Denny's - 10-Q quarterly report FY

 

 

 

 

 

 

(Exact name of registrant as specified in its charter)

(Address of principal executive offices)

(Zip Code)

(Registrant’s telephone number, including area code)

 

 

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):

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

As of November 1, 2006, 92,641,987 shares of the registrant’s common stock, par value $.01 per share, were outstanding.

 

 

 

 

See accompanying notes

 

 

 

See accompanying notes

 

 

See accompanying notes

 

 

 

See accompanying notes

 

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 footnotes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America 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. These interim consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 28, 2005 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 28, 2005. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire fiscal year ending December 27, 2006.

 

There have been no 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 28, 2005, other than the adoption of Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised 2004), “Share-Based Payment,” or SFAS 123(R).  See Note 9 to the Condensed Consolidated Financial Statements, “Share-Based Compensation.”

 

 

In June 2006, we recorded adjustments to correct an error in our accounting for receivables and certain related payables recorded in periods prior to December 31, 2003. Though we concluded that the adjustments were inconsequential, we have adjusted the prior periods currently presented to reflect the correction. The adjustments had no impact on our results of operations for the periods presented in this Form 10-Q or for any of the periods presented in our most recently filed Form 10-K. The following line items were impacted by this adjustment on the Condensed Consolidated Balance Sheet and the Condensed Consolidated Statement of Shareholders' Deficit as of December 28, 2005:  

 

 

 

 

 

 

 

The components of the change in accrued exit cost liabilities are as follows:

 

 

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

 

 

At the beginning of fiscal 2006, the liability for severance and other restructuring charges was $0.2 million. During the three quarters ended September 27, 2006, an additional $1.7 million of expense was recorded and $1.1 million was paid related to these charges. The remaining balance of $0.8 million is expected to be paid during the next 12 months. 

 

Our subsidiaries, Denny’s, Inc. and Denny’s Realty, LLC (formerly Denny's Realty, Inc.) (the “Borrowers”), have senior secured credit facilities with an aggregate principal amount of $337 million. The credit facilities consist of a first lien facility and a second lien facility. At September 27, 2006, the first lien facility consists of a $142 million five-year term loan facility (the “Term Loan Facility”) and a $75 million four-year revolving credit facility, of which $55 million was available for the issuance of letters of credit (the “Revolving Facility” and together with the Term Loan Facility, the “First Lien Facility”). The second lien facility consists of an additional $120 million six-year term loan facility (the “Second Lien Facility,” and together with the First Lien Facility, the “Credit Facilities”). The Second Lien Facility ranks pari passu with the First Lien Facility in right of payment, but is in a second lien position with respect to the collateral securing the First Lien Facility.

The Term Loan Facility matures on September 30, 2009 and amortizes in equal quarterly installments of $0.4 million with all remaining amounts due on the maturity date. The Revolving Facility matures on September 30, 2008. The Second Lien Facility matures on September 30, 2010 with no amortization of principal prior to the maturity date.

The interest rates under the First Lien Facility are as follows: At the option of the Borrowers, Adjusted LIBOR plus a spread of 3.25% per annum (3.50% per annum for the Revolving Facility) or ABR (the Alternate Base Rate, which is the higher of the Bank of America Prime Rate and the Federal Funds Effective Rate plus 1/2 of 1%) plus a spread of 1.75% per annum (2.0% per annum for the Revolving Facility). The interest rate on the Second Lien Facility, at the Borrower’s option, is Adjusted LIBOR plus a spread of 5.125% per annum or ABR plus a spread of 3.625% per annum. The weighted-average interest rates on the First Lien Facility and Second Lien Facility at September 27, 2006 were 8.7% and 10.5%, respectively.

At September 27, 2006, we had outstanding letters of credit of $42.5 million under our Revolving Facility, leaving net availability of $32.5 million. There were no revolving loans outstanding at September 27, 2006.

The Credit Facilities are secured by substantially all of our assets and are guaranteed by Denny’s Corporation, Denny’s Holdings and all of their subsidiaries. The Credit Facilities contain certain financial covenants (i.e., maximum total debt to EBITDA (as defined under the Credit Facilities) 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 Facilities as of September 27, 2006.

