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Yesterday, Denny's Corporation (NASDAQ:DENN) reported 3Q 2007 results:

3Q 2007 Highlights

  • Revenue down to $241.4 million from $258.2 million in 3Q 2006
  • Franchise revenue up to $24.62 million from $23.49 million in 3Q 2006
  • Cost of sales $225.1 million from $202.6 million in 3Q 2006
  • SSS up 1.3% at company-owned restaurants; SSS up 3.2% at franchise-operated restaurants
  • Guest check average up 6%
  • Guest count down 4.5%
  • Company restaurant operating margin 11.9% from 13% in 3Q 2006
  • Net income down to $5.3 million ($0.05 per share) from $25.5 million ($0.26 per share) in 3Q 2006
  • Profit margin 2.2% from 9.88% in 3Q 2006
  • Diluted share count 98,605,000
  • $29.08 million in cash
  • Debt down $26.6 million to $408.09 million
  • Interest expense down 30% to $10.5 million mainly due to less debt balances and improved borrowing costs
  • YTD debt has been reduced by $45.2 million (approximately 10%)
  • Opened 2 new company restaurants and 2 franchise restaurants
  • 22 company restaurants sold to eight franchisees for $8.7 million (56 sold year-to-date)
  • 22 franchise restaurant commitments signed in quarter - 71 commitments signed year-to-date
  • Operating total of 1,539 restaurants (468 company-owned; 1,071 franchise-operated)

Fiscal 2007 Outlook

  • Now expecting $8 million to $10 million income before taxes (this is at the high range of previously given guidance)
  • Expecting company-owned restaurant SSS of 0% to 1%
  • Expecting franchise-operated restaurant SSS of 1% to 2%
  • Expecting company-owned restaurant openings of 6
  • Expecting franchise-operated restaurant openings of 18
  • Expecting 96-106 refranchised units
  • Expecting company restaurant revenue of $840 million to $850 million
  • Expecting franchise revenue of $93 million to $94 million
  • Expecting interest expense of $43 million to $44 million
  • Expecting cash CapEx of $37 million to $39 million

Analysts were on average expecting an EPS of $0.04 on sales of $239.96 million. Denny's managed to beat both these expectations, it's the first quarter they've beaten EPS expectations since the 4Q 2006. While at first glance this may not look like a wildly successful quarter, Denny's is definitely heading in the right direction with its balance sheet and debt management. This is the most important issue for management to address if this turnaround is to be successful. So far this year, 10% of the company's debt balance has been paid off, which is quite a good achievement considering the company has been having difficulties in other areas of the business. I like the fact that this management team isn't worrying about the short-term operating results but rather the long-term stability and success of the business. Management continues to look for ways to cut costs and pay down debt; both possible largely due to the company's strong (but often unnoticed) cash flow production.

For now it looks like management is going the route of making most Denny's franchise-operated restaurants. This strategy makes the most sense at this point in time, franchise restaurants initially cost less to build than company restaurants and it does keep costs down. So I'm pleased that management is going this route rather than risk extra costs on company restaurants. Different restaurants do better with different models - Chipotle (NYSE:CMG) is doing amazingly well with their company-owned restaurants, for instance. Denny's can always buy some franchise restaurants in the future if that's what the business needs - but currently management is smart in realizing that the top priorities now are keeping costs down (keep margins stable) and paying down debt. So far I'm very confident that they have a strategy and are determined to execute it. 2008 will be an interesting year for Denny's, I think we'll be seeing more cost-cutting moves as well as a good amount more debt paid off.

One thing I'm disappointed to see is the once again declining guest counts. The higher guest check average has helped offset this, but in the long run management must find a way to bring customers back to Denny's. I'm confident that they can and will, mainly because over the past 12-18 months some new managers have been brought on board who have experience with marketing-related areas. Denny's reputation isn't the strongest right now and it will certainly take a lot of work to change that. That's one reason why I believe new managers have been brought on; it's what the company needs and will continue to need in the future.

The key for Denny's over the next 5+ years will be paying off debt and strengthening the balance sheet, improving and stabilizing margins, and improving the image and reputation of Denny's restaurants around the world. These qualities are not going to come overnight and won't be cheap, but I believe it's what eventually needs to happen. So far I've gotten the impression that management is thinking in a similar manner, and I think they're as good as anyone else to get the job done. I remain a pleased, happy shareholder and look forward to following the company's progress.

For the coming 4Q 2007, analysts are on average expecting an EPS of $0.05 with total sales of $230.49 million.

Disclosure: Author has a long position in DENN

Source: Denny's 3Q Shows Continued Progress With Turnaround