q2-2007_10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 27, 2007
 
DENNY'S CORPORATE LOGO
 
 Commission File Number 0-18051
DENNY’S CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
13-3487402
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization
 
Identification No.)

203 East Main Street
Spartanburg, South Carolina 29319-0001
(Address of principal executive offices)
(Zip Code)

(864) 597-8000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days 

Yes [X]                                                                                       No [    ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [    ]                                                                Accelerated filer [X]                                                      Non-accelerated filer [    ] 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [    ]                                                                                       No [X]

As of July 27, 2007, 93,920,452 shares of the registrant’s common stock, par value $.01 per share, were outstanding.
 
 



TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
3
3
4
5
6
7
13
21
21
 
 
 
 
 
22
Item 4. Submission of Matters to a Vote of Security Holders
22
22
23
 
 

2


PART I - FINANCIAL INFORMATION

Item 1.   Financial Statements

Denny’s Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)

 
 
 
Quarter Ended
   
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands, except per share amounts)
 
Revenue:
 
 
   
 
   
 
   
 
 
Company restaurant sales
  $
218,316
    $
221,008
    $
434,117
    $
446,030
 
Franchise and license revenue
   
22,626
     
22,483
     
43,576
     
45,446
 
Total operating revenue
   
240,942
     
243,491
     
477,693
     
491,476
 
Costs of company restaurant sales:
                               
Product costs
   
56,323
     
54,981
     
111,449
     
110,710
 
Payroll and benefits
   
91,932
     
91,862
     
184,800
     
185,870
 
Occupancy
   
13,024
     
12,589
     
26,152
     
25,726
 
Other operating expenses
   
31,782
     
35,882
     
62,095
     
68,326
 
Total costs of company restaurant sales
   
193,061
     
195,314
     
384,496
     
390,632
 
Costs of franchise and license revenue
   
6,933
     
7,235
     
13,408
     
14,448
 
General and administrative expenses
   
17,167
     
15,590
     
33,093
     
32,819
 
Depreciation and amortization
   
12,480
     
14,120
     
25,358
     
28,185
 
Operating gains, losses and other charges, net
    (13,047 )     (5,938 )     (15,680 )     (6,788 )
Total operating costs and expenses
   
216,594
     
226,321
     
440,675
     
459,296
 
Operating income
   
24,348
     
17,170
     
37,018
     
32,180
 
Other expenses:
                               
Interest expense, net
   
10,953
     
14,847
     
22,294
     
29,490
 
Other nonoperating expense (income), net
   
(228
   
138
      (425 )     (24 )
Total other expenses, net
   
10,725
     
14,985
     
21,869
     
29,466
 
Net income before income taxes and cumulative effect of change in accounting
    principle
   
13,623
     
2,185
     
15,149
     
2,714
 
Provision for income taxes
   
2,123
     
331
     
2,486
     
380
 
Net income before cumulative effect of change in accounting principle
   
11,500
     
1,854
     
12,663
     
2,334
 
Cumulative effect of change in accounting principle, net of tax        
   
     
     
     
232
 
Net income
  $
11,500
    $
1,854
    $
12,663
    $
2,566
 
 
                               
Basic net income per share:
                               
Basic net income before cumulative effect of change in accounting principle, net of tax
  $
0.12
    $
0.02
    $
0.14
    $
0.03
 
Cumulative effect of change in accounting principle, net of tax
   
     
     
     
0.00
 
 Basic net income per share
  $
0.12
    $
0.02
    $
0.14
    $
0.03
 
 
                               
Diluted net income per share:
                               
Diluted net income before cumulative effect of change in accounting principle, net of tax
  $
0.12
    $
0.02
    $
0.13
    $
0.02
 
Cumulative effect of change in accounting principle, net of tax
   
     
     
     
0.01
 
Diluted net income per share
  $
0.12
    $
0.02
    $
0.13
    $
0.03
 
 
                               
Weighted average shares outstanding:
                               
Basic
   
93,692
     
92,045
     
93,554
     
91,915
 
Diluted
   
98,967
     
97,741
     
98,796
     
97,435
 
 
 
See accompanying notes

3


Denny’s Corporation and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
 
   
June 27, 2007
   
December 27, 2006
 
   
(In thousands)
 
Assets
           
Current Assets:
           
Cash and cash equivalents
  $
47,263
    $
26,226
 
Receivables, net
   
13,626
     
14,564
 
Inventories
   
8,065
     
8,199
 
Assets held for sale
   
4,178
     
4,735
 
Prepaid and other current assets
   
6,740
     
9,072
 
Total Current Assets
   
79,872
     
62,796
 
                 
Property, net
   
216,224
     
236,264
 
                 
Other Assets:
               
Goodwill
   
48,124
     
50,064
 
Intangible assets, net
   
64,873
     
66,882
 
Deferred financing costs, net
   
5,980
     
6,311
 
Other assets
   
23,570
     
21,595
 
Total Assets
  $
438,643
    $
443,912
 
                 
Liabilities and Shareholders' Deficit
               
Current Liabilities:
               
Current maturities of notes and debentures
  $
3,941
    $
5,532
 
Current maturities of capital lease obligations
   
6,716
     
6,979
 
Accounts payable
   
36,637
     
42,148
 
Other
   
86,721
     
81,143
 
Total Current Liabilities
   
134,015
     
135,802
 
                 
Long-Term Liabilities:
               
Notes and debentures, less current maturities
   
402,252
     
415,801
 
Capital lease obligations, less current maturities
   
21,828
     
24,948
 
Liability for insurance claims, less current portion
   
28,015
     
28,784
 
Deferred income taxes
   
11,759
     
12,126
 
Other noncurrent liabilities and deferred credits
   
47,988
     
50,469
 
Total Long-Term Liabilities
   
511,842
     
532,128
 
Total Liabilities
   
645,857
     
667,930
 
                 
Total Shareholders’ Deficit
    (207,214 )     (224,018 )
Total Liabilities and Shareholders’ Deficit
  $
438,643
    $
443,912
 

 
See accompanying notes
 

4


Denny’s Corporation and Subsidiaries
Condensed Consolidated Statement of Shareholders’ Deficit and Comprehensive Loss
(Unaudited)

 
   
 Common Stock   
               
Accumulated Other Comprehensive
   
Total Shareholders'
 
   
Shares
   
Amount
   
Paid-in Capital
   
Deficit
   
 Loss, Net
   
Deficit
 
   
(In thousands)
 
Balance, December 27, 2006
   
93,186
    $
932
    $
527,911
    $ (735,438 )   $ (17,423 )   $ (224,018 )
Comprehensive income:
                                               
Net income
   
     
     
     
12,663
     
     
12,663
 
Recognition of unrealized gain on hedged
transactions, net of tax
   
 
   
       
     
      1,475       1,475  
Comprehensive income
   
     
     
     
12,663
     
1,475
     
14,138
 
Share-based compensation on equity classified
awards
   
     
     
1,637
     
     
     
1,637
 
Issuance of common stock for share-based
compensation
   
44
     
     
222
     
     
     
222
 
Exercise of common stock options
   
487
     
5
     
802
     
     
     
807
 
Balance, June 27, 2007
   
93,717
    $
937
    $
530,572
    $ (722,775 )   $ (15,948 )   $ (207,214 )


See accompanying notes
 

5


Denny’s Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 

   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Cash Flows from Operating Activities:
           
Net income
  $
12,663
    $
2,566
 
Adjustments to reconcile net income to cash flows provided by operating activities:
               
Cumulative effect of change in accounting principle, net of tax
   
     
(232
Depreciation and amortization
   
25,358
     
28,185
 
Operating gains, losses and other charges, net
   
(15,680
   
(6,788
Amortization of deferred financing costs
   
585
     
1,747
 
Loss on early extinguishment of debt
    67      
 
Deferred income tax expense
    2,161          
Share-based compensation
   
2,319
     
3,673
 
Changes in assets and liabilities, net of effects of acquisitions and dispositions:
               
Decrease (increase) in assets:
               
Receivables
   
938
     
1,552
 
Inventories
    134      
(606
Other current assets
   
2,333
     
1,270
 
Other assets
    (1,728 )     (2,280 )
Increase (decrease) in liabilities:
               
