UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 28, 2016
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 incorporation or organization) | (I.R.S. employer identification number) |
203 East Main Street, Spartanburg, South Carolina | 29319-9966 |
(Address of principal executive offices) | (Zip Code) |
(864) 597-8000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered |
$.01 Par Value, Common Stock | The Nasdaq Stock Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No þ
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 þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | þ | Accelerated filer | o | Non-accelerated filer | o | Smaller reporting company | o |
(Do not check if a smaller reporting company) | |||||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No þ
The aggregate market value of the voting common stock held by non-affiliates of the registrant was approximately $703.3 million as of June 29, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing sales price of the registrant’s common stock on that date of $10.70 per share and, for purposes of this computation only, the assumption that all of the registrant’s directors, executive officers and beneficial owners of 10% or more of the registrant’s common stock are affiliates.
As of February 22, 2017, 70,737,307 shares of the registrant’s common stock, $.01 par value per share, were outstanding.
Documents incorporated by reference:
Portions of the registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Page | |
FORWARD-LOOKING STATEMENTS
The forward-looking statements included in the “Business,” “Risk Factors,” “Legal Proceedings,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Quantitative and Qualitative Disclosures About Market Risk” sections and elsewhere herein, which reflect our best judgment based on factors currently known, involve risks and uncertainties. Words such as “expect,” “anticipate,” “believe,” “intend,” “plan,” “hope,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements speak only as to the date thereof. Except as may be required by law, we expressly disclaim any obligation to update these forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events. Actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors including, but not limited to, the factors discussed in such sections and, in particular, those set forth in the cautionary statements contained in “Risk Factors.” The forward-looking information we have provided in this Form 10-K pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 should be evaluated in the context of these factors.
PART I
Item 1. Business
Description of Business
Denny’s Corporation (Denny’s) is one of America’s largest franchised full-service restaurant chains based on the number of restaurants. Denny’s, through its wholly-owned subsidiary, Denny’s, Inc., owns and operates the Denny’s brand. At December 28, 2016, the Denny’s brand consisted of 1,733 franchised, licensed and company operated restaurants around the world with combined sales of $2.8 billion, including 1,610 restaurants in the United States and 123 international locations. As of December 28, 2016, 1,564 of our restaurants were franchised or licensed, representing 90% of the total restaurants, and 169 were company operated.
Denny’s is known as America's Diner, or in the case of our international locations, “the local diner.” Open 24/7 in most locations, we provide our guests quality food that emphasizes everyday value and new products through our compelling limited time only offerings, delivered in a warm, friendly “come as you are” atmosphere. Denny's has been serving guests for over 60 years and is best known for its breakfast fare, which is available around the clock. The Original Grand Slam, introduced in 1977, remains one of our most popular menu items. In addition to our breakfast-all-day items, Denny's offers a wide selection of lunch and dinner items including burgers, sandwiches, salads and skillet entrées, along with an assortment of beverages, appetizers and desserts.
In 2016, Denny's average annual restaurant sales were $2.3 million for company restaurants and $1.6 million for domestic franchised restaurants. At our company restaurants, the guest check average was $9.95 with an approximate average of 4,400 guests served per week. Because our restaurants are open 24 hours, we have four dayparts (breakfast, lunch, dinner and late night), accounting for 25%, 35%, 22% and 18%, respectively, of average daily sales at company restaurants. Across all dayparts, takeout sales comprised 5.8% of sales at company restaurants during 2016. Weekends have traditionally been the most popular time for guests to visit our restaurants. In 2016, 36% of an average week of sales at company restaurants occurred between Friday late night and Sunday lunch.
References to “Denny's,” the “Company,” “we,” “us,” and “our” in this Form 10-K are references to Denny's Corporation and its subsidiaries.
Restaurant Development
Franchising
Our criteria to become a Denny’s franchisee include minimum liquidity and net worth requirements and appropriate operational experience. We believe that Denny’s is an attractive financial proposition for current and potential franchisees and that our fee structure is competitive with other full-service brands. Traditional twenty-year Denny’s franchise agreements have an initial fee of up to $40,000 and a royalty payment of up to 4.5% of gross sales. Additionally, our franchisees are required to contribute up to 3% of gross sales for brand promotion and may make additional advertising contributions as part of a local marketing co-operative. Franchise agreements for nontraditional locations, such as university campuses and military bases, may contain higher royalty and lower advertising contribution rates than the traditional franchise agreements. For 2016, our average domestic royalty rate was approximately 4.11%.
We work closely with our franchisees to plan and execute many aspects of the business. The Denny's Franchisee Association (“DFA”) was created to promote communication among our franchisees and between the Company and our franchise community. DFA board members and Company management primarily work together through Brand Advisory Councils relating to Development, Marketing and Operations matters, as well as through a Supply Chain Oversight Committee for procurement and distribution matters.
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Site Selection
The success of any restaurant is significantly influenced by its location. Our development team works closely with franchisees and real estate brokers to identify sites which meet specific standards. Sites are evaluated on the basis of a variety of factors, including but not limited to:
• | demographics; |
• | traffic patterns; |
• | visibility; |
• | building constraints; |
• | competition; |
• | environmental restrictions; and |
• | proximity to high-traffic consumer activities. |
Domestic Development
To accelerate the growth of the brand in certain under-penetrated markets, we offer certain incentive programs. These programs provide significant incentives for franchisees to develop multiple locations in areas where Denny's does not have the top market share. The benefits to franchisees include reduced franchise fees, lower royalties for a limited time period and credits towards certain development services, such as training fees.
In recent years, we opened restaurant locations within travel centers, primarily with Pilot and Pilot Flying J Travel Centers. We also recently opened four travel center restaurants in partnership with Kwik TripTM convenience stores. Additionally, we have opened nontraditional locations, which are primarily on university campuses.
Through our various development efforts, we currently have approximately 80 domestic franchised restaurants in our development pipeline. The majority of these restaurants are expected to open over the next five years. While we anticipate the majority of the restaurants to be opened under these agreements, generally as scheduled, from time to time some of our franchisees' ability to grow and meet their development commitments may be hampered by the economy, the lending environment or other circumstances.
International Development
In addition to the development agreements signed for domestic restaurants, we have approximately 80 international franchised restaurants in our development pipeline. The international pipeline includes 27 restaurants in the Middle East, 15 in Indonesia, 12 in Canada, ten in Turkey, eight in the Philippines and eight in Mexico. During 2016, we opened 14 international franchised locations, including four in Canada, three in Mexico, two in Honduras, two in the Philippines, one in the United Arab Emirates, one in Trinidad and one in Puerto Rico.
During 2017, we expect to open a total of 45 to 50 franchised restaurants in domestic and international markets, resulting in net growth of ten to 20 restaurants.
Franchise Focused Business Model
Through our development and refranchising efforts we have achieved a restaurant portfolio mix of 90% franchised and 10% company operated. The majority of our future restaurant openings and growth of the brand will come primarily from the development of franchised restaurants. The following table summarizes the changes in the number of company restaurants and franchised and licensed restaurants during the past five years (excluding relocations):
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2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||
Company restaurants, beginning of period | 164 | 161 | 163 | 164 | 206 | |||||||||
Units opened | 1 | 3 | 1 | — | 1 | |||||||||
Units acquired from franchisees | 10 | 3 | — | 2 | 1 | |||||||||
Units sold to franchisees | (6 | ) | (1 | ) | — | (2 | ) | (36 | ) | |||||
Units closed | — | (2 | ) | (3 | ) | (1 | ) | (8 | ) | |||||
End of period | 169 | 164 | 161 | 163 | 164 | |||||||||
Franchised and licensed restaurants, beginning of period | 1,546 | 1,541 | 1,537 | 1,524 | 1,479 | |||||||||
Units opened | 49 | 42 | 37 | 46 | 39 | |||||||||
Units purchased from Company | 6 | 1 | — | 2 | 36 | |||||||||
Units acquired by Company | (10 | ) | (3 | ) | — | (2 | ) | (1 | ) | |||||
Units closed | (27 | ) | (35 | ) | (33 | ) | (33 | ) | (29 | ) | ||||
End of period | 1,564 | 1,546 | 1,541 | 1,537 | 1,524 | |||||||||
Total restaurants, end of period | 1,733 | 1,710 | 1,702 | 1,700 | 1,688 | |||||||||
The table below sets forth information regarding the distribution of single-store and multi-store franchisees as of December 28, 2016:
Franchisees | Percentage of Franchisees | Restaurants | Percentage of Restaurants | ||||||||
One | 94 | 35.3 | % | 94 | 6.0 | % | |||||
Two to five | 104 | 39.1 | % | 297 | 19.0 | % | |||||
Six to ten | 31 | 11.7 | % | 237 | 15.1 | % | |||||
Eleven to fifteen | 14 | 5.3 | % | 176 | 11.3 | % | |||||
Sixteen to thirty | 13 | 4.9 | % | 282 | 18.0 | % | |||||
Thirty-one and over | 10 | 3.7 | % | 478 | 30.6 | % | |||||
Total | 266 | 100.0 | % | 1,564 | 100.0 | % | |||||
Restaurant Operations
We believe that the consistent and reliable execution of basic restaurant operations in each Denny’s restaurant, whether it is company or franchised, is critical to our success. To meet and exceed our guests’ expectations, we require both our company and our franchised restaurants to maintain the same strict brand standards. These standards relate to the preparation and efficient serving of quality food and the maintenance, repair and cleanliness of each restaurant.
We devote significant effort to ensuring all restaurants offer quality food served by friendly, knowledgeable and attentive employees in a clean and well-maintained restaurant. We seek to ensure that our company restaurants meet our high standards through a network of Directors of Company Operations, Company District Managers and restaurant level managers, all of whom spend the majority of their time in the restaurants. A network of Regional Directors of Franchise Operations and Franchise Business Coaches provide oversight of our franchised restaurants to ensure compliance with brand standards, promote operational excellence and provide general support to our franchisees.
A principal feature of our restaurant operations is the consistent focus on improving operations at the restaurant level. Our Pride Review Program, executed by the Franchise Business Coaches, is designed to continuously improve the execution of our brand standards and shift management at each company and franchised restaurant. In addition, Denny’s maintains training programs for hourly employees and restaurant management. Hourly employee training programs (including eLearning) are position-specific and focus on skills and tasks necessary to successfully fulfill the responsibilities assigned to them, while continually enhancing guest satisfaction. Denny's Manager In Training (“MIT”) program provides managers with the knowledge and leadership skills needed to successfully operate a Denny's restaurant. The MIT program is required for all new managers of company restaurants and is also available to Denny's franchisees to train their managers.
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Product Development and Marketing
Menu Offerings
The Denny’s menu offers a large selection of high-quality, moderately priced products designed to appeal to all types of guests. We offer a wide variety of entrées for breakfast, lunch, dinner and late night dining, in addition to appetizers, desserts and beverages. Our Fit Fare® menu helps our guests identify items best suited to their dietary needs. Most Denny’s restaurants offer special items for children and seniors at reduced prices. Our “America’s Diner” brand positioning, which provides the promise of Everyday Value with craveable, indulgent products served in a friendly and welcoming atmosphere, establishes the framework for our primary marketing strategies. These strategies focus on optimizing our product offering to further align with consumer needs, which includes enhancing our core “breakfast all day” platform while providing everyday affordability, primarily through our $2 $4 $6 $8 Value Menu® and delivering compelling limited-time-only products.
