DineEquity, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended September 30, 2012; results compare the three and nine months ended September 30, 2012 with the corresponding 2011 periods. DineEquity operated Applebee’s and IHOP. Its strategy was to shift Applebee’s to a predominantly franchised model; 97.8% of the combined system was franchised at quarter-end. The company completed the sale of 39 Virginia Applebee’s restaurants on October 3, bringing the Applebee’s system to approximately 99% franchised.
Financial performance and liquidity
- Revenue: Third-quarter revenue was $216.3 million, down 18.2% from $264.5 million; nine-month revenue was $691.3 million, down 17.0% from $833.0 million. The principal driver was refranchising, which reduced company restaurant sales while increasing franchise royalties. Q3 franchise revenue rose to $102.7 million from $97.7 million, while company restaurant sales fell to $79.6 million from $131.6 million.
- Profit and EPS: Q3 net income was $60.6 million versus $16.5 million; nine-month net income was $108.9 million versus $46.6 million. Diluted EPS was $3.14 and $5.66, respectively, versus $0.85 and $2.38. Results included gains on asset dispositions of $73.7 million in Q3 and $89.6 million for the nine months, primarily from Applebee’s refranchising. Nine-month results also benefited from lower prior-year impairment charges.
- Segment performance and margins: Gross segment profit was $96.4 million in Q3 versus $100.6 million, and $303.2 million for nine months versus $311.6 million. Applebee’s company restaurant operating margin was 15.5% in Q3 versus 14.2%, and 16.8% for nine months versus 14.4%; these comparisons were affected by which restaurants remained company-operated. Franchise segment profit increased 3.9% in Q3 and 4.6% for nine months.
- Cash flow: Nine-month operating cash flow was $68.1 million, down from $95.1 million. Free cash flow, as defined by the company, was $64.9 million versus $84.2 million. Investing activities provided $135.2 million, including $137.4 million in asset-sale proceeds; financing activities used $192.1 million, primarily for debt repayment. Cash ended at $71.8 million, up from $60.7 million at year-end 2011.
- Debt and liquidity: Long-term debt, including current maturities, was $1.240 billion at September 30, down from $1.419 billion at year-end. The company repaid $184.2 million of long-term debt during the nine months. It had no revolver borrowings outstanding, with $12.4 million of letters of credit reducing availability under its $75 million facility. The company reported covenant leverage of 4.8x against a 7.25x maximum and cash-interest coverage of 2.4x against a 1.5x minimum; it was in compliance with covenants. Management said cash, operating cash flow and borrowing capacity were expected to cover needs over the next 12 months.
- Other metrics: Total assets were $2.422 billion and stockholders’ equity was $283.1 million. Q3 domestic same-restaurant sales increased 2.0% at Applebee’s and decreased 2.0% at IHOP. The nine-month effective tax rate was 33.2%, versus 31.8%; Q3 included a $6.3 million state tax benefit related to refranchising.
Material changes, outlook, and risks
- Applebee’s domestic same-restaurant sales growth in Q3 was attributed mainly to higher average guest checks from pricing and product mix, partly offset by lower traffic. IHOP’s Q3 sales decline was mainly traffic-related. Management described initiatives to improve value, guest experience and retention at both brands.
- Management expected Applebee’s franchisees to open 30–40 restaurants and IHOP franchisees to open 45–55 in 2012. Fiscal 2012 capital expenditures were expected to be approximately $18–$20 million. After reviewing its structure as a highly franchised company, management expected annualized G&A savings of approximately $10–$12 million, beginning in Q4 2012. No full-year earnings guidance was provided.
- The Virginia transaction was expected to generate an approximately $14 million gain in Q4; its $24 million after-tax proceeds were used to retire debt. Management did not expect significant asset-disposition proceeds going forward, so future debt repayment would rely more on operating cash flow.
- A $9.0 million settlement of a long-running Applebee’s wage case was agreed to, subject to court approval; the settlement was not an admission of wrongdoing. The company also had $432.0 million of maximum potential lease-guarantee exposure on assigned leases, with no material liability recorded. Management cautioned that ordinary-course litigation could still result in losses.
- Other items to monitor include continued IHOP traffic weakness, restaurant development conditions, commodity and labor costs, and the effect of the transition to franchising on revenue, segment profit and cash generation. Management reported no significant impairment indicators and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much reported earnings depended on refranchising gains and the discrete tax benefit, versus recurring operating performance.
- Whether Applebee’s and IHOP sales and traffic trends, franchisee development, and the planned G&A savings progressed as management expected.
- Debt repayment capacity after the one-time refranchising proceeds, including covenant headroom and future interest costs.
- Court approval and final cost of the $9.0 million settlement, and developments in other litigation and lease guarantees.