Earnings Labs

Dine Brands Global, Inc. (DIN)

Q2 2017 Earnings Call· Thu, Aug 10, 2017

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Transcript

Operator

Operator

Hello and welcome to the Second Quarter 2017 DineEquity Earnings Conference Call. My name is Eric and I will be your operator for today’s call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ken Diptee. Please go ahead, sir.

Ken Diptee

Analyst

Good morning and welcome to DineEquity’s second quarter 2017 conference call. I’m joined by Richard Dahl, Chairman and Interim CEO; Gregg Kalvin, Interim CFO and Corporate Controller; Darren Rebelez, President of IHOP; John Cywinski, President of Applebee’s, and Daniel del Olmo, President of International division. Before I turn the call over to Richard, please remember our safe harbor regarding forward-looking information. During the call, 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 substantially different than those expressed or implied. We caution you to evaluate such forward-looking information in the context of these factors which are detailed in today’s press release and 10-Q filing. The forward-looking statements are made as of today and assumes no obligation to update or supplement these statements. We may also refer to certain non-GAAP financial measures which are described in our press release and also available on DineEquity’s investor relations website. With that, I will now turn the call over to Richard.

Richard Dahl

Analyst

Thank you, Ken, and good morning, everyone. We have a lot to cover today and I trust you all had the opportunity to review our press releases on earnings, the dividend, and last but certainly not least, the appointment of our new Chief Executive Officer. We have search long and hard for a new Chief Executive Officer for DineEquity. We’ve assessed talent, both within the industry and outside of our industry. It became quite clear as our process evolved that Steve Joyce would be the best choice for the CEO of Dine. He is a doer. He is excellent with franchisees, turning around assets, building culture, and catalyzing growth in the hospitality business. The restaurant and hospitality industries are similar, and the loyalty and revenue increases are dependent upon providing a compelling product at a strong value. Steve will become CEO, effective September 12, 2017. I’ve known Steve over the past several years as a fellow director His clear vision and innovation make him the perfect leader for our Company. His experiences in the restaurant and hospitality industry, both as the franchisor, operator and owner, make him uniquely qualified. And importantly, his skill in dealing with challenged businesses fits our current situation. Steve is on this call, and I will ask him to say a few words as we wrap up the discussion on our earnings and the presentations by the division presidents. I would like to focus on a few issues before I ask Gregg Kalvin, John Cywinski, and Darren Rebelez to add their comments. For Applebee’s, we have a great group of franchisees who are fully invested as is Dine in restoring guest confidence and financial health to our brand. Efforts to re-empower the brand with necessary financial and human resources are well underway. John will discuss significant…

Gregg Kalvin

Analyst

Thank you, Richard. Good morning, everyone. For the second quarter, our adjusted EPS was $1.30 compared to $1.59 for the second quarter of 2016. The variance is primarily driven by lower gross profit due to 6.2% decline in Applebee’s comp sales, slower collection of Applebee’s royalties and higher Applebee’s restaurant closures. The impact of these declines on adjusted EPS was partially offset by fewer weighted average diluted shares outstanding. Turning to G&A expenses. A slight increase in G&A for the second quarter of 2017 compared to the same period of 2016 was mainly due to higher cost for professional services. The increase in professional services was primarily driven by investments in Applebee’s stabilization initiatives, which include the utilization of third-party consultants to assess the brand’s performance and provide actionable recommendations. Regarding the $10 million in cost associated with the Applebee’s stabilization initiatives we discussed last quarter, approximately $6 million was incurred in the first half of 2017. We now expect the remaining $4 million will be incurred ratably over the second half of the year. As a reminder, we anticipate the substantial amount of these costs will not recur in 2018. Lastly, I would like to highlight that these costs are unrelated to the $8 million committed to the Applebee’s national advertising fund, which will not be included in our G&A. These costs will be recorded as an expense in our franchise segment ratably over the third and fourth quarters of 2017. Turning to our tax rate. Our GAAP effective tax rate for the second quarter of 2017 was 46.5% compared to 32.5% for the same period last year. The variance was primarily due to increase in our estimated unrecognized tax benefits in 2017 related to deductions associated with certain internally developed software and the adoption of new accounting guidance…

