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Edited Transcript of DENN earnings conference call or presentation 29-Oct-19 8:30pm GMT

Q3 2019 Denny's Corp Earnings Call

SPARTANBURG Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Denny's Corp earnings conference call or presentation Tuesday, October 29, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Curt Nichols

Denny's Corporation - Senior Director of IR & Financial Analysis

* F. Mark Wolfinger

Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director

* John C. Miller

Denny's Corporation - CEO, President & Director

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Conference Call Participants

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* Brett Saul Levy

MKM Partners LLC, Research Division - Executive Director

* Michael A. Tamas

Oppenheimer & Co. Inc., Research Division - Associate

* Nerses Setyan

Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst

* Todd Morrison Brooks

CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst

* William Everett Slabaugh

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day and welcome to the Denny's Third Quarter 2019 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.

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Curt Nichols, Denny's Corporation - Senior Director of IR & Financial Analysis [2]

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Thank you, Shanade, and good afternoon, everyone. Thank you for joining us for Denny's Third 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 third 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 third 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.

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John C. Miller, Denny's Corporation - CEO, President & Director [3]

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Thank you, Curt, and good afternoon, everyone. Let me start by saying that the growth and progress of this brand continues to resonate with our customers as evidenced by our positive same-store sales growth and that many franchisees have expressed their support for the returns on quality investments that we are making to continually improve our food, our service and our atmosphere. This enthusiasm and positive energy was quite clear at the Denny's Annual Franchisee Association Convention held earlier this month.

Franchisees also expressed their appreciation for the way in which we collaborate together on all significant initiatives, and we are thrilled to be working with such a talented and passionate group of franchisees, vendors and employees.

In addition to the excitement from the convention, this collective team and our company's effort to collectively and effectively execute against our strategic initiatives yielded positive domestic system-wide same-store sales during the third quarter despite a choppy industry environment. I'm also delighted to report we have continued to make progress with our refranchising transactions, and we expect to be substantially complete with the sale of restaurants by the end of this year.

In the midst of our transition to a more highly franchised brand, I'm especially proud of our team for their steadfast commitment to our vision of being the world's largest, most admired and beloved family of local restaurants. Progress towards this vision is driven by our consistent execution of our 4 strategic pillars: first, delivering a differentiated and relevant brand with the goal of perpetuating consistent same-store sales growth; second, operating great restaurants; 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 franchisees on virtually all brand initiatives.

We continue to evolve our menu to meet guest expectations for higher-quality and more craveable product. And our current limited time offer features big Bourbon flavors, including a Bourbon Bacon Burger and an Apple Bourbon Pancake breakfast, while also continuing to feature our recently introduced array of crepe options. We've also been featuring the Super Slam starting at $5.99 as part of our everyday value offering to drive traffic.

Furthermore, our expanding off-premise strategy enables us to reach younger guests and increase our brand awareness. These off-premise sales represented approximately 11% of total sales at company and franchised restaurants during the third quarter, which is up from approximately 7% at the launch of Denny's on Demand in mid-2017.

Delivery continues to drive the expansion in our off-premise business with approximately 88% of our domestic system actively engaged with at least one delivery partner. These transactions continue to be incremental and deliver total margin rates from the low teens to upper 20% after considering product cost, labor cost and the delivery fee. And our Heritage remodel program continues to perform well and consistently receives favorable guest feedback.

Our franchisees completed 31 remodels during the third quarter, resulting in approximately 87% 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.

Our learning and development team continues to create and deploy progressive curriculum to the Denny's system through our Ignite and e-learning platform, which is currently focused on our Delight and Make it Right service initiatives. And our franchisees' pride scores continue to rise.

Moving to development. Our growth initiatives have led to 370 new restaurant openings since the beginning of our revitalization efforts in 2011, representing over 20% of the current system. Franchisees opened 13 restaurants in the third quarter, including 4 international openings in the Philippines, Canada and Mexico.

Turning to our refranchising and development strategy. We completed the sale of 56 restaurants in the third quarter and have closed on an additional 6 restaurants so far in the fourth quarter, resulting in a total of 110 restaurants sold since the announcement of our strategy 1 year ago. This is a total of between 115 and 125 to complete the refranchising strategy.

