UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark one) [X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 25, 2003 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to _______ 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 29319-9966 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (864) 597-8000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X] No [ ] As of August 8, 2003, 40,742,929 shares of the registrant's Common Stock, par value $.01 per share, were outstanding. 1
PART I - FINANCIAL INFORMATION Item 1. Financial Statements Denny's Corporation Condensed Consolidated Statements of Operations (Unaudited) <TABLE> <CAPTION> Quarter Quarter Ended Ended June 25, 2003 June 26, 2002 ------------- ------------- <S> <C> <C> (In thousands, except per share amounts) Revenue: Company restaurant sales $ 208,457 $ 217,452 Franchise and license revenue 21,603 22,890 --------- --------- Total operating revenue 230,060 240,342 --------- --------- Costs of company restaurant sales: Product costs 53,008 51,531 Payroll and benefits 92,151 88,112 Occupancy 11,947 12,170 Other operating expenses 28,086 28,583 --------- --------- Total costs of company restaurant sales 185,192 180,396 Costs of franchise and license revenue 6,778 7,376 General and administrative expenses 13,044 14,033 Depreciation and amortization 14,420 20,860 Restructuring charges and exit costs (982) 2,781 Impairment charges 410 497 Gains on disposition of assets and other, net (2,552) (1,764) -------- --------- Total operating costs and expenses 216,310 224,179 -------- --------- Operating income 13,750 16,163 -------- --------- Other expenses: Interest expense, net 18,989 18,920 Gains on exchanges of debt and other, net (127) (19,271) -------- --------- Total other expenses (income), net 18,862 (351) -------- --------- Income (loss) before income taxes (5,112) 16,514 Provision for income taxes 265 302 -------- --------- Net income (loss) $ (5,377) $ 16,212 ========= ========= Per share amounts: Basic and diluted net income (loss) per share $ (0.13) $ 0.40 ========= ========= Weighted average shares outstanding: Basic 40,743 40,276 ========= ========= Diluted 40,743 40,478 ========= ========= </TABLE> See accompanying notes 2
Denny's Corporation Condensed Consolidated Statements of Operations (Unaudited) <TABLE> <CAPTION> Two Quarters Two Quarters Ended Ended June 25, 2003 June 26, 2002 ------------- ------------- <S> <C> <C> (In thousands, except per share amounts) Revenue: Company restaurant sales $ 407,901 $ 429,686 Franchise and license revenue 43,000 45,115 --------- --------- Total operating revenue 450,901 474,801 --------- --------- Cost of company restaurant sales: Product costs 102,083 103,225 Payroll and benefits 180,695 176,404 Occupancy 24,047 24,569 Other operating expenses 56,831 57,890 --------- --------- Total costs of company restaurant sales 363,656 362,088 Costs of franchise and license revenue 13,270 14,621 General and administrative expenses 26,247 28,211 Depreciation and amortization 28,677 41,558 Restructuring charges and exit costs (936) 3,079 Impairment charges 699 497 Gains on disposition of assets and other, net (4,869) (3,580) --------- --------- Total operating costs and expenses 426,744 446,474 --------- --------- Operating income 24,157 28,327 --------- --------- Other expenses: Interest expense, net 38,206 38,207 Gains on exchanges of debt and other, net (120) (19,271) --------- --------- Total other expenses, net 38,086 18,936 --------- --------- Income (loss) before income taxes (13,929) 9,391 Provision for (benefit from) income taxes 530 (2,137) --------- --------- Net income (loss) $ (14,459) $ 11,528 ========= ========= Per share amounts: Basic and diluted income (loss) per share: $ (0.36) $ 0.29 ========= ========= Weighted average shares outstanding: Basic 40,628 40,255 ========= ========= Diluted 40,628 40,443 ========= ========= </TABLE> See accompanying notes 3
Denny's Corporation Condensed Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> June 25, December 25, 2003 2002 ------------ ------------ <S> <C> <C> (In thousands) Assets Current Assets: Cash and cash equivalents $ 4,547 $ 5,717 Receivables, net 7,941 11,980 Inventories 8,643 7,715 Other 12,727 8,329 ---------- ---------- Total Current Assets 33,858 33,741 ---------- ---------- Property, net 307,479 324,725 Other Assets: Goodwill 50,404 50,073 Intangible assets, net 88,502 92,257 Deferred financing costs, net 10,698 12,646 Other 34,324 38,049 ---------- ---------- Total Assets $ 525,265 $ 551,491 ========== ========== Liabilities Current Liabilities: Current maturities of notes and debentures $ 583 $ 554 Current maturities of capital lease obligations 3,536 3,886 Accounts payable 46,937 50,660 Other 90,482 97,703 ---------- ---------- Total Current Liabilities 141,538 152,803 ---------- ---------- Long-Term Liabilities: Notes and debentures, less current maturities 562,468 560,359 Capital lease obligations, less current maturities 29,556 31,177 Liability for insurance claims 24,955 25,160 Other noncurrent liabilities and deferred credits 59,781 60,883 ---------- ---------- Total Long-Term Liabilities 676,760 677,579 ---------- ---------- Total Liabilities 818,298 830,382 Total Shareholders' Deficit (293,033) (278,891) ---------- ---------- Total Liabilities and Shareholders' Deficit $ 525,265 $ 551,491 ========== ========== </TABLE> See accompanying notes 4