John Cywinski

Analyst

Thanks, Gregg, and good morning, everyone. Over my first 120 days or so with brand, I’ve spent considerable time with our 33 franchise partners to truly understand the perspectives on our recent past and to gain alignments on our path forward. While the past 24 plus months have been extraordinarily difficult, our partnership and commitment to one another is strong as is our understanding that a turnaround won’t happen overnight. Together, we have concluded the initial assessment stage of the plan, and we have a firm grasp on where things went wrong, as well as the detailed action plan to enhance Applebee’s relevance and performance, moving forward. Now, I’d like to frame my remarks this morning around the following components of the business: Restaurant operations; our guests; culinary innovation; and brand marketing. So, starting with operations. We’ve had too much restaurant variability across our system as well as a rather high percentage of guests not satisfying with their experience. Franchisees however have shown significant improvement on this front over the past few quarters with the percentage of fully operated restaurants narrowing from a high of 16%, down to about 4% where we currently stand. Our focus moving forward is simplifying our operation while elevating guest experience across all 33 franchise groups. As part of this initiative, we have retained PricewaterhouseCoopers to help us unlock between 100 and 200 basis points of restaurant level profitability over the next couple of years, which can be redeployed as necessary to labor and food investment. Now, as Gregg outlined, we will be aggressive on restaurant closures this year. These closures typically fall into one or two categories. The first consists of older locations in lapse trade areas where once vibrant retail, residential and traffic characteristics are just no longer present, often where the desirable…

Darren Rebelez

Analyst

All right. Thanks, John, and good morning, everyone. We ended the second quarter as well as first six months of 2017 on slightly positive franchise restaurant sales, which consisted of 1% growth over the respective periods in the prior year. This was offset by a 2.6% decline in second quarter comp sales. Although we downwardly revised comp sales guidance, as a result, we upwardly revised expectations for franchisees to develop between 80 and 95 restaurants globally this year, the majority of which are domestic openings. The solid pace of development by franchisees in the first half of 2017 led to 33% growth in new restaurant openings over the first six months of last year. We are clearly disappointed in IHOP’s comp sales declines. This was mainly due to do softness in the dinner daypart as a result of promotions that did not have the impact on sales and traffic, as expected. The family dining category remains highly competitive as guests continue to focus on value and convenience. But, IHOP remains on solid ground as we continue to execute our strategy including developing off-premise occasion, enhancing the guest experience, remodeling restaurants and technology, and expanding our innovative culinary pipeline. Our planned focus is on also improving the guest experience outside of the restaurant. Consumers’ desire speed, quality, portability of food and affordability. They also utilize online ordering and apps to reduce their wait time. To further build on our revitalized IHOP and go platform, which is designed to grow off-premise sales and meet the convenience needs of our guests, we completed the rollout of our proprietary new packaging. This ensures that IHOP’s food will be just as delicious when taken off-premise. Additionally, we began the rollout of our online ordering platform in the second quarter. We anticipate completing the deployment system-wide,…

Richard Dahl

Analyst

Thanks, Darren. I’d like to add a few comments about our International division, which represents both Applebee’s and IHOP. Over the past five years our international restaurant development has a compound annual growth rate of over 8%. We should be up to approximately 290 restaurants by year-end 2017. Currently, IHOP development is outpacing Applebee’s in the key markets of Mexico, Canada and the Middle East. Many opportunities exist throughout the Far East and Latin America as well. Daniel del Olmo of this division is with us today, should you have any current questions. In the future, we’ll have Daniel comment on the progress of this important growth opportunity. In closing, I’m optimistic about the future of Dine. I believe that we have the right people, resources and strategy in place to position the company, our franchisees and our brands for long-term success. Finally, I would like to congratulate and thank our team members and our franchisees for their hard work and dedication. I also wish to thank the Board of Directors for their support of me. They are 110% engaged in the success of this business. We know, we have a lot more work to do, but I’m confident we’re up for the challenge. With that, I’d like to ask Steve Joyce to say a words. Steve, may be familiar to many of you as the CEO of Choice Hotels and prior to that Marriott. As I indicated, he has tremendous amount of experience that I could not and the Board and hope you all feel the same way, could not be more pleased with him stepping into the role as permanent CEO. Steve will have a few comments; he will not be able to answer questions as you’ll have plenty of time to do that with him once he sits in the chair. Steve, if I can turn this over to you for a few minutes and then back to me.

