Ken Diptee - Executive Director and IR Richard Dahl - Chairman and Interim CEO Gregg Kalvin - Interim CFO and Corporate Controller Darren Rebelez - President, IHOP John Cywinski - President, Applebee’s Daniel del Olmo - President, International Steve Joyce - Incoming CEO.
Brian Vaccaro - Raymond James Michael Gallo - C.L. King John Ivankoe - JP Morgan Stephen Anderson - Maxim Group.
Hello and welcome to the Second Quarter 2017 DineEquity Earnings Conference Call. My name is Eric and I will be your operator for today’s call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ken Diptee. Please go ahead, sir..
Good morning and welcome to DineEquity’s second quarter 2017 conference call. I’m joined by Richard Dahl, Chairman and Interim CEO; Gregg Kalvin, Interim CFO and Corporate Controller; Darren Rebelez, President of IHOP; John Cywinski, President of Applebee’s, and Daniel del Olmo, President of International division.
Before I turn the call over to Richard, 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 be substantially different than those expressed or implied.
We caution you to evaluate such forward-looking information in the context of these factors which are detailed in today’s press release and 10-Q filing. The forward-looking statements are made as of today and assumes no obligation to update or supplement these statements.
We may also refer to certain non-GAAP financial measures which are described in our press release and also available on DineEquity’s investor relations website. With that, I will now turn the call over to Richard..
Thank you, Ken, and good morning, everyone. We have a lot to cover today and I trust you all had the opportunity to review our press releases on earnings, the dividend, and last but certainly not least, the appointment of our new Chief Executive Officer. We have search long and hard for a new Chief Executive Officer for DineEquity.
We’ve assessed talent, both within the industry and outside of our industry. It became quite clear as our process evolved that Steve Joyce would be the best choice for the CEO of Dine. He is a doer. He is excellent with franchisees, turning around assets, building culture, and catalyzing growth in the hospitality business.
The restaurant and hospitality industries are similar, and the loyalty and revenue increases are dependent upon providing a compelling product at a strong value. Steve will become CEO, effective September 12, 2017.
I’ve known Steve over the past several years as a fellow director His clear vision and innovation make him the perfect leader for our Company. His experiences in the restaurant and hospitality industry, both as the franchisor, operator and owner, make him uniquely qualified.
And importantly, his skill in dealing with challenged businesses fits our current situation. Steve is on this call, and I will ask him to say a few words as we wrap up the discussion on our earnings and the presentations by the division presidents.
I would like to focus on a few issues before I ask Gregg Kalvin, John Cywinski, and Darren Rebelez to add their comments. For Applebee’s, we have a great group of franchisees who are fully invested as is Dine in restoring guest confidence and financial health to our brand.
Efforts to re-empower the brand with necessary financial and human resources are well underway. John will discuss significant improvement in restaurant operations; work on our culinary pipeline and new advertising material. Also today, we will discuss revised guidance on the closure of Applebee’s restaurants.
We are long overdue in rationalizing the size of our system and closing poorly performing restaurants. Additionally, we will discuss a contribution by Dine to help sure up the shortfall in the Applebee’s 2017 ad fund, which is clearly necessary at this time to produce new media material and get our message out.
We will also bringing you up to date on important Curbside to Go initiative. The vitality of our IHOP is tremendous.
Net development activity is robust along with remodels and new store concept, while the comp stores -- while comp sales have indeed suffered, Darren will address this, as well as the fact that franchise revenues and overall guest satisfaction scores are both very positive.
Also, Darren will fill you in on our new packaging innovation and the launch of our initiatives in the to-go and delivery business. This is a tough year, but a very exciting year.
Before I turn the call over to John and Darren, I’ll ask Gregg to walk you through the relevant financial results of the quarter as well as our revised 2017 performance guidance.
Gregg?.
Thank you, Richard. Good morning, everyone. For the second quarter, our adjusted EPS was $1.30 compared to $1.59 for the second quarter of 2016. The variance is primarily driven by lower gross profit due to 6.2% decline in Applebee’s comp sales, slower collection of Applebee’s royalties and higher Applebee’s restaurant closures.
The impact of these declines on adjusted EPS was partially offset by fewer weighted average diluted shares outstanding. Turning to G&A expenses. A slight increase in G&A for the second quarter of 2017 compared to the same period of 2016 was mainly due to higher cost for professional services.
The increase in professional services was primarily driven by investments in Applebee’s stabilization initiatives, which include the utilization of third-party consultants to assess the brand’s performance and provide actionable recommendations.