While the sale of restaurants is expected to be substantially complete by the end of the year, the concurrent effort to upgrade the quality of our real estate portfolio through a series of like-kind exchanges is still expected to extend into 2020. 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.

In addition to investing in our brand, our long-standing internal review process continues to actively consider multiple alternative uses of cash. This practice is thorough and comprehensive with a full array of considerations, from evaluating the acquisition of another concept, to acquisitions for conversion like our Flying J transaction earlier in the decade, to considering a dividend, to our ongoing share repurchase program, each with due consideration to accretion and to risk. We balance these various considerations with our leverage philosophy and more recently, proceeds from refranchising transactions.

We have remaining capacity in our revolving credit facility and intend to moderately increase leverage beyond the approximately 3x EBITDA level from when we began our latest refranchising exercise. Near term, leverage decreased temporarily from the notable inflow of refranchising proceeds. We remain steadfast, however, in our commitment to increase our leverage moderately and generate the most accretive risk-adjusted shareholder returns through the timing and prudent assessment of these alternatives.

In closing, as we transition to a more asset-light business model, we remain focused on our brand-enhancing strategies, including quality enhancements to a menu and 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 and generation of 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 to Mark Wolfinger, Denny's Chief Financial Officer and Chief Administrative Officer. Mark?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [4]

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Thank you, John, and good afternoon, everyone. Our third quarter highlights include growing domestic system-wide same-store sales by 1.1% and generating adjusted EBITDA of $24.2 million. Adjusted free cash flow was $3.7 million and adjusted net income per share increased 4.7% to $0.18 from $0.17 in the prior year quarter.

We ended the quarter with 1,706 total restaurants as Denny's franchisees opened 13 restaurants. These openings were offset by 9 franchised restaurant closings.

Franchise and license revenue increased 11.5% to $60.7 million primarily due to the impact of our refranchising and development strategy and a 1.2% increase in domestic same-store sales. Franchise operating margin was 48.7% compared to 48.2% in the prior year quarter. This margin rate expansion was driven by the company's refranchising and development strategy, which yielded an improved occupancy margin and an increase in royalty revenue.

Moving to our company restaurants. Sales were impacted by our refranchise and a development strategy, which resulted in a lower number of equivalent company restaurants and a 0.2% decline in same-store sales. Consequently, sales were $63.6 million for the quarter or down approximately 38.6%.

Company restaurant operating margin was 14.6% compared to 15.2% in the prior year quarter primarily due to increases in other operating costs and occupancy expense. Other operating costs were impacted by an increase in repairs and maintenance costs related to the sale of company restaurants and unfavorable legal settlement costs. Occupancy expense was impacted by unfavorable general liability experience, higher property insurance costs and refranchise restaurants where we own the real estate. In this last case, a larger portion of the remaining company portfolio that is subject to a lease drives the total occupancy rate higher. These cost increases were partially offset by a decrease in payroll and benefits costs from the leveraging benefit from franchising restaurants.

Total general and administrative expenses of $16.4 million were impacted by higher share-based compensation expense partially offset by a $700,000 reduction in personnel costs. These results contributed to adjusted EBITDA of $24.2 million.

Depreciation and amortization expense was approximately $2.4 million lower at $4.3 million, primarily resulting from a lower number of equivalent company restaurants due to our refranchising and development strategy and classifying restaurants as held for sale.

Interest expense was approximately $4.2 million compared to $5.3 million in the prior year quarter primarily due to a decrease in the balance of our credit facility. The provision for income taxes was $15.3 million, reflecting an effective income tax rate of 23.7%.

Adjusted net income per share was $0.18 compared to $0.17 in the prior year quarter. Adjusted free cash flow after cash interest, cash taxes and cash capital expenditures was $3.7 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 and an increase in cash capital expenditures partially offset by a decrease in cash interest.

Cash capital expenditures included facilities maintenance and real estate acquisitions of $10.6 million compared to $7.8 million in the prior year quarter.

