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 29, 2005 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 29319-0001 - -------------------------------------------------------------------------------- (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 [X] No [ ] As of August 1, 2005, 91,167,192 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 and Subsidiaries Condensed Consolidated Statements of Operations (Unaudited) <TABLE> <CAPTION> Quarter Ended ------------- June 29, 2005 June 30, 2004 ------------- ------------- (In thousands, except per share amounts) <S> <C> <C> Revenue: Company restaurant sales $ 223,994 $ 217,906 Franchise and license revenue 22,581 21,835 ----------- ----------- Total operating revenue 246,575 239,741 ----------- ----------- Costs of company restaurant sales: Product costs 56,577 56,361 Payroll and benefits 92,897 90,018 Occupancy 12,952 12,142 Other operating expenses 31,419 29,166 ----------- ----------- Total costs of company restaurant sales 193,845 187,687 Costs of franchise and license revenue 7,452 7,049 General and administrative expenses 16,151 14,228 Depreciation and amortization 13,769 14,194 Restructuring charges and exit costs, net 86 (519) Impairment charges 265 497 Gains on disposition of assets and other, net (865) (158) ----------- ----------- Total operating costs and expenses 230,703 222,978 ----------- ----------- Operating income 15,872 16,763 ----------- ----------- Other expenses: Interest expense, net 13,664 19,457 Other nonoperating expense (income), net (88) 1 ----------- ----------- Total other expenses, net 13,576 19,458 ----------- ----------- Income (loss) before income taxes 2,296 (2,695) Provision for income taxes 227 203 ----------- ----------- Net income (loss) $ 2,069 $ (2,898) =========== =========== Net income (loss) per share: Basic $ 0.02 $ (0.07) =========== =========== Diluted $ 0.02 $ (0.07) =========== =========== Weighted average shares outstanding: Basic 90,771 41,258 =========== =========== Diluted 97,835 41,258 =========== =========== </TABLE> See accompanying notes 2
Denny's Corporation and Subsidiaries Condensed Consolidated Statements of Operations (Unaudited) <TABLE> <CAPTION> Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ------------- ------------- (In thousands, except per share amounts) <S> <C> <C> Revenue: Company restaurant sales $ 442,009 $ 425,668 Franchise and license revenue 44,615 43,468 ----------- ----------- Total operating revenue 486,624 469,136 ----------- ----------- Cost of company restaurant sales: Product costs 112,773 109,436 Payroll and benefits 184,556 178,276 Occupancy 26,049 24,690 Other operating expenses 61,540 57,205 ----------- ----------- Total costs of company restaurant sales 384,918 369,607 Costs of franchise and license revenue 14,461 14,217 General and administrative expenses 32,219 29,409 Depreciation and amortization 27,039 28,412 Restructuring charges and exit costs, net 2,360 (414) Impairment charges 265 497 Gains on disposition of assets and other, net (1,750) (232) ----------- ----------- Total operating costs and expenses 459,512 441,496 ----------- ----------- Operating income 27,112 27,640 ----------- ----------- Other expenses: Interest expense, net 26,876 38,925 Other nonoperating income, net (459) (64) ----------- ----------- Total other expenses, net 26,417 38,861 ----------- ----------- Income (loss) before income taxes 695 (11,221) Provision for income taxes 86 407 ----------- ----------- Net income (loss) $ 609 $ (11,628) =========== =========== Net income (loss) per share: Basic $ 0.01 $ (0.28) =========== =========== Diluted $ 0.01 $ (0.28) =========== =========== Weighted average shares outstanding: Basic and diluted 90,495 41,161 =========== =========== Diluted 98,019 41,161 =========== =========== </TABLE> See accompanying notes 3
Denny's Corporation and Subsidiaries Condensed Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> June 29, 2005 December 29, 2004 ------------- ----------------- (In thousands) <S> <C> <C> Assets Current Assets: Cash and cash equivalents $ 27,094 $ 15,561 Receivables, net 12,216 12,375 Inventories 8,041 8,289 Prepaid and other current assets 6,342 7,330 ----------- ----------- Total Current Assets 53,693 43,555 ----------- ----------- Property, net 272,292 285,401 Other Assets: Goodwill 50,186 50,186 Intangible assets, net 74,501 77,484 Deferred financing costs, net 17,507 19,108 Other assets 25,930 24,759 ----------- ----------- Total Assets $ 494,109 $ 500,493 =========== =========== Liabilities Current Liabilities: Current maturities of notes and debentures $ 2,424 $ 1,975 Current maturities of capital lease obligations 3,396 3,396 Accounts payable 34,303 42,647 Other current liabilities 86,471 88,226 ----------- ----------- Total Current Liabilities 126,594 136,244 ----------- ----------- Long-Term Liabilities: Notes and debentures, less current maturities 518,018 519,236 Capital lease obligations, less current maturities 27,020 28,149 Liability for insurance claims 30,424 28,108 Other noncurrent liabilities and deferred credits 52,194 54,186 ----------- ----------- Total Long-Term Liabilities 627,656 629,679 ----------- ----------- Total Liabilities 754,250 765,923 Total Shareholders' Deficit (260,141) (265,430) ----------- ----------- Total Liabilities and Shareholders' Deficit $ 494,109 $ 500,493 =========== =========== </TABLE> See accompanying notes 4
Denny's Corporation and Subsidiaries Condensed Consolidated Statement of Shareholders' Deficit (Unaudited) <TABLE> <CAPTION> Accumulated Additional Accumulated Other Total Common Stock Paid-in Earnings Comprehensive Shareholders' Shares Amount Capital (Deficit) Income (Loss) (Deficit) ------ ------ ------- --------- ------------- --------- (In thousands) <S> <C> <C> <C> <C> <C> <C> Balance, December 29, 2004 89,987 $ 900 $ 510,686 $ (757,303) $ (19,713) $ (265,430) ------ ---- -------- --------- -------- --------- Net income -- -- -- 609 -- 609 Unrealized gain on hedged transaction -- -- -- -- 295 295 Stock option expense -- -- 1,891 -- -- 1,891 Issuance of common stock, pursuant to stock-based compensation plans 373 3 1,635 -- -- 1,638 Exercise of common stock options 662 7 849 -- -- 856 ------ --- -------- --------- --------- --------- Balance, June 29, 2005 91,022 $ 910 $ 515,061 $ (756,694) $ (19,418) $ (260,141) ====== ==== ======== ========= ========= ========= </TABLE> See accompanying notes 5
