slabaugh:.

What I said in my remarks is we've gone from 7% in mid-year 2017 to about 11% now. I didn't give the quarterly growth. I can look that up for you. I'll have to get back to you. I don't have that right in front of me..

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

Thank you. Congrats on the great comp.

Would you guys mind breaking out the transactions versus the mix, versus pricing in the quarter?.

Sure. I've got a -- just looking at the system. We were -- the comps were 3.8%. We had pricing in the mid 2% range. Mix shifts in the mid 2% range, which gave at least on the company side about flat traffic. And I think that answers your question..

As we kind of think about the egg costs, baking costs and as we kind of think about contracting for 2020.

What are we seeing in terms of food costs inflation?.

Nick, obviously, there's been a lot of discussion news around pork bellies and pork pricing. And I think the latest research I read and we've been looking at is that has not taken hold from an inflationary standpoint as much as people feared. So far for the first half of the year, and again I'm talking to 2019, not to your question on 2020 yet.

But I think 2019, again what we know right now is shaping up to be pretty similar last couple years. I mean, we're thinking, again, without some kind of significant change in pork prices, we're thinking it's going to probably be between 1% and 3%. And that's been pretty much the same range we've seen the last couple years.

But again, part of that is commodity change -- again, I say 1 to 3, that's Denny's specifically. But you know maybe half of that was commodity effect. So commodities have not been that inflationary. And part of it was menu improvements on our part.

So decisions we made to upgrade certain ingredients within our menu and that was, again about half of that 1 to 3 range. So -- but again, to your question on '19. So far, the pork pricing side has held up okay for us, it hasn't been as severe or inflationary as certainly some of the articles and news reports several months ago.

On 2020, we really haven't talked yet on that. We'll probably give a little bit more insight into 2020 as we get into the third quarter call at the end of October, and really get a much better insight since we're only about halfway through the current year..

Last question on the comps.

Do you see any kind of geographic variances and also dayparts, if you can talk about dayparts as well?.

Sure. I'll do dayparts first, Nick. Dayparts comps strongest was breakfast at nearly 2.5% then followed by lunch, and then softer at dinner and late night. The dinner and late night were actually negative and positive breakfast and lunch.

On regional, our strongest region for the quarter was California followed by Florida, New York and then Texas and year-to-date a California, Texas, New York and Florida, slightly it will reorder on a year-to-day basis.

But those continue to be -- the relative strength is in some of our more deeply penetrated states with some nice things going on in New York with the transference of franchisees out of the system into, I'd say, newer energy there with some improvements in operations..

And we will take our next question from Stephen Anderson with Maxim Group..

Steve, it's Mark. Do you have a question for us. It looks like we may have lost, Steve….

[Operator instructions] We will take another question from Stephen Anderson with Maxim Group..

Just wanted to ask how much you have on your share buyback authorization given your outlook for adjusted free cash flow?.

I think we talked about that a little bit in my comments, I will clarify that. I think what we -- we moved the timeframe a little bit, because we wanted to give everybody an update on our buyback up through the -- basically yesterday July 29th. And the year-to-date buy back number and shares in dollar terms is a little bit over $47 million.

And we also I think quoted a number, I think we've got about $80 million left on our $200 million share authorization that we put in place, so two years ago. So again, that's July 29th date but about $80 million.

And we repurchased through the 29th of July year-to-date, so that would be the second quarter plus the activity in July, just slightly over $47 million in stock..

[Operator Instructions].

Okay. So I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in late October, during which we will discuss our third quarter 2019 results. Thank you each and all, and have a great evening..