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DIN > SEC Filings for DIN > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for DINEEQUITY, INC

Form 10-K for DINEEQUITY, INC


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Cautionary Statement Regarding Forward-Looking Statements Statements contained in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those expressed or implied in such statements. You can identify these forward-looking statements by words such as "may," "will," "should," "expect," "anticipate," "believe," "estimate," "intend," "plan" and other similar expressions. You should consider our forward-looking statements in light of the risks discussed under the heading "Risk Factors," as well as our consolidated financial statements, related notes, and the other financial information appearing elsewhere in this report and our other filings with the United States Securities and Exchange Commission. The forward-looking statements contained in this report are made as of the date hereof and the Company assumes no obligation to update or supplement any forward-looking statements.
You should read the following Management's Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this report. Business Overview
The Company
The first International House of Pancakes restaurant opened in 1958 in Toluca Lake, California. Shortly thereafter, the Company's predecessor began developing and franchising additional restaurants. The Company was incorporated under the laws of the State of Delaware in 1976 with the name IHOP Corp. In November 2007, the Company completed the acquisition of Applebee's International, Inc., which became a wholly-owned subsidiary of the Company. Effective June 2, 2008, the name of the Company was changed to DineEquity, Inc. ("DineEquity," "we" or "our"). Through various subsidiaries (see Exhibit 21, Subsidiaries of DineEquity, Inc.) we own, franchise and operate two restaurant concepts:
Applebee's Neighborhood Grill & Bar® ("Applebee's®"), in the bar and grill segment within the casual dining category of the restaurant industry, and International House of Pancakes® ("IHOP®"), in the family dining category of the restaurant industry. References herein to Applebee's and IHOP restaurants are to these two restaurant concepts, whether operated by franchisees, area licensees or us.
Domestically, IHOP restaurants are located in all 50 states and the District of Columbia, while Applebee's restaurants are located in every state except Hawaii. Internationally, IHOP restaurants are located in two United States territories and eight foreign countries; Applebee's restaurants are located in one United States territory and 15 foreign countries. With over 3,600 restaurants combined, we believe we are the largest full-service restaurant company in the world. Our Vision
To become the preferred franchisor of choice and deliver maximum franchisee and shareholder value.
Our Mission
To unite great franchisees, iconic brands and team members to create the world's leading restaurant company - one guest at a time. To achieve this mission, our strategies are designed to ensure strong brands; drive profitable, organic growth; identify and exploit complementary concepts and extensions; and create and monetize new value-added services.
2013 Highlights
2013 marked our first full year of operation with both of our brands 99% franchised. We believe this highly franchised business model requires less capital investment and general and administrative overhead, generates higher gross profit margins and reduces the volatility of free cash flow performance, as compared to a model based on owning a significant number of company-operated restaurants.

On February 26, 2013, our Board of Directors approved a capital allocation strategy that contemplates the return of a significant portion of our free cash flow to our stockholders. The Board of Directors also approved a stock repurchase authorization of up to $100 million of our common stock. Pursuant to this strategy, we returned cash of $87.1 million to our stockholders in 2013 in the form of:

•Four quarterly dividends, each $0.75 per share of our common stock, declared and paid totaling $57.4 million, and
• Repurchases of over 412,000 shares of our common stock totaling $29.7 million, with authorization remaining to repurchase an additional $70.3 million.


Other highlights of our fiscal 2013 performance include:
• Increased IHOP's domestic systemwide same-restaurant sales by 2.4% during 2013, the first full year of growth in domestic systemwide same-restaurant sales since fiscal 2008 and the highest yearly increase since 2006;

• Generated cash from operating activities of greater than $100 million for the fourth time in the last five years;

• Opened 58 new restaurants worldwide by IHOP franchisees and area licensees and 26 new restaurants by Applebee's franchisees;

• Expanded our international footprint with restaurant openings by IHOP franchisees in the Philippines, Kuwait and the Kingdom of Saudi Arabia and by an Applebee's franchisee in Egypt and the Dominican Republic;

• Remodeled over 500 restaurants system-wide during 2013. Applebee's and its franchisees remodeled 289 restaurants during 2013, while IHOP and its franchisees remodeled 215 restaurants. Over the past three years, approximately 70% of Applebee's restaurants and 40% of IHOP restaurants have been remodeled; and

• Named to Fast Company's annual list of Most Innovative Companies, ranking number two in the category of "The World's Most Innovative Companies in Food."

