Dine Brands Global, Inc. Q2 FY2020 Earnings Call

Hello and welcome to the Second Quarter 2020 Dine Brands Global Earnings Conference Call. My name is Patty and I will be your conference operator today. At this time, all participants are in a listen-only mode. Please note that this conference is being recorded. I will now turn the call over to Mr. Ken Diptee, Executive Director of Investor Relations. Sir, you may begin.

Good morning and welcome to Dine Brands' second quarter conference call. I'm joined by Steve Joyce, CEO; Tom Song, CFO; Jay Johns, President of IHOP; and John Cywinski, President of Applebee's. Before I turn the call over to Steve for opening remarks, please remember our Safe Harbor regarding forward-looking information. During the call, management may discuss statements forward-looking and involves known and unknown risks, uncertainties, and other factors which may cause the actual results to be different from those expressed or implied. Please evaluate the forward-looking information in the context of these factors which were detailed in today's press release and 10-Q filing. The forward-looking statements are as of today and assumes no obligation to update or supplement these statements. You may also refer to certain non-GAAP financial measures which are described in our press release and also available on Dine Brands' Investor Relations website. With that I'll turn the call over to Steve.

Thank you, Ken. Well, good morning everyone and thank you for joining us. Before we get started, I know the last few months have been challenging for everyone, so I hope you're all safe and doing well. I'd also like to recognize our franchisees and team members for their continued hard work during these difficult times, which has brought out the best in our team across both our organization and system. From creating resourceful ways to drive our business during these times to having a solid focus on our guests and welcoming them back into our restaurants. Our approach has generated some good progress. With that let's turn to the second quarter results. When we last spoke to you, we provided a look into the sequential improvement in weekly comp sales trends for April. Notably after reaching lows in late March, the sales trajectory for both brands continued to improve through June as dining restrictions were eased and states began to gradually reopen. Guests who felt more comfortable about restaurant dining were eager to get out after a long period of staying in home whether that was through off-premise, outdoor, or indoor dining. We set out to bolster this variety of options to meet the different needs of our guests and establish stringent safety protocols that would instill confidence and keep guests coming back. Despite the impact of COVID-19, our brand showed meaningful progress in recovery, which we believe reflects the successful execution of our off-premise business and the affinity guests have for our brands. While our restaurants have always offered guests rest in a place to enjoy being with friends and family, they've continued to savor our great food increasingly in the comfort of their own homes as the strong growth of our off-premise business demonstrates. We remain optimistic about the overall market improvement in industry sales and traffic data since April which would support continued momentum in our business. We're closely monitoring those states that have recently reversed their reopening plans. This situation is obviously fluid at both the state and local levels, so it will be premature to attempt to quantify any impact presently. However, we're staying nimble in this ever-changing environment and shifting our approaches when warranted such as refocusing on outdoor dining and off-premise service where it makes sense. We've demonstrated the ability to manage our business during a challenging second quarter and our franchisees proved their tremendous resiliency in meeting the convenience and safety needs of our guests. We've also leveraged our digital capabilities to support significant growth in our off-premise business. To provide some details, Applebee's online to-go sales for the second quarter increased sequentially by approximately 18 percentage points to 23% of total sales with off-premise sales representing 61% of total sales. Similarly, IHOP experienced growth of 28 percentage points in online to-go sales to 35% of total sales during the same period, with off-premise sales representing 54% of total sales. The off-premise business at both brands continued to post significant growth in the second quarter as guests became more familiar with the platform. We believe our sales will be further supported as dining room restrictions are lowered. John and Jay will provide additional details on their respective brands later. During the reopening process, Dine's crisis management team remains fully engaged with local, state, and federal authorities to obtain the latest information available enabling us and our franchisees to make well-informed decisions. I'm pleased to say that at the end of the second quarter, 95% of our domestic restaurants are open for either dine-in or off-premise service. This compares to 82% at the end of the first quarter which primarily consisted of takeout and delivery service. As we reopen dine-ins in accordance with government mandates the health and safety of our guests, franchisees, and team members are top priorities. In addition to following guidelines provided by the CDC as well as state and local governments, we've implemented our own operating procedures at both Applebee's and IHOP. These include, but are not limited to safe food handling procedures in addition to practices to ensure that the restaurants are sanitized, including team members who focus on cleaning and sanitizing common touch points throughout the restaurant. As we continue to welcome guests back, we want to ensure that they feel safe and comfortable, whether they choose to dine-in restaurant or off-premise. Our research has shown that consumers have a strong desire to return to restaurants. In fact, out of the top five categories that consumers said brought them the most joy, dining out was ranked the highest. As we enter a new normal for dine-in, we know that guests will view health and safety as equal to value and craveability and we'll continue to serve our guests' needs and desires. Our cross-functional teams have worked relentlessly to ensure our franchisees are equipped with the right information to make sound decisions for their operations and their teams. We're working closely with our franchisees and taking the necessary steps to prepare our restaurants so that we can emerge from this pandemic in a strong competitive position. The coronavirus has had a profound impact on businesses across the country and the globe. As you know, the restaurant industry has been especially hard hit. As a result, industry analysts estimate that a substantial number of independent restaurants that have closed due to COVID-19 will not survive. In contrast, Dine Brands has the advantage of scale, a strong cash position and liquidity, experienced restaurant operators, and an asset-light business model. Collectively, this profile has enabled us to withstand the challenges facing our industry, which makes me more optimistic about our future. Looking ahead, we believe that there are potential opportunities to increase our market share due to expected closures of independent restaurants. We'll continue to assess the competitive landscape as we focus on our near-term priority, which is returning our core business to sustainable growth. With that, I'll now turn the call to Tom to provide an overview of the first quarter results. Tom?

