Business context and reporting period
DineEquity, Inc. (now Dine Brands Global, Inc.) owns and franchises Applebee’s and IHOP. Nearly all of its more than 3,700 restaurants are franchised; the company also has rental, financing and limited company-operated restaurant activities. This Form 10-Q covers the first quarter of 2017, presented as the three months ended March 31; the company’s fiscal quarter actually ended April 2, 2017. Comparisons are with the corresponding 2016 quarter.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $156.2 million | $163.5 million | Down 4.5% |
| Gross profit | $92.5 million | $99.4 million | Down 6.9% |
| Gross margin | 59.2% | 60.8% | Down 1.6 percentage points |
| Income before taxes | $24.2 million | $41.1 million | Down $16.9 million |
| Net income | $14.4 million | $25.5 million | Down 43.5% |
| Diluted EPS | $0.79 | $1.37 | Down 42.3% |
| Operating cash flow | $19.5 million | $37.5 million | Down $18.0 million |
- Net margin was approximately 9.2%, compared with 15.6% a year earlier. The effective tax rate rose to 40.7% from 37.9%, including a $0.8 million charge from adoption of share-based payment accounting guidance.
- Adjusted free cash flow, a company-defined non-GAAP measure, was $19.2 million versus $38.8 million. Capital expenditures were $3.0 million; management expected about $12 million for full-year 2017.
- Cash and cash equivalents were $129.2 million, including $56.2 million held for gift card programs and advertising funds. Current assets were $299.0 million and current liabilities $223.9 million. Restricted cash totaled $46.0 million, including current and non-current amounts.
- Long-term debt was $1.284 billion, primarily the 4.277% fixed-rate securitized notes. The company also reported $70.1 million of long-term capital lease obligations and $39.5 million of long-term financing obligations. Its leverage ratio was 4.81x and debt service coverage ratio 4.97x. The $100 million variable funding facility was undrawn; $95 million remained available after letters of credit.
- Dividends paid were $17.4 million ($0.97 per share); the company repurchased $10.0 million of stock during the quarter. Management said it did not expect further repurchases under the program during the rest of 2017.
Material changes and drivers
- Applebee’s domestic same-restaurant sales fell 7.9%, driven mainly by lower traffic and slightly lower average check. IHOP’s domestic same-restaurant sales declined 1.7%, as lower traffic was partly offset by a higher average check. Both brands underperformed their respective dining segments, according to the company’s cited industry data.
- Applebee’s franchise revenue declined 10.8%; weaker comparable sales, more royalties recognized only when cash is received, fewer franchise restaurants and lower termination fees contributed. Applebee’s franchise gross profit fell $6.9 million, including higher bad-debt expense. IHOP franchise revenue was essentially unchanged.
- General and administrative expense rose $10.9 million to $50.3 million. The increase included $8.8 million of CEO separation costs ($5.9 million severance and related costs and $2.9 million accelerated equity-award vesting), as well as higher professional services and personnel costs. The Chairman and CEO resigned effective March 1, 2017.
- Operating cash flow declined amid lower earnings and less favorable working-capital movements. Financing cash outflows included dividends, share repurchases and lease-obligation payments; net cash, cash equivalents and restricted cash decreased $10.2 million.
Outlook, risks and contingencies
- Management forecast 20–30 Applebee’s openings globally and 40–60 closures in 2017, with the anticipated net decline potentially reducing royalties. For IHOP, it projected 75–90 global openings and about 18 closures. Actual development and closures may differ from expectations.
- The company expected approximately $10 million of Applebee’s stabilization-initiative costs in 2017, excluding possible franchisee assistance; about $3 million had been incurred in the quarter. Any franchisee assistance could add costs. Management engaged consultants to address Applebee’s traffic and sales declines and franchisee financial health.
- Management believed cash flow, available cash and borrowing capacity would meet liquidity needs for the next 12 months. No formal full-year revenue or earnings guidance was provided in the filing.
- Substantially all domestic revenue-generating assets and domestic intellectual property secure the securitized notes. A debt-service coverage ratio below specified thresholds could trigger cash trapping, rapid amortization, manager termination or default events; reported coverage was 4.97x. The notes also include other customary default and rapid-amortization triggers.
- The company guaranteed or could remain liable for $361.8 million of franchisee-related lease payments in a default scenario; no material guarantee liability was recorded. Ordinary-course litigation and claims remained pending; management did not expect a material adverse impact, but could not assure outcomes.
- The filing reported no interim goodwill impairment test was considered necessary, despite Applebee’s operating weakness. The company also anticipated that new lease accounting would materially affect its balance sheet when adopted, and was assessing revenue-standard effects, including deferral of certain franchise fees and gross presentation of Applebee’s advertising-fund activity.
Important facts for investors to verify
- Whether Applebee’s traffic, same-store sales, bad debt and franchisee financial health stabilize, and whether planned restaurant closures exceed expectations.
- Whether announced Applebee’s stabilization spending or franchisee support exceeds the forecast, and its effect on earnings and cash flow.
- Debt-service covenant headroom, available liquidity and the company’s capacity to sustain dividends amid declining operating cash flow.
- The timing and financial effects of franchise-fee revenue deferrals and Applebee’s advertising-fund presentation under the new revenue standard.
- Potential exposure from the $361.8 million lease guarantees, pending litigation and tax matters, including the IRS examination of tax years 2011–2013.