Dine Brands Global, Inc. (DIN) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 DineEquity Earnings Conference call. My name is Larry, and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Julia Stewart, Chairman and CEO; Tom Emrey, Chief Financial Officer; and Ken Diptee, Executive Director of Investor Relations. Please proceed.

Good morning, and thank you for participating on DineEquity's First Quarter 2012 Investor Conference Call. Today, I'm joined by Julia Stewart, Chairman and CEO; and Tom Emrey, CFO. Before I turn the call over to Julia and Tom, let me remind you of our Safe Harbor regarding forward-looking information. Today, management may discuss information that is forward-looking and involves known and unknown risks, uncertainties and other factors which may cause the actual results to be materially different than those expressed or implied in such statements. We caution you to evaluate such forward-looking information in the context of these factors, which are detailed in today's press release, as well as in our most recent 10-Q filings with the Securities and Exchange Commission. The forward-looking statements made today are made as of the date hereof and assumes no obligation to update or supplement any forward-looking statements. Additionally, on this call, we may refer to certain non-GAAP financial measures. These non-GAAP financial measures are described in our press release today and are also available on DineEquity's Investor Relations website. With that, I'll turn the call over to Julia Stewart, Chairman and CEO. Julia?

Thanks, Ken, and good morning, everyone. Welcome to our first quarter 2012 earnings call. I'd like to use this opportunity to provide additional commentary on the news release we issued this morning regarding our results, and we'll open the call for your questions. Let me begin by saying we're pleased with our first quarter performance and importantly, our business fundamentals remain strong. We continue to deliver in our strategy to generate significant free cash flow and reduce debt. I'm also delighted that we made additional progress on re-franchising Applebee's company-operated restaurants. We've entered into an asset purchase agreement without financial contingencies the sale of 39 restaurants in Virginia. With the completion of these transactions, we will have 98 restaurants remaining to sell. And we'll keep 23 restaurants in Kansas City as an R&D test market. The net proceeds will be used for further debt reduction. Consistent with our historical practice, we will issue new guidance when this deal closes, likely some time in the third quarter. Now I will review our operating performance for the quarter beginning with Applebee's. We achieved domestic same-restaurant sales growth of 1.2% in the first quarter compared to strong growth of 3.9% in the first quarter of 2011. This means we achieved sales growth of 5.1% over the last 2 years. Same-restaurant sales experienced a lift in part from the mild winter weather and from our ongoing remodel program. However, we recognize the need for more traffic-driving innovation across products, service platforms and promotions at Applebee's. To that end, I'm challenging the organization to speed up innovation even more than we've already done so. And remember, we have upgraded or replaced over 90% of the menu over the last 4 years. That process is well under way, and I want to call attention to some new product introductions which occurred in the quarter, including a number of dishes from our Unbelievably Great Tasting & Under 550 Calories menu that resonated strongly with our guests. In February, we refreshed our signature "2 for $20" menu with the launch of jazzed-up flavors of Bourbon Street. This promotion continued through the end of the first quarter and featured 2 new items, Blackened Chicken Penne and Bourbon Street Chicken & Shrimp, which was an extension of our popular Sizzling Entrees platform. Applebee's has built a significant and compelling value proposition for our guests with "2 for $20". And as we've said previously, the Applebee's remodel program is another significant part of our strategy to reinvigorate the brand. In the first quarter, our franchisees continued the rapid pace with an additional 87 restaurants remodeled. When combined with new openings and previous remodels, 671 Applebee's restaurants with 36% of the domestic system have a new look. We expect more than 50% of the domestic system to have this exciting new physical appearance by the end of this year. Our franchisees are enthusiastic about the remodel and see the benefit of the program. On average, remodeled restaurants continue to experience a mid-single-digit percentage increase in sales, pre-post net of control. Next, I'd like to review Applebee's gift card sales and redemptions, which continues to serve as a catalyst for growth. After achieving $300 million in system sales in 2011, an increase of 6% over 2010, we experienced solid redemptions throughout