Denny's Corporation Condensed Consolidated Statement of Shareholders' Deficit (Unaudited) <TABLE> <CAPTION> Accumulated Additional Other Total Common Stock Paid-in Accumulated Comprehensive Shareholders' Shares Amount Capital Deficit Loss Deficit ------ ------ ---------- ----------- ------------- ------------- <S> <C> <C> <C> <C> <C> (In thousands) Balance, December 25, 2002 40,290 $ 403 $ 417,415 $ (681,733) $ (14,976) $ (278,891) ------ ----- --------- ---------- --------- ---------- Net loss --- --- --- (14,459) --- (14,459) Issuance of common stock 453 4 313 --- --- 317 ------ ----- --------- ---------- ---------- ---------- Balance, June 25, 2003 40,743 $ 407 $ 417,728 $ (696,192) $ (14,976) $ (293,033) ====== ===== ========= ========== ========== ========== </TABLE> See accompanying notes 5
Denny's Corporation Condensed Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> Two Quarters Two Quarters Ended Ended June 25, 2003 June 26, 2002 ------------- ------------- <S> <C> <C> (In thousands) Cash Flows from Operating Activities: Net income (loss) $ (14,459) $ 11,528 Adjustments to reconcile net income (loss) to cash flows provided by operating activities: Depreciation and amortization 28,677 41,558 Impairment charges 699 497 Restructuring charges and exit costs (936) 3,079 Recognition of deferred gains (1,909) (3,776) Amortization of deferred financing costs 2,382 2,097 Gains on disposition of assets and other, net (4,869) (3,580) Amortization of debt premium (802) (947) Gain on early extinguishment of debt --- (19,246) Changes in assets and liabilities, net of effects of acquisitions and dispositions: Decrease (increase) in assets: Receivables 4,640 (916) Inventories (928) 124 Other current assets (4,319) 2,800 Other assets (743) 303 Increase (decrease) in liabilities: Accounts payable 1,042 (2,383) Accrued salaries and vacations (384) (6,644) Accrued taxes 17 578 Other accrued liabilities (3,247) (7,797) Other noncurrent liabilities and deferred credits (2,341) (5,540) --------- --------- Net cash flows provided by operating activities 2,520 11,735 --------- --------- Cash Flows from Investing Activities: Purchase of property (13,958) (13,853) Proceeds from disposition of property 11,882 5,451 Receipts from discontinued operations, net --- 4,086 Deposits made to secure FRD letters of credit --- 4,083 --------- --------- Net cash flows used in investing activities (2,076) (233) --------- --------- </TABLE> See accompanying notes 6
Denny's Corporation Condensed Consolidated Statements of Cash Flows - Continued (Unaudited) <TABLE> <CAPTION> Two Quarters Two Quarters Ended Ended June 25, 2003 June 26, 2002 ------------- ------------- <S> <C> <C> (In thousands) Cash Flows from Financing Activities: Net borrowings under credit agreement $ 3,200 $ 3,300 Long-term debt payments (2,258) (2,799) Deferred financing costs paid (1,058) (1,920) Proceeds from exercise of stock options --- 26 Net bank overdrafts (1,498) (13,133) ---------- ---------- Net cash flows used in financing activities (1,614) (14,526) ---------- ---------- Decrease in cash and cash equivalents (1,170) (3,024) Cash and Cash Equivalents at: Beginning of period 5,717 6,696 ---------- ---------- End of period $ 4,547 $ 3,672 ========== ========== </TABLE> See accompanying notes 7
Denny's Corporation Notes to Condensed Consolidated Financial Statements June 25, 2003 (Unaudited) Note 1. General - ---------------- 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 consolidated financial statements are unaudited and include all adjustments we believe are necessary for a fair presentation of the results of operations for such interim periods. All 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 25, 2002 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our 2002 Annual Report on Form 10-K. The results of operations for the two quarters ended June 25, 2003 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2003. Note 2. Restructuring Charges and Exit Costs - --------------------------------------------- As a result of changes in our organizational structure and in our portfolio of restaurants, we have recorded charges for restructuring and exit costs. These costs consist primarily of severance and outplacement costs for terminated employees and the costs of future obligations related to closed units. In assessing the cost of obligations related to units closed or identified for closure prior to December 26, 2002, the date we adopted SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities," we make assumptions regarding the timing of units' closures, amounts of future subleases, amounts of future property taxes and costs of closing the units. If these assumptions or their related estimates change in the future, we may be required to record additional exit costs or reduce exit costs previously recorded. Exit costs recorded for each of the periods presented include the effect of such changes in estimates. As a result of the adoption of SFAS 146, discounted liabilities for future lease costs and the fair value of related subleases of units closed after December 25, 2002 are recorded when the unit is closed. All other costs related to unit closures, including property taxes and maintenance related costs, are expensed as incurred. The following table summarizes the activity for the two quarters ended June 25, 2003 related to discounted accrued exit cost liabilities: (in thousands) Balance, December 25, 2002 $ 19,680 Reversal of accrued exit costs, net (1,526) Payments, net (5,171) Interest accretion 980 -------- Balance, June 25, 2003 $ 13,963 ======== During the two quarters ended June 25, 2003, we entered into a settlement agreement on the lease for our former corporate headquarters. As a result we recorded a reversal of approximately $1.6 million of related exit costs. In addition, we recorded approximately $0.6 million of restructuring charges related to the elimination of twenty out-of-restaurant support staff positions. 8