Regarding the $10 million in cost associated with the Applebee’s stabilization initiatives we discussed last quarter, approximately $6 million was incurred in the first half of 2017. We now expect the remaining $4 million will be incurred ratably over the second half of the year.
As a reminder, we anticipate the substantial amount of these costs will not recur in 2018. Lastly, I would like to highlight that these costs are unrelated to the $8 million committed to the Applebee’s national advertising fund, which will not be included in our G&A.
These costs will be recorded as an expense in our franchise segment ratably over the third and fourth quarters of 2017. Turning to our tax rate. Our GAAP effective tax rate for the second quarter of 2017 was 46.5% compared to 32.5% for the same period last year.
The variance was primarily due to increase in our estimated unrecognized tax benefits in 2017 related to deductions associated with certain internally developed software and the adoption of new accounting guidance that addresses the treatment of certain aspects of shared-based payments.
For adjusted earnings per share, we currently expect our effective tax rate for the full year 2017 would be approximately 40%; this compares to our previous full year guidance of approximately 38%. Moving to the cash flow statement.
Cash flows from operating activities for the first six months, of 2017, were approximately $21 million, compared to $54 million for the same period of last year. The overall decline was mainly attributed to lower net income resulted from a decrease in gross profit from franchise operations and higher G&A.
The increase in G&A was primarily due to approximately $9 million of non-recurring cash severance and equity compensation charges incurred in the first quarter, related to the separation of our previously CEO and the $6 million incurred in first half of 2017 for the Applebee’s stabilization initiatives.
Cash from operations was additionally impacted by net changes in working capital, which used cash of approximately $25 million for the first half of 2017 compared to using cash of roughly $12 million in the same period of 2016. The variance was primarily due to the timing of brand advertising campaign.
Adjusted free cash flow for the six months of 2017 was approximately $19 million compared to approximately $56 million in the first half of 2016. The decline was due to lower cash from operations, as previously discussed, and higher capital expenditures compared to the first six months of 2016.
The increase in capital expenditures was mainly due particularly to test kitchen related construction costs at our corporate headquarters and additional investments in IT for consumer facing initiatives. Turning to an update on Applebee’s franchisee financial health.
We continue to partner with our franchisees and our financial advisor Trinity Capital. This is a very thorough and thoughtful process by which all franchisees may avail themselves to various financial assistance programs including restaurant closures and direct financial support.
Franchisee financial health matters are reviewed by both the brand and Trinity. Direct financial support where necessary, is progressing. Currently only minority number of Applebee’s franchisees have availed themselves to a direct financial assistance in this program.
However, I’d like to point out that all, but a few franchisees have participated in the improved closure process for underperforming restaurants. As we have discussed previously, not all Applebee’s franchisee are in the same position and each case is being reviewed separately.
With that said, there is a franchisee who account for approximately 5% of our domestic system-wide sales that is exhibiting a higher level of financial difficulty. We are actively working to address this franchisee-specific situation. Regarding the sale of the remaining company operated IHOP restaurants.
This past year, we refranchised 9 of the 10 restaurants in the Cincinnati market, which were used mainly for test market purposes. The one restaurant that was not refranchised was closed. With the refranchising and sale of the related restaurant assets completed, we know longer operate any IHOP restaurants. Both brands are now 100% franchised.
Finally, I’ll turn to our revised performance guidance for fiscal 2017. I would like to provide a few highlights, but please see our press release issued today for complete detail. We now expect Applebee’s comp sales to range between negative 6% and negative 8%.
Our guidance reflects the expected timeframe we believe it will take to implement sales and traffic-driving initiatives to see meaningful results. At IHOP, we now expect comp sales to range between negative 1% to negative 3%, reflecting the brand’s performance in the first half of 2017.
We now forecast Applebee’s closures to range between approximately 105 and 135 restaurants to reflect the ongoing franchisee financial health work discussed earlier. Our G&A is now expected to range between approximately $166 million and $172 million including non-cash stock-based compensation expense and deprecation of approximately $22 million.
There revised range mainly reflects expectations for the timing of hiring for new positions and lower incentive compensation costs.
As a reminder, G&A is inclusive of approximately $9 million of nonrecurring cash severance and equity compensation charges in the first quarter of 2017, which was added back in our calculation of year-to-date adjusted EPS. Turning to the adjusted free cash flow.
Based on our revised guidance for segment profit, G&A expenses and taxes, we now expect the range of approximately $76 million to $86 million. Lastly, capital expenditures are now estimated to be approximately $14 million, projected small increase compared to 2016, it’s primarily due to IP related costs.