Our quarter end debt to adjusted EBITDA leverage ratio was 2.3x, and we had approximately $230 million of total debt outstanding, including $213 million under our revolving credit facility.

We allocated $12.8 million to our share repurchases during the quarter. Between the end of the quarter and October 28, 2019, we allocated an additional $7.9 million to share repurchases, resulting in $58.7 million allocated to share repurchases year-to-date.

As of October 28, 2019, the company had approximately $70 million remaining in authorized share repurchases under its existing $200 million share repurchase authorization. Since beginning our share repurchase program in late 2010, we've allocated over $482 million to repurchase over 50 million shares at an average price of $9.56 per share, leading to a net reduction in our share count of approximately 41%.

Now I'd like to take a few minutes and update everyone on the status of our previously announced refranchising and development strategy. As a reminder, the company anticipates selling between 115 and 125 total company restaurants with between 70 and 80 attached development commitments. We expect to receive multiples in the range of 4.5 to 5.5x restaurant-level EBITDA on these transactions, yielding total pretax refranchising proceeds of between $125 million and $135 million. These refranchising transactions are expected to be substantially complete by the end of 2019.

Program to date, we have sold a total of 110 restaurants, including 6 restaurants sold thus far in the fourth quarter with over 75 attached development commitments. We have received approximately $127 million in pretax proceeds, front-end fees and other transaction fees at an EBITDA multiple of approximately 4.8x.

While this transition to a lower-risk, more asset-light 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.

The EBITDA contribution of the restaurants we expect to sell will be partially offset by royalty revenue, rental income and cost rationalization. We are beginning to rationalize approximately $11 million to $13 million of business costs with approximately 40% of the savings coming from reductions in field support functions currently captured in our company and franchise 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.

While we will continue to operate 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. 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.

The second part of our strategy includes upgrading the quality of our real estate portfolio through a series of like-kind exchanges. We anticipate generating 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 2 properties for approximately $2.1 million and acquired 2 properties for approximately $4.8 million through a series of like-kind transactions.

Based on third quarter results and management expectations at this time, we are tightening our same-store sales guidance range to between 1.5% and 2.5% compared to our previous guidance range of 1% to 3%. Additionally, we are now expecting 30 to 35 new restaurant openings compared to our previous guidance of 35 to 40 new restaurant openings. We are reaffirming our current guidance of approximately flat net restaurant growth.

We are reaffirming our other annual guidance metrics, including adjusted EBITDA expectations in the range of $93 million to $96 million and adjusted free cash flow of $7 million to $10 million.

If the anticipated real estate transactions were excluded, along with the incremental cash taxes from anticipated gains on refranchising transactions, our expectation 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 the $50 million in adjusted free cash flow delivered in 2017 and 2018, respectively.

That wraps up our prepared remarks. I'll now turn the call over to the operator to begin the Q&A portion of our call. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll now take our first question from Will Slabaugh from Stephens.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [2]

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This is the first time I can remember you mentioning other uses of cash. So I was wondering if you could tell us where you and the Board may be in that discussion and if this is something new or you're simply just talking about it more publicly in terms of whether an acquisition could come or acquisitions for conversions or dividends.

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John C. Miller, Denny's Corporation - CEO, President & Director [3]

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Well, it's certainly not new, Will. That is a great question. I think what we're trying to do is just to add clarity around the process that's been around for a while here, quite a number of years where, on a very regular basis, we talk about all the uses you can imagine and sort of weigh those against risk and sort of where we are in the journey. We've obviously favored share repurchases and continue to do so at the moment. But at the same time, I wanted to make sure that, that array was clearer to how robust that process actually is.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [4]

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Got it. And then as far as the results themselves, we've heard about California in particular being a weak market for a lot of full-service restaurants. I was wondering if you could comment if you saw that or anything else that stood out to you during the quarter.

