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Introduction

After looking at Buffalo Wild Wings' quarterly results, I decided to have a look at Denny's (NASDAQ:DENN) quarterly results. In this article I'll have a look at the Q2 financial statements and the company's balance sheet. This will result in my investment thesis at the end, where I'll propose an option trade on Denny's as well.

The Q2 financial statements

Denny's revenue for the quarter came in at $116.6M, down 6.5% from $124.7M in the same period last year. This lower revenue caused the company to record an operating income of just $12.6M, down considerably by 33.5% from last year's $19M. Fortunately Denny's had a lower non-operating expense count (even though the company had to pay $1.2M in fees for a new bank facility), which saved the day for the net profit, which came in at $6.2M, up 35% from last year's $4.6M. This resulted in an EPS of $0.07 versus last year's $0.05 profit per share (adjusted net income of $0.08 vs last year's $0.07) as the company's share count dropped by 3.6% after its share repurchases.

Denny's continues to be shareholder friendly, as the company used a major part of its $11.1M free cash flow ($23.3M in the first half of the year) to buy back 1.7M shares, which will further reduce the share count and enhance the earnings per share. I expect Denny's to continue share repurchases and to end the year with less than 90 million outstanding shares (versus the current 91.7M outstanding shares).

The Balance Sheet

The company has (not surprisingly) a negative working capital of (26.1M), which is an improvement of $1.1M over last year's ($27.2M) working capital deficit. The book value per share came in at $0.027 versus -$0.047 at the same time last year.

Outlook

The company now expects to have an EBITDA at the lower range of the previously announced $76-80M and is aiming for a free cash flow of between $43-46M. As the company is authorized to buy back in excess of 10M shares under the current buyback program, which was increased in April of this year, I expect Denny's to spend a considerable amount of its free cash flow to buy back more of its own shares. I expect Denny's to end the year with less than 90M outstanding shares, and am hoping for a total share count of 87-88M by year's end, which would be another 4-5% reduction.

Investment Thesis

Denny's net profit seems to be quite low, but that's mainly caused by the company's expected $30M hit in Depreciation, Amortization and cash expenses. When looking at the free cash flow generation, things look much better as Denny's expects to generate almost $0.50/share in free cash flow this year.

I'm looking at writing put options with a strike price of $5 and expiring in February 2014. There currently is a big spread between the bid and ask (see image), but I think it must be possible to catch an option premium of $0.25, which would be 5% in 6.5 months or an annualized return a little bit over 9%. If Denny's expires below $5/share, you'll likely be assigned the stock at a total cost of $4.75 (excluding broker commissions). If Denny's expires higher than $5/share, you can keep the $0.25 option premium in your pocket.

(click to enlarge)

Source: Denny's Increases Net Income By 35%