Dine Brands Global, Inc. (DIN) Earnings Call Transcript & Summary

Good afternoon. Just struck noon here on the East Coast. Thank you for joining us. My name is Jeff Bernstein, and I'm the Restaurant & Foodservice Distribution analyst at Barclays. I'm thrilled to introduce our next and final presenting company for the day, Dine Brands. With us this afternoon from Glendale, California. Having breakfast as we speak, we have John Peyton, CEO and Vance Chang, CFO. By way of background, for those not familiar, Dine's portfolio is comprised of Applebee's with 1,700 global units and IHOP with 1,750 global units. And those are the leaders in terms of units within both the casual dining and family dining categories, respectively. And they are unique in their categories as the portfolio has a 98% franchise mix relative to sit-down peers in both casual dining and family dining who typically operate a primarily company-operated system. So a defensive aspect of the franchise model within a traditional sit-down casual dining and family dining category. With that said, I want to thank John and Vance for joining us this afternoon for us, this morning for you, and I will kick it off with some bigger picture industry questions.

So I think very high level, I'm just wondering, the last time I hosted a fireside chat with Dine, there was a different CEO and a different CFO. With that said, I'm just wondering if you can maybe prioritize the changes that have been made in your respective roles, whether those changes are noticeable to franchise operators or more kind of behind the scenes? Just trying to get your perspective since both kind of new to your seats, what changes have been implemented in your new roles.

Jeff, are you talking about leadership changes at Dine or more about the business?

More about the business?

Okay. So thanks for having us, and appreciate everyone who's dialed in today. As Jeff said, I'm the new CEO. I'm just coming up on 1 year. I started in January after almost 20 years at Starwood Hotels and Resorts and 4 years heading up the franchise group at Realogy; franchisor of CENTURY 21, Coldwell Banker and other brands. The pandemic has changed our business in some very positive ways, right, which is I know difficult to say, given how challenging the pandemic was for the business and for individuals and things like that. But I'll give you a couple of examples. The first is, Jeff, that before COVID, about 10% to 12% of our sales were off premise. Now it's 25% to 28%, depending on the brand. And what's even more important than the percentage mix is the absolute dollar value, right? Because as guests return to in-restaurant dining, the percentage will decline. But the absolute dollar value of both brands has been trading in the same band of about $12,000 a week per restaurant for Applebee's and $8,000 for IHOP. Is that correct, Vance? Make sure I got it right, 12 and 8. And that trading range has been consistent for months and months and months and months from 2020 to 2021. So we view this as new incremental business. And while we were not really in the consideration set for takeout and delivery pre-pandemic, we are now, right? And so that's a new piece of business for us. And we've had to make investments in technology, clearly and integrating even more seamlessly with the third-party delivery apps. We've had to improve our own apps and sites in terms of allowing our guests to customize their orders, et cetera. We've had to streamline our menus. So another big change that will stick with us going forward is Applebee's, for example, reduced its menu items by 1/3 during COVID. And we are constantly asking our restaurant General Managers and our guests are we missing anything because we add everything back. And our restaurant GMs are telling us don't add back a single item because guests aren't asking for what we cut and our kitchens are more efficient, both in terms of food waste, operationally, preparation. And so we've become more cost effective with a more streamlined menu going forward. And we're investing in cool features on the app to facilitate off-prem, like we partnered with FlyBuy right? So that if you order on our app that we know when you're 5-miles way, 4-miles way, 3-miles way pulling into the parking lot. So we know when to fire up the food delivered to you hot as you drive in, and it's a great customer experience. So a lot of what we've learned during the pandemic and a lot of what was accelerated in terms of new consumer behavior is actually good for our business over the long term.

Jeff, from my perspective, John and I work very closely on our capital allocation plan. So all the initiatives that John just mentioned, it takes money, it takes capital, takes investment. And so a big part of what we're working on and we'll have an Investor Day in Q1 to go into more details. But the plan is -- we started looking at our business for the past few years and looking at how we allocate our capital in the past and how we want to do it going forward. And this is sort of just trying to marry the capital plan against what the strategic plan and making sure that we fund the initiatives appropriately. And then another thing that John and I are working on is, we're really taking a partnership approach with our franchisee partners. So they are our customers, right? And so it's almost -- it's almost not just the end guests, it's the franchisees. So we're building that relationship. We're getting to know each other, getting to work together and things are working well so far in the first 6 months that I've been here and John been here for about a year.

