Dine Brands Global, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; the company’s fiscal second quarter actually ended July 1, 2018. Unless noted, amounts are in millions. Comparative 2017 figures were retrospectively adjusted for adoption of ASC 606.
Business context
Dine Brands owns and franchises Applebee’s and IHOP. Its nearly 3,700 restaurants were franchised at quarter-end; the company no longer operated restaurants permanently. Revenue is principally from franchise operations, with additional rental and financing revenue.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Total revenue | $184.5 | $188.7 | $372.6 | $380.1 |
| Gross profit | $78.6 | $93.0 | $162.1 | $187.3 |
| Gross margin | 42.6% | 49.3% | 43.5% | 49.3% |
| Income before taxes | $24.6 | $40.9 | $47.3 | $66.9 |
| Net income | $12.7 | $22.1 | $29.8 | $37.7 |
| Diluted EPS | $0.69 | $1.23 | $1.61 | $2.09 |
First-half operating cash flow was $25.8, investing cash flow provided $5.0, and financing activities used $44.1. Cash, cash equivalents and restricted cash totaled $149.8 at period-end; unrestricted cash and cash equivalents were $95.7. Adjusted free cash flow, a non-GAAP measure, was $28.1 versus $19.2 in the prior-year period.
At June 30, total debt carrying value was approximately $1.298 billion, including $1.265 billion long-term and $33.0 million current. The company also had $57.6 million of long-term capital lease obligations and $38.8 million of long-term financing obligations. The balance sheet reported a $223.3 million stockholders’ deficit. The $100 million variable funding facility had $20 million drawn and $76.9 million available after letters of credit. Leverage ratio was 5.73x; debt service coverage ratio was 3.75x.
Changes and management commentary
- Revenue declined 2.2% in Q2 and 2.0% in the first half. The prior-year company-operated IHOP restaurants had been refranchised or closed, reducing 2018 revenue by about $3 million in Q2 and $8 million in the first half, with minimal gross-profit effect.
- Gross profit fell 15.5% in Q2 and 13.5% in the first half, primarily because Dine Brands contributed $16.5 million and $30.0 million, respectively, to the Applebee’s National Advertising Fund. Applebee’s franchise gross profit declined $15.1 million in Q2 and $28.4 million in the first half.
- Applebee’s domestic same-restaurant sales rose 5.7% in Q2 and 4.5% in the first half, supported by higher traffic and a modestly higher average check. IHOP same-restaurant sales rose 0.7% and 0.9%, respectively, but customer traffic had declined for eleven consecutive quarters.
- First-half G&A expense decreased $7.0 million, mainly because $8.8 million of executive separation costs recorded in 2017 did not recur. Q2 G&A increased $1.4 million.
- Net income and EPS also reflected a $5.7 million additional tax provision related to IRS audits of 2011–2013. The first-half effective tax rate was 37.0%, down from 43.7% in 2017; Q2’s rate was 48.3%. Management expected an approximately $12 million tax refund within 12 months.
Outlook, risks and unusual items
- For 2018, management expected 10–15 Applebee’s openings and 75–90 net closures globally; for IHOP, 85–100 openings and 45–70 net openings. These are expectations, not guarantees. Capital expenditures were expected to be approximately $16 million.
- Management said operating cash flow, available cash and borrowing capacity were expected to meet liquidity needs for the next 12 months. It anticipated required quarterly principal payments on the Class A-2 notes for the remainder of 2018 because leverage exceeded the 5.25x threshold for suspending payments.
- Applebee’s franchisee financial health remains a risk. One franchisee entered Chapter 11 after termination notices; litigation followed, while the restaurants continued operating and making current royalty and advertising payments. Dine Brands had approximately $14 million in loans to franchisees outstanding.
- Lease guarantees tied to previously sold restaurants had a maximum potential liability of $296.1 million; excluding unexercised options, potential future payments were $48.5 million. The company said pending ordinary-course legal matters were not expected to have a material adverse impact, but could not assure that outcome.
- ASC 606 adoption changed revenue presentation, including recognition of Applebee’s advertising fees as franchise revenue and spreading franchise and development fees over agreement terms. 2017 comparatives were restated; cash flows were unaffected. The company expected the upcoming lease-accounting standard to materially increase reported assets and liabilities.
- Q2 closure and impairment results included a $2.7 million credit from reversal of previously established property closure reserves. First-half results included a $1.4 million gain on disposition of a favorable lease asset. The prior-year period included a $6.2 million gain from IHOP refranchising.
Important facts for investors to verify
- Whether Applebee’s sales momentum continues and translates into franchisee financial stability, collections and sustained royalty revenue.
- The effect of Applebee’s advertising-fund contributions on franchise profitability, and the temporary franchisee advertising-rate increase through 2019.
- Progress and financial consequences of the Chapter 11 case, related litigation, and outstanding franchisee loans and receivables.
- Debt repayment capacity, leverage covenant-related thresholds, available revolver capacity, and the ability to maintain dividends and repurchases. First-half dividends paid were $28.8 million and share repurchases were $20.0 million.
- Resolution of the IRS audit and the expected tax refund, along with any changes to provisional Tax Act accounting.
- Potential exposure under lease guarantees and the balance-sheet impact of adopting the new lease standard.