Dine Brands Global - Earnings Call - Q3 2017

Transcript

Speaker 0

Welcome to the Third Quarter twenty seventeen Dine Equity, Inc. Earnings Conference Call. My name is Sylvia, and I will be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer Please note that this conference is being recorded.

I will now turn the call over to Ken Fifteenth. Ken, you may begin.

Speaker 1

Good morning, and welcome to Dynek Group's third quarter twenty seventeen conference call. I'm joined by Steve Joyce, CEO Greg Calvin, Interim CFO and Corporate Controller Darren Revelis, President of IHOP and John Czewinski, President of Applebee's. Before I turn the call over to Steve, please remember our Safe Harbor regarding forward looking information. During the call, management may discuss information that is forward looking, involves known and unknown risks, uncertainties and other factors, which may cause the actual results to be 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 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 our Investor Relations website. With that, turn the call over

Speaker 2

to Steve. Thanks, Ken. Good morning, everyone. I appreciate your interest and participation in today's call. So first, I'd like to say that I'm truly honored and very excited about the opportunity to lead this tremendous company, which has such great potential.

I assumed the role of CEO two months ago, but I've also been a member of Dine Equity's Board of Directors for the past five years. During this time, I had developed a deep understanding of the company, the business and most importantly, our two incredibly strong brands. I've come to realize many of the strengths, weaknesses and opportunities before us. And as a Board member, I also have insight into what has worked and what has not. I have almost forty years of experience in the hospitality and food and beverage industries combined as well with international development.

With over thirty years of working with franchisees, I've developed a deep understanding of what makes a successful franchisor franchisee relationship. I'm looking forward to working further with my talented senior management team to strengthen the efforts already underway to build on the partnership with our franchisees. When I became CEO, I knew that positioning Applebee's and IHOP for long term growth would require some heavy lifting. I also know that we have dedicated franchisees and committed team members challenge. I am extremely optimistic about our future and realizing this company's full potential and long term success.

I will judge this success by one measure and that is total shareholder return generated over the next several years. Our first priority will always be the most efficient return of capital to shareholders. Now realizing our full potential will not happen overnight, it is certainly achievable with a change in our philosophy of what Dine Equity is. We are no longer a brand company that oversees two great brands, but a holding company whose attention and committed team members will be focused on supporting the success of the brands as well and in particular our franchisees. From my experience, you need a strong culture to succeed.

And with that, I want to talk a little bit about strategic priorities to achieve our goal and evolve our future. One, we will establish a performance driven culture here at Dine. Two, we will drive sustainable positive sales at Applebee's and IHOP. And three, we will return Dine to a growth company. Regarding developing a robust performance based culture, we'll place an emphasis on agility and innovation that will create opportunities for Dine and our franchisees.

Franchisees. In turn, I believe this approach will drive the maximum value for our shareholders. A shift in culture is very important to fostering greater collaboration both internally and externally, being bolder, taking risks and moving forward. I am bringing this focus to Dine and making certain that our iconic brands remain strong and that our franchise system benefits from relevant brands that lead their respective categories. Our success is driven by the success of our franchisees.

Our second and equally important priority is to drive positive sustainable sales at both brands. Industry conditions remain challenging and highly competitive. In this environment, our brands must continue to be nimble and able to respond to the ever changing needs of consumers. We are executing on several initiatives at both Applebee's and IHOP to change the trajectory of comp sales and stem the declines in traffic. At Applebee's, our dedicated and savvy franchisees are moving forward with simplifying restaurant operations while elevating the guest experience.

This focus has resulted in marked improvement in the brand's overall guest satisfaction score over the last twelve months and recently in revenue performance. The entire Applebee's team is currently focusing on what needs to be done to make the brand more relevant and to jump start its growth. This action plan includes using breakthrough advertising to better communicate our message, implementing refined national media strategy, promotions and expanding our culinary pipeline, providing abundant craveable food, so that once again our customers are eating good in the neighborhood. We are working diligently to put Applebee's best days ahead of it. John Cywinski and his team are ensuring that the brand has the tools and resources needed to succeed.

In fact, over the last few months, we have thoughtfully restructured the organization to ensure that Applebee's has the dedicated resources to support our franchisees and the brand's growth strategy. Turning to IHOP, Our franchisees are equally committed to improving performance and creating abundant value for our customers. To this end, we have made great strides in building on our IHOP and Go platform. The franchisees are also enthusiastically remodeling their restaurants and we're tracking to achieve our target of 300 remodeled restaurants this year. To meet the convenience needs of the guests, we are executing on our strategies to expand on our off premise business to deliver a great IHOP experience in different ways, including the use of technology.

I'm confident in the steps we're taking to drive positive sales and traffic growth at both Applebee's and IHOP. Our brand presidents are with us this morning and they'll provide additional detail on their respective strategies shortly. Regarding our third priority, returning Dine Equity to a growth company, we are investing prudently for growth both in our people and our brands. We are investing in tools and consumer insight analytics to provide franchisees with optimal support by having a best in class understanding of consumer trends and behavior. More rigorous quantitative analysis will provide a better understanding of key trends in customer expectations.