Steve Joyce

Analyst

Thanks, Richard. So first of all, I’d like to thank you for your service in stepping into a difficult situation and really providing tremendous leadership over the last eight or nine months in a very difficult situation. I think the Board is very appreciative and I know I am. Secondly, I’m appreciative of the confidence the Board has shown in me. And third, I’d just like to say, this is exactly the type of opportunity I was looking for, post-Choice. It is a tremendous company with tremendous assets that obviously needs some adjustments. But I think we’ve got good leadership. I think we’ll be able to add some talent to the team. I think we’re going to do a lot of different things that I think will add value as a long-time leader of choice than other public companies. My first priority is and always will be return to shareholders. That is the priority. And I think we’ve got a tremendous opportunity in this situation to drive real value for the shareholders to create a company that is a long-term viable opportunity with strong growth potential and a capitalization on two of the most iconic brands in the business. I have had some significant exposure to the restaurant business; I’m incredibly excited to be back in it full-time. Obviously, my background is a strong and consistent leadership of franchise systems. I know many of the franchisees here already, so I’m excited to spend more time with them and talk about what we’re going to do together. We’ve obviously, as you heard on this call, have strong leadership of not only the financial aspects of the company, but also with of the brands. So, I’m very interested and learning from the folks that are running those brands at this point and also helping support them in the efforts they were describing. And I’m also very interested in working with Richard in his new role as Chairman of the Company. And I’m ready, rolling and excited about starting on the 12. You’ll hear from me in a not too distant future., I’ll work with senior leadership and the Board to develop a comprehensive plan, which I would expect to deliver within the next 60 to 90 days, and then you can hold us accountable to that plan, because that’s really where we’ll be holding ourselves. So, I couldn’t be more excited about the opportunity. I think this is a tremendous company with tremendous potential, and I think we’ve got the leadership team and the Board to make that happen. So, with that, let me turn it back over to you, Richard.

Richard Dahl

Analyst

Great. Thank you, Steve. And again congratulations and we look forward to your leadership. With that, operator, what I’d like to do now is open the call for questions.

Operator

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Brian Vaccaro from Raymond James. Brian, your line is now open.

Brian Vaccaro

Analyst

Thank you, and good morning. Just had a couple of questions on the Applebee’s side and starting with the closures. I was curious was the increase in the closures for the year primarily related to the franchisee that you mentioned on the call or does it reflect more of the sort of the broader review of the system?

John Cywinski

Analyst

Brian, this is John. It’s a fairly complex process. Really, the change in guidance around closures reflects the fact that we tackle these one at a time, and each one requires a substantial negotiation unless it’s at lease end with the landlord. And so, we just have greater visibility another quarter into this as to where we stand. And so gain, I personally view this number and this range as necessary. I do not anticipate the same extent of closures next year, although there certainly will be some, and this is part of reestablishing financial health. But again, the change in guidance is just because we have visibility now to reality.

Richard Dahl

Analyst

Further to your question, the referenced franchisee, while there were store closures is not all due to that particular franchisee. It’s a widespread of pruning the stores across a wide range of franchisees. As Gregg indicated, just about very franchisee with few expectations has indeed used this opportunity to close doors, prune the system to rationalize it and improve it.

Brian Vaccaro

Analyst

And now that you’re little bit further down the road on the financial health review, I’m not asking for individual franchisee profitability, but can you comment on the system average overall of the franchisee profitability and also how much leverage the average franchisee has on their balance sheet?

Gregg Kalvin

Analyst

This is Greg. We don’t comment on individual franchisees or their leverage. What we do -- what when we have done, as I said is, had a thorough and thoughtful process reviewing every franchisee’s particular situation. And everybody’s unique, Brian because for obvious reasons they have different businesses and even in addition to Applebee’s. But we look at those on an individual basis and today, we focus on foreclosure as we previously said, but we consider all options open. And there are a lot of vehicles we can use to help our franchisees and their direct financial assistance. To-date it’s been mostly on the closure side. But again, we look at their individual situation all separately and they’re all unique.

Brian Vaccaro

Analyst

Okay. And then just two -- one more for me, if I could. You mentioned the improvement in some of the poorly operated units on the Applebee’s side, going from 16% to 4%. I guess what have been some of the primary areas in which that improvement occurred? Are we talking about reinvesting in labor to elevate services, is it climate, is it -- can you just give us some color on that?