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John C. Miller, Denny's Corporation - CEO, President & Director [5]

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It was -- the quarter was the same as year-to-date, Will. The California, Arizona, Washington continue to lead the way for us. Ohio and Florida have been softer. That's through both quarter and so our 2 weakest of the same year-to-date this quarter.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [6]

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Got it. And lastly, we've heard a number of sort of conflicting opinions about the consumer already this earnings season. So I was curious if you had any updated thoughts there in terms of health of the consumer and if you saw anything in your business in terms of customer either pulling on value more or less during the period.

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John C. Miller, Denny's Corporation - CEO, President & Director [7]

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I think we're in a value season. And so you have to be -- well, check goes up to cover primarily wage inflation that usually has a traffic consequence. So it's sort of imbalancing a large franchise system. We think the healthiest thing for us to do right now is pay close attention to having a little bit of everything there for our guests. We have premium offers for those that feel prosperous. We have add-on opportunities for those that shop a deal but then still want a little more. We have improved menu quality and premium offers. We have deals. So we have a little bit of everything based on what's going on competitively and where there are some pressures from price increases. So as those go through, you sort of have to soften that with a deal to push those through.

So overall, I think the consumer is just a smart consumer that's taking advantage of this competitive battle for share where inflation is driving prices, which has some traffic consequences, which creates a lot of dealing and the customer is saying, I'm loving it, I have lots of choices. So let the competition remain intense. It's a good deal for consumers right now.

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Operator [8]

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We'll now take our next question from Nick Setyan from Wedbush Securities.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [9]

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Any early thoughts on commodities into next year, particularly on pork?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [10]

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Nick, it's Mark. We really -- we're obviously sort of capturing that information as we speak, as we go through our normal annual operating plan process, but we really haven't given any indication yet of where we think that inflation is going to be in 2020. And we'll obviously share more of that as we go through our annual guidance elements in February '20.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [11]

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Got it. What's the run rate? I mean how should we think about like the run rate, other OpEx going forward? Maybe you could quantify the magnitude of the onetime impact in the quarter.

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John C. Miller, Denny's Corporation - CEO, President & Director [12]

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Yes. I'll start, Nick. I can just say that sort of the big picture is it's really choppy as you can see, but the guidance is solid. And I think as we've talked throughout the start of this refranchising process and to the end, the portfolio we keep is very solid in that 19% to 21% margin range at the sort of completion at the other end. It's too early to start guiding '20 yet, but that's -- I'd say we're confident about the overall program falling in place and right now choppy. Mark might want to add some additional commentary about the current environment.

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [13]

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Thanks, John. Yes. I think, Nick, when we looked at this and a little bit what was outlined in my script, but where we saw, I'll say, some of the unfavorability that went through the company margin side was -- it was about 100 basis points that went through repair and maintenance. So that goes through the other operating cost line per se.

And we looked at that as we went through this -- the choppiness, but the transition really in this refranchising and development strategy. So when you're preparing stores for sale, our focus from the franchiser standpoint is to make sure that they are appropriately fully repaired as we go through these transactions.

So the bottom line is about 100 basis points differential in repair and maintenance. There was some unfavorable legal settlement costs. Those came through probably about 70 basis points. And then the other pieces that came through in the company margin piece was an impact in general liability, we call GL, the general liability, and then a small piece went through the property insurance and rent line.

And I think when you add up all those numbers, because I just went through a lot, it's about 260 basis points between those various categories that had an unfavorable impact. And I think as I mentioned in my comments, when you look at cost of goods and actually when you look at -- cost of goods is relatively flat year-over-year. Cost of labor was actually favorable by a couple of 100 basis points, and we saw that in a number of different line items within labor, team labor, management labor, et cetera.

So I think back to John's comment, I go back to the investor deck that we've used, talk about pre and post on a company margin. And again, we anticipate as we get beyond the refranchising strategy, so we get into more of a normalized environment, as those slides have shown, we anticipate the company margin numbers to be sort of in that 19% to 21% range. And I think we continue to be very confident along those lines.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [14]

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Got it. And then just lastly, the guest counts versus average check breakdown. Sorry if I missed that if it was in your prepared remarks. And also, the forward guidance, the implied range is relatively wide with only 2 months to go. I mean any color around the exit rate out of the quarter or the big trends would be really helpful.