To close, we expect the business to generate substantial adjusted free cash flow this year, despite the challenges facing our brands. We’re committed to ensuring the financial health of our franchisees and making the necessary investments to further strengthen the business for the long term and drive shareholder value.
And with that, I will turn the call over to John..
Restaurant operations; our guests; culinary innovation; and brand marketing. So, starting with operations. We’ve had too much restaurant variability across our system as well as a rather high percentage of guests not satisfying with their experience.
Franchisees however have shown significant improvement on this front over the past few quarters with the percentage of fully operated restaurants narrowing from a high of 16%, down to about 4% where we currently stand. Our focus moving forward is simplifying our operation while elevating guest experience across all 33 franchise groups.
As part of this initiative, we have retained PricewaterhouseCoopers to help us unlock between 100 and 200 basis points of restaurant level profitability over the next couple of years, which can be redeployed as necessary to labor and food investment. Now, as Gregg outlined, we will be aggressive on restaurant closures this year.
These closures typically fall into one or two categories. The first consists of older locations in lapse trade areas where once vibrant retail, residential and traffic characteristics are just no longer present, often where the desirable trade area within a town has simply moved over time.
The second category consists of underperforming and perhaps even brand-damaging restaurants with unsustainable unit economics.
These are typically well below average unit volumes where the franchisee portfolio benefits financially from the closure and the brand benefits because we are no longer experiencing -- our guests are no longer experiencing a substandard Applebee’s.
Again, the resulting sales impact is perhaps less than expected as these are very low volume restaurants. In either case, these restaurants need to close and perhaps should have closed long ago. Of course, these are complex, requiring exit negotiation of the remaining lease obligations.
This removal of nonviable restaurants is an important tool to stabilize the financial health of franchisees and I anticipate it continuing to a lesser extent in 2018.
It’s also possible that we experience the consolidation of an existing franchise entity or the addition of a new franchisee before the end of this year as part of our ongoing optimization. Again, this is all part of our long overdue portfolio rationalization that should have taken place probably in the normal course of the business.
Now, let’s shift attention to our guests and perhaps one of the brand’s strategic missteps.
Over the past few years, the brand’s set out to reposition our reinvent Applebee’s as a modern bar and grill in overt pursuit of a more youthful and affluent demographic with a more independent or even sophisticated dining mindset, including a clear pendulum swing towards millennials.
In my perspective, this pursuit led to decisions that created confusion among core guests, as Applebee’s intentionally drifted from its what I’ll call, its Middle America roots and it’s abundant value position. While we certainly hope to extend our reach, we can’t alienate boomers or Gen-Xers in the process.
Much of what we are currently unwinding at the moment is related to this offensive repositioning. Now directionally speaking, the Applebee’s guest is more middle income and upper income; our age demographics remain broad; and we over index with families. Moving forward, we’ll primarily focus on two target segments.
The first we categorize as routine traditionalists. They like CDR Chain restaurants; that’s important. They skew a bit over; they not mind spending more for good and they tend to be creatures of habit ordering familiar favorites more often than that. The other equally important group is value seekers, not surprisingly.
These folks also like CDR chain restaurants. However, they tend to be brand switchers, searching for the best deal rather than a specific menu item. Together, these segments are predisposed to like Applebee’s a lot and they make up a meaningful percentage of our core guests and revenue.
From a culinary perspective, we recently hired, and I’m pleased Chef Stephen Bulgarelli as our new Chief Culinary Officer. Stephen is a CDR veteran, and has been leading Chili’s efforts over the past five or so years. Stephen brings deep experience commercializing many initiatives across large scale brands.
What I value most is his clear guest orientation, his passion for ops driven innovation without unnecessary complexity and his commitment to franchisee collaboration. These traits will certainly serve Stephen well here at Applebee’s. And as he steps into his role, we have three immediate culinary priorities.
Number one, reestablish a relevant innovation pipeline with a new discipline validation process. Much of our 2016 innovation work was focused on hand-cut wood-fired steak, so the broader pipeline requires replenishment.
The good news is our testing process is now in place and partnership with our marketing and insights team, and we’ll begin to see tested propositions beginning in early in Q1 2018. Number two, address the quality and value gaps that have emerged from our core menu satisfaction study.
Our action steps are clear, work is underway with an emphasis on abundant value, presentation and taste including the possible reintroduction of a guest favorites that were removed as part of the earlier referenced repositioning effort.
Again, proper testing and supply chain lead time, these initiatives will impact our menu, also beginning next year in Q1. Number three on culinary, assess whether the brand gets credit, truly gets credit for hand-cutting steaks in the restaurant and whether we should continue with this approach.
