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Denny’s Corporation’s (DENN - Snapshot Report) second-quarter 2013 adjusted earnings of 8 cents per share beat both the Zacks Consensus Estimate and the year-ago quarter’s earnings of 7 cents by 14.3%. Earnings in the quarter received a boost from lower taxes and reduced share count in the quarter.

Total operating revenues was nearly $117 million in line with the Zacks Consensus Estimate but were lower than the year-ago quarter’s revenues by 6.5%. Lower company restaurant sales pressurized the total revenue during the quarter.

Performance Highlights in the Quarter

During the quarter, sales at the company-operated restaurants declined 9.2% year over year to $82.8 million, with the decline in the number of company restaurants annually by 24 owing to the company’s divestment and refranchising activities and decline in same-store sales (comps).

Franchise and license revenues increased 0.7% to $33.7 million, attributable to an improvement in royalties as well as occupancies, propelled by 32 additional franchised restaurants in operation at the end of the quarter in comparison with the year-ago quarter.

Due to a 1.7% decline in traffic at company-owned units, comps at company restaurants were down 0.5%. Comps at franchised restaurants were up 0.7% with the rise in guest check average offsetting the decline in same-store traffic. System-wide same-restaurant sales (comps) nudged up 0.6%, lower than a 0.8% growth in overall comps witnessed in the year-earlier quarter.

Company-operated restaurants’ operating margin contracted 110 basis points (bps) to 13.7% due to a rise in the product cost and higher labor expenses which was offset by the decline in payroll, benefit expenses and operating costs. Hence, operating income, as a percentage of revenue reduced 440 bps to 10.8%.

Store Update

During the quarter, the company unveiled 11 franchised units. Moreover, Denny’s shut down 10 franchised restaurants. At quarter end, the company had 165 company-owned and 1,525 franchised and licensed restaurants. Apart from this, Denny’s completed the acquisition of a restaurant in Miami for $3.2 million.

The company remains steadfast in its goal to expand its footprint internationally. It has recently added a restaurant in its Latin American portfolio by opening a unit in Mexico. The company expects to introduce nearly 40-45 franchised restaurants in 2013.

Liquidity

Denny’s ended the quarter with cash and cash equivalents of $2.0 million versus $10.3 million in the prior quarter. Long-term debt, at the quarter end, came in at $153.8 million as compared with $156.8 million in the first quarter.

Share Repurchase

During the second quarter, the company bought back 1.7 million shares worth $9.4 million. Currently, 11.5 million shares remain under the company’s existing share repurchase program. Since the beginning of its share repurchase in 2010 the company has repurchased 13.5 million shares worth $59 million.

Guidance Lowered

For 2013, Denny’s lowered the higher end of comps guidance. The company projects that system-wide comps growth will be within the range of 0%-1%, down from the previous range of 0%-1.5%. Franchise comps will be flat to up 1% while comps at company-owned units will be down 1%.

Commodity cost is expected to be within 2% to 3% in 2013. The company also anticipates that franchise margin to be at the higher end of its guidance of 65%-66% while company restaurant margin is expected to be at the lower end of 14%-15%.

Capital expenditure will be within $20 million - $22 million, up from $19 million - $21 million.

In order to improve the visibility of its brand, the company continues to promote itself as America's Diner. Apart from this, Denny’s has undertaken several initiatives such as menu innovation and aggressive expansion to significantly drive its revenues. The company is increasingly focusing on refranchising to generate more free cash flow.

Our Take

Although, Denny’s earnings beat the earnings estimate in the second quarter, we remain concerned about the lower top line and sluggish comps growth. Moreover, lowered guidance is a major headwind. We believe that this Zacks Rank #4 (Sell) company is still in a transitional stage and will take some time to stabilize the operation both at company-owned and franchised units.

Some other players in the restaurant industry which look attractive at the current level include Yum! Brands Inc. (YUM - Analyst Report), Buffalo Wild Wings Inc. (BWLD - Analyst Report) and Burger King Worldwide, Inc. (BKW - Analyst Report). All these companies carry a Zacks Rank #2 (Buy).

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