Accounts payable
    (826 )     (5,744 )
Accrued salaries and vacations
    (469 )     (2,461 )
Accrued taxes
    (731 )    
(26
Other accrued liabilities
    6,231      
(744
Other noncurrent liabilities and deferred credits
    (4,505 )    
(1,914
Net cash flows provided by operating activities
   
28,850
     
18,198
 
                 
Cash Flows from Investing Activities:
               
Purchase of property
    (10,992 )     (17,794 )
Proceeds from disposition of property
   
26,888
     
11,765
 
Acquisition of restaurant units
    (2,208 )    
(825
Collection of note receivable payments from former subsidiary
   
     
1,239
 
Net cash flows provided by (used in) investing activities
    13,688       (5,615 )
                 
Cash Flows from Financing Activities:
               
Long-term debt payments
    (18,996 )     (4,445 )
Deferred financing costs paid
   
(321
   
 
Proceeds from exercise of stock options
   
807
     
588
 
Net bank overdrafts
    (2,991 )     (1,209 )
Net cash flows used in financing activities
    (21,501 )     (5,066 )
                 
Increase in cash and cash equivalents
   
21,037
     
7,517
 
                 
Cash and Cash Equivalents at:
               
Beginning of period
   
26,226
     
28,236
 
End of period
  $
47,263
    $
35,753
 
 
See accompanying notes


6


Denny’s Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 1.   Introduction and Basis of Reporting

Denny’s Corporation, through its wholly owned subsidiaries, Denny’s Holdings, Inc. and Denny’s, Inc., owns and operates the Denny’s restaurant brand, or Denny’s.

Our unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Therefore, certain information and notes normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. In our opinion, all adjustments considered necessary for a fair presentation of the interim periods presented have been included. Such adjustments are of a normal and recurring nature. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable. These interim condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 27, 2006 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the fiscal year ended December 27, 2006. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire fiscal year ending December 26, 2007.

Note 2.   Summary of Significant Accounting Policies
 
Effective December 28, 2006, the first day of fiscal 2007, we adopted the Financial Accounting Standards Board's ("FASB") Interpretation No. 48 “Accounting for Uncertainty in Income Taxes,” or FIN 48. See Note 10 to the Condensed Consolidated Financial Statements, “Income Taxes.”

There have been no other material changes to our significant accounting policies and estimates from the information provided in Note 2 of our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 27, 2006.
 
Note 3.   Assets Held for Sale

Assets held for sale of $4.2 million and $4.7 million, as of June 27, 2007 and December 27, 2006, respectively, include real estate related to closed restaurants and restaurants operated by franchisees. We expect to sell each of these assets within 12 months. Our Credit Facility (defined in Note 6) requires us to make mandatory prepayments to reduce outstanding indebtedness with the net cash proceeds from the sale of the real estate related to the certain restaurants operated by franchisees. As a result, we have classified a corresponding $2.0 million and $3.5 million of our long-term debt as a current liability in the Condensed Consolidated Balance Sheet as of June 27, 2007 and December 27, 2006, respectively. These amounts represent the net book value of the specified properties as of the balance sheet dates.
 
Note 4.   Goodwill and Other Intangible Assets
 
The changes in carrying amounts of goodwill for the two quarters ended June 27, 2007 are as follows:
 
   
(In thousands)
 
Balance at December 27, 2006   $ 50,064  
Reversal of valuation allowance related to deferred tax assets     (2,528 )
Goodwill related to acquisition of restaurant unit     588  
Balance at June 27, 2007   $ 48,124  
 
The following table reflects goodwill and intangible assets as of June 27, 2007 and December 27, 2006:
 
   
June 27, 2007   
   
December 27, 2006   
 
   
Gross Carrying Amount
   
Accumulated Amortization
   
Gross Carrying Amount
   
Accumulated Amortization
 
   
(In thousands)
 
Goodwill   $ 48,124     $     $ 50,064     $  
                                 
Intangible assets with indefinite lives:                                
Trade names
  $ 42,375     $     $ 42,323     $  
Liquor licenses
    279             279        
Intangible assets with definite lives:
                               
Franchise and license agreements
    62,477       40,258       65,602       41,322  
Intangible assets   $ 105,131     $  40,258     $ 108,204     $ 41,322  
 
7

Note 5.   Operating Gains, Losses and Other Charges, Net

Operating gains, losses and other charges, net represent gains or losses on the sale of assets, restructuring charges, exit costs and impairment charges and were comprised of the following:
 
   
Quarter Ended
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Gains on sales of assets and other, net
  $
(14,479
  $ (7,098 )   $
(17,750
)   $ (8,669 )
Restructuring charges and exit costs
   
1,192
     
1,160
     
1,830
     
1,881
 
Impairment charges
    240              240        
Operating gains, losses and other charges, net
  $
(13,047
  $ (5,938 )   $
(15,680
  $ (6,788 )
 
Gains on Sales of Assets
 
Proceeds and gains on sales of assets were comprised of the following:
 
   
Quarter Ended June 27, 2007
   
Quarter Ended June 28, 2006
 
   
Net Proceeds
   
Gains
   
Net Proceeds
   
Gains
 
   
(In thousands)         
 
Sales of restaurant operations and related real estate to
franchisees
  $ 20,241     $ 13,659     $     $  
Sales of other real estate assets     911       305       8,692       7,067  
Recognition of deferred gains           515             31  
Total   $ 21,152     $ 14,479     $ 8,692     $ 7,098  
 
   
Two Quarters Ended June 27, 2007
   
Two Quarters Ended June 28, 2006
 
   
Net Proceeds
   
Gains
   
Net Proceeds
   
Gains
 
   
(In thousands)         
 
Sales of restaurant operations and related real estate to
franchisees
  $ 21,853     $ 14,062     $     $  
Sales of other real estate assets     5,035       3,142       11,765       8,607  
Recognition of deferred gains           546             62  
Total   $ 26,888     $ 17,750     $ 11,765     $ 8,669  
 
Restructuring Charges and Exit Costs

Restructuring charges and exit costs were comprised of the following:                                                                                                                                 
 
   
Quarter Ended
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Exit costs
  $
588
    $ 275     $
735
    $
486
 
Severance and other restructuring charges
   
604
     
885
     
1,095
     
1,395
 
Total restructuring and exit costs
  $
1,192
    $
1,160
    $
1,830
    $
1,881
 

The components of the change in accrued exit cost liabilities are as follows:
 
   
(In thousands)
 
 Balance, beginning of year
 
$
11,934
 
 Provisions for units closed during the year
   
50
 
 Changes in estimate of accrued exit costs, net
   
685
 
 Payments, net
   
(2,509
)
 Accretion expense
   
486
 
 Balance, end of quarter
   
10,646
 
 Less current portion included in other current liabilities
   
2,536
 
 Long-term portion included in other noncurrent liabilities
 
$
8,110
 
 
8

Estimated net cash payments related to exit cost liabilities in the next five years are as follows:

  
 
(In thousands)
 
 Remainder of 2007
 
$
1,833
 
 2008
   
2,633
 
 2009
   
2,069
 
 2010
   
1,713
 
 2011
   
1,469
 
 Thereafter
   
3,627
 
 Total
   
13,344
 
 Less imputed interest
   
2,698
 
 Present value of exit cost liabilities
 
$
10,646
 

At the beginning of fiscal 2007, the liability for severance and other restructuring charges was $0.5 million. During the two quarters ended June 27, 2007, an additional $1.1 million of expense was recorded and $0.7 million was paid related to these charges. The remaining balance of $0.9 million is expected to be paid during the next 12 months.

Note 6.   Long-Term Debt
 
Credit Facility

Our subsidiaries, Denny's, Inc. and Denny's Realty, LLC (the "Borrowers"), have a senior secured credit agreement consisting of a $50 million revolving credit facility (including up to $10 million for a revolving letter of credit facility), a $230.6 million term loan and an additional $40 million letter of credit facility (together, the "Credit Facility"). At June 27, 2007, we had outstanding letters of credit of $37.8 million (comprised of $35.2 million under our letter of credit facility and $2.6 million under our revolving facility). There were no revolving loans outstanding at June 27, 2007. These balances result in availability of $4.8 million under our letter of credit facility and $47.4 million under the revolving facility.
 