A tested guest and ops-driven decision will be reached with franchisees over the next few months. Now, on the marketing front. We have near-term challenges as our national ad fund is reduced from year ago, as Gregg referenced, due to negative sales, restaurant closures and some franchisees experiencing financial difficulty.
As mentioned earlier, the $8 million DineEquity contribution will partially offset this erosion. In addition to the ad fund decline, our biggest marketing constraints have been the absence of tested, proven propositions, as well as the absence frankly of lead time. This has led to a compromised plan with few alternatives and core execution.
The good news is that’s behind us. Our marketing and culinary teams have developed a fully integrated 2018 brand marketing plan, which has the enthusiastic endorsement of our Franchise Business Council. Additionally, we refined our national media strategy for greater impact, beginning right now as we approach Q4 this year.
So, our marketing priorities moving forward are clear. Number one, become more relevant from a price value perspective. Affordability has always been a cornerstone of the Applebee’s brand and it’s essential to our guests now more than ever. Bottom-line, we’ve taken our eye off the ball here, and we have work to do.
Number two, better leverage guest insights and ensure a strong correlation between test results and end-market performance. We’ve addressed both of these with an entirely different and disciplined process, which will pay dividends in 2018.
Number three, reestablish our off-premise business as a growth engine under the leadership of Scott Gladstone, our new Vice President of Strategy and a Former BCG consultant. Applebee’s led the CDR category of Car Side to Go in the early 2000s and then allowed that leadership position to drift over time.
While it’s been a priority for our convenience-driven guests, it simply hasn’t been a priority for the brand. We have work to do here from the guest perspective as our to-go experience is highly variable from one restaurant to the next.
Our website will be redesigned for enhanced branding, functionality and personalization effective early Q4, not far away, of this year. You’ll hear more as we progress, particularly around operating standards, online ordering and payment, packaging, marketing, as well as our very encouraging delivery test initiatives.
Number four on the marketing front, reignite beverage innovation as a driver of incremental check and revenue. In particular, bar is a latent brand equity in a highly profitable 14% of our sales mix.
We’re excited about this initiative under the leadership of our Vice President for Beverage Innovation, Patrick Kirk, who came to us last year from Buffalo Wild Wings. Finally, we plan to reestablish Eatin’ Good In The Neighborhood as our core brand and advertising platform right out of the gate in 2018.
There is equity and differentiation here and we plan to leverage it, moving forward. From a marketing perspective, we’re fixated on core guest insights, discipline and developing relevant content to simply marry the right target with the right programming and the right message, something that frankly we haven’t done well of late.
In summary, we’re back to basics in virtually every respect as we view 2017 as a transitional year for the brand. Our optimization and turnaround is underway, but it’ll take time to restore Applebee’s to financial health. And I don’t expect that trajectory change in our performance until we begin to implement our initiatives in early 2018.
We remain committed to our franchise partners and they in turn are aligned and enthusiastic around our vision for the future. With that I will turn it to Darren..
All right. Thanks, John, and good morning, everyone. We ended the second quarter as well as first six months of 2017 on slightly positive franchise restaurant sales, which consisted of 1% growth over the respective periods in the prior year. This was offset by a 2.6% decline in second quarter comp sales.
Although we downwardly revised comp sales guidance, as a result, we upwardly revised expectations for franchisees to develop between 80 and 95 restaurants globally this year, the majority of which are domestic openings.
The solid pace of development by franchisees in the first half of 2017 led to 33% growth in new restaurant openings over the first six months of last year. We are clearly disappointed in IHOP’s comp sales declines.
This was mainly due to do softness in the dinner daypart as a result of promotions that did not have the impact on sales and traffic, as expected. The family dining category remains highly competitive as guests continue to focus on value and convenience.
But, IHOP remains on solid ground as we continue to execute our strategy including developing off-premise occasion, enhancing the guest experience, remodeling restaurants and technology, and expanding our innovative culinary pipeline. Our planned focus is on also improving the guest experience outside of the restaurant.
Consumers’ desire speed, quality, portability of food and affordability. They also utilize online ordering and apps to reduce their wait time. To further build on our revitalized IHOP and go platform, which is designed to grow off-premise sales and meet the convenience needs of our guests, we completed the rollout of our proprietary new packaging.
This ensures that IHOP’s food will be just as delicious when taken off-premise. Additionally, we began the rollout of our online ordering platform in the second quarter. We anticipate completing the deployment system-wide, by the end of Q3.