Denny's Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ------------- ------------- (In thousands) <S> <C> <C> Cash Flows from Operating Activities: Net income (loss) $ 609 $ (11,628) Adjustments to reconcile net income (loss) to cash flows provided by operating activities: Depreciation and amortization 27,039 28,412 Impairment charges 265 497 Restructuring charges and exit costs, net 2,360 (414) Amortization of deferred financing costs 1,748 3,187 Gains on disposition of assets and other, net (1,750) (232) Amortization of debt premium --- (920) Stock option expense 1,891 --- Changes in assets and liabilities, net of effects of acquisitions and dispositions: Decrease (increase) in assets: Receivables 1,594 997 Inventories 248 (541) Other current assets 988 807 Other assets (3,267) (1,048) Increase (decrease) in liabilities: Accounts payable (1,805) (3,767) Accrued salaries and vacations (2,911) 5,768 Accrued taxes 126 (1,320) Other current liabilities 456 6,302 Other noncurrent liabilities and deferred credits 612 (901) ----------- ----------- Net cash flows provided by operating activities 28,203 25,199 ----------- ----------- Cash Flows from Investing Activities: Purchase of property (15,182) (14,156) Proceeds from disposition of property 3,278 526 ----------- ----------- Net cash flows used in investing activities (11,904) (13,630) ----------- ----------- </TABLE> See accompanying notes 6
Denny's Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flows - Continued (Unaudited) <TABLE> <CAPTION> Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ------------- ------------- (In thousands) <S> <C> <C> Cash Flows from Financing Activities: Net borrowings (repayments) under credit agreement $ --- $ (9,350) Long-term debt payments (2,621) (2,338) Deferred financing costs paid (296) --- Proceeds from exercise of stock options 856 266 Costs of equity issuance --- (483) Net bank overdrafts (2,705) (2,989) ----------- ----------- Net cash flows used in financing activities (4,766) (14,894) ----------- ----------- Increase (decrease) in cash and cash equivalents 11,533 (3,325) Cash and Cash Equivalents at: Beginning of period 15,561 7,363 ----------- ----------- End of period $ 27,094 $ 4,038 =========== =========== </TABLE> See accompanying notes 7
Denny's Corporation and Subsidiaries Notes to Condensed Consolidated Financial Statements June 29, 2005 (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 29, 2004 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our 2004 Annual Report on Form 10-K. The results of operations for the quarter ended June 29, 2005 are not necessarily indicative of the results for the entire fiscal year ending December 28, 2005. Note 2. Restructuring Charges and Exit Costs ------------------------------------ Restructuring charges and exit costs consist primarily of severance and outplacement costs for terminated employees and the costs of future obligations related to closed units. In assessing the discounted liabilities for future costs related to units closed or identified for closure prior to December 26, 2002, the date we adopted Statement of Financial Accounting Standards No. 146 "Accounting for Costs Associated with Exit or Disposal Activities," or SFAS 146, 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 net of 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. Restructuring charges and exit costs were comprised of the following: <TABLE> <CAPTION> Quarter Ended Two Quarters Ended ------------- ------------------ June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands) <S> <C> <C> <C> <C> Exit costs, net $ (116) $ (569) $ 747 $ (525) Severance and other restructuring charges 202 50 1,613 111 ------------ ------------- ----------- ------------ Total restructuring and exit costs $ 86 $ (519) $ 2,360 $ (414) ============ ============= =========== ============ </TABLE> 8
The components of the change in accrued exit cost liabilities are as follows: (In thousands) Balance, December 29, 2004 $ 9,841 Provisions for units closed in 2005 788 Reversals of accrued exit costs, net (41) Payments, net (1,378) Interest accretion 533 --------- Balance, June 29, 2005 $ 9,743 ========= Estimated net cash payments related to exit cost liabilities in the next five years are as follows: (In thousands) Remainder of 2005 $ 1,337 2006 1,895 2007 1,373 2008 1,328 2009 1,359 Thereafter 7,881 --------- Total 15,173 Less imputed interest 5,430 --------- Present value of exit cost liabilities $ 9,743 ========= At the beginning of fiscal 2005, the liability for severance and other restructuring charges was $0.1 million. During the two quarters ended June 29, 2005, an additional $1.6 million of expense was recorded, $1.3 million of which was paid during the same period. The remaining balance of $0.4 million is expected to be paid through the first two quarters of 2006. Note 3. Credit Facility --------------- Our subsidiaries, Denny's, Inc. and Denny's Realty, Inc. (the "Borrowers"), have senior secured credit facilities with an aggregate principal amount of $420 million. The credit facilities consist of a first lien facility and a second lien facility. The first lien facility consists of a $225 million five-year term loan facility (the "Term Loan Facility") and a $75 million four-year revolving credit facility, of which $45 million is 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 $0.6 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 highest 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 interest rates on the First Lien Facility and Second Lien Facility at June 29, 2005 were 6.44% and 8.45%, respectively. At June 29, 2005, we had outstanding letters of credit of $37.5 million under our Revolving Facility, leaving net availability of $37.5 million. There were no revolving loans outstanding at June 29, 2005. The Credit Facilities are secured by substantially all of our assets and 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 June 29, 2005. During the first quarter of 2005, we entered into an interest rate swap with a notional amount of $75 million. The Company has designated the interest rate swap as a cash flow hedge of the Company's exposure to variability in future cash flows attributable to payments of LIBOR plus a fixed 3.25% spread due on a related $75 million notional debt obligation under the Term Loan Facility. Under 9