No, that's great color. And John, I mean, I've been talking to a lot of company-operated businesses where we'll talk a lot about the volatility from a sales and inflation and all different means of operating the business. Obviously, you're in a primarily franchise business. But as you sit in your seat, what keeps you up at night in terms of the business in what I think everyone would agree is such an unprecedented environment, but a lot of it has to do with, from an operating perspective. So maybe I should be asking your franchisees, but what do you think is the biggest headwind for you as you think about your leadership role in this environment?

In the short to medium term, what keeps me up at night is availability of labor and cost of labor and availability of cost of goods, you know food and paper products, delivery products as well as the cost of those products. And so, to give you just some data points, Jeff, our cost of goods will be up about 6% for the year, and most of that is in food cost. The -- if you think about the math, right, the food cost for Applebee's and IHOP, depending on the brand, is about 20% to 25% of the expense total. So it's not a one-to-one relationship, right? So we just make it easy and say 10% inflation. Franchisees only need to raise prices, for example, 2.5% to offset the cost of inflation. So when you think about price, for example, and franchisee profitability; historically they've raised menu prices 1% to 2% a year. This year, they've done about 3%. And what we like about that is we're really aligned with them in both brands and not losing sight of the fact that these are value brand and we lose our customers if we price ourselves out of the market. And so our franchisees are viewing this as an opportunity to grow market share. And I think they've been appropriate in the way they're taking price. When it comes to labor, [ we are about ] 85% of where we need to be in terms of full staffing. And so the implication on where we're short is those later night hours that are not Applebee's that used to be up until 2:00 in the morning or midnight are now closing at 10:00 or 11:00. Overnight IHOPs are not doing the 24-hour service. And so that's the tailwind that we've got is that as labor becomes more available, we've got this tailwind in hours that are not -- we're not currently open, where we were pre pandemic. I believe both the labor and the cost of goods are a moment in time. But as we work with our purchasing co-op and all of that, I don't think it's a particularly short-term phenomenon. I think we'll be experiencing this deep into 2022, and that's what we're planning for. We're also taking a long-term view about what if this is the new normal for labor? And we're all asking the question, where have all these workers gone and no one seems to be able to answer that question definitively. But if they don't come back, we have to start to and we are looking at automation, new equipment in kitchen to help streamlined because we're going to have to plan for the case that perhaps if this is the new normal, where we're 15% to 20% fewer workers than we've had in the past.

Understood.

The -- when there's uncertainty in the market space, it's the best time for opportunities. And so it's a great time for us to grab market share. And so we just -- we have to be able to execute. We have to set ourselves apart versus other brands and how we market, how we invest in tech, how we price. Everything sort of comes together in this time and it's actually -- I think what keeps me up at night is just making sure that we don't miss this opportunity to gain market share, as John said.

I'll just tag on one thing, Jeff, because it keeps me up at night because I didn't mention COVID and the latest strain of it. And COVID has, it's -- I think we're on the verge of it becoming the current normal, right? Because it's looking more and more like it's not going away, right? We're seeing that. What we're seeing in the data from our guests is that even during the peak of Delta in states that were surging; Texas, Florida, Oklahoma, et cetera, we didn't see a material reduction in visits to in-restaurant dining in those states during the peak of Delta. And so my -- our conclusion is, if for whatever reason, someone chose not to become vaccinated, they also didn't choose to stay in their homes, right, and hide. They were out living their lives. And so we follow all the federal, state local guidelines. We'll follow wherever the federal government lands with the current OSHA proposals once they work their way through the courts. We've been rigorous and fanatical along with our franchisees. But I think what we're seeing is Americans are learning to live with it, and it's less and less of a headwind over time.

Understood. Scary, but understood. In terms of COVID, just because you brought it up. I mean, it seems like it's had an accelerating effect on structural changes in the industry that has been going on actually for years. Obviously, you're newer to the restaurant side of things, but I don't doubt it was very similar in your old role. So, just wondering if you could talk about what you think has been the most transformative change during the pandemic, whether positive or negative for your business, something that I think you already mentioned the to-go and how that's accelerated so meaningfully. Anything else that COVID has accelerated?