Although it’s early, I’m pleased to say that we’re seeing average guest check growth from the online ordering platform versus phone orders. We are very optimistic about the potential impact of online ordering on our to-go sales, which today accounts for approximately 5% of our sales mix.
Another opportunity for us to create an additional revenue channel is through delivery. We’re currently in discussions with Amazon and other potential partners regarding the limited delivery tests. We’ll share more information with you as this progresses. Turning to the remodel program.
This is an important part of our strategy to drive sales and traffic as well as enhance the guest experience inside our restaurants. The Rise ‘N Shine remodel program continued at a healthy pace with 79 remodels completed in the second quarter. Through the end of Q2, our franchisees have completed 136 remodels this year.
We are again targeting a total of 300 completions by the end of 2017, reflecting a total investment by franchisees of approximately $38 million this year. The IHOP remodel provides our restaurants with the fresh new look and feel, which we believe will elevate the dining experience and further differentiate us from competition.
Regarding new restaurant openings, our franchisees opened 17 restaurants in the second quarter, also with the Rise ‘N Shine image. IHOP’s innovation not only influences our culinary efforts but also our development strategy.
In addition to our nontraditional restaurants, I’m pleased to say that we’ve opened two prototype small format traditional restaurants this year. The restaurants are located in Rolla, Missouri and Chester, Maryland. The small format units are approximately 3,500 square feet and have a seating capacity of a 140.
This concept gives our franchise developers a format that can work in more rural areas as well as help them penetrate more concentrated urban areas where real estate is at a premium.
We also believe that these restaurants are ideally suited for consumer environment where carryout and delivery have the potential to play a larger role in the overall sales mix of our business.
Also as Gregg mentioned earlier, during the quarter and as part of our plan to maximize our resources dedicated to supporting the brand and our franchisees, we refranchised the remaining company operated restaurants in the Cincinnati area, completing DineEquity’s transition to a 100% franchised restaurant system.
We remain confident that our testing needs will continue to be eagerly met by our franchisees, as they are today. Continuing to elevate the guest experience through improved operations is core to our strategy.
We’ve successful collaborated with our franchisees to complete a series of meetings across the country to focus on our operations excellence and restaurant execution. As a result, we are seeing some momentum and achieved a highest overall guest satisfaction score this quarter since the program began in the first quarter of 2016.
This is a testament to the hard work and dedication of our franchisees and teams to provide best-in-class service to our guests. Turning to marketing, being nimble and bringing fresh new thinking to our business is paramount in this changing environment.
Therefore, I’m excited to announce that we’ve hired a new Chief Marketing Officer to lead the marketing and culinary functions at IHOP. Brad Haley brings to the IHOP brand over 25 years of restaurant marketing experience, most recently as the CMO for CKE Restaurants, for the last six years.
Brad was instrumental in the turnaround of the Hardee’s brand where he leveraged their significant breakfast equity into broader daypart appeal. He also has a wealth of experience in collaborating with franchisees to bring compelling programs to life. We look forward to Brad’s leadership of the IHOP marketing team.
At IHOP, culinary innovation is at the core of everything we do. Consumers told us that they want fresh, quality product and we responded. We introduced our all-new Fresh Market offering, pairing our made-to-order signature breakfast items with seasonally fresh fruits.
Starting at only 4.99, the offering provided guests with the compelling and customizable value proposition. Following up on this promotion, we took creativity to the next level. We’re very excited about our recently launched all-new French Toasted Doughnuts. These are unique items that you can only find at IHOP.
Doughnuts are product category that are on trend or meeting that guest need in a unique way that only IHOP can deliver. The launch has been extremely popular, has garnered a lot of attention in the media, resulting in over 250 stories and generating more than 357 million earned media impressions.
With that said, we’re very optimistic about the potential for these new items. Lastly, IHOP recently celebrated its 59th anniversary on July 18th, by offering guests with short stacks of our world famous buttermilk pancakes for $0.59 from 7 am to 7 pm at participating restaurants.
We aggressively promoted the anniversary to drive even more traffic into our restaurants through increased and advanced publicity, marketing and advertising. Our efforts included traditional media as well as digital and social media. The event was a success as we saw 59% increase in sales, on that day.
To wrap up, I’m confident that our strategy will change the trajectory at IHOP sales over time. We’re taking the right steps to drive sustainable positive sales and traffic, expand IHOP’s appeal across dayparts, include additional channels to access the brand. With that, I’ll now turn the call back to Richard for his closing comments..
