Item 1A. Risk Factors.
The occurrence of any of the events discussed in the following risk factors may materially adversely affect our business, financial condition and results of operations, which may materially adversely affect the value of our common stock. It is not possible to identify or predict all risk factors. There may be risks and uncertainties that are not currently known or that are currently deemed by us to be immaterial. These other risks and uncertainties may also impact our business, financial condition and results of operations.
Risks Relating to Our Business and Financial Condition
The novel coronavirus (COVID-19) pandemic has disrupted and may further disrupt our business, which could further materially affect our operations, and business and financial results. In addition, any other epidemic, disease outbreak or public health emergency may result in similar adverse effects.
The COVID-19 pandemic has impacted and may continue to impact sales and traffic at our and our franchisees’ restaurants, may make it more difficult to staff restaurants and, in more severe cases, may damage our reputation, cause an inability to obtain supplies, increase commodity costs or continue to cause partial or total closures of impacted restaurants. The extent to which the COVID-19 pandemic and other epidemics, disease outbreaks or public health emergencies will impact our business, liquidity, financial condition, and results of operations, will depend on numerous evolving factors that we may not be able to accurately predict or assess, including the duration and scope of the pandemic, epidemic, disease outbreak, or public health emergency; the negative impact on the economy; the short and longer-term impacts on the demand for restaurant services and levels of consumer confidence; the ability of us and our franchisees to successfully navigate the impacts; government action, including restrictions on restaurant operations; increased unemployment; and reductions in consumer discretionary spending. Even if a virus or other disease does not spread significantly, the perceived risk of infection or health risk may damage our reputation and adversely affect our business, liquidity, financial condition and results of operations. The COVID-19 pandemic has heightened many of the other risks described in this Item 1A, “Risk Factors.”
We and our franchisees have been and could further be adversely affected by government restrictions on public gatherings; shelter-in-place orders; and limitations on operations of restaurants, including dine-in restrictions, mandatory or voluntary closures or restrictions on hours of operations. Certain restaurants in the U.S. and abroad are currently under government mandates or guidelines to temporarily suspend operation of restaurants or limit restaurant dine-in business in light of COVID-19. We are unable to predict when these measures may be scaled back, or how quickly our operations will return to previous levels after the measures are scaled back. Certain other restaurants have had dine-in restrictions and other operational limitations lifted but we are unable to predict whether or when these restrictions may be reinstated or new restrictions may be implemented if the COVID-19 pandemic worsens. To assist franchisees impacted by COVID-19, we have offered deferral of royalty, advertising, and other fees, including, in some cases, lease payments. We have allowed franchisee to defer development obligations for up to 15 months. These changes and any additional changes may materially adversely affect our business, liquidity, financial condition, and results of operations, particularly if these changes are in place for a prolonged amount of time. The COVID-19 pandemic as well as other epidemics, disease outbreaks or public health emergencies may also materially adversely affect our ability to implement our growth plans, including delays in development of new locations or adversely impact our overall ability to successfully execute our plans to enter into new markets.
As we previously announced, we drew down a significant majority of the amount available under our revolving facility. The increase in our level of debt may adversely affect our financial and operating activities or ability to incur additional debt. Furthermore, the impacts of COVID-19 could cause us to fail to meet certain financial performance measures, including debt service coverage ratios and minimum domestic franchise system sales amounts, that must be met to avoid a possible rapid amortization event or event of default under the terms of our existing debt arrangements. In addition, as a result of the risks described above, we may be required to raise additional capital, and there is no guarantee that debt and/or equity financings will be available in the future to fund our obligations, or will be available on terms consistent with our expectations.
Our business is affected by general economic conditions that are largely out of our control. Our business is dependent to a significant extent on national, regional and local economic conditions, and, to a lesser extent, on global economic conditions, particularly those conditions affecting the demographics of the guests that frequently patronize Applebee's or IHOP restaurants. If our customers' disposable income available for discretionary spending is reduced (because of circumstances such as job losses, credit constraints, higher housing costs, changes to tax regulations, energy costs, interest rates or other costs) or if the perceived wealth of customers decreases (because of circumstances such as lower residential real estate values, increased foreclosure rates, changes to tax regulations or other economic disruptions), our business could experience a decline in sales and/or customer traffic as potential customers choose lower-cost alternatives (such as quick-service restaurants) or other alternatives to dining out. Additionally, negative trends in the availability of credit and in expenses such as interest rates and the cost of construction materials could affect our and our franchisees' ability to maintain and remodel existing restaurants. Any
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decreases in customer traffic or average customer check due to these or other reasons could reduce gross sales at our and our franchised restaurants, resulting in lower revenues, royalty payments and other payments from franchisees. This could negatively impact the financial performance of our company-operated restaurants and reduce the profitability of franchised restaurants, potentially impacting the ability of franchisees to make royalty payments owed to us when due and negatively impacting franchisees’ ability to develop new restaurants as may be required in their respective development agreements.
Our level of indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under our debt. As of December 31, 2020, certain of our indirect, wholly-owned subsidiaries had approximately $1.5 billion of long-term debt. In addition, we had approximately $0.5 billion in operating lease, finance lease and other financing obligations as of December 31, 2020. We may incur substantial additional indebtedness in the future. If new debt is added to our current debt levels, the related risks that we now face could increase. Our level of indebtedness and the financial and other restrictive covenants in our indebtedness could have important consequences to our financial health. For example, it could:
•make it more difficult for us to satisfy our obligations with respect to our debt or refinance any of our debt on attractive terms, commercially reasonable terms, or at all;
•increase our vulnerability to general adverse economic and industry conditions or a downturn in our business;
•require us to dedicate a substantial portion of our cash flow from operations to debt service, thereby reducing the availability of our cash flow to pay dividends to our stockholders, repurchase shares of our common stock, fund working capital, capital expenditures and other general corporate purposes;
•limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
•place us at a competitive disadvantage compared to our competitors that are not as highly leveraged;
•limit our ability to borrow additional funds;
•prevent us from taking actions that we believe would be in the best interest of our business and make it difficult for us to successfully execute our business strategy;
•subject us to risks associated with rising interest rates and uncertainty related to the proposed phase-out of the London Interbank Offered Rate (LIBOR); and
•result in an event of default if we fail to satisfy our obligations under our debt or fail to comply with the financial and other restrictive covenants contained in our debt documents, which event of default could result in all of our debt becoming immediately due and payable and could permit certain of our lenders to foreclose on our assets securing such debt.
The terms of the securitized debt issued by certain of our indirect, wholly-owned subsidiaries have restrictive terms and the failure to comply with such restrictive terms could put us in default, which would have an adverse effect on our business and prospects. Unless and until we repay all outstanding borrowings under our securitized debt, we will remain subject to the restrictive terms of the securitized debt issued by certain of our indirect, wholly-owned subsidiaries. For example, the indenture entered into by such subsidiaries in connection with the securitized debt contains covenants that limit the ability of certain of our wholly-owned subsidiaries to, among other things: sell assets; alter the business conducted by such subsidiaries; engage in mergers or acquisitions; declare dividends or redeem or purchase certain equity interests; incur, assume or permit to exist additional indebtedness or guarantees; make loans and investments; incur liens; and enter into transactions with affiliates other than on an arms-length basis. These covenants are applicable only to the securitization subsidiaries and do not apply to any of Dine Brands Global, Inc., International House of Pancakes, LLC, Applebee’s International, Inc. or Dine Brands International, Inc. as these entities are not parties to the indenture. A breach of a covenant could result in a rapid amortization event or default under the securitized debt.
Further, the securitized debt also includes limitations on our ability to incur additional indebtedness and contains a number of financial performance measures that must be met to avoid a possible rapid amortization event or event of default. The most significant of these measures include a minimum debt service coverage ratio and minimum domestic franchise system sales. The ability to meet these financial performance measures can be affected by events beyond our control and there can be no assurance that we will satisfy these financial measures.
If amounts owed under the securitized debt are accelerated because of a default and we are unable to pay such amounts, the investors may have the right to assume control of substantially all of the securitized assets, which consist of substantially all of our domestic revenue-generating assets and domestic intellectual property.
During the five-year term following issuance, the outstanding fixed-rate class A-2-I senior notes will accrue interest at a rate of 4.194% per year. During the seven-year term following issuance, the outstanding fixed-rate class A-2-II senior notes will accrue interest at a rate of 4.723% per year. Additionally, the fixed-rate class A-2-I and class A-2-II senior notes have scheduled quarterly principal amortization payments of $1.75 million and $1.5 million, respectively. If we maintain a leverage ratio of less than or equal to 5.25x total debt to adjusted EBITDA, we may elect to not make the scheduled principal payments. From time
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to time, our leverage ratio has exceeded the 5.25x total debt to adjusted EBITDA ratio and we have made the required scheduled principal payments. If we are unable to refinance or repay amounts under the securitized debt prior to the expiration of the applicable five- or seven-year term, our cash flow would be directed to the repayment of the securitized debt and, other than a weekly management fee sufficient to cover minimal selling, general and administrative expenses, would not be available for operating our business.