Thank you, Steve. Good morning everyone. I hope that you and your families are all doing well. Given the circumstances, I'm going to first review the financial initiatives and decisions that Dine has taken during the pandemic. Then I'll discuss our financial results for the quarter. First, we responded by fortifying our financial position during this challenging period for our industry. As a reminder, we borrowed a total of $220 million from our revolving credit facility in March. As of June 30, the entire amount remains strong. At the end of the second quarter, we continue to have a strong liquidity position and significant cash on our balance sheet totaling $342.5 million, of which $278.5 million is unrestricted. I would like to highlight that non-current restricted cash increased by $16.4 million due to Dine voluntarily doubling its interest reserve, to enhance our securitization structure. In addition to further support our securitization, we voluntarily accelerated the funding of quarterly interest. And as of today for example, we have already fully funded interest payments due on September 8. We did not repurchase our common stock during the quarter and anticipate this will continue for the foreseeable future. Turning to our G&A. We made some very difficult decisions to furlough approximately one-third of our corporate staff which led to the sharp decrease in G&A for the second quarter of 2020 to $30.9 million as compared to $39.4 million for the second quarter of 2019. This represents a 22% decline. The decrease was mainly due to lower compensation expenses as well as reductions in other discretionary costs. I would like to clarify that during this quarter of extreme austerity, we were able to reduce our gross cash G&A to approximately $27 million which includes capital expenditures. However, we are not changing a $30 million per quarter figure that we previously mentioned for G&A and capital expenditures for the remainder of the year, as we recall some of our team members from furlough and anticipate resourcing our business to serve our franchisees. To provide financial support for our franchisees, we disclosed last quarter that we implemented franchisee assistance measures aimed at enhancing the stability of both brands. The assistance primarily consisted of deferrals of royalty and advertising payments, primarily from March and April for both brands and for certain IHOP franchisees also rent payments. Additionally, we allowed IHOP franchisees to further remodel the new unit development obligations for 2020. Most franchisees did avail themselves of our support. In aggregate, we provided nearly $56 million of deferral for our franchisees. Offsetting these significant deferrals, we received approximately $11 million as deferrals and maintenance from our landlords on IHOP properties that are subleased to our franchisees, as well as our other leased properties. While the programs offered, both through Dine and the CARES Act, helped to somewhat mitigate the financial impact of COVID-19 on our franchisees, the effect of dining room closures and restrictions has caused a significant deterioration in franchising cash flows. As a result, we recognized over $5 million of bad debt expense during the second quarter. I would like to note that after the deferral period both Applebee's and IHOP franchisee collections have been strong and each brand's ad fund is in a stable position at this point. Also as previously disclosed, an IHOP franchisee that operated at 49 locations initiated an assignment for the benefit of creditors and then subsequently filed for bankruptcy. In July, 41 of the 49 units were sold to a new franchisee approved by us. As part of the transaction, we received $4.6 million, which represents a complete recovery in fees. Let's switch gears to our second quarter financial results. For the second quarter of 2020, we reported an adjusted net loss per diluted share of $0.87 compared to adjusted EPS of $1.71 for the same quarter of 2019. While we started the quarter at a very low point with weekly comps down to 77% at Applebee's and down 82% at IHOP for the week ended April 5, both brands improved dramatically with Applebee's down 18% and IHOP down 34% for the last week of the quarter. This represents improvements of 59 percentage points and 47 percentage points for Applebee's and IHOP respectively. You'll also see in our reported results that we recorded over $114 million of impairment losses for the quarter, most of which was attributable to Applebee's goodwill and intangibles. Turning towards securitization. Our leverage ratio as of June 30 was 6.3 times, up from 4.8 times as of March 31. Under our securitization structure, we are required to make quarterly principal payments of $3.25 million, when our leverage ratio is greater than or equal to 5.25 times, which is our total debt at quarter end divided by adjusted EBITDA for the four preceding quarters. Please note that exceeding the leverage ratio of 5.25 times does not violate any covenants related to the securitization. We anticipate making a principal payment in the fourth quarter of 2020. I would like to highlight that our debt service coverage ratio or DSCR remains robust at 3.34 times as of June 30. The first key DSCR measurement is tripped when a ratio is below 1.75 times. So we have ample cushion. Adjusted EBITDA for the second quarter of 2020 was $12.1 million compared to $68 million in last year's second quarter. Turning to our tax rate. Our GAAP effective tax rate for the second quarter of 2020 was 8.2% tax benefit compared to 26.4% expense for the second quarter of last year. The primary reason for the variance was due to the non-deductibility of the impairment of Applebee's goodwill in the amount of $92 million. I'll wrap up on a positive note. Our international business is off to a promising start in the third quarter. We recently opened four new restaurants. These include two IHOPs in Canada, one Applebee's in Mexico City and one Applebee's in Puerto Rico. We also recently entered into a 13-unit development agreement for IHOPs in India with a very experienced multi-unit QSR developer. This is a key market for us and complements our prior development agreement for Applebee's in India, which we executed in late 2019. I would also like to welcome Tony Moralejo, President of our International Division; and Justin Skelton, our new CIO onto Dine's executive team. To close, while our industry remains challenged, we have taken steps to ensure we continue to maintain strong liquidity and remain responsive to franchisees. Our brands have significant scale as Steve mentioned and are well positioned to benefit from any potential contraction in restaurant industry competition. We've experienced meaningful improvement in our off-premise business at both brands, which will greatly complement our dine-in sales when restrictions on restaurant operations are further lifted. With that, I'll now turn the call over to John.

