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Denny's eyes higher food costs, price hikes

Denny’s Corp. executives said they will need to raise menu prices to counter inflation pressures in a call with analysts discussing third-quarter earnings.

Company officials remain cautiously optimistic on the chain’s current strategy of blending everyday value propositions and compelling limited-time offers, and said those methods will continue to help build sales.

The Spartanburg, S.C.-based operator, franchisor and licensor of 1,677 family-dining restaurants said net income fell 19.2 percent to $8 million, or 8 cents per share, for the quarter ended Sept. 28, compared with $9.9 million, or 10 cents a share, in the same quarter last year.

Quarterly same-store sales increased 1.1 percent at company-owned restaurants and 0.8 percent at franchised and licensed locations, compared with the prior year, Denny’s said. Corporate revenue fell 2.3 percent to $136.7 million on lower company-store sales from refranchising and lower franchising income compared with the prior year, when a conversion deal with Pilot Flying J Travel Centers brought in additional dollars not available in the latest quarter.

Inflation challenges

John Miller, president and chief executive of Denny’s Corp., said the company’s third quarter results reflect how the chain is “overcoming what remains a fairly challenging consumer economic environment, as well as inflation pressures impacting both our business and customers’ wallets.”

“Our success is being achieved with consistent brand execution leveraging our three primary marketing strategies of delivering every day affordability, creating compelling limited time only product offerings and deriving sales beyond breakfast,” he said.

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“We’re pleased with what the beyond breakfast initiatives are bringing us … Our dinner and late night are responding in a positive way,” Miller added.

“Even with all the new product news we have, our guests continue to desire value, as evidenced by our $2-$4-$6-$8 Value Menu increasing slightly from the second quarter,” Miller said. “The value menu mix remained in the high teens during the quarter, which was much lower than the 20-percent mix seen during the third quarter of last year.”

He added that Denny’s “everyday affordability strategy continues to work hard for us, driven by our $2-$4-$6-$8 value menu and store-level discounts directed by our local [advertising] co-ops.”

Denny’s expects the prices it pays for goods to rise 3 percent to 5 percent next year, said Mark Wolfinger, chief financial and administrative officer.

“Strategically, we will remain focused on our price value advantage relative to our competitors and potential negative impact of pricing to long-term guest traffic, which is why we are looking at taking a modest amount of pricing next year to offset inflationary pressures,” he said.

Although executives did not provide details on projected price increases, they said price hikes will likely come “earlier” in 2012 than they did this year, when the chain raised prices in June.

New unit growth

Denny’s officials said the company is no longer planning to open in 2011 two units of a fast-casual version of its restaurants called Denny’s Café that it is testing.

“It is [research and development], and we’re excited about our opportunities in nontraditional formats, and we’ll continue to work towards a new introduction,” Miller said. “We’re not ready with details at the moment of the timing of that and the nature of it.

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“Given what we have learned on campuses and that venue, we are excited about the future potential of it,” he added. “We do believe that a smaller-footprint Denny’s can assist the brand, especially in penetrating those urban centers the farther east you go, New York, Boston, D.C. and markets like that, where there could be some tremendous upside.”

This year, franchisees will open five Denny’s units on college campuses, which is down from the 10 such openings originally cited in guidance by the franchisor. The chain operates both food court restaurants and fast-casual units on campuses.

Miller said Denny’s is bullish on opening restaurants at colleges, but noted the learning curve in timing new unit development as the company deals with two new franchisee groups: universities and multinational contract foodservice organizations.

“We are very excited about the 11 university units we have opened since the beginning of 2010 and the attractiveness of the Denny’s brand in new distribution points,” Miller said. ”Although we do not expect to open any more university units in 2011, we remain focused on building our pipeline for 2012 and beyond.”

Other highlights from the call:

• Denny’s Corp. repaid another $10 million of term debt in the third quarter, Wolfinger said.

“We’ve reduced debt by $320 million, or 58 percent, since the end of 2005, lowering interest expense by $33 million, when comparing full-year 2005 to the last 12 months,” he said.

• Focus is shifting to franchising.

“The franchise side of our business contributed 59 percent of the gross profit margin in the third quarter, which is $6.5 million more than our company restaurants,” Wolfinger said. “The income shift to a franchise focus business model allows us to increase the predictability of our earnings.”

• At the end of the third quarter, Denny’s Corp. had sold a total of 327 units to franchisees since 2007 as part of its goal of operating just 10 percent of systemwide units. About 87 percent of the system is now operated by franchisees, Miller and Wolfinger said.

Denny’s expects to achieve its desired 10-percent/90-percent ratio by the end of 2012, and plans to sell another 40 to 50 units in the next 15 months.

Contact Alan J. Liddle at [email protected].
Follow him on Twitter: @AJ_NRN

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