This information will help us make better business decisions going forward. To succeed and remain competitive, we must reignite sustainable growth. This will be driven by developing a clear vision of our business, opportunities and obstacles. We will focus on improving profitability through operational efficiency and closely managing our G and A. We will thoroughly assess opportunities to expand in unpenetrated markets through non traditional and small format traditional development.

If we are not relevant to our consumers and growing, you can sure as hell bet our competition will be. Make no mistake, the competitive landscape will continue to change, so we must evolve to be where our guests want us to be. We will also explore the potential for increasing our brand portfolio. International expansion continues to provide an attractive growth opportunity. Although our international operations comprised less than 3% of total consolidated revenues for our last fiscal year, it is still a very relevant part of our business and our strategy going forward.

In fact, our international franchisees across both brands developed 24 new restaurants combined in the first nine months of twenty seventeen, representing approximately 33% growth over the same period last year. So with that, I'm going ask Greg to walk you through the financial results for the quarter. Greg?

Speaker 3

Thank you, Steve. Good morning, everyone. I'll briefly cover our financial performance for the third quarter before turning to our revised performance guidance for the remainder of 2017. For the third quarter, our adjusted EPS was $0.91 compared to $1.46 for the same period of 2016. The decline was primarily due to a decrease in gross profit from franchise operations as a result of lower Applebee's revenue due to 7.7% decline in comp sales, royalties not recognized until paid in cash and an increase in Applebee's bad debt expense, the impact of 2017 closures and a modest increase in G and A due to personnel related costs.

I would like to point out that the franchise operation expenses in the third quarter were higher compared to the same period of 2016, primarily due to an increase in Applebee's bad debt expense and a $4,000,000 franchisor contribution to the Applebee's National Advertising Fund. As discussed on our last earnings call, we expect to contribute an additional $4,000,000 in the fourth quarter or $8,000,000 during the 2017. Finally, an update regarding the $10,000,000 stabilization initiatives we discussed previously, approximately $8,000,000 was incurred in the 2017. We expect the balance to be incurred in the fourth quarter. Regarding our third quarter impairment charges.

In the third quarter, we incurred non cash impairment charges totaling $532,000,000 related to the write downs of both Applebee's goodwill and other intangible assets. The impairment charge consists of a $358,000,000 related to goodwill and $173,000,000 related to other intangible assets. The impairment of Applebee's goodwill is not deductible for federal income tax purposes, so there's no tax benefit associated with it, we did recognize a deferred tax benefit of approximately $65,000,000 related to the other intangible asset impairment. Please note that the impairment of Applebee's other intangible assets can be deducted for federal tax purposes in the future, even though it's not deductible in the current year. The tax benefit coupled with our approximate annual run rate of 12,000,000 to $15,000,000 for reduction in deferred taxes resulted in the $77,000,000 item for deferred taxes that you'll see in the statement of cash flows for the nine months ending September 30.

Let me provide some additional comments regarding this charge. We are required under General Acceptance Accounting Principles to periodically assess goodwill and other intangible assets for impairment when certain indicators exist. During the 2017, based on various factors related to the performance of the Applebee's business over the first nine months of the year and the overall market capitalization of DynaEquity, we determined that a valuation of goodwill and other intangible assets was warranted. The result of this valuation resulted in this non cash impairment charge. With that said, please note that this charge has no impact on the company's ability to generate future earnings and cash flows.

It does not impact our debt covenants. And finally, it does not impact our ability to pay dividends or repurchase shares. Turning to our tax rate. Our GAAP effective tax rate for the 2017 was an 11% tax benefit compared to a 35% expense in the third quarter of last year. The primary reasons for the variance is due to our book loss for the quarter and the non deductibility of the goodwill impairment discussed earlier.

For adjusted earnings per share, we currently expect that our effective tax rate for full year 2017 will be approximately 40%. Now turning to our cash flow statement. Cash flows from operating activities for the first nine months of 2017 were $31,000,000 compared to approximately $62,000,000 for the same period of last year. The overall decline was mainly due to lower net income resulting from a decrease in gross profit from franchise operation and higher G and A. The increase in G and A was primarily due to a $9,000,000 of non recurring cash severance and equity compensation charges incurred in the first quarter related to the separation of our previous CEO and $8,000,000 incurred in the 2017 for the Applebee's stabilization initiative.

Adjusted free cash flow for the 2017 was approximately $29,000,000 compared to approximately $66,000,000 for the comparable period of 2016. The variance was due to the decline in cash from operations as previously discussed and higher capital expenditures compared to the 2016. The increase in capital expenditures for the 2017 compared to the same period last year was mainly due to construction costs related to the test kitchen at our corporate headquarters and additional investments in IT for consumer facing initiatives. Turning to an update on our Applebee's franchisees financial health. We continue to partner with our franchisees and our financial advisor Trinity Capital.