the terms of the swap, the Company will pay a fixed rate of 3.76% on the $75 million notional amount and receive payments from a counterparty based on the 3-month LIBOR rate for a term ending on September 30, 2007. Interest rate differentials paid or received under the swap agreement are 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 (loss). The components of the cash flow hedge included in accumulated other comprehensive income (loss) in the Condensed Consolidated Statement of Shareholders' Deficit for the quarter and two quarters ended June 29, 2005 and June 30, 2004 are as follows: <TABLE> <CAPTION> Quarter Ended Two Quarters Ended ------------- ------------------ June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands) <S> <C> <C> <C> <C> Interest expense recognized as a result of interest rate swaps $ (128) $ --- $ (261) $ --- Unrealized gain (loss) for change in fair value of interest rate swaps (546) --- 556 --- ------------- ------------- ------------- ------------- Net increase (decrease)in Accumulated Other Comprehensive Income (Loss) $ (674) $ --- $ 295 $ --- ============= ============= ============= ============= </TABLE> The Company did not note any ineffectiveness in the hedge during the two quarters ended June 29, 2005. We do not enter into derivative financial instruments for trading or speculative purposes. Note 4. Defined Benefit Plans --------------------- We maintain defined benefit plans which cover a substantial number of employees. Benefits are based upon each employee's years of service and average salary. Our funding policy is based on the minimum amount required under the Employee Retirement Income Security Act of 1974. The pension plan was closed to new participants as of December 31, 1999. Benefits ceased to accrue for pension plan participants as of December 31, 2004. 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: <TABLE> Pension Plan Other Defined Benefit Plans ---------------------------------- -------------------------------- Quarter Ended Quarter Ended ------------- ------------- June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands) <S> <C> <C> <C> <C> Service cost $ 115 $ 120 $ --- $ 77 Interest cost 738 733 59 56 Expected return on plan assets (756) (699) --- --- Amortization of net loss 220 200 8 6 ------------ ------------ ------------ ------------ Net periodic benefit cost $ 317 $ 354 $ 67 $ 139 ============ ============ ============ ============ </TABLE> 10
<TABLE> <CAPTION> Pension Plan Other Defined Benefit Plans ---------------------------------- -------------------------------- Two Quarters Ended Two Quarters Ended ------------------ ------------------ June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands) <S> <C> <C> <C> <C> Service cost $ 230 $ 240 $ --- $ 155 Interest cost 1,476 1,466 118 113 Expected return on plan assets (1,513) (1,398) --- --- Amortization of net loss 441 400 16 12 ------------ ------------ ------------ ------------ Net periodic benefit cost $ 634 $ 708 $ 134 $ 280 ============ ============ ============ ============ </TABLE> We made contributions of $1.3 million and $0.6 million to our pension plan during the two quarters ended June 29, 2005 and June 30, 2004, respectively. We made contributions of $0.7 million and $0.1 million to our other defined benefit plans during the two quarters ended June 29, 2005 and June 30, 2004, respectively. We expect to contribute $1.9 million to our pension plan and $0.1 million to our other defined benefit plans during the remainder of fiscal 2005. Note 5. Stock Based Compensation ------------------------ We have adopted the disclosure-only provisions of SFAS 123, "Accounting for Stock Based Compensation," while continuing to follow Accounting Principles Board Opinion No. 25, or APB 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for our stock-based compensation plans (i.e., the "intrinsic method"). Under APB 25, compensation expense is recognized when the exercise price of our employee stock options is less than the market price of the underlying stock on the date of grant. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Our pro forma information follows: <TABLE> Quarter Ended Two Quarters Ended ------------- ------------------ June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands, except per share amounts) <S> <C> <C> <C> <C> Reported net income (loss) $ 2,069 $ (2,898) $ 609 $ (11,628) Stock-based employee compensation expense included in reported net income (loss), net of related taxes 1,845 328 4,112 655 Less total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (2,551) (415) (5,866) (946) ------------ ------------ ----------- ------------- Pro forma net income (loss) $ 1,363 $ (2,985) $ (1,145) $ (11,919) ============ =--========= =========== ============= Income (loss) per share - as reported: Basic $ 0.02 $ (0.07) $ 0.01 $ (0.28) ============ ============ =========== ============= Diluted $ 0.02 $ (0.07) $ 0.01 $ (0.28) ============ ============ =========== ============= Income (loss) per share - pro forma: Basic $ 0.02 $ (0.07) $ (0.01) $ (0.29) ============ ============ =========== ============= Diluted $ 0.01 $ (0.07) $ (0.01) $ (0.29) ============= ============= ============ ============= </TABLE> Stock-based employee compensation expense, which is included as a component of general and administrative expenses, consisted of $0.7 million related to stock options and $1.2 million related to restricted stock units for the quarter ended June 29, 2005, and $0.3 million related to restricted stock units for the quarter ended June 30, 2004. Stock-based employee compensation expense consisted of $1.9 million related to stock options and $2.6 million related to the restricted stock units for the two quarters ended June 29, 2005, and $0.7 million related to restricted stock units for the two quarters ended June 30, 11