Estimated net cash payments related to exit cost liabilities at June 25, 2003 are as follows: (in thousands) Remainder of 2003 $ 2,491 2004 3,290 2005 2,173 2006 1,729 2007 1,477 Subsequent years 9,324 -------- Total 20,484 Less imputed interest 6,521 -------- Discounted accrued exit cost liabilities $ 13,963 ======== Note 3. Capital Structure - -------------------------- Stock Based Compensation We account for stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation cost is reflected in the condensed consolidated statement of operations, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation", or SFAS 123, to stock-based employee compensation. <TABLE> <CAPTION> Quarter Ended Two Quarters Ended ------------- ------------------ June 25, June 26, June 25, June 26, 2003 2002 2003 2002 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> (in thousands, except per share amounts) Net income (loss), as reported $ (5,377) $ 16,212 $ (14,459) $ 11,528 Total stock-based employee compensation expense determined under fair value based method for all awards 377 519 760 1,012 --------- --------- --------- --------- Pro forma net income (loss) $ (5,754) $ 15,693 $ (15,219) $ 10,516 ========= ========= ========= ========= Income (loss) per share: Basic and diluted - as reported $ (0.13) $ 0.40 $ (0.36) $ 0.29 ========= ========= ========= ========= Basic and diluted - pro forma $ (0.14) $ 0.39 $ (0.37) $ 0.26 ========= ========= ========= ========= </TABLE> Income (Loss) Per Share The calculations of basic and diluted income (loss) per share have been based on the weighted average number of shares outstanding. Warrants have been omitted from the calculation of weighted average diluted shares for all periods as they would be antidilutive. Because of the net loss for the quarter and two quarters ended June 25, 2003, options have been omitted from the calculation of weighted average diluted shares. Common stock equivalents for the quarter and two quarters ended June 26, 2002 were 202 and 188, respectively. Note 4. Revolving Credit Facility - ---------------------------------- In December of fiscal 2002, we entered into a new senior secured credit facility, or credit facility, which provides Denny's with a working capital and letter of credit facility of up to $125 million. The credit facility matures on December 20, 2004. At June 25, 2003, we had working capital advances of $49.9 million and letters of credit outstanding of $38.3 million under our credit facility, leaving net availability of $36.8 million. Advances under the credit facility accrue interest at a variable rate (approximately 6.3% at June 25, 2003) based on the prime rate or an adjusted Eurodollar rate. 9
Profitability was below our expectations for the first two quarters of 2003. Accordingly, we were required to obtain an amendment to the credit facility to provide less restrictive financial covenants effective for the quarter ended June 25, 2003 and for the remaining term of the facility. We were in compliance with the terms of the credit facility, as amended, as of June 25, 2003. Also, pursuant to the amendment, the proceeds of certain additional debt issued by Denny's Holdings (a wholly-owned subsidiary of Denny's Corporation) subsequent to the amendment may be used for general corporate purposes or to repay the credit facility without a concurrent reduction of the facility commitments. Note 5. Supplemental Cash Flow Information - ------------------------------------------- <TABLE> <CAPTION> Two Quarters Ended ------------------ June 25, June 26, 2003 2002 ------------- ------------- <S> <C> <C> (in thousands) Income taxes paid, net $ 18 $ 613 =========== =========== Interest paid, net $ 34,053 $ 37,219 =========== =========== Noncash investing activities: Notes received related to sale of properties $ --- $ 82 =========== ============ Receivables forgiven related to reacquisition of restaurants $ 366 $ 186 =========== ============ Noncash financing activities: Capital leases entered into $ 412 $ 688 =========== ============ </TABLE> Note 6. Implementation of New Accounting Standards - --------------------------------------------------- In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement replaces Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a Restructuring)". The principal difference between SFAS 146 and EITF 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity's commitment to an exit plan. A fundamental conclusion reached by the Board in SFAS 146 is that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. SFAS 146 eliminates the definition and requirements for recognition of exit costs in EITF 94-3. This statement also establishes that fair value is the objective for initial measurement of the liability. The adoption of SFAS 146 did not have a material impact on our financial position and results of operations; however, the timing of the recognition of future costs under SFAS 146 is substantially different than the timing under EITF 94-3. SFAS 146 is effective for exit and disposal activities initiated after December 31, 2002. In November 2002, the FASB issued Interpretation No. 45, or FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on the Company's consolidated financial statements. 10