This includes the ability of franchisees to 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 will continue as necessary. Currently, only a limited number of Applebee's franchisees have availed themselves to any direct financial assistance in this program. However, I'd like to point out that all but a few franchisees have participated in the approved closure process for underperforming restaurants.

Lastly, I'll discuss the revisions to our performance guidance for fiscal twenty seventeen. Please see our press release we issued today for complete details on our guidance. We now expect Applebee's comparable sales to range between negative 5.5% to negative 6.5%. Our guidance reflects the traction seen in the early fourth quarter from the implementation of our sales and traffic driving initiatives. We have lowered our expectations for franchise segment profit to range between $297,000,000 and $3.00 $3,000,000 primarily due to continuing royalty collectability related to a limited number of Applebee's franchisees.

We've revised our expectations for cash flows from operating activities to raise between $64,000,000 and $74,000,000 mainly due to the timing of our marketing spend in the fourth quarter and the impact of the collectability of Applebee's franchisee royalties previously mentioned. Turning to our adjusted free cash flow. Based on our revised guidance for cash from operating activities, we now expect a range of approximately 60,000,000 to $70,000,000 for 2017. To conclude, despite our 2017 challenges, our business model continues to generate ample adjusted free cash flow. The financial health of our franchisees is a high priority for us and we are committed to their success.

We closely monitor the cost side of our business while making appropriate investments in our brands and people. With that, I'll now turn the call over to John.

Speaker 4

Thanks, Greg, and good morning, everyone. As anticipated, Q3 was a challenging quarter for Applebee's. In particular, our National Media spending in Q3 represented a very unfavorable comparison with the same quarter last year. Additionally, we were off air more weeks in the quarter when compared to a year ago. Now with that said, we remain focused on our 2018 turnaround plan as we expect to see our initiatives take hold beginning in Q1.

In fact, we saw a change in our trajectory here in October through a combination of new initiatives. We supplemented the ad fund with $4,000,000 contribution. We reintroduced Eating Good in the Neighborhood, our new campaign with some terrific new advertising. And we focused on our core two for 20 value proposition with the beverage underlay. And for the first month since about 2015, we saw positive traffic and sales growth in October.

On another positive note, we just concluded our Applebee's conference and our franchisees are both confident and optimistic as we look to next year. We outlined our turnaround strategy as well as a comprehensive 2018 plan and we have franchisee alignment in support of all components of this plan. Most importantly, we once again have the proper lead time required to execute at a consistently high level, particularly at the restaurants. I'd simply categorize our partnership with franchisees as the best it's been in years and one of the primary reasons I'm very bullish about our future. Speaking of franchisees, I'd like to take a moment to recognize our largest franchisee, Apple American Group, who we just announced as our twenty seventeen Franchisee of the Year.

I'm proud of Greg Flynn and his team, because they consistently walk the talk on all key operating metrics and they really represent the brand exceptionally well kind of day in and day out. In addition, I'd like to welcome our newest franchisee Apple Mountain LLC, operating 10 newly acquired restaurants in Utah. As we look forward, we'll likely have additional transactions as part

Speaker 5

of our long overdue

Speaker 4

portfolio optimization. Now turning to operations. We remain focused on narrowing variability across the system, while removing complexity in our restaurants. I'm very pleased to welcome Kevin Carroll to his new role as Chief Operations Officer for Applebee's. Kevin is a seasoned leader with tremendous experience in delivering operational excellence and guest satisfaction, while building a vibrant operating culture of accountability.

Kevin will hold our franchisees accountable for an elevated guest experience through partnership, sharing of best practices and adherence to brand standards. From a marketing perspective, we'll embrace our Applebee's brand essence. We're fundamentally well positioned as an all American value oriented and family friendly brand with deep connections throughout the communities in which we operate. You'll see us fully leverage our Eaten Good in the Neighborhood positioning across all touch points. We'll target routine traditionalists as well as those very important value seekers who prefer casual dining restaurants and Applebee's in particular.

Our approach to content development has been refined, media and advertising strategies have been substantially enhanced and our brand voice and personality will become crystal clear to our guests as we move through 2018. On the culinary front, we'll shy away from niche and trendy menu items, while embracing broadly appealing mainstream flavor profiles as well as abundant value. Our new disciplined testing and validation process is now in place as we build our innovation pipeline with a relentless guest orientation. Importantly, all culinary innovations will have a clear operations complexity filter prior to consideration. This is an essential part of our new process.

And from a supply chain standpoint, we'll activate our partnership with PricewaterhouseCoopers in pursuit of enhanced restaurant profitability that can be redeployed to both labor and food investments over the next twenty four plus months. Now off premise remains a priority requiring greater operational consistency as well as technology and packaging enhancements. These investments are slated for implementation in 2018, once we have validated the ideal service model. We continue to see the off premise business as a growth engine for the brand, with to go being the near term focus, while we actively test and expand our delivery footprint currently present in about 150 restaurants. To Go currently accounts for just over 8% of total sales and we're very optimistic about the opportunity to grow this platform.