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John C. Miller, Denny's Corporation - CEO, President & Director [15]

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Yes. Obviously, Q3 is what we can speak the most about. We did come into Q3 following the Q2 of '18, which was a challenging quarter from us where we were -- did the Star Wars promotion, didn't have a lot of product or promotion on air. So we came out of that with a strong value offer, which created quite a bit of traffic momentum in Q3 that we're lapping this year.

So the early part of the quarter was off to a tough comparison, but we had a very strong check growth over prior year because of a little less of that by comparison. So check was up about 6.5% for the quarter. So it suggests traffic pretty soft for the quarter because of the value -- or going over the Super Slam comparison.

We were willing, however, in our co-ops and the management through our franchise system to make that trade to get that behind us. So it creates a little bit of a choppy environment in the middle of all these franchise transactions as well. Check overall, $10 to $11, depending on the menu code in what part of the country. July and August, the most choppy. And then as we got that rollover behind us, September rebounded to sort of pre-July transaction trends and obviously just sort of ride on the predictions that we had and that persisted to some degree.

One quarter remaining, the guidance, I'd say, is very solid in that range. Midpoint of that being in that 2% range for the balance of the year.

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Operator [16]

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We'll now take our next question from Michael Tamas from Oppenheimer.

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Michael A. Tamas, Oppenheimer & Co. Inc., Research Division - Associate [17]

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Just on the sales trends, can you just talk about maybe anything else you saw that changed during the quarter? Was there any change in like the off-premise business or so that kind of seemed to slow down a little bit by our math? So just wondering if you can talk about that at all.

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John C. Miller, Denny's Corporation - CEO, President & Director [18]

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The -- no. I think everything just rolled along. Sort of the year-over-year comparisons remained sort of steady, and third-party delivery year-over-year at about 1% to 1.5% comp growth in the to-go business. It's -- there was nothing remarkable. I'd say one thing that was interesting is that we saw similar competitive or peer set changes in the August -- in the July and August period. So that was conspicuous now that we weren't the only brand that had an interesting comparison to Q2.

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Michael A. Tamas, Oppenheimer & Co. Inc., Research Division - Associate [19]

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Got you. And then the units that you're keeping, you talked about them being in the 19% to 21% margin range once you're through all of this. So I'm just wondering, can you talk about what that has maybe looked like over the last year or 2? Or any way you can kind of quantify it just so we can have an idea of how those units have performed?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [20]

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Yes. I think -- Michael, it's Mark. I mean, I think -- and I'll go back to the chart that we've utilized there, again, sort of go through the pre and post a little bit, and I might be a little repetitive having done this in various conferences. But the way we looked at it is the stores that we've targeted to sell run volume-wise between $1.9 million and $2.1 million, margin is sort of in that 10% to 12% range. The overall current portfolio when we started this process, so again, I'll start with the current portfolio, was a little bit higher than that, $2.3 million, 15.3% margin. So again, targeting the sale of stores that were in the $1.9 million to $2.1 million volume range, 10% to 12% margin.

And so when you get on the other side of it, and again, obviously, we've done all the analytics behind this, that's how we've mentioned the 19% to 21% margin in the remaining store base. That's the remaining store base that would remain as company assets with volumes in the $2.7 million to $2.9 million range. And you can imagine the amount of analytics that went through this as we looked at a combination of the performance of these stores but also looking at the kind of tight range coverage we wanted from a field management structure.

So again, looking at the 2- or 3-year history of the stores, sort of going through the analytics, and obviously then we landed on the store base that we wanted to keep and the store base that we've been selling. It's interesting, again, with all the dynamics of the numbers, again, we certainly have been very pleased with the kind of multiples we're getting on the sale of these assets, the proceeds that are coming in and the development agreements. I think the development agreements, I think in my comments I mentioned where we targeted 70 to 80. And I think with the latest activity, including the early transactions in the month of October, so call it, the first month of the fourth quarter, we're 75 or more in development agreements already. So again, the combination of all these has been quite positive.