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51". This interpretation addresses the consolidation by business enterprises of variable interest entities, as defined in the interpretation, and sets forth additional disclosure regarding such interests. FIN 46 applies immediately to variable interest entities created, or in which the Company obtains an interest, after January 31, 2003, and becomes effective June 26, 2003 for all variable interest entities held by the Company prior to that date. The adoption of FIN 46 has not had and is not expected to have a material effect on the Company's consolidated financial statements. In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123." SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation" and provides for alternative methods for accounting for a change by registrants to the fair value method of accounting for stock-based compensation. Additionally, SFAS 148 amends the disclosure requirements of SFAS 123 to require disclosure in the significant accounting policy footnote of both annual and interim financial statements of the method of accounting for stock-based compensation and the related pro-forma disclosures when the intrinsic value method continues to be used. SFAS 148 is effective for fiscal years beginning after December 15, 2002. Annual disclosures are effective for years ending after December 15, 2002. Interim disclosures are effective for the first fiscal quarter beginning after December 31, 2002. See Note 3. In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS 150 requires issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not have any financial instruments within the scope of the SFAS 150 as of June 25, 2003, and, therefore, does not anticipate that SFAS 150 will have a material impact to the Company's consolidated financial statements. 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 25, 2003 and results of operations for the quarter and two quarters ended June 25, 2003 compared to the quarter and two quarters ended June 26, 2002. 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, including the initiatives and efforts specifically mentioned herein; adverse publicity; changes in business strategy or development plans; terms and availability of capital; regional weather conditions; overall changes in the general economy, particularly at the retail level; political environment (including acts of war and terrorism); and other factors included in the discussion below, or in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 25, 2002 and in Exhibit 99 thereto. 11
Restaurant Operations and Unit Activity - --------------------------------------- <TABLE> <CAPTION> Quarter Ended Two Quarters Ended ------------- ------------------ June 25, June 26, Increase/ June 25, June 26, Increase/ 2003 2002 (Decrease) 2003 2002 (Decrease) -------- -------- ---------- -------- -------- ---------- <S> <C> <C> <C> <C> <C> <C> (Dollars in thousands) Total systemwide sales (a) $ 545,685 $ 562,846 (3.0%) $ 1,071,650 $ 1,104,668 (3.0%) Company-owned data: Average unit sales 372.2 368.9 0.9% 727.0 717.2 1.4% Same-store sales decrease (b)(c) (0.6%) (0.4%) (0.5%) (0.3%) Guest check average increase (b)(c) 3.9% 2.1% 3.2% 1.7% Guest count decrease (b)(c) (4.3%) (2.4%) (3.6%) (1.9%) Franchise data: Average unit sales 300.4 305.5 (1.7%) 593.1 597.2 (0.7%) Same-store sales decrease (b)(c) (2.1%) (1.3%) (1.8%) (1.3%) </TABLE> - ------------------ (a) Total systemwide sales includes sales from company-owned, franchised and licensed restaurants and is not a measure which has been determined in accordance with accounting principles generally accepted in the United States of America. (b) Same-store sales, guest check average, and guest count calculations include restaurants that were open the same days in both the current year and prior year. (c) Prior year amounts have not been restated for 2003 comparable units. The table below summarizes Denny's restaurant unit activity for the quarter ended June 25, 2003. <TABLE> <CAPTION> Ending Ending Ending Units Units Franchised Units Units March 26, Opened/ Units Units June 25, June 26, 2003 Acquired Reacquired Closed 2003 2002 --------- -------- ---------- ------ -------- -------- <S> <C> <C> <C> <C> <C> <C> Company-owned 563 --- 1 (1) 563 588 Franchised units 1,091 5 (1) (10) 1,085 1,112 Licensed units 15 --- --- --- 15 14 ------ --- --- --- ----- ----- 1,669 5 --- (11) 1,663 1,714 ====== === === === ===== ===== </TABLE> 12