In the event that a rapid amortization event occurs under the indenture (including, without limitation, upon an event of default under the indenture or the failure to repay the securitized debt at the end of the applicable five- or seven-year term), the funds available to us would be reduced or eliminated, which would in turn reduce our ability to operate or grow our business.
Our ability to refinance all or a portion of our indebtedness or obtain additional financing depends on many factors beyond our control. No assurance can be given that any refinancing or additional financing will be possible when needed or that we will be able to negotiate favorable terms. In addition, our access to capital is affected by prevailing conditions in the financial and capital markets and other factors beyond our control. There can be no assurance that market conditions will be favorable at the times that we require new or additional financing. Further, changes by any rating agency to our credit rating may negatively impact the value and liquidity of both our debt and equity securities, as well as the potential costs associated with refinancing our debt. Downgrades in our credit ratings could also affect the terms of any such financing and restrict our ability to obtain additional financing in the future.
We are heavily dependent on information technology and any material failure of that technology could impair our ability to effectively and efficiently operate our business. We rely heavily on information technology systems across our operations, including point-of-sale processing in our and our franchisees' restaurants, online ordering and delivery, management of our supply chain, collection of cash and other receivables, payment of obligations and various other processes and procedures. Our ability to effectively and efficiently manage our business depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, problems with maintenance, upgrades or the transition to replacement systems, inaccurate or fraudulent manipulation of sales reporting from our restaurants resulting in loss of sales and royalty payments, or a breach in security of these systems could be harmful and cause delays in customer service, reduce efficiency in our operations and negatively impact our business. Significant capital investment might be required to remediate any problems.
In addition, we outsource certain essential technology-based business processes to third-party vendors and we may share sensitive financial and other information with third party vendors which subjects us to risks, including disruptions in business, increased costs and exposure to data breaches or privacy law compliance issues of our third-party vendors.
The occurrence of cyber incidents, or a deficiency in our cybersecurity, could negatively impact our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our employee and business relationships, all of which could subject us to loss and harm our brands. Any adverse event that threatens the confidentiality, integrity, or availability of our information resources is considered to be a cyber incident. More specifically, a cyber incident is an intentional attack or an unintentional event that can include gaining unauthorized access to systems to disrupt operations, corrupt data, or steal confidential information about our customers, franchisees, vendors and employees. As our reliance on technology has increased, so have the risks posed to our systems, both internal and those that we have outsourced. Primary adverse events that could directly result from the occurrence of a cyber incident include (i) exposure of confidential data about our customers, franchisees, vendors and employees, (ii) damage to the reputation of our brands (iii) damage to our relationship with our franchisees; (iv) interruption of our business; and (v) an event of default under our securitized debt agreements if a cybersecurity breach impacts our ability to comply with the terms of securitized debt agreements. We, our franchisees, third-party vendors and others with whom we may do business or interact with may have inadequate cyber liability insurance or coverage terms may be restrictive or insufficient to cover potential losses and remediation costs associated with a cyber incident.
As a merchant and service provider of point of sale related services, we and our franchisees are subject to PCI DSS, issued by the Payment Card Industry Council. PCI DSS contains compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. Despite our cybersecurity measures and our efforts to comply with PCI DSS guidelines, we cannot be certain that all of our information technology systems are able to prevent, contain or detect any cyber-attacks or security breaches from known malware or malware that may be developed in the future.
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Our use of personal information is regulated by international, federal and state laws, as well as by certain third-party agreements. If our security and information systems are compromised or if our employees or franchisees fail to comply with these laws and regulations, and this information is obtained by unauthorized persons or used inappropriately, it could adversely affect our reputation and could disrupt our operations and result in costly litigation, judgments, or penalties resulting from violation of federal and state laws and payment card industry regulations. As privacy and information security laws and regulations change, we may incur additional costs to ensure that we remain in compliance with those laws and regulations. For example, we are subject to the California Consumer Privacy Act and pending California Privacy Rights Act, which require various processes and protections to be implemented.
We face a variety of risks associated with doing business in international markets. Our expansion into and continued operations in international markets could create risks to our brands and reputation. There is no assurance that our international operations will be profitable or that international growth will continue. Our international operations are subject to the same risks associated with our domestic operations, as well as a number of additional risks. These include, among other things, international economic and political conditions, issues with collections, international currency fluctuations, difficulty in enforcing intellectual property rights, terrorism, civil unrest, global travel risks and differing cultures and consumer preferences.
We also are subject to governmental regulations throughout the world that impact the way we do business with our international franchisees and vendors. These include antitrust and tax requirements, import/export/customs regulations, anti-boycott regulations, other international trade regulations, the USA Patriot Act and the Foreign Corrupt Practices Act. Failure to comply with any such legal requirements could subject us to monetary liabilities and other sanctions, which could harm our business, results of operations and financial condition.
We may be subject to litigation and other legal proceedings that could be time consuming, require significant amounts of management time and result in the diversion of significant operational resources. We are involved in lawsuits, claims and proceedings incident to the ordinary course of our business. Litigation is inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. There have been a growing number of lawsuits in recent years. There also has been a rise in employment-related lawsuits. From time to time, we have been subject to these types of lawsuits. The cost of defending claims against us or the ultimate resolution of such claims may harm our business and operating results. In addition, the increasingly regulated business environment may result in a greater number of enforcement actions and private litigation. This could subject us to increased exposure to stockholder lawsuits.
We and our franchisees are subject to complaints or litigation from guests alleging illness, injury or other food quality, food safety, health or operational concerns as well as claims related to social issues (e.g., allegations of discrimination), the Americans with Disabilities Act and other premises liability. We and our franchisees are also subject to "dram shop" laws in some states pursuant to which we and our franchisees may be subject to liability in connection with personal injuries or property damages incurred in connection with wrongfully serving alcoholic beverages to an intoxicated person.
Although our franchise agreements require our franchisees to defend and indemnify us, we may be named as a defendant and sustain liability in legal proceedings against franchisees under the doctrines of vicarious liability, agency, negligence or otherwise. Claims against our franchisees may reduce the ability of our franchisees to make payments to us. We may also initiate legal proceedings against franchisees for breach of the terms of their franchise agreements, including underreporting of sales, failure to operate restaurants according to standard operating procedures and payment defaults. These claims also may reduce the ability of franchisees to enter into new franchise agreements with us.
Third-party claims with respect to intellectual property assets, if decided against us, may result in competing uses or require adoption of new, non-infringing intellectual property, which may in turn adversely affect sales and revenues. We regard our service marks and trademarks related to our restaurant businesses as having significant value and being important to our marketing efforts. To protect our brands from infringement, we rely on contracts, copyrights, patents, trademarks, service marks and other common law rights, such as trade secret and unfair competition laws. We have registered certain trademarks and service marks in the United States and international jurisdictions; however, effective intellectual property protection may not be available in every country in which we have or intend to open or franchise a restaurant. Although we believe we have taken appropriate measures to protect our intellectual property, there can be no assurance that these protections will be adequate.
In addition, there can be no assurance that third parties will not assert infringement or misappropriation claims against us, or assert claims that our rights in our trademarks, service marks and other intellectual property assets are invalid or unenforceable. Any such claims could have a material adverse effect on us or our franchisees if such claims were to be decided against us. If our rights in any intellectual property were invalidated or deemed unenforceable, it could permit competing uses
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of intellectual property which, in turn, could lead to a decline in restaurant revenues and sales of other branded products and services (if any). If the intellectual property became subject to third-party infringement, misappropriation or other claims, and such claims were decided against us, we may be forced to pay damages, be required to develop or adopt non-infringing intellectual property or be obligated to acquire a license to the intellectual property that is the subject of the asserted claim. There could be significant expenses associated with the defense of any infringement, misappropriation, or other third-party claims.
Our delivery initiatives and use of third-party delivery vendors subjects us and our franchisees to a variety of risks related to the delivery of our products by third parties and may not generate expected returns. There can be no assurance that delivery vendors will not take actions that could have a material adverse effect on our brands and or subject us to increased litigation and costs. Our delivery initiatives also introduce new operating procedures to our and our franchisees’ restaurants, which could adversely affect the business, brands, and the experience of our guests.