The revolving facility matures on December 15, 2011. The term loan and the $40 million letter of credit facility mature on March 31, 2012. The term loan amortizes in equal quarterly installments at a rate equal to approximately 1% per annum with all remaining amounts due on the maturity date. The Credit Facility is available for working capital, capital expenditures and other general corporate purposes. We will be required to make mandatory prepayments under certain circumstances (such as required payments related to asset sales) typical for this type of credit facility and may make certain optional prepayments under the Credit Facility. Upon the event of a refinancing transaction, under certain circumstances before March 8, 2008, we would be required to pay the term loan and letter of credit facility lenders a 1.0% prepayment premium.

The Credit Facility is guaranteed by Denny's and its other subsidiaries and is secured by substantially all of the assets of Denny's and its subsidiaries. In addition, the Credit Facility is secured by first-priority mortgages on 132 company-owned real estate assets. The Credit Facility contains certain financial covenants (i.e., maximum total debt to EBITDA (as defined under the Credit Facility) ratio requirements, maximum senior secured debt to EBITDA ratio requirements, minimum fixed charge coverage ratio requirements and limitations on capital expenditures), negative covenants, conditions precedent, material adverse change provisions, events of default and other terms, conditions and provisions customarily found in credit agreements for facilities and transactions of this type. We were in compliance with the terms of the Credit Facility as of June 27, 2007.

Interest on loans under the new revolving facility is payable at per annum rates equal to LIBOR plus 250 basis points and will adjust over time based on our leverage ratio. Effective March 8, 2007, interest on the new term loan and letter of credit facility is payable at per annum rates equal to LIBOR plus 200 basis points. The weighted-average interest rate under the term loan was 7.1% as of June 27, 2007. The weighted average interest rate under the term loan facility was 8.7% as of June 28, 2006.
 
Interest Rate Swap

During the second quarter of fiscal 2007, we entered into an interest rate swap with a notional amount of $150 million to hedge a portion of the cash flows of our variable rate debt. We have designated the interest rate swap as a cash flow hedge of our exposure to variability in future cash flows attributable to interest payments on $150 million of floating rate debt. Under the terms of the swap, we will pay a fixed rate of 4.8925% on the $150 million notional amount and receive payments from the counterparties based on the 3-month LIBOR rate for a term ending on March 30, 2010, effectively resulting in a fixed rate of 6.8925% on the $150 million notional amount. Interest rate differentials paid or received under the swap agreement will be recognized as adjustments to interest expense.

To the extent the swap is effective in offsetting the variability of the hedged cash flows, changes in the fair value of the swap are not included in current earnings but are reported as other comprehensive income. The components of the cash flow hedge included in accumulated other comprehensive income in the Condensed Consolidated Statement of Shareholders’ Deficit for the two quarters ended June 27, 2007 and June 28, 2006, are as follows:
  
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
 Net interest (income) expense recognized as a result of interest rate swap
  $ (170   $
(370
 Unrealized gain (loss) for changes in fair value of interest swap rates 
   
1,645
     
739
 
 Net increase in Accumulated Other Comprehensive Income, net of tax 
  $
1,475
    $
369
 
 
We did not note any ineffectiveness in the hedge during the two quarters ended June 27, 2007. We do not enter into derivative financial instruments for trading or speculative purposes.

9

Note 7.   Defined Benefit Plans

The components of net pension cost of the pension plan and other defined benefit plans as determined under Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” as amended by Statement of Financial Accounting Standards No. 158, "Employer's Accounting for Defined Benefit Pension and Other Postretirement Plans," are as follows:

   
Pension Plan
   
Other Defined Benefit Plans
 
   
Quarter Ended
   
Quarter Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Service cost
  $
88
    $
92
    $
    $
 
Interest cost
   
789
     
770
     
47
     
48
 
Expected return on plan assets
    (879 )     (814 )    
     
 
Amortization of net loss
   
224
     
252
     
6
     
6
 
Net periodic benefit cost
  $
222
    $
300
    $
53
    $
54
 
 
   
Pension Plan
   
Other Defined Benefit Plans
 
   
Two Quarters Ended
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Service cost
  $
175
    $
183
    $
    $
 
Interest cost
   
1,572
     
1,541
     
95
     
96
 
Expected return on plan assets
    (1,764 )     (1,628 )    
     
 
Amortization of net loss
   
441
     
503
     
12
     
12
 
Net periodic benefit cost
  $
424
    $
599
    $
107
    $
108
 
 
We made contributions of $1.8 million and $1.6 million to our qualified pension plan during the two quarters ended June 27, 2007 and June 28, 2006, respectively. We made contributions of $0.2 million and $0.1 million to our other defined benefit plans during the two quarters ended June 27, 2007 and June 28, 2006, respectively. We expect to contribute $1.4 million to our qualified pension plan and $0.1 million to our other defined benefit plans during the remainder of fiscal 2007.

Additional minimum pension liability of $17.4 million is reported as a component of accumulated other comprehensive loss in the Condensed Consolidated Statement of Shareholders’ Deficit and Comprehensive Loss as of June 27, 2007 and December 27, 2006.

Note 8.   Share-Based Compensation

Total share-based compensation included as a component of net income was as follows:

   
Quarter Ended
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Share-based compensation related to liability classified restricted stock units
  $
209
    $
(248
  $
682
    $
818
 
Share based compensation related to equity classified awards:
   
 
     
 
     
 
     
 
 
Stock options
  $ 421      862     $ 619      1,654  
Restricted stock units
    426        546       858        1,033  
Board deferred stock units
    79       81      
160
     
168
 
Total share-based compensation related to equity classified awards
   
926
     
1,489
     
1,637
     
2,855
 
Total share-based compensation
  $
1,135
    $
1,241
    $
2,319
    $
3,673
 

During the two quarters ended June 27, 2007, we issued approximately 44,000 shares of common stock in lieu of cash to pay approximately $0.2 million of incentive compensation.
 
Stock Options

During the two quarters ended June 27, 2007, we granted approximately 0.7 million stock options to certain employees. The options granted vest evenly over 3 years and have a 10-year contractual life. The weighted average fair value per option of options granted during the two quarters ended June 27, 2007 was $3.08.

The fair value of the stock options granted in the period ended June 27, 2007 was estimated at the date of grant using the Black-Scholes option pricing model. Use of this option pricing model requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). Changes in the subjective assumptions can materially affect the estimate of the fair value of share-based compensation and consequently, the related amount recognized in the Consolidated Statements of Operations.

10

We used the following weighted average assumptions for the stock option grants:
 
   
Two Quarters Ended
 
   
June 27, 2007
 
Dividend yield     0.0 %
Expected volatility     68 %
Risk-free interest rate     4.5 %
Weighted-average expected term  
6.0 years
 
 
The dividend yield assumption was based on our dividend payment history and expectations of future dividend payments. The expected volatility was based on the historical volatility of our stock for a period approximating the expected life. The risk-free interest rate was based on published U.S. Treasury spot rates in effect at the time of grant with terms approximating the expected life of the option. The weighted average expected term of the options represents the period of time the options are expected to be outstanding based on historical trends.
 
As of June 27, 2007, there was approximately $3.0 million of unrecognized compensation cost related to unvested stock option awards granted, which is expected to be recognized over a weighted average of 2.0 years.

Restricted Stock Units

During the two quarters ended June 27, 2007, we granted approximately 0.5 million performance shares (which are equity classified) and performance units (which are liability classified) with a grant date fair value of $4.61 per share to certain employees. The award will be earned (from 0% to 200% of the target award) based on certain operating performance measures for fiscal 2007. Once earned, the performance shares and units will vest 15% as of December 26, 2007, 35% as of December 31, 2008 and 50% as of December 30, 2009. Subsequent to the vesting periods, the earned performance shares will be paid to the holder in shares of common stock and the earned performance units will be paid to the holder in cash, provided the holder is then still employed with Denny’s or an affiliate. Compensation expense related to the award is based on the number of shares and units expected to vest, the period over which they are expected to vest and the fair market value of the common stock on the date of grant. 
 