Results of Operations - --------------------- Quarter Ended June 25, 2003 Compared to Quarter Ended June 26, 2002 - ------------------------------------------------------------------- Company Operations Company restaurant sales are the revenues generated from restaurants operated by Denny's. Company restaurant sales decreased $9.0 million (4.1%) due to a net 25-unit decrease in company-owned restaurants and a 0.6% decline in same-store sales for the current quarter. The decrease in company-owned restaurants resulted from store closures and the sale of restaurants to franchisees. Total costs of company restaurant sales increased $4.8 million (2.7%). As a percentage of company restaurant sales, total costs of company restaurant sales increased to 88.8% from 83.0%. Product costs increased to 25.4% from 23.7%, including a $0.9 million reduction of deferred gain amortization related to the sale of former distribution subsidiaries in previous years. Excluding deferred gains for both years, product costs as a percentage of sales were 25.9% in 2003 and 24.6% in 2002. This increase resulted from a shift in menu mix and increases in commodity costs, especially pork. Payroll and benefits increased to 44.2% from 40.5% due to higher medical costs, increased restaurant staffing levels aimed at improving customer satisfaction and higher wage rates. Occupancy costs increased to 5.7% from 5.6% of company restaurant sales. Other operating expenses increased to 13.5% from 13.1% as a result of increases in utilities and repairs and maintenance expenses compared to the prior quarter, partially offset by lower marketing expenses. Franchise Operations Franchise and license revenues are the revenues received by Denny's from its franchisees and include royalties, initial franchise fees and occupancy revenue related to restaurants leased or subleased to franchisees. The composition of the franchise portfolio and the nature of individual lease arrangements have a significant impact on franchise occupancy revenue, as well as the related franchise occupancy expense and franchise operating margins. Franchise and license revenue was $21.6 million for the quarter ended June 25, 2003, comprised of royalties and initial franchise fees of $13.5 million and occupancy revenue of $8.1 million, compared with $22.9 million for the quarter ended June 26, 2002, comprised of royalties and fees of $14.5 million and occupancy revenues of $8.4 million. The revenue decrease of $1.3 million (5.6%) resulted primarily from a 26-unit decrease in franchised and licensed units due to unit closures and a decrease in initial franchise fees on fewer franchise restaurant openings compared to the prior year quarter. Costs of franchise and license revenue include occupancy costs related to restaurants leased or subleased to franchisees and direct costs consisting primarily of payroll and benefit costs of franchise operations personnel and bad debt expense. Costs of franchise and license revenue were $6.8 million for the quarter ended June 25, 2003, comprised of occupancy costs of $5.4 million and other direct expenses of $1.4 million, compared with $7.4 million for the quarter ended June 26, 2002, comprised of occupancy costs of $5.7 million and other direct expenses of $1.7 million. Costs of franchise and license revenue decreased $0.6 million (8.1%) as a result of a decrease in initial expenses associated with the opening of new restaurants and reductions in other direct expenses. As a percentage of franchise and license revenues, these costs decreased to 31.4% for the quarter ended June 25, 2003 from 32.2% for the quarter ended June 26, 2002. 13
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 decreased $1.0 million (7.0%) compared with the prior year quarter. The decrease resulted primarily from reductions in corporate overhead costs related to organizational changes and lower accruals for incentive compensation because certain annual bonus targets for 2003 are not projected to be met. Depreciation and amortization decreased $6.4 million primarily resulting from certain assets becoming fully depreciated. In January 1998, certain assets were revalued and assigned a five year life as a result of the company's emergence from bankruptcy. Those assets became fully amortized in January 2003. Restructuring and exit costs for the quarter ended June 25, 2003 reflect the reversal of rent obligations resulting from our release from the remaining lease term of our former corporate headquarters in California. See Note 2 to our Condensed Consolidated Financial Statements. Gains on disposition of assets and other, net of $2.6 million in 2003 and $1.8 million in 2002 primarily represented gains on sales of surplus properties. Operating income was $13.8 million for the quarter ended June 25, 2003 compared with income of $16.2 million for the quarter ended June 26, 2002. Interest expense, net for the quarter ended June 25, 2003 was comprised of $19.4 million interest expense offset by $0.4 million interest income compared with $20.1 million interest expense offset by $1.2 million interest income for the quarter ended June 26, 2002. The decrease in interest expense resulted from lower borrowings under our credit facility during 2003 and the effects of our senior note exchanges during 2002, partially offset by higher deferred financing cost amortization related to our credit facility. The decrease in interest income resulted from the repayment in 2002 of the credit facility of FRD Acquisition Co., our former subsidiary (with respect to which Denny's was the lender). Gains on exchanges of debt and other, net of $19.2 million for the quarter ended June 26, 2002 primarily represents a gain on the exchange of a portion of our 11 1/4% Senior Notes for 12 3/4% Senior Notes. The provision for income taxes was $0.3 million for each of the quarters ended June 25, 2003 and June 26, 2002, respectively. These provisions for income taxes primarily represent gross receipts based state and foreign income taxes which do not directly fluctuate in relation to changes in loss 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. Accordingly, no additional (benefit from) or provision for income taxes has been reported for the periods presented. Net loss was $5.4 million for the quarter ended June 25, 2003 compared with net income of $16.2 million for the quarter ended June 26, 2002 due to the factors noted above. 14