Thanks, Tom and good morning, good afternoon, everyone. I've been looking forward to sharing these results. Given all that's unfolded since we last spoke about 90 days ago. I plan to provide detail on Q2 as well as a review of what's transpired here in the month of July. Let's start with a bit of context. Pre-COVID, the Applebee's brand had tremendous momentum. We posted a 3.2% comp sales increase through March 8, meaningfully outperforming the casual dining category and delivering 10 consecutive weeks of positive sales to start the year. Once the pandemic emerged in March, we temporarily closed about 250 restaurants and quickly moved to an off-premise business model. As a result, April comp sales declined 70.4%, May sales declined 54.1%, as we began to reopen our dining rooms and June sales were down 29.3%, as we began to see a real shift in momentum. Four primary factors impacted our Q2 results. The most obvious was the closing of dining rooms, which represented approximately 85% of our business pre-COVID. Once dining rooms began to reopen, the government-imposed capacity constraints represented another meaningful variable with most geographies in posting a 25% to 50% capacity restriction. Another factor limiting our revenue recovery is the understandably cautious nature of the American consumer in this environment, which of course, varies depending upon the geography. And finally, we chose to discontinue all national marketing back on March 18 and we've been on a self-imposed media hiatus through almost all of Q2. In hindsight, this was absolutely the right strategy as we allowed our ad fund to replenish, while waiting for the right time to reintroduce Applebee's to America. Now let's talk about where we are today. I'm very pleased to announce that 1,600 Applebee's restaurants are currently open for business in the U.S., representing 97% of our portfolio. The remaining 56 restaurants are a combination of temporary and permanent closures that will evolve slightly as we progress through the balance of the year. Of the 1,600 open restaurants about 1,450 are fully operational with open dining rooms. And given the recent dining room shutdowns in New Jersey, New York, California, New Mexico, South Florida, and Philly to name most of them we now have about 150 restaurants operating in an off-premise only mode with some outdoor dining. And we certainly expect these numbers to evolve as local governments modify their guidelines in this very fluid environment. I want to take a moment to talk about our franchise partners, the restaurant teams, and our cross-functional leadership team. Throughout this pandemic, our top priority has always been the safety of our team members and guests and our partners have simply been exceptional in delivering upon our elevated brand standards. Remember there was no playbook for this back in March. The pandemic took us all by surprise. Yet this adversity has unlocked a remarkable entrepreneurial spirit of creativity, agility, and resilience. Virtually everything we do in this environment is new and different and in many cases better than it was four months ago. And I couldn't be more proud to be associated with this talented team than I am today. I've often stated that Applebee's is at its best in tough times and that's certainly proving to be the case once again. And the good news is we're now beginning to see genuine momentum return to the business. Thanks to our franchise partners and our Chief Operations Officer, Kevin Carroll, our restaurants were prepared and ready with respect to safety, sanitation, parking lots staging, social distancing, contact-free dining, outdoor dining as well as all of our food and beverage standards. After an approximate 90-day media hiatus, we returned to national marketing in mid-June with a terrific digital media plan crafted by our Chief Marketing Officer, Joel Yashinsky. That plan was broadened in early July to welcome guests back to our dining rooms, while continuing our off-premise messaging. In particular, we received positive feedback around the tonality and authenticity of our current advertising to the music from Welcome Back, Kotter, for those of you, I have to call old enough to remember that show. I hope you've had a chance to see that ad because it's the perfect message for Applebee's as those lyrics were written specifically for us at this precise point in time and it appears to have really resonated with our guests. In addition, the current product we're featuring, Applebee's Irresist-A-Bowls is a great example of abundant value and broadly appealing innovation developed by our Chief Culinary Officer, Stephen Bulgarelli. And this also illustrates importantly the power of our supply chain team and their ability to move fast and supply the brand with very little notice as was certainly the case here. Our restaurant P&Ls have also benefited in this environment from a substantial reduction in our core menu, resulting in the simplification of our operation, better execution, and a reduction in food and labor costs. Of course, some of this benefit is offset by a heavier reliance upon off-premise and its packaging cost as well as our investments related to safety and sanitation. So let's talk about our business momentum and provide the complete picture as to where we stand today. After steady and sequential progress throughout Q2, we saw a noteworthy change in our comp sales trajectory from minus 37% in early June to an average of minus 18% over the past six weeks. While posting a minus 15.6% result this past week ending July 26, representing our best comp sales performance since the crisis began. Additionally and importantly, according to the most recent four weeks of Black Box reporting Applebee's is once again outperforming the casual dining category. At present, of our 1,450 restaurants with open dining rooms, average weekly sales are about $39,000 with 64% of this volume being dine-in and 36% off-premise. Now of this off-premise volume approximately 68% is Applebee's Carside To-Go and 32% would be delivery. From my perspective, this convenience-oriented and digitally-led business has really thrived under the leadership of Scott Gladstone. And for obvious reasons it's more important to us and our guests than ever before. We remain very well-positioned in this off-premise segment and execution has really become a core competency of the Applebee's brand. Interestingly, as we reopen dining rooms, we appear to be holding most of our off-premise business with only about a 15% to 20% cannibalization rate suggesting the relevance and staying power of Applebee's To-Go and delivery. On another positive note after the deferral of March-April royalty and advertising payments, I'd like to highlight that Applebee's ad fund is now in a cash flow positive position as we're also beginning to restore our royalty income stream. While we navigate the uncertainties of this environment, we remain 100% aligned with our franchise partners to return our business to its full revenue potential as quickly as market conditions allow. In closing, I believe Americans will choose brands they trust in this environment and we've been working hard to nurture that long-standing trust in Applebee's over the past several months. Looking forward, I'm confident Applebee's is well-positioned to continue its trajectory particularly given our momentum in the likely contraction of CDR restaurant supply over time. With that I'll turn it to Jay.