the first quarter. The Gift Card business continued to be an important part of our overall marketing strategy. And on the development front, Applebee's franchisees opened 6 new restaurants in the first quarter, of which 5 were international. And while pleased with the overall 2-year comp sales trend, we are keenly focused on driving sustainable traffic growth. We've established a strong innovation track record at Applebee's, but we need to do even more to strengthen our leadership position. To do that, we must drive value which, of course, remains top of mind with our guests. It's important to reiterate that value doesn't just mean price. So we remain committed to driving traffic through innovation in every aspect of our business, from menu, marketing and technology innovation, which we believe will propel us forward. Now let's turn to IHOP. Our journey to re-energize the brand continues, and we clearly have additional work ahead of us. While first quarter domestic system-wide sales restaurants declined slightly at 0.5%, there are some positive results driven by the Plan for Success initiative to improve IHOP's restaurant operations and increase traffic and sales. Nothing is more important for us than getting IHOP back where it needs to be, innovating and growing. On operations. In the first quarter, we launched our revamped Service Excellence Program, which is our in-restaurant service model to enhance the guest experience, speed and attentiveness. Early results from the Service Excellence Program showed that our guests are seeing a positive change. The restaurants that have implemented the program are consistently achieving higher guest satisfaction scores in guest loyalty, intent to return, likely to recommend and overall satisfaction. We ultimately expect this to translate -- into higher sales. To that end, we continually work closely with our franchisees to analyze their guest loyalty index scores to ensure that franchisees address the areas that their loyal guests share with them. On value. To drive sales and further enhance our value platform, we launched IHOP's first nationally promoted value offering in the first quarter with our 7 for $7 menu, which features 7 great entrées for $7 every day. We gained some very valuable insight here and that we'll have significant long-term benefit. So stay tuned as we drive value that is relevant to IHOP's consumers. On the menu. We're implementing the first phase of our new menu strategy, which is in restaurants today, to simplify and optimize the menu by focusing on key items that our guests know us for. As I mentioned on previous investor calls, we have restructured our menu strategy around 4 culinary platforms: core equity, which includes items like our famous pancakes and coffee; branded signature items, such as stuffed French toast, which helps to differentiate IHOP; enhance value items, such as our 7 for $7 offering, which provides everyday value; and health and wellness, which includes items like our spinach, mushroom and tomato omelette. We have some more work to do here but there is encouraging progress. On advertising. Another aspect of our plan to drive sales is the development of new advertising to leverage our iconic brand heritage and play to our strengths. We intend for this new advertising to help us redefine the American breakfast experience. Look for this new ad campaign in the second quarter. IHOP has increased its resources to understand the interests of our guests and accelerate the culinary pipeline with new and exciting offerings. Additionally, our efforts in digital marketing and social media will allow IHOP to reach a broad spectrum of guests and better meet their changing needs and expectations. Regarding development, IHOP's franchisees opened 10 new restaurants in the first quarter, 9 of which were domestic. And lastly, IHOP celebrated another successful National Pancake Day, its annual free pancake fundraiser. IHOP raised more than $3 million in donations for Children's Miracle Network hospitals and other local charities, meeting its 2011 fundraising total by more than 20%. We've now raised more than $10 million for Children's Miracle Network hospitals and other local charities. We're thrilled with the generosity demonstrated by both our franchisees and guests, who help us give back to the communities in which we operate and enrich the lives of children in need. We have some very interesting innovation at both brands aimed at ensuring each achieves its full promise. And while the initiatives we just discussed show some real potential, more needs to be done to unite them in a cohesive everyday guest experience, and I'm personally working on that with the Brands and the Culinary teams. All in all, I do believe both brands are on the right track, but we have real work to do and I'm proud of our team. They are very much responding to the challenge. With that, I'd like to turn the call over to our CFO, Tom Emrey, for discussion of our financial results. Tom?