Results of Operations - --------------------- Two Quarters Ended June 25, 2003 Compared to Two Quarters Ended June 26, 2002 - ----------------------------------------------------------------------------- Company Operations Company restaurant sales decreased $21.8 million (5.1%) primarily due to a net 25-unit decrease in company-owned restaurants. The decrease in company-owned restaurants resulted from store closures and the sale of restaurants to franchisees. Total costs of company restaurant sales increased $1.6 million (0.4%). As a percentage of company restaurant sales, total costs of company restaurant sales increased to 89.2% from 84.3%. Product costs increased to 25.0% from 24.0%, including a $1.9 million reduction of deferred gain amortization related to the sale of former distribution subsidiaries in previous years. Excluding deferred gains for both years, product costs as a percentage of sales were 25.5% in 2003 and 24.9% in 2002. This increase resulted from a shift in menu mix and increases in commodity costs, especially pork. Payroll and benefits increased to 44.3% from 41.1% due to higher medical costs, increased restaurant staffing levels aimed at improving customer satisfaction and higher wage rates. Occupancy costs increased to 5.9% from 5.7% of company restaurant sales. Other operating expenses increased to 13.9% from 13.5% as a result of increases in utilities and repairs and maintenance, partially offset by lower marketing expenses. Franchise Operations Franchise and license revenues are the revenues received by Denny's from its franchisees and include royalties, initial franchise fees and occupancy revenue related to restaurants leased or subleased to franchisees. Franchise and license revenue was $43.0 million for the two quarters ended June 25, 2003, comprised of royalties and initial franchise fees of $26.8 million and occupancy revenue of $16.2 million, compared with $45.1 million for the two quarters ended June 26, 2002, comprised of royalties and fees of $28.0 million and occupancy revenue of $17.1 million. The revenue decrease of $2.1 million (4.7%) resulted primarily from a 26-unit decrease in franchised and licensed units due to unit closures and a decrease in initial franchise fees on fewer franchise restaurant openings. Costs of franchise and license revenue include occupancy costs related to restaurants leased or subleased to franchisees and direct costs consisting primarily of payroll and benefit costs of franchise operations personnel and bad debt expense. Costs of franchise and license revenue were $13.3 million for the two quarters ended June 25, 2003, comprised of occupancy costs of $10.9 million and other direct expenses of $2.4 million compared with $14.6 million for the two quarters ended June 26, 2002, comprised of occupancy costs of $11.2 million and other direct expenses of $3.4 million. Costs of franchise and license revenue decreased $1.4 million (9.2%) as a result of a decrease in initial expenses associated with the opening of new restaurants and a net $0.3 million reduction in bad debt expense. As a percentage of franchise and license revenues, these costs decreased to 30.9% in the two quarters ended June 25, 2003 from 32.4% in the two quarters ended June 26, 2002. 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 decreased $2.0 million (7.0 %) compared to the two quarters ended June 26, 2002. The decrease resulted primarily from reductions in corporate overhead related to organizational changes and lower accruals for incentive compensation because certain annual bonus targets for 2003 are not projected to be met. 15
Depreciation and other amortization decreased $12.9 million primarily resulting from certain assets becoming fully depreciated. In January 1998, certain assets were revalued and assigned a five year life as a result of the company's emergence from bankruptcy. Those assets became fully amortized in January 2003. Restructuring and exit costs for the two quarters ended June 25, 2003 reflect the reversal of rent obligations resulting from our release from the remaining lease term of our former corporate headquarters in California. See Note 2 to our Condensed Consolidated Financial Statements. Gains on disposition of assets and other, net of $4.9 million in 2003 and $3.6 million in 2002 primarily represent gains on sales of surplus properties. Operating income was $24.2 million for the two quarters ended June 25, 2003 compared with income of $28.3 million for the two quarters ended June 26, 2002. Interest expense, net, for the two quarters ended June 25, 2003 was comprised of $38.9 million interest expense offset by $0.7 million interest income compared with $40.6 million interest expense offset by $2.4 million interest income for the two quarters ended June 26, 2002. The decrease in interest expense resulted from lower borrowings under our credit facility during 2003 and the effects of our