The indenture governing the Denny’s Holdings 10% Senior Notes due 2012 (the “Indenture”) is fully and unconditionally guaranteed by Denny’s Corporation. Denny’s Corporation is a holding company with no independent assets or operations, other than as related to the ownership of the common stock of Denny’s Holdings and its status as a holding company. Denny’s Corporation is not subject to the restrictive covenants in the Indenture. Denny’s Holdings is restricted from paying dividends and making distributions to Denny’s Corporation under the terms of the Indenture.

On July 17, 2006, the Credit Facilities were amended to allow for the sale of 84 specified properties, primarily company-owned, franchisee-operated real estate, with the net cash proceeds from such sales to be applied to reduce outstanding indebtedness under the Credit Facilities. In addition, the amendments increased the limit on Letter of Credit Commitments under the Revolving Facility from $45 million to $55 million and increased the allowance during a fiscal year for the sale of restaurant businesses or property (excluding the specified properties) from $5 million to $15 million, thereby requiring the proceeds from any asset sales greater than $15 million be used to pay down our debt .

 

 

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 three quarters ended September 27, 2006 and September 28, 2005, are as follows:

  

 

We did not note any ineffectiveness in the hedge during the three quarters ended September 27, 2006. We do not enter into derivative financial instruments for trading or speculative purposes.

 

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,” are as follows:

 

 

 

We made contributions of $3.1 million and $2.5 million to our pension plan during the three quarters ended September 27, 2006 and September 28, 2005, respectively. We made contributions of $0.3 million and $1.1 million to our other defined benefit plans during the three quarters ended September 27, 2006 and September 28, 2005, respectively. We expect to contribute $0.9 million to our pension plan and $0.1 million to our other defined benefit plans during the remainder of fiscal 2006.

 

We maintain four plans (the Denny’s Corporation 2004 Omnibus Incentive Plan (the “2004 Omnibus Plan”), the Denny’s, Inc. Omnibus Incentive Compensation Plan for Executives, the Advantica Stock Option Plan and the Advantica Restaurant Group Director Stock Option Plan) under which stock options and other awards granted to our employees, directors and consultants are outstanding. On August 25, 2004, our stockholders approved the 2004 Omnibus Plan which replaced the other plans as the vehicle for granting share-based compensation to our employees, officers and directors. The 2004 Omnibus Plan is administered by the Compensation Committee of the Board of Directors or the Board of Directors as a whole. Ten million shares of our common stock are reserved for issuance upon the grant and exercise of awards pursuant to the 2004 Omnibus Plan, plus a number of additional shares (not to exceed 1,500,000) underlying awards outstanding as of August 25, 2004 pursuant to the other plans which thereafter cancel, terminate or expire unexercised for any reason. The 2004 Omnibus Plan authorizes the granting of incentive awards from time to time to selected employees, officers, directors and consultants of Denny’s and its affiliates. However, we reserve the right to pay discretionary bonuses, or other types of compensation, outside of the 2004 Omnibus Plan.

The Compensation Committee, or the Board of Directors as a whole, has sole discretion to determine the exercise price, term and vesting schedule of options awarded under such plans. Under the terms of the above referenced plans, optionees who terminate for any reason other than cause, disability, retirement or death will be allowed 60 days after the termination date to exercise vested options. Vested options are exercisable for one year when termination is by a reason of disability, retirement or death. If termination is for cause, no option shall be exercisable after the termination date.

Additionally, under the 2004 Omnibus Plan and the previous director plan, directors have been granted options under terms which are substantially similar to the terms of the plans noted above.

 

Effective December 29, 2005, the first day of fiscal 2006, we adopted SFAS 123(R). This standard requires all share-based compensation to be recognized in the statement of operations based on fair value and applies to all awards granted, modified, cancelled or repurchased after the effective date. Additionally, for awards outstanding as of December 29, 2005 for which the requisite service has not been rendered, compensation expense will be recognized as the requisite service is rendered. The statement also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. We adopted this accounting treatment using the modified-prospective-transition method, therefore, results for prior periods have not been restated. SFAS 123(R) supersedes SFAS 123, “Accounting for Stock Based Compensation,” or SFAS No. 123, which had allowed companies to choose between expensing stock options or showing pro forma disclosure only.