Our business depends on the proper allocation of our human capital and our ability to attract and retain talented management and other key employees. We have dedicated brand resources for key functions such as marketing, consumer insights and operations and a shared service model for certain other functions such as legal, technology and human resources. There can be no assurance that our allocation of our human capital will effectively meet the needs of our business and brands. Further, our business is based on successfully attracting and retaining talented employees. The market for highly skilled employees and leaders in our industry is extremely competitive. If we are less successful in our recruiting efforts, or if we are unable to retain management and other key employees, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. The departure of a key executive or employee and/or the failure to ensure an effective transfer of knowledge and a smooth transition upon such departure may be disruptive to the business and could hinder our strategic planning and execution.
Our failure or the failure of our franchisees to comply with federal, state and local governmental regulations may subject us to losses and harm our brands. We and our franchisees are subject to the Fair Labor Standards Act (which governs such matters as minimum wage, overtime, collective bargaining and other working conditions), along with the Americans with Disabilities Act (which provides civil rights protections to individuals with disabilities in the context of employment, public accommodations, and other areas), the Immigration Reform and Control Act of 1986, various family leave mandates and a variety of other laws enacted, or rules and regulations promulgated by federal, state and local governmental authorities that govern these and other employment matters, including tip credits, working conditions, safety standards, collective bargaining and immigration status. There have been several complaints alleging franchisors to be joint employers with franchisees. Although we do not consider ourselves to be joint employers with our franchisees, there can be no assurance that other franchisors will not receive similar complaints in the future which may result in legal proceedings based on the actions of franchisees. Increases in payroll expenses as a result of any federal and state mandated increases in the minimum wage or changes to the tip credit may negatively impact our and our franchisees’ profitability. Enactment and enforcement of various federal, state and local laws, rules and regulations on immigration, collective bargaining and labor organizations may adversely impact the availability and costs of labor in a particular area or across the United States. Other labor shortages, unionization or increased team member turnover could also impact labor costs. In addition, our vendors may be affected by higher minimum wage standards or availability of labor, which may increase the price of goods and services they supply to us. The Patient Protection and Affordable Care Act has impacted our franchisees’ employee costs in some respects. There are no assurances that a combination of cost management and price increases can accommodate all of the costs associated with compliance.
We and our franchisees are subject to extensive federal, state and local governmental regulations, including those relating to food safety and inspection and the preparation and sale of food and alcoholic beverages. Disruptions within any government agencies could impact the U.S. food industry, which may have an adverse effect on our business. We and our franchisees are also subject to laws and regulations relating to building and zoning requirements. Our and our franchisees' restaurants are also subject to licensing and regulation by alcoholic beverage control, health, sanitation, safety and fire agencies in the state, county and/or municipality where the restaurant is located. We cannot assure you that we or our franchisees will not encounter material difficulties or failures, including with respect to obtaining and maintaining required licenses and approvals, which could impact the continuing operations of an existing restaurant, or delay or prevent the opening of a new restaurant.
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In addition, we are subject to laws and regulations, which vary from jurisdiction to jurisdiction, relating to nutritional content and menu labeling. Compliance with these laws and regulations may lead to increased costs and operational complexity and may increase our exposure to governmental investigations or litigation. In connection with the continued operation or remodeling of certain restaurants, we and our franchisees may be required to expend funds to meet federal, state, local and international regulations. The inability to obtain or maintain such licenses or publicity resulting from actual or alleged violations of such laws could have an adverse effect on our results of operations.
We are subject to federal regulation and certain foreign and state laws, including state laws that govern the offer and sale of franchises. Many state franchise laws contain provisions that supersede the terms of franchise agreements, including provisions concerning the termination or non-renewal of a franchise. Some state franchise laws require that certain materials be registered before franchises can be offered or sold in that state. The failure to obtain or retain licenses or approvals to sell franchises could adversely affect us and the franchisees. Changes in, and the cost of compliance with, government regulations could have a material effect on operations.
Finally, regulatory changes or actions under current or future U.S. political administrations may impact the laws or regulations described above. We cannot predict whether or when any of these potential changes in law might become effective in any jurisdiction nor the impact, if any, of these changes to our business.
We are subject to risks associated with self-insurance for medical, dental and vision benefits. We self-insure all of our employee medical, dental and vision benefits. We maintain a per claim stop loss coverage but do not maintain coverage at an aggregate level. Our reserves are based on historical loss trends that may not correlate to actual loss experience in the future. If we experience an unexpectedly large number of claims that result in costs or liabilities in excess of our projections, our reserves may prove to be insufficient and we may be exposed to significant and unexpected losses. For these and other reasons, including our inability to renew stop loss coverage at competitive rates, we are subject to risks associated with self-insurance that may have an adverse effect on our financial condition and operating results.
In addition, access to personal medical information is regulated by federal, state and/or local laws as well as by certain third-party agreements. If our security and information systems or the systems of our third-party vendors are compromised, we could be subject to costly litigation or penalties and our reputation and operations could be adversely affected.
Any inability or failure to execute on a comprehensive business continuity plan following a major natural disaster such as an earthquake, tornado, flood or a man-made disaster, including terrorism, civil unrest or a cyber incident, at or affecting our corporate facilities could materially adversely impact our business. Our corporate systems and processes and corporate support for our restaurant operations are handled primarily at our restaurant support centers. We have disaster recovery procedures and business continuity plans in place to address most events of a crisis nature, including earthquakes, tornadoes, floods and other natural or man-made disasters, and back up and off-site locations for recovery of electronic and other forms of data and information. However, if we are unable to fully implement our disaster recovery plans, we may experience delays in recovery of data, inability to perform vital corporate functions, tardiness in required reporting and compliance, failures to adequately support field operations and other breakdowns in normal communication and operating procedures that could have a material adverse effect on our financial condition, results of operation and exposure to administrative and other legal claims.
Development initiatives outside our core business could negatively impact our brands. Our business expansion into non-traditional restaurant formats, including restaurants with a smaller footprint, restaurants located in non-traditional locations and restaurants that operate on a delivery-only and/or ghost kitchen basis, could create new risks to our brand and reputation.
Failure of our internal controls over financial reporting and future changes in accounting standards may cause adverse unexpected operating results, affect our reported results of operations or otherwise harm our business and financial results. Our management is responsible for establishing and maintaining effective internal controls over financial reporting. Internal controls over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that we would prevent or detect a misstatement of our financial statements or fraud. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. A significant financial reporting failure or material weakness in internal control over financial reporting could cause a loss of investor confidence and decline in the market price of our common stock.
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A change in accounting standards can have a significant effect on our reported results and may affect our reporting of transactions before the change is effective. New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future. Changes to existing accounting rules or the questioning of current accounting practices may adversely affect our reported financial results. Additionally, our assumptions, estimates and judgments related to complex accounting matters could significantly affect our financial results. Generally accepted accounting principles and related accounting pronouncements, implementation guidelines and interpretations are highly complex and involve many subjective assumptions, estimates and judgments by us. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by us could significantly change our reported or expected financial performance.
Risks Related to Our Franchised Business Model
Restaurant development plans under development agreements may not be implemented effectively and developed restaurants may not achieve desired results. We rely on franchisees to develop Applebee's and IHOP restaurants. From time to time, our franchisees have failed to fulfill their commitments to build new restaurants in the numbers and within the timeframes required by their development agreements, and we expect that this will continue to varying degrees in the future. Restaurant development and the success of restaurants opened by our franchisees involve substantial risks, including the following:
•the demand for Applebee’s and IHOP restaurants and the selection of appropriate franchisee candidates;
•costs of construction, permit issuance and regulatory compliance;
•the availability of suitable locations and terms for potential development sites, including lease or purchase terms for new locations;
•the availability of financing, at acceptable rates and terms, to both franchisees and third-party landlords, for restaurant development and/or implementation of our business strategy through new remodel programs and other operational changes;
•delays in obtaining construction permits and in completion of construction;
•competition for suitable development sites;
•changes in governmental rules, regulations, and interpretations (including interpretations of the requirements of the Americans with Disabilities Act); and
•general economic and business conditions.
Additionally, developed restaurants may not achieve desired revenue or cash flow levels once opened. This could result in restaurant closures, which may be significant in number, and may cause our royalty revenues and financial performance to decline. The inability to open new restaurants that achieve and sustain acceptable sales volumes and/or the closure of existing restaurants that do not achieve or sustain acceptable sales volumes may have a material adverse effect on our business and financial condition.