An equally important part of our brand optimization is the overt shift of Dine Equity shared resources to dedicated Applebee's resources. To date, we've implemented the structural change with consumer insights, business analytics, operation services and restaurant training. This evolution ensures we have a fully autonomous structure with a distinct Applebee's culture and very clear brand accountabilities. While 2017 is a transitional year for Applebee's, we once again have clarity on who we are and what we stand for. We know what our guests value and what makes us so unique in this crowded space.

And we are most certainly aligned with our franchisees and how we execute this turnaround plan moving forward. Again, our initiatives begin to line up in Q1 and we expect to see sequential improvement throughout 2018. Thank you everyone. And with that, I'll turn it over to you, Jern.

Speaker 5

All right. Thank you, John, and good morning, everyone. IHOP's third quarter comp sales declined by 3.2%, partially reflecting the continuation of soft industry conditions, specifically one of the steepest quarterly declines in family dining comp traffic over the last two years. IHOP's results were primarily driven by that decline in comp traffic as well as underperformance in the dinner daypart due to cycling a successful Kidney free promotion in 2016. Despite the declines in both category sales and traffic this year, development by IHOP franchisees continues at a very solid pace.

Franchisees opened a total of 50 restaurants globally gross in the first nine months of 2017. This represents a 108% increase over the same period last year. I'll provide more details on our development results later. Our top priority at IHOP is to rebuild sales and traffic momentum by executing against a broad four pronged strategy, which includes significantly enhancing the guest experience, running great restaurants, building and driving traffic and being where the guest is. I'll briefly discuss each of these, starting with game changing enhancements to the guest experience.

We know that the atmosphere in our restaurants is an integral part of the dining experience. We've added a dedicated consumer insights team to conduct in-depth analysis to better understand who our guests are, what matters to them, why they care about the brand and what role our great food plays in their lives. Through this work, we know that value is top of mind for everyone and guests expect a great experience based on the strong brand equity we've built with consumers across a very broad age demographic. Make no mistake, we are more in tune with our guests than ever before and our focus is to drive higher frequency among our existing IHOP guests. Providing a warm and welcoming environment is just as relevant to our guests as the service itself.

To that end, the IHOP Rise and Shine remodel program has elevated the dining experience and we believe has helped to further differentiate us from our competitors. I'm pleased to report that our franchisees remodeled 92 restaurants in the third quarter, bringing the total to two thirty restaurants this year. We're on track to complete 300 remodeled restaurants for the second consecutive year. To meet the needs of today's technology savvy consumer on the go, we will also better leverage consumer facing technology to increase the brand's accessibility. These initiatives include enhancing IHOP's website and launching a mobile app, both of which we expect to roll out this quarter.

Lastly, we're making progress on our growing our off premise business, which includes online ordering and delivery. I'm pleased to announce that our online ordering platform is almost fully deployed and will support the revamped IHOP and GO program that we launched earlier this year. These combined initiatives have yielded positive results, generating overall To Go comp sales growth of 8.3% in the third quarter, with solid growth in both traffic and check. This compares to To Go comp sales growth of 7.1% in the same quarter of last year. Regarding delivery, we'll start limited tests this quarter with Amazon and DoorDash.

Once we confirm that the online ordering integration with these initial vendors has met our operating standards, we'll be able to quickly expand to other restaurants offering the platform that are within the respective coverage areas. Additionally, we plan to start testing with Grubhub in the first quarter of next year. Today, IHOP's to go sales account for slightly more than 5% of our sales mix, which is approximately 50 basis points higher compared to the third quarter of last year. While the platform is still in the early stages, we're optimistic about the potential that this incremental revenue channel represents. Let's shift gears to running rate restaurants.

Our sharp focus on all aspects of restaurant operations has helped IHOP to be the leader in family dining for ten consecutive years according to rankings issued by Nation's Restaurant News in July. We're building on this success by addressing hospitality and operational basics. Our efforts resulted in IHOP reaching a new high and overall guest satisfaction score in the third quarter. I'd like to thank our franchisees and team members for their hard work in achieving this. To continually improve, we're focusing on hospitality training programs to provide our guests with an even better experience.

We're also collaborating with franchisees and operational improvements by using tools to help with sales forecasting, food costs and labor scheduling. We also plan to increase the frequency of our operations meetings in 2018, as well as our high touch people centric training events to provide franchisees with the tools they need to train their teams and foster better implementation. Additionally, we'll continue to have a major focus on our off premise business and best practices and effective execution to further unlock operational efficiency. Lastly, we've realigned our training organization to report into field operations, which will better enable that team to support the needs of franchisees at a local level. Taken collectively, we believe that these initiatives will drive our business improve results over time.