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Michael A. Tamas, Oppenheimer & Co. Inc., Research Division - Associate [21]

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Got you. And one quick last one on the leverage. You're talking about taking it up modestly over time. But obviously, over the last couple of quarters, it has been coming down. So is there a trigger point that sort of allows you to start increasing that leverage? Is it once you're actually through the refranchising? Or is it just something that we can kind of start to see sooner rather than later?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [22]

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Yes, I think -- and I know we've spent a lot of time on this from the standpoint of -- obviously, it was outlined when we put the original strategy together on refranchising and the development. And at that point in time, when we started the process, we were just slightly over 3x levered. I think there's 3.02 levered. And then we came down in leverage in the previous quarter to about 2.85. And obviously, the most recent quarter, we're 2.3.

Now the significant decline in leverage in the most recent quarter was the fact that we sold 56 units and got $70 million of cash in. So when you think about the share repurchase side of that, obviously, we didn't take the entire $70 million and put it back to the share repurchase side.

Let me go back to what we said originally. Originally, when we were at 3x levered, Mike, we said that we would focus on a modest increase in leverage. And I think at that time, our long-term range for leverage was 2.5 to 3.5x. So again, we're still focused on that moderate increase. This quarter was a bit different primarily because of the $70 million in cash that came in during the quarter, which obviously was a result of all the transactions that occurred in the quarter itself.

I think the other comment I would add to John's script is the fact that the other thing we want to continue to emphasize is that we're very focused on accretive return to our stakeholders. We -- obviously, one of the things that we focused on and the strategy is the fact that our annual free cash flow number would improve because of the lower store base and the savings in CapEx is firmly committed to that. And even on the adjusted free cash flow for this year, as I mentioned, that's up in sort of the mid-$50 million range when you back out the impact of cash taxes on transactions and the 1031 exchange process, the purchase of the real estate that's going through CapEx.

So we're already starting to see that free cash flow change. And then obviously, our balance sheet at 2.3x levered is not a moderate increase off of 3x, and we recognize that. And obviously, we're still targeting an increase in leverage long term.

And just as a reminder, our current debt facility is 2 years old. It's a 5-year facility. That facility was put in place in October of '17. So we're 2 years into it at this point. So we obviously have plenty of time in that facility as well. And hopefully, I've answered your question in a rather long-winded way.

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Operator [23]

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We'll now take our next question from Brett Levy from MKM Partners.

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Brett Saul Levy, MKM Partners LLC, Research Division - Executive Director [24]

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Actually, it's going to be 3, if you don't mind. I guess the first one is across the menu. Just how are you thinking about everything from value to how much pricing you think you have the ability to take? And also, if you could elaborate a little bit more on why you're looking at the Beyond test. What were the driving forces?

Second question is with respect to M&A, how are you thinking about that if that is something that is really on the forefront? Is that something of scale? Or is that something that might be more of a bolt-on modest acquisition like what a Cracker Barrel recently did? And then just any of the biggest concerns or learnings that came out of the franchisee convention that you could share.

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John C. Miller, Denny's Corporation - CEO, President & Director [25]

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All right. Maybe half a dozen questions in there. But sure, let's talk about across the menu and then the pricing component of that first. Across the menu, we sort of -- we are America's diner. We are anywhere from 55% to 60% all day mix of breakfast items. Over time, as we come toward the end of our Heritage remodel program, our aspiration for the brand is to sort of exploit the all day, the breakfast, lunch, dinner and late night dayparts more fully than we do today.

Today, we have a stronger reputation around breakfast all day than we do as brands that enjoy the credibility as being sort of a full diner menu. So we built burger credibility, a few melts and skillets, but mostly, we sell a lot of breakfast all day.

So across the menu, we've made some quality investments improvements, but we've not been loud and proud about merchandising those or pushing that agenda just yet. But we believe that we will get there in time.

When it comes to pricing, sort of the simple math around pricing is that a good portion of the brands in higher wage inflation, no different at Denny's, are taking prices to mitigate the inflationary pressures for wage inflation. And so if you try to get that all at once in 1 step instead of 2, that's a little bit of a step process where if you take too much price, it can have bigger traffic consequences and cost more to get guests back. If you don't -- if you take it in steps, then you have -- then you give up a little margin near term.

So the balance between pricing power and consumer sentiment around price has sort of entered the -- it's created challenges for brands where there's high wage inflation. And effectively, what's happening is across the industry, not just our brand, but many are sort of mitigating some of the price increase with consumers that are willing to pay for the items they love or equities they built in the brand, offset by consumers that might leak and say, I'll make a different choice at that price coming back with a deal or an offer to motivate them to stay.

And so the process and precision around getting those calendars and promotional activity just right represents brands that are doing a little better than others in the marketplace. But that's what's going on. So when you ask the question about pricing power across the menu, it's a complex answer tied into mix and trades and add-on sales and premium offers sort of all blended into one. It's not as simple as a barbell strategy, but there's a lot that goes into the market planning and co-op management throughout different regions of the country where there's different sensitivities.

Beyond is really a consumer expectation. You have those that are already opting out for worry about what goes in it to make it. That would be the kind of crowd that doesn't want genetically modified corn that's been around for 100 years. And there will be those others that don't want anything modified, and so they're not drawn to this product. The others say, but I want a hamburger or something that tastes like one, but I don't want red meat. So it is a consumer preference. We think consumers should make their own adult decisions and make their own choice. And as long as we're responsible and transparent in menu merchandising, this, we think, will be here for a while. We don't know. I'm usually pretty good at predicting fads and trends. But this one we'll wait and see. But there's 2 front-runners in the market that are dominating the news and getting quite a bit of trial. And so we didn't think we should be at the bleeding edge, but we shouldn't be left behind either, and so that's why the test.

The M&A activity, because there's really nothing actionable other than just the clarity in the script here to say that we do these kinds of things on a regular basis, I would say if I were to give any more color to it, it'd be along the lines of our discussions, and those discussions basically say it ought to complement our portfolio, and that's about as far as we've gotten. So hopefully, that adds a little bit of an answer to your question if we were ever to do anything. And again, these conversations have been around for quite a number of years. And so far, there's not been a compelling reason to do that. But it's always in the consideration set.

And then the last question was around franchising, I apologize...

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [26]

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Franchisee Convention...

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John C. Miller, Denny's Corporation - CEO, President & Director [27]

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Convention, the convention.

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [28]

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Key takeaways.

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John C. Miller, Denny's Corporation - CEO, President & Director [29]

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Key takeaways. I'd say the key takeaway there is there was great attendance, a very positive vibe. One of the funnest parts of the convention is always the fireside chat where we take questions on what people are feeling out there this year. The questions were around the very questions that you have. What's going on with the consumer? How much dealing will persist from competitors? How do we hold on to our share? Those kinds of questions. But it's a very positive convention. I think the key takeaways are that more and more people are happy to be in the system. There seems to be more momentum for scale in our system than there has been in the past. And quite a bit of interest to people that are smaller, they would like to become larger in the Denny's system. Other key takeaways, Mark, to add to that?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [30]

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I think that covers it, John. A lot of very, very positive energy.

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Operator [31]

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(Operator Instructions) We'll now take our next question from Todd Brooks from CL King & Associates.

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Todd Morrison Brooks, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [32]

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First question would be if you look at the off-premise penetration, kind of sticking at that 11% level. I know you talked about 88% of the system being engaged with at least one partner. As you think about where off-premise can go as a percent of sales and if you can talk about maybe stores that are engaged with multiple partners and seeing what that lifts the penetration to when you use more than one partner.

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John C. Miller, Denny's Corporation - CEO, President & Director [33]

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Sure. Well, the multiple partners do a little bit better on the averages. It is more complex. So higher-volume restaurants are drawn to it a little more because they have staffing and the slighter-volume restaurants are a little concerned about it for the off-peak shifts where they can be caught missing a transaction. If you have multiple tablets sitting at the front desk on a slow night, the fear of missing an order, making somebody angry has been other concern, just a transitional concern as we learn how to get good at it.

