Dine Brands Global, Inc. Q4 FY2020 Earnings Call

Hello and welcome to the Fourth Quarter 2020 Dine Brands Global Earnings Conference Call. My name is Grace, and I will be your operator for today's call. Please note that this conference call is being recorded. I will now turn the call over to Ken Diptee, Executive Director of Investor Relations. Sir, you may begin.

Good morning, and welcome to Dine Brands' fourth quarter and fiscal 2020 conference call. I'm joined by John Peyton, CEO; Allison Hall, Interim CFO and Controller Tom Song, CFO; Jay Johns, President of IHOP; and John Cywinski, President of Applebee's. Before I turn the call over to John, please remember our safe harbor regarding forward-looking information. During the call, management may discuss information that is forward-looking and involves known and unknown risks, uncertainties and other factors, which may cause the actual results to differ from those expressed or implied. Please evaluate the forward-looking information in the context of these factors, which are detailed in today's press release and 10-K filing. The forward-looking statements are as of today and assume 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 John.

Thanks, Ken. Good morning, everyone. And thanks for joining us. I'll start by saying it's an honor for me to join Dine Brands. I believe in Dine Brands because I believe in restaurants; restaurants are essential to strong communities and human connection. And people appreciate that now more than ever before. I believe we're on the cusp of a restaurant renaissance. As we enter what we expect to be the beginning of the end of the pandemic, all restaurants face a common challenge, and that's that eating out in America has changed. Those who win in the new era of restaurants are those who remained resilient and those who invested in new menu and service innovations and new technology during 2020. And that's the story of Dine Brands—with solid fundamentals, two iconic brands, and certainly the most talented team members and franchisees in the industry. Let me pause and tell you a bit about my story. As a teen, I worked at my parent's restaurant, it was called the Southern Omelet Station in West Philadelphia. I was humbled by the almost 24/7 demands required of my parents. After college, I went on to work as a consultant for PwC. Then I was at Starwood Hotels and most recently at Realogy. I joined Dine because I believe in the power and the lure of strong brands. Two decades ago, a mentor of mine taught me that brands win when they're different, better and special, and our brands are truly different, better and special. For example, IHOP is a pancake-obsessed breakfast innovator that makes the most important meal of the day, also the most fun. Applebee's embodies what it means to be all-American and locally relevant. We call that eating good in the neighborhood. In other words, Applebee's and IHOP are iconic brands that connect in an emotional way with our guests. And that's important because we know restaurants are essential to the fabric of community and human connections. I also like our business model, which is 98% franchise and asset light; we are a significant generator of cash. Our franchise model helps buffer us from fluctuations in the market, generally requiring less significant investments of capital. It allows those who are best at operating restaurants—our franchisee owners—to do so with our support. My 20-plus years of experience at Starwood and Realogy taught me that successful franchising requires true partnership, and that we work hard every day to ensure that our independent franchisees build valuable businesses to create generational wealth. So over the last few months, I've been on the move, conducting a deep dive across the company. So far, I've spoken with 40 franchisees in the US and around the world, representing 50% of the Applebee's system and more than a third of IHOP restaurants. I've also connected with our suppliers, bankers and team members. I've visited our restaurants and our test kitchen. I can report that our network is aligned in its desire to grow, invest, and win. Despite the impact of the pandemic, Dine's fundamentals remain solid. You may recall that in March of 2020, S&P placed our whole business securitization notes on credit watch negative, as it did with two other whole business securitizations in our industry at that time. Six months later, S&P removed our note from credit watch and reaffirmed our BBB rating. Dine was the only issuer of the three not to have its note downgraded or remain on credit watch due to the pandemic. S&P's decision last fall was a great achievement for Dine and illustrates that our fundamentals remain strong. Because we emerged in 2020 on sound financial footing, we plan to repay in full the $220 million drawn from our revolver last March. We expect to complete the repayment this month, resulting in interest expense savings of approximately $5 million. In addition to strong fundamentals, we have passionate franchisees who remain in very good standing. Our collection rate for royalty and marketing fees stands at approximately 99%. The fees we deferred during Q2 of last year are being paid back according to schedule. In addition to our fabulous franchisees, both brands are led by a veteran executive team with exceptional experience and industry knowledge. You'll hear from Jay and John shortly. Their expertise and collective wisdom truly paid off during 2020. Looking ahead, we anticipate a rebound in the second half of the year, driven primarily by increases in vaccination rates. Overall weekly sales trends for both brands have also improved since the week ending January 3, 2021. Applebee's improved by approximately eight percentage points, and IHOP posted gains of about six points. We're encouraged by our off-premise business; both brands maintained off-premise sales of approximately one-third of total sales during the fourth quarter. We view off-premise dining as a new consumer behavior that will extend beyond the pandemic. We're continuing to invest in technology to support our growing off-premise business. We're optimistic about the outlook for Applebee's and IHOP because during times of crisis, guests, just like me and like you, look to brands they trust. As restaurant guests return to indoor dining, they will trust that our franchisees and restaurant teams at IHOP and Applebee's are committed to their health and safety. Taking collectively, the fundamentals uniquely position Dine Brands to navigate the challenges of the pandemic and position us for long-term sustainable growth. Our team is focused on three objectives over the next 12 to 24 months. The first is to navigate what we believe is the beginning of the end of the crisis. The second is to win the recovery and the new normal that follows, and the third is to evaluate long-term growth vehicles. Our focus will be on continuous improvement in operational health and safety standards in our restaurants, and preparing compelling marketing campaigns and new products to drive recovery. We'll leverage our recent investments in consumer insights, and digital to reactivate our guests through targeted marketing. We'll continue to evaluate long-term growth opportunities, including new prototypes for both brands, virtual brands, and ghost kitchens. As I wrap up, I want to emphasize that Dine views the crisis as both a threat and an opportunity. We've continued to invest in new digital products and innovative menu items like IHOP Happy Hour and Applebee's new virtual brand, Cosmic Wings. Our franchisees have supported their communities by feeding frontline workers in need. It's all of these investments combined that will pay off as our guests return to indoor dining. With that, I'll turn it over to Allison to provide an overview of our financial results.