Turning to driving traffic. Attracting new guests into our restaurants and enticing repeat visits from existing ones are imperative to rebuilding IHOP's momentum. To break through the clutter, we're going to focus on continued culinary innovation, a sharper value proposition and more effective advertising to drive traffic. Regarding culinary, we introduced our all new French toasted donuts with a bold new marketing campaign during the quarter. While this product garnered positive guest sentiment and purchase intent, we believe the lack of a compelling price point caused it to underperform versus our expectations.

This promotion was followed by the introduction of our new Latte Lovers pancakes, which are inspired by delicious flavors found in the most popular coffee beverages. Starting at just $4.99 this offers the guests a compelling value combined with our core equities available across each daypart that takes creativity to the next level. Early indications are that this combination of value and core equities is resonating with the guests. To better communicate IHOP's value proposition and what we stand for as a brand, we recently selected Droga5 as our ad agency of record. Droga5 will assist us in both creating effective messaging and generating new breakthrough creative that resonate with consumers and help drive traffic into our restaurants.

This firm is widely regarded as one of the leading agencies in the country, has been named Agency of the Year multiple times by Advertising Age, Adweek and the Cannes Advertising Festival, in some cases since their inception. We're confident that this change will allow the IHOP brand to stand out and break through the clutter. Regarding the final element of our strategy, being where the guest is. Approximately 46% of adults and 61% of millennials surveyed said the most important factors when choosing a restaurant are availability, convenience and friendliness. For these reasons, offering more ways to access IHOP and providing convenient carryout service in our restaurants are more important than ever.

An important aspect of our plan encompasses both traditional and non traditional development by franchisees, which continued at a healthy pace in the third quarter. Our franchisees opened 12 domestic restaurants, four of which were non traditional. This includes the recent opening of an IHOP Express at the Dallas Fort Worth International Airport, which is our first location after the TSA screening area. This newest restaurant is in response to longtime demand from guests for great IHOP food on the go. Passengers traveling through the airport will be able to enjoy their freshly prepared favorites, like our world famous buttermilk pancakes twenty four hours a day, but we'll also have the option of several hot grab and go items ideal for those in a hurry.

This opening is part of our growth strategy, which includes expanding the brand's overall traditional footprint, introducing smaller prototype restaurants and expanding into locations like airports, universities, casinos and travel centers. We've had success with this strategy and developed a total of 25 non traditional IHOP restaurants in The U. S. To date. I'd also like to clear up some confusion about IHOP's development.

First, I'd like to reiterate our previous guidance of between eighty and ninety five new restaurants globally, the majority of which are domestic openings. We also expect to close between twenty five and thirty restaurants globally. This level of closures is completely consistent with our historical annual run rate and simply reflects lease expirations and market optimization moves. Our net development is on pace to reach the highest level since 02/2009. There continues to be very strong interest in the IHOP brand globally and our franchisees are growing.

This Saturday is Veterans Day and each year IHOP participates in celebrating our veterans and their service to our country. We honor those that have served by offering both retired and active duty service members a free short stack of our red, white and blue pancakes. Last year, we provided approximately 405,000 free pancakes throughout the domestic system. We expect this year's celebration on November 11 to be a great success as well as fulfilling fulfilling way to thank our veterans. In addition, we're announcing our partnership with the Children of Fallen Patriots Foundation, whose mission is to provide college scholarships to children who have lost a military parent in the line of duty.

The IHOP system will donate $1 for every red, white and blue pancake combo sold in the month of November to this worthy cause. To wrap up, we're doing the necessary heavy lifting to rebuild IHOP's sales and traffic momentum. I'm very confident in the steps that we're taking to drive the business forward as we approach our sixtieth year of providing guests with an inviting and warm atmosphere to enjoy their favorite IHOP meals. We recently wrapped up our global franchisee conference where we shared our plans for the future. Franchisees are excited about what's to come and aligned around our direction moving forward.

With that, I'll turn the call back to Steve for his closing comments. Steve?

Speaker 2

Thanks, Darren. Well, obviously, we're very excited about creating this company into a dynamic enterprise, which is going to do great things. And we're working with a talented and seasoned management team. We have the best franchisees in the business who have demonstrated their commitment to success and confidence in our long term growth plans.

Speaker 3

We have

Speaker 2

a lot of work ahead of us as we execute on our strategies to establish a performance driven culture, driving sustainable sales at both brands and return Dine Equity to a growth company. As I said on the second quarter call, I think we're going to do a lot of different things that will add value. We have tremendous assets that need some adjustments. And we're looking forward to providing comprehensive updates on our progress. We're going to give you a vision for the company going forward early next year.

I'm enthusiastic about the opportunity to realize the company's full potential and I feel very confident in the steps that we're taking to achieve that. With that, let's open it up to any questions you might have. Operator?

Speaker 0

Thank you. We will now begin the question and answer session. Answer session. And our first question comes from Stephen Anderson from Maxim Group.

Speaker 6

Yes, good morning. Certainly taking a look at the comp improvement we've seen so far in the quarter. I just wanted to ask, can you pin down how much of the improvement as well as any kind of effect that you saw in third quarter from the two hurricanes we've got?