Thanks, Darren. I’d like to add a few comments about our International division, which represents both Applebee’s and IHOP. Over the past five years our international restaurant development has a compound annual growth rate of over 8%. We should be up to approximately 290 restaurants by year-end 2017.
Currently, IHOP development is outpacing Applebee’s in the key markets of Mexico, Canada and the Middle East. Many opportunities exist throughout the Far East and Latin America as well. Daniel del Olmo of this division is with us today, should you have any current questions.
In the future, we’ll have Daniel comment on the progress of this important growth opportunity. In closing, I’m optimistic about the future of Dine. I believe that we have the right people, resources and strategy in place to position the company, our franchisees and our brands for long-term success.
Finally, I would like to congratulate and thank our team members and our franchisees for their hard work and dedication. I also wish to thank the Board of Directors for their support of me. They are 110% engaged in the success of this business. We know, we have a lot more work to do, but I’m confident we’re up for the challenge.
With that, I’d like to ask Steve Joyce to say a words. Steve, may be familiar to many of you as the CEO of Choice Hotels and prior to that Marriott. As I indicated, he has tremendous amount of experience that I could not and the Board and hope you all feel the same way, could not be more pleased with him stepping into the role as permanent CEO.
Steve will have a few comments; he will not be able to answer questions as you’ll have plenty of time to do that with him once he sits in the chair. Steve, if I can turn this over to you for a few minutes and then back to me..
Thanks, Richard. So first of all, I’d like to thank you for your service in stepping into a difficult situation and really providing tremendous leadership over the last eight or nine months in a very difficult situation. I think the Board is very appreciative and I know I am. Secondly, I’m appreciative of the confidence the Board has shown in me.
And third, I’d just like to say, this is exactly the type of opportunity I was looking for, post-Choice. It is a tremendous company with tremendous assets that obviously needs some adjustments. But I think we’ve got good leadership. I think we’ll be able to add some talent to the team.
I think we’re going to do a lot of different things that I think will add value as a long-time leader of choice than other public companies. My first priority is and always will be return to shareholders. That is the priority.
And I think we’ve got a tremendous opportunity in this situation to drive real value for the shareholders to create a company that is a long-term viable opportunity with strong growth potential and a capitalization on two of the most iconic brands in the business.
I have had some significant exposure to the restaurant business; I’m incredibly excited to be back in it full-time. Obviously, my background is a strong and consistent leadership of franchise systems. I know many of the franchisees here already, so I’m excited to spend more time with them and talk about what we’re going to do together.
We’ve obviously, as you heard on this call, have strong leadership of not only the financial aspects of the company, but also with of the brands. So, I’m very interested and learning from the folks that are running those brands at this point and also helping support them in the efforts they were describing.
And I’m also very interested in working with Richard in his new role as Chairman of the Company. And I’m ready, rolling and excited about starting on the 12.
You’ll hear from me in a not too distant future., I’ll work with senior leadership and the Board to develop a comprehensive plan, which I would expect to deliver within the next 60 to 90 days, and then you can hold us accountable to that plan, because that’s really where we’ll be holding ourselves.
So, I couldn’t be more excited about the opportunity. I think this is a tremendous company with tremendous potential, and I think we’ve got the leadership team and the Board to make that happen. So, with that, let me turn it back over to you, Richard..
Great. Thank you, Steve. And again congratulations and we look forward to your leadership. With that, operator, what I’d like to do now is open the call for questions..
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Brian Vaccaro from Raymond James. Brian, your line is now open..
Thank you, and good morning. Just had a couple of questions on the Applebee’s side and starting with the closures.
I was curious was the increase in the closures for the year primarily related to the franchisee that you mentioned on the call or does it reflect more of the sort of the broader review of the system?.
Brian, this is John. It’s a fairly complex process. Really, the change in guidance around closures reflects the fact that we tackle these one at a time, and each one requires a substantial negotiation unless it’s at lease end with the landlord. And so, we just have greater visibility another quarter into this as to where we stand.
And so gain, I personally view this number and this range as necessary. I do not anticipate the same extent of closures next year, although there certainly will be some, and this is part of reestablishing financial health. But again, the change in guidance is just because we have visibility now to reality..
Further to your question, the referenced franchisee, while there were store closures is not all due to that particular franchisee. It’s a widespread of pruning the stores across a wide range of franchisees.
As Gregg indicated, just about very franchisee with few expectations has indeed used this opportunity to close doors, prune the system to rationalize it and improve it..
And now that you’re little bit further down the road on the financial health review, I’m not asking for individual franchisee profitability, but can you comment on the system average overall of the franchisee profitability and also how much leverage the average franchisee has on their balance sheet?.