Thank you, John. Good morning, everyone. I'll begin with a business update, then review our results for the fourth quarter, and discuss our financial performance guidance for 2021. During a very challenging year, we took steps to maintain our financial flexibility, including drawing down $220 million in March 2020 from our revolving credit facility, which remains outstanding as of December 31st. We plan to repay the $220 million during the month of March. Because of this proactive measure, we continue to maintain strong liquidity. We ended 2020 with total cash and cash equivalents of $456 million, including restricted cash of $72.7 million, excluding the $220 million drawn from our revolver, cash on the balance sheet was $64 million higher at the end of 2020 compared to a year-end 2019. The increase was primarily due to the temporary suspension of both our quarterly cash dividends and our share repurchase program, which were important steps taken in response to the COVID-19 pandemic. Additionally, we maintained tight G&A management during the year and were able to lower compensation costs following the difficult decision to furlough approximately one-third of our corporate staff for several months during 2020. Turning to our financial results, I'll begin with notable changes on our income statement. For the fourth quarter, adjusted EPS was $0.39, compared to $1.78 for the same quarter of 2019. For 2020, adjusted EPS was $1.79 compared to $6.95 in 2019. The year-over-year decreases are due to a significant decline in customer traffic, resulting from governmental capacity restrictions on dining and operations. This led to declines in domestic comparable sales at both brands, a decrease in the number of operational Applebee's and IHOP restaurants, and lower gross profit. The pandemic's impact on franchise operations caused an increase in bad debt; our bad debt was approximately $12.8 million for 2020 compared to virtually no bad debt for 2019. Given our asset-light business model, G&A remains an important lever. In 2020, it constituted 30% of our total revenues, excluding advertising. G&A for the fourth quarter of 2020 improved to $39.4 million from $41.7 million for the same quarter last year, primarily due to lower travel and compensation costs. G&A for 2020 was $144.8 million, including $4.3 million related to the company restaurant segment, compared to $162.8 million in 2019. The decline was largely due to tighter management in response to the resurgence of COVID. Cash from operations for 2020 was $96.5 million, compared to $155.2 million in 2019. Our highly franchised model continued to generate strong adjusted free cash flow of $106.6 million in 2020 compared to $148.8 million in the prior year. We believe that our cash on hand, cash from operations, and the steps taken to mitigate the effects of the pandemic will allow us to maintain strong liquidity throughout the year as our business improves. Regarding capital allocation, we are currently reevaluating our strategy as industry conditions improve. We plan to repay the $220 million drawn last March and will also consider reinstating our quarterly cash dividends and share repurchase program. We're evaluating investments in our existing brands for both organic and non-organic growth. Dine Brands provided approximately $55.7 million in royalty, advertising fees, and rent payment deferrals to our franchisees and will continue to provide assistance on a case-by-case basis. Our consolidated adjusted EBITDA for 2020 was $158.7 million, compared to $273.5 million for 2019. The decrease was primarily due to a significant decline in customer traffic from government-mandated dine-in capacity restrictions. Due to our asset-light model, CapEx represented only 7% of 2020 adjusted EBITDA. In terms of financial performance guidance for fiscal 2021, we currently cannot provide a complete business outlook due to ongoing uncertainty from COVID-19. However, G&A is expected to range from approximately $160 million to $170 million, including non-cash stock-based compensation expense and depreciation of approximately $45 million. Capital expenditures are expected to be approximately $14 million, including about $5 million related to the company restaurant segment. To wrap up, Dine Brands has strong cash on the balance sheet and has maintained financial flexibility despite adverse conditions. Comparable sales of both brands have improved significantly since the onset of the pandemic. While there’s work ahead, we believe the accomplishments this year have laid a solid foundation for growth. With that, I'll turn it over to John Cywinski.

