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Denny’s Corporation (DENN - Snapshot Report) recently reported third quarter 2012 earnings of 6 cents per share, missing the Zacks Consensus Estimate of 9 cents and year-ago quarter earnings of 8 cents per share.

Total revenue declined 11.6% year over year to $120.9 million, but surpassed the Zacks Consensus Estimate of $119.0 million.

Performance Highlights

During the quarter, sales at the company-operated restaurants declined 17.3% year over year to $86.6 million, due to 49 less operating units as compared to the prior year, as well as muted growth of same-restaurant sales.

Franchise and license revenue increased 7.3% to $34.4 million, attributable to an improvement in occupancy and a $0.9 million increase in royalties, propelled by 60 additional franchised restaurants in operation at the end of the quarter compared with the year-ago quarter.

System-wide same-restaurant sales (comps) nudged up 0.4% based on 0.6% growth in franchised units partially offset by a 0.5% decline in company-operated units. System-wide comps marked the sixth consecutive quarter of positive comps.

However, the improvement was lower than a 2.0% growth in overall comps witnessed in the year-earlier quarter. Same-store guest count fell 2.2% but guest check average inched up 1.8%. While same-store guest count exhibited a downward trend from the year-ago level, guest check showed signs of improvement.   

Company-operated restaurants’ operating margin enhanced 60 basis points (bps) to 14.7% due to lower utilities, marketing, legal settlements as well as occupancy and other operating costs. Franchise operating margin declined 150 bps to 64.9%. Hence, total operating margin expanded 260 bps to 29.0%.

Store Update

During the quarter, Denny’s closed 9 system-wide units, including one company-owned and 8 franchised and licensed restaurants. The company did not open any company-owned unit in the quarter but unveiled 12 franchised ones. The company also refranchised 5 units in the quarter. At quarter-end, the company had 171 company-owned and 1,516 franchised and licensed restaurants.

Denny's plans to end the year 2012 with 46–48 new restaurants.

Liquidity

Denny’s ended the quarter with cash and cash equivalents of $24.1 million and long-term debt of $166.3 million.

Share Repurchase

The company bought back 2.4 million shares in the third quarter.

Guidance

For 2012, Denny’s slashed its guidance for company-operated same-store sales growth to the range of flat to 0.5% (prior flat to 2.0%) and franchise same-store sales to the range of 1—1.5% (prior 1—3%). Guidance for adjusted income before taxes is reduced to the range of $45.0—$48.0 million (prior $45.0—$49.0 million).

The franchisor and operator of one of America's largest full-service restaurant chains also lowered its free cash flow guidance to the range of $49.0—$52.0 million (prior $51—$55 million).

Our Take

We are vigilant about the stock given the company’s continued lower-than-expected results as well as slowdown in key matrices. Sluggish same-restaurant traffic count and management’s cut in guidance were also matters of concern.

However, we believe, Denny’s is still in the transitional stage and will take some time to stabilize the operation both at company-owned and franchised units. Continued margin expansion at company-owned stores amid a value-sensitive business environment remains another positive factor. To counter the challenging economy, the company is also actively considering international expansion.

Denny’s, which competes with the likes of Kona Grill Inc. (KONA - Snapshot Report), currently carries a Zacks #4 Rank, which translates into a short-term ‘Sell’ rating.

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