Thank you, John. Good morning everyone. I hope you're all doing well. IHOP's performance continued to be impacted by the effects of governmental mandated restrictions on restaurant operations due to COVID-19. This was consistent with the overall family dining category according to industry data. For the second quarter IHOP's comp sales declined 59.1% as traffic remained challenged primarily due to dine-in restrictions with statewide stay-at-home orders, continued high unemployment and temporary restaurant closures. However, I'd like to highlight that our weekly comp sales for the second quarter improved since the week ending April 5. In fact, the brand posted 12 consecutive weeks of sequential sales improvement in the second quarter. Additionally, comp traffic improved sequentially every week during the quarter as states began to gradually allow dining rooms to reopen with capacity restrictions which were generally around 50%. As we entered the third quarter our performance in July reflected the resurgence of coronavirus cases and dining room restrictions put in place by state and local governments due to the spike. Additionally, we did not utilize national media through the first three weeks of July. As a reminder we discontinued our marketing late in the first quarter except for some basic local marketing and a brief off-premise campaign. Regarding daypart performance, every daypart's sales and traffic improved sequentially month-to-month in the second quarter. While the overall sales improvement from April to June was fairly even across all dayparts breakfast was approximately 200 basis points behind lunch and dinner respectively. Mainly due to statewide mandates to remain at home and rising unemployment there were essentially fewer people stopping for breakfast on their way to work. Additionally, the breakfast category in general has faced some pressure compared to other meal periods. According to NPD group, breakfast or the morning snack occasion has experienced its steepest transaction declines. However, with more people generally staying at home, I'm pleased to report continued strong growth in our off-premise business even as dining rooms started to reopen. Off-premise comp sales for the second quarter increased by 145% primarily driven by traffic. Delivery sales accounted for 23.4% of sales mix and takeout accounted for 33.5% of sales mix for the second quarter. We're successfully leveraging technology to support our go business, while meeting the convenience needs of our guests. In the second quarter digital sales grew by approximately 28 percentage points to 35% of total sales. Another facet of our off-premise platform experiencing meaningful growth is curbside pickup which was launched during the week ending March 29. The service doubled to 6.3% as a percentage of total off-premise sales for the week ending April 5 compared to the prior week. I'm pleased to say, we've seen progressive growth increasing to 8% of all term sales for the week ending June 28. We believe our collective on-premise initiatives will continue to drive sustainable growth as more people are utilizing to-go now than before the pandemic. As a result, a wider range of guests are familiar with the ease and convenience of having their favorite IHOP meals to pick up or be delivered. Now let's switch gears to the status of reopening our domestic dining rooms. We started reopening on April 21. As of June 30 approximately 92% of our domestic system was open for business of which 88% was opened for in-restaurant dining and 4% for takeout delivery only. Approximately 8% were temporarily closed. As of July 27, 1565 domestic restaurants or 92% were open for dine-in or off-premise. Undoubtedly, the coronavirus is having a profound impact on our industry. As a result, a significant number of independent restaurants are not expected to survive as Steve mentioned earlier. This scenario actually provides an opportunity for IHOP to increase its market share as some independents close their doors permanently and IHOP continues to grow through traditional and nontraditional development. While our growth this year has been adversely affected by COVID-19, our franchisees opened 13 restaurants in the first half of the year reflecting their continued confidence in the brand and our long-term strategy. Looking ahead, our near-term priorities are to quickly and most importantly safely restore sales and traffic to last year's levels. This can be achieved by: first, focusing on the safety of our guests and team members to provide a comfortable environment in our restaurants; secondly, continue to grow our off-premise business; and third, to provide compelling value propositions to entice guests to come back into our restaurants. While consumers still had some concerns about dining out, there is a strong desire to return to restaurants based on our proprietary consumer research. Now to tie this all together, we have plans to return to marketing broadly and emphasize IHOP's appeal across all dayparts while also focusing on driving off-premise sales. In fact, we recently started national advertising again on the 22nd of this month. To wrap up, our goal is to return to a sense of normalcy in a way that meets the comfort needs of our guests. We've made some good progress in the second quarter to improve our sales and traffic, but there is more work to be done obviously. I believe IHOP is well-positioned to withstand current industry headwinds and demonstrate why the brand has been ranked the leader in family dining based on domestic restaurant sales for over 10 consecutive years according to Nation's Restaurant News. I'm very optimistic about the road ahead as state and local government restrictions on restaurant operations are lowered. With that, I'll turn the call back over to Steve for closing comments.

Thanks, Jay. To recap, both Applebee's and IHOP posted steady improvement in weekly comp sales and traffic during the quarter. Our off-premise business continued to deliver substantial growth as guests became more familiar with the to-go service. We ended the quarter with a strong cash position and ample liquidity. Lastly, we are well-positioned to withstand current industry headwinds and stand to benefit from the potential opportunities to expand our market share. Now, we'll be pleased to open up the call to any questions you may have. Operator?

We have a question from the queue from Mr. Jake Bartlett from SunTrust. Your line is open, sir.

Thank you for taking the questions. My first one is about how many stores are currently offering dine-in after California was shut down. Some of the numbers you provided were from the end of June, so I would appreciate clarification on that. Additionally, regarding Applebee's, it's great to hear the detail on average weekly sales for stores offering dine-in, which I believe was 39,000. How does that figure compare to the same period last year? I'm trying to understand how those stores are performing compared to those with only off-premise options.

Okay. So, let's start with opened restaurants and then John answer, the Applebee's.

