DineEquity, Inc. — Q2 2017 Form 10-Q
Reporting period: Second fiscal quarter of 2017 ended July 2, 2017 (the company refers to it as June 30 for convenience); six-month results are through the same fiscal quarter. Comparative periods ended July 3, 2016. DineEquity owned and franchised Applebee’s and IHOP, with more than 3,700 restaurants combined. In June, it refranchised nine company-operated IHOP restaurants and closed the tenth; it had no permanently company-operated IHOP restaurants at quarter-end.
Financial results and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $155.2 million | $160.3 million | $311.4 million | $323.8 million |
| Gross profit | $91.8 million | $97.4 million | $184.4 million | $196.8 million |
| Net income | $21.3 million | $26.8 million | $35.6 million | $52.4 million |
| Diluted EPS | $1.18 | $1.45 | $1.98 | $2.82 |
| Effective tax rate | 46.5% | 32.5% | 44.3% | 35.2% |
- Q2 revenue declined 3.2%; gross profit declined 5.7%. Gross margin was approximately 59.2%, compared with 60.8% a year earlier. Six-month revenue and gross profit each declined about 3.8% and 6.3%, respectively.
- Q2 pretax income was essentially unchanged at $39.7 million, but net income fell 20.7%, primarily reflecting the higher tax provision. For the first half, pretax income fell $16.9 million and net income fell 31.9%.
- Operating cash flow was $20.9 million for the first half, versus $53.9 million. Investing activities provided $3.8 million and financing activities used $51.7 million; cash, cash equivalents and restricted cash declined $27.0 million.
- Cash and cash equivalents were $112.3 million at quarter-end, including $51.8 million held for gift card programs and advertising funds; restricted cash was $46.1 million in total. The company reported $1.284 billion of long-term debt, plus capital lease and financing obligations. Its leverage ratio was 5.02x and debt-service coverage ratio was 4.82x.
- The $100 million variable-funding facility was undrawn; $5 million was pledged for letters of credit, leaving $95 million available. Management said cash, operating cash flow and borrowing capacity should meet liquidity needs for the next 12 months.
- First-half dividends paid were $34.9 million; share repurchases were $10.0 million. Adjusted free cash flow, a non-GAAP measure, was $19.2 million versus $56.4 million.
Changes versus prior period
- Applebee’s was the main operating headwind: domestic same-restaurant sales fell 6.2% in Q2 and 7.0% in the first half. Applebee’s franchise gross profit declined $5.7 million in Q2 and $12.5 million in the first half, reflecting lower sales, restaurant closures and higher bad-debt expense.
- IHOP domestic same-restaurant sales declined 2.6% in Q2 and 2.1% in the first half, despite net restaurant development. IHOP’s franchise revenue was slightly higher year over year.
- Applebee’s restaurant count ended the quarter at 1,968, down 59 from a year earlier; IHOP ended at 1,752, up 57. The company cited lower customer traffic at both brands.
- General and administrative expense rose $0.9 million in Q2 and $11.8 million in the first half. The first-half increase included $8.8 million of former CEO separation costs and higher consulting expense, including Applebee’s stabilization work.
- A $6.2 million gain on refranchising nine IHOP restaurants helped offset Q2 operating declines. The transaction generated $1.1 million cash and a $4.8 million note receivable; the company also recorded $2.3 million of net favorable lease assets.
Outlook, commentary and risks
- Management expected a second-half 2017 effective tax rate of approximately 40%; no overall revenue or earnings guidance was provided in the filing.
- The company expected approximately $10 million of Applebee’s stabilization costs in 2017, of which about $6 million had been incurred in the first half, and planned an approximately $8 million contribution to the Applebee’s National Advertising Fund in the second half.
- For 2017, management expected 20–30 Applebee’s openings and 105–135 closures, and 80–95 IHOP openings and 20–25 closures. It warned that Applebee’s closures would reduce royalty revenue and that franchise gross profit could face greater pressure in the second half from closures, bad debt and cash-basis royalties.
- Capital expenditures were expected to be approximately $14 million in 2017. The company said the new lease accounting standard, expected to be adopted in 2019, would materially increase reported assets and liabilities, but was not expected to materially affect income or cash flows.
- Risks include continued traffic and same-store sales declines, franchisee financial distress and restaurant closures, and debt securitization triggers. A franchisee representing about 5% of Applebee’s domestic system-wide sales was experiencing elevated financial difficulty. The company had $331.5 million of maximum potential lease-guarantee exposure, or $58.7 million excluding unexercised option periods; no material guarantee liability was recorded. Management did not expect current litigation to have a material adverse impact but noted outcomes were uncertain.
- The first-half tax rate was elevated by increased uncertain tax positions related primarily to domestic production activity deductions and adoption of share-based payment accounting guidance. Gross unrecognized tax benefits were $6.0 million at June 30, 2017; the company estimated up to $3.8 million could decrease over the next 12 months.
Important facts for investors to verify
- Whether Applebee’s traffic, same-store sales, franchisee credit quality and planned closures stabilize or deteriorate further.
- Whether the planned Applebee’s stabilization spending and advertising-fund contribution improve sales, and how much additional support franchisees require.
- Cash conversion and dividend sustainability in light of lower operating cash flow, adjusted free cash flow and the company’s substantial debt and lease obligations.
- Progress and potential outcomes of the IRS examination, uncertain tax positions, and the projected second-half tax rate.
- Whether restaurant opening and closure forecasts, lease guarantees and securitized-debt coverage thresholds change materially.