Key Performance Indicators
In evaluating the performance of each dining concept, we consider the key performance indicators to be net franchise restaurant development and the percentage change in domestic system-wide same-restaurant sales. Since we are a 99% franchised company, expanding the number of franchise restaurants is an important driver of revenue growth. We currently do not plan to open any new Applebee's or IHOP company-operated restaurants. Revenue from our rental and financing operations, legacies from the Previous IHOP Business Model we operated under prior to 2003, is subject to progressive decline over time as interest-earning balances are repaid. Therefore, growth in both the number of franchise restaurants and sales at those restaurants will drive franchise revenues in the form of higher royalty revenues, additional franchise fees and, in the case of IHOP restaurants, sales of proprietary pancake and waffle dry mix.

An overview of our 2013 performance in these metrics is as follows:

                                                               Applebee's     IHOP
Percentage (decrease) increase in domestic system-wide
same-restaurant sales                                            (0.3)%       2.4%
Net franchise restaurant development(1)                           (23)         38


_____________________________________________________
(1) Franchise and area license openings, net of closings

IHOP's increase of 2.4% in domestic system-wide restaurant sales for the year ended December 31, 2013 resulted from a higher average customer check partially offset by a decrease in customer traffic. The increase reflects sequential improvement throughout 2013, with a decrease of 0.5% in the first quarter of 2013 followed by increases of 1.9%, 3.6% and 4.5% in the second, third and fourth quarters, respectively. The increase in the fourth quarter was the largest since the first quarter of 2006. Applebee's decrease of 0.3% in domestic system-wide restaurant sales for the year ended December 31, 2013 resulted from a decrease in customer traffic partially offset by an increase in average customer check. The decrease was the first annual decline in domestic system-wide restaurant sales for Applebee's since 2009. With the decrease in 2013, Applebee's cumulative increase over the past four years is 3.2%. Applebee's net restaurant development for the year ended December 31, 2013 was adversely impacted by restaurant closures during 2013. Applebee's franchisees opened 26 new franchise restaurants in 2013 but closed 49 restaurants. The largest single group of closures took place in the second quarter of 2013, when an Applebee's franchisee that owned and operated 33 restaurants located in Illinois filed for bankruptcy protection. As a result of those proceedings, 15 of the restaurants were sold in June 2013 to an affiliate of an existing franchisee and operated without interruption during the transition of ownership. The remaining 18 restaurants were closed. However, we did receive termination fees of $3.8 million related to the closure of the 18 restaurants. We have entered into a development agreement with the new franchisee to open additional restaurants in Illinois in the future.
IHOP franchisees and area licensees opened 58 new franchise restaurants in 2013, with net restaurant development of 38 restaurants. The 2013 openings included three restaurants in the Philippines, the first IHOP franchise restaurants in the Asia Pacific region. Over the past five years, IHOP net restaurant development totaled 217, an annual growth average of 43 restaurants per year.


In evaluating the performance of the consolidated enterprise, we consider the key performance indicators to be consolidated cash flows from operating activities and consolidated free cash flow (cash from operations, plus receipts from notes, equipment contracts and other long-term receivables, minus capital expenditures, principal payments on capital leases and financing obligations and the mandatory annual repayment of 1% of the principal balance of our Term Loans).

Consolidated cash flows from operating activities and consolidated free cash flow for the years ended December 31, 2013 and 2012 were as follows:

                                                        Year ended December 31,
                                                            2013               2012
                                                             (In millions)
Consolidated cash flows from operating activities $       127.8               $ 52.9
Consolidated free cash flow                       $       120.1               $ 29.9

The primary reasons for the increase in cash flows from operating activities were lower income tax payments, lower general and administrative expenses and lower interest costs for the year ended December 31, 2013 compared to the same period of 2012, partially offset by lower segment profit that resulted from the refranchising of Applebee's company-operated restaurants.
Additional information on each of these metrics is presented under the captions "Restaurant Data," "Company Restaurant Operations" and "Liquidity and Capital Resources" that follow.
Key Overall Strategies
DineEquity's Key Strategies
With the completion of our refranchising initiative, we are continuing with our efforts to drive stockholder and franchisee value. We have an ongoing program to leverage core competencies across the entire enterprise that is focused on three primary goals:
• Optimize organization capability;

• Drive profitable organic growth; and

• Reduce costs for both ourselves and our franchisees.