2004. Additionally, 0.3 million shares of common stock were issued during the two quarters ended June 29, 2005 related to restricted stock units earned. Based on the number of options outstanding at June 29, 2005 and their related vesting period, compensation expense related to stock options is estimated to be $1.6 million for the remainder of fiscal 2005. Amounts of additional expense to be recorded related to restricted stock units will be dependent upon meeting certain performance measures and the fair market value of the stock over the performance and vesting periods. As of June 29, 2005, 3.0 million restricted stock units were outstanding, 1.0 million of which have vested. Note 6. 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: <TABLE> <CAPTION> June 29, 2005 December 29, 2004 ------------- ----------------- <S> <C> <C> Additional minimum pension liability $ (19,713) $ (19,713) Unrealized gain on hedged transaction 295 --- ------------ ----------- $ (19,418) $ (19,713) ============ =========== </TABLE> Total comprehensive income (loss) for the two quarters ended June 29, 2005 and June 30, 2004 were $0.9 million and $(11.6) million, respectively. Note 7. Net Income (Loss) Per Share --------------------------- <TABLE> <CAPTION> Quarter Ended Two Quarters Ended June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (In thousands, except per share amounts) <S> <C> <C> <C> <C> Numerator for basic and diluted income (loss) per share -- income (loss) from continuing operations $ 2,069 $ (2,898) $ 609 $ (11,628) ============= ============= ============= ============= Denominator: Denominator for basic income (loss) per share--weighted average shares 90,771 41,258 90,495 41,161 Effect of dilutive securities: Options 5,103 --- 5,437 --- Restricted stock units and awards 1,961 --- 2,087 --- ------------- ------------- ------------- ------------- Denominator for diluted income (loss) per share--adjusted weighted average shares and assumed conversions of dilutive securities 97,835 41,258 98,019 41,161 ============= ============= ============= ============= Basic and diluted income (loss) per share from continuing operations $ 0.02 $ (0.07) $ 0.01 $ (0.28) ============= ============= ============= ============= Stock options excluded (1) 327 6,724 327 6,724 ============= ============= ============= ============= Common stock warrants excluded (1) --- 3,236 --- 3,236 ============= ============= ============= ============= </TABLE> - ----------------------------------------------- (1) Excluded from diluted weighted-average shares outstanding as the impact would have been antidilutive. The common stock warrants expired on January 7, 2005. The dilutive effect of options and restricted stock units and awards outstanding is calculated using the treasury stock method. 12
Note 8. Supplemental Cash Flow Information ---------------------------------- Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ------------- ------------- (In thousands) Income taxes paid, net $ 729 $ 442 =========== =========== Interest paid $ 22,179 $ 35,793 =========== =========== Noncash financing activities: Capital leases entered into $ 589 $ 1,801 =========== =========== Issuance of common stock, pursuant to stock-based compensation plans $ 1,638 $ --- =========== =========== Note 9. Implementation of New Accounting Standards ------------------------------------------ In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised) (SFAS 123-R), "Share-Based Payment". This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123 which had allowed companies to choose between expensing stock options or showing pro forma disclosure only. On April 14, 2005, the SEC announced the adoption of a rule that delays the effective date of SFAS 123-R. This standard will be effective as of the beginning of the Company's 2006 fiscal year and will apply to previously issued and unvested awards, as well as all awards granted, modified, cancelled or repurchased after the effective date. The Company is currently evaluating the expected impact that the adoption of SFAS 123-R will have on its financial condition or results of operations. Pro forma information regarding net income and earnings per share as if we had accounted for our employee stock options granted under the fair value method of SFAS 123 is presented in Note 5 to our Condensed Consolidated Financial Statements. Note 10. Commitments and Contingencies ----------------------------- On September 24, 2002, the California Labor Commission filed a lawsuit in the Superior Court of California, County of Alameda against Denny's Inc. and Denny's Corporation for unpaid vacation benefits, penalties and interest. The lawsuit alleges that Denny's Vacation Pay Plan contains forfeiture clauses that are illegal under California law. Denny's has and intends to continue to vigorously defend this lawsuit, as well as to explore with the California Labor Commission alternatives for resolution of the lawsuit. Denny's is in the process of discovery and is investigating possible affirmative defenses. At this point, it is not possible to determine the total ultimate loss in this matter. Denny's has accrued $3.0 million of liabilities related to this case since its initial filing, approximately $1.0 million of which was recorded during the quarter ended June 29, 2005 based on the current status of mediation efforts. 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. 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, results of operations or cash flows. 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 29, 2005 and results of operations for the quarter and two quarters ended June 29, 2005 compared with the quarter and two quarters ended June 30, 2004. 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 13