Yeah. JK, this is John. 1,450 plus restaurants have dining rooms open at Applebee's and that number is fluid. It literally fluctuates on a daily weekly basis. California being the most recent where we lost, I think, 90-plus restaurants in terms of shutting down dining rooms, and I'll come back on the other question after Jay speaks to IHOP.

On the IHOP side, 78% of our restaurants are currently open without restrictions, totaling over 1,320 locations. We have 244 restaurants that are now limited to on-premise only, primarily due to changes in California. This represents 14% of our system being off-premise, and about 8% of our locations are still closed. In California, we have a larger presence compared to Applebee's, which has an impact on us. Overall, about 35% of our business is to-go across the nation, and this increase is apparent in California when dine-in options are reduced. Comparing our performance, restaurants open for dine-in are seeing sales down by nearly 30%, while those only doing off-premise are down around 57%. This shows a clear difference of over 20% in performance without dine-in service.

And then Jake your final question, the $39,000 weekly volume per restaurant that I referenced as recent as last week that would be to your question, about 15% drop from a year ago average weekly restaurant volumes last year. Keep in mind for brand, it's $2.4 million, $2.5 million annual volume, would be about $46,000 weekly. So, we're getting close, and we're seeing sequential improvement each month.

But I think it's also important to note that those numbers are highly variable depending on market. So, we've got some folks that are pretty close to where they were on occasion ahead. We've got some folks, particularly in California, that are obviously given the restrictions are struggling. So, those are averages and it's varying quite significantly across the board.

I think that's an important point. You can see in a state like California where the comparable sales number is down by 50%, while other areas are showing positive comparable sales. We are currently experiencing that situation.

Great. And would you be able to share on the Applebee's side much like Jay, just shared on the IHOP side. The percentage down for dine-in versus off-premise, I think we can kind of roughly do the math but if you could help us out that would be great.

The percentage down, look the delta between – I'll just frame it this way. The delta between total system performance in dining rooms would be about 200 to 300 basis points. In other words, if those dining rooms were open you'd see a 200 to 300 basis point lift in system comp sales.

Great. And then last question. It was really on the – you shared on the last call some breakeven estimates for sales declines at the store level. Have those changed now that you've had experience with dining rooms being open? Just if you can update us on kind of breakeven cash flow, sales levels and basically kind of what – I guess what that would mean for restaurant margins going forward?

Tom, why don't you help with that?

Yeah. Jake as Steve alluded to there is a tremendous amount of variability. So we did indicate more view on averages is applicable in a highly stressed environment also benefiting from the fee relief program that we provided in Q2. So at this point, you do have a range where – depending on where our franchisees are located. They're experiencing a variety of different cash flow situations and we are closely monitoring that. I will speak to our company-operated portfolio, which we have obviously a lot of visibility. This is our North and South Carolina Applebee's. And so we've obviously experienced dramatic improvements in our portfolio is performing in line with the entire Applebee's system. And there we anticipate from a four-wall profitability perspective to be EBITDA positive for the year, and so hopefully, that gives you a little bit of indication just as a data point.

Great. Thank you very much.

Yeah. And I think the point that Tom made that's important is, we are very closely working with our franchisees on their financial health, which obviously has been significantly enhanced by the PPP program. However, we're working very closely with the leadership groups as well as monitoring every single franchisee in terms of where they stand so that we know when people need help and individually we will work with them to help everybody survive.

Your next question comes from the line of Mr. Nick Setyan with Wedbush. Your line is open, sir.

Thanks for taking the questions. It's great to – obviously, it's great to see the trends here in July, and the cadence of the topline. Tom, just to address a couple of the bigger concerns out there relative to the Q2 closure rates and relative to the Q2 gross margins where are we headed in the near term? Can we safely assume that those gross margins in Q2 were as bad as it's going to get? And also just kind of address, what your thoughts are around unit closures for each brand?

Yeah. So, we haven't updated guidance. We suspended it as you know Nick. But let me give you some context into why some of these – normally, we wouldn't be able to provide some color on that. But the reason why it's a little tough is simply, because you had circumstances, for example, the instance of the IHOP franchisee that had some closures. And then we were able to get a good amount of them transferred to a new franchisee. And so we did have some closures that we deemed permanent during the quarter, but the predictability of that is going to be difficult to determine at this point. With respect to gross margins, a lot of that is influenced obviously by our collections experience. And as I mentioned that the good news there is our collections are getting to be very strong coming out of the release program. So we believe the relief program had a good intended effect. The PPP program provided a lot of liquidity into the system. And now as Steve mentioned, we are monitoring our individual franchisees very closely.

One other comment, I've been in this business almost 40 years. I've never seen a quarter like this quarter. I sure hope we're not going to see anything else like this. So it's getting better and it's got to get better from here. So it's a remarkable period. I mean, I just have never seen anything like a quarter like this and it's just good to have it behind us and good as be moving forward with some momentum.

Yeah, absolutely fair enough. And then just on the marketing for both brands. Clearly, the Applebee's marketing has had some – has really worked. How are you thinking about the rest of the year? Are we back to pretty much a normalized cadence? Are there going to be any period short periods or long periods where you're going to go off again? Is menu innovation going to come back with the value focus? How are we thinking about all of those things?