Thanks, Julia. I'd like to review a few points in the press release we issued this morning. Free cash flow resulting in debt reduction and lower interest costs are the main themes. In the first quarter of 2012, we reduced our total debt by $86 million. Bank debt was reduced by $69 million, bond debt by $5 million and combined financing and capital lease obligations by $12 million. Our leverage ratio at the end of the first quarter was 5.2x. Our ability to steadily generate significant free cash flow has enabled us to substantially reduce our debt by approximately $795 million since the Applebee's acquisition in 2007. Interest expense was reduced by $6 million in the first quarter of 2012 from a year ago, primarily as a result of our debt-reduction strategy, as well as the repricing of our senior secured credit facility in February of 2011. The strength of our highly franchised business model allows us to generate strong and stable free cash flow with reduced volatility. It's worth noting that we've generated free cash flow in excess of $100 million in each of the last 3 fiscal years. For the first quarter of 2012, we generated free cash flow of $44 million. Now note that the first quarter will generate a disproportionate share of non-refranchising-related free cash flow due to timing, primarily attributable to gift cards and the interest payment on our bonds, which occurs semi-annually in the second and fourth quarter of our fiscal year. Regarding income for the first quarter, adjusted net income available to common stockholders was $25 million or $1.36 per diluted share, compared to $26 million or $1.42 per diluted share a year ago. The year-over-year decrease of $1 million was primarily due to a higher income tax rate and lower segment profit, driven by the execution of our strategy to refranchise Applebee's company-operated restaurants, partially offset by lower cash interest expense. Our franchise segment gross profit is up approximately 5% over 2011 with the franchise margin improving to 74.5% for the first quarter of 2012 from 73.8% a year ago. The improvement is primarily driven by the additional restaurants from the refranchising of Applebee's company-operated restaurants and new restaurant development by franchisees year-over-year. The effective tax rate for the first quarter of 2012 was 36.1% compared to 27.9% in the first quarter of last year. The prior year effective tax rate was lower due to the release of liabilities for gift card-related tax benefit, as a result of the issuance of first quarter 2011 guidance by the Internal Revenue Service. And on G&A, G&A expenses were $40 million for the first quarter of 2012 compared to $38 million in last year's first quarter. Most of these year-over-year increase was attributable to higher stock-based compensation and severance charges. During the quarter, we refranchised Applebee's company-operated restaurants in the mid-south area at a pre-tax gain of approximately $17 million. This gain is not reflected in our adjusted EPS but it is in our GAAP EPS. Lastly, I'd like to review company-operated restaurant margins which were strong in the quarter. For the first quarter of 2012, Applebee's company-operated restaurant margin for the 160 restaurants was 17.8% compared to 15.3% in the first quarter of last year. The increase was primarily driven by the refranchising of lower-margin restaurants, higher sale, lower hourly labor expense and a reduction in depreciation. These items were partially offset by commodities inflation. It's important to reiterate that as refranchising progresses, the company margins become less relevant. In fact, when we sell the balance of our Applebee's company-operated restaurants, we will no longer separately report on the remaining 33 DineEquity R&D restaurants. And with that, I will now turn the call back to Julia.

Thanks, Tom. As we discussed earlier, we entered into an asset purchase agreement for the sale of 39 Applebee's company-operated restaurants in Virginia, taking another significant step towards our strategic goal of being a predominantly franchise system. We expect the transaction to close during the third quarter. And just to reiterate, as we've done in the past, we will update our guidance after the transaction closes. And to summarize, we had a solid first quarter and continued to leverage our strong and stable free cash flow to significantly reduce our debts. We made additional refranchising progress with the completed sale of 17 Applebee's restaurants in the mid-south region. We continue to work closely with our brands to create new and innovative menu items and improve operational performance. And we remain focused on helping our franchisees increased their profitability. And one last comment, I'm sure you saw yesterday's news release announcing our new 10-year exclusive deal with Pepsi to supply beverages to both IHOP and Applebee's. This strategy is core to DineEquity and represents a real win for our franchisees and just as with our purchasing co-op, shows our commitment to drive real value for them. Our success depends on our franchisees' success. I'd like to close by saying that we delivered against our strategic objectives in the first quarter. We continue to generate strong free cash flow, reduce our debt and refranchise Applebee's company-operated restaurants. We continue to rejuvenate Applebee's and differentiate the brand. And at IHOP, we are executing on our strategy to drive sales by improving operations, innovating the menu and delivering a stronger, value proposition to our guests. And looking forward, we've got work to do and we're doing it. I want to be clear that I am optimistic about our long-term plan to continue to drive shareholder value through strong cash flow. Now Tom and I would be pleased to answer your questions. Operator?

[Operator Instructions] And our first question comes from the line of Will Slabaugh of Stephens.

On IHOP, just curious there on how you think of your value message here and how you think it's resonating, both in general and then as it relates to your new "7 for $7" menu.