Speaker 3

Hi, this is Greg. The effects were pretty minimal to our businesses. The amount of time the stores were closed down versus when they reopened was relatively quick and there's usually a bounce back in people coming out after the restaurants reopen. So very minimal on the sales line for the quarter.

Speaker 6

Okay. But going to fourth quarter, so we saw NapTrak come out late last night up 1.4% on casual dining. And looking at that, we saw some big gains in Florida and Texas. And I just want to see of the sales and traffic gains in the quarter, can you attribute some of that from the hurricane recoveries?

Speaker 2

No. Actually, I think where we feel we are now is what we're doing is working. October does not make the year, we were pretty positive about what happened But we think we're attributing it to in both of our brands. We're doing better marketing, providing better value, running better restaurants and capturing the customers' interest with some really interesting approaches to not only our advertising, but also the food that we're serving in the restaurants.

And I think look, our brands represent the 99%. So we think anything that's positive in these categories, we're obviously going to benefit from. But we attribute it mostly to the things we're doing that are making a positive difference.

Speaker 3

All right. Thank you.

Speaker 0

Our next question comes from Michael Gallo from CL King.

Speaker 7

Hi. Good morning. And just want to echo the positive signs of stabilization. Good to see it early in the game here.

Speaker 2

Thank you. Good morning.

Speaker 7

Good morning. Stephen, just I know this maybe this is still to be unveiled when you think about your vision for each of these companies, but you've been on the Board for some time. You've seen the positives and negatives of having these brands together. Obviously, you'll have an opportunity with when the make whole securitization goes away in the spring. You have any high level thoughts on whether you think ultimately these brands benefit from being together, don't benefit from being together, whether it might make sense at some point to split them apart?

And just some thoughts on maybe it's too early to answer, but some high level thoughts there would be helpful. Thanks.

Speaker 2

Oh, it's not too early at all. So let me tell you some. Franchise business is about scale. Scale allows you to balance your costs over a larger number of units. The incremental value of a unit to us is almost entirely profitable.

This business is a scale business. You can expect us to grow that scale not shrink it.

Speaker 7

Great. And then just want to delve in on IHOP a little bit. Obviously, it's had a little bit more of a challenging year relative to some of the prior years. You've had some success in To Go, but it just seems the promotion since you changed the advertising campaign last September, it just seems that it's gone from outperforming the category for a long time to underperforming. I was wondering whether you might look at the same evaluation regarding the ad campaign campaign and how effective that is as you're undertaking at Applebee's?

Thanks.

Speaker 5

Well, yes, Mike, we're really focusing on a number of things to positively drive that. As I mentioned last quarter, we made a change with our Chief Marketing Officer and brought in someone who's got nearly twenty years of experience in that role. And then we further went on, as I mentioned just a few minutes replace our ad agency to arguably the top creative agency in the country. So we've got a lot of great food. We've got great service in our restaurants.

We're remodeling the restaurants and creating new and more contemporary atmosphere. And we felt like we really needed a top notch agency to highlight all of those changes in our restaurants and that's what we've done. So we absolutely expect to see better results in the coming quarters as a result of that those changes.

Speaker 2

And we think all those things are going to drive what is already a brand that everybody loves. But one of the things that we're focusing on which we think is important and we've heard from our consumers is we're going to provide greater value than ever. And so that value concept communicated well in a way that's befitting of this brand is just going to reignite this brand to levels that it should be at and we're like and we think we're starting to see results already.

Speaker 7

Great. Thank you.

Speaker 0

Our next question comes from Brian Vaccaro from Raymond James.

Speaker 8

Thank you and good morning. So it's pretty encouraging to see the traffic and sales rebound in October, especially at Applebee's. And John, you mentioned a few initiatives, but I didn't hear any attribution to the Dollar Rita promotion. Could you provide some color on how that promotion performed? Maybe some perspective on both sales and profitability during the month of October versus the past three to six months?

Speaker 4

Hey, Brian. Good morning.

Speaker 5

As much as I'd love to look just for competitive reasons we're not

Speaker 4

going to delve into any detail here. Suffice it to say the combination really this from all of our qualitative and quantitative work this new advertising, which is basically a formula that we've used previously around Eat'n'Good in the neighborhood with great success is resonating. Our value propositions are resonating both on the food and beverage side. And we're lined up for 2018. I'm a little surprised by the early fraction in October, but we expect all of these initiatives on all fronts to hit beginning in Q1 and frankly early Q1.

So I'm going to resist the temptation to disclose any detail for competitive reasons Brian. And I know you understand that. Yes.

Speaker 2

But we can also say look there are three or four factors contributing to that change. And so first of all, the advertising as John mentioned is resonating much more with consumers than what we're doing previously. The that we sold more two for 20s than we've sold in I think in the history of the brand. That program and offer clearly is driving people into these restaurants. And then we've had successful promotions as well.