Product Development
Denny’s is a consumer-driven brand focusing on hospitality, menu choices and the overall guest experience. Our Product Development team works closely with consumer insights obtained through primary and secondary qualitative and quantitative studies. Input and ideas from our franchisees, vendors and operators are also integrated into this process. These insights form the strategic foundation for menu architecture, pricing, promotion and advertising. Before a new menu item can be brought to market, it is rigorously tested against consumer expectations, standards of culinary discipline, food science and technology, nutritional analysis, financial benefit and operational execution. This testing process ensures that new menu items are not only appealing, competitive, profitable and marketable, but can be prepared and delivered with excellence in our restaurants.
The added value of these insights and strategic understandings also assists our Restaurant Operations and Information Technology staff in the evaluation and development of new restaurant processes and upgraded restaurant equipment that may enhance our speed of service, food quality and order accuracy.
We continually evolve our menu through new additions, deletions or improvements to meet the needs of a changing consumer and market place.
Product Sources and Availability
Our Purchasing department administers programs for the procurement of food and non-food products. Our franchisees also purchase food and non-food products directly from the vendors under these programs. Our centralized purchasing program is designed to ensure uniform product quality as well as to minimize food, beverage and supply costs. The size of our brand provides significant purchasing power, which often enables us to obtain products at favorable prices from nationally recognized manufacturers.
While nearly all products used in our restaurants are contracted for by our Purchasing department, the majority are purchased and distributed through Meadowbrook Meat Company (“MBM”), a wholly owned subsidiary of McLane Company, Inc., under a long-term distribution contract. MBM distributes restaurant products and supplies to the Denny’s system from approximately 200 vendors, representing approximately 90% of our restaurant product and supply purchases. We believe that satisfactory alternative sources of supply are generally available for all the items regularly used by our restaurants. We have not experienced any material shortages of food, equipment, or other products which are necessary to our restaurant operations.
Marketing and Advertising
Our Marketing team employs integrated marketing and advertising strategies that promote the Denny’s brand. Brand and communications strategy, advertising, broadcast media, social media, digital media, menu management, product innovation and development, consumer insights, target segment marketing, public relations, field marketing and national/local promotions and partnerships all fall under the marketing umbrella.
We focus our marketing campaigns on amplifying Denny's brand strengths as America's Diner, promoting the various breakfast, lunch, dinner, late night and Fit Fare® menu offerings in addition to both value and premium limited time only offerings. Denny's deploys comprehensive marketing strategies on a national level and through local co-operatives, targeting customers through network, cable and local television, radio, online, digital, social, outdoor and print media.
4
Brand Protection, Quality & Regulatory Compliance
Denny’s will only serve our guests food that is safe, wholesome and meets our quality standards. Our systems, from “farm to fork,“ are based on Hazard Analysis and Critical Control Points (“HACCP”), whereby we prevent, eliminate or reduce hazards to a safe level to protect the health of our employees and guests. To ensure this basic expectation of our guests, Denny’s also has risk-based systems in place to validate only approved vendors and distributors which meet and follow our product specifications and food handling procedures. Vendors, distributors and restaurant employees follow regulatory requirements (federal, state and local), industry “best practices” and Denny’s Brand Standards.
The Current Good Manufacturing Practice, Hazard Analysis, and Risk-based Preventive Controls for Human Food regulation (referred to as the Preventive Controls for Human Food Regulation) is intended to ensure safe manufacturing/processing, packing and holding of food products for human consumption in the United States. The regulation requires that certain activities must be completed by a “preventive controls qualified individual” who has “successfully completed training in the development and application of risk-based preventive controls”. Our Chief Food Safety Officer, Food Safety and Quality Assurance teams have been certified.
We use multiple approaches to food quality and safety including third-party unannounced restaurant inspections (utilizing Denny’s Brand Protection Reviews), health department reviews, guest complaints and employee/manager training in their respective roles. It is a brand standard that all regulatory reviews/inspections be submitted to the Brand Protection, Quality & Regulatory Compliance department within 24 hours. We follow-up on all inspections received, and assist operations and facilities personnel, as well as franchisees, where applicable, to bring resolution to regulatory issues or concerns. If operational brand standard expectations are not met, a remediation process is immediately initiated. Our HACCP program uses nationally recognized food safety training courses and American National Standards Institute accredited certification programs.
All Denny’s restaurants are required to have a person certified in food protection on duty for all hours of operation. Our Food Safety/HACCP program has been recognized nationally by regulatory departments, the restaurant industry and our peers. We continuously work toward improving our processes and procedures. We are advocates for the advancement of food safety within the industry’s organizations, such as the National Council of Chain Restaurants (“NCCR” Board Member), NCCR Food Safety Task Force, the National Restaurant Association (“NRA”) and the NRA's Quality Assurance Executive Study Groups.
Seasonality
Restaurant sales are generally higher in the second and third calendar quarters (April through September) than in the first and fourth calendar quarters (October through March). Additionally, severe weather, storms and similar conditions may impact sales volumes seasonally in some operating regions.
Trademarks and Service Marks
Through our wholly-owned subsidiaries, we have certain trademarks and service marks registered with the United States Patent and Trademark Office and in international jurisdictions, including “Denny's®”, “Grand Slam®”, “$2 $4 $6 $8 Value Menu®” and “Fit Fare®”. We consider our trademarks and service marks important to the identification of our restaurants and believe they are of material importance to the conduct of our business. In addition, we have registered various domain names on the internet that incorporate certain of our trademarks and service marks, and believe these domain name registrations are an integral part of our identity. From time to time, we may resort to legal measures to defend and protect the use of our intellectual property. Generally, with appropriate renewal and use, the registration of our service marks and trademarks will continue indefinitely.
Competition
The restaurant industry is highly competitive. Restaurants compete on the basis of name recognition and advertising; the price, quality, variety and perceived value of their food offerings; the quality and speed of their guest service; and the convenience and attractiveness of their facilities.
Denny’s direct competition in the full-service category includes a collection of national and regional chains, as well as thousands of independent operators. We also compete with quick service restaurants as they attempt to upgrade their menus with premium sandwiches, entrée salads, new breakfast offerings and extended hours.
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We believe that Denny’s has a number of competitive strengths, including strong brand recognition, well-located restaurants and market penetration. We benefit from economies of scale in a variety of areas, including advertising, purchasing and distribution. Additionally, we believe that Denny’s has competitive strengths in the value, variety and quality of our food products, and in the quality and training of our employees. See “Risk Factors” for certain additional factors relating to our competition in the restaurant industry.
Economic, Market and Other Conditions
The restaurant industry is affected by many factors, including changes in national, regional and local economic conditions affecting consumer spending; the political environment (including acts of war and terrorism), changes in customer travel patterns including changes in the price of gasoline; changes in socio-demographic characteristics of areas where restaurants are located; changes in consumer tastes and preferences; food safety and health concerns; outbreaks of flu viruses (such as avian flu) or other diseases; increases in the number of restaurants; and unfavorable trends affecting restaurant operations, such as rising wage rates, health care costs, utilities expenses and unfavorable weather. See “Risk Factors” for additional information.
Government Regulations
We and our franchisees are subject to local, state, federal and international laws and regulations governing various aspects of the restaurant business.
We are subject to Federal Trade Commission regulation and a number of state laws which regulate the offer and sale of franchises. We also are subject to a number of state laws which regulate substantive aspects of the franchisor-franchisee relationship. We believe we are in material compliance with applicable laws and regulations, but we cannot predict the effect on operations of the enactment of additional regulations in the future.
We are also subject to federal and state laws, including the Fair Labor Standards Act, governing matters such as minimum wage, tip reporting, overtime, exempt status classification and other working conditions. A substantial number of our employees are paid the minimum wage. Accordingly, increases in the minimum wage or decreases in the allowable tip credit (which reduces wages deemed to be paid to tipped employees in certain states) increase our labor costs. This is especially true for our operations in California, where there is no tip credit. Employers must pay the higher of the federal, state or local minimum wage. We have attempted to offset increases in the minimum wage through pricing and various cost control efforts, however, there can be no assurance that we will be successful in these efforts in the future.
We continue to evaluate the impacts of The Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act on our business, and accommodate various parts of the law and related rules and regulations as they take effect.
We are subject to governmental regulations in our international markets impacting the way we conduct business with our international franchisees. These include antitrust and tax requirements, anti-boycott regulations, import/export/customs and other international trade regulations, the USA Patriot Act and the Foreign Corrupt Practices Act.
We are subject to federal, state and local environmental laws and regulations, but these rules have not historically had a material impact on our operations. However, we cannot predict the effect of possible future environmental legislation or regulations on our operations.
See “Risk Factors” for a discussion of risks related to governmental regulation of our business.
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Executive Officers of the Registrant
The following table sets forth information with respect to each executive officer of both Denny’s Corporation and Denny's Inc.:
Name | Age | Positions | ||
Christopher D. Bode | 54 | Senior Vice President, Chief Operating Officer | ||
John W. Dillon | 45 | Senior Vice President, Chief Marketing Officer | ||
Stephen C. Dunn | 52 | Senior Vice President, Chief Global Development Officer | ||
Timothy E. Flemming | 56 | Senior Vice President, General Counsel and Chief Legal Officer | ||
John C. Miller | 61 | Chief Executive Officer and President | ||
Jill A. Van Pelt | 48 | Senior Vice President, Chief People Officer | ||
Robert P. Verostek | 45 | Senior Vice President, Finance | ||
F. Mark Wolfinger | 61 | Executive Vice President, Chief Administrative Officer and Chief Financial Officer | ||
Mr. Bode has been Senior Vice President, Chief Operating Officer since October 2014. He previously served as Senior Vice President, Operations from January 2013 to October 2014, as Divisional Vice President, Franchise Operations from January 2012 to January 2013 and as Vice President, Operations Initiatives from March 2011 to January 2012. Prior to joining the Company, Mr. Bode served as Chief Operating Officer of QSR Management, LLC (a franchisee of Dunkin’ Donuts) from 2008 to 2010.
Mr. Dillon has been Senior Vice President, Chief Marketing Officer since October 2014. He previously served as Vice President, Brand and Field Marketing from June 2013 to October 2014 and as Vice President, Marketing from July 2008 to June 2013.
Mr. Dunn has been Senior Vice President, Chief Global Development Officer since July 2015. He previously served as Senior Vice President, Global Development from April 2011 to July 2015 and Vice President, Company and Franchise Development from September 2005 to April 2011.
Mr. Flemming has been Senior Vice President, General Counsel and Chief Legal Officer since March 2009. He previously served as Vice President, General Counsel and Chief Legal Officer from June 2008 to March 2009.
Mr. Miller has been Chief Executive Officer and President since February 2011. Prior to joining the Company, he served as Chief Executive Officer and President of Taco Bueno Restaurants, Inc. (an operator and franchisor of quick service Mexican eateries) from 2005 to February 2011.
Ms. Van Pelt has been Senior Vice President and Chief People Officer since October 2014. She previously served as Vice President, Human Resources from October 2008 to October 2014.
Mr. Verostek has been Senior Vice President, Finance since October 2016. He previously served as Vice President, Financial Planning & Analysis and Investor Relations from January 2012 to October 2016.
Mr. Wolfinger has been Executive Vice President and Chief Administrative Officer since April 2008 and Chief Financial Officer since September 2005. He previously served as Executive Vice President, Growth Initiatives from October 2006 to April 2008.
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Employees
At December 28, 2016, we had approximately 8,700 employees, of whom 8,300 were restaurant employees, 100 were field support employees and 300 were corporate personnel. None of our employees are subject to collective bargaining agreements. Many of our restaurant employees work part-time, and many are paid at or above minimum wage levels. As is characteristic of the restaurant industry, we experience a high level of turnover among our restaurant employees. We have experienced no significant work stoppages, and we consider relations with our employees to be satisfactory.