Accrued compensation expense included as a component of the Condensed Consolidated Balance Sheet was as follows:
 
   
June 27, 2007
   
December 27, 2006
 
   
(In thousands)   
 
Liability classified restricted stock units:            
Other current liabilities                                            
  $ 1,202     $ 848  
Other noncurrent liabilities
  $ 3,003     2,675  
                 
Equity classified restricted stock units:                 
Additional paid-in capital
  $ 4,028     $ 3,170  
 
As of June 27, 2007, there was approximately $6.4 million of unrecognized compensation cost (approximately $2.0 million for liability classified units and approximately $4.4 million for equity classified units) related to all unvested restricted stock unit awards granted, which is expected to be recognized over a weighted average of 2.6 years.

Board Deferred Stock Units

During the two quarters ended June 27, 2007, we granted approximately 0.1 million deferred stock units (which are equity classified) with a weighted-average grant date fair value of $5.37 to non-employee members of the Board of Directors in return for attendance at non-regularly scheduled meetings. These awards are restricted in that they may not be exercised until the recipient has ceased serving as a member of the Board of Directors for Denny's.
 
Note 9.   Accumulated Other Comprehensive Income (Loss)

The components of Accumulated Other Comprehensive Income (Loss) in the Condensed Consolidated Statement of Shareholder’s Deficit are as follows:

   
June 27, 2007
   
December 27, 2006
 
   
(In thousands)
 
Additional minimum pension liability
  $ (17,423 )   $ (17,423 )
Unrealized gain on hedged transaction
   
1,475
     
 
Accumulated other comprehensive income (loss)
  $ (15,948 )   $ (17,423 )

11

Note 10.   Income Taxes

Adoption of FIN 48

Effective December 28, 2006, the first day of fiscal 2007, we adopted FIN 48. This interpretation clarifies the accounting for uncertainty in income tax recognized in an entity’s financial statements in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes.” FIN 48 requires companies to determine whether it is more-likely-than-not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. This interpretation also provides guidance on derecognition, classification, accounting in interim periods, and expanded disclosure requirements. FIN 48 does not require or permit retrospective application, thus the cumulative effect of the change in accounting principle, if any, is recorded as an adjustment to opening retained earnings.

We file income tax returns in the U.S. federal jurisdictions and various state jurisdictions. With few exceptions, we are no longer subject to U.S. Federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003.

As a result of the implementation of FIN 48, we did not recognize any change to our liability for unrecognized tax benefits. The total amount of unrecognized tax benefits as of the date of adoption was approximately $0.7 million. These benefits, if recognized, would also affect our effective tax rate.

We recognize interest and penalties accrued related to unrecognized tax benefits in income tax expense. The total amount of accrued interest and penalties at date of adoption was less than $0.1 million.
 
We expect that, during the next twelve months, the liability for unrecognized tax benefits will be settled in full. We remain subject to examination for U.S. Federal taxes for 2003-2006 and in the following major state jurisdictions: California (2002-2006); Florida (2003-2006) and Texas (2002-2006).

Note 11.   Net Income Per Share

   
Quarter Ended
   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands, except for per share amounts)
 
Numerator:
                       
Numerator for basic and diluted net income per share - net income from
continuing operations before cumulative effect of change in accounting principle
  $
11,500
    $
1,854
    $
12,663
    $
2,334
 
Numerator for basic and diluted net income per share - net income
  $
11,500
    $
1,854
    $
12,663
    $
2,566
 
                                 
Denominator:
                               
Denominator for basic net income per share – weighted average shares
   
93,692
     
92,045
     
93,554
     
91,915
 
Effect of dilutive securities:
                               
Options
   
4,159
     
4,636
     
4,131
     
4,585
 
Restricted stock units and awards
   
1,116
     
1,060
     
1,111
     
935
 
Denominator for diluted net income per share - adjusted weighted average
shares and assumed conversions of dilutive securities
   
98,967
     
97,741
     
98,796
     
97,435
 
                                 
Basic net income per share before cumulative effect of change in accounting
principle
  $
0.12
    $
0.02
    $
0.14
    $
0.03
 
Diluted net income per share before cumulative effect of change in
accounting principle
  $
0.12
    $
0.02
    $
0.13
    $
0.02
 
Basic net income per share   $ 0.12     0.02     0.14     0.03  
Diluted net income per share
  $
0.12
    $
0.02
    $
0.13
    $
0.03
 
                                 
Stock options excluded (1)
   
1,853
     
1,580
     
1,799
     
1,378
 
Restricted stock units and awards excluded (1)
   
     
     
     
 

(1)                  Excluded from diluted weighted-average shares outstanding as the impact would have been antidilutive.
 
12

Note 12.   Supplemental Cash Flow Information

   
Two Quarters Ended
 
   
June 27, 2007
   
June 28, 2006
 
   
(In thousands)
 
Income taxes paid, net
  $
1,231
    $
671
 
Interest paid
  $
18,144
    $
26,964
 
                 
Noncash financing activities:
               
Issuance of common stock, pursuant to share-based compensation plans
  $
222
    $
209
 
Execution of capital leases
  $
597
    $
1,884
 
 
Note 13.   Implementation of New Accounting Standards
 
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 ("SFAS 159"), “The Fair Value Options for Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for the first fiscal period beginning after November 15, 2007. We may choose to apply SFAS 159 to eligible items, existing as of the effective date, in the first quarter of fiscal 2008. We are currently evaluating the impact of adopting SFAS 159 on the Condensed Consolidated Financial Statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 ("SFAS 157"), “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. SFAS 157 is effective for the first fiscal period beginning after November 15, 2007. We are required to adopt SFAS 157 in the first quarter of fiscal 2008. We are currently evaluating the impact of adopting SFAS 157 on our Condensed Consolidated Financial Statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Condensed Consolidated Financial Statements upon adoption.

Note 14.   Commitments and Contingencies

There are various claims and pending legal actions against or indirectly involving us, including actions concerned with civil rights of employees and customers, other employment related matters, taxes, sales of franchise rights and businesses and other matters. Based on our examination of these matters and our experience to date, we have recorded our best estimate of liabilities, if any, with respect to these matters. However, the ultimate disposition of these matters cannot be determined with certainty.

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 

The following discussion is intended to highlight significant changes in our financial position as of June 27, 2007 and results of operations for the quarter and two quarters ended June 27, 2007 compared to the quarter and two quarters ended June 28, 2006. The forward-looking statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations, which reflect our best judgment based on factors currently known, involve risks, uncertainties, and other factors which may cause our actual performance to be materially different from the performance indicated or implied by such statements. Such factors include, among others: competitive pressures from within the restaurant industry; the level of success of our operating initiatives and advertising and promotional efforts; adverse publicity; changes in business strategy or development plans; terms and availability of capital; regional weather conditions; overall changes in the general economy (including with regard to energy costs), particularly at the retail level; political environment (including acts of war and terrorism); and other factors included in the discussion below, or in Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Part I. Item 1A. Risk Factors, contained in our Annual Report on Form 10-K for the year ended December 27, 2006.


13

Statements of Operations
 
The following table contains information derived from our Condensed Consolidated Statements of Operations expressed as a percentage of total operating revenues, except as noted below.  Percentages may not add due to rounding.
 