We are significantly franchised; as a result, we are highly dependent upon our franchisees. All IHOP and almost all Applebee’s restaurants are owned and operated by our franchisees. Our dependence on our franchisees could adversely affect us, our brands, and our business, financial condition and results of operations. Our financial results are significantly contingent upon the performance of our franchised restaurants because we derive a substantial portion of our revenues from royalties that are based on a percentage of gross sales at franchised restaurants. Worsening economic conditions and declining trends in sales, traffic and/or average check could impact the performance of our franchised restaurants, resulting in lower royalty, advertising fund and other payments from franchisees. If declining conditions persist, franchisee profitability and financial health may worsen and franchisees may suffer from financial, personal or other difficulties, including insolvency. Franchisees may also experience financial risks unrelated to the operation of restaurants under our brands, such as a decline in performance of other brands or businesses held by franchisees. Additionally, lenders to our franchisees may be less likely to provide current or prospective franchisees necessary financing on favorable terms, or at all, due to market conditions and our or our franchisees’ operating results. These and other factors could impact franchisees’ ability to make royalty and other payments owed to us when due and franchisees could default on their financial obligations to us. A decrease in franchisee profitability as well as other reasons could also cause franchisees’ failure or inability to meet new restaurant development obligations and other obligations such as maintenance or remodel requirements and rent obligations for certain leases on which we retain contingent liability.
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Additionally, our franchise agreements have expiration dates. Upon expiration, franchisees are generally required to enter into new franchise agreements in order to extend the franchise relationship. We or the franchisee may or may not elect to enter into these successor franchise agreements based on a number of factors, including a failure to meet our criteria, lack of interest by either party and/or the inability of franchisees to enter into successor franchise agreements. It is expected that, in the ordinary course of business, some franchise agreements will expire without successor franchise agreements. However, a substantial number of franchise agreements are set to expire in 2021 for Applebee’s and 2024 through 2028 for IHOP, and while we have begun efforts to extend the terms of these franchise agreements, we cannot ensure that we and/or our franchisees will enter into successor franchise agreements or extensions once current terms expire. This may result in reduced royalties and other payments due to a decrease in the number of restaurants operating under our brands.
As independent third parties, franchisees own, operate and oversee the daily operations of their restaurants and their employees are not our employees. Accordingly, we do not control their actions. While our franchise agreements are designed to maintain brand consistency, having almost all franchisee-operated restaurants may expose us to risks not otherwise encountered if we maintained ownership and control of all of the restaurants. Franchisees may breach the terms of their franchise agreements in a manner that adversely affects our brands, such as failing to operate restaurants in accordance with our required standards, and we may be limited in our ability to enforce franchise obligations. Franchisees are required to conform to specified product quality standards and other requirements pursuant to their franchise agreements in order to protect our brands and to optimize restaurant performance. If franchisees do not successfully operate their restaurants in a manner consistent with our standards, or customers have negative experiences due to issues with food quality or operational execution, our reputation and brands could suffer, and we could be subject to claims by guests even if we are not legally liable for the franchisee's actions or failure to act. This could result in a material adverse effect on our business. The quality of franchisees’ operations may also be diminished by factors beyond our control, including a lack of investment in enhancing or maintaining acceptable standards for restaurant operations due to financial and other constraints. Franchisees also may fail or be unable to hire or retain qualified managers and other personnel and training of managers and other personnel may be inadequate. These and other such negative factors could reduce franchisees' restaurant revenues, impact payments to us under the franchise agreements and could have a material adverse effect on us.
Various other risks associated with the operation of a franchised business model that may have a material adverse effect on our business or financial condition include:
•inability or unwillingness of franchisees to participate in implementing changes or to participate in business strategy changes;
•inability or unwillingness of franchisees to support our marketing programs and strategic initiatives;
•inability of franchisees to participate in business strategy changes due to financial constraints;
•failure of franchisees to report sales information accurately;
•greater proportional impact of general and administrative expenses on our business and financial condition; and
•inability to retain franchisees in the future, both in terms of number and quality, and inability to attract, retain and motivate sufficient numbers of franchisees of the same caliber, including top performing franchisees.
While we try to maintain positive working relationships with our franchisees, the nature of the franchisor-franchisee relationship inherently subjects us to potential disagreements with our franchisees on matters pertaining to the business and/or our brands. From time to time, we have experienced, and we may continue to experience, poor franchise relations caused by the efforts of one or more of our larger franchisees or an organized franchise association.
Concentration of Applebee's franchised restaurants in a limited number of franchisees subjects us to greater risk. As of December 31, 2020, Applebee's franchisees operated 1,531 Applebee's restaurants in the United States. Of those restaurants, the ten largest Applebee's franchisees owned 1,160 restaurants, representing 76% of all franchised Applebee's restaurants in the United States. The largest Applebee's franchisee owned 444 restaurants, representing 29% of all franchised Applebee's restaurants in the United States. The concentration of franchised restaurants in a limited number of franchisees subjects us to a potentially higher level of risk with respect to such franchisees because their obligations to us, including financial obligations, are greater as compared to those franchisees with fewer restaurants. The risk associated with these franchisees is also greater where franchisees are the sole or dominant franchisee for a particular region of the United States, as is the case for most domestic Applebee's franchised territories. In particular, if any of these franchisees experience financial or other difficulties, the franchisee may default on its obligations under multiple franchise agreements, notes receivable or other agreements, including payments to us and the maintenance and improvement of its restaurants. From time to time, we may work with our franchisees who are experiencing financial difficulties to assess and address their financial health and their ability to satisfy their financial obligations to us. In certain of these situations, we may agree to alternative arrangements with franchisees for the payment of amounts due to us under our franchise and other agreements. We cannot assure you that these arrangements will be successful, nor can we assure you that they will result in us receiving all or any of the amounts due to us under our franchise agreements,
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notes receivable and other agreements. Any franchisee that owns and operates a significant number of Applebee's restaurants and fails to comply with other obligations under the franchise agreement, such as those relating to the quality and preparation of food and maintenance of restaurants, could cause significant harm to the Applebee's brand and subject us to claims by consumers even if we are not legally liable for the franchisee's actions or failure to act. Development rights for Applebee's restaurants are also concentrated among a limited number of existing franchisees. If any of these existing franchisees experience financial difficulties, future development of Applebee's restaurants may be materially adversely affected.
An insolvency or bankruptcy proceeding involving a franchisee could prevent or delay the collection of payments or the exercise of rights under the related franchise agreement. An insolvency proceeding involving a franchisee could prevent or delay us from collecting payments or exercising any of our other rights under the related franchise agreement. If a franchisee is subject to bankruptcy or insolvency proceedings, a bankruptcy court may prevent the termination of the related franchise and development agreement. In particular, the protection of the statutory automatic stay that arises under Section 362 of the United States Bankruptcy Code upon the commencement of a bankruptcy proceeding by or against a franchisee may prohibit us from terminating a franchise agreement previously entered into with a franchisee. Furthermore, a franchisee that is subject to bankruptcy proceedings may reject the franchise agreement in which case we would be limited to a general unsecured claim against the franchisee's bankruptcy estate on account of breach-of-contract damages arising from the rejection. Payments previously made to us by a franchisee that is subject to a bankruptcy proceeding also may be recoverable from us on behalf of the franchisee as a preferential transfer under the United States Bankruptcy Code.
We are subject to credit risk from our IHOP franchisees operating under our Previous IHOP Business Model, and a default by these franchisees may negatively affect our cash flows. Prior to 2003, new IHOP restaurants were generally developed by us, and we were involved in all aspects of the construction and financing of the restaurants. We typically identified and leased or purchased the restaurant sites for new company-developed IHOP restaurants, built and equipped the restaurants and then franchised them to franchisees. In addition, we typically financed as much as 80% of the franchise fee for periods ranging from five to eight years and leased the restaurant and equipment to the franchisee over a 25-year period. Therefore, in addition to franchise fees and royalties, the revenues received from an IHOP franchisee operating under the Previous IHOP Business Model may include, among other things, lease or sublease rents for the restaurant property building, rent under an equipment lease and interest income from the financing arrangements for the unpaid portion of the franchise fee under the franchise notes. If any of these IHOP franchisees were to default on their payment obligations to us, we may be unable to collect the amounts owed under the building property lease/sublease agreement and our notes and equipment contract receivables, as well as outstanding franchise royalties. The additional amounts owed to us by each of these IHOP franchisees subject us to greater credit risk and defaults by IHOP franchisees operating under our Previous IHOP Business Model and may negatively affect our cash flows. Of the 1,518 IHOP domestic franchise restaurants as of December 31, 2020, approximately 620 restaurants have property lease/sublease agreements and/or notes and equipment contract obligations outstanding.