Our approach to brand management centers on a strategic combination of marketing, menu, operations and remodel initiatives that creates a distinctive and relevant connection with our customers. Additionally, our shared services operating platform allows our senior management to focus on key factors that drive the business while leveraging the resources and expertise of our scalable, centralized support structure. We believe this is a competitive point of difference. Together, this closely integrated approach is expected to strengthen brand performance and enable growth.
Applebee's Key Strategies

We continue to revitalize the Applebee's brand. Applebee's domestic system-wide same restaurant sales have increased in three of the past four years, with a cumulative increase of 3.2% over that time. We plan to grow by executing on the following key strategies: (i) drive profitable sales and traffic; (ii) invest in process and product innovation; (iii) transform the business; and (iv) improve franchisee margins and restaurant level economics.

Drive Profitable Sales and Traffic

• Continued focus on meeting the consumer's need for value throughout 2013, with such promotions as the return of our successful "Sizzling Entrées" starting at $9.99 nationwide, the return of our Fresh Flavors of the Season, and the rotation of new products into our "2 for $20" offering. We ended the year with Spirited Cuisine featuring our new Chicken and Shrimp Tequila Tango, Marsala Shrimp Sirloin and highly popular new Brew Pub Pretzels & Beer Cheese Dip;

• Increased our focus on lunch through improved lunch menu items supported by lunch-specific messaging on national television. We introduced a new Lunch Combos platform in May that allows guests to choose any two of a variety of new sandwiches, soups, salads, and lunch entrées;


• Continued innovation of the menu. Since the acquisition in 2007, more than 90% of Applebee's menu now consists of either new offerings or improved offerings with high quality ingredients;

• Continued our unique healthy food offerings by refreshing our "Under 550" calorie menu in January 2013 with Roma Pepper Chicken and Napa Chicken and Portabellos. Since its launch in 2011, our "Under 550" calorie menu combined with our Weight Watchers menu has established us as a category leader in providing healthy dining options to our guests;

• Broadened our commitment to healthy dining by introducing a new Kids Menu featuring 10 new Kids Live Well-approved meals. The new menu, which has received very positive guest feedback, offers a variety of new entrées and sides that are both healthy and kid-approved. This allows parents to concentrate on engaging with their family knowing their growing kids can get a fun, healthy meal at Applebee's; and

• Focused on late-night business through beverage and appetizer innovation and local restaurant marketing efforts.

Invest in Process and Product Innovation

We continue to invest in and drive innovation at Applebee's from both a product and process perspective. We maintain a significant test and implementation focus to both develop and discover new trends and opportunities within the casual dining segment and beyond. Our history of innovation is readily apparent in our continual evolution of limited-time product offerings as well as core menu items. We take a similar approach to evaluation of media strategies and consumer touch points.

Transform the Business

In June 2010, we rolled out "Connections," the new comprehensive restaurant revitalization program involving people, place and promotional aspects. The people aspect involves re-training and re-certification for kitchen staff and team members. The place aspect involves exterior and interior modifications to the restaurant to signal change. The promotional aspect involves a local public relations and marketing plan to re-connect with the neighborhood. Our franchisees have embraced this initiative and by year-end 2013, over 70% of the restaurants in the domestic system have been revitalized.

Along with our historical focus on food innovation, the completion of our refranchising transition in 2012 has allowed Applebee's to place additional focus on development and implementation of innovative technology solutions. We realize that customers' tastes are constantly changing and as a brand, Applebee's continues to learn and grow with our customers, evolving into a brand of the future.

Improve Franchisee Margins and Restaurant Level Economics

We have continued to build upon process and system improvements deployed in prior years by ongoing improvement efforts in operating metrics for our franchise partners. Our franchisees continue to reap the benefits of our supply chain co-op by leveraging our scale to manage through commodity cost inflation, which was also mitigated by the realignment of our distribution centers in 2010.