Thanks, Allison, and good morning, everyone. I'm very proud of what the Applebee's team accomplished in 2020 and remain extremely optimistic about our business prospects here in 2021. In partnership with our franchisees, we fundamentally altered our business model to adapt to this new environment. Applebee's comp sales progressed from a decline of 49.4% in Q2 to a decline of 13.3% in Q3 to a decline of 1.9% in October when we last spoke. Almost immediately thereafter, we experienced a resurgence of COVID, impacting our Q4 trajectory. As a result, in November, comp sales were down 15.0%, while December came in at minus 30.1%. The good news is that business is now improving; comp sales for January and the first three weeks of February combined were down 18.1%, rolling over a strong increase of 3.3% from the same timeframe last year. Additionally, given COVID-related restrictions, we scaled back our media spending in December, January, and February. It's important to note that not all casual dining brands are impacted equally by these restrictions; each brand has a different geographic distribution. Applebee's has a significant presence in the Northeast and Midwest, which were hardest hit by dining restrictions. While reflected in our recent results, this will ultimately benefit us as restrictions decrease over the coming months. As of the end of December, 412 of our dining rooms were closed due to government-imposed mandates. Thankfully, the landscape has changed dramatically over the past month, and virtually all of our 1,600 dining rooms are now open for business. In many respects, our current operating environment feels similar to late summer of last year. If you recall, we saw Applebee's sales momentum accelerate as restrictions were eased, including our first positive sales week at the end of September. Barring unforeseen circumstances, I anticipate a similar dynamic to unfold in 2021. For the month of February, Applebee's sales mix consisted of 63% dine-in, 22% Carside To-Go, and 15% delivery. We continue to enhance Carside To-Go with the introduction of a third-party app called Flyby that notifies restaurant teams when guests arrive. Our franchise partner in Arkansas recently opened Applebee's first drive-thru window. This dedicated lane eliminates weather challenges, improves throughput, and extends our late-night To-Go operating hours. Our tamper-evident packaging is now fully deployed, reassuring our guests. Our off-premise investments over the past year have broadened Applebee's reach and relevance across this convenience-driven occasion. Regarding our on-premise business, I anticipate our 63% sales mix to grow as indoor dining gradually returns. I believe dining room service will be a core strength for Applebee's as guests look to reconnect over a good meal and perhaps a drink. Most importantly, these guests will naturally gravitate to brands that have earned their trust and loyalty during the pandemic. Our strong brand affinity and visit intent metrics are reliable leading indicators of brand performance. As the year progresses, we'll continue to deploy guest-facing digital tech, such as our pay-and-go initiative for easy mobile payments. We've recently launched Cosmic Wings, a differentiated virtual brand targeting a younger audience around the wings meal occasion. Currently, Cosmic Wings is an online delivery only concept available via Uber Eats, fulfilled through approximately 1,250 Applebee's kitchens. In addition to craveable wings and tenders, we offer unique items like Cheetos Original Wings and Cheetos Flamin' Hot Wings. The team has seen great results; Cosmic Wings averaged $510 of incremental sales per restaurant in its first full week. We've also piloted ghost kitchens in partnership with franchisees in Philadelphia, Los Angeles, and Miami. This model features low capital investment, small footprint kitchens designed to satisfy online delivery demand where we lack a restaurant presence. As I reflect on this past year, I know our guests genuinely trust Applebee's more than ever. Whether in their family rooms or our dining rooms, our positioning as a neighborhood brand resonates deeply. Thanks to the resilience of our franchise partners, the Applebee's ad fund is in great shape, allowing us to reestablish our national media presence. Last week, we launched a national event—five boneless wings for $1 with any burger. This promotion resonated extraordinarily well; Applebee's achieved its highest sales volume week since the pandemic began. I believe Applebee's is nearing an inflection point, and America's pent-up demand for dining out is very real. We saw this trajectory last year until the resurgence of the virus, and I am confident we'll see it again this year. Our franchise partners are well-positioned to unlock the full potential of the Applebee's brand.