The staff for a typical restaurant consists of one General Manager, two or three Restaurant Managers and approximately 45 hourly employees. The Chief Operating Officer, along with the VP of Franchise Operations, the VP of Training and the VP of Company Operations and Strategic Initiatives, establish the strategic direction and key initiatives for the Operations Teams. In addition, we employ a Director of International Operations, three Directors of Company Operations, four Regional Directors of Franchise Operations and a team of Company District Managers and Franchise Business Coaches to guide and support the franchisees and in-restaurant teams. The duties of the Directors of Operations, District Managers and Franchise Business Coaches include regular restaurant visits and inspections, as well as frequent interactions with our franchisees, employees and guests, which ensure the ongoing adherence to our standards of quality, service, cleanliness, value and hospitality.
Available Information
We make available free of charge through our website at investor.dennys.com (in the SEC Filings section) copies of materials that we file with, or furnish to, the Securities and Exchange Commission (“SEC”), including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC. In addition, we have made available on our website (in the Corporate Governance - Code of Conduct section) our code of ethics entitled “Denny’s Code of Conduct” which is applicable to the Company’s Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Corporate Controller, all other executive officers and key financial and accounting personnel as well as each salaried employee of the Company.
We will post on our website any amendments to, or waivers from, a provision of the Denny’s Code of Conduct that applies to the Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and Corporate Controller or persons performing similar functions, and that relates to (i) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; (ii) full, fair, accurate, timely, and understandable disclosure in reports and documents that we file with, or submit to, the SEC and in other public communications made by us; (iii) compliance with applicable governmental laws, rules and regulations; (iv) the prompt internal reporting of violations of Denny’s Code of Conduct to an appropriate person or persons identified in the code; or (v) accountability to adherence to the code.
Item 1A. Risk Factors
Various risks and uncertainties could affect our business. Any of the risk factors described below or elsewhere in this report or our other filings with the SEC could have a material and adverse impact on our business, financial condition and results of operations. In any such event, the trading price of our common stock could decline. It is not possible to predict or identify all risk factors. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations.
A decline in general economic conditions could adversely affect our financial results.
Consumer spending habits, including discretionary spending on dining at restaurants such as ours, are affected by many factors including:
• | prevailing economic conditions, including interest rates; |
• | energy costs, especially gasoline prices; |
• | levels of employment; |
• | salaries and wage rates, including tax rates; |
• | consumer confidence; and |
• | consumer perception of economic conditions. |
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Weakness or uncertainty regarding the United States economy, as a result of reactions to consumer credit availability, increasing energy prices, inflation, increasing interest rates, unemployment, war, terrorist activity or other unforeseen events could adversely affect consumer spending habits, which may result in lower restaurant sales.
The restaurant business is highly competitive, and if we are unable to compete effectively, our business will be adversely affected.
Each of our restaurants competes with a wide variety of restaurants ranging from national and regional restaurant chains to locally owned restaurants. The following are important aspects of competition:
• | restaurant location; |
• | advantageous commercial real estate suitable for restaurants; |
• | number and location of competing restaurants; |
• | attractiveness and repair and maintenance of facilities; |
• | ability to develop and support evolving technology to deliver a consistent and compelling guest experience; |
• | food quality, new product development and value; |
• | dietary trends, including nutritional content; |
• | training, courtesy and hospitality standards; |
• | ability to attract and retain high quality staff; |
• | quality and speed of service; and |
• | the effectiveness of marketing and advertising programs, including the effective use of social media platforms and digital marketing initiatives |
The returns and profitability of our restaurants may be negatively impacted by a number of factors, including those described below.
Food service businesses and the performance of our individual restaurants may be materially and adversely affected by factors such as:
• | consumer preferences, including nutritional and dietary concerns; |
• | consumer spending habits; |
• | global, national, regional and local economic conditions; |
• | demographic trends; |
• | traffic patterns; |
• | the type, number and location of competing restaurants; and |
• | the ability to renew leased properties on commercially acceptable terms, if at all. |
Dependence on frequent deliveries of fresh produce and other food products subjects food service businesses to the risk that shortages or interruptions in supply caused by adverse weather, food safety warnings, animal disease outbreak or other conditions beyond our control could adversely affect the availability, quality and cost of ingredients. Our inability to effectively manage supply chain risk could increase our costs and limit the availability of products critical to our restaurant operations.
In addition, the food service industry in general, and our results of operations and financial condition in particular, may be adversely affected by unfavorable trends or developments such as:
• | inflation; |
• | volatility in certain commodity markets; |
• | increased food costs; |
• | health concerns arising from food safety issues and other food-related pandemics, outbreaks of flu viruses, such as avian flu, or other diseases; |
• | increased energy costs; |
• | labor and employee benefits costs (including increases in minimum hourly wage, employment tax rates, health care costs and workers’ compensation costs); |
• | regional weather conditions; and |
• | the availability of experienced management and hourly employees. |
Operating results that are lower than our current estimates may cause us to incur impairment charges on certain long-lived assets and potentially close certain restaurants.
9
The financial performance of our franchisees can negatively impact our business.
As we are heavily franchised, our financial results are contingent upon the operational and financial success of our franchisees. We receive royalties, advertising contributions and, in some cases, lease payments from our franchisees. While our franchise agreements are designed to require our franchisees to maintain brand consistency, the significant percentage of franchise-operated restaurants may expose us to risks not otherwise encountered if we maintained ownership and control of the restaurants. If our franchisees do not successfully operate their restaurants in a manner consistent with our standards, or if customers have negative experiences due to issues with food quality or operational execution at our franchised locations, our brand could be harmed, which in turn could negatively impact our business. Additional risks include franchisee defaults on their obligations to us arising from financial or other difficulties encountered by them, such as the inability to pay financial obligations including royalties, rent on leases on which we retain contingent liability, and certain loans on which we have guarantees; limitations on enforcement of franchise obligations due to bankruptcy or insolvency proceedings; the inability to participate in business strategy changes due to financial constraints; and failure to operate restaurants in accordance with required standards, including food quality and safety. If a significant number of franchisees become financially distressed, it could harm our operating results. For 2016, our ten largest franchisees accounted for 29% of our franchise revenue. The balance of our franchise revenue is derived from the remaining 256 franchisees.
Our growth strategy depends on our ability and that of our franchisees to open new restaurants. Delays or failures in opening new restaurants could adversely affect our planned growth.
The development of new restaurants may be adversely affected by risks such as:
• | costs and availability of capital for the company and/or franchisees; |
• | competition for restaurant sites; |
• | inability to identify suitable franchisees; |
• | negotiation of favorable purchase or lease terms for restaurant sites; |
• | inability to obtain all required governmental approvals and permits; |
• | delays in completion of construction; |
• | challenge of identifying, recruiting and training qualified restaurant managers; |
• | developed restaurants not achieving the expected revenue or cash flow; |
• | challenges specific to the growth of international operations and nontraditional restaurants that are different from traditional domestic development; and |
• | general economic conditions. |
The locations where we have restaurants may cease to be attractive as demographic patterns change.
The success of our owned and franchised restaurants is significantly influenced by location. Current locations may not continue to be attractive as demographic patterns change. It is possible that the neighborhood or economic conditions where our restaurants are located could decline in the future, potentially resulting in reduced sales at those locations.
Our expansion into international markets may present increased risks due to lower customer awareness of our brand, our unfamiliarity with those markets and other factors.
The international markets in which our franchisees currently operate and any additional markets our franchisees may enter outside of the United States, have many differences compared to our domestic markets. There may be lower consumer familiarity with the Denny’s brand in these markets, as well as different competitive conditions, consumer tastes and economic, political and health conditions. Additionally, there are risks associated with sourcing quality ingredients and other commodities in a cost-effective and timely manner. As a result, our franchised international restaurants may take longer to reach expected sales and profit levels, and may never do so, thereby affecting the brand’s overall growth and profitability. Building brand awareness may take longer than expected, which could negatively impact our profitability in those markets.
We are subject to governmental regulations in our international markets impacting the way we do business with our international franchisees. These include antitrust and tax requirements, anti-boycott regulations, import/export/customs and other international trade regulations, the USA Patriot Act and the Foreign Corrupt Practices Act. Failure to comply with any such legal requirements could subject us to monetary liabilities and other sanctions, which could adversely impact our results of operations and financial condition.
10
Failure of computer systems, information technology or cyber security could result in material harm to our reputation and business.
We and our franchisees rely on computer systems and information technology to conduct our business. A material failure or interruption of service or a breach in security of our computer systems caused by malware or other attack could cause reduced efficiency in operations, loss or misappropriation of data, or business interruptions, or could impact delivery of food to restaurants or financial functions such as vendor payment or employee payroll. We have business continuity plans that attempt to anticipate and mitigate such failures, but it is possible that significant capital investment could be required to rectify these problems, or more likely that cash flows could be impacted, in the shorter term.
We receive and maintain certain personal information about our guests, employees and franchisees. Our use of this information is regulated at the federal and state levels, as well as by certain third-party contracts. If our security and information systems are compromised and this information is obtained by unauthorized persons or used inappropriately, it could adversely affect our reputation, operations, results of operations and financial condition, and could result in litigation against us or the imposition of penalties. As privacy and information security laws and regulations change or cyber risks evolve pertaining to this data, we may incur additional costs to ensure we remain in compliance.
Numerous government regulations impact our business, and our failure to comply with them could adversely affect our business.
We and our franchisees are subject to federal, state and local laws and regulations governing, among other things:
• | preparation, labeling, advertising and sale of food; |
• | sanitation and safety; |
• | land use, sign restrictions and environmental matters; |
• | employee health care requirements, including the implementation and uncertain legal, regulatory and cost implications of the health care reform law; |
• | management and protection of the personnel data of our guests, employees and franchisees; |
• | payment card regulation and related industry rules; |
• | the sale of alcoholic beverages; |
• | hiring and employment practices, including minimum wage and tip credit laws and fair labor standards; and |
• | Americans with Disabilities Act. |
The operation of our franchisee system is also subject to regulations enacted by a number of states and rules promulgated by the Federal Trade Commission. Due to our international franchising, we are subject to governmental regulations throughout the world impacting the way we do business with our international franchisees. Additionally, given our significant concentration of restaurants in California, changes in regulations in that state could have a disproportionate impact on our operations. If we or our franchisees fail to comply with these laws and regulations, we or our franchisees could be subjected to restaurant closure, fines, penalties and litigation, which may be costly and could adversely affect our results of operations and financial condition. In addition, the future enactment of additional legislation regulating the franchise relationship could adversely affect our operations.
We continue to accommodate the various parts of The Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act as they take effect. Additionally, the health care reform laws will require restaurant companies such as ours to disclose calorie information on their menus effective May 4, 2017. We early adopted this requirement during 2015 and did not incur any material costs from compliance with this provision of the law.
We are also subject to federal, state and international laws regulating the offer and sale of franchises. Such laws impose registration and disclosure requirements on franchisors in the offer and sale of franchises, and may contain provisions that supersede the terms of franchise agreements, including limitations on the ability of franchisors to terminate franchises and alter franchise arrangements.
11
Litigation may adversely affect our business, financial condition and results of operations.
We are subject to the risk of, or are involved in from time to time, complaints or litigation brought by former, current or prospective employees, customers, franchisees, vendors, landlords, shareholders or others. We assess contingencies to determine the degree of probability and range of possible loss for potential accrual in our financial statements. An estimated loss contingency is accrued if it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Because lawsuits are inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review contingencies to determine the adequacy of the accruals and related disclosures. However, the amount of ultimate loss may differ from these estimates. A judgment that is not covered by insurance or that is significantly in excess of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations. In addition, regardless of whether any claims against us are valid or whether we are found to be liable, claims may be expensive to defend, and may divert management’s attention away from operations and hurt our performance. Further, adverse publicity resulting from claims may harm our business or that of our franchisees.