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, 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 29, 2004 and in Exhibit 99 thereto. Statements of Operations - ------------------------ <TABLE> <CAPTION> Quarter Ended Two Quarters Ended ------------- ------------------ June 29, 2005 June 30, 2004 June 29, 2005 June 30, 2004 ----------------- ----------------- ----------------- ----------------- (Dollars in thousands) (Dollars in thousands) <S> <C> <C> <C> <C> Revenue: Company restaurant sales...................... $ 223,994 90.8% $ 217,906 90.9% $ 442,009 90.8% $ 425,668 90.7% Franchise and license revenue................. 22,581 9.2% 21,835 9.1% 44,615 9.2% 43,468 9.3% --------- ------ --------- ------ --------- ------ --------- ------ Total operating revenue.................... 246,575 100.0% 239,741 100.0% 486,624 100.0% 469,136 100.0% --------- ------ --------- ------ --------- ------ --------- ------ Costs of company restaurant sales (a): Product costs................................ 56,577 25.3% 56,361 25.9% 112,773 25.5% 109,436 25.7% Payroll and benefits......................... 92,897 41.5% 90,018 41.3% 184,556 41.8% 178,276 41.9% Occupancy.................................... 12,952 5.8% 12,142 5.6% 26,049 5.9% 24,690 5.8% Other operating expenses..................... 31,419 14.0% 29,166 13.4% 61,540 13.9% 57,205 13.4% --------- ------ --------- ------- --------- ------ --------- ------ Total costs of company restaurant sales... 193,845 86.5% 187,687 86.1% 384,918 87.1% 369,607 86.8% Costs of franchise and license revenue (a)..... 7,452 33.0% 7,049 32.3% 14,461 32.4% 14,217 32.7% General and administrative expenses............ 16,151 6.6% 14,228 5.9% 32,219 6.6% 29,409 6.3% Depreciation and amortization.................. 13,769 5.6% 14,194 5.9% 27,039 5.6% 28,412 6.1% Restructuring charges and exit costs, net...... 86 0.0% (519) (0.2%) 2,360 0.5% (414) (0.1%) Impairment charges............................. 265 0.1% 497 0.2% 265 0.1% 497 0.1% Gains on disposition of assets and other, net.. (865) (0.4%) (158) (0.1%) (1,750) (0.4%) (232) 0.0% --------- ------ --------- ------ --------- ------ --------- ------ Total operating costs and expenses........ 230,703 93.6% 222,978 93.0% 459,512 94.4% 441,496 94.1% --------- ------ --------- ------ --------- ------ --------- ------ Operating income............................... 15,872 6.4% 16,763 7.0% 27,112 5.6% 27,640 5.9% --------- ------ --------- ------ --------- ------ --------- ------ Other expenses: Interest expense, net........................ 13,664 5.5% 19,457 8.1% 26,876 5.5% 38,925 8.3% Other nonoperating expense (income), net..... (88) 0.0% 1 0.0% (459) (0.1%) (64) 0.0% --------- ------ --------- ------ --------- ------ --------- ------ Total other expenses, net................. 13,576 5.5% 19,458 8.1% 26,417 5.4% 38,861 8.3% --------- ------ --------- ------ ---------- ------ --------- ------ Income (loss) before income taxes.............. 2,296 0.9% (2,695) (1.1%) 695 0.1% (11,221) (2.4%) Provision for income taxes..................... 227 0.1% 203 0.1% 86 0.0% 407 0.1% --------- ------ --------- ------ --------- ------ --------- ------ Net income (loss) ............................. $ 2,069 0.8% $ (2,898) (1.2%) $ 609 0.1% $ (11,628) (2.5%) ========= ====== ========= ====== ========= ====== ========= ====== Other Data: Company-owned average unit sales............... $ 411.4 $ 393.0 $ 809.4 $ 766.1 Same-store sales increase (company-owned) (b).. 4.1% 4.6% 5.2% 5.5% Guest check average increase (b)............. 5.1% 3.4% 4.2% 3.2% Guest count increase (decrease) (b).......... (1.0%) 1.1% 1.0% 2.2% </TABLE> - ------------------ (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. Unit Activity - ------------- <TABLE> <CAPTION> Ending Units Ending Ending Units Opened/ Units Units Units March 30, 2005 Acquired Closed June 29, 2005 June 30, 2004 -------------- -------- ------ ------------- ------------- <S> <C> <C> <C> <C> <C> Company-owned restaurants 549 --- (1) 548 556 Franchised and licensed restaurants 1,037 12 (9) 1,040 1,063 ----- --- -- ----- ----- 1,586 12 (10) 1,588 1,619 ===== === === ===== ===== </TABLE> 14
Quarter Ended June 29, 2005 Compared with Quarter Ended June 30, 2004 - --------------------------------------------------------------------- Company Restaurant Operations During the quarter ended June 29, 2005, we realized a 4.1% increase in same-store sales, comprised of a 5.1% increase in guest check average and a 1.0% decrease in guest counts. Company restaurant sales increased $6.1 million (2.8%). Higher sales resulted primarily from the increase in same-store sales for the current quarter partially offset by a nine equivalent-unit decrease in company-owned restaurants. The decrease in company-owned restaurants resulted from store closures. Total costs of company restaurant sales as a percentage of company restaurant sales increased to 86.5% from 86.1%. Product costs decreased to 25.3% from 25.9% due to shifts in menu mix and the impact of a higher guest check average. Payroll and benefits increased to 41.5% from 41.3% due to higher investments in labor, wage rate increases and higher fringe benefit related costs. These cost increases were partially offset by a reduction in management bonuses and favorability in health benefit costs. Occupancy costs increased slightly to 5.8% from 5.6% as a result of higher sales based rents. Other operating expenses were comprised of the following amounts and percentages of company restaurant sales: Quarter Ended ------------- June 29, 2005 June 30, 2004 ---------------- ---------------- (Dollars in Thousands) Utilities $ 9,703 4.3% $ 9,376 4.3% Repairs and maintenance 4,424 2.0% 4,171 1.9% Marketing 7,507 3.4% 7,775 3.6% Other 9,785 4.3% 7,844 3.6% ------- ----- --------- ---- Other operating expenses $ 31,419 14.0% $ 29,166 13.4% ======== ===== ========= ===== Other operating expenses for the quarter ended June 29, 2005 includes an increase of $1.0 million in legal settlement expense relating to pending litigation. See Note 10 to our Condensed Consolidated Financial Statements. 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. 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. 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 29, 2005 June 30, 2004 ---------------- ---------------- (Dollars in Thousands) Royalties and initial fees $ 14,892 65.9% $ 14,018 64.2% Occupancy revenue 7,689 34.1% 7,817 35.8% -------- ------ -------- ------ Franchise and license revenue 22,581 100.0% 21,835 100.0% ======== ====== ======== ====== Occupancy costs 5,180 22.9% 5,216 23.9% Other direct costs 2,272 10.1% 1,833 8.4% -------- ------ -------- ------ Costs of franchise and license revenue $ 7,452 33.0% $ 7,049 32.3% ======== ====== ======== ====== The revenue increase of $0.7 million (3.4%) resulted from a 6.1% increase in franchisee same-store sales. The increase was partially offset by a twenty-seven equivalent-unit decrease in franchise and licensed units due to unit closures. 15