Thank you, John. Good morning, everyone. We are very optimistic about the road ahead for IHOP for several reasons. First, quarterly comp sales improved meaningfully from a decline of 59.1% in Q2 to a decline of 13.1% in Q4, reflecting a net increase of 29 percentage points since the pandemic began. Second, the brand is well-positioned to benefit from pent-up demand when restrictions on dining capacity are eased, and we have a strategy in place to capture it. Lastly, our development pipeline remains strong and new opportunities are being pursued. As we close out the fourth quarter, IHOP's comp sales declined 30.1%, which is on par with the family dining category. Our performance, especially in the final six weeks, was adversely impacted by the resurgence in COVID cases, particularly affecting California and Texas, which comprise approximately 25% of our domestic restaurants. Our January 2021 results improved to a decline of 26.8%, representing a gain of 10 percentage points from December. Our February comp sales through the weekend of February 21 were down 27.6%. Our sales mix consisted of 66% dine-in, 16.9% To-Go, and 17.1% delivery. We have four strategies to drive growth moving forward: focusing on our PM Day part, providing value, maintaining gains in off-premise sales, and pursuing development growth. To address our PM Day part and value strategies, we launched IHOP Happy Hour on September 28, offering a wide array of value options during afternoon and evening hours. This initiative is driving incremental sales in the mid to high teens and approximately 20% incremental traffic compared to other meal times, translating to a low to mid-single digit lift in sales and traffic throughout the week. Our robust off-premise business has shown resilience, comprising 33.3% of total sales in Q4, up from 32.4% in Q3. To-Go accounted for 17% of our sales mix, while delivery accounted for 16%. Our off-premise comp sales in Q4 grew 130%, driven primarily by increased traffic. We believe we can retain a significant portion of this growth even as dining capacity restrictions are eased. The portability of the IHOP menu and our proprietary off-premise packaging, which keeps food warm for approximately 40 minutes, contribute to this success. Additionally, we've quickly rolled out Carside To-Go in response to the pandemic and continue investing in our IHOP To-Go platform. Our latest menu innovation, our new signature burritos and bowls, is performing well since its January launch, capturing approximately 8% of ticket order incidents. To grow IHOP, we have four platforms: traditional development, non-traditional partnerships for 94 restaurants over five years, resumption of the flipped by IHOP concept, and testing a new small prototype for growth in areas we couldn't previously penetrate. For 2021, we expect to continue regrowing the brand that was hindered by the pandemic. As of December 31st, 1,174 restaurants, or 70% of our domestic system, were open for in-restaurant dining with restrictions. This is down from 85% open as of September 30th, primarily due to rising COVID-19 cases. The closure strategy focused only on greatly underperforming restaurants; we ended up with 41 closures, well below our initial projection of 100. I'm confident that we will eventually replace these underperforming locations and grow our footprint with stronger performers. We're executing our strategies, including PM Day part expansion, value, maintaining gains in off-premise sales, and development growth. I'm proud of our franchisees and team members for their accomplishments during this challenging year and very optimistic about the road ahead.