Food safety and quality concerns may negatively impact our business and profitability.
Incidents or reports of food- or water-borne illness, or other food safety issues, food contamination or tampering, employee hygiene and cleanliness failures, improper employee conduct, or presence of communicable disease at our restaurants or suppliers could lead to product liability or other claims. Such incidents or reports could negatively affect our brand and reputation and a decrease in customer traffic resulting from these reports could negatively impact our revenues and profits. Similar incidents or reports occurring at other restaurant brands unrelated to us could likewise create negative publicity, which could negatively impact consumer behavior towards us. In addition, if a regional or global health pandemic occurs, depending upon its location, duration and severity, our business could be severely affected.
We rely on our domestic and international vendors, as do our franchisees, to provide quality ingredients and to comply with applicable laws and industry standards. A failure of one of our domestic or international vendors to meet our quality standards, or meet domestic or international food industry standards, could result in a disruption in our supply chain and negatively impact our brand and our business and profitability. Our inability to manage an event such as a product recall or product related litigation could also cause our results to suffer.
Unfavorable publicity, or a failure to respond effectively to adverse publicity, could harm our brand's reputation.
Multi-unit food service businesses such as ours can be materially and adversely affected by widespread negative publicity of any type, including food safety, outbreak of flu viruses (such as avian flu) or other health concerns, criminal activity, guest discrimination, employee relations or other operating issues. The increasing use of social media platforms has increased the speed and scope of unfavorable publicity and could hinder our ability to quickly and effectively respond to such reports. Regardless of whether the allegations or complaints are accurate or valid, negative publicity relating to a particular restaurant or a limited number of restaurants could adversely affect public perception of the entire brand.
If we fail to recruit, develop and retain talented employees, our business could suffer.
Our future success significantly depends on the continued services and performance of our key management personnel. Our future performance will depend on our ability to attract, motivate and retain these and other key officers and key team members, particularly regional and area managers and restaurant general managers. Competition for these employees is intense.
If our internal controls are ineffective, we may not be able to accurately report our financial results or prevent fraud.
Our management is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States. We maintain a documented system of internal controls which is reviewed and tested by the company’s full time Internal Audit department. The Internal Audit department reports directly to the Audit and Finance Committee of the Board of Directors. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that we would prevent or detect a misstatement of our financial statements or fraud. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. A significant financial reporting failure or material weakness in internal control over financial reporting could cause a loss of investor confidence and decline in the market price of our common stock.
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A change in accounting standards can have a significant effect on our reported financial results. New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future. Changes to existing accounting rules or the questioning of current accounting practices may adversely affect our reporting financial results. Additionally, generally accepted accounting principles and related accounting pronouncements, implementation guidelines and interpretations are highly complex and involve many subjective assumptions, estimates and judgments by us. Changes in these principles or their interpretations or changes in underlying assumptions, estimates and judgments by us could significantly change our reported or expected financial performance.
Many factors, including those over which we have no control, affect the trading price of our common stock.
Factors such as reports on the economy or the price of commodities, as well as negative or positive announcements by competitors, regardless of whether the report directly relates to our business, could have an impact on the trading price of our common stock. In addition to investor expectations about our prospects, trading activity in our common stock can reflect the portfolio strategies and investment allocation changes of institutional holders, as well as non-operating initiatives such as our share repurchase programs. Any failure to meet market expectations whether for same-store sales, restaurant unit growth, earnings per share or other metrics could cause our share price to decline.
Our indebtedness could have an adverse effect on our financial condition and operations.
As of December 28, 2016, we had total indebtedness of $245.6 million, including capital leases. Although we believe that our existing cash balances, funds from operations and amounts available under our credit facility will be adequate to cover our cash flow and liquidity needs, we could seek additional sources of funds, including incurring additional debt, to maintain sufficient cash flow to fund our ongoing operating needs, pay interest and scheduled debt amortization and fund anticipated capital expenditures. We have no material debt maturities scheduled until March 2020. The credit agreement governing our indebtedness contains various covenants that could have an adverse effect on our business by limiting our ability to take advantage of financing, merger, acquisition or other corporate opportunities and to fund our operations. Though we currently participate in a share repurchase program, it is subject to restrictions under our credit agreement and there can be no assurance that we will repurchase our common stock pursuant to the program. If we incur additional debt in the future, covenant limitations on our activities and risks associated with such increased debt levels generally could increase. If we are unable to satisfy or refinance our current debt as it comes due, we may default on our debt obligations and lenders could elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. For additional information concerning our indebtedness see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Most Denny’s restaurants are free-standing facilities with property sizes averaging approximately one acre. The restaurant buildings average between 3,800 - 5,000 square feet, allowing them to accommodate an average of 110-170 guests. The number and location of our restaurants as of December 28, 2016 are presented below:
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United States | Company | Franchised / Licensed | Total | ||||||
Alabama | — | 6 | 6 | ||||||
Alaska | — | 3 | 3 | ||||||
Arizona | 9 | 74 | 83 | ||||||
Arkansas | — | 9 | 9 | ||||||
California | 63 | 337 | 400 | ||||||
Colorado | — | 27 | 27 | ||||||
Connecticut | — | 12 | 12 | ||||||
Delaware | — | 1 | 1 | ||||||
District of Columbia | — | 2 | 2 | ||||||
Florida | 19 | 117 | 136 | ||||||
Georgia | 1 | 21 | 22 | ||||||
Hawaii | 2 | 4 | 6 | ||||||
Idaho | — | 10 | 10 | ||||||
Illinois | 7 | 48 | 55 | ||||||
Indiana | — | 38 | 38 | ||||||
Iowa | 1 | 2 | 3 | ||||||
Kansas | — | 8 | 8 | ||||||
Kentucky | 1 | 14 | 15 | ||||||
Louisiana | 1 | 3 | 4 | ||||||
Maine | — | 6 | 6 | ||||||
Maryland | 4 | 20 | 24 | ||||||
Massachusetts | — | 6 | 6 | ||||||
Michigan | 4 | 17 | 21 | ||||||
Minnesota | — | 17 | 17 | ||||||
Mississippi | — | 5 | 5 | ||||||
Missouri | 5 | 35 | 40 | ||||||
Montana | — | 4 | 4 | ||||||
Nebraska | — | 5 | 5 | ||||||
Nevada | 6 | 28 | 34 | ||||||
New Hampshire | — | 3 | 3 | ||||||
New Jersey | — | 9 | 9 | ||||||
New Mexico | — | 27 | 27 | ||||||
New York | 1 | 52 | 53 | ||||||
North Carolina | — | 28 | 28 | ||||||
North Dakota | — | 4 | 4 | ||||||
Ohio | 4 | 39 | 43 | ||||||
Oklahoma | — | 15 | 15 | ||||||
Oregon | — | 23 | 23 | ||||||
Pennsylvania | 12 | 27 | 39 | ||||||
Rhode Island | — | 5 | 5 | ||||||
South Carolina | — | 17 | 17 | ||||||
South Dakota | — | 3 | 3 | ||||||
Tennessee | — | 7 | 7 | ||||||
Texas | 17 | 178 | 195 | ||||||
Utah | — | 30 | 30 | ||||||
Vermont | — | 2 | 2 | ||||||
Virginia | 9 | 20 | 29 | ||||||
Washington | — | 45 | 45 | ||||||
West Virginia | — | 3 | 3 | ||||||
Wisconsin | 3 | 21 | 24 | ||||||
Wyoming | — | 4 | 4 | ||||||
Total Domestic | 169 | 1,441 | 1,610 | ||||||
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International | Company | Franchised / Licensed | Total | ||||||
Canada | — | 73 | 73 | ||||||
Costa Rica | — | 3 | 3 | ||||||
Curacao N.V. | — | 1 | 1 | ||||||
Dominican Republic | — | 3 | 3 | ||||||
El Salvador | — | 1 | 1 | ||||||
Guam | — | 2 | 2 | ||||||
Honduras | — | 5 | 5 | ||||||
Mexico | — | 9 | 9 | ||||||
New Zealand | — | 7 | 7 | ||||||
Philippines | — | 2 | 2 | ||||||
Puerto Rico | — | 13 | 13 | ||||||
Trinidad | — | 1 | 1 | ||||||
United Arab Emirates | — | 3 | 3 | ||||||
Total International | — | 123 | 123 | ||||||
Total Domestic | 169 | 1,441 | 1,610 | ||||||
Total | 169 | 1,564 | 1,733 | ||||||
Of the total 1,733 restaurants in the Denny's brand, our interest in restaurant properties consists of the following:
Company Restaurants | Franchised Restaurants | Total | ||||||
Owned properties | 36 | 57 | 93 | |||||
Leased properties | 133 | 237 | 370 | |||||
169 | 294 | 463 | ||||||
We have generally been able to renew our restaurant leases as they expire at then-current market rates. The remaining terms of leases range from less than one to approximately 46 years, including optional renewal periods. In addition to the restaurant properties, we own an 18-story, 187,000 square foot office building in Spartanburg, South Carolina, which serves as our corporate headquarters. Our corporate offices currently occupy 17 floors of the building, with a portion of the building leased to others.
See Note 10 to our Consolidated Financial Statements for information concerning encumbrances on substantially all of our properties.
Item 3. Legal Proceedings
There are various claims and pending legal actions against or indirectly involving us, incidental to and arising out of the ordinary course of the business. In the opinion of management, based upon information currently available, the ultimate liability with respect to these proceedings and claims will not materially affect the Company's consolidated results of operations or financial position. We record legal settlement costs as other operating expenses in our Consolidated Statements of Income as those costs are incurred.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed under the symbol “DENN” and trades on the NASDAQ Capital Market (“NASDAQ”). The following table lists the high and low sales prices of our common stock for each quarter of fiscal years 2016 and 2015, according to NASDAQ.
High | Low | |||||||
2016 | ||||||||
First quarter | $ | 10.59 | $ | 8.71 | ||||
Second quarter | 11.36 | 9.84 | ||||||
Third quarter | 11.89 | 10.28 | ||||||
Fourth quarter | 13.16 | 10.02 | ||||||
2015 | ||||||||
First quarter | $ | 12.08 | $ | 9.61 | ||||
Second quarter | 12.10 | 10.20 | ||||||
Third quarter | 12.80 | 10.86 | ||||||
Fourth quarter | 11.54 | 9.18 | ||||||
Stockholders
As of February 22, 2017, there were 70,737,307 shares of our common stock outstanding and approximately 10,200 record and beneficial holders of our common stock.
Dividends and Share Repurchases
Our credit facility allows for the payment of cash dividends and/or the repurchase of our common stock, subject to certain limitations and continued maintenance of all relevant covenants before and after any such payment of any dividend or stock purchase. An aggregate amount is available for such dividends or stock repurchases as follows:
• | not to exceed $50.0 million if the Consolidated Leverage Ratio (as defined in the Credit Agreement, as amended) is 3.0x or greater and unlimited if the Consolidated Leverage Ratio is below 3.0x, provided that, in each case, at least $20.0 million of availability is maintained under the revolving credit facility after such payment; and |
• | an additional annual aggregate amount equal to $0.05 times the number of outstanding shares of our common stock, as of December 31, 2014, plus each additional share of our common stock that is issued after such date. |
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Though we have not historically paid cash dividends, we have in recent years undertaken share repurchases. The table below provides information concerning repurchases of shares of our common stock during the quarter ended December 28, 2016.