Yes. I would say they're -- and they're almost all positives, including we're more focused on cleanliness, health and safety in front of house and back of house. And the programs we've put in place around cleanliness and hygiene will stick with us we know and that's a good thing for the industry and for our guests. As I mentioned, for us specifically, as full-service restaurants, we'd become a clear part of the consideration set for off-prem. That's good for our business. It's accelerated our investments in the consumer-facing technology needed to integrate with the third-party delivery apps as well as our own website and apps. It's streamlined our menu. It's helped us get more efficient back of house. The other thing it's done is it's also accelerated these new ideas around ghost kitchens and virtual brands. So I think they've also probably gotten more in the last 2 years than they would have done in 5 years without COVID. And I think both of these concepts, particularly someone in the industry are fascinating and potentially big ideas, right? Because a virtual brand or a ghost kitchen enables you to enter a market, right, at low cost, no capital. You can target very specifically at a demographic, at a day-part, at a cuisine. You can test, if it doesn't go well, you turn it off and you try a new one. So we're currently re-launching Cosmic Wings because we've now actually solved the chicken wing inventory issue, the cost of this slow it down. So you may have seen in the last week or 2, we've begun actually TV advertising as well as digital re-launching Cosmic Wings. IHOP is just finished its first test in Denver of 2 virtual brands that we're very excited about. We'd expand to 3 more markets in the next couple of weeks, targeted at PM day-part. And I do want to talk about it, which is the vast majority of our IHOPs have what we call double galley kitchens, 2 full flat tops next to each other. We only uses the 2 on Saturday and Sundays, right, which is peak time for IHOPs. And those -- the second half of that kitchen is dark in the evening. And it's just like a hotel room that goes unused or an airline ticket that goes unused. If we can start to target these virtual brands that are unique to IHOP, only served out of IHOP kitchens and they're targeted at PM business, that's all upside for our franchisees, and they're excited about that. So you know just another good example of just the new business model that's been accelerated by the pandemic.

Yes. No, that's really interesting. I think a lot of people have talked about being able to do more with less during the pandemic. And again, I guess I'm thinking more about your franchisees. But it seems like everyone is more efficient, more tech savvy, implementing a lot of these new initiatives. And with sales now back to full strength, definitely at Applebee's, took a little longer at IHOP, but is there an upside to the operating margin? Again, right now, we're in an unusual inflationary environment. But if we took that out for a moment, the franchisees looking at their businesses, are they now at a higher margin level because of these different initiatives like a to-go, which is presumably a higher margin or some of the things you've initiated. Is that a fair statement?

It's a fair statement if you take the inflationary pressure on labor and cost of goods off the table. The franchisees have become more efficient. These, as I mentioned, like the investments we've made in technology on their behalf, the streamlined menus and the fact that they're operating their restaurants with, on average, nationally 15% labor. One of the proof points that's besides just the margins, Jeff, that is working is our customer satisfaction scores now are equal to pre-pandemic time, despite the fact that you might have to wait longer for a table because we can't speak to you or we don't have enough staff, et cetera. So Americans are understanding of the shortage of staff and retailing in general. And I think the team members we have -- the ones we do have are excited to be there and delivering great service. So despite the challenges right now, particularly around staffing, our customer service scores are really good, which we think is an indication of the fact that this more efficient staffing model that's been forced on us is not harming us.

Yes. Right. And being a franchisor, there's less discussion, I'm sure about -- well, I'm sure you hear it every day, but the commodity and the labor inflation. But looking through the lens of a franchisee as they look to 2022, I mean do you see either of these pressures fading? I know you talked about commodity inflation for this year, ultimately ending up around 6%, but my guess is it ended at a higher point, it's going to start '22 at a higher point. So I'm just trying to think about it from your franchisee's perspective, both commodities and labor, kind of what's the outlook for 2022? Is this a new steady state now and just going to grow at a more normal rate off of this? Or could it actually come back down... [Technical Difficulty] Unfortunately, we did have a brief audio issue. It seems like we are now back to full strength. I'm not good at reading lips. So I did miss the last minute or so of John and Vance's commentary, but I will definitely encourage them to revisit the topic in terms of, from the franchisees' perspective, commodity and labor inflation, the manageability for that in 2022. What your expectations are?