Yes. I think this notion of communicating value to the consumer is really important to us. But clearly, we have to find that right niche. And part of what we've been working on is what resonates and how do we make certain that it comes through in a way that it works for consumers, both during the week, weekend, what can we find sort of that sweet spot. And as I said in the prepared remarks, we've learned so much from the "7 for $7". I think that will help us throughout the balance of the year as you see us do more in this value messaging. It's really hitting the sweet spot for us at IHOP. And that's what we're very focused on.

Okay. And then as far as the messaging, I was just wondering if you had any more color on the new marketing strategy and how you think that's working so far, specifically, just talking about the menu inserts, handouts versus your historical LTO strategy there.

Yes. I think the short answer is, we're a work in progress, and you should ask me more about that on the next call because I'll have a lot more data. We just put all that through in real time. But at least, the preliminary feedback that we've gotten in some of the consumer insights works that we've done is that people like it. It resonates with them. It's easy to read, easy to get to. So we've a lot of -- sort of like general comments like, "Boy, I really like this. This makes it easy for me." A lot of people are not even looking at the menu. Looking at the insert if you've been to an IHOP recently, it is very well done inside. So a lot of positive feedback. But in terms of, what it's done to mix and what it's done to profitability and the overall, I'll have more of that knowledge base on the next investor call.

Our next question comes from the line of Carla Casella of JPMorgan.

My question relates to the different day parts. Can you just talk about whether you're seeing more competition for either of the chains during the different day parts?

No. I think it's about the same as it's always been. I mean, clearly, when you think about IHOP, we're not just competing in family dining. We're also competing in the overall breakfast category. That's been going on for a while now. But I don't see -- nothing stands out as a particularly strong strength or weakness in any of the day parts. We have an opportunity and that's the focus that we've been working on, especially at Applebee's on the individual strategies. I think I've mentioned for the last 2 or 3 calls this focus on lunch with radio, dinner with TV, late-night with social media. It's very focused on the different day parts.

Okay, great. And then, on the -- I guess, I was just wondering if -- that what you're seeing in terms of the consumer strength or weakness. And does that -- when you see consumer weakness, is that a certain day part that gets affected more than another? And if you're seeing any improvement in the overall -- this consumer trend?

Yes. I think I've said before, I don't notice any real blips up or down. And I think I've said before, I think the real opportunity is us. I think we have an opportunity to better differentiate both brands and that's the focus. I don't see any really -- I know there's people who will tell you there's direct corollaries and the like. I think we view our consumers as there for the taking and just very focused on the differentiating of both the brands.

Our next question comes from the line of Reza Vahabzadeh of Barclays.

As far as leverage, would you anticipate, Julia and Tom, that you can get into that 4x leverage neighborhood by beginning of next fiscal year? Would you target lower leverage next fiscal year as well?

I think -- here's the way to think about it. We've said, for the foreseeable future, we're just paying down debt. And so if you think about our free cash flow projection paying down debt, hopefully trying to sell as many company restaurants as possible, at that rate, you will end up with a 4x on your leverage at some point in 2013.

Got it. And then was weather a factor either way for your same-store sales in the first quarter?

I think the way to look at it is itsy bitsy spider. I mean, it had probably a teeny, teeny, teeny impact on both brands but not enough to wave a flag and talk about. I mean -- and to be very candid with you, it's not an exact science. I mean, I could have the team spending weeks on it. Intuitively, I think Tom and I would tell you -- feel free to jump in here, that there probably was a slight positive impact but not enough to.

Yes, there is. And from a management standpoint, it's really not actionable. So we don't spend a lot of time with it.

Right. But it wasn't a huge number, I guess, is the better way to say it.

Got it. And then on the franchisee margins, as you highlighted, you got good operating leverage there in this quarter. Is that something that one should broadly expect to occur over the balance of the year? And going forward, just getting that higher operating leverage on franchisee revenues?

No, I don't know that I would say that. I think the first quarter tends to be a little bit front loaded in terms of the margins. And I think we stand by the guidance that we issued, and we're just going to watch it like you do.

Our next question comes from the line of Peter Saleh of Telsey Advisory Group.

I just want to ask about the menu mix and what you're seeing across your system, both lunch and dinner. Are you seeing more alcohol sales, more desserts, more appetizers? Or is that kind of holding steady?