Period | Total Number of Shares Purchased | Average Price Paid Per Share (1) | Total Number of Shares Purchased as Part of Publicly Announced Programs (2)(3) | Approximate Dollar Value of Shares that May Yet be Purchased Under the Programs (2)(3) | |||||||||||
(In thousands, except per share amounts) | |||||||||||||||
September 29, 2016 - October 26, 2016 | 550 | $ | 10.40 | 550 | $ | 112,443 | |||||||||
October 27, 2016 – November 23, 2016 | 1,897 | (4) | 12.12 | (4) | 1,897 | (4) | $ | 82,564 | (5) | ||||||
November 24, 2016 – December 28, 2016 | 267 | 12.67 | 267 | $ | 79,171 | ||||||||||
Total | 2,714 | $ | 11.83 | 2,714 | |||||||||||
(1) | Average price paid per share excludes commissions. |
(2) | On April 1, 2015, we announced that our Board of Directors approved a new share repurchase program, authorizing us to repurchase up to an additional $100 million of our common stock (in addition to prior authorizations). Such repurchases may take place from time to time on the open market (including pre-arranged stock trading plans in accordance with the guidelines specified in Rule 10b5-1 under the Exchange Act) or in privately negotiated transactions, subject to market and business conditions. During the quarter ended December 28, 2016, we purchased 1,418,402 shares of our common stock for an aggregate consideration of approximately $18.2 million, pursuant to this share repurchase program, thus completing the program. |
(3) | On May 26, 2016, we announced that our Board of Directors approved a new share repurchase program, authorizing us to repurchase up to an additional $100 million of our common stock (in addition to prior authorizations). Such repurchases are to be made in a manner similar to, and will be in addition to, authorizations under the April 1, 2015 repurchase program. During the quarter ended December 28, 2016, we purchased 1,295,995 shares of our common stock for an aggregate consideration of approximately $13.9 million, pursuant to this share repurchase program. |
(4) | Includes the initial delivery of approximately 1.5 million shares of our common stock received under the variable term, capped accelerated share repurchase (the “ASR”) agreement we entered into in November 2016 to repurchase an aggregate of $25 million of our common stock. These shares were recorded at the Hedge Period Reference Price, as defined by the ASR agreement, and represent the minimum shares to be delivered based on the cap price. The total aggregate number of shares of our common stock repurchased pursuant to the ASR agreement will be based generally on the average of the daily volume-weighted average prices of our common stock, less a fixed discount, over the term of the ASR agreement, subject to a minimum number of shares. |
(5) | Includes the full $25 million payment related to the ASR agreement, consisting of $18.1 million for the initial delivery of approximately 1.5 million shares of our common stock and $6.9 million for the equity forward contract related to the settlement of the ASR agreement. |
17
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of December 28, 2016 with respect to our compensation plans under which equity securities of Denny’s Corporation are authorized for issuance.
Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights (2) | Number of securities remaining available for future issuance under equity compensation plans | |||||||||||
Equity compensation plans approved by security holders | 3,897,053 | (1) | $ | 2.82 | 1,538,384 | (3) | ||||||||
Equity compensation plans not approved by security holders | 200,000 | (4) | 3.89 | 827,589 | (5) | |||||||||
Total | 4,097,053 | $ | 3.01 | 2,365,973 | ||||||||||
(1) | Includes shares issuable in connection with our outstanding stock options, performance share awards and restricted stock units awards. |
(2) | Includes the weighted-average exercise price of stock options only. |
(3) | Includes shares of our common stock available for issuance as awards of stock options, restricted stock, restricted stock units, deferred stock units and performance awards under the 2012 Omnibus Plan. |
(4) | Includes shares of our common stock issuable pursuant to the grant or exercise of employment inducement awards of stock options and restricted stock units granted outside of the Denny's Incentive Plans in accordance with NASDAQ Listing Rule 5635(c)(4). |
(5) | Includes shares of our common stock available for issuance as awards of stock options and restricted stock units outside of the Denny's Incentive Plans in accordance with NASDAQ Listing Rule 5635(c)(4). |
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Performance Graph
The following graph compares the cumulative total shareholders’ return on our common stock for the five fiscal years ended December 28, 2016 (December 28, 2011 to December 28, 2016) against the cumulative total return of the Russell 2000® Index and a peer group. The graph and table assume that $100 was invested on December 28, 2011 (the last day of fiscal year 2011) in each of the Company’s common stock, the Russell 2000® Index and the peer group and that all dividends were reinvested.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
ASSUMES $100 INVESTED ON DECEMBER 28, 2011
ASSUMES DIVIDENDS REINVESTED
FISCAL YEAR ENDED DECEMBER 28, 2016
Russell 2000® Index (1) | Peer Group (2) | Denny's Corporation | |||||||||
December 28, 2011 | $ | 100.00 | $ | 100.00 | $ | 100.00 | |||||
December 26, 2012 | $ | 115.74 | $ | 117.82 | $ | 125.92 | |||||
December 25, 2013 | $ | 162.44 | $ | 177.21 | $ | 193.72 | |||||
December 31, 2014 | $ | 170.75 | $ | 215.05 | $ | 269.90 | |||||
December 30, 2015 | $ | 165.19 | $ | 205.14 | $ | 261.52 | |||||
December 28, 2016 | $ | 198.52 | $ | 234.86 | $ | 336.91 | |||||
(1) | The Russell 2000 Index is a broad equity market index of 2,000 companies that measures the performance of the small-cap segment of the U.S. equity universe. As of December 28, 2016, the weighted average market capitalization of companies within the index was approximately $2.1 billion with the median market capitalization being approximately $0.8 billion. |
(2) | The peer group consists of 15 public companies that operate in the restaurant industry. The peer group includes the following companies: BJ's Restaurants, Inc. (BJRI), Bob Evans Farms, Inc. (BOBE), Buffalo Wild Wings, Inc. (BWLD), The Cheesecake Factory Incorporated (CAKE), Cracker Barrel Old Country Store, Inc. (CBRL), DineEquity, Inc. (DIN), Brinker International, Inc. (EAT), Fiesta Restaurant Group, Inc. (FRGI), Jack In The Box Inc. (JACK), Popeye's Louisana Kitchen (PLKI), Panera Bread Company (PNRA), Red Robin Gourmet Burgers, Inc. (RRGB), Ruby Tuesday, Inc. (RT), Sonic Corp. (SONC) and Texas Roadhouse, Inc. (TXRH). |
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Item 6. Selected Financial Data
The following table provides selected financial data that was extracted or derived from our audited financial statements. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and related notes included elsewhere in this report.
Fiscal Year Ended | ||||||||||||||||||||
December 28, 2016 (a) | December 30, 2015 | December 31, 2014 (b) | December 25, 2013 | December 26, 2012 | ||||||||||||||||
(In millions, except ratios and per share amounts) | ||||||||||||||||||||
Statement of Income Data: | ||||||||||||||||||||
Operating revenue | $ | 506.9 | $ | 491.3 | $ | 472.3 | $ | 462.6 | $ | 488.4 | ||||||||||
Operating income | $ | 47.0 | $ | 63.2 | $ | 57.3 | $ | 47.5 | $ | 56.4 | ||||||||||
Income from continuing operations | $ | 19.4 | $ | 36.0 | $ | 32.7 | $ | 24.6 | $ | 22.3 | ||||||||||
Basic net income per share: | $ | 0.26 | $ | 0.44 | $ | 0.38 | $ | 0.27 | $ | 0.23 | ||||||||||
Diluted net income per share: | $ | 0.25 | $ | 0.42 | $ | 0.37 | $ | 0.26 | $ | 0.23 | ||||||||||
Cash dividends per common share (c) | — | — | — | — | — | |||||||||||||||
Balance Sheet Data (at end of period): | ||||||||||||||||||||
Current assets (d) | $ | 35.9 | $ | 36.4 | $ | 56.1 | $ | 53.8 | $ | 64.6 | ||||||||||
Working capital deficit (e) | $ | (57.5 | ) | $ | (65.1 | ) | $ | (24.3 | ) | $ | (20.3 | ) | $ | (27.2 | ) | |||||
Net property and equipment | $ | 133.1 | $ | 124.8 | $ | 109.8 | $ | 105.6 | $ | 107.0 | ||||||||||
Total assets | $ | 306.2 | $ | 297.0 | $ | 289.9 | $ | 295.8 | $ | 324.9 | ||||||||||
Long-term debt and capital lease obligations, excluding current portion | $ | 242.3 | $ | 212.5 | $ | 151.1 | $ | 165.9 | $ | 177.5 | ||||||||||
(a) | During 2016, we completed the liquidation of the Advantica Pension Plan (the "Pension Plan"). Accordingly, we made a final contribution of $9.5 million to the Pension Plan and recognized a settlement loss of $24.3 million, reflecting the recognition of unamortized actuarial losses that were recorded in accumulated other comprehensive income. |
(b) | The fiscal year ended December 31, 2014 includes 53 weeks of operations compared with 52 weeks for all other years presented. We estimate that the additional operating week added approximately $10.7 million of operating revenue in 2014. |
(c) | Our credit facility allows for the payment of cash dividends and/or the purchase of our common stock subject to certain limitations. See Part II Item 5. |
(d) | During 2015, we early adopted ASU 2015-17, which simplifies the presentation of deferred taxes by requiring that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. We chose to prospectively apply the guidance, therefore, as a result of our early adoption, all deferred taxes are reported as noncurrent in our Consolidated Balance Sheet as of December 30, 2015. Prior periods were not retrospectively adjusted. |
(e) | A negative working capital position is not unusual for a restaurant operating company. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with “Selected Financial Data” and our Consolidated Financial Statements and the notes thereto.
Overview
Nature of Our Business
Denny’s Corporation (Denny’s) is one of America’s largest franchised full-service restaurant chains. Denny’s, through its wholly-owned subsidiary, Denny’s, Inc., owns and operates the Denny’s brand. At December 28, 2016, the Denny’s brand consisted of 1,733 franchised, licensed and company operated restaurants. Of this amount, 1,564 of our restaurants were franchised or licensed, representing 90% of the total restaurants, and 169 were company operated.
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Our revenues are derived primarily from two sources: the sale of food and beverages at our company restaurants and the collection of royalties and fees from restaurants operated by our franchisees under the Denny’s name. Sales and customer traffic at both company and franchised restaurants are affected by the success of our marketing campaigns, new product introductions, product quality enhancements, customer service and menu pricing, as well as external factors including competition, economic conditions affecting consumer spending and changes in guests' tastes and preferences. Sales at company restaurants and royalty income from franchise restaurants are also impacted by the opening of new restaurants, the closing of existing restaurants, the sale of company restaurants to franchisees and the acquisition of restaurants from franchisees.
Our operating costs are exposed to volatility in two main areas: payroll and benefit costs and product costs. The volatility of payroll and benefit costs results primarily from changes in wage rates and increases in labor related expenses, such as medical benefit costs and workers' compensation costs. Additionally, changes in guest counts and investments in store-level labor impact payroll and benefit costs as a percentage of sales. Many of the products sold in our restaurants are affected by commodity pricing and are, therefore, subject to price volatility. This volatility is caused by factors that are fundamentally outside of our control and are often unpredictable. In general, we purchase food products based on market prices or we set firm prices in purchase agreements with our vendors. In an inflationary commodity environment, our ability to lock in prices on certain key commodities is imperative to controlling food costs. In addition, our continued success with menu management helps us offer menu items that provide a compelling value to our customers while maintaining attractive product costs and profitability.
2016 Summary of Operations
During 2016, we achieved domestic system-wide same-stores sales growth of 0.9%, comprised of a 1.1% increase at company restaurants and a 0.8% increase at domestic franchised restaurants. In addition to growing system-wide same-store sales in 14 of the past 15 quarters, Denny’s achieved its sixth consecutive year of positive system-wide same-store sales.