Costs of franchise and license revenue increased $0.4 million (5.7%). The increase as a percentage of franchise and license revenue was primarily due to $0.2 million of bad debt expense related to a long-term receivable from a franchisee and costs associated with twelve franchise restaurant openings during the quarter. These increased costs were partially offset by lower occupancy costs compared to the prior year as a result of the decrease in the number of franchise and licensed units. 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 29, 2005 June 30, 2004 ------------- ------------- (Dollars in Thousands) Stock-based compensation $ 2,048 $ 328 Transaction costs --- 560 Other general and administrative expenses 14,103 13,340 ------------- ------------ Total general and administrative expenses $ 16,151 $ 14,228 ============= ============ The increase in stock-based compensation costs resulted from the issuance of stock options and restricted stock units during the fourth quarter of 2004. Additional information related to stock-based compensation is presented in Note 5 to our Condensed Consolidated Financial Statements. Transaction costs recorded in the 2004 quarter represented costs associated with the refinancing transactions completed in the third and fourth quarters of 2004 as further discussed below. Depreciation and amortization decreased slightly to $13.8 million in the second quarter of 2005 from $14.2 million in the second quarter of 2004. Gains on disposition of assets and other, net of $0.9 million in the second quarter of 2005 and $0.2 million in the second quarter of 2004 primarily represent gains on cash sales of surplus properties. Operating income was $15.9 million for the quarter ended June 29, 2005 compared with $16.8 million for the quarter ended June 30, 2004. Interest expense, net for the quarter ended June 29, 2005 was comprised of $14.0 million of interest expense offset by $0.4 million of interest income, compared with $19.8 million of interest expense offset by $0.3 million of interest income for the quarter ended June 30, 2004. The decrease in interest expense is attributable to a reduction in both outstanding borrowings and interest rates as a result of the refinancing transactions completed in the third and fourth quarters of 2004. These refinancing transactions generally consisted of a private placement of common stock, refinancing our previous credit facilities, issuing new senior notes, and repurchasing previously issued senior notes. The provision for income taxes was $0.2 million for each of the quarters ended June 29, 2005 and June 30, 2004. The provision for income taxes for the quarter ended June 29, 2005 was determined using our effective tax rate estimated for the entire fiscal year, as the Company currently expects to have income for the entire fiscal year. The provision for income taxes for the quarter ended June 30, 2004 primarily represents gross receipts-based state and foreign income taxes which do not directly fluctuate in relation to changes in income or 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 generated in previous periods. In establishing our valuation allowance, we have taken into consideration certain tax planning strategies involving the sale of appreciated properties in order to alter the timing of the expiration of 16
certain net operating loss, or NOL, carryforwards in the event they were to expire unused. Such strategies, if implemented in future periods, are considered by us to be prudent and feasible in light of current circumstances. Circumstances may change in future periods such that we can no longer conclude that such tax planning strategies are prudent and feasible, which would require us to record additional deferred tax valuation allowances. Net income was $2.1 million for the quarter ended June 29, 2005 compared with a net loss of $2.9 million for the quarter ended June 30, 2004 due to the factors noted above. Two Quarters Ended June 29, 2005 Compared with Two Quarters Ended June 30, 2004 - ------------------------------------------------------------------------------- Company Restaurant Operations During the two quarters ended June 29, 2005, we realized a 5.2% increase in same-store sales, comprised of a 4.2% increase in guest check average and a 1.0% increase in guest counts. Company restaurant sales increased $16.3 million (3.8%). Higher sales resulted primarily from the increase in same-store sales for the current quarter partially offset by a nine equivalent-unit decrease in company-owned restaurants. The decrease in company-owned restaurants resulted primarily from store closures. Total costs of company restaurant sales as a percentage of company restaurant sales increased to 87.1% from 86.8%. Product costs decreased to 25.5% from 25.7% due to shifts in menu mix and the impact of a higher guest check average. Payroll and benefits decreased slightly to 41.8% from 41.9% due to a reduction in management bonuses and favorability in health benefit costs. These cost reductions were partially offset by higher investments in labor, wage rate increases and higher fringe benefit related costs. Occupancy costs increased slightly to 5.9% from 5.8% as a result of higher sales based rents. Other operating expenses were comprised of the following amounts and percentages of company restaurant sales: Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ---------------- ---------------- (Dollars in Thousands) Utilities $ 19,998 4.5% $ 19,216 4.5% Repairs and maintenance 8,944 2.0% 7,518 1.8% Marketing 14,783 3.3% 15,239 3.6% Other 17,815 4.1% 15,232 3.5% ------- ----- --------- ---- Other operating expenses $ 61,540 13.9% $ 57,205 13.4% ======== ===== ========= ===== Other operating expenses for the two quarters ended June 29, 2005 includes an increase of $1.0 million in legal settlement expense relating to pending litigation. See Note 10 to our Condensed Consolidated Financial Statements. 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 29, 2005 June 30, 2004 ---------------- --------------- (Dollars in Thousands) Royalties and initial fees $ 29,121 65.3% $ 27,925 64.2% Occupancy revenue 15,494 34.7% 15,543 35.8% -------- ------ -------- ------ Franchise and license revenue 44,615 100.0% 43,468 100.0% ======== ====== ======== ====== Occupancy costs 10,448 23.4% 10,603 24.4% Other direct costs 4,013 9.0% 3,614 8.3% -------- ------ -------- ------ Costs of franchise and license revenue $ 14,461 32.4% $ 14,217 32.7% ======== ====== ======== ====== 17