So you can expect us to continue all of that. And you can expect we think that all that is the formula for putting us on a positive sustainable sales growth going forward.

Speaker 8

Okay. Would you be willing to disclose your alcohol sales mix in the quarter?

Speaker 4

Brian, look our alcohol mix generally speaking is in that 14% to 15% range on an annual basis. And I honestly wouldn't disclose any detail beyond that. Frankly, I wouldn't even have it at my disposal. But we're pleased with where we are on both the food and alcohol front.

Speaker 2

Yes. And by the way, we think the bar is an opportunity for us because we think we can move that needle.

Speaker 8

All right. Fair enough. And you mentioned the advertising weights were down pretty significantly in the third quarter at Applebee's. How did that comparison look in October? Was that also part of normalizing year on year?

And then also fourth quarter is advertising weights going to be up year on year another down quarter? Any perspective there would be helpful.

Speaker 4

Hey Brian, I think you nailed it. Q3 was a bit of an anomaly year over year. Q4 is back to kind of a normalized year over year comparison. I wouldn't call it an increase year over year, but stable is probably the best way to categorize it. And again, we don't have those issues moving forward into 2018, so very bullish as we look forward.

Speaker 8

All right. And shifting gears to the guidance. So the adjusted free cash flow guidance lowered pretty meaningfully on a reduction in the franchise segment profitability. And if you parse down and really drill down on the fourth quarter, it implies an even greater year on year decline, it would seem in the Applebee's franchise segment profit. Can you help parse that out between of the cash basis royalties and the collectability there versus maybe the bad debt expense?

Speaker 3

Well, they're all this is Greg, Brian. They're all in effect on our cash, if you will, whether it's a bad debt or not collecting it in the first place because either way it relates to collectability. So those items that are projected for the rest of the year plus we mentioned in our guidance that we're going to have some additional weighted marketing spend on a cash basis in the fourth quarter. Those two items is what's driving the revision of the adjusted free cash flow to where we're comfortable with it for the rest of the year.

Speaker 2

And they're roughly in equal weights? Yes, essentially. Look, I haven't been in this business a long time, I can tell you this. The way to improve your receivables and collectibles is to have your franchisees make more money and that's what we're doing.

Speaker 8

Okay. And just to be clear on that, so the NAF contribution that you're accruing in the expense line, Applebee's franchise expense, I think that was $4,000,000 in the third quarter. That also be $4,000,000 in the fourth quarter? Or is it going to be more than that because of what you just said on the cash spend on ad spend?

Speaker 3

It will be for our contribution will be $4,000,000 in the fourth quarter also. So 8,000,000 for the whole year for the second half of the year.

Speaker 2

But that fourth quarter is in advance,

Speaker 3

not an expense. There's part expense and part advance. Yes. So the $4,000,000 there will be a 4,000,000 statement hit in the fourth quarter that will go through franchise expense. And then like I said earlier, we're also advanced spending some money on the marketing from our cash for marketing spend in the fourth quarter that will be incremental to normal run rates if you will.

Speaker 8

Okay. All right. I'll follow-up offline on that. And then the last question on the IHOP unit growth outlook. I know this has been the best year in a while on net unit growth.

But I guess as you look at the next few years, where do you see net unit growth trending given you're at nearly 1,800 system units with most of those domestic? And I guess maybe your latest thoughts on total ultimate domestic opportunity? And the last piece of it, is part of the comp weakness at IHOP you think related to intensifying cannibalization? Thank you.

Speaker 5

Yes, Brian. I think, well, just to correct one of your numbers, we have around sixteen fifty domestic restaurants. So a little bit less than that 1,800 that you were citing. But yes, we absolutely believe we have more room to grow and we're not seeing the comp challenges come from cannibalization, because our franchisees are the ones that are really driving the development. So they're less inclined to cannibalize themselves.

So we're seeing good incremental growth there. The other channel that we really think gives us a lot of upside is the nontraditional channel. And it's really allowing us to penetrate some areas that we traditionally have not gone after. But our guests are telling us that they want access to the IHOP brand. So we have we're pretty bullish on our growth moving forward and we think we can do that without cannibalizing our existing restaurants.

Speaker 2

So and I guess the way we think about it is we think we've got a long runway for IHOP domestically. But also more importantly that brand is incredibly in demand globally. So there is just a strong interest in almost on every continent. And so you're going to see us talking in the future about we're in discussions on several multiunit deals. We don't have anything to tell you at this point.

But it's one of the many nice surprises I've gotten since joining this company is seeing the demand for our brands particularly IHOP International.

Speaker 8

All right. That's helpful. Thank you.

Speaker 0

Our following question comes from John Ivankoe from JPMorgan.

Speaker 9

Hi. Thank you. There's some initial comments made that the success of this business was going to be around driving total shareholder return. To state the obvious, it's a combination of dividend and capital appreciation. Your dividend is extremely high, very, very close to what a given year's net income is, but you do have some cash on the balance sheet.