A total of 240 remodels were completed during 2016, comprised of 27 at company restaurants and 213 at franchised restaurants. These remodels were in our Heritage image, which we launched late in 2013. This updated look reflects a more contemporary diner feel to further reinforce our America's Diner positioning. We anticipate over 200 remodels will be completed system-wide in 2017. By the end of 2018, we expect 75% of the system will have been remodeled to the most current image.
During 2014, we implemented a new franchise agreement, which included a royalty rate of 4.5% and an advertising contribution of 3%, excluding any incentives. There were approximately 600 franchised restaurants (42%) operating under this agreement as of December 28, 2016, and we expect there to be approximately 700 franchised restaurants (49%) operating under this agreement by the end of 2017. We anticipate that existing franchisees will elect to migrate to the new fee structure over the next decade as incentives under previous franchise agreements expire. Due to the long-term migration of existing franchisees, we will not see the full benefit of the higher royalty rate for some time. For 2016, our average domestic royalty rate was approximately 4.11%.
During 2014, our Board of Directors approved the termination and liquidation of the Advantica Pension Plan (the “Pension Plan”). During 2016, we completed the liquidation of the Pension Plan. Accordingly, we made a final contribution of $9.5 million to the Pension Plan and recognized a settlement loss of $24.3 million, reflecting the recognition of unamortized actuarial losses that were recorded in accumulated other comprehensive income. As a result, operating income decreased $16.2 million to $47.0 million in 2016 from $63.2 million in 2015. Net income decreased $16.6 million to $19.4 million, or $0.25 per diluted share, in 2016 compared to $36.0 million, or $0.42 per diluted share, in 2015.
Growing the Brand
Over the last five years our growth initiatives have led to 219 new restaurant openings. During 2016, we had net restaurant growth of 23 restaurants, with 50 openings and 27 closures. Our openings included 14 franchised international locations, including four in Canada, three in Mexico, two in Honduras, two in the Philippines, one in the United Arab Emirates, one in Trinidad and one in Puerto Rico. Our goal is to increase net restaurant growth through all avenues: domestic, international and nontraditional. Domestic growth will focus on markets in which we have modest penetration.
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Balancing the Use of Cash
We are focused on balancing the use of cash between reinvesting in our base of company restaurants, growing and strengthening the brand and returning cash to shareholders. During 2016, cash capital expenditures were $34.0 million, comprised of $19.7 million in capital expenditures and restaurants acquisition costs of $14.3 million. The capital expenditures included approximately $6.4 million allocated towards the remodel of 27 company restaurants. The restaurant acquisition costs include $13.7 million for ten high-volume franchised restaurants and $0.6 million related to a franchised restaurant that was acquired during 2015.
In November 2016, as part of our previously authorized share repurchase programs, we entered into a variable term, capped accelerated share repurchase (the “2016 ASR”) agreement with MUFG Securities EMEA plc (“MUFG”), to repurchase an aggregate of $25 million of our common stock. Pursuant to the terms of the 2016 ASR agreement, we paid $25 million in cash, received approximately 1.5 million shares of our common stock (which represents the minimum shares to be delivered based on the cap price) and recorded $18.1 million of treasury stock related to these shares. The remaining balance of $6.9 million is included as additional paid-in capital in shareholders' equity as of December 28, 2016 as an equity forward contract. The total aggregate number of shares of our common stock repurchased pursuant to the ASR agreement will be based generally on the average of the daily volume-weighted average prices of our common stock, less a fixed discount, over the term of the 2016 ASR agreement, subject to a minimum number of shares. Subsequent to the year ended December 28, 2016, we settled the 2016 ASR agreement. See Note 19 to our Consolidated Financial Statements.
During 2016, including shares repurchased under the 2016 ASR, we repurchased a total of 4.6 million shares for $51.8 million. In addition, we recorded 1.5 million shares and $13.1 million in treasury stock as a result of settling the 2015 ASR. Since initiating our share repurchase programs in November 2010, we have repurchased a total of 35.8 million shares of our common stock for $265.9 million. As of December 28, 2016, there was $79.2 million remaining under the current repurchase program.
Factors impacting comparability
For 2016, 2015 and 2014, the following items impacted the comparability of our results:
• | Company restaurant sales have increased from $334.7 million in 2014 to $367.3 million in 2016, primarily as a result of the increase in same-store sales and acquisitions of restaurants from franchisees. |
• | Royalty income, which is included as a component of franchise and license revenue, has increased from $90.8 million in 2014 to $98.4 million in 2016, primarily as a result of the increase in same-store sales and a higher royalty rate. |
• | Initial franchise fees, included as a component of franchise and license revenue, are generally recognized in the period in which a restaurant is sold to a franchisee or when a new restaurant is opened. These initial fees are completely dependent on the number of restaurants sold to or opened by franchisees during a particular period and, as a result, can cause fluctuations in our total franchise and license revenue from year to year. |
• | Occupancy revenues, also included as a component of franchise and license revenue, result from leasing or subleasing restaurants to franchisees. When restaurants are sold and leased or subleased to franchisees, the occupancy costs related to these restaurants move from costs of company restaurant sales to costs of franchise and license revenue to match the related occupancy revenue. As leases or subleases with franchisees expire, franchise occupancy revenue and costs could decrease if franchisees enter into direct leases with landlords. At the end of 2016, we had 294 franchise restaurants that are leased or subleased from Denny’s. |
• | Our fiscal year ends on the last Wednesday in December. As a result, a fifty-third week is added to a fiscal year every five or six years. We had a 52 week year in 2016 and 2015 and a 53 week year in 2014, which impacts the comparison of our financial information. We estimate that the additional 2014 operating week added approximately $8.3 million of company restaurant sales and $2.4 million of franchise and license revenue and resulted in approximately $0.6 million of additional general and administrative expenses, $3.6 million of additional operating income and $2.2 million of additional net income. |
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Statements of Income
Fiscal Year Ended | ||||||||||||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | ||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Revenue: | ||||||||||||||||||||
Company restaurant sales | $ | 367,310 | 72.5 | % | $ | 353,073 | 71.9 | % | $ | 334,684 | 70.9 | % | ||||||||
Franchise and license revenue | 139,638 | 27.5 | % | 138,220 | 28.1 | % | 137,611 | 29.1 | % | |||||||||||
Total operating revenue | 506,948 | 100.0 | % | 491,293 | 100.0 | % | 472,295 | 100.0 | % | |||||||||||
Costs of company restaurant sales (a): | ||||||||||||||||||||
Product costs | 90,487 | 24.6 | % | 89,660 | 25.4 | % | 86,825 | 25.9 | % | |||||||||||
Payroll and benefits | 142,823 | 38.9 | % | 136,626 | 38.7 | % | 133,280 | 39.8 | % | |||||||||||
Occupancy | 19,557 | 5.3 | % | 20,443 | 5.8 | % | 20,845 | 6.2 | % | |||||||||||
Other operating expenses | 49,229 | 13.4 | % | 47,628 | 13.5 | % | 47,858 | 14.3 | % | |||||||||||
Total costs of company restaurant sales | 302,096 | 82.2 | % | 294,357 | 83.4 | % | 288,808 | 86.3 | % | |||||||||||
Costs of franchise and license revenue (a) | 40,805 | 29.2 | % | 43,345 | 31.4 | % | 44,761 | 32.5 | % | |||||||||||
General and administrative expenses | 67,960 | 13.4 | % | 66,602 | 13.6 | % | 58,907 | 12.5 | % | |||||||||||
Depreciation and amortization | 22,178 | 4.4 | % | 21,472 | 4.4 | % | 21,218 | 4.5 | % | |||||||||||
Operating (gains), losses and other charges, net | 26,910 | 5.3 | % | 2,366 | 0.5 | % | 1,270 | 0.3 | % | |||||||||||
Total operating costs and expenses, net | 459,949 | 90.7 | % | 428,142 | 87.1 | % | 414,964 | 87.9 | % | |||||||||||
Operating income | 46,999 | 9.3 | % | 63,151 | 12.9 | % | 57,331 | 12.1 | % | |||||||||||
Interest expense, net | 12,232 | 2.4 | % | 9,283 | 1.9 | % | 9,182 | 1.9 | % | |||||||||||
Other nonoperating expense (income), net | (1,109 | ) | (0.2 | )% | 139 | 0.0 | % | (612 | ) | (0.1 | )% | |||||||||
Net income before income taxes | 35,876 | 7.1 | % | 53,729 | 10.9 | % | 48,761 | 10.3 | % | |||||||||||
Provision for income taxes | 16,474 | 3.2 | % | 17,753 | 3.6 | % | 16,036 | 3.4 | % | |||||||||||
Net income | $ | 19,402 | 3.8 | % | $ | 35,976 | 7.3 | % | $ | 32,725 | 6.9 | % | ||||||||
Other Data: | ||||||||||||||||||||
Company average unit sales | $ | 2,254 | $ | 2,217 | $ | 2,100 | ||||||||||||||
Franchise average unit sales | $ | 1,563 | $ | 1,555 | $ | 1,506 | ||||||||||||||
Company equivalent units (b) | 163 | 159 | 159 | |||||||||||||||||
Franchise equivalent units (b) | 1,556 | 1,538 | 1,534 | |||||||||||||||||
Company same-store sales increase (c)(d) | 1.1 | % | 6.5 | % | 4.2 | % | ||||||||||||||
Domestic franchised same-store sales increase (c) | 0.8 | % | 5.7 | % | 2.5 | % | ||||||||||||||
(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) | Equivalent units are calculated as the weighted average number of units outstanding during a defined time period. |
(c) | Same-store sales include sales from restaurants that were open the same period in the prior year. |
(d) | Prior year amounts have not been restated for 2016 comparable restaurants. |
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Unit Activity
Fiscal Year Ended | ||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | ||||||
Company restaurants, beginning of period | 164 | 161 | 163 | |||||
Units opened | 1 | 3 | 1 | |||||
Units acquired from franchisees | 10 | 3 | — | |||||
Units sold to franchisees | (6 | ) | (1 | ) | — | |||
Units closed | — | (2 | ) | (3 | ) | |||
End of period | 169 | 164 | 161 | |||||
Franchised and licensed restaurants, beginning of period | 1,546 | 1,541 | 1,537 | |||||
Units opened | 49 | 42 | 37 | |||||
Units purchased from Company | 6 | 1 | — | |||||
Units acquired by Company | (10 | ) | (3 | ) | — | |||
Units closed | (27 | ) | (35 | ) | (33 | ) | ||
End of period | 1,564 | 1,546 | 1,541 | |||||
Total restaurants, end of period | 1,733 | 1,710 | 1,702 | |||||
Company Restaurant Operations
Company same-store sales increased 1.1% in 2016 and 6.5% in 2015 compared with the respective prior year. Company restaurant sales for 2016 increased $14.2 million, or 4.0%, primarily resulting from the increase in same-store sales and a 4 equivalent unit increase in company restaurants. Company restaurant sales for 2015 increased $18.4 million, or 5.5%, primarily resulting from the increase in same-store sales and from the November 2014 reopening of our highest volume restaurant in Las Vegas, Nevada.
Total costs of company restaurant sales as a percentage of company restaurant sales were 82.2% in 2016, 83.4% in 2015 and 86.3% in 2014.
Product costs were 24.6% in 2016, 25.4% in 2015 and 25.9% in 2014. The decrease in 2016 was primarily due to lower commodity costs. The decrease in 2015 was primarily due to the favorable impact of product mix and the leveraging effect of higher sales, partially offset by the increased cost of eggs.