Thanks, Jay. We have a tremendous team. I want to thank Allison, John, and Jay. It's because of their leadership, particularly during the pandemic, that Dine and its brands are poised to enjoy significant upside potential in 2021 and beyond. While we understand our meaningful change in performance trajectory will not happen immediately, I'm confident in our ability to restore sustainable same-restaurant sales momentum in the second half of 2021, as more people are vaccinated and guests who are eager to dine out return to our restaurants. I have absolute faith that our franchisees and talented team members will lead us into a new restaurant renaissance. Our strong fundamentals remain intact. We're positioning Dine for long-term growth and continuing to evolve with a gift-centric, data-driven organization. With that, we’re pleased to take your questions. Thank you.

The first question comes from Jake Bartlett from Truist Securities.

Great, thanks for taking the question. My first is really on the regional performance. I understand there’s a lot going on with weather and restrictions being tightened. But can you give us a sense of how stores performed in the markets with fewer restrictions, like Florida? In terms of how their sales and indoor dining have been recovering, and what's been happening with the off-premise mix in those markets?

Jake, this is John Cywinski. It's a good question. I can’t quantify what we see. But suffice it to say those geographies with very few restrictions perform well. You'd see, not surprisingly, a larger percentage mix for dine-in compared to the national average, and the inverse of what we observed in our most restricted geographies—where two-thirds of our business was off-premise and a third on-premise. In the least restrictive areas, we see a better revenue result there, and we're eager to get the full national brand back to that point. We have significant variability across the country, and those specific geographies you referenced provide a benchmark for us; they present a favorable picture.

Hey, Jake, this is Jay Johns at IHOP. Adding to what John said, the correlation between restaurant openings and the performance of those locations is clear. I think our To-Go business has held up well even as restaurants have opened up; most of that To-Go business is maintained. We're doing a better job as these areas open up.

Great. That's really helpful. And a question for you, John, regarding Applebee's. You made the comment that last week's average weekly sales were the strongest since the COVID crisis began. Does that imply that same-store sales were actually positive for Applebee's last week?

Jake, it won’t. Again, I'll resist quantifying that. But I will make two points. The last week data I referenced is not included in the data disclosed in our release, which only covers the first three weeks of February. Suffice it to say it indicated a significant positive trajectory shift compared to the earlier part of February.

That's helpful. Thanks. And regarding the closures at IHOP, I want to clarify when you mentioned the potential for 100 stores—was that a domestic figure? I noticed there was a fair amount of international closures this quarter but fewer domestically than I expected, which is great. I want to clarify that and also whether we should expect elevated closures bleeding into 2021 or if the system has essentially been cleaned up already.