We and our franchisees are subject to potential losses that may not be covered by insurance. We and our franchisees may have insufficient insurance coverage to cover all of the potential risks associated with the ownership and operation of restaurants. We and our franchisees may have insufficient funds to cover future unanticipated increases in insurance premiums or losses that are not covered by insurance. Certain extraordinary hazards may not be insurable and insurance may not be available (or may be available only at prohibitively expensive rates) with respect to many other risks. Moreover, there is no assurance that any loss incurred will not exceed the limits on the policies obtained, or that claim payments on such policies will be received on a timely basis. Further, there can be no assurance that any such payments, even if obtained on a timely basis, will prevent losses to franchisees or enable timely franchise payments. Accordingly, in cases in which a franchisee experiences increased insurance premiums or must pay claims out-of-pocket, the franchisee may not have the funds necessary to make franchise and other payments to us, and franchisees may be unable to perform other obligations under their franchise agreements.
If franchisees and other licensees do not observe the required quality and trademark usage standards, our brands may suffer reputational damage, which could in turn adversely affect our business. We license our intellectual property to our franchisees, product suppliers, manufacturers, distributors, advertisers and other third parties. The franchise agreements and other license agreements require that each franchisee or other licensee use our intellectual property in accordance with established or approved quality control guidelines. However, there can be no assurance that the franchisees or other licensees will use the intellectual property assets in accordance with such guidelines. Franchisee and licensee noncompliance with the terms and conditions of the governing franchise agreement or other license agreement may reduce the overall goodwill associated with our brands. Franchisees and other licensees may refer to our intellectual property improperly in communications, resulting in the weakening of the distinctiveness of our intellectual property. There can be no assurance that the franchisees or other licensees will not take actions that could have a material adverse effect on the Applebee's or IHOP intellectual property.
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In addition, even if the licensee product suppliers, manufacturers, distributors, or advertisers observe and maintain the quality and integrity of our intellectual property assets in accordance with the relevant license agreement, any product manufactured by such suppliers may be subject to regulatory sanctions and other actions by third parties which can, in turn, negatively impact the perceived quality of our restaurants and the overall goodwill of our brands, regardless of the nature and type of product involved. Any such sanctions or actions could reduce restaurant revenues and corresponding franchise payments to us.
Our business strategy may not achieve anticipated results. We expect to continue to apply a business strategy that includes operation of a significantly franchised restaurant system across multiple brands and brand-specific business strategies suited to each brand. There can be no assurance that the business strategy we apply to one franchise system will be suitable or will achieve results similar to the application of such business strategy to another franchise system. In addition, operational improvement, purchasing and other strategic initiatives for any of our brands may not be successful or achieve the desired results, and there can be no assurance that franchisees will respond favorably to such initiatives. Additionally, our strategic initiatives may subject us and our franchisees to new and additional risks. Our business strategy includes the addition of new brands to our restaurant portfolio through mergers and acquisitions. There can be no assurance that any such transaction will be successful or produce favorable financial or other results.
Risks Related to Operating in the Restaurant Industry
Our performance is subject to risks associated with the restaurant industry, including the highly competitive nature of the industry. We derive a substantial portion of our revenues in the form of (i) royalties based on the gross sales of our franchised restaurants and (ii) gross sales derived from company-operated restaurants. Sales and profitability of these restaurants may be negatively impacted by a number of factors associated with operating in the restaurant industry, some of which are outside of our control. These factors include:
•changes in consumer behavior driven by macro-level shifts in retail, technology, media, e-commerce, global safety and demography which may impact where, when, whether and how often customers visit full-service restaurants;
•declines in comparable restaurant sales growth rates due to: (i) failure to meet or adequately adapt to changing customer expectations for food type, quality and taste, or to innovate and develop new menu items to retain existing customers and attract new customers; (ii) competitive intrusions in our markets, including competitive pricing initiatives and daypart expansion by competitors; (iii) opening new restaurants that cannibalize the sales of existing restaurants; (iv) failure of national or local marketing to be effective; and (v) natural or man-made disasters or adverse weather conditions;
•negative trends in operating expenses such as: (i) increases in food and other commodity costs or related distribution costs; (ii) increases in labor costs due to minimum wage and other employment laws or regulations, immigration reform, the potential impact of union organizing efforts and tight labor market conditions; and (iii) increases in other operating costs including advertising, utilities, lease-related expenses and credit card processing fees;
•the highly competitive nature of the restaurant and related industries with respect to, among other things: (i) price, service, location, personnel and the type and quality of food; (ii) the trend toward convergence in grocery, deli, retail and restaurant services, as well as the continued expansion of restaurants into the breakfast daypart; (iii) the entry of major market players in non-competing industries into the food services market; (iv) the decline in the price of groceries which may increase the attractiveness of dining at home versus dining out; and (v) the emergence of new or improved technologies and changes in consumer behavior facilitated by such technology;
•the inability to increase menu pricing to offset increased operating expenses; and
•failure to effectively manage further penetration into mature markets.
Factors outside our control may harm our brands' reputations. The success of our business is largely dependent upon brand recognition and the strength of our franchise systems. Our and our franchisees’ continued success is directly dependent upon maintaining a favorable public view of the Applebee's and IHOP brands. Negative publicity (e.g., crime, scandal, litigation, on-site accidents and injuries or other harm to customers, social issues, and food-borne illness) at a single Applebee's or IHOP location can have a substantial negative impact on all restaurants within the Applebee's or IHOP system. Multi-unit food service businesses such as ours can be materially and adversely affected by widespread negative publicity of any type, including through social media, but particularly regarding food quality, food-borne illness, food tampering or preparation, obesity, discrimination or bias, injury or other health concerns with respect to certain foods and actions of our or our franchisees’ managers or employees, regardless of whether such claims are accurate or valid.
The risk of food-borne illness or food tampering cannot be completely eliminated. Any outbreak of food-borne illness or other food-related incidents attributed to Applebee's or IHOP restaurants or within the food service industry or any widespread negative publicity regarding the Applebee's or IHOP brands or the restaurant industry in general could harm our reputation.
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Even where such food-related incidents occur solely at restaurants of our competitors or within the industry, our business could be adversely affected by negative publicity about the restaurant industry generally. Our company-owned restaurants and our franchisees may produce or receive through the supply chain sub-standard or non-compliant food or beverage products. In addition, our franchisees’ failure to comply with food quality and preparation requirements may subject us to potential losses, even when we are not legally liable for a franchisee's actions or failure to act. Although the Company maintains liability insurance, and each franchisee is required to maintain liability insurance pursuant to its franchise agreements, a liability claim could injure the reputation of all Applebee's or IHOP restaurants, whether or not it is ultimately successful.
A lack of availability of suitable locations for new restaurants or a decline in the quality of the locations of our current restaurants may adversely affect our sales and results of operations. The success of our brands depends in large part on restaurant locations. As demographic and economic patterns change, current locations may not continue to be attractive or profitable. Potential declines in neighborhoods where restaurants are located or adverse economic conditions in areas surrounding those neighborhoods could result in reduced sales in those locations. In addition, desirable locations for new restaurant openings or for the relocation of existing restaurants may not be available at an acceptable cost when we identify a particular opportunity for a new restaurant or relocation. Additionally, restaurant revitalization initiatives may not be completed as and when projected and may not produce the results we expect. We also may be unable to operate effectively in new and/or highly competitive geographic regions or local markets in which our franchisees have limited operating experience.
We may experience shortages or interruptions in the supply or delivery of food and other products from third parties or in the availability of utilities. Our and our franchised restaurants are dependent on frequent deliveries of fresh produce, food, beverages and other products. Shortages or interruptions in food and beverage supplies may result from a variety of causes, including shortages due to adverse weather, labor unrest, labor shortages, political unrest, terrorism, pandemics, epidemics, outbreaks of food-borne illness, disruption of operation of production facilities, financial difficulties (including bankruptcy) of our distributors or suppliers or other unforeseen circumstances. Such shortages could adversely affect our and our franchisees’ ability to operate our restaurants and, in turn, affect our and our franchisees’ revenue and profits. Additionally, the inability to secure adequate and reliable supplies or distribution of food and beverage products could limit our ability to make changes to our core menus or offer promotional "limited time only" menu items, which may limit our ability to implement our business strategies. Our and our franchisees’ restaurants bear risks associated with the timeliness of deliveries by suppliers and distributors as well as the solvency, reputation, labor relationships, freight rates, prices of raw materials and health and safety standards of each supplier and distributor. Other significant risks associated with our suppliers and distributors include improper handling of food and beverage products and/or the adulteration or contamination of such food and beverage products. Disruptions in our relationships with suppliers and distributors may reduce the payments we receive from our franchisees or our pancake and waffle dry mix distributors or the profits generated by our company-operated restaurants. In addition, interruptions to the availability of gas, electric, water or other utilities may adversely affect the operations of our and our franchised restaurants.
Any inability to effectively manage or forecast appropriate inventory levels may adversely affect our business. Effective management of inventory levels depends, in part, on our ability to anticipate and respond in a timely manner to changing consumer demand and preferences. From time to time, we may carry excessive inventory resulting from menu events that vary from forecasted demand which may result in financial loss to us and/or to our franchisees. Conversely, if we underestimate demand, we may experience inventory shortages which may result in lost revenues.
