Dine Brands Global, Inc. quarterly report, Q2 FY2019

Dine Brands Global, Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Dine Brands owns and franchises Applebee’s and IHOP, with more than 3,600 restaurants, most operated by franchisees. The company began operating 69 Applebee’s restaurants acquired in December 2018, affecting year-over-year comparisons.

Financial results

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Revenue	$228.1 million	$184.5 million	$465.3 million	$372.6 million
Gross profit	$94.9 million	$78.6 million	$197.4 million	$162.1 million
Net income	$21.4 million	$12.7 million	$53.0 million	$29.8 million
Diluted EPS	$1.18	$0.69	$2.91	$1.61
Operating cash flow	Not provided by quarter	$69.3 million	$25.8 million

• Q2 revenue rose 23.6%; first-half revenue rose 24.9%. Growth reflected the acquired company-operated restaurants, increased Applebee’s advertising contributions, and IHOP development. Advertising revenue is matched by advertising expense.
• Gross profit increased 20.7% in Q2 and 21.8% for the first half. Reported gross margin was approximately 41.6% in Q2 versus 42.6% a year earlier; the mix shift and advertising pass-through affect comparison. Franchise gross margin was 51.5% versus 45.4% in Q2.
• First-half operating cash flow was $69.3 million; investing activities provided $0.9 million and financing activities used $92.9 million. Adjusted free cash flow, a non-GAAP measure defined by the company, was $66.0 million versus $28.1 million.
• At June 30, cash and cash equivalents were $127.6 million, including funds held for gift-card programs and advertising; current assets were $304.3 million and current liabilities $296.4 million. Additional restricted cash was $50.1 million in current and non-current accounts.
• Net long-term debt was $1.287 billion. The company refinanced approximately $1.28 billion of prior notes with $1.3 billion of new securitized notes: $700 million at 4.194% and $600 million at 4.723%. A $225 million revolving facility had $222.8 million available, net of letters of credit. Leverage was 4.57x and debt-service coverage ratio was 5.40x.
• Interest expense, net, was $14.6 million in Q2 and $30.0 million for six months. Q2 included an $8.3 million debt-extinguishment loss related to unamortized issuance costs.

Material changes and management commentary

• Applebee’s domestic same-restaurant sales declined 0.5% in Q2 and increased 0.6% for the first half; management cited weaker traffic, partly offset by higher average checks. The Q2 comparison was adversely affected by an estimated 20-basis-point Easter timing shift and competitive discounting.
• IHOP domestic same-restaurant sales increased 2.0% in Q2 and 1.7% for the first half, with higher average checks partly offset by lower traffic. Easter timing added an estimated 30 basis points to Q2 results.
• Applebee’s franchisees had 147 fewer effective restaurants in Q2 year over year. Applebee’s system sales fell 3.0% in Q2; IHOP system sales increased 3.2%.
• Applebee’s franchisees’ advertising contribution rate rose temporarily from 3.50% to 4.25% beginning July 2018. In July 2019, franchisees agreed to extend the increase through December 31, 2020. The higher rate added approximately $7.9 million to Q2 and $15.6 million to first-half advertising revenue, with corresponding advertising expense.
• Effective January 2019, the company adopted ASC 842 and recorded operating lease obligations of $453.0 million and right-of-use assets of $395.6 million at adoption. Management said adoption did not significantly affect operating results or operating cash flow. June 30 operating lease obligations totaled $446.8 million.
• The first-half effective tax rate was 24.5% versus 37.0%, mainly because 2018 included $5.7 million of tax provision for IRS audit adjustments. The IRS examination for 2011–2013 concluded in Q2 2019; the company received a $13.3 million refund, including interest.

Outlook, risks and contingencies

• For 2019, management expected Applebee’s franchisees to close 20–30 net restaurants globally, mostly domestic, and IHOP franchisees and area licensees to develop 20–30 net restaurants, mostly domestic. These are development expectations, not financial guidance; actual results may differ.
• Management believed operating cash flow, available cash and borrowing capacity would meet liquidity needs for the next 12 months. Principal payments on the new notes were not required for Q3 2019 because leverage was at or below the 5.25x threshold.
• The notes are secured by substantially all domestic revenue-generating assets and intellectual property of specified securitization entities. Debt-service coverage shortfalls can trigger cash-flow retention, rapid amortization, manager termination or default provisions. The reported 5.40x ratio was above the disclosed trigger levels.
• The company reported maximum potential lease-guarantee exposure of $271.5 million related to previously sold Applebee’s restaurants; excluding unexercised lease options, potential future payments were $42.1 million. Ordinary-course litigation and claims remain pending; management did not expect a material adverse impact but gave no assurance of outcome.
• Other disclosed risks include indebtedness and refinancing, franchisee financial health and restaurant closures, consumer demand and competition, information technology and cybersecurity, food safety, litigation, regulation, and execution of restaurant development plans. The company reported no material change to its previously disclosed risk factors.

Most important facts for investors to verify

• How much of reported growth and earnings improvement is sustainable versus attributable to the acquired restaurants, Applebee’s advertising-rate increase, nonrecurring 2018 advertising-fund contributions and lower comparative tax expense.
• Whether Applebee’s traffic and restaurant closures stabilize, and whether IHOP’s same-store sales gains persist despite traffic declines.
• The refinancing’s effective cost and amortization terms, collateral scope, available revolver capacity, and compliance with leverage and debt-service triggers.
• Whether cash generation can support dividends and repurchases alongside debt obligations; first-half repurchases were $46.4 million and dividends paid were $23.3 million.
• Actual restaurant openings and closures, lease-guarantee exposure, franchisee collectibility, and any material developments in litigation or tax contingencies.