 
 
Quarter Ended
 
 
Two Quarters Ended
 
 
 
June 27, 2007
 
 
June 28, 2006
 
 
June 27, 2007
 
June 28, 2006
 
 
 
(Dollars in thousands)
 
 
(Dollars in thousands)
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company restaurant sales
 
$
218,316
 
 
90.6
%
 
$
221,008
 
 
90.8
%
 
$
434,117
 
 
90.9
%
$
446,030
 
 
90.8
%
Franchise and license revenue
 
 
22,626
 
 
9.4
%
 
 
22,483
 
 
9.2
%
 
 
43,576
 
 
9.1
%
 
45,446
 
 
9.2
%
Total operating revenue
 
 
240,942
 
 
100.0
%
 
 
243,491
 
 
100.0
%
 
 
477,693
 
 
100.0
%
 
491,476
 
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Costs of company restaurant sales (a):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product costs
 
 
56,323
 
 
25.8
%
 
 
54,981
 
 
24.9
%
 
 
111,449
 
 
25.7
%
 
110,710
 
 
24.8
%
Payroll and benefits
 
 
91,932
 
 
42.1
%
 
 
91,862
 
 
41.6
%
 
 
184,800
 
 
42.6
%
 
185,870
 
 
41.7
%
Occupancy
 
 
13,024
 
 
6.0
%
 
 
12,589
 
 
5.7
%
 
 
26,152
 
 
6.0
%
 
25,726
 
 
5.8
%
Other operating expenses
 
 
31,782
 
 
14.6
%
 
 
35,882
 
 
16.2
%
 
 
62,095
 
 
14.3
%
 
68,326
 
 
15.3
%
Total costs of company restaurant
sales
 
 
193,061
 
 
88.4
%
 
 
195,314
 
 
88.4
%
 
 
384,496
 
 
88.6
%
 
390,632
 
 
87.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Costs of franchise and license revenue (a)
 
 
6,933
 
 
30.6
%
 
 
7,235
 
 
32.2
%
 
 
13,408
 
 
30.8
%
 
14,448
 
 
31.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative expenses
 
 
17,167
 
 
7.1
%
 
 
15,590
 
 
6.4
%
 
 
33,093
 
 
6.9
%
 
32,819
 
 
6.7
%
Depreciation and amortization
 
 
12,480
 
 
5.2
%
 
 
14,120
 
 
5.8
%
 
 
25,358
 
 
5.3
%
 
28,185
 
 
5.7
%
Operating gains, losses and other charges
 
 
(13,047
)
 
(5.4
%)
   
(5,938
)
 
(2.4
%)
 
 
(15,680
)
 
(3.3
%)
 
(6,788
)
 
(1.4
%)
Total operating costs and expenses
 
 
216,594
 
 
89.9
%
 
 
226,321
 
 
92.9
%
 
 
440,675
 
 
92.3
%
 
459,296
 
 
93.5
%
Operating income
 
 
24,348
 
 
10.1
%
 
 
17,170
 
 
7.1
%
 
 
37,018
 
 
7.7
%
 
32,180
 
 
6.5
%
Other expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
 
 
10,953
 
 
4.5
%
 
 
14,847
 
 
6.1
%
 
 
22,294
 
 
4.7
%
 
29,490
 
 
6.0
%
Other nonoperating expense (income),
net
 
 
(228
)
 
(0.1
%)
 
 
138
 
 
0.1
%
 
 
(425
)
 
(0.1
%)
 
(24
)
 
(0.0
%)
Total other expenses, net
 
 
10,725
 
 
4.5
%
 
 
14,985
 
 
6.2
%
 
 
21,869
 
 
4.6
%
 
29,466
 
 
6.0
%
Net income before income taxes and
cumulative effect of change in accounting principle
 
 
13,623
 
 
5.7
%
 
 
2,185
 
 
0.9
%
 
 
15,149
 
 
3.2
%
 
2,714
 
 
0.6
%
Provision for income taxes
 
 
2,123
 
 
0.9
%
 
 
331
 
 
0.1
%
 
 
2,486
 
 
0.5
%
 
380
 
 
0.1
%
Net income before cumulative effect of
change in accounting principle
 
 
11,500
 
 
4.8
%
 
 
1,854
 
 
0.8
%
 
 
12,663
 
 
2.7
%
 
2,334
 
 
0.5
%
Cumulative effect of change in accounting
principle,  net of tax
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
232
 
 
0.0
 %
Net income
 
$
11,500
 
 
4.8
%
 
$
1,854
 
 
0.8
%
 
$
12,663
 
 
2.7
%
$
2,566
 
 
0.5
%
                                                       
Other Data:
                                                     
Company-owned average unit sales
 
$
427.7
         
$
412.5
         
$
843.7
       
$
832.1
       
Franchise average units sales
   
379.8
           
362.0
           
746.3
         
727.7
       
Same-store sales increase (decrease) 
(company-owned) (b) (c)
   
2.8
%
         
(0.4)
%
         
0.5
%
       
2.1
%
     
Guest check average increase (c)
   
3.6
%
         
4.0
%
         
3.1
%
       
6.0
%
     
Guest count decrease (c)
   
(0.8
)%
         
(4.2)
%
         
(2.6
)%
       
(3.6)
%
     
Same-store sales increase (franchised and
licensed units) (b) (c)
   
4.0
%
         
1.4
%
         
1.6
%
       
3.7
%
     
__________________

(a) Costs of company restaurant sales percentages are as a percentage of company restaurant sales. Costs of franchise and license revenue percentages are as a percentage of franchise and license revenue. All other percentages are as a percentage of total operating revenue.
 
(b) Same-store sales include sales from restaurants that were open the same days in both the current year and prior year.
 
(c) Prior year amounts have not been updated for 2007 comparable units. 
14

 Quarter Ended June 27, 2007 Compared with Quarter Ended June 28, 2006

   
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
Company-owned restaurants, beginning of period
   
517
     
545
 
Units opened
   
     
 
Units acquired from franchisees
   
     
 
Units sold to franchisees
    (28 )    
 
Units closed
   
(1
    (2 )
End of period
   
488
     
543
 
 
               
Franchised and licensed restaurants, beginning of period
   
1,028
     
1,030
 
Units opened 
   
2
     
3
 
Units acquired by Company
   
     
 
Units purchased from Company
   
28
     
 
Units closed
    (7 )     (10 )
End of period
   
1,051
     
1,023
 
Total company-owned, franchised and licensed restaurants, end of period
   
1,539
     
1,566
 

 Company Restaurant Operations

During the quarter ended June 27, 2007, we realized a 2.8% increase in same-store sales, comprised of a 3.6% increase in guest check average and a 0.8% decrease in guest counts. Company restaurant sales decreased $2.7 million or (1.2%). Decreased sales resulted primarily from a 25 equivalent-unit decrease in company-owned restaurants, offset by the increase in same-store sales for the current quarter.  The decrease in company-owned restaurants primarily resulted from prior year store closures and the sale of company-owned restaurants to franchisees during the current quarter.
 
Total costs of company restaurant sales as a percentage of company restaurant sales remained constant at 88.4%. Product costs increased to 25.8% from 24.9% due to modest changes in commodity costs and unfavorable shifts in menu mix. Payroll and benefits costs increased  to 42.1% from 41.6% primarily as a result of wage increases, offset by $0.9 million of favorable workers' compensation claims development. Occupancy costs increased to 6.0% from 5.7% primarily due to higher general liability expense.  Other operating expenses were comprised of the following amounts and percentages of company restaurant sales:

 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(Dollars in thousands)
 
Utilities
  $
10,032
      4.6 %   $
10,674
      4.8 %
Repairs and maintenance
   
4,818
      2.2 %    
4,755
      2.2 %
Marketing
   
7,315
      3.4 %    
7,525
      3.4 %
Legal
   
985
      0.4 %    
3,185
      1.4 %
Other
   
8,632
      4.0 %    
9,743
      4.4 %
Other operating expenses
  $
31,782
      14.6 %   $
35,882
      16.2 %

The decrease in utilities is primarily the result of lower natural gas costs.  The decrease in legal is due to amounts recognized in the prior year for the development of certain legal cases.  The decrease in other expenses is primarily the result of decreased pre-opening costs and lower professional service fees. 
 
Franchise Operations
 
Franchise and license revenue and costs of franchise and license revenue were comprised of the following amounts and percentages of franchise and license revenue for the periods indicated:
 
 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(Dollars in thousands)
 
Royalties and initial fees
  $
16,778
      74.2 %   $
14,979
      66.6 %
Occupancy revenue
   
5,848
      25.8 %    
7,504
      33.4 %
Franchise and license revenue
   
22,626
      100.0 %    
22,483
      100.0 %
 
                               
Occupancy costs
   
4,932
      21.8 %    
5,113
      22.7 %
Other direct costs
   
2,001
      8.8 %    
2,122
      9.5 %
Costs of franchise and license revenue
  $
6,933
      30.6 %   $
7,235
      32.2 %

15

Royalties and initial fees increased by $1.8 million, or 12.0%, primarily due to the $1.1 million increase in initial fees related to the sale of 28 company-owned restaurants to franchisees. These sales resulted in a four equivalent-unit increase in franchised and licensed units. Additionally, franchised and licensed units realized a 4.0% increase in same-store sales. The $1.7 million, or 22.1%, decline in occupancy revenue is attributable to the sale of franchise-operated real estate properties during 2006 and 2007. Occupancy revenue included in franchise and license revenue for the quarter ended June 28, 2006 related to the sold properties was approximately $1.7 million. We continue to collect royalties from the franchisees operating restaurants at these properties.