A failure to develop and implement innovative marketing and guest relationship initiatives, ineffective or improper use of social media or other marketing initiatives and increased advertising and marketing costs could adversely affect our business results. If our competitors increase their spending on advertising and promotions, if our advertising, media or marketing expenses increase, or if our advertising and promotions become less effective than those of our competitors, we could experience a material adverse effect on our business results. A failure to sufficiently innovate, develop guest relationship initiatives, or maintain adequate and effective advertising could inhibit our ability to maintain brand relevance and drive increased sales.
As part of our marketing efforts, we rely on search engine marketing and social media platforms to attract and retain guests. These efforts may not be successful, resulting in expenses incurred without the benefit of higher revenues or increased employee engagement. In addition, a variety of risks are associated with the use of social media, including the improper disclosure of proprietary information, posting of negative comments about our brands or experiences in our or our franchisees’ restaurants, exposure of personal information, fraud, and use of outdated information. The use, including any inappropriate or otherwise harmful use, of social media vehicles by our franchisees and their employees, guests, our employees or others in the general public could increase our costs, lead to litigation or result in negative publicity that could damage our reputation.
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Changing health or dietary preferences may cause consumers to avoid Applebee's and IHOP restaurants in favor of alternative options. The food service industry as a whole rests on consumer preferences and demographic trends at the local, regional, national and international levels. Franchise development and system-wide sales depend on the sustained demand for our products, which may be affected by factors we do not control. New information regarding diet, nutrition and health and efforts by advocacy groups to influence consumer eating habits may negatively affect the demand for our food. Various additional factors such as: (i) the Food and Drug Administration’s menu labeling rules, (ii) nutritional guidelines issued by the United States Department of Agriculture and issuance of similar guidelines or statistical information by state or local municipalities, (iii) academic studies; or (iv) efforts by environmental, animal welfare and sustainability advocacy groups, may impact consumer choice and cause consumers to select foods other than those that are offered by Applebee's or IHOP restaurants. We may not be able to adequately adapt Applebee's or IHOP restaurants' menu offerings to keep pace with developments in consumer preferences, which may result in reduced royalty revenues from a decline in demand for our food and fewer guests visiting Applebee’s and IHOP restaurants.
Risks Related to Ownership of Our Common Stock
Declines in our financial performance have resulted in and could result in future impairment charges. United States generally accepted accounting principles (“U.S. GAAP”) require annual (or more frequently if events or changes in circumstances warrant) impairment tests of goodwill, intangible assets and other long-lived assets. Generally speaking, if the carrying value of the asset is in excess of the estimated fair value of the asset, the carrying value will be adjusted to fair value through an impairment charge. Fair values of goodwill and intangible assets are primarily estimated using discounted cash flows based on five-year forecasts of financial results that incorporate assumptions including, among other things, same-restaurant sales trends, future development plans, brand-enhancing initiatives, restaurant closures and an appropriate discount rate. Fair values of long-lived tangible assets are primarily estimated using discounted cash flows over the estimated useful lives of the assets. Significant underachievement of forecasted results or changes in the discount rate assumption could reduce the estimated fair value of these assets below the carrying value, requiring non-cash impairment charges to reduce the carrying value of the asset. In the second quarter of 2020, as a result of performing the interim quantitative test, we recognized an impairment of Applebee's goodwill of $92.2 million, an impairment of Applebee's tradename of $11.0 million and an impairment of various long-lived assets of $17.2 million. As of December 31, 2020, our total stockholders' deficit was $354.7 million. Any significant impairment write-down of goodwill, intangible assets or long-lived assets in the future could increase the stockholders' deficit. Repurchases of our common stock will also increase the stockholders' deficit. While such a deficit balance does not create an event of default in any of our contractual agreements, the negative perception of such a deficit could have an adverse effect on our stock price and could impair our ability to obtain new financing, or refinance existing indebtedness on commercially reasonable terms or at all.
Many factors, including those over which we have no control, affect the trading volatility and price of our stock. Many factors, in addition to our operating results, may have an impact on the trading volatility and price of our common stock. These factors include general economic and market conditions, publicity regarding us, our competitors, or the restaurant industry generally, changes in financial estimates by securities analysts, changes in financial or tax reporting and accounting principles or practices, trading activity in our common stock, overall liquidity and the impact of our capital allocation initiatives, including any future stock repurchase programs or dividend declarations. Many of these factors are outside of our control, and any failure to meet market expectations whether for sales growth, earnings per share or other metrics could cause our share price to decline.
Our actual operating and financial results in any given period may differ from guidance we provide to the public, including our most recent public guidance. From time to time, in press releases, SEC filings, public conference calls and other contexts, we have provided guidance to the public regarding current business conditions and our expectations for our future financial results. We expect that we will provide guidance periodically in the future. Our guidance is based upon a number of assumptions, expectations and estimates that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In providing our guidance, we also make various assumptions with respect to our future business decisions, some of which will change. Our actual financial results, therefore, may vary from our guidance due to our inability to meet the assumptions upon which our guidance is based and the impact on our business of the various risks and uncertainties described in these risk factors and in our public filings with the SEC. Variances between our actual results and our guidance may be material. To the extent that our actual financial results do not meet or exceed our guidance, the trading prices of our securities may be materially adversely affected.
Item 1B. Unresolved Staff Comments.
None.
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Item 2. Properties.
The table below shows the location and ownership type of Applebee's and IHOP restaurants as of December 31, 2020:
Applebee's (a) IHOP (a)
Franchise Company Total Applebee's Franchise Company Area License Total IHOP
United States
Connecticut 6 — 6 9 — — 9
District of Columbia — — — 2 — — 2
Hawaii — — — 5 — — 5
Montana 8 — 8 4 — — 4
Rhode Island 8 — 8 5 — — 5
South Dakota 6 — 6 2 — — 2
Vermont 3 — 3 1 — — 1
Wyoming 4 — 4 3 — — 3
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Applebee's (a) IHOP (a)
Franchise Company Total Applebee's Franchise Company Area License Total IHOP
International
Bahrain 1 — 1 — — — —
Brazil 2 — 2 — — — —
Dominican Republic 2 — 2 — — — —
Ecuador — — — 5 — 5
Egypt 1 — 1 — — — —
Guatemala 4 — 4 — — — —
India — — — 3 — — 3
Kuwait 6 — 6 — — — —
Pakistan — — — 1 — — 1
Peru — — — 1 — 1
Puerto Rico 8 — 8 6 — — 6
Qatar 7 — 7 — — — —
Thailand — — — 1 — — 1
(a) The properties identified in this table generate revenue in our franchise, rental, financing and company restaurant operating segments.
(b) Of these restaurants, 25 in Florida and six in Canada have been sub-licensed by the area licensee.
Of the 1,611 IHOP restaurants operated by franchisees, 57 were located on sites owned by us, 564 were located on sites leased by us from third parties and 990 were located on sites owned or leased by franchisees. All of the IHOP restaurants operated by area licensees and 1,640 of the franchisee-operated Applebee's restaurants were located on sites owned or leased by the area licensees or the franchisees. We owned one site on which a franchisee-operated Applebee's restaurant was located and one franchisee-operated Applebee's restaurant was located on site leased by us from third parties. The 69 Applebee's restaurants we operated as of December 31, 2020 were located on sites leased by us from third parties.
Leases of IHOP restaurants generally provide for an initial term of 20 to 25 years, with most having one or more five-year renewal options. Leases of Applebee's restaurants generally have an initial term of 10 to 20 years, with renewal terms of five to 20 years. In addition, a substantial number of the leases for both IHOP and Applebee's restaurants include provisions calling for the periodic escalation of rents during the initial term and/or during renewal terms. The leases typically provide for payment of rents in an amount equal to the greater of a fixed amount or a specified percentage of gross sales and for payment of taxes, insurance premiums, maintenance expenses and certain other costs. Historically, it has been our practice to seek to extend, through negotiation, those leases that expire without renewal options. However, from time to time, we choose not to renew a lease or are unsuccessful in negotiating satisfactory renewal terms. When this occurs, the restaurant is closed and possession of the premises is returned to the landlord.
Under our Applebee's franchise agreements, we have certain rights to gain control of a restaurant site in the event of default under the franchise agreement. Because substantially all IHOP franchised restaurants developed by us under our Previous IHOP Business Model are subleased to the franchisees, IHOP has the ability to regain possession of the subleased restaurant if the franchisee defaults in the payment of rent or other terms of the sublease.