Payroll and benefits were 38.9% in 2016, 38.7% in 2015 and 39.8% in 2014. The increase in 2016 was primarily due to a 0.8 percentage point increase in labor costs, a 0.3 percentage point increase in group insurance and a 0.2 percentage point increase in workers' compensation costs, partially offset by a 1.1 percentage point decrease in incentive compensation costs. Contributing to the increase in labor costs was the impact of the California Paid Sick Leave law, which became effective in July 2015. The decrease in 2015 was primarily due to a 1.0 percentage point decrease in labor costs, a 0.7 percentage point decrease in workers' compensation costs and a 0.2 percentage point decrease in group insurance, partially offset by a 0.8 percentage point increase in incentive compensation costs.
Occupancy costs were 5.3% in 2016, 5.8% in 2015 and 6.2% in 2014. The 2016 decrease is primarily related to a 0.3 percentage point decrease in general liability costs and a 0.2 percentage point decrease in rent and property taxes due to an increase in capital leases during the year. The 2015 decrease is primarily related to a 0.4 percentage point decrease in general liability costs.
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Other operating expenses were comprised of the following amounts and percentages of company restaurant sales:
Fiscal Year Ended | ||||||||||||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | ||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Utilities | $ | 12,426 | 3.4 | % | $ | 12,866 | 3.6 | % | $ | 13,915 | 4.2 | % | ||||||||
Repairs and maintenance | 6,406 | 1.7 | % | 6,017 | 1.7 | % | 5,971 | 1.8 | % | |||||||||||
Marketing | 13,112 | 3.6 | % | 12,527 | 3.5 | % | 12,329 | 3.7 | % | |||||||||||
Other direct costs | 17,285 | 4.7 | % | 16,218 | 4.6 | % | 15,643 | 4.7 | % | |||||||||||
Other operating expenses | $ | 49,229 | 13.4 | % | $ | 47,628 | 13.5 | % | $ | 47,858 | 14.3 | % | ||||||||
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:
Fiscal Year Ended | ||||||||||||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | ||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Royalties | $ | 98,416 | 70.5 | % | $ | 94,755 | 68.6 | % | $ | 90,835 | 66.0 | % | ||||||||
Initial fees | 2,717 | 1.9 | % | 2,478 | 1.8 | % | 1,893 | 1.4 | % | |||||||||||
Occupancy revenue | 38,505 | 27.6 | % | 40,987 | 29.7 | % | 44,883 | 32.6 | % | |||||||||||
Franchise and license revenue | $ | 139,638 | 100.0 | % | $ | 138,220 | 100.0 | % | $ | 137,611 | 100.0 | % | ||||||||
Occupancy costs | $ | 28,062 | 20.1 | % | $ | 30,416 | 22.0 | % | $ | 33,134 | 24.1 | % | ||||||||
Other direct costs | 12,743 | 9.1 | % | 12,929 | 9.4 | % | 11,627 | 8.4 | % | |||||||||||
Costs of franchise and license revenue | $ | 40,805 | 29.2 | % | $ | 43,345 | 31.4 | % | $ | 44,761 | 32.5 | % | ||||||||
Royalties increased by $3.7 million, or 3.9%, in 2016 primarily resulting from a 18 equivalent unit increase in franchised and licensed restaurants, a 0.8% increase in domestic same-store sales and a higher average royalty rate as compared to 2015. Royalties increased by $3.9 million, or 4.3%, in 2015 primarily resulting from a 5.7% increase in domestic same-store sales and a higher average royalty rate as compared to 2014. The higher average royalty rates for both periods resulted as certain restaurants transitioned to a higher rate structure.
Initial fees increased by $0.2 million, or 9.6%, in 2016 as a higher number of restaurants were opened by franchisees and sold to franchisees during the current year period. Initial fees increased by $0.6 million, or 30.9%, in 2015 as a higher number of restaurants were opened by franchisees and a higher number of successor franchise agreements were signed compared to the prior year period. Occupancy revenue decreased by $2.5 million, or 6.1%, in 2016 and by $3.9 million, or 8.7%, in 2015 primarily resulting from lease expirations.
Occupancy costs decreased by $2.4 million, or 7.7%, in 2016 and by $2.7 million, or 8.2%, in 2015 primarily resulting from lease expirations. Other direct costs were essentially flat in 2016 and increased by $1.3 million, or 11.2%, in 2015 due to increased franchise administrative costs. As a result, costs of franchise and license revenue decreased by $2.5 million, or 5.9%, in 2016 and by $1.4 million, or 3.2%, in 2015.
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.
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General and administrative expenses are comprised of the following:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Share-based compensation | $ | 7,610 | $ | 6,635 | $ | 5,846 | |||||
Other general and administrative expenses | 60,350 | 59,967 | 53,061 | ||||||||
Total general and administrative expenses | $ | 67,960 | $ | 66,602 | $ | 58,907 | |||||
General and administrative expenses increased by $1.4 million in 2016. The increase in share-based compensation is primarily the result of forfeitures during 2015. The increase in other general and administrative expenses is comprised of $2.3 million in investments in personnel and technology and $0.8 million related to market valuation changes in our deferred compensation plan liabilities, partially offset by a $2.7 million decrease in incentive compensation. General and administrative expenses increased by $7.7 million in 2015 primarily resulting from increases of $3.2 million in incentive compensation, $1.9 million in payroll and benefits and $0.8 million in share-based compensation.
Depreciation and amortization is comprised of the following:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Depreciation of property and equipment | $ | 17,012 | $ | 16,548 | $ | 15,627 | |||||
Amortization of capital lease assets | 3,630 | 3,449 | 3,536 | ||||||||
Amortization of intangible and other assets | 1,536 | 1,475 | 2,055 | ||||||||
Total depreciation and amortization expense | $ | 22,178 | $ | 21,472 | $ | 21,218 | |||||
The increase in depreciation and amortization expense is primarily the result of our investments in company unit remodels during the past two years.
Operating (gains), losses and other charges, net are comprised of the following:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Pension settlement loss | $ | 24,297 | $ | — | $ | — | |||||
Losses (gains) on sales of assets and other, net | 29 | (93 | ) | (112 | ) | ||||||
Restructuring charges and exit costs | 1,486 | 1,524 | 981 | ||||||||
Impairment charges | 1,098 | 935 | 401 | ||||||||
Operating (gains), losses and other charges, net | $ | 26,910 | $ | 2,366 | $ | 1,270 | |||||
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The pre-tax pension settlement loss of $24.3 million related to the completion of the Pension Plan liquidation during the year ended December 28, 2016. See Note 11 to our Consolidated Financial Statements for details on the Pension Plan liquidation.
Restructuring charges and exit costs were comprised of the following:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Exit costs | $ | 591 | $ | 697 | $ | 335 | |||||
Severance and other restructuring charges | 895 | 827 | 646 | ||||||||
Total restructuring and exit costs | $ | 1,486 | $ | 1,524 | $ | 981 | |||||
Impairment charges for 2016 and 2015 resulted primarily from the impairment of restaurants identified as assets held for sale. The impairment charges for 2014 resulted primarily from the impairment of an underperforming restaurant.
Operating income was $47.0 million in 2016, $63.2 million in 2015 and $57.3 million in 2014.
Interest expense, net is comprised of the following:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Interest on credit facilities | $ | 4,606 | $ | 2,789 | $ | 3,519 | |||||
Interest on interest rate swaps | 789 | 859 | — | ||||||||
Interest on capital lease liabilities | 4,768 | 3,537 | 3,319 | ||||||||
Letters of credit and other fees | 1,185 | 1,180 | 1,381 | ||||||||
Interest income | (116 | ) | (66 | ) | (80 | ) | |||||
Total cash interest | 11,232 | 8,299 | 8,139 | ||||||||
Amortization of deferred financing costs | 593 | 507 | 483 | ||||||||
Interest accretion on other liabilities | 407 | 477 | 560 | ||||||||
Total interest expense, net | $ | 12,232 | $ | 9,283 | $ | 9,182 | |||||
Interest expense, net increased during 2016 primarily due to the increased balance of our credit facility and an increase in capital leases.
Other nonoperating (income) expense, net was income of $1.1 million for 2016, expense of $0.1 million for 2015 and income of $0.6 million for 2014. The income for the 2016 period was primarily the result of gains on deferred compensation plan investments. The expense for the 2015 period consisted primarily of $0.3 million of write-offs of deferred financing costs related to our 2015 debt refinancing, partially offset by gains on lease terminations and deferred compensation plan investments. The income for the 2014 period consisted primarily of $0.5 million of gains on deferred compensation plan investments.
The provision for income taxes was $16.5 million for 2016, $17.8 million for 2015 and $16.0 million for 2014. The effective tax rate was 45.9% for 2016, 33.0% for 2015 and 32.9% for 2014. For the 2016 period, the difference in the overall effective rate from the U.S. statutory rate was primarily due to state taxes, the generation of employment tax credits, the Pension Plan liquidation, and foreign tax credits generated with the filings of federal amended tax returns. The 2016 rates were impacted by the recognition of a $2.1 million tax benefit related to the $24.3 million pre-tax settlement loss on the Pension Plan liquidation. This benefit was at a rate lower than the effective tax rate due to the previous recognition of an approximate $7.2 million tax benefit recognized with the reversal of our valuation allowance in 2011. In addition, we amended prior years’ U.S. tax returns in order to maximize a foreign tax credit in lieu of a foreign tax deduction, resulting in a net tax benefit of approximately $3.7 million during the year.
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For 2015, the difference in the overall effective rate from the U.S. statutory rate was primarily related to state taxes and the generation of employment and foreign tax credits.
For 2014, the difference in the overall effective rate from the U.S. statutory rate was primarily due to state and foreign taxes, the generation of employment tax credits and two discrete tax items. State job tax credits of 1.3% were claimed during 2014 for the current year’s hiring activity. State job tax credits of 1.1% were also claimed during the 2014 period resulting from the prior year's hiring activity. In addition, share-based compensation adjustments resulted in an out-of-period tax benefit of 1.0%. We do not believe the out-of-period adjustment was material to any prior or current year financial statements or on earnings trends.
Net income was $19.4 million for 2016, $36.0 million for 2015 and $32.7 million for 2014.
Liquidity and Capital Resources
Summary of Cash Flows
Our primary sources of liquidity and capital resources are cash generated from operations and borrowings under our credit facility (as described below). Principal uses of cash are operating expenses, capital expenditures and the repurchase of shares of our common stock.
The following table presents a summary of our sources and uses of cash and cash equivalents for the periods indicated:
Fiscal Year Ended | |||||||||||
December 28, 2016 | December 30, 2015 | December 31, 2014 | |||||||||
(In thousands) | |||||||||||
Net cash provided by operating activities | $ | 71,162 | $ | 80,637 | $ | 74,574 | |||||
Net cash used in investing activities | (32,656 | ) | (32,735 | ) | (21,289 | ) | |||||
Net cash used in financing activities | (37,585 | ) | (49,305 | ) | (53,154 | ) | |||||
Net increase (decrease) in cash and cash equivalents | $ | 921 | $ | (1,403 | ) | $ | 131 | ||||
Net cash flows provided by operating activities were $71.2 million for the year ended December 28, 2016 compared to $80.6 million for the year ended December 30, 2015. The decrease in cash flows provided by operating activities is primarily due to the funding of our pension liability during 2016. We believe that our estimated cash flows from operations for 2017, combined with our capacity for additional borrowings under our credit facility, will enable us to meet our anticipated cash requirements and fund capital expenditures over the next twelve months.
Net cash flows used in investing activities were $32.7 million for the year ended December 28, 2016. These cash flows are primarily comprised of capital expenditures of $19.7 million and restaurant acquisition costs of $14.3 million. The capital expenditures included the remodel of 27 company restaurants. The restaurant acquisition costs include $13.7 million for ten franchised restaurants reacquired during 2016 and the payment of $0.6 million for a franchised restaurant that was reacquired during 2015.