senior note exchanges during 2002, partially offset by higher deferred financing cost amortization related to our credit facility. The decrease in interest income resulted from the repayment in 2002 of the credit facility of FRD Acquisition Co., our former subsidiary (with respect to which Denny's was the lender). Gains on exchanges of debt and other, net of $19.2 million for the two quarters ended June 26, 2002 primarily represents a gain on the exchange of a portion of our 11 1/4% Senior Notes for 12 3/4% Senior Notes. The provision for (benefit from) income taxes was $0.5 million and $(2.1) million for the two quarters ended June 25, 2003 and June 26, 2002, respectively. Included in income taxes for the two quarters ended June 26, 2002 was a $2.7 million benefit related to the enactment of H.R. 3090, the Job Creation and Worker Assistant Act of 2002. Excluding this benefit, we recorded a provision for income taxes of $0.6 million for the two quarters ended June 26, 2002. These provisions for income taxes primarily represent gross receipts based state and foreign income taxes which do not directly fluctuate in relation to changes in loss 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. Accordingly, no additional (benefit from) or provision for income taxes has been reported for the periods presented. Net loss was $14.5 million for the two quarters ended June 25, 2003 compared with net income of $11.5 million for the two quarters ended June 26, 2002 due to the factors noted above. Liquidity and Capital Resources - ------------------------------- Revolving Credit Facility In December 2002, we entered into a new senior secured credit facility, or credit facility, which provides Denny's with a working capital and letter of credit facility of up to $125 million. The credit facility matures on December 20, 2004. At June 25, 2003, we had working capital advances of $49.9 million and letters of credit outstanding of $38.3 million under the new credit facility, leaving net availability of $36.8 million. Advances under the credit facility accrue interest at a variable rate (approximately 6.3% at June 25, 2003) based on the prime rate or an adjusted Eurodollar rate. 16
Profitability was below our expectations for the first two quarters of 2003. Accordingly, we were required to obtain an amendment to the credit facility to provide less restrictive financial covenants effective for the quarter ended June 25, 2003 and for the remaining term of the facility. We were in compliance with the terms of the credit facility, as amended, as of June 25, 2003. Under the most restrictive provisions of the amended credit facility (minimum EBITDA test, as defined in the credit facility), EBITDA could have been approximately $5.4 million less for the four quarters ended June 25, 2003 and we would still have been in compliance. Also, pursuant to the amendment, the proceeds of certain additional debt issued by Denny's Holdings (a wholly-owned subsidiary of Denny's Corporation) subsequent to the amendment may be used for general corporate purposes or to repay the credit facility without a concurrent reduction of the facility commitments. Cash Requirements Our principal capital requirements have been largely associated with remodeling and maintaining our existing restaurants and facilities. For the two quarters ended June 25, 2003, our capital expenditures were $14.4 million. Of that amount, approximately $0.4 million was financed through capital leases. Capital expenditures during 2003 are expected to total $35.0 million to $40.0 million; however, we are not committed to spending this amount and could spend more or less if circumstances require. Historically, we have met our liquidity requirements with funds from operations, amounts available under our credit facility, and funds from selected asset sales. Although we believe that these sources will provide adequate funds to cover our liquidity needs through 2003, we may be required to seek additional sources of funds including additional financing sources and continued selected asset sales to maintain sufficient cash flow to fund our ongoing operating needs, pay interest and scheduled debt amortization and fund anticipated capital expenditures over the next twelve months. We believe that we would be able to access these additional sources of funds, if needed; however, no assurances can be given that we would be able to do so on commercially reasonable terms. Our working capital deficit was $107.7 million at June 25, 2003 compared with $119.1 million at December 25, 2002. This working capital deficit decrease of $11.4 million resulted primarily from the use of cash on hand and borrowings under the credit facility to satisfy current liabilities. 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 Note 6 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 credit facility bear interest at a variable rate based on the prime rate or an adjusted Eurodollar rate. A 100 basis point change in the credit facility interest rate (approximately 6.3% at June 25, 2003) would cause the interest expense for the remainder of 2003 to change by approximately $0.2 million. This computation is determined by considering the impact of hypothetical interest rates on our variable long-term debt at June 25, 2003. 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. 17