Under SFAS 123(R), we are required to estimate potential forfeitures of share-based awards and adjust the compensation cost accordingly. Our estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Prior to the adoption of SFAS 123(R), we recorded forfeitures as they occurred. As a result of this change, we recognized a cumulative effect of change in accounting principle in the Condensed Consolidated Statement of Operations of $0.2 million in the first quarter of 2006. Additionally, in accordance with SFAS 123(R), $2.5 million related to restricted stock units payable in shares, previously recorded as liabilities, was reclassified to additional paid-in capital in the Condensed Consolidated Balance Sheet during the first quarter of 2006. Our previous practice was to accrue compensation expense for restricted stock units payable in shares as a liability until such time as the shares were actually issued.

Options granted to date generally vest evenly over 3 years, have a 10-year contractual life and are generally issued at the market value at the date of grant.

A summary of our stock option plans is presented below:

 

The aggregate intrinsic value was calculated using the difference between the market price of our stock on September 27, 2006 and the exercise price for only those options that have an exercise price that is less than the market price of our stock. The aggregate intrinsic value of the options exercised was $0.2 million and $1.2 million during the quarter and three quarters ended September 27, 2006 and was $2.5 million and $4.6 million during the quarter and three quarters ended September 28, 2005, respectively.

 

The following table summarizes information about stock options outstanding at September 27, 2006 (option amounts in thousands):  

On November 11, 2004, we granted options under the 2004 Omnibus Plan to certain employees with an exercise price of $2.42 (included in the table above). These options vest 1/3 of the shares on each of December 29, 2004, December 28, 2005 and December 27, 2006, respectively. The vesting of these options was subject to the achievement of certain performance measures which were met as of December 29, 2004. As a result of performance criteria and the issuance of the options with an exercise price below the market price at the date of grant, prior to the adoption of SFAS 123(R), we recognized compensation expense related to these options equal to the difference between the exercise price of the options and the market price of $4.40 on December 29, 2004, the measurement date, ratably over the options’ vesting period.

There were no options granted during the quarter ended September 27, 2006. The weighted average fair value per option of options granted during the three quarters ended September 27, 2006 was $3.20. The weighted average fair value per option of options granted during the quarter and three quarters ended September 28, 2005 was $3.23 and $3.16, respectively.

 

The fair value of the stock options granted in the periods ended September 27, 2006 and September 28, 2005 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 Condensed Consolidated Statements of Operations.  We used the following weighted average assumptions for the grants:

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.

Compensation expense for options granted prior to fiscal 2006 is recognized based on the graded vesting attribution method.  Compensation expense for options granted subsequent to December 28, 2005 is recognized on a straight-line basis over the requisite service period for the entire award. We recognized compensation expense of approximately $0.8 million and $2.5 million for the quarter and three quarters ended September 27, 2006 and $1.0 million and $2.8 million for the quarter and three quarters ended September 28, 2005, respectively, related to these options, which is included as a component of general and administrative expenses in our Condensed Consolidated Statements of Operations. Compensation expense for the quarter and three quarters ended September 28, 2005 related to the intrinsic value of options with an exercise price that was below the market price on the measurement date.

As of September 27, 2006, there was approximately $2.7 million of unrecognized compensation cost related to unvested stock option awards granted, which is expected to be recognized over a weighted average of 1.3 years.

 

 

The following table summarizes information about restricted stock units outstanding at September 27, 2006:  

 

 

We granted approximately 3.4 million restricted stock units (half of which are liability classified and half of which are equity classified) with a grant date fair value of $4.22 per share and approximately 0.6 million restricted stock units (half of which are liability classified and half of which are equity classified) with a grant date fair value of $4.06 per share to certain employees. As of September 27, 2006 and December 28, 2005, approximately 2.9 million and 3.3 million of these units were outstanding, respectively.

These restricted stock units will be earned in 1/3 increments (from 0% to 100% of the target award for each such increment) based on the “total shareholder return” of our common stock over a 1-year performance period (measured as the increase of stock price plus reinvested dividends, divided by beginning stock price) as compared with the total shareholder return of a peer group of restaurant companies over the same period. The first such period ended on June 30, 2005. Subsequent periods end on June 30th of each year thereafter with any amounts not earned carried over to possibly be earned over a 2-year or 3-year period. The full award will be considered earned after 5 years based on continued employment if not earned in the first three years based on the performance criteria.

Once earned, the restricted stock units will vest over a period of two years based on continued employment of the holder. On each of the first two anniversaries of the end of the performance period, 50% of the earned restricted stock units will be paid to the holder (half of the units will be paid in cash and half in shares of common stock), provided that the holder is then still employed with Denny’s or an affiliate. During the quarter ended September 27, 2006, we made payments of $0.8 million (before taxes) in cash and issued 0.2 million shares of common stock related to the 0.4 million units that vested as of June 30, 2006.