John Cywinski

Analyst

Sure, Brian. This is John. Some of those -- but we have an internal set of metrics, some of those are kind of internal looking components of this formula around cleanliness and quality and safety. Most of what we’re talking about is guest facing. And specific improvements have been around guest satisfaction in particular and we’ve seen a significant tightening of our -- what was a pretty good variability previously, and again, most of that around guest satisfaction, the interaction between our servers and guests. I won’t speak specifically to investments in labor, that’s been a challenge at the restaurant level and we’re taking steps in the future to ensure that we can deploy labor more properly moving forward. But we’re pleased with the progress; we’re hearing that from our guests.

Operator

Operator

And our next question comes from Michael Gallo from C.L. King. Michael, your line is now open.

Michael Gallo

Analyst

Hi. Good morning. A couple of questions, if I may. First question, when we look at some of the costs you had this year for a onetime or perhaps ongoing, obviously there is the $10 million diagnostic. Should we think about the $8 million investment in advertising as something that’s going to be ongoing to some degree? Is that something you’re doing this year and see how it works and revaluate? Because obviously, as you are looking at more closures, it will likely put pressure on the advertising budget going forward. So, I was wondering how we should think about the $8 million? Thanks.

John Cywinski

Analyst

Michael, this is John. Look, the $8 million, as we speak is a necessary initiative as addressing some of that. Shortfall that we have in the ad fund, the shortfall is certainly larger than $8 million referenced. As to whether that would continue in the future, I don’t know, we don’t know. We’re committed to reestablishing financial health and sustain growth. This is a year-over-year challenge, 2017 versus 2016 at the moment and it’s fairly substantial. We would be in a better position and we certainly expect performance to improve across the system early part of next year and continuing. So, the best I can do at the moment is to whether there would be steps next year, it’s very much contingent upon our next, and we’ll keep you posted.

Michael Gallo

Analyst

Second question I have, just looking at the overall SG&A structure now, obviously you’re rationalizing the remaining IHOP stores and you’re 100% franchised. I was wondering, whether your plan to look comprehensively at the SG&A structure and whether you think, as you move the Company in a little different direction, whether you think there might be some opportunities? Thanks.

Gregg Kalvin

Analyst

I think the way to think about it initially, we’ve got the costs that we believe will not recur next year, which is the $10 million. We’ve also got in the G&A this year, the severance costs. That’s 19 off the top, if you will, as a starting point. We consistently evaluate our internal structure with regard to people, third-party expense and all of the components in G&A. And we will be taking a hard look at that as we always do on a go forward basis for the remainder of 2017, which is currently built into our guidance, and then into 2018 and thereafter.

Richard Dahl

Analyst

Michael, Richard here. I’d just like to add a little bit to that. As you may recall from our earlier calls, we really shifted our focus from a heavy shared service model to re-empowering the brands and putting a lot of that talent down into, directly into the brands themselves to speed up our decision making. And so 2017 will establish a very good baseline for where we really need to be on SG&A. I think there are certainly opportunities there and 2017 will be that base year for us to go forward into 2018. But feel strongly that getting the resources, both dollars and human resource into these brands we’ll empower these brands to the success.

Operator

Operator

And our next question comes from John Ivankoe from JP Morgan. John, your line is now open.

John Ivankoe

Analyst

Two questions if I may. The first is I think related to just the prior question. $10 million of non-recurring stabilization initiatives in 2017 is worth around $5,000 a store, so if you think about it in that context, it’s not a lot of money. That $8 million of advertising is worth around $4,000 a store. I mean, those don’t sound like big numbers. I mean, that’s -- I mean, if there is going to be real financial and advertising support given to the stores, one would probably get the multiple, many, many times, something like $4,000 or $5,000 a store for each of the different programs. Could you help me think about whether it’s -- is that the right way to think about it, the wrong to think about it? When the franchisees are just kind of thinking about, hey, we need this much money on a per store basis to really reinvigorate things, how much might that spend per store be?

John Cywinski

Analyst

Look, we’re taking a comprehensive view to the business. The $10 million is very much around assessing state of the business with an independent third-party across virtually all components. The $8 million is a very specific need to address the advertising fund. And we don’t look at that on kind of the way you framed it, on a per restaurant basis. And we’ll have some visibility to performance once we turn the corner on the year. So, these are need based specific to quarter-by-quarter business requirements. And in the aggregate, they’re substantial, but they’re addressing specific needs. So, we are kind of more need based than we are let’s direct a specific dollar figure per restaurant to the system. We will do what is necessary and required. And I should -- I’d be remiss if I don’t emphasize that our partnership with franchisees is perhaps stronger than it’s been in years. And don’t take my words for that. There is a very cautious optimism, but tremendous enthusiasm about our strategy and our alignment and much of what we do if not everything we do, is in concert with our franchisee leadership. So, more to come as we look at 2018 in terms of whether there are incremental investments or not.