Costs of franchise and license revenue decreased $0.3 million or 4.2%, primarily due to a decrease in occupancy costs resulting from the sale of franchise-operated real estate properties during 2006 and 2007. Occupancy costs related to the sold properties was approximately $0.2 million for the quarter ended June 28, 2006. As a percentage of franchise and license revenue, costs of franchise and license revenue decreased to 30.6% for the quarter ended June 27, 2007 from 32.2% for the quarter ended June 28, 2006.
 
Other Operating Costs and Expenses

Other operating costs and expenses such as general and administrative expenses and depreciation and amortization expense relate to both company and franchise operations.

General and administrative expenses are comprised of the following:

 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Share-based compensation
  $
1,135
    $
1,241
 
General and administrative expenses
   
16,032
     
14,349
 
Total general and administrative expenses
  $
17,167
    $
15,590
 

The increase in general and administrative expenses is primarily the result of higher incentive compensation expense.

Depreciation and amortization is comprised of the following:

 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Depreciation of property and equipment
  $
9,632
    $
11,139
 
Amortization of capital lease assets
   
1,216
     
1,295
 
Amortization of intangible assets
   
1,632
     
1,686
 
Total depreciation and amortization expense
  $
12,480
    $
14,120
 

The overall decrease in depreciation and amortization expense is primarily due to the sale of real estate properties during 2006 and 2007.

Operating gains, losses and other charges, net represent gains or losses on the sale of assets, restructuring charges, exit costs and impairment charges and were comprised of the following:

 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Gains on sales of assets and other, net
  $ (14,479 )   $ (7,098 )
Restructuring charges and exit costs
   
1,192
     
1,160
 
Impairment charges
   
240
     
 
Operating gains, losses and other charges, net
  $ (13,047 )   $ (5,938 )
 
Gains on sales of assets and other, net of $14.5 million in the second quarter of 2007 include gains on sales of restaurant operations to franchisees and gains on real estate related to closed restaurants and restaurants operated by franchisees.
 
Restructuring charges and exit costs were comprised of the following:
 
   
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Exit costs
  $
588
    $
275
 
Severance and other restructuring charges
   
604
     
885
 
Total restructuring and exit costs
  $
1,192
    $
1,160
 

Operating income was $24.3 million for the quarter ended June 27, 2007 compared with $17.2 million for the quarter ended June 28, 2006.

16

Interest expense, net is comprised of the following:

 
 
Quarter Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Interest on senior notes
  $
4,363
    $
4,363
 
Interest on credit facilities
   
4,201
     
7,386
 
Interest on capital lease liabilities
   
995
     
1,099
 
Letters of credit and other fees
   
590
     
730
 
Interest income
    (321 )     (480 )
Total cash interest
   
9,828
     
13,098
 
Amortization of deferred financing costs
   
297
     
874
 
Interest accretion on other liabilities
   
828
     
875
 
Total interest expense, net
  $
10,953
    $
14,847
 
 
The decrease in interest expense primarily resulted from the repayments of debt made in the third and fourth quarters of 2006 and lower interest rates resulting from the refinancing of our credit facility.

The provision for income taxes was $2.1 million for the quarter ended June 27, 2007 compared with $0.3 million for the quarter ended June 28, 2006. The provision for income taxes for the second quarter of 2007 was determined using our effective tax rate estimated for the entire fiscal year. The quarter ended June 27, 2007 also included the recognition of $0.3 million of current tax benefits and a $0.6 million reduction to the valuation allowance. These items resulted from the enactment of certain federal and state laws that benefited us in the second quarter of 2007. The provision for income taxes for the second quarter of 2006 primarily represents gross receipts-based state and foreign income taxes which do not directly fluctuate in relation to changes in income before income taxes. We have provided valuation allowances related to any benefits from income taxes resulting from the application of a statutory tax rate to our net operating losses generated in previous periods. In establishing our valuation allowance in the second quarter of 2006, we had taken into consideration certain tax planning strategies involving the sale of appreciated properties. These tax planning strategies were discontinued in the third quarter of 2006 in light of the sale of appreciated properties during 2006. In addition, in the second quarter of 2007, we utilized certain federal and state net operating loss carryforwards whose valuation allowance was established in connection with fresh start reporting on January 7, 1998. Accordingly, for the quarter ended June 27, 2007, we recognized approximately $2.4 million of federal and state deferred tax expense with a corresponding reduction to the goodwill that was recorded in connection with fresh start reporting on January 7, 1998.

Net income was $11.5 million for the quarter ended June 27, 2007 compared with $1.9 million for the quarter ended June 28, 2006 due to the factors noted above.

Two Quarters Ended June 27, 2007 Compared with Two Quarters Ended June 28, 2006
  
   
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
Company-owned restaurants, beginning of period
   
521
     
543
 
Units opened
   
1
     
1
 
Units acquired from franchisees
   
1
     
1
 
Units sold to franchisees
    (34 )    
 
Units closed
   
(1
    (2 )
End of period
   
488
     
543
 
 
               
Franchised and licensed restaurants, beginning of period
   
1,024
     
1,035
 
Units opened 
   
5
     
7
 
Units acquired by Company
    (1 )     (1 )
Units purchased from Company
   
34
     
 
Units closed
    (11 )     (18 )
End of period
   
1,051
     
1,023
 
Total company-owned, franchised and licensed restaurants, end of period
   
1,539
     
1,566
 

Company Restaurant Operations

During the two quarters ended June 27, 2007, we realized a 0.5% increase in same-store sales, comprised of a 3.1% increase in guest check average and a 2.6% decrease in guest counts. Company restaurant sales decreased $11.9 million or (2.7%). Decreased sales resulted primarily from a 21 equivalent-unit decrease in company-owned restaurants, offset by the increase in same-store sales for the current year. The decrease in company-owned restaurants primarily resulted from prior year store closures and the sale of company-owned restaurants to franchisees during the two quarters ended June 27, 2007.
 
Total costs of company restaurant sales as a percentage of company restaurant sales increased to 88.6% from 87.6%. Product costs increased to 25.7% from 24.8% due to modest changes in commodity costs and unfavorable shifts in menu mix. Payroll and benefits increased to 42.6% from 41.7% primarily as a result of wage increases, offset by $0.9 million of favorable workers' compensation claims development. Occupancy costs increased to 6.0% from 5.8% primarily due to increased general liability expense. Other operating expenses were comprised of the following amounts and percentages of company restaurant sales:

17

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(Dollars in thousands)
 
Utilities
  $
20,795
      4.8 %   $
22,322
      5.0 %
Repairs and maintenance
   
8,765
      2.0 %    
9,067
      2.0 %
Marketing
   
14,468
      3.3 %    
14,988
      3.4 %
Legal
   
1,530
      0.4 %    
3,160
      0.7 %
Other
   
16,537
      3.8 %    
18,789
      4.2 %
Other operating expenses
  $
62,095
      14.3 %   $
68,326
      15.3 %

The decrease in utilities is primarily the result of lower natural gas costs. The decrease in legal is due to amounts recognized in the prior year for the development of certain legal cases. The decrease in other expenses is primarily the result of decreased pre-opening costs and lower professional service fees. 
 