Yeah. Let me – let both folks address their individual brands. But in general, our view is we're going to make sure that our marketing efforts are sufficient to the opportunity. And that we're on air when we need to be. There are some – obviously, as we have every year some planned gaps, but they're carefully planned so that we don't believe that they're going to cause drops in the momentum. And the interesting thing for Applebee's it had a lot of momentum going into this. And so now we want to obviously recoup that. IHOP was doing okay but we are hoping to pick-up from that and they're showing that they're running neck and neck with the competition at this point. Applebee's looks like they're actually running a little ahead of the competition so obviously, we want to maintain that positioning. What you will see is we have significantly increased the level of digital. Because of the fact that a lot of the efforts that we're doing are about off-premise and we want to make sure that we're communicating to our 10 million or 11 million members between IHOP's program and Applebee's program about specials that we've got available and reasons to come either pick-up or come into the restaurant and dine. And so you'll see us shifting a little bit more towards the digital side as we've done and had some great success. And then obviously as we bring additional technology to bear where use your own device and a technology menu that allows us then to continue to grow our ability to communicate with customers. You're going to see us probably step up those digital efforts and then obviously we're going to continue to be on air with commercials that we think drive folks either to off-premise or into the restaurant. So Jay you want to talk a little bit about IHOP?

Yes. We just went back on the air on the 22 this month. And I would think for us without disclosing what we're planning on doing I think, the calendar of using marketing will look more similar to what we would typically do. We intentionally turned off our marketing for a long period of time to save that money for the more appropriate time to start marketing we think the appropriate time is now. I think the other thing we'll do is we've already pivoted behind the scenes a couple of times as to when we were going to start marketing and what we wanted to market, et cetera. And I think that we'll continue to do that the rest of the year. This is a very fluid situation still as you can see with them closing down dining rooms in California again. So we don't want to spend a ton of marketing dollars pushing just a get back into the restaurant message if those restaurants aren't going to be open for dine-in or they have too much of a capacity restriction. So we're going to be watching the situation closely. We do have the funds and we will be doing marketing. What we market, we will pivot as time goes by to think about what's the value play we want to do, what the innovation we want to talk about, what's the capacity in restaurants, how do you keep supporting the off-premise to-go message. We'll balance all of that and make good decisions through the balance of the year to market the right things.

And then Nick, on the Applebee's front we're pretty good at this. We know how to market effectively in this environment. We've demonstrated that. Our fund is healthy. That's really important. That was the benefit of taking that 90-day hiatus will continue market. Our objective is to maintain top of mind awareness and we'll have extraordinary sensitivity to the environment. That's everything from how our guests feel about dining out both from a dine-in perspective and an off-premise perspective to the variability across the country in terms of government restrictions. We can effectively drive demand as to the constraint on that demand. We will actively seek that out. And then to your final question there'll be a balance of value orientation and innovation probably less innovation to be quite frank in this environment given our reduced menu which has had some significant operational benefits. And then the final point that I would make is, the media landscape is going to be different. America needs its sports. And I'm hopeful that some of those currently restricted media vehicles become available. As a result, I anticipate that the media landscape generally speaking as we go into next year is going to have less demand. And for the first time in a long time an absence of inflation which is good news. And then you have the election variable, which will be interesting come November.

Thank you very much.

Your next question comes from the line of Mr. Jeffrey Bernstein from Barclays. Your line is open, sir.

Great. Thank you very much. Two questions. One it seemed like both brands you talked about independence and potential for significant store closures, I'm just wondering what you've seen already or what your expectation is in terms of the industry as a whole, or whether any particular brand is more or less vulnerable? Presumably that creates a market share opportunity for you. And it does raise the question because I think many people think of franchisees as "independent operators." So I'm just wondering whether you guys see yourself vulnerable to more closures in your system at either brand? And then I had one follow-up.

Let me begin and then invite others to join in. You're observing the same figures we are, showing projections of 75% or more of independent operators closing. This indicates that a significant number of properties will be available for conversion. Some brands were already facing challenges prior to the pandemic, and we've seen numerous restaurants closing. We are monitoring this situation closely. Certain restaurants are likely to close, many of which were struggling even before this began, so this may accelerate the closure of a few more locations. However, we do not see this as a significant shift for either of our systems, and we are ready to step in and support individual franchisees where appropriate. We're also evaluating restaurants that might have been on the edge long-term, determining their viability. It's an opportune moment to consider divesting from those locations, especially if we can find replacements. Overall, we believe this is a combination of factors that presents mostly positive outcomes for us. Eventually, we expect that companies with strong financial foundations will be well-positioned for growth, and that's our perspective on the situation. Tom, would you like to share your thoughts on what our brand representatives have to say?

Yeah. I think the one thing independents don't have and to your point on whether or not franchisees are viewed as independents. We view them as independent operators, obviously, but they're affiliated with a national brand with all of our resources. And I did mention we are bringing back resources as appropriate. We also have a very strong liquidity position and we are willing to step in. We did that in the past. We have our own company operated portfolio obviously Jeff. And so we have a number of levers that we can apply that true independents probably don't have at their disposal.

From the IHOP perspective, we opened 13 restaurants at the start of the year and are eager to grow further. We had plans to open more locations this year but allowed some franchisees to defer those openings. We believe our growth will resume once the current challenges are resolved. As mentioned, we have a strong track record of collaborating with franchisees to assess situations where restaurants have closed. The reasons for closures can vary, and we evaluate whether a restaurant can thrive under new ownership or needs to be replaced altogether. While I anticipate more closures, it's difficult to predict how many due to numerous uncertainties. Whenever possible, we strive to avoid permanent closures and instead aim for temporary ones, which allows us to recover those restaurants. Recently, we lost 49 restaurants due to bankruptcy, but we expect to reclaim about 41 of them soon.

And then Jeff this is John. The reason I'm optimistic about Applebee's is that when you examine the categories, including QSR, fast casual, and casual dining, casual dining stands out as the category that is heavily reliant on independent restaurants. Over 90 percent of all restaurants in casual dining are independent, which means that strong, vibrant brands with scale are well-positioned to gain significantly. It represents the one category that offers considerable opportunity.

I want to clarify something. Steve, at the beginning of your comments, you mentioned that you thought you heard numbers indicating that 75% of independents were potentially closing. I just want to ensure I understood that correctly.

