Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2008, for DineEquity, Inc. (formerly IHOP Corp.). The company operates two primary restaurant concepts: Applebee's Neighborhood Grill & Bar and International House of Pancakes (IHOP). The reporting period includes the full impact of the Applebee's acquisition completed in November 2007. The company is transitioning its Applebee's business model from company-operated to a heavily franchised system to reduce capital requirements and improve margins.
Key Financial Metrics
| Metric | Three Months Ended Sept 30, 2008 | Nine Months Ended Sept 30, 2008 |
|---|---|---|
| Total Revenues | $391.2 million | $1,258.1 million |
| Net Loss | $(11.8) million | $(17.3) million |
| Net Loss Available to Common Stockholders | $(16.4) million | $(32.0) million |
| Diluted EPS | $(0.98) | $(1.91) |
| Cash Flow from Operating Activities | N/A | $61.3 million |
| Long-Term Debt | $1,920.8 million | $1,920.8 million |
| Financing Obligations (Sale-Leaseback) | $363.6 million | $363.6 million |
| Cash and Cash Equivalents | $100.1 million | $100.1 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased significantly due to the inclusion of Applebee's operations. For the nine months ended September 30, 2008, total revenues rose $987.1 million compared to the prior year. IHOP franchise revenues grew 7.4% year-over-year.
- Profitability: The company reported a net loss for the period, contrasting with a net income of $13.8 million for the nine months ended September 30, 2007. This shift is primarily driven by high interest expense ($152.7 million for nine months) related to acquisition debt and significant impairment charges.
- Impairment Charges: The company recorded $69.5 million in impairment and closure charges for the nine-month period. This includes a $40.8 million charge in Q2 related to sale-leaseback transactions where the net book value of real estate exceeded proceeds, and $28.3 million in Q3 related to Applebee's properties and an IHOP property due to credit market deterioration.
- Interest Expense: Interest expense surged $143.8 million year-over-year for the nine-month period, attributable to the $2.3 billion in debt incurred to finance the Applebee's acquisition.
Guidance, Outlook, and Risks
- Strategic Shift: Management is aggressively franchising company-operated Applebee's restaurants. In 2008, the company franchised 44 restaurants and has agreements to franchise an additional 66. The goal is to transition to a ~98% franchised system.
- Liquidity and Debt: The company utilized proceeds from sale-leaseback transactions ($378 million) and asset sales to repay $350 million of senior notes. However, the Lehman Brothers bankruptcy filing in September 2008 created uncertainty regarding the $100 million revolving credit facility (Lehman Facility). The company borrowed the full $100 million available under this facility as of September 30, 2008.
- Outlook: Management anticipates that cash from operations, sale-leaseback transactions, and franchising will be sufficient to meet obligations for the next 12 months. No share repurchases are expected in the remainder of 2008 or 2009.
- Risks: Key risks include the impact of the credit crisis on real estate valuations (leading to impairments), the uncertainty of the Lehman Brothers credit facility, and the ability to successfully execute the transition of company-operated restaurants to franchisees.
Investor Verification Checklist
- Debt Covenants: Verify compliance with debt covenants given the high leverage and recent credit market volatility.
- Lehman Facility Status: Monitor the status of the $100 million revolving credit facility with Lehman Brothers Holdings Inc. following their Chapter 11 filing.
- Franchising Progress: Track the execution of the plan to franchise the remaining company-operated Applebee's restaurants to reduce capital intensity.
- Real Estate Valuations: Assess the risk of further impairment charges on real estate assets held for sale or subject to sale-leaseback transactions.
- Applebee's Same-Store Sales: Review trends in Applebee's same-store sales, which declined 3.1% in the third quarter, to gauge brand performance independent of the acquisition.