Yes. I'm not sure where you lost us, Jeff. Did hear my sort of opening about between our 69 own restaurants and our joint -- you didn't hear that part? Okay. So I wanted to just sort of give the context that even though we're 98% franchised, we do have direct exposure to the cost issue and the inflation issue in 2 ways. One is, we own 69 Applebee's in North and South Carolina. So we have the same perspective of our franchisees in that regard. The other one is our franchisees, IHOP and Applebee's jointly own a purchasing co-op that does all the purchasing on behalf of both brands in the U.S. and we sit on that board as well. That co-op purchases about $2 billion a year in goods and services. And that gives us a very regular and hands-on view of availability of food and other products as well as the cost. We haven't given specific guidance yet for next year on our cost assumptions, which we'll do next quarter. But what we can say generally is, we think that the cost pressure will continue deep into 2022. And we'll put a number on that when we have our next earnings call.

Understood. And then in terms of the -- your conversations with franchisees, obviously, they make their own pricing decisions in response to the inflation. I know on the Applebee's side, you have some very large franchisees. So it's not necessarily a mom and pop more so on the IHOP side where there's more smaller operators. But what's the conversations like in terms of menu pricing? I know you want to maintain your value positioning. But at the same time, some franchisees might have a knee-jerk reaction because they need short-term profitability rather than a vision over the next number of years for market share. So, how is that conversation perceived at each of the 2 brands?

So, those are conversations that we have. It's always important to a franchisor to state that we are not recommending or deciding on pricing. We do provide analytical tools that help them do the analysis and we also talk about philosophically that what it means to be a value brand and where we think that range is. As I mentioned before, the average price increase for both brands this year has been about 3%. So it's an average. So that means there are some franchisees that have done 4% and 5% and some that have been less. But on aggregate it's 3%. And to your point, particularly on the Applebee's side, we've got 30 franchisees for our almost 1,700 restaurants. So these are larger, more institutional owners. And even on the IHOP side, where we have 300 franchisees, the top 20 or 30, right, are larger companies as well that own 20, 30, 40, 50 restaurants. And they are taking the long view that this is an opportunity to gain share. It's an opportunity. It's an important moment not to alienate customers and that they are -- particularly the larger ones are the ones that are close to the 3% and not above that.

Understood. And how do you think about the broader category just on that front? I mean, it seems like of late, the industry has been largely muted from discounting and promotions. I mean, obviously, you can highlight products, I've seen your wing commercial. But it seems like the desire to eat out is outpacing the supply of seats. So it does seem like there's no reason to aggressively pursue discounting. I was just wondering what your thought is whether this is a step change in the industry or for your brands, particularly because obviously, that's good for profitability.

Yes. I mean you answered the question, right, which is I think the industry, in general, and we, frankly, as well, have been surprised by the extent to which Americans returned to, particularly indoor dining, right, as well as this new incremental business we have with off-prem in 2021. So we didn't have the need to discount because of the robust return to the business. So Applebee's is going to finish at 106% or 107% of 2021. IHOP is going to be just about at 2021 levels. As I mentioned, still a tailwind because of our unstaffed hours and some of our capacity issues. In terms of what the future looks like, I can't predict that other than saying that discounting is not our strategy, right? That's a response we have to certain market conditions if we think they're necessary. It's something not that we go first. And so, based upon the trends that we're seeing and the momentum we have, it's not a plan for next year unless something triggers a need to do that. It's not our strategy.

Understood. And then as we think about -- I mean, everyone likes to talk about same-store sales growth, but exciting to hear you guys talking about unit development. So hoping to dive into that for a couple of minutes. I think you talked about IHOP being able to develop 80 units annually. And maybe not next year, but the year after Applebee's is going to return to net unit growth. So your confidence in that, obviously, when it's being driven by franchisees, it's somewhat out of your hands. So the visibility you have in terms of returning Dine to a net unit growth story. Can you walk us through that?