Yeah, those are the headlines we've been seeing. I've come across numbers ranging from 75% to 85%, but I'm unsure of their accuracy. Additionally, the restaurant association suggests that the total industry losses could be around one-third to 40%, mostly impacting independent establishments. This highlights the challenges faced by independents in terms of scale, brand recognition, digital capabilities, and technology access, which are typically beyond their reach. Consequently, they are experiencing the most significant effects of this situation. We do expect that some restaurants will close, but we don’t anticipate the number to be substantial. Articles about the industry being in distress often mention closures, like how IHOP closed 49 restaurants, without acknowledging that they also reopened 41, which has been the pattern in several cases. Therefore, while we will have some closures, we expect to retain most of our locations and anticipate a lot of growth opportunities afterward.

Understood. Thanks for the color.

Your next question comes from the line of Brett Levy from MKM Partners.

Thank you for taking my call. I hope you're all well. I'd like to revisit some of the questions that were previously raised. I'll frame them differently to see if I can get a new perspective. When you compare your breakeven points for locations with dining rooms to those that operate solely off-premise, what sales gap do you see? Is there a possibility that the margins, due to the operational improvements you're implementing, could actually increase beyond previous levels, or are the additional costs associated with expanding off-premise and enhancing safety significant enough to negate any potential recovery?

So that's a great question. So I'm going to have Tom weigh a little bit, on the margin. So, here's the way to think about it. We've got some incremental costs associated with PPE, making sure that guests are safe and associates are safe. But those have been offset and probably benefited from a more tightly grouped menu, with a focus on the things that are really moving. So one of the benefits of this is in both brands we have had extensive menus. And have been working with franchisees to try not to bring that number down. Obviously everybody feels their guests, like something different. So hence the proliferation of products on the menu, but this has allowed us to tighten the menu, in conjunction with the franchisees in a way that allows better execution in the kitchen. And also provides better cost management, as a result. So our view is coming out of this, we have the opportunity to maintain that off-premise. And return to comparable dining room levels, over a period of time. Your guest as to the recovery line is as good as mine at this point. Well, I think, we'll know a lot more this fall. But the opportunity on the upside is, if we gain back those restaurant sales. And we maintain the bulk of the off-premise that puts us in a better position from a revenue standpoint than before. And with a lower number of different items on the menu, a higher efficiency in the kitchen, we're probably going to be more profitable. Now that's notwithstanding, sort of food cost spikes that we're seeing whether it's in pork, or beef, or whatever. But those will presumably settle out as well. So the opportunity going forward for profitability in the restaurants is probably better than it was provided we return everybody back into the dining room. And so, the combination of those two we feel is potentially an upside in the long-term.

So Brett, let me share some additional data points here. Regarding the one-time costs of reopening the restaurants, we asked both brands' operations teams to evaluate these expenses, which are related to enhancing sanitation standards. On average, these costs amount to about $3,000 per restaurant, with ongoing costs around $1,000 per week. These are not insignificant and are additional costs for the restaurants. When comparing dining rooms that are open to those operating solely on an off-premise basis, I will apply this information to both brands, as it is similar. There is a 30-point sales increase if the dining rooms can be opened. Our average comps reflect a mix of open and closed dining rooms, and having them open yields a 30 percentage point lift. However, it is important to note that even open restaurants are not operating at full capacity due to restrictions such as six-foot distancing or 50% capacity limits, as seen in our North and South Carolina locations. This capacity limitation affects sales performance even in open dining rooms. For Applebee's, there are also restrictions on late-night operations or bar service after a certain hour. We believe that as the situation in the country improves and more restrictions are lifted, there is potential for increased sales performance, even in those restaurants where dining rooms are currently open.

So I would just state from an IHOP standpoint. If you talk to our franchisees they will tell you there are puts and takes on this right? In some ways, how to reduce menu probably reduces some food cost you get more efficient with what you're managing et cetera. And some franchisees have seen less prep labor, because they're not making as many things that we were doing before. But the takes, the amount of cost for the ongoing sanitizer, gloves, masks et cetera are probably outweighing that right now. So if you talk to the franchisees, they would probably tell you, none enough puts too many takes right now. I think what the key things Steve said though was, we have a huge top line opportunity coming out of this. Because we have taught people how to use this for to-go and to do off-premise. And as Steve said, we can maintain, even half of the increase we've gotten on that. And get our dining rooms back with full capacity, our sales are up. And that flow through and that leverage is going to lead to higher profit. So there is a big opportunity for us. But if you ask the franchisees right now while they're still down 35% in sales, they will tell you it's not working for them right now. We got to get the top line back.

Nothing to add at my end, Brett.

And if you think about the franchise system just in general, if you could bucket it like what percentage of the system do you think is healthy versus of those that are still extremely or significantly challenged and might need some additional help either handholding or financially? And then what kind of bucket of your franchisees are out there saying you know what we are interested in buying more. We are interested in building more. We want to get back to the growth algorithm.

Yes, there are differences in the health of our franchisees, which existed even before the virus. The situation may have intensified due to the virus. Fortunately, the majority of our franchisees benefited from the PPP program, which has been helpful. We are also working with individual franchisees who may need short-term assistance to navigate through these challenging times, rather than implementing a broad program as we did at the onset of the virus. Generally, we believe franchisees are in a decent position, but this largely depends on the pace of recovery. If we see a quick rebound this fall and into next year, we should be in good shape. However, if recovery takes longer, some franchisees will need support while they determine the best long-term strategies for their restaurants. It's a week-by-week situation. Our restaurants in Northern South Carolina are cash flow positive, albeit not very profitable, and many franchisees are in a similar situation. Conversely, some franchisees in more challenging markets, like California, are struggling with closed dining rooms, meaning they are not generating any revenue. The key question is how long these conditions will persist and whether they have enough resources to last until reopening and recovery. We will provide individualized assistance to franchisees to help them find long-term solutions or sustain themselves until recovery.