We currently occupy our principal corporate offices and restaurant support center located in Glendale, California, under a lease expiring in April 2023. We lease approximately 50,000 square feet of office space in Kansas City, Missouri, under a lease expiring in October 2021. We lease approximately 3,000 square feet of office space in Raleigh, North Carolina under a lease expiring in April 2024.
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Item 3. Legal Proceedings.
We are subject to various lawsuits, administrative proceedings, audits, and claims arising in the ordinary course of business. Some of these lawsuits purport to be class actions and/or seek substantial damages. We are required to record an accrual for litigation loss contingencies that are both probable and reasonably estimable. Legal fees and expenses associated with the defense of all of our litigation are expensed as such fees and expenses are incurred. Management regularly assesses our insurance deductibles, analyzes litigation information with our attorneys and evaluates our loss experience in connection with pending legal proceedings. While we do not presently believe that any of the legal proceedings to which we are currently a party will ultimately have a material adverse impact on us, there can be no assurance that we will prevail in all the proceedings we are party to, or that we will not incur material losses from them.
Item 4. Mine Safety Disclosure.
Not Applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is traded on the NYSE under the symbol “DIN”.
Holders
As of February 23, 2021, there were 381 holders of our common stock. This number does not include beneficial owners whose shares are held in street name by brokers and other nominees.
Dividends on Common Stock
Please refer to Note 12 - Stockholders' Deficit, of the Notes to the Consolidated Financial Statements for information on dividends declared and paid in the fiscal years ended December 31, 2020 and December 31, 2019.
In light of the COVID-19 pandemic, our Board of Directors did not declare a dividend for the second, third and fourth quarters of 2020. We will reevaluate our capital allocation strategy as industry conditions improve and normal restaurant operations resume, in consideration of our current and forecast earnings, financial condition, cash requirements and other factors.
Issuer Purchases of Equity Securities
Purchases of Equity Securities by the Company
(a) These amounts represent shares owned and tendered by employees to satisfy tax withholding obligations arising upon the vesting of restricted stock awards. Shares so surrendered by the participants are repurchased by us pursuant to the terms of the plan under which the shares were issued and the applicable individual award agreements and not pursuant to publicly announced repurchase authorizations.
(b) In February 2019, our Board of Directors approved the 2019 Repurchase Program authorizing the Company to repurchase up to $200 million of the Company's common stock. The 2019 Repurchase Program, as approved by the Board of Directors, does not require the repurchase of a specific number of shares and can be terminated at any time.
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Stock Performance Graph
The graph below shows a comparison of the cumulative total stockholder return on our common stock with the cumulative total return on the Standard & Poor's 500 Composite Index and the Value-Line Restaurants Index (“Restaurant Index”) over the five-year period ended December 31, 2020. The graph and table assume $100 was invested at the close of trading on the last day of trading in 2015 in our common stock and in each of the market indices, with reinvestment of all dividends. Stockholder returns over the indicated periods should not be considered indicative of future stock prices or stockholder returns.
Comparison of Five-Year Cumulative Total Stockholder Return
Dine Brands Global, Inc., Standard & Poor's 500 and Value Line Restaurants Index
(Performance Results through December 31, 2020)
(1)The Value Line Restaurants index is a comprehensive restaurant industry index. In addition to family dining and casual dining, the Index includes the fast-casual and quick-service segments of the restaurant industry.
The foregoing performance graph is being furnished as part of this report solely in accordance with the requirement under Rule 14a-3(b)(9) to furnish our stockholders with such information, and therefore, shall not be deemed to be filed or incorporated by reference into any filings by the Company under the Securities Act of 1933, as amended (the “Securities Act”) or the Exchange Act.
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Item 6. Selected Financial Data.
Not Applicable
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
General
The following discussion provides an analysis of our results of operations and reasons for material changes for 2020 as compared to 2019 and should be read together with the financial statements included in this Annual Report on Form 10-K. For a detailed discussion of year-to-year comparisons between fiscal 2019 and fiscal 2018, please refer to “Management's Discussion and Analysis of Financial Condition and Results of Operations” contained in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 24, 2020.
The financial tables appearing in Management's Discussion and Analysis present amounts in millions of dollars that are rounded from our consolidated financial statements presented in thousands of dollars. As a result, the tables may not foot or cross foot due to rounding.
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. and on February 20, 2018, the name of the Company was changed to Dine Brands Global, Inc.SM (“Dine Brands Global,” “we” or “our”). Through various subsidiaries (see Exhibit 21, Subsidiaries of Dine Brands Global, Inc.), we own, franchise and operate the Applebee's Neighborhood Grill + Bar® (“Applebee's”) concept in the bar and grill segment within the casual dining category of the restaurant industry and we own and franchise the International House of Pancakes® (“IHOP”) concept in the family dining category of the restaurant industry. References herein to Applebee's® and IHOP® restaurants are to these two concepts, whether operated by franchisees, area licensees or us.
Domestically, IHOP restaurants are in all 50 states and the District of Columbia, while Applebee's restaurants are located in every state except Hawaii. Internationally, IHOP restaurants are in two United States territories and nine countries; Applebee's restaurants are in two United States territories and 11 countries. With over 3,400 restaurants combined, the substantial majority of which are franchised, we believe we are one of the largest full-service restaurant companies in the world. The June 15, 2020 issue of Nation's Restaurant News reported that IHOP and Applebee's were the largest restaurant systems in the family dining and casual dining categories, respectively, in terms of United States system-wide sales during 2019.
We have a 52/53 week fiscal year ending on the Sunday nearest to December 31 of each year. For convenience, in this annual report on Form 10-K, we refer to all fiscal years as ending on December 31 and all interim fiscal quarters as ending on March 31, June 30 and September 30 of the respective fiscal year. There were 53 calendar weeks in our 2020 fiscal year ended January 3, 2021 and our fiscal 2020 fourth quarter contained 14 calendar weeks. There were 52 calendar weeks in our 2019 and 2018 fiscal years that ended on December 29, 2019 and December 30, 2018, respectively.
COVID-19 Pandemic
In March 2020, the World Health Organization declared a global pandemic related to the outbreak of a novel strain of coronavirus, designated “COVID-19.” Initially, federal, state, local and international governments reacted to the COVID-19 pandemic by encouraging or requiring social distancing, instituting shelter-in-place orders, and requiring, in varying degrees, reduced operating hours, restaurant dine-in and/or indoor dining limitations, capacity limitations or other restrictions that largely limited restaurants to off-premise sales (take-out and delivery) in the early months of the pandemic. Over the course of 2020, certain of these restrictions on indoor dining were relaxed as incidents of infection from the initial outbreak declined, but many of the restrictions were reinstituted as incidents of infection surged. The nature, degree and duration of the restrictions varied by individual geographic area.
Since the onset of the pandemic in March 2020, we have taken numerous actions to mitigate the effects of the COVID-19 pandemic on the Company, its operations and its franchisees, as discussed below:
•We drew down a total of $220 million from our revolving credit facility. Including approximately $3 million in letters of credit, $223 million of the total $225 million available under our revolving facility has been utilized. We had no immediate need for additional liquidity, but in light of then-current market conditions and uncertainty related to the COVID-19 pandemic, we drew on the revolving facility to maximize our financial flexibility. We plan to repay the $220 million drawn on the revolving credit facility in the month of March 2021.
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•We have stopped repurchasing our common stock and our Board of Directors did not declare a dividend for the second, third and fourth quarters of 2020. We will reevaluate our capital allocation strategy as industry conditions improve and normal restaurant operations resume, in consideration of our current and forecast earnings, financial condition, cash requirements and other factors. Prior to taking these actions, we used cash totaling $53.8 million for dividends and stock repurchases in 2020 as compared to using cash of $156.6 million for dividends and stock repurchases in 2019.
•We voluntarily increased the interest reserve set aside for our securitized debt, from the required $16.4 million to $32.8 million. We also voluntarily accelerated the funding of interest on our securitized debt with the redirection of cash receipts within the securitization structure. As of the date of this report, the interest payments on long-term debt due March 5, 2021 and June 5, 2021 have been fully funded.
•We have reduced discretionary costs, limited new hiring and significantly reduced the use of independent contractors. At the outset of the pandemic, we temporarily furloughed certain team members across various functional groups in our restaurant support centers and company-operated restaurants and curtailed the hours of substantially all of the hourly restaurant associates at our company-operated restaurants. Most hourly restaurant associates at our company-operated restaurants returned to work following re-opening of those restaurants, and there were no team members from the restaurant support centers remaining on furlough as of December 31, 2020. Our General & Administrative (“G&A”) expenses for the year ended December 31, 2020 were $18.0 million lower than the prior year.