We continue to monitor our franchisees through our franchisee operations rating system, which provides visibility concerning their performance in relation to guest experience, food safety and training.

With our transition to a 99% franchised system, restaurant operating margin at the remaining 23 Applebee's company-operated restaurants is not significant to our results of operations. Given that the primary focus of these restaurants in the future will be to test new products and processes, their operating margin as a percentage of sales is expected to decline. However, we will continue to invest in product and process innovation to help our franchisees maintain and improve their restaurant level economics for the overall financial well-being of the Applebee's system.

In a challenging economic environment and a highly competitive casual dining category, there can be no assurance that the strategies described above, when implemented, will achieve the intended results.

IHOP's Key Strategies

To re-ignite growth we have been pursuing key initiatives within the three pillars of our strategic framework: (1) re-energize and grow the IHOP brand;
(2) improve operations performance; and (3) optimize franchise development.


Re-energize and Grow the IHOP Brand

To re-energize and grow the IHOP brand, we have continued our efforts to drive new and existing consumers to our restaurants by: 1) continuously strengthening our advertising message; 2) maximizing our media effectiveness across both traditional and new media outlets; and 3) transforming the IHOP menu to reflect evolving consumer tastes.

To ensure our advertisements resonate with consumers, we have continued to employ "Everything You Love About Breakfast" as our tagline and theme, leveraging our substantial brand equity in breakfast. We have further refined our message by incorporating in our advertising consumer testimonials that show a wide range of ages and demographics enjoying our freshly made items. These testimonials have been effective in reinforcing the welcoming environment at our restaurants.

While national advertising remains core to our strategy, we recognize that media consumption is evolving and we must reach consumers through a range of media channels to drive traffic to our restaurants. Gaining the attention of consumers in a highly competitive and diverse media market requires that we constantly update where and how we reach consumers. We continue to successfully build and increase consumer engagement with the IHOP brand in digital and social media, recognizing the importance of these channels to a significant segment of the population.

We continuously evolve our menu to deliver appealing items to our wide range of consumers presented in an easy-to-use style that is consistent with our brand message. Our new Brioche French Toast is a recent example that was met with high consumer interest. In addition, we recently launched the latest menu revision with a new layout that is easier to read and navigate. The new layout allows customers to more quickly identify their favorite choices, increasing guest satisfaction. Substantially all IHOP restaurants are using pollable point-of-sale systems to capture and report a broad range of sales and product mix data. This information is used by management to, among other things, gauge customer acceptance of menu items and the success of promotions and limited time offers.

Improve Operations Performance

We constantly strive to improve every aspect of our restaurant operations. To enhance our guest-centric culture, and enable our franchisees to assess and improve their service and the condition of their restaurants, we continue to evolve how we interpret and implement changes to address feedback from our guests. We deploy a range of feedback mechanisms including national consumer tracking studies about our brand, a guest feedback tool, our "Voice of the Guest" program, as well as operational evaluations conducted by our own employees and operational assessments conducted by a third party service provider. Our field based operations team is trained to work with franchisees to use this data to enhance their restaurant operations. We believe this wide range of data enables us to clearly identify areas of opportunity. While results from our efforts have been positive, we recognize that operations excellence is a continually evolving process.

Optimize Franchise Development and Franchise System Health

Under the Current Business Model, IHOP seeks to optimize franchise development by recruiting franchise developers within and outside the current system and working with these franchise developers in the site selection and building process. This strategy has proved successful as our franchisees have developed approximately 543 restaurants since the inception of the Current Business Model and our franchisees have a pipeline of 263 additional new restaurants committed, optioned or pending. The existing franchisee base accounts for most of these future development obligations. In 2013, an IHOP franchisee opened the first three IHOP restaurants in the Philippines, continuing to demonstrate the interest in the IHOP brand outside of North America. We continue to explore opportunities to grow in existing and new international markets.

In addition, we may take steps to consolidate and rehabilitate existing markets if we believe that doing so is advisable in order to fully realize development potential. We consistently monitor individual franchisee health and compliance with franchise agreements and we also may take steps to exercise our contractual rights within the franchise agreement in the event of noncompliance.