So, at the end of last year, at the last investor call, we talked about the fact that at Applebee's for the year, we had averaged 14% in alcohol mix, which was a record high for us at Applebee's. That's the highest it's been. And we're sort of tracking along like that, which is really good news. I think that is twofold. I think that is the work that the chain has done a great job of getting food servers to suggest its sell at dinner. And I also think that's the work we're doing at late night in the individual program. So part of our increase has to do with late night. Part of our increase has to do with upselling at dinner and so that sort of continued. I haven't seen any really big change in that. And I think we always said that we had upside and opportunity. When we first bought the brand, the mix was about 12%. So we've made some huge inroads there. That is absolutely and of course, it means more profitability for the franchisees, the liquor mix. So that's good news. In terms of other items in the brands, I think we've had the steady improvement which we feel good about on Under 550 and Fabulous, Weight Watchers. Those have been really nice. That healthy wellness items at IHOP, we've seen some steady increases. So I think this notion of whether we're health conscious or had caloric sort of focus, that's been a nice positive uptick in mix. "2 for $20" has stayed about the same. It goes up ever so slightly when we go on television. But in terms of dramatic shift, not really. We've seen some nice steady progression, I would say, since the last couple of years.

And then on the remodel side, I'm sorry if I missed this at the beginning of the call. But where do we stand on the remodels? How many are done? How many are planning to be done for the rest of this year? And then the returns that you're seeing there?

Let Tom speak to the returns pre-post net of control. In terms of the what's been done thus far, it's 671 or about 37% of the system. We'll be just about 50% of the system by the end of this year. I think we've always said that we'll be pretty much all done by early part of 2014 which is really good news since the franchisees contractually have to do it in 6 years. But they have been so about the remodel, so supportive of it. They'll get it done probably closer to 4. And you want to talk about the...

Oh, the list has been what we continued to be what we have seen so far, which is mid-single-digit pre/post net of control.

[Operator Instructions] And our last question comes from the line of Michael Gallo of CL King.

I just wanted to delve a little bit on "7 for $7". Can you talk a little bit about where that's mixing, how consumers are using the menu and whether you think it's the right platform, whether you think it's additive, whether you think it cannibalizes any of the core items or just a little more on how the consumers are using that?

Yes. The "7 for $7" right now is giving about 5% of the mix. And that's been pretty consistent since we went on the air. I think, in terms of the long-term what's the right message, that's the work that I told you we're spending some more time in consumer insights. And by the July call, I should have a lot more data on. We're fairly new into that. The really, really good news is that the franchisees, and remember we have a lot of them at IHOP, are very supportive and aligned on this notion of creating the right value message. And that, I am thrilled about, because it means that we've got a system that is supportive of trying to figure out what's exactly the right message. There's no question that just doing this handout, if you've been at an IHOP recently, I encourage you to do so. If you see that handout, that is really resonating with everyone. So I think this notion of mixing new items with a value message all in the inserts works for IHOP. It sort of attracts all the different folks that were getting into an IHOP. That's, I think, our sweet spot. The actual dollar number and what's the right mix, that's what we're working on as we speak. But I really feel very comfortable in saying, we'll have a lot more data on that come the next call. It's a great question.

Great. The other question I have is on the Applebee's side. I was wondering if you saw any regional differences in comps in terms of California versus northeast versus some of the other areas?

We always have slight differences but nothing extreme. You might see a point here, 1/2 a point there, but nothing worth talking about in a meaningful way.

And we have one more question coming from the line of Brian Vaccaro of Raymond James.

Just one quick one for me, a nitpick. On the G&A, you mentioned that there's some severance in there. Can you specify how much that was in the quarter?

Well, it's in the hundreds of thousands of dollars. I don't want to start to get into specifics. That was a -- it's a huge number.

The way you should think about it is, as you know, we reiterated on the press release guidance for the year and so a lot of this is timing. So we were just calling it out for you. But we've reiterated guidance for the year in G&A. So that's probably a better way to think about it.

With no further questions, I would like to turn the call back over to Julia Stewart for closing remarks.

Well, thanks, all, for joining us this morning. Our second quarter reporting date is July 31. If you have any questions, please feel free to call Ken, Tom or myself. We're here for you, and we thank you for your time.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may disconnect at this time. Have a great day.