Thank you very much.

Your last question comes from the line of Mr. Brian Vaccaro from Raymond James. Your line is open.

Hey, yes. Thanks for taking questions. So back to the last one. You were just talking about on franchisee health. And in the past I guess a few years ago probably did a nice job disclosing sort of how many franchisees you were working with, the nine and the three that obviously healed from there. But would you be willing to maybe just frame a little bit more how many franchisees or what percent of units at each brand are operated by franchisees that are on your radar of receiving additional relief for help?

Yes. The reason we're not pursuing that is because the situation is quite different now. There are a few franchisees we may start discussions with, but it's not comparable to the previous downturn for Applebee's franchisees. Everyone is facing challenges and is seeking profitability. We are significantly increasing our collaborative efforts with the franchisees to evaluate long-term sustainability. If current conditions persist through the end of the year and the following year begins slowly, that will significantly alter the scenario. However, there is currently no major program in place.

And Brian, the other point I want to emphasize is quite clear. We are making a concerted effort to restore each business to its full revenue potential as swiftly as possible, given the current market conditions. Therefore, the third quarter is crucial. It will provide us with insights into our progress towards achieving positive sales.

Yes. And I think the two you've heard about were problems pre-virus they had nothing to do with the virus and those both turned out pretty well for us.

Yes. Yes. Understood. Okay. And I guess just to be clear on the status of franchisee relief more recently as the business has recovered are essentially all franchisees now paying royalties and advertising fees in the case of IHOP rental payments? And if not what percent of each brand are still receiving some level of deferrals?

Brian so for all intents and purposes, we're back to kind of a normative rate of collections on both brands. And with respect to IHOP, actually there were many of our franchisees that you saw the numbers they were struggling. Having said that, one of the conditions of PPP was that the money was used to pay, not only employees but also rent. And so we had a good rate of payment on the rents as well after the deferral period.

Okay. All right. And then I wanted to ask on the Applebee's side back to some of the operational changes that were made. In terms of streamlining the menu, could you help frame what percent of the items you've removed? And how do you plan to manage adding back items to the menu? And where could that land ultimately compared to the historical menu?

Hey, Brian, that's a good question. This is John. The expansion of the menu in any mature brand has been a trend over several decades. We have taken about one-third of our menu items off, which will remain off, as we concentrate on items that are in high demand, high velocity, and low complexity. The one-third we removed represents around 10% of our dollar volume, but we can easily shift guests to similar items. Our franchisees are very positive about this change. Regarding adding items back, I don't foresee further expansion being wise or strategic. If we choose to add items, we will also remove others. This disciplined approach has been in place for some time. The pandemic has sped up our transition to a simplified operation, which benefits both guests and our finances.

Yes. This is Jay. On the IHOP side, we did very similar thing. We cut the menu by a percentage and we intend to leave most of that off as well. We think there'll be some items that may come back and more importantly, we leave ourselves a little bit of space for some new innovation as time goes by. But it's not going to get back to the level that it was.

Okay. And then also on the operational side, could you provide more color on the measures that franchisees have taken to expand capacity during COVID, whether it be expanded outdoor seating or adding plastic barriers in the restaurants to optimize booth seating? Just kind of frame or quantify how important those factors have been?

We have 30 partners at Applebee's who are naturally entrepreneurial and have been successful. We observe a lot of creativity in expanding capacity, especially if outdoor dining is permitted, which can be complex. Additionally, there’s been innovation inside restaurants to increase capacity, like using flexiglass to separate booths, allowing for better social distancing without the need for 6-foot spacing. These solutions are typically branded and of high quality. While there are some initial one-time costs involved, they help maximize capacity under current constraints. Creativity is thriving in this area every day.

On the IHOP side, we're doing very similar things. It's great to be in a franchise system because franchisees tend to be more entrepreneurial. When their survival is at stake, they find creative ways to solve problems and have done some interesting things. We often share the local innovations as best practices across the system. We hold regular town hall calls with our franchisees, and we even had our architect join one of the recent calls to guide them on execution, depending on local municipal regulations, as well as the steps and specifications needed. It's been very successful what they're planning.

All right. Thank you. I'll pass it on.

Thanks, Brian. Thank you. So just for the question about sort of the overall industry, there is a National Restaurant Association statement out that says the restaurants have lost more revenues and jobs than any other industry. And they estimate that in June for the first three months of the pandemic, it was $120 billion in lost revenue, which is why we're working with the National Restaurant Association, International Franchise Association, National Retail Federation for more assistance for the industry and our franchisees. And then according to the Restaurant Coalition, the Independent Restaurant Coalition, they were the ones who put out the number that 85% of independent restaurants may go out of business by the end of 2020. So sobering numbers. However, one person's crisis is another person's opportunity. And our view is we're going to emerge from this thing with a lot of strength and capital and that's going to put us in a position to resume a significant growth trajectory for the company. And we are excited about seeing that momentum build and we get a recovery and full opening of all the restaurants and then take the lessons learned and have higher revenues and higher profitability as a result. It looks like a long road to that at this point, but there is a road and a vision to get there over time. So with that, I just want to close say thank you for time. I hope everyone is staying safe and healthy. This is our restaurants. We do a good job of creating a safe healthy environment with great food. So thank you again for your time and we look forward to speaking with you next quarter.

This concludes today's conference call. Thank you everyone for joining. You may now disconnect. Have a great day.