To positively impact the costs of IHOP franchisees, management works closely with CSCS, an independent cooperative entity, formed by us and franchisees of Applebee's and IHOP domestic restaurants. We recognize the importance of managing the costs of food and non-food items and believe the successful relationship among IHOP, its franchisees and CSCS presents an important differentiator.

However, in a challenging economic environment and a highly competitive family dining category, there can be no assurance that the strategies described above, when implemented, will achieve the intended results within the time frame anticipated.


Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact Comparisons of Reported or Future Results Same-restaurant Sales Trends
[[Image Removed]]
Applebee's domestic system-wide same-restaurant sales decreased 0.7% for the three months ended December 31, 2013 from the same period in 2012. For the full year ended December 31, 2013, Applebee's domestic system-wide same-restaurant sales decreased 0.3%, due to a decline in customer traffic partially offset by an increase in average customer check. The decrease was the first annual decline in domestic system-wide restaurant sales for Applebee's since 2009.

[[Image Removed]]
IHOP's domestic system-wide same-restaurant sales increased 4.5% for the three months ended December 31, 2013, IHOP's largest quarterly increase since the first quarter of 2006. For the full year ended December 31, 2013, IHOP's domestic system-wide same-restaurant sales increased 2.4% due to an increase in average customer check that was substantially larger than a decrease in customer traffic. We believe the increase in average customer check was due in part to the new IHOP menu launched in June 2013 which influenced customers' purchasing patterns and resulted in a favorable shift in product mix. Additionally, we believe the average customer check declined in 2012 because of strong consumer interest in promotional menu items, resulting in a lower base for comparison.


Same-restaurant Traffic
Both of our brands have generally experienced a decline in customer traffic in recent years including the year ended December 31, 2013. Based on data from Black Box Intelligence, a restaurant sales reporting firm, customer traffic declined in 2013 for the restaurant industry overall, as well as for the casual dining and family dining segments of the restaurant industry. In the short term, a decline in customer traffic may be offset by an increase in average customer check resulting from an increase in menu prices, a favorable change in product sales mix, or a combination thereof. A sustained decline in same-restaurant customer traffic that cannot be offset by an increase in average customer check could have an adverse effect on our business, results of operations and financial condition. We continue to evaluate and assess opportunities to drive same-restaurant sales and traffic

Franchisee Matters

We consistently monitor individual franchisee health. However, from time to time, some of our franchisees may experience financial difficulties, including bankruptcy, that may or may not relate to the financial performance of their franchised IHOP or Applebee's restaurants.

In February 2013, an IHOP franchisee and its affiliated entities which owned and operated 19 restaurants located in the states of Illinois, Wisconsin and Missouri filed for bankruptcy protection. As a result of an order issued by the bankruptcy court, two of the 19 restaurants were returned to us in the third quarter of 2013. A non-cash charge of $0.5 million was recorded in the Consolidated Statement of Comprehensive Income against deferred rental revenue associated with the leases for those two restaurants. During the third quarter of 2013, we received favorable rulings from the bankruptcy court which, if upheld, would allow the transfer of the remaining 17 restaurants to another franchisee. These rulings have been appealed by the current franchisee and are presently subject to a continued stay order, pursuant to which the current franchisee is operating these restaurants only on a day-to-day basis and is continuing to make payments to us pursuant to the terms of the original franchise agreements. Accordingly, we are unable to determine the ultimate outcome of the bankruptcy proceedings at this time.

In an unrelated matter, in April 2013, an Applebee's franchisee which owned and operated 33 restaurants located in Illinois filed for bankruptcy protection. Pursuant to the bidding procedures approved by the bankruptcy court, 15 of the restaurants were sold in June 2013 to an affiliate of an existing franchisee and operated without interruption during the transition of ownership. The remaining 18 restaurants were closed in June 2013. We received approximately $3.8 million in termination payments and other fees in connection with the closure of these restaurants. We also have entered into a development agreement with the franchisee that acquired the 15 restaurants to open additional restaurants in Illinois in the future.


Restaurant Data
The following table sets forth, for each of the past three years, the number of "Effective Restaurants" in the Applebee's and IHOP systems and information . . .

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