Business context and reporting period
DineEquity, Inc. (the registrant named in this filing; operating Applebee’s and IHOP) filed this unaudited Form 10-Q for the quarter ended June 30, 2011. The company’s fiscal second quarter actually ended July 3, 2011; comparative results are for the corresponding 2010 periods. Unless noted, amounts are in U.S. dollars.
The company operated a mix of franchised restaurants, company restaurants, rental operations and franchisee financing. At quarter-end it had 1,768 franchised Applebee’s and 1,511 IHOP franchise or area-license restaurants; it also operated 244 Applebee’s and 11 IHOP restaurants.
Financial results and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total segment revenue | $268.3 million, down 21.1% from $340.1 million | $568.5 million, down 18.6% from $698.2 million |
| Gross segment profit | $100.3 million, down from $107.4 million | $211.1 million, down from $222.5 million |
| Net income | $0.3 million, versus $14.0 million | $30.0 million, versus $33.7 million |
| Net income available to common shareholders; diluted EPS | $(0.3) million; $(0.02), versus $7.4 million; $0.42 | $27.9 million; $1.53, versus $20.3 million; $1.16 |
| Operating cash flow | $48.2 million for six months, versus $50.3 million |
Quarterly revenue fell mainly because Applebee’s restaurants were refranchised; franchise revenue rose 5.6%, while company restaurant sales fell 36.1%. Applebee’s domestic system same-restaurant sales increased 3.1% in the quarter and 3.5% year to date; IHOP’s declined 2.9% and 2.8%, respectively. Company restaurant segment margin was 12.9% for the quarter versus 13.6% a year earlier; six-month margin was 13.9% in both periods. The quarter’s very low net income reflected, among other items, a $21.2 million Lenexa facility termination charge.
Interest expense was $32.9 million for the quarter and $69.2 million for the half year, down from $43.7 million and $88.7 million, respectively. The six-month effective tax rate was 30.1%; the quarterly rate was 81.1%, primarily due to unrecognized tax benefits and state deferred-tax adjustments.
At June 30, cash and equivalents were $34.5 million, down from $102.3 million at year-end 2010. Current assets were $250.0 million and current liabilities $208.2 million. Total debt, net of discount, was $1.487 billion, including $7.4 million current maturities; long-term debt was $1.479 billion. Debt was down from $1.641 billion at December 31, 2010. The company also reported $204.3 million of long-term financing obligations and $139.4 million of long-term capital lease obligations.
Six-month investing cash flow was positive $48.5 million, including $55.5 million of asset-sale proceeds and $13.5 million of capital expenditures. Financing used $164.4 million, principally for debt repayment. Cash declined $67.8 million. The company forecast fiscal 2011 capital expenditures of approximately $26 million.
Material changes and management commentary
- Applebee’s refranchising reduced company restaurant sales and profit, while lifting franchise revenues and profit. The system was approximately 88% franchised at quarter-end. Management expected two further transactions covering 67 restaurants to close in August and the fourth quarter of 2011; if completed, approximately 91% of the system would be franchised.
- The six-month results included a $22.5 million gain on disposition of assets, mainly from Applebee’s restaurant sales; $26.8 million of impairment and closure charges, mainly the $21.2 million Lenexa sublease termination and $4.5 million facility impairment; and $7.9 million of debt-extinguishment losses plus $4.1 million of debt-modification costs.
- In February 2011, the credit agreement amendment reduced the LIBOR loan margin from 4.50% to 3.00% and increased revolving commitments from $50 million to $75 million. The company repaid $110 million of term loans and repurchased $39.8 million face amount of 9.5% senior notes for $43.5 million, including premium.
- Management said operating cash, available cash and revolver capacity should meet liquidity needs for the next 12 months. The company reported compliance with its debt covenants: trailing-four-quarter leverage of 5.6x against a 7.5x maximum and cash-interest coverage of 2.3x against a 1.5x minimum. The $75 million revolver had no balance outstanding at quarter-end; letters of credit were $15.9 million.
Outlook, risks and contingencies
Management expected Applebee’s franchisees to open 24–28 restaurants and IHOP franchisees to open 55–65 restaurants in 2011. The filing provides no specific full-year revenue or earnings forecast. Management said future restaurant openings and refranchising timing depend on economic conditions, franchisee financing, construction and regulatory approvals, and acceptable sale proceeds. It expects a more franchised Applebee’s model to require less capital and reduce cash-flow volatility, while noting that refranchising may reduce reported segment profit as restaurant operating profit is replaced by lower-rate royalties.
Management cited economic uncertainty and consumer spending as risks to sales. Applebee’s positive same-store sales reflected higher average checks partly offset by lower traffic; IHOP’s decline was attributed mainly to traffic, promotions that did not generate expected repeat visits, and economic uncertainty. Restaurant cost pressures included commodities, staffing, payroll taxes, insurance and utilities.
Applebee’s faced the nationwide Gerald Fast Fair Labor Standards Act collective action concerning tipped employees’ non-tipped work. The Eighth Circuit affirmed a ruling applying a 20% limit to certain related duties; rehearing was denied in July 2011. The company sought a stay while considering Supreme Court review, asserted meritorious defenses, and said the possible loss or range could not be estimated; no accrual was recorded. The company also guaranteed or potentially remained liable for $213.3 million of assigned restaurant lease payments; no material liability was recorded. Management said other ordinary-course legal matters were not expected to have a material adverse impact.
Most important facts for investors to verify
- Whether the planned refranchising of 67 Applebee’s restaurants closed on schedule and at satisfactory proceeds, and how proceeds were applied to debt.
- Whether Applebee’s sales momentum and IHOP’s traffic and same-store sales improved or deteriorated after the reported period.
- Current cash, revolver availability, debt balances, covenant headroom and the cost of any further debt retirement.
- Developments and potential exposure in the Gerald Fast litigation, for which the filing provides no estimable loss range.
- The cash and earnings effects of the Lenexa closure, remaining lease guarantees and other contingencies.