John Ivankoe

Analyst

That’s great. And whenever you guys are ready to put one of the big franchisees or someone from the franchisee advisory council on one of these calls, I’m sure it’s something that everyone would benefit a lot from. I understand it’s not today, but perhaps in the future, understanding the business from their perspective would be very, very valuable for that little free advice there. And then, secondly, I’m going to see if I can answer this question in a correct way. The current run rate of comps, the current visibility of costs, outside of the stores that you’ve announced the closure, do you have a sense of how many stores at the store level, not at the organization level, but at the store level are kind of nearing cash flow breakeven? I understand you don’t want to close a store if it’s cash flow breakeven, if you think results are getting better in a couple of years, but what percentage of the system again is kind of taking the current run rate of results -- kind of nearing that point of marginal profitability at the store level?

Gregg Kalvin

Analyst

This is Greg, John. What we said previously is that we’ve got -- we analyze each of these on a case by case basis. Obviously, if these stores are close to breakeven or having cash flow issues, that’s a pretty strong indicator that that is up for closure. And it’s built into the closures that we have estimated for this year. So, that’s the first cut we take at it. And then other areas around that we consider but the cash flow is obviously the main point that we look at. We don’t disclose how many stores that we -- that are cash flow and not cash flowing, but we’ve built that into our analysis and how we evaluate each franchisee and all of their stores during this process. There is a lot of work that goes into it and we are thoughtful about each store before we decide to close it.

John Ivankoe

Analyst

Okay. All right. I think I heard that. In the release, and I’m sorry if I missed this, there was mention of uncollectible royalties -- how big -- I think there was some in the first quarter that began to peak up, if I’m remembering that correctly. How big might that number be in 2017, and at least at this point do you think the number grows in 2018?

Gregg Kalvin

Analyst

So, right now, the guidance that we just issued that number, if you think of about franchise revenues on a gross basis for Applebee’s which we break out in our public documents, it’s running for the rest -- we expect it right now to run for the rest of the year about 7% to 8% of that number, and that’s where we currently believe we are headed as far as possibility of royalties as what we are targeting about here. So that’s what it amounts to.

Operator

Operator

And our next question comes from Stephen Anderson from Maxim Group. Stephen, your lines are now open.

Stephen Anderson

Analyst

Thank you. Taking a look at your reduced free cash flow expectations for 2017, I want to ask about your ability to continue paying the dividend and what the outlook for that will be going in 2018? Thank you.

Richard Dahl

Analyst

Clearly the dividend but all of capital allocation issues are aggressively studied by the Board at each meeting. And obviously with the announcement of the dividend I think now today is confirmed that the ability to pay the dividend is there and the desire to do so. As I say, this is looked at steadily, but we certainly understand the interest in shareholders of the stability of the dividend and so on, and we look at that every time we meet.

Stephen Anderson

Analyst

So, the debt service covenant ratios, and I know you publish that with the 10-K, can you provide a little bit color into that?

Gregg Kalvin

Analyst

Well, this is Greg. We have a coverage ratio that we -- leverage ratio that we publish, if you will, in our 10-Q. And that is the ratio that we focus on the most. There is a debt service coverage ratio that is in the discussion really because -- the cushion is so large, but we have a leverage ratio that we publish every quarter and it’s about five times right now is what’s it at. And that’s where it stands at the end of the second quarter.

Stephen Anderson

Analyst

Thank you.

Ken Diptee

Analyst

And Steve just to add to that, this is Ken. With regard to the FCR, we’re about 300 basis points above if any cash strapped event might occur.

Operator

Operator

And there are no additional questions at this time. And I would like to turn it back over to speakers for closing remarks.

Richard Dahl

Analyst

Okay. Well, thank you again for joining us on the call today. We’re scheduled to report the results of the third quarter in November, I believe November 1st. And we look forward to speaking to you then or perhaps even earlier, as Steve gets into the chair. And again, I want to thanks Steve for joining us today, as well as all of you. Thank you.

Operator

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.