This is Greg. We don’t comment on individual franchisees or their leverage. What we do -- what when we have done, as I said is, had a thorough and thoughtful process reviewing every franchisee’s particular situation. And everybody’s unique, Brian because for obvious reasons they have different businesses and even in addition to Applebee’s.
But we look at those on an individual basis and today, we focus on foreclosure as we previously said, but we consider all options open. And there are a lot of vehicles we can use to help our franchisees and their direct financial assistance. To-date it’s been mostly on the closure side.
But again, we look at their individual situation all separately and they’re all unique..
Okay. And then just two -- one more for me, if I could. You mentioned the improvement in some of the poorly operated units on the Applebee’s side, going from 16% to 4%.
I guess what have been some of the primary areas in which that improvement occurred? Are we talking about reinvesting in labor to elevate services, is it climate, is it -- can you just give us some color on that?.
Sure, Brian. This is John. Some of those -- but we have an internal set of metrics, some of those are kind of internal looking components of this formula around cleanliness and quality and safety. Most of what we’re talking about is guest facing.
And specific improvements have been around guest satisfaction in particular and we’ve seen a significant tightening of our -- what was a pretty good variability previously, and again, most of that around guest satisfaction, the interaction between our servers and guests.
I won’t speak specifically to investments in labor, that’s been a challenge at the restaurant level and we’re taking steps in the future to ensure that we can deploy labor more properly moving forward. But we’re pleased with the progress; we’re hearing that from our guests..
And our next question comes from Michael Gallo from C.L. King. Michael, your line is now open..
Hi. Good morning. A couple of questions, if I may. First question, when we look at some of the costs you had this year for a onetime or perhaps ongoing, obviously there is the $10 million diagnostic.
Should we think about the $8 million investment in advertising as something that’s going to be ongoing to some degree? Is that something you’re doing this year and see how it works and revaluate? Because obviously, as you are looking at more closures, it will likely put pressure on the advertising budget going forward.
So, I was wondering how we should think about the $8 million? Thanks..
Michael, this is John. Look, the $8 million, as we speak is a necessary initiative as addressing some of that. Shortfall that we have in the ad fund, the shortfall is certainly larger than $8 million referenced. As to whether that would continue in the future, I don’t know, we don’t know.
We’re committed to reestablishing financial health and sustain growth. This is a year-over-year challenge, 2017 versus 2016 at the moment and it’s fairly substantial. We would be in a better position and we certainly expect performance to improve across the system early part of next year and continuing.
So, the best I can do at the moment is to whether there would be steps next year, it’s very much contingent upon our next, and we’ll keep you posted..
Second question I have, just looking at the overall SG&A structure now, obviously you’re rationalizing the remaining IHOP stores and you’re 100% franchised.
I was wondering, whether your plan to look comprehensively at the SG&A structure and whether you think, as you move the Company in a little different direction, whether you think there might be some opportunities? Thanks..
I think the way to think about it initially, we’ve got the costs that we believe will not recur next year, which is the $10 million. We’ve also got in the G&A this year, the severance costs. That’s 19 off the top, if you will, as a starting point.
We consistently evaluate our internal structure with regard to people, third-party expense and all of the components in G&A. And we will be taking a hard look at that as we always do on a go forward basis for the remainder of 2017, which is currently built into our guidance, and then into 2018 and thereafter..
Michael, Richard here. I’d just like to add a little bit to that. As you may recall from our earlier calls, we really shifted our focus from a heavy shared service model to re-empowering the brands and putting a lot of that talent down into, directly into the brands themselves to speed up our decision making.
And so 2017 will establish a very good baseline for where we really need to be on SG&A. I think there are certainly opportunities there and 2017 will be that base year for us to go forward into 2018. But feel strongly that getting the resources, both dollars and human resource into these brands we’ll empower these brands to the success..
And our next question comes from John Ivankoe from JP Morgan. John, your line is now open..
Two questions if I may. The first is I think related to just the prior question. $10 million of non-recurring stabilization initiatives in 2017 is worth around $5,000 a store, so if you think about it in that context, it’s not a lot of money. That $8 million of advertising is worth around $4,000 a store. I mean, those don’t sound like big numbers.
I mean, that’s -- I mean, if there is going to be real financial and advertising support given to the stores, one would probably get the multiple, many, many times, something like $4,000 or $5,000 a store for each of the different programs.
Could you help me think about whether it’s -- is that the right way to think about it, the wrong to think about it? When the franchisees are just kind of thinking about, hey, we need this much money on a per store basis to really reinvigorate things, how much might that spend per store be?.