The revenue increase of $1.1 million (2.6%) resulted from a 6.6% increase in franchisee same-store sales. The increase was partially offset by a twenty-six equivalent-unit decrease in franchise and licensed units due to unit closures. Costs of franchise and license revenue increased $0.2 million (1.7%). The increase as a percentage of franchise and license revenue was primarily due to increased franchise operations personnel incentive compensation and costs associated with thirteen franchise restaurant openings during the two quarters ended June 29, 2005. These increased costs were partially offset by lower occupancy costs compared to the prior year as a result of the decrease in the number of franchise and licensed units. Other Operating Costs and Expenses General and administrative expenses are comprised of the following: Two Quarters Ended ------------------ June 29, 2005 June 30, 2004 ------------- ------------- (Dollars in Thousands) Stock-based compensation $ 4,692 $ 655 Transaction costs --- 2,542 Other general and administrative expenses 27,527 26,212 ------------- ------------ Total general and administrative expenses $ 32,219 $ 29,409 ============= ============ The increase in stock-based compensation costs resulted from the issuance of stock options and restricted stock units during the fourth quarter of 2004. Additional information related to stock-based compensation is presented in Note 5 to our Condensed Consolidated Financial Statements. Transaction costs recorded in the 2004 quarters represented costs associated with the refinancing transactions completed in the third and fourth quarters of 2004 as further discussed below. Depreciation and amortization decreased $1.4 million in the first two quarters of 2005 primarily resulting from certain assets becoming fully depreciated at the end of 2004. Gains on disposition of assets and other, net of $1.8 million in the first two quarters of 2005 and $0.2 million in the first two quarters of 2004 primarily represent gains on cash sales of surplus properties. Operating income was $27.1 million for the two quarters ended June 29, 2005 compared with $27.6 million for the two quarters ended June 30, 2004. Interest expense, net for the two quarters ended June 29, 2005 was comprised of $27.6 million of interest expense offset by $0.7 million of interest income, compared with $39.6 million of interest expense offset by $0.7 million of interest income for the two quarters ended June 30, 2004. The decrease in interest expense resulted from the completion of our refinancing transactions during the third and fourth quarters of 2004. The provision for income taxes was $0.1 million for the two quarters ended June 29, 2005 compared with $0.4 million for the two quarters ended June 30, 2004. The provision for income taxes for the two quarters ended June 29, 2005 was determined using our effective tax rate estimated for the entire fiscal year, as the Company currently expects to have income for the entire fiscal year. The provision for income taxes for the two quarters ended June 30, 2004 primarily represents gross receipts-based state and foreign income taxes which do not directly fluctuate in relation to changes in income or 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 generated in previous periods. In establishing our valuation allowance, we have taken into consideration certain tax planning strategies involving the sale of appreciated properties in order to alter the timing of the expiration of 18
certain net operating loss, or NOL, carryforwards in the event they were to expire unused. Such strategies, if implemented in future periods, are considered by us to be prudent and feasible in light of current circumstances. Circumstances may change in future periods such that we can no longer conclude that such tax planning strategies are prudent and feasible, which would require us to record additional deferred tax valuation allowances. Net income was $0.6 million for the two quarters ended June 29, 2005 compared with net loss of $11.6 million for the two quarters ended June 30, 2004 due to the factors noted above. Liquidity and Capital Resources - ------------------------------- Credit Facilities Our subsidiaries, Denny's, Inc. and Denny's Realty, Inc. (the "Borrowers"), have senior secured credit facilities with an aggregate principal amount of $420 million. The credit facilities consist of a first lien facility and a second lien facility. The first lien facility consists of a $225 million five-year term loan facility (the "Term Loan Facility") and a $75 million four-year revolving credit facility, of which $45 million is 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 $0.6 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 highest 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 interest rates on the First Lien Facility and Second Lien Facility at June 29, 2005 were 6.44% and 8.45%, respectively. At June 29, 2005, we had outstanding letters of credit of $37.5 million under our Revolving Facility, leaving net availability of $37.5 million. There were no revolving loans outstanding at June 29, 2005. The Credit Facilities are secured by substantially all of our assets and 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 facility as of June 29, 2005. 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 29, 2005, our capital expenditures were $15.8 million. Of that amount, approximately $0.6 million was financed through capital leases. Capital expenditures during 2005 are expected to total between approximately $55 million and $65 million; however, we are not committed to spending this amount and could spend more or less if circumstances require. 19