So can you there's different ways to basically cut this. I mean, you could imagine a situation where a meaningfully lower dividend allows you to reinvest in your business in the short term in order to drive long term value of the equity and or you could also imagine that more the TSR would be driven by the dividend itself. So since you brought that up and you want to be measured by total shareholder return, it's obviously very different ways to get there between dividend and capital appreciation. Was hoping that you could elaborate on that.

Speaker 3

John, this is Greg. As we've done consistently, our Board and management evaluates the payment the rate of the dividend every quarter. And we have an existing dividend being paid next early next year. But it's always a careful thoughtful evaluation as to how to deploy that capital. As far as the cash goes, we I think we've said that probably about half of our cash on our balance sheet is or more is related to gift cards and advertising money.

So there's probably at the end of the third quarter, there's probably about 40,000,000 or $50,000,000 of free cash if you will. The rest of it is really tied up in those funds if you will that are earmarked for specific purposes. And it's been that way for a while. So there's not a huge amount of cash that we have at our disposal at any point in time for that. But about half and half is what it is.

And the dividend as I've said is will be evaluated quarterly.

Speaker 2

So right now we don't have we are happy with our position. We obviously are going to continue to reevaluate it. I measure my performance and this company's performance and this management's team's performance by what we give the shareholders. And so the our model, we are going to continually reevaluate how we allocate our resources. But what we're going to do long term that you can count on is we're going to be the most efficient company in terms of how we deliver value to the shareholders.

So as environments change and lots of things are in the mix right now, who knows what's going to happen on the tax bill. There's a whole bunch of different things that could change our outlook. But right now, we're satisfied with where we are and we'll continue to update you on where we think we're going.

Speaker 9

Thank you for that. And then secondly, as you're talking to the franchise community and they're making their 2018 plans, the industry doesn't have a lot of pricing power. Labor costs in certain markets are actually a problem. Commodities aren't going down like they used to where they did for a couple of years. Maybe they're even ticking up depending on the commodity.

It's hard to see a path where franchisee profitability will be up 2018 over 2017. So just hoping to kind of get your comments on that and just your sense on the overall franchise community of how they're looking at their cost structure in the middle of the P and L and whether that influences their willingness or ability to reinvest at the levels that you would like them to?

Speaker 2

Yes. So we've got several things working on that front. We actually think we're pretty optimistic about 2018 and so are our franchisees. We had a we just had our convention and the Applebee's folks during the general session were voting on a number of questions we were asking. One of them which was how do you think we're going to do in 2018?

And their response was uniformly positive that we're going to do well. So there are some things on the cost side that we're doing. We're trying to drive efficiencies around labor, because you're right labor costs are not going down. We're trying to drive efficiencies around our buy and that is the Pricewaterhouse study that was mentioned earlier. We think that's going to yield well, we know it's already yielding positive results, but we don't have the final.

We've got a very aggressive target for the benefit of that study. And at this point we think we're going to achieve it. And so but the other big thing is we're going to drive traffic. And if we drive people into those restaurants, we're going make more money. And that's it doesn't get any simpler than that.

Speaker 9

And so just two related points. One, your belief that Applebee's drives traffic in 2018, is that conditional on the belief that the industry bar and grill casual dining however you want to define it drives traffic in 2018?

Speaker 2

Look, I think we're going to outpace the industry, but we can't if the industry is not in a reasonable environment, then we're not going to drive we're going generally follow the industry, but our plan is to outperform the industry. So wherever you're going to put the industry, put us above it.

Speaker 9

Okay. Sorry. No, thank you for that clarification. And the final question, when you and the franchisees look at your menu, your average ticket relative to traditional and nontraditional competition, how do you feel about the average ticket? And do you have opportunities up or down on average ticket in 2018 versus 2017?

Speaker 2

We think in both brands, our greatest opportunity is to drive more value for the consumer and that's what we're planning on doing.

Speaker 4

Yes, John. This is John Siklinski. I look, we're much more fixated on traffic than we are check growth and when we look

Speaker 2

at 2018 quite frankly.

Speaker 5

Yes. This is Darren. I'd reiterate the same thing. We've got alignment with our franchisees around focusing more on more sustainable value proposition and that's what we're working on right now.

Speaker 9

Thanks.

Speaker 0

And our final question comes from Steven Anderson from Maxim Group.

Speaker 6

So I just wanted to follow-up on the comments about your contribution to the ad fund. As you think about 2018, do you can you comment yet about whether you'll see any additional contribution for 2018?

Speaker 3

This is Greg. We don't give guidance right now for 2018. We carefully evaluate everything that we need to assist our franchisees in the business overall. And so we wouldn't comment on that right now. But we will when we go out with that guidance, you will know.

All right. Thank you.

Speaker 2

Okay. So thank you for your interest. Thanks for participating in the call. Obviously very excited about where we are now, but also more importantly where we're headed. And we look forward to sharing that with you over the next several quarters.

Have a great day.

Speaker 0

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