Our other outstanding long-term debt bears fixed rates of interest. The estimated fair value of our fixed rate long-term debt (excluding capital leases) was approximately $418.7 million at June 25, 2003. The carrying value of such debt was approximately $513.2 million at June 25, 2003. This computation is based on market quotations for the same or similar debt issues or the estimated borrowing rates available to us. The difference in the estimated fair value of long-term debt compared to its historical cost reported in our consolidated balance sheets at June 25, 2003 relates primarily to market quotations for our 11 1/4% Notes. We have established a policy to identify, control and manage market risks which may arise from changes in interest rates, foreign currency exchange rates, commodity prices and other relevant rates and prices. We do not use derivative instruments for trading purposes, and no interest rate or other financial derivatives were in place at June 25, 2003. Item 4. Controls and Procedures As of the end of the period covered by this report, we carried out an evaluation (under the supervision and with the participation of management, including our President and Chief Executive Officer, Nelson J. Marchioli, and our Senior Vice President and Chief Financial Officer, Andrew F. Green) of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(b) of the Securities Exchange Act of 1934, as amended. Based upon the evaluation, Messrs. Marchioli and Green each concluded that disclosure controls and procedures are effective in timely alerting them to material information required to be included in Denny's Corporation's periodic SEC filings. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 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. Our ultimate legal and financial liability with respect to these matters cannot be estimated with certainty. However, we believe, based on our examination of these matters and our experience to date, that the ultimate disposition of them will not significantly affect our financial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of stockholders of Denny's Corporation was held on Thursday, May 29, 2003, at which the following matters were voted on by the stockholders of Denny's Corporation: (i) Election of Directors --------------------- Votes Against Name Votes For or Withheld ---- --------- ----------- Vera K. Farris 32,299,803 513,305 Vada Hill 32,300,623 512,485 Nelson J. Marchioli 32,256,318 556,790 Robert E. Marks 32,299,825 513,283 Charles F. Moran 32,299,347 513,761 Elizabeth A. Sanders 32,300,804 512,304 Donald R. Shepherd 32,299,803 513,305 Debra Smithart-Oglesby 32,300,621 512,489 18
(ii) Ratification of the Selection of KPMG LLP as Auditors for the 2003 fiscal ------------------------------------------------------------------------- year ---- Votes For Votes Against Votes Abstaining --------- ------------- ---------------- 32,306,757 22,205 484,146 (iii) Approval of 2003 Incentive Program for the Company's Employees -------------------------------------------------------------- Votes For Votes Against Votes Abstaining --------- ------------- ---------------- 30,741,659 2,064,746 6,705 Item 6. Exhibits and Reports on Form 8-K a. The following are included as exhibits to this report: Exhibit No. Description ------- ----------- 10.1 Amendment, dated May 30, 2003, to the Employment Agreement, dated January 2, 2001, between Nelson J. Marchioli and Advantica Restaurant Group, Inc. (now known as Denny's Corporation). 10.2 Amendment No. 1, dated as of June 30, 2003, to the Credit Agreement, dated as of December 16, 2002, among Denny's Inc. and Denny's Realty, Inc., as borrowers, Denny's Corporation, Denny's Holdings, Inc. and DFO, Inc., as guarantors, the lenders named therein, JPMorgan Chase Bank as issuing bank, administrative agent, and collateral agent, and Foothill Capital Corporation, as syndication agent. 31.1 Statement 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 Statement of Andrew F. Green, Senior Vice President 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 Statement of Nelson J. Marchioli, President and Chief Executive Officer of Denny's Corporation and Andrew F. Green, Senior Vice President 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. b. On April 17, 2003, we reported on Form 8-K (under Item 9) that, on April 10, 2003, we issued a press release announcing same-store sales for our company-owned restaurants during the five weeks period and the quarter ended March 26, 2003. On April 30, 2003, we reported on Form 8-K/A (under Item 4), amending our report on Form 8-K (under Item 4) filed on April 23, 2003, that we notified Deloitte & Touche LLP that it would not be retained to perform the audit of our company's financial statements for the fiscal year ended December 31, 2003. We also reported that we engaged KPMG LLP as independent accountants to audit the company's financial statements for the fiscal year ended December 31, 2003. On May 8, 2003, we reported on Form 8-K (under Item 9) that we issued a press release on May 7, 2003 announcing financial results for the quarter ended March 26, 2003. 19
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: August 6, 2003 By: /s/ Rhonda J. Parish -------------------- Rhonda J. Parish Executive Vice President, General Counsel and Secretary Date: August 6, 2003 By: /s/ Andrew F. Green ------------------- Andrew F. Green Senior Vice President and Chief Financial Officer 20