Sure. So I'll start with Applebee's. Applebee's is at the end of an intentional 3-year process in which we took out about -- we closed about 300 restaurants in conjunction with our franchisees that were not profitable or opened 20 years ago and their market is away from them, et cetera. And so now we have a core of these 1,650 restaurants that are restaurants in the right place that have the right level of profitability, et cetera, that we can start to grow again. The second thing is we have a lot of tools, as you can imagine. We have looked at the U.S. and we have looked at every market and we've identified all of the markets that we think can support an Applebee's. And we've begun to have a conversation with our franchisees about their development commitments and opportunities going forward. And the way we're facilitating that and energizing them is, we are at the very end of completing the design of our next-gen Applebee's restaurants, you know the box. And we do that in partnership with the franchisees. So it was just a couple of weeks ago that we had our Franchise Business Council, which is our Top 7 or 8 elected franchisees who represent the brand, where we spent literally an entire day going through the schematics of next-gen Applebee's, which is cost less to build and less to operate, getting all of their feedback. It's a very collaborative process that they then are engaged in not only designing the new prototype, but then wanting to build it. So when we look at, number one, the opportunities in the marketplace; number two, what we've heard from our franchisees about their enthusiasm about the new prototype and even very encouraging signals like Sun Holdings, you know Guillermo Perales last month purchased 130 Applebee's. He is one of the largest owner of restaurants in the country, and it's showing, as an expert, his enthusiasm for the brand and potential. That's all of what gives us enthusiasm right about where Applebee's will head. IHOP historically does 40 or 50 new restaurants a year. We think we can double that for similar reasons, right? We looked at all the opportunities we've got within the market. With IHOP we've got 4 different offerings. We have the regular sized IHOP, full-service IHOP, a smaller full service IHOP, they have flipped, and we have non-traditional colleges, roadside stops. And it's a very conversion-friendly brand as well. Half of the band is [indiscernible]. So it's sort of like, if you want to build an IHOP, we got an IHOP for you, right? We've got 4 different choices as well as conversions. And there too, we believe in the pipeline we've got and the opportunity. And one of my observations when I got here is that development was not our strength. We tended to be more order takers. We weren't out there strategically bringing opportunities to franchisees or new franchisees, knocking on doors. But as I mentioned last quarter, we hired a new leader of development in each of our previous units; 2 and 1 international that are -- we're investing in the talent that also drive these plans forward.

Jeff, I think I was just at the RFDC in Vegas, having -- we had very productive conversation with potential lenders. And so the lending community starting to opening back up to CDRs. And so, that's another reason why we're optimistic about the development pipeline as well, it's just because franchisees are starting to have access to capital, which helps, obviously.

Understood. And my final question on the last moment or 2 that we have, just thinking more about it from the franchisor's perspective and capital allocation. Vance, I said -- I know you're working close with the entire C-suite on that front. But recently, you restarted your dividend. I'm just wondering if you can remind us your capital allocation priorities as you are such a strong generator of cash, maybe dividend versus share repo versus any other means to deploy that excess free cash.

Yes. We've had a very strong track record of returning capital to shareholders and that will remain one of our top priorities. Our capital allocation priorities are; one, to return capital to shareholders, as we said, which includes dividends and share repurchases, while concurrently making additional capital expenditure and G&A investments in the business to support long-term growth, right? We also need liquidity -- flexibility to manage our leverage level as well as remain -- the sort of any remaining uncertainty from the pandemic. So that's sort of the -- those are kind of the 4 key things that's on our mind when we think about how we prioritize our capital allocation. When we talk about share repurchases, the level of repurchases will primarily be based on our analysis of our intrinsic value and market movement, whether -- when the market is shifting the whole sector regardless of which brand it is, we know there's opportunity for us and we'll support the stock that way. And then, as we progress throughout the year next year, I think this -- our current dividend level is just a starting point, and there's room to move up.

And when does leverage come into play within that? How do you think about the right level of leverage today versus a year from now?

Yes. Ideally sort of EBITDA performance holds and leverage will come down gradually because of that. But we compare -- we look at our casual dining comp sets, and then we look at our highly franchised comp sets, and we kind of sit in between, which I think is the right place to be. We should be higher lever than casual dining because we don't own as many restaurants as they do, and our business model is different. But I don't think we should be in the 6 handle range like the other QSRs because frankly, that's a different business model than us, even though we're both highly franchised. So we like where we sit. The business has recovered well. We have plenty of cushion in terms of all of our covenants that we track. So I think it depends on what the market would bear and -- but the key point is we want that flexibility, just in case the new variant causes more trouble for us or any other unforeseen factors that came into play. But we're in a good position right now, though, to answer your questions directly. Jeff, we lost you. I can't -- I don't know what's going on. We can't hear you.

All right. So on behalf of Jeff, thank you all for listening. We appreciate the invitation. We love the opportunity to tell our story. We're proud of our brands, and we think we've got -- we know we have a great strategy and great plan and a great team and terrific franchisees and we've really done well in 2021, and we've got a lot of momentum heading into 2022.

John, you did a great job. I commend you, don't take my job. Thank you guys very much for joining us today. Thank everyone who's listening to us. We hope that you have a great afternoon of productive meetings. Have a happy and healthy holiday season. We look forward to speaking with you again soon.

Thank you, Jeff.

Thank you.

Thank you.