To begin with your question, the reference to 100 was domestic. This program focused on very specific underperforming restaurants based on research and discussions with franchisees. That program has concluded, resulting in 41 closures, with regular business practices resuming around franchisee requests. So while closures will still occur as part of normal business, the special program for evaluating these underperforming locations is over.

Your next question comes from Nick Setyan from Wedbush Securities.

Hey, thank you. Is the marketing now back? And regarding the virtual brands, is there a target weekly sales number internally that you are aware of, especially since there is a peer benchmark out there?

Hey, Nick. This is John Cywinski. On marketing, we will be rebooting as we look at the year. I must admit, we pulled back on media spending in January and February, so Q2, Q3, and Q4 are going to look favorable overall. For the virtual brand, while we expect a minimum threshold of incremental sales, it's too early to delineate specific numbers since we only have 10 days of data; we're seeing steady improvements day by day.

This is Allison. The gross profit margin on Applebee's includes an increase in bad debt year-over-year, but we’re not providing guidance for 2021 beyond G&A—sorry, G&A and CapEx.

Hi, thank you, and good afternoon. I had a couple of questions about the quarter-to-date trends. You mentioned average weekly sales improved for each brand, and I appreciate the comments. You mentioned Applebee's improved by 6%, but could you disclose average weekly sales for each brand in the quarter-to-date period?

This is Jay from IHOP. Regarding fourth-quarter data, I think I mentioned that we have improved by 10 percentage points from December to January. Given our struggles during the last six weeks of Q4, we are recovering well in January and February. The trends from last year showed significant progress until the final six weeks when we faced challenges due to closures.

On the Applebee's front, we were down 30.1% in December, but we saw a favorable improvement by 12 percentage points down to 18% in the first seven weeks of the quarter. Keep in mind there were weather impacts during a few of those weeks in February. We’re beginning to reengage with meaningful national marketing now; that should have a significant impact moving forward.

Thanks for that context. Regarding the dining rooms, you mentioned 80% of Applebee's and 70% for IHOP were open at the end of December, but what does that look like today in terms of units actually open?

Currently, around 33 restaurants are not open in some capacity, and about 200 may still be operating primarily To-Go or patio service, particularly in California. Many of our restaurants continue to be impacted.

We have about 10 dining rooms currently closed, most in California and Oregon. We expect them to be open soon, which is encouraging news.

If we could dive into capital allocation plans, it seems that paying down debt will be the most immediate priority. How do you balance shareholder returns with investment in the infrastructure and franchisee support?

In terms of capital allocation strategy, we're dedicated to repaying the drawn $220 million, which we plan to do this month, with a focus on maintaining strong financial flexibility. While discussing dividends, repurchases, and possible investments, we find it difficult to make any definitive statements due to the volatility in industry conditions.

As for M&A, we’re considering tuck-in acquisitions that are substantial enough for accretion but remain open to the potential for growth in high growth sectors complementary to our existing brands.

Could you comment on the greatest opportunities for low-hanging fruit within Dine Brands? What do you identify as the largest challenges to recovery and gaining market share?

In short-term, our biggest opportunity is vaccination. We’re optimistic that people are eager to return to restaurants to enjoy human connection in a more significant way. Long-term, our focus remains on the digital technology investments to facilitate off-premise dining. We believe this market segment will settle above pre-pandemic levels, introducing new consumers to our brands and increasing our delivery capabilities.

Thank you, and that is the time we have for questions today. I would now like to turn the conference back over to Mr. John Peyton for any closing remarks.

Thank you to all for your questions. For Allison and me, this was our first time speaking with all of you, and we appreciated it. I look forward to conversations throughout the day. Thanks to our veterans John and Jay for telling their brand stories and answering questions with insight. We appreciate your interest and investment in our company and look forward to continuing this conversation. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you all for joining. You may now all disconnect.