Franchise Operations

Franchise and license revenue and costs of franchise and license revenue were comprised of the following amounts and percentages of franchise and license revenue for the periods indicated:

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(Dollars in thousands)
 
Royalties and initial fees
  $
32,095
      73.7 %   $
30,152
      66.3 %
Occupancy revenue
   
11,481
      26.3 %    
15,294
      33.7 %
Franchise and license revenue
   
43,576
      100.0 %    
45,446
      100.0 %
 
                               
Occupancy costs
   
9,534
      21.9 %    
10,238
      22.5 %
Other direct costs
   
3,874
      8.9 %    
4,210
      9.3 %
Costs of franchise and license revenue
  $
13,408
      30.8 %   $
14,448
      31.8 %

Royalties and initial fees increased by $1.9 million, or 6.4%, primarily due to the $1.4 million increase in initial fees related to the sale of 34 company-owned restaurants to franchisees. Additionally, franchised and licensed units realized a 1.6% increase in same-store sales. These increases were partially offset by the effects of a three equivalent-unit decrease in franchise and licensed units. The $3.8 million, or 24.9%, decline in occupancy revenue is attributable to the sale of franchise-operated real estate properties during 2006 and 2007. Occupancy revenue included in franchise and license revenue for the two quarters ended June 28, 2006 related to the sold properties was approximately $3.4 million. We continue to collect royalties from the franchisees operating restaurants at these properties.

Costs of franchise and license revenue decreased by $1.0 million, or 7.2%, primarily due to a decrease in occupancy costs resulting from the sale of franchise-operated real estate properties during 2006 and 2007. Occupancy costs related to the sold properties was approximately $0.6 million for the two quarters ended June 28, 2006. As a percentage of franchise and license revenue, costs of franchise and license revenue decreased to 30.8% for the two quarters ended June 27, 2007 from 31.8% for the two quarters ended June 28, 2006.
 
Other Operating Costs and Expenses

General and administrative expenses are comprised of the following:

 
 
Two Quarters Ended
 
  
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Share-based compensation
  $
2,319
    $
3,673
 
General and administrative expenses
   
30,774
     
29,146
 
Total general and administrative expenses
  $
33,093
    $
32,819
 

The increase general and administrative expenses is primarily the result of an increase in payroll costs due to investments in corporate staffing and higher incentive compensation expense. The decrease in share-based compensation expense is primarily the result of the vesting of certain stock options and restricted stock units during the prior year. 
 
18

Depreciation and amortization is comprised of the following:

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Depreciation of property and equipment
  $
19,436
    $
22,386
 
Amortization of capital lease assets
   
2,425
     
2,569
 
Amortization of intangible assets
   
3,497
     
3,230
 
Total depreciation and amortization expense
  $
25,358
    $
28,185
 
 
The overall decrease in depreciation and amortization expense is primarily due to the sale of real estate properties during 2006 and 2007.

Operating gains, losses and other charges, net represent gains or losses on the sale of assets, restructuring charges, exit costs and impairment charges and were comprised of the following:

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Gains on sales of assets and other, net
  $ (17,750 )   $ (8,669 )
Restructuring charges and exit costs
   
1,830
     
1,881
 
Impairment charges
   
240
     
 
Operating gains, losses and other charges, net
  $ (15,680 )   $ (6,788 )
 
Gains on sales of assets and other, net of $17.8 million for the two quarters ended June 27, 2007 include gains on sales of restaurant operations to franchisees and gains on real estate related to closed restaurants and restaurants operated by franchisees.
 
Restructuring charges and exit costs were comprised of the following:
         
 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Exit costs 
  $
735
    $
486
 
Severance and other restructuring charges
   
1,095
     
1,395
 
Total restructuring and exit costs
  $
1,830
    $
1,881
 
 
Operating income was $37.0 million for the two quarters ended June 27, 2007 compared with $32.2 million for the two quarters ended June 28, 2006.

Interest expense, net is comprised of the following:

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Interest on senior notes
  $
8,726
    $
8,726
 
Interest on credit facilities
   
8,853
     
14,451
 
Interest on capital lease liabilities
   
1,999
     
2,228
 
Letters of credit and other fees
   
1,183
     
1,496
 
Interest income
    (672 )     (916 )
Total cash interest
   
20,089
     
25,985
 
Amortization of deferred financing costs
   
585
     
1,747
 
Interest accretion on other liabilities
   
1,620
     
1,758
 
Total interest expense, net
  $
22,294
    $
29,490
 

The increase in interest expense primarily resulted from the effect of higher interest rates on the variable-rate portion of our credit facilities.

19

The provision for income taxes was $2.5 million for the two quarters ended June 27, 2007 compared with $0.4 million for the two quarters ended June 28, 2006. The provision for income taxes for the two quarters ended June 27, 2007 was determined using our effective tax rate estimated for the entire fiscal year. The two quarters ended June 27, 2007 also included the recognition of $0.3 million of current tax benefits and a $0.6 million reduction to the valuation allowance. These items resulted from the enactment of certain federal and state laws that benefited us during the second quarter of 2007. The provision for income taxes for the two quarters ended June 28, 2006 primarily represents gross receipts-based state and foreign income taxes which do not directly fluctuate in relation to changes in income before income taxes. We have provided valuation allowances related to any benefits from income taxes resulting from the application of a statutory tax rate to our net operating losses generated in previous periods. In establishing our valuation allowance in the two quarters ended June 28, 2006, we had taken into consideration certain tax planning strategies involving the sale of appreciated properties. These tax planning strategies were discontinued in the third quarter of 2006 in light of the sale of appreciated properties during 2006. In addition, in the two quarters ended June 27, 2007, we utilized certain federal and state net operating loss carryforwards whose valuation allowance was established in connection with fresh start reporting on January 7, 1998. Accordingly, for the two quarters ended June 27, 2007, we recognized approximately $2.5 million of federal and state deferred tax expense with a corresponding reduction to the goodwill that was recorded in connection with fresh start reporting on January 7, 1998.
 
As a result of adopting SFAS 123(R), we recorded a cumulative effect of change in accounting principle, net of tax of $0.2 million during the two quarters ended June 28, 2006.

Net income was $12.7 million for the two quarters ended June 27, 2007 compared with $2.6 million for the two quarters ended June 28, 2006 due to the factors noted above.

Liquidity and Capital Resources

The following table presents a summary of our sources and uses of cash and cash equivalents for the periods indicated:

 
 
Two Quarters Ended
 
 
 
June 27, 2007
   
June 28, 2006
 
 
 
(In thousands)
 
Net cash provided by operating activities
  $
28,850
    $
18,198
 
Net cash provided by (used in) investing activities
    13,688       (5,615 )
Net cash used in financing activities
    (21,501 )     (5,066 )
Net increase in cash and cash equivalents
  $
21,037
    $
7,517
 
 
Net cash flows provided by operating activities were $28.9 million for the two quarters ended June 27, 2007, which represent a $10.7 million increase from the two quarters ended June 28, 2006. The increase is primarily the result of timing differences related to certain operating accruals. We believe that our estimated cash flows from operations for 2007, combined with our capacity for additional borrowings under our credit facility, will enable us to meet our anticipated cash requirements and fund capital expenditures through the end of 2007.
 
Net cash flows provided by investing activities were $13.7 million for the two quarters ended June 27, 2007. These cash flows primarily represent net proceeds of $26.9 million on sales of restaurant operations to franchisees, real estate related to closed restaurants and restaurants operated by franchisees and other assets. The proceeds were offset by capital expenditures of $11.6 million for the two quarters ended June 27, 2007, of which $0.6 million was financed through capital leases. Our principal capital requirements have been largely associated with remodeling and maintaining our existing company-owned restaurants and facilities.
 
Cash flows used in financing activities were $21.5 million for the two quarters ended June 27, 2007, which included $13.9 million of prepayments and $5.1 million of scheduled debt payments made through a combination of asset sale proceeds, as noted above, and surplus cash.
 
Our credit facility consists of a $50 million revolving credit facility (including up to $10 million for a revolving letter of credit facility), a $230.6 million term loan and an additional $40 million letter of credit facility. At June 27, 2007, we had outstanding letters of credit of $37.8 million (comprised of $35.2 million under our letter of credit facility and $2.6 million under our revolving facility). There were no revolving loans outstanding at June 27, 2007. These balances result in availability of $4.8 million under our letter of credit facility and $47.4 million under the revolving facility.
 
The revolving facility matures on December 15, 2011. The term loan and the $40 million letter of credit facility mature on March 31, 2012. The term loan amortizes in equal quarterly installments at a rate equal to approximately 1% per annum with all remaining amounts due on the maturity date. The credit facility is available for working capital, capital expenditures and other general corporate purposes. We will be required to make mandatory prepayments under certain circumstances (such as the sale of specified properties) typical for this type of credit facility and may make certain optional prepayments under the credit facility.