Our working capital deficit was $72.9 million at June 29, 2005 compared with $92.7 million at December 29, 2004. 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 9 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 First Lien Facility bear interest at a variable rate based on LIBOR (adjusted LIBOR rate plus 3.25%) or an alternative base rate (highest of Prime Rate or Federal Funds Effective Rate plus 0.5%) plus a spread of 1.75%. Borrowings under the Second Lien Facility bear interest at adjusted LIBOR plus 5.125% or the alternative base rate plus 3.625%. During the first quarter of 2005, we entered into an interest rate swap with a notional amount of $75 million. The Company has designated the interest rate swap as a cash flow hedge of the Company's exposure to variability in future cash flows attributable to payments of LIBOR plus a fixed 3.25% spread due on a related $75 million notional debt obligation under the Term Loan Facility. Under the terms of the swap, the Company will pay a fixed rate of 3.76% on the $75 million notional amount and receive payments from a counterparty based on the 3-month LIBOR rate for a term ending on September 30, 2007. The swap effectively increases our ratio of fixed rate debt from approximately 38% of total debt to approximately 51%. Based on the levels of borrowings under the Credit Facilities at June 29, 2005, if interest rates changed by 100 basis points our annual cash flow and income before income taxes would change by approximately $2.7 million, after considering the impact of the interest rate swap. This computation is determined by considering the impact of hypothetical interest rates on the variable rate portion of the Credit Facilities at June 29, 2005. However, the nature and amount of our borrowings under the Credit Facilities 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 leases) was approximately $181.9 million, compared with a book value of $176.0 million at June 29, 2005. This fair value 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 29, 2005 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 $2.0 million and $0.2 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 $2.1 million and $0.2 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 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, foreign currency exchange rates, commodity prices and other relevant rates and prices. We do not enter into financial instruments for trading or speculative purposes. 20
Item 4. Controls and Procedures As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, our management conducted an evaluation (under the supervision and with the participation of our President and Chief Executive Officer, Nelson J. Marchioli, and our Senior Vice President and Chief Financial Officer, Andrew F. Green) 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 Securities Exchange Act of 1934, as amended. Based on that evaluation, Messrs. Marchioli and Green 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 Securities Exchange Act of 1934, as amended, 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 Securities Exchange Act of 1934, as amended, that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II - OTHER INFORMATION Item 1. Legal Proceedings On September 24, 2002, the California Labor Commission filed a lawsuit in the Superior Court of California, County of Alameda against Denny's Inc. and Denny's Corporation for unpaid vacation benefits, penalties and interest. The lawsuit alleges that Denny's Vacation Pay Plan contains forfeiture clauses that are illegal under California law. Denny's has and intends to continue to vigorously defend this lawsuit, as well as to explore with the California Labor Commission alternatives for resolution of the lawsuit. Denny's is in the process of discovery and is investigating possible affirmative defenses. At this point, it is not possible to determine the total ultimate loss in this matter. Denny's has accrued $3.0 million of liabilities related to this case since its initial filing, approximately $1.0 million of which was recorded during the quarter ended June 29, 2005 based on the current status of mediation efforts. 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. 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, results of operations or cash flows. 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 25, 2005, and 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 63,042,817 164,809 Vada Hill 63,094,087 113,539 Brenda J. Lauderback 63,010,431 197,195 Nelson J. Marchioli 63,094,222 113,404 Robert E. Marks 63,094,022 113,604 Michael Montelongo 63,086,094 121,532 Henry Nasella 63,087,419 120,207 Donald R. Shepherd 63,093,224 114,402 Debra Smithart-Oglesby 63,093,975 113,651 21
(ii) Ratification of the Selection of KPMG LLP as Auditors for the 2005 fiscal ------------------------------------------------------------------------- year ---- Votes For Votes Against Votes Abstaining --------- ------------- ---------------- 63,184,938 13,626 9,062 (iii) Approval of an Amendment to the Denny's Corporation 2004 Omnibus Incentive ------------------------------------------------------------------------- Plan ---- Votes For Votes Against Votes Abstaining --------- ------------- ---------------- 40,742,181 1,774,050 20,027,190 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 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 Certification 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. 10.1 Employment Agreement between Denny's Corporation and Nelson J. Marchioli dated May 11, 2005 (incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 13, 2005). 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: August 5, 2005 By: /s/ Rhonda J. Parish ----------------------------- Rhonda J. Parish Executive Vice President, Chief Administrative Officer, General Counsel and Secretary Date: August 5, 2005 By: /s/ Andrew F. Green ----------------------------- Andrew F. Green Senior Vice President and Chief Financial Officer 23