Look, we’re taking a comprehensive view to the business. The $10 million is very much around assessing state of the business with an independent third-party across virtually all components. The $8 million is a very specific need to address the advertising fund. And we don’t look at that on kind of the way you framed it, on a per restaurant basis.
And we’ll have some visibility to performance once we turn the corner on the year. So, these are need based specific to quarter-by-quarter business requirements. And in the aggregate, they’re substantial, but they’re addressing specific needs.
So, we are kind of more need based than we are let’s direct a specific dollar figure per restaurant to the system. We will do what is necessary and required. And I should -- I’d be remiss if I don’t emphasize that our partnership with franchisees is perhaps stronger than it’s been in years. And don’t take my words for that.
There is a very cautious optimism, but tremendous enthusiasm about our strategy and our alignment and much of what we do if not everything we do, is in concert with our franchisee leadership. So, more to come as we look at 2018 in terms of whether there are incremental investments or not..
That’s great. And whenever you guys are ready to put one of the big franchisees or someone from the franchisee advisory council on one of these calls, I’m sure it’s something that everyone would benefit a lot from.
I understand it’s not today, but perhaps in the future, understanding the business from their perspective would be very, very valuable for that little free advice there. And then, secondly, I’m going to see if I can answer this question in a correct way.
The current run rate of comps, the current visibility of costs, outside of the stores that you’ve announced the closure, do you have a sense of how many stores at the store level, not at the organization level, but at the store level are kind of nearing cash flow breakeven? I understand you don’t want to close a store if it’s cash flow breakeven, if you think results are getting better in a couple of years, but what percentage of the system again is kind of taking the current run rate of results -- kind of nearing that point of marginal profitability at the store level?.
This is Greg, John. What we said previously is that we’ve got -- we analyze each of these on a case by case basis. Obviously, if these stores are close to breakeven or having cash flow issues, that’s a pretty strong indicator that that is up for closure. And it’s built into the closures that we have estimated for this year.
So, that’s the first cut we take at it. And then other areas around that we consider but the cash flow is obviously the main point that we look at. We don’t disclose how many stores that we -- that are cash flow and not cash flowing, but we’ve built that into our analysis and how we evaluate each franchisee and all of their stores during this process.
There is a lot of work that goes into it and we are thoughtful about each store before we decide to close it..
Okay. All right. I think I heard that. In the release, and I’m sorry if I missed this, there was mention of uncollectible royalties -- how big -- I think there was some in the first quarter that began to peak up, if I’m remembering that correctly.
How big might that number be in 2017, and at least at this point do you think the number grows in 2018?.
So, right now, the guidance that we just issued that number, if you think of about franchise revenues on a gross basis for Applebee’s which we break out in our public documents, it’s running for the rest -- we expect it right now to run for the rest of the year about 7% to 8% of that number, and that’s where we currently believe we are headed as far as possibility of royalties as what we are targeting about here.
So that’s what it amounts to..
And our next question comes from Stephen Anderson from Maxim Group. Stephen, your lines are now open..
Thank you. Taking a look at your reduced free cash flow expectations for 2017, I want to ask about your ability to continue paying the dividend and what the outlook for that will be going in 2018? Thank you..
Clearly the dividend but all of capital allocation issues are aggressively studied by the Board at each meeting. And obviously with the announcement of the dividend I think now today is confirmed that the ability to pay the dividend is there and the desire to do so.
As I say, this is looked at steadily, but we certainly understand the interest in shareholders of the stability of the dividend and so on, and we look at that every time we meet..
So, the debt service covenant ratios, and I know you publish that with the 10-K, can you provide a little bit color into that?.
Well, this is Greg. We have a coverage ratio that we -- leverage ratio that we publish, if you will, in our 10-Q. And that is the ratio that we focus on the most.
There is a debt service coverage ratio that is in the discussion really because -- the cushion is so large, but we have a leverage ratio that we publish every quarter and it’s about five times right now is what’s it at. And that’s where it stands at the end of the second quarter..
Thank you. .
And Steve just to add to that, this is Ken. With regard to the FCR, we’re about 300 basis points above if any cash strapped event might occur..
And there are no additional questions at this time. And I would like to turn it back over to speakers for closing remarks..
Okay. Well, thank you again for joining us on the call today. We’re scheduled to report the results of the third quarter in November, I believe November 1st. And we look forward to speaking to you then or perhaps even earlier, as Steve gets into the chair. And again, I want to thanks Steve for joining us today, as well as all of you. Thank you..
Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect..