Strong Q3 Results Posted for Denny’s

Date: OCT 27th, 2006

Topic: Franchise News

Denny’s (NASDAQ: DENN) has posted its results for its third quarter that ended September 27, 2006.

Q3 Summary:

• Company unit same-store sales increased 4.2%
• Franchised unit same-store sales increased 4.7%
• Total operating revenue increased $9.5 million to $258.2 million
• The divestiture of 65 real estate assets for gross proceeds of $67 million resulted in gains on disposition of assets of $39 million
• Denny''s prepaid $80 million in debt with proceeds from asset sales and surplus cash
• The asset sales resulted in an incremental $13.1 million provision for income taxes
• Operating income (excluding asset sale gains) increased $7.5 million to $16.6 million
• Net income (excluding gains and tax provision) increased $4.9 million to $0.1 million

Denny’s President and Chief Executive Officer, Nelson Marchioli, said: 'Denny's results in the third quarter were driven by a strong positive response to our promotional and product offerings. During the quarter, Denny's also launched a new television campaign along with a targeted discounting program. Together, these initiatives successfully revitalized demand and produced solid sales growth. Denny's value proposition in the quarter was particularly effective in driving guest traffic without sacrificing average check. This contributed to our improved sales momentum despite the challenging consumer environment and the difficult traffic trends experienced by our industry in 2006.

'During the third quarter, we made significant progress towards our goal of reducing long-term debt. Through the sale of non-core real estate we reduced our debt by $80 million. Denny's is stronger financially than at any time in the past 15 years, carrying less debt and lower interest costs. As a result, Denny's is better positioned to reinvest in this great brand and to focus its efforts on new unit development in the coming years,' Marchioli concluded.

Q3 Results

For Q3 of 2006, Denny's reported total operating revenue of $258.2 million, a positive increase of 3.8%, or $9.5 million over the past year’s quarter. Restaurant sales increased 3.9%, or $8.9 million, to $234.7 million as a result of a 4.2% increase in same-store sales. This sales increase offset a decline in company-owned restaurants by an eleven units since Q3 of 2005. Franchise revenue is up 2.6%, or $0.6 million, to $23.5 million as a 4.7% increase in same-store sales offset a twelve-unit decline in franchised locations.

Operating margin (as a % of restaurant sales) for Q3 was 13.8% compared with 10.7% for the same period in 2005. Product costs for the third quarter increased by 0.3 percentage points compared with last year due primarily to a shift in entrée mix towards lunch and dinner items. Payroll and benefits improved by 1.1 percentage points due primarily to improving experience in worker's compensation costs. Other operating costs improved 2.4 percentage points due to a $7.2 million reduction in legal settlement costs resulting primarily from $5.8 million in specific charges taken in the prior year period. Partially offsetting the decrease in legal costs was a $1.0 million increase in utilities and a $0.6 million decrease in supplemental restaurant income.

Administrative and general expenses for the third quarter increased $1.8 million from the same period last year due for the most part to higher incentive and stock-based compensation as well as additional staff at the corporate level.

Revenue on the sale of assets increased $39.0 million due to the sale of 65 restaurant properties owned by the company that were previously leased to franchisees.

Operating income for the third quarter was $55.6 million, an increase of $46.4 million compared with 2005 operating income of $9.2 million. This increase was due primarily to $39.0 million in asset sale gains. Excluding these gains, operating income increased $7.5 million to $16.6 million compared with $9.1 million in the prior year period.

Expenses due to interest for Q3 increased $1.0 million to $15.0 million due to higher interest rates on the variable-rate portions of Denny's debt compared with the prior year period. Other non-operating expense increased $1.6 million due to a pro rata write-off of deferred financing costs associated with the $80.0 million prepayment of first lien term loan debt during the quarter.

Provision for income taxes for the third quarter increased by $14.9 million over the prior year due primarily to $12.8 million in deferred income taxes and $0.3 million in current income taxes recorded as a result of the asset sales. The deferred income tax provision relates primarily to the usage of deferred income tax assets that had been previously recorded relying on various tax planning strategies.

Net income for the third quarter was $25.5 million, or $0.26 per diluted common share, an increase of $28.9 million compared with prior year net loss of $3.4 million, or $0.04 per common share.

Real Estate Sales / Debt Reduction

Denny's made substantial progress on its initiative to sell non-core real estate assets and utilize the proceeds to reduce debt in the third quarter. Previously, Denny's announced a sale transaction of 60 restaurant properties for gross proceeds of approximately $62 million. An additional five properties were sold during the third quarter for gross proceeds of $5 million. Denny's applied the net proceeds from these transactions, along with surplus cash, to reduce the outstanding balance on its first lien term loan by $80 million during the quarter. YTD Denny's has reduced its debt balances by approximately 15%, or $84 million.

At the end of the third quarter, Denny's owned 21 restaurant properties that were being marketed for sale. Six of these properties are contracted for sale under the earlier multi-property transaction and are expected to close by year end. In total, 19 of the remaining properties are expected to be sold within the next twelve months.

Business Outlook

Denny’s acknowledges that third quarter sales results were higher than previously expected and it remains cautious in the sales outlook for the fourth quarter based on the uncertain macroeconomic environment and the challenge presented when estimating revenues. Given an improved outlook for full-year sales, the Company would expect adjusted EBITDA at the upper end of the previous guidance range of $113 to $118 million.

The EPS guidance management previously provided is no longer relevant due to the asset sale gains, restructuring and impairment charges, non-operating expenses and provision for income taxes recorded in Q3. The expectation of further gains, charges and non-operating expenses, along with a potential debt refinancing transaction, could cause fourth quarter earnings to vary materially.