In March 2006, we granted approximately 0.4 million restricted stock units (which are equity classified) with a grant date fair value of $4.45 per share to certain employees. These restricted stock units will be earned (from 0% to 200% of the target award) based on certain operating performance measures for fiscal 2006. Once earned, the restricted stock units will vest over a period of two years based on continued employment of the holder. Subsequent to the two-year vesting period, the earned restricted stock units will be paid to the holder in shares of common stock, provided the holder is then still employed with Denny's or an affiliate.  As of September 27, 2006, approximately 0.4 million of these units were outstanding.

Compensation expense related to the equity classified units is based on the number of units expected to vest, the period over which the units are expected to vest and the fair market value of the common stock on the grant date. Compensation expense related to the liability classified units is based on the number of units expected to vest, the period over which the units are expected to vest and the fair market value of the common stock on the date of payment. Therefore, balances related to the liability classified units are adjusted to fair value at each balance sheet date. We recognized compensation expense of approximately $0.8 million and $2.6 million for the quarter and three quarters ended September 27, 2006 and $0.4 million and $3.0 million for the quarter and three quarters ended September 28, 2005, respectively, related to the restricted stock units, which is included as a component of general and administrative expenses in our Condensed Consolidated Statements of Operations.

 

At September 27, 2006, approximately $2.4 million of accrued compensation was included as a component of other current liabilities (based on the fair value of the related shares for the liability classified units as of September 27, 2006) and $2.8 million was included as a component of additional paid-in capital in the Condensed Consolidated Balance Sheet related to the equity classified restricted stock units.

As of September 27, 2006, there was approximately $6.8 million of unrecognized compensation cost (approximately $2.8 million for liability classified units and approximately $4.0 million for equity classified units) related to unvested restricted stock unit awards granted, which is expected to be recognized over a weighted average of 3.2 years.

 

 

Non-employee members of the Board of Directors are granted deferred stock units 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 Corporation.  As of September 27, 2006 and December 28, 2005, approximately 0.2 million and 0.1 million of these units were outstanding.

 

 

Total share-based compensation included as a component of net income was as follows (in thousands):

 

 

Prior to the adoption of SFAS 123(R), we accounted for our share-based compensation plans under the provisions of SFAS 123, while continuing to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB 25, and related interpretations. The following table illustrates the effect on net income (loss) and net income (loss) per common share had we applied the fair value recognition provisions of SFAS 123 to share-based compensation for the quarter and three quarters ended September 28, 2005 (in thousands, except for per share amounts):

 

Note 10.   Income Taxes

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

 

 

 

 

In June 2006, the Emerging Issues Task Force ("EITF") ratified EITF Issue 06-3, "How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)." A consensus was reached that entities may adopt a policy of presenting taxes in the income statement on either a gross or net basis. An entity should disclose its policy of presenting taxes and the amount of any taxes presented on a gross basis should be disclosed, if significant. The guidance is effective for periods beginning after December 15, 2006 and we are required to adopt it in the first quarter of fiscal 2007. We present sales net of sales taxes. EITF 06-3 will not impact the method for recording these sales taxes in our Consolidated Financial Statements.

 

 

There are various other 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 reserves reflecting our best estimate of liability, if any, with respect to these matters. However, the ultimate disposition of these matters cannot be determined with certainty.

 

Certain forward-looking statements are included in Management’s Discussion and Analysis of Financial Condition and Results of Operations.  Words such as "expects", "anticipates", "believes", "intends", "plans", and "hopes", variations of such words and similar expressions are intended to identify such forward-looking statements, which reflect our best judgment based on factors currently known.  These statements involve risks, uncertainties, and other factors which may cause our actual performance to be materially different from the performance expressed or implied.  Such factors include, among others: our ability and the ability of our franchisees to open and operate additional restaurants profitably; our ability to attract and retain qualified franchisees; our ability to control restaurant costs; the level of success of our operating initiatives; the level of success of our advertising and promotional efforts; adverse publicity; changes in business strategy or development plans; terms and availability of capital; competitive pressures from within the restaurant industry; changes in minimum wage and other employment laws; regional weather conditions; overall changes in the general economy (including 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 28, 2005.

 

 

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.