The credit facility is guaranteed by Denny's and its other subsidiaries and is secured by substantially all of the assets of Denny's and its subsidiaries. In addition, the credit facility is secured by first-priority mortgages on 132 company-owned real estate assets. The credit facility contains certain financial covenants (i.e., maximum total debt to EBITDA (as defined under the credit facility) ratio requirements, maximum senior secured debt to EBITDA ratio requirements, minimum fixed charge coverage ratio requirements and limitations on capital expenditures), negative covenants, conditions precedent, material adverse change provisions, events of default and other terms, conditions and provisions customarily found in credit agreements for facilities and transactions of this type. We were in compliance with the terms of the credit facility as of June 27, 2007.

20

As of June 27, 2007, interest on loans under the new revolving facility is payable at per annum rates equal to LIBOR plus 250 basis points and will adjust over time based on our leverage ratio. Interest on the new term loan and letter of credit facility is payable at per annum rates equal to LIBOR plus 200 basis points. The weighted-average interest rate under the term loan was 7.1% as of June 27, 2007.

Our working capital deficit was $54.1 million at June 27, 2007 compared with $73.0 million at December 27, 2006. We are able to operate with a substantial working capital deficit because (1) restaurant operations and most food service operations are conducted primarily on a cash (and cash equivalent) basis with a low level of accounts receivable, (2) rapid turnover allows a limited investment in inventories, and (3) accounts payable for food, beverages and supplies usually become due after the receipt of cash from the related sales.
 
Implementation of New Accounting Standards

See Notes 2, 10 and 13 to our Condensed Consolidated Financial Statements.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

We have exposure to interest rate risk related to certain instruments entered into for other than trading purposes. Specifically, borrowings under the term loan and revolving credit facility bear interest at variable rates based on LIBOR plus a spread of 2.00% per annum for the term loan and letter of credit facility and 2.50% per annum for the revolving credit facility.

During the second quarter of fiscal 2007, we entered into an interest rate swap with a notional amount of $150 million to hedge a portion of the cash flows of our variable rate debt. We have designated the interest rate swap as a cash flow hedge of our exposure to variability in future cash flows attributable to interest payments on $150 million of floating rate debt. Under the terms of the swap, we pay a fixed rate of 4.8925% on the $150 million notional amount and receive payments from a counterparty based on the 3-month LIBOR rate for a term ending on March 30, 2010, effectively resulting in a fixed rate of 6.8925% on the $150 million notional amount. As of June 30, 2007, the swap effectively increases our ratio of fixed rate debt from approximately 43% of total debt to approximately 80% of total debt.
 
Based on the levels of borrowings under the credit facility at June 27, 2007, if interest rates changed by 100 basis points our annual cash flow and income before income taxes would change by approximately $0.8 million. This computation is determined by considering the impact of hypothetical interest rates on the variable rate portion of the credit facility at June 27, 2007. However, the nature and amount of our borrowings under the credit facility may vary as a result of future business requirements, market conditions and other factors.
 
Our other outstanding long-term debt bears fixed rates of interest. The estimated fair value of our fixed rate long-term debt (excluding capital lease obligations and revolving credit facility advances) was approximately $184.0 million, compared with a book value of $175.6 million at June 27, 2007. This computation is based on market quotations for the same or similar debt issues or the estimated borrowing rates available to us. The difference between the estimated fair value of long-term debt compared with its historical cost reported in our consolidated balance sheets at June 27, 2007 relates primarily to market quotations for our 10% Senior Notes due 2012.
 
We also have exposure to interest rate risk related to our pension plan, other defined benefit plans, and self-insurance liabilities. A 25 basis point increase in discount rate would reduce our projected benefit obligation related to our pension plan and other defined benefit plans by $1.9 million and $0.1 million, respectively, and reduce our annual net periodic benefit cost related to our pension plan by $0.1 million. A 25 basis point decrease in discount rate would increase our projected benefit obligation related to our pension plan and other defined benefit plans by $2.0 million and $0.1 million, respectively, and increase our annual net periodic benefit cost related to our pension plan by $0.1 million. The annual impact of a 25 basis point increase or decrease in discount rate on periodic benefit costs related to our other defined benefit plans would be less than $0.1 million. A 25 basis point increase or decrease in discount rate related to our self-insurance liabilities would result in a decrease or increase to the liabilities of $0.2 million, respectively.

We have established a policy to identify, control and manage market risks which may arise from changes in interest rates, commodity prices and other relevant rates and prices. We do not enter into financial instruments for trading or speculative purposes.

Item 4.   Controls and Procedures

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) our management conducted an evaluation (under the supervision and with the participation of our President and Chief Executive Officer, Nelson J. Marchioli, and our Executive Vice President, Growth Initiatives and Chief Financial Officer, F. Mark Wolfinger) as of the end of the period covered by this report, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, Messrs. Marchioli and Wolfinger each concluded that Denny’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that Denny’s files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
 
There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
21


PART II - OTHER INFORMATION

Item 1.   Legal Proceedings

There are various claims and pending legal actions against or indirectly involving us, including actions concerned with civil rights of employees and customers, other employment related matters, taxes, sales of franchise rights and businesses and other matters. Based on our examination of these matters and our experience to date, we have recorded our best estimate of legal and financial liabilities, if any, with respect to these matters. However, the ultimate disposition of these matters cannot be determined with certainty.

Item 4.   Submission of Matters to a Vote of Security Holders

The annual meeting of stockholders of Denny’s Corporation was held on Wednesday, May 23, 2007, and the following matters were voted on by the stockholders of Denny’s Corporation:
 
 (i)
 
Election of Directors
 
 
Name
 
 Votes For
 
Votes Against or Withheld
 
 
 
 
 
 
 
 
 
 Vera K. Farris
 
 89,020,362
 
   390,573
 
 
 Brenda J. Lauderback
 
 84,349,117
 
5,061,818
 
 
 Nelson J. Marchioli
 
 89,167,011
 
   243,924
 
 
 Robert E. Marks
 
 89,142,581
 
   268,354
 
 
 Michael Montelongo
 
 89,157,497
 
   253,438
 
 
 Henry Nasella
 
 89,145,190
 
   265,745
 
 
 Donald R. Shepherd
 
 89,093,630
 
   317,305
 
 
 Debra Smithart-Oglesby
 
 89,148,001
 
   262,934
 
 
 (ii)
 
Ratification of the Selection of KPMG LLP as the independent registered public accounting firm for the 2007 fiscal year
 
 
Votes For
 
Votes Against
 
Votes Abstaining
 
 
 
 
 
 
 
 
 
 88,746,305
 
621,569
 
43,061 
 
 
 (iii)
 
Stockholder Proposal requesting a report on the use of controlled-atmosphere killing by poultry suppliers
 
 
Votes For
 
Votes Against
 
Votes Abstaining
 
 
 
 
 
 
 
 
 
 1,809,184
 
65,653,653
 
4,675,478 

Item 6.   Exhibits
 
a.   The following are included as exhibits to this report:
 
 Exhibit No.
 
Description 
 
 
 
31.1
 
Certification of Nelson J. Marchioli, President and Chief Executive Officer of Denny’s Corporation, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of F. Mark Wolfinger, Executive Vice President, Growth Initiatives and Chief Financial Officer of Denny’s Corporation, pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of Nelson J. Marchioli, President and Chief Executive Officer of Denny’s Corporation and F. Mark Wolfinger, Executive Vice President, Growth Initiatives and Chief Financial Officer of Denny’s Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

22


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
  DENNY'S CORPORATION  
       
Date: July 31, 2007
By:
/s/  Rhonda J. Parish  
    Rhonda J. Parish  
   
Executive Vice President,
Chief Legal Officer and
Secretary
 
       
       
Date: July 31, 2007
By:
/s/  F. Mark Wolfinger  
    F. Mark Wolfinger  
   
Executive Vice President,
Growth Initiatives and
Chief Financial Officer
 
       
       
Date: July 31, 2007
By:
/s/  Jay C. Gilmore  
    Jay C. Gilmore  
   
Vice President,
Chief Accounting Officer and
Corporate Controller
 
       


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