But the stores that are good at it and manage multiple devices are sort of teaching the rest of the system how to do it. And the adoption rate has sort of stepped up with every passing quarter. We're now at 88%. I think that can get into the mid-90s over time. And I think 11% total to go, it does have a limit. I don't know what that is. I would suspect that somewhere around the middle of the upper teens, somewhere in that range, you'd start to go, that's pretty good right there. And to drive it beyond that might mean your business model has altered more than you wanted to.

We are not necessarily pushing to get there at some accelerated rate but rather watching the margins and the investment and the complexity. And as technology improves for integration between tablets and automatically getting orders to the kitchen, we want to push more of those habits to those devices rather than have all you can get at the moment.

We think we have a very good start, and then we'll just continue to train the guest to use the more convenient, more reliable versions for the benefit of service and frankly margin and then continue to sort of build it from there. But I do believe this 11% will continue to modestly expand.

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Todd Morrison Brooks, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [34]

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Great. And then secondly, on the refranchising process and the fact that we're getting towards the end of the process as we get towards the end of 2019. What at this point drives the outcome of refranchising 115 units versus 125? Is this, okay, these are some of our crown jewels that we wanted to keep, the people are coming and they're willing to pay up for them and we would sell those incremental 10 units? So what at this point drives where we land in that 115 to 125 spectrum?

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F. Mark Wolfinger, Denny's Corporation - Executive VP, Chief Administrative Officer, CFO & Director [35]

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It's a very good question, Todd, because obviously, we're coming to the end. I think you classified it correctly. I think what we're seeing is that, one, the demand for these units has been very strong. And it's not unusual as we -- or it wasn't unusual as we went through the process to have multiple bids from multiple franchisees for the same group of stores. And so high demand, both West Coast, East Coast, Mid Central U.S. But at the same time, we've maintained a pretty strong discipline around multiples and around development agreements. So again, it has to meet certain criteria. And so I think from our standpoint, we've got obviously a few transactions left to get up into that range of sort of final numbers. But ultimately, it's going to be driven by the focus on stakeholder value and what makes sense from a multiple standpoint and the development agreement standpoint.

So as an example, if we were doing a transaction, this is hypothetical only, we're doing a transaction where the multiple, the bids that came in didn't meet our multiple criteria and/or the development agreement number did not meet our criteria, we would give it a second hard look by the transaction team here internally. But again, overall, the program, we've seen high demand from franchisees, both inside and outside the system. And to your point, this thing is close to being wrapped up.

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Todd Morrison Brooks, CL King & Associates, Inc., Research Division - Senior VP & Senior Research Analyst [36]

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Okay. Great. And a final quick question. I know, historically, in times of kind of disaster-related upheaval, there's puts and takes to the impact on restaurants as far as being a place for people to go through without power, but at the same time, there's a lot of disruption in California right now. Can you just maybe talk qualitatively about the impact to the California store base based on the wildfire trends this year?

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John C. Miller, Denny's Corporation - CEO, President & Director [37]

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Yes. So first of all, philosophically, we're not one to rush to excuses when there's trouble. So you rarely get us talking about weather or fire or hurricane-type impacts unless there's really enough materiality to it -- to call attention to it. The -- to the extent that there's an issue with any particular unit, we do have about 1/4 of our brand based in California. So it's a good question to qualify what the impact could be.

So I would say, so far, to the extent that there's any challenges of traffic or groups cut off or access to daily routines to dine with us has not been evident in any material way at this stage. And there -- when there are impacts in a handful of locations, there's usually a corresponding cabin fever effect on the other side of it that makes up for it. So I'd say, for us, right now, we're not -- we don't see anything to call attention to at this age to making me very nervous.

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Operator [38]

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There are no further questions in the queue at this time. I'd like to pass the call back to Curt Nichols for any closing remark.

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Curt Nichols, Denny's Corporation - Senior Director of IR & Financial Analysis [39]

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Thank you, Shanade. I'd like to thank everyone for joining us on today's call. We look forward to our next earnings conference call in February, during which we will discuss our fourth quarter 2019 results. Thank you, and have a great evening.

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Operator [40]

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Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.