Our principal capital requirements have been largely associated with the following:
Fiscal Year Ended | |||||||
December 28, 2016 | December 30, 2015 | ||||||
(In thousands) | |||||||
Facilities | $ | 7,365 | $ | 9,743 | |||
New construction | 3,347 | 2,262 | |||||
Remodeling | 6,374 | 12,688 | |||||
Information technology | 1,299 | 1,002 | |||||
Other | 1,364 | 1,282 | |||||
Capital expenditures | $ | 19,749 | $ | 26,977 | |||
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Capital expenditures for fiscal 2017 are expected to be between $22-$24 million.
Cash flows used in financing activities were $37.6 million for the year ended December 28, 2016, which included stock repurchases of $51.6 million and the purchase of a $6.9 million equity forward contract related to the 2016 ASR agreement, partially offset by net long-term debt borrowings of $20.3 million.
Our working capital deficit was $57.5 million at December 28, 2016 compared with $65.1 million at December 30, 2015. The decrease in working capital deficit is primarily related to the 2016 funding of our pension liability and the timing of payments impacting payable balances. 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.
Credit Facility
As of December 28, 2016, we had outstanding revolver loans of $218.5 million and outstanding letters of credit under the senior secured revolver of $22.4 million. These balances resulted in availability of $84.1 million under the credit facility. Prior to considering the impact of our interest rate swaps, described below, the weighted-average interest rate on outstanding revolver loans was 2.45% and 1.76% as of December 28, 2016 and December 30, 2015, respectively. Taking into consideration the interest rate swaps, the weighted-average interest rate of outstanding revolver loans was 2.74% and 2.31% as of December 28, 2016 and December 30, 2015, respectively.
A commitment fee of 0.25% is paid on the unused portion of the revolving credit facility. Borrowings under the credit facility bear a tiered interest rate, which is based on the Company's consolidated leverage ratio and was set at LIBOR plus 175 basis points as of December 28, 2016. The maturity date for the credit facility is March 30, 2020.
The credit facility is available for working capital, capital expenditures and other general corporate purposes. The credit facility is guaranteed by the Company and its material subsidiaries and is secured by assets of the Company and its subsidiaries, including the stock of the Company's subsidiaries. It includes negative covenants that are usual for facilities and transactions of this type. The credit facility also includes certain financial covenants with respect to a maximum consolidated leverage ratio and a minimum consolidated fixed charge coverage ratio.
During the fourth quarter of 2016, the credit facility was used to fund a $25 million accelerated share repurchase agreement.
Interest Rate Hedges
We have interest rate swaps to hedge a portion of the cash flows of our floating rate debt. See Part II Item 7A. Quantitative and Qualitative Disclosures About Market Risk for details on our interest rate swaps.
Contractual Obligations
Our future contractual obligations and commitments at December 28, 2016 consisted of the following:
Payments Due by Period | |||||||||||||||||||
Total | Less than 1 Year | 1-2 Years | 3-4 Years | 5 Years and Thereafter | |||||||||||||||
(In thousands) | |||||||||||||||||||
Long-term debt | $ | 218,500 | $ | — | $ | — | $ | 218,500 | $ | — | |||||||||
Capital lease obligations (a) | 65,761 | 8,628 | 15,092 | 12,316 | 29,725 | ||||||||||||||
Operating lease obligations | 178,802 | 28,470 | 49,478 | 35,638 | 65,216 | ||||||||||||||
Interest obligations (a) | 24,199 | 5,977 | 16,131 | 2,091 | — | ||||||||||||||
Defined contribution plan obligations | 259 | 259 | — | — | — | ||||||||||||||
Purchase obligations (b) | 196,372 | 196,372 | — | — | — | ||||||||||||||
Unrecognized tax benefits (c) | 1,180 | — | — | — | — | ||||||||||||||
Total | $ | 685,073 | $ | 239,706 | $ | 80,701 | $ | 268,545 | $ | 94,941 | |||||||||
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(a) | Interest obligations represent payments related to our long-term debt outstanding at December 28, 2016. For long-term debt with variable rates, we have used the rate applicable at December 28, 2016 to project interest over the periods presented in the table above, taking into consideration the impact of the interest rate swaps for the applicable periods. The capital lease obligation amounts above are inclusive of interest. |
(b) | Purchase obligations include amounts payable under purchase contracts for food and non-food products. Many of these agreements do not obligate us to purchase any specific volumes and include provisions that would allow us to cancel such agreements with appropriate notice. For agreements with cancellation provisions, amounts included in the table above represent our estimate of purchase obligations during the periods presented if we were to cancel these contracts with appropriate notice. |
(c) | Unrecognized tax benefits are related to uncertain tax positions. As we are not able to reasonably estimate the timing or amount of these payments, the related balances have not been reflected in the “Payments Due by Period” section of the table. |
Off-Balance Sheet Arrangements
Except for operating leases entered into during the normal course of business, we do not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to self-insurance liabilities, impairment of long-lived assets, restructuring and exit costs and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.
Our significant accounting policies, including the critical accounting policies listed below, are fully described in Note 2 to our Consolidated Financial Statements. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:
Self-insurance liabilities. We are self-insured for a portion of our losses related to certain medical plans, workers’ compensation, general, product and automobile insurance liability. In estimating these liabilities, we utilize independent actuarial estimates of expected losses, which are based on statistical analysis of historical data. Our estimates of expected losses are adjusted over time based on changes to the actual costs of the underlying claims, which could result in additional expense or reversal of expense previously recorded.
Impairment of long-lived assets. We evaluate our long-lived assets for impairment at the restaurant level on a quarterly basis, when assets are identified as held for sale or whenever changes or events indicate that the carrying value may not be recoverable. For assets identified as held for sale, we use the market approach and consider proceeds from similar asset sales. We assess impairment of restaurant-level assets based on the operating cash flows of the restaurant, expected proceeds from the sale of assets and our plans for restaurant closings. Generally, all restaurants with negative cash flows from operations for the most recent twelve months at each quarter end are included in our assessment. For underperforming assets, we use the income approach to determine both the recoverability and estimated fair value of the assets. To estimate future cash flows, we make certain assumptions about expected future operating performance, such as revenue growth, operating margins, risk-adjusted discount rates, and future economic and market conditions. If the long-lived assets of a restaurant are not recoverable based upon estimated future, undiscounted cash flows, we write the assets down to their fair value. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges.
Restructuring and exit costs. Discounted liabilities for future lease costs of closed restaurants, net of the fair value of related subleases, are recorded when the restaurants are closed. All other costs related to closed restaurants are expensed as incurred. In assessing the discounted liabilities for future costs of obligations related to closed restaurants, we make assumptions regarding amounts of future subleases.
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The most significant estimates included in our accrued exit cost liabilities relate to the timing and amount of estimated subleases. If any of the estimates or their related assumptions change in the future, we may be required to record additional exit costs or reduce exit costs previously recorded.
Income taxes. We make certain estimates and judgments in the calculation of our provision for income taxes, in the resulting tax liabilities, and in the recoverability of deferred tax assets. We record valuation allowances against our deferred tax assets, when necessary. Realization of deferred tax assets is dependent on future taxable earnings and is therefore uncertain. We assess the likelihood that our deferred tax assets in each of the jurisdictions in which we operate will be recovered from future taxable income. Deferred tax assets do not include future tax benefits that we deem likely not to be realized.
We record a liability for unrecognized tax benefits resulting from tax positions taken, or expected to be taken, in an income tax return. We recognize any interest and penalties related to unrecognized tax benefits in income tax expense. Penalties, when incurred, are recognized in general and administrative expense. Assessment of uncertain tax positions requires judgments relating to the amounts, timing and likelihood of resolution.
Recent Accounting Pronouncements
See the Accounting Standards to be Adopted section of Note 2 to our Consolidated Financial Statements included in Part II, Item 8 of this report for further details of recent accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We have exposure to interest rate risk related to certain instruments entered into for other than trading purposes. Specifically, as of December 28, 2016, borrowings under our credit facility bore interest at variable rates based on LIBOR plus a spread of 175 basis points per annum.
We have interest rate swaps to hedge a portion of the cash flows of our floating rate debt. We designated these interest rate swaps as cash flow hedges of our exposure to variability in future cash flows attributable to payments of LIBOR due on specific notional amounts.
Based on the interest rate as determined by our consolidated leverage ratio in effect as of December 28, 2016, under the terms of the swaps, we will pay the following fixed rates on the notional amounts noted:
Period Covered | Notional Amount | Fixed Rate | |||||
(In thousands) | |||||||
March 31, 2015 - March 29, 2018 | $ | 120,000 | 2.88 | % | |||
March 29, 2018 - March 31, 2025 | 170,000 | 4.19 | % | ||||
April 1, 2025 - March 31, 2026 | 50,000 | 4.21 | % | ||||
As of December 28, 2016, the fair value of the interest rate swaps was a liability of $0.8 million, which is recorded as a component of other noncurrent liabilities on our Consolidated Balance Sheets.
As of December 28, 2016, the swap effectively increased our ratio of fixed rate debt from approximately 11% of total debt to approximately 60% of total debt. We expect to reclassify approximately $0.7 million from accumulated other comprehensive loss related to our interest rate swaps during the next twelve months. This amount will be included as a component of interest expense in our Consolidated Statements of Income. See Note 10 to our Consolidated Financial Statements for additional details.
Based on the levels of borrowings under the credit facility at December 28, 2016, if interest rates changed by 100 basis points, our annual cash flow and income before taxes would change by approximately $1.0 million. This computation is determined by considering the impact of hypothetical interest rates on the credit facility at December 28, 2016, taking into consideration the interest rate swap. However, the nature and amount of our borrowings may vary as a result of future business requirements, market conditions and other factors.
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Commodity Price Risk
We purchase certain food products, such as beef, poultry, pork, eggs and coffee, and utilities such as gas and electricity, that are affected by commodity pricing and are, therefore, subject to price volatility caused by weather, production problems, delivery difficulties and other factors that are outside our control and which are generally unpredictable. Changes in commodity prices affect us and our competitors generally and often simultaneously. In general, we purchase food products and utilities based upon market prices established with vendors. Although many of the items purchased are subject to changes in commodity prices, the majority of our purchasing arrangements are structured to contain features that minimize price volatility by establishing fixed pricing and/or price ceilings and floors. We use these types of purchase arrangements to control costs as an alternative to using financial instruments to hedge commodity prices. In many cases, we believe we will be able to address commodity cost increases which are significant and appear to be long-term in nature by adjusting our menu pricing or changing our product delivery strategy. However, competitive circumstances could limit such actions and, in those circumstances, increases in commodity prices could lower our margins. Because of the often short-term nature of commodity pricing aberrations and our ability to change menu pricing or product delivery strategies in response to commodity price increases, we believe that the impact of commodity price risk is not significant.
We have established a process to identify, control and manage market risks which may arise from changes in interest rates, commodity prices and other relevant rates and prices. We do not use derivative instruments for trading purposes.
Item 8. Financial Statements and Supplementary Data
See Index to Financial Statements which appears on page F-1 herein.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive and financial officers, including the Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), evaluated the effectiveness of our design and operation of our disclosure controls and procedures pursuant to and as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report.
Based on their assessment as of December 28, 2016, our CEO and CFO have concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during our fourth quarter ended December 28, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 28, 2016 based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 28, 2016.
The effectiveness of our internal control over financial reporting as of December 28, 2016 has also been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report that appears herein.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Denny's Corporation
We have audited Denny’s Corporation’s (the Company) internal control over financial reporting as of December 28, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A.). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accor