•We offered Applebee's franchisees the opportunity to defer payment of their royalty, advertising and other fees, primarily for the months of March and April. A total of 30 franchisees representing 94% of Applebee’s restaurants have deferred payments totaling $33.4 million. Repayment of deferred amounts, scheduled over up to nine months, began in the third quarter of 2020. As of December 31, 2020, the outstanding balance was approximately $13.7 million, with five franchisees having repaid their deferred balances in full.
•We offered IHOP franchisees the opportunity to defer their royalty, advertising, equipment rent and sublease rent payments, primarily for the months of March and April. Initially, 193 franchisees representing 58% of IHOP restaurants deferred payments totaling $24.1 million. Including subsequent deferrals made on a case-by case basis, the deferral program totaled $27.4 million. Repayment of deferred amounts, scheduled over up to 36 weeks, began in the third quarter of 2020. In certain instances, repayments were temporarily paused for up to 60 days. As of December 31, 2020, the outstanding balance was approximately $15.4 million, with 56 franchisees having repaid their deferred balances in full.
•We received rent deferrals and abatements on properties we lease of approximately $11 million, primarily related to rent deferrals for properties on which IHOP restaurants are located. As of December 31, 2020, the deferred rent balance was approximately $5 million, the significant majority of which is due to be paid in 2021.
•We allowed franchisees to defer their development obligations for up to 15 months and we allowed franchisees to defer their 2020 unit remodel obligations until the end of 2022.
•We have worked with our franchisees to offer a limited menu and to modify their operating hours in a manner that optimizes the functionality of their restaurants. Our expectation is restaurants will return to normal operating hours as sales return to pre-pandemic levels.
•We hired external consultants to work with franchisees in assessing their financial health and to better understand performance variability. We began this process in the third quarter of 2020 working closely with key franchise leaders.
In March 2020, in light of the COVID-19 pandemic, Standard & Poor's (“S&P”) placed the Company on “credit watch-negative” with respect to its 2019 Class A-2 Notes. In September 2020, S&P removed the Company from the credit watch and reaffirmed the BBB rating of the 2019 Class A-2 Notes.
The significance of the impacts of the COVID-19 pandemic resulted in our performing impairment assessments of our long-lived assets, goodwill and other intangible assets. As a result of these assessments, we recorded impairment charges of $123.7 million in the second fiscal quarter of 2020. See “Consolidated Results of Operations - Fiscal 2020, 2019 and 2018 - Impairment and Closure Costs” for further discussion of the impairments. Additional impairment and closure charges of $8.1 million were recorded during the fourth fiscal quarter of 2020, primarily related to closure of IHOP restaurants.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted in response to the COVID-19 pandemic. Among the various provisions in the CARES Act, the Company is utilizing the payroll tax deferrals and has claimed an Employee Retention Credit. As of December 31, 2020, the Company has deferred the payment of $3.1 million of payroll taxes, of which 50% is due to be paid by December 31, 2021 and the remaining 50% is due to be paid by December 31, 2022. The Company also has claimed an Employee Retention Credit of $0.6 million as of December 31, 2020. The Company did not receive any form of loan pursuant the Paycheck Protection Program established under the CARES Act. Other than the deferrals and credits noted above, the Company did not receive financial aid pursuant to assistance programs offered by the federal government related to the COVID-19 pandemic.
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The severity of the continued impact of the COVID-19 pandemic on the Company's business will depend on a number of factors, including, but not limited to, how long the pandemic will last, whether/when recurrences of the virus may arise, what restrictions on restaurant operations may be enacted or re-enacted, the availability and acceptance of vaccines, the timing and extent of customer re-engagement with the Company's brands and, in general, what short- and long-term impact on consumer discretionary spending the COVID-19 pandemic might have on the Company and the restaurant industry as a whole, all of which are uncertain and cannot be predicted.
Overview of 2020 Performance
Key Performance Indicators
In evaluating the performance of each restaurant concept, we consider the key performance indicators to be the system-wide sales percentage change, the percentage change in domestic system-wide same-restaurant sales (“domestic same-restaurant sales”), net franchise restaurant development/reduction and the change in total effective restaurants. Changes in both domestic same-restaurant sales and in the number of Applebee's and IHOP restaurants will impact our system-wide retail sales that drive franchise royalty revenues. Net franchise restaurant development/reduction also impacts franchise revenues in the form of initial franchise fees and, in the case of IHOP restaurants, sales of proprietary pancake and waffle dry mix and, where applicable, rental payments under leases that partially may be based on a percentage of their sales.
An overview of our key performance indicators for the year ended December 31, 2020 is as follows:
Applebee's IHOP
System-wide sales percentage decrease (24.1) % (34.9) %
Domestic system-wide same-restaurant sales percentage decrease (22.4) % (32.8) %
Net franchise restaurant reduction (1) (76) (69)
Net decrease in total effective restaurants (2) (122) (133)
________________________________________
(1)Franchise and area license restaurant closings, net of openings, during the year ended December 31, 2020.
(2)Change in the weighted average number of franchise, area license and company-operated restaurants open during the year ended December 31, 2020, compared to the weighted average number of those open during the same period of 2019.
The Applebee's and IHOP sales percentage decreases for the year ended December 31, 2020 were due to a decrease in domestic same-restaurant sales primarily as a result of the effects of COVID-19, as well as a decrease in total effective restaurants. The decrease in total effective restaurants for each brand reflects both a net reduction in franchise restaurants due to permanent closures, net of openings, and the weighted effect of restaurants temporarily closed during the course of the year ended December 31, 2020.
Financial Summary Favorable(Unfavorable) Variance
(In millions, except per share amounts)
(Loss) income before income taxes $ (108.6) $ (247.0) $ 138.4
Income tax benefit (provision) 4.6 38.7 (34.1)
Variance
Net (loss) income per diluted share $ (6.43) $ (12.28) $ 5.85
Weighted average diluted shares outstanding 16.2 (1.0) 17.2
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Income before income taxes for the year ended December 31, 2020 decreased $247.0 million compared to the year ended December 31, 2019. The primary reasons for the decrease are summarized as follows:
(In millions)
Decrease in gross profit:
Franchise operations $ (107.9)
Company operations (11.5)
All other operations (14.7)
Total gross profit decrease (134.1)
Increase in impairment and closure charges (131.1)
Decrease in G&A expenses 18.0
All other 0.2
Decrease in income before income taxes $ (247.0)
Each of these material changes resulted in some manner from impacts of the COVID-19 pandemic. Revenues and cash flows of our franchise, company-operated restaurant and rental operations were significantly affected by the varying degrees of limitations imposed on restaurant operations throughout the majority of 2020. The impacts of the pandemic were considered a potential indicator of impairment which required interim tests of impairment of our goodwill, intangible assets and long-lived assets that resulted in impairment charges of $123.7 million recorded in the second quarter of 2020. To partially mitigate the impact on cash flow, management undertook actions to reduce G&A, such as the furloughing of employees noted above.
Our 2020 effective tax rate of 4.2% applied to pretax book loss was significantly different than the statutory Federal income tax rate of 21% primarily because a $92.2 million impairment of goodwill incurred in the second quarter is not deductible for income tax purposes and therefore has no associated tax benefit. See Note 16 - Income Taxes, of the Notes to the Consolidated Financial Statements for a reconciliation between our effective rate and the statutory Federal income tax rate.
Restaurant Data - System-wide Sales and Domestic Same-Restaurant Sales
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 regarding the percentage change in sales at those restaurants compared to the same periods in the prior two years. Sales at restaurants that are owned by franchisees and area licensees are not attributable to the Company and, as such, the percentage changes in sales presented below are based on non-GAAP sales data. However, we believe that presentation of this information is useful in analyzing our revenues because franchisees and area licensees pay us royalties and advertising fees that are generally based on a percentage of their sales, and, where applicable, rental payments under leases that partially may be based on a percentage of their sales. Management also uses this information to make decisions about future plans for the development of additional restaurants as well as evaluation of current operations.
Applebee's
Year Ended December 31,
System-wide:(b)
Domestic sales percentage change(c) (24.1) % (3.0) % 2.3 %
Domestic same-restaurant sales percentage change(d) (22.4) % (0.7) % 5.0 %
Franchise:(b)
Domestic sales percentage change(c) (e) (24.3) % (5.9) % 2.1 %
Domestic same-restaurant sales percentage change(d) (22.6) % (0.7) % 4.9 %
Domestic average weekly unit sales (in thousands) $ 37.1 $ 47.3 $ 46.7
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IHOP
Year Ended December 31,
Global Effective Restaurants:(a)
System-wide:(b)
Sales percentage change(c) (34.9) % 2.2 % 3.9 %
Domestic same-restaurant sales percentage change(d) (f) (32.8) % 1.1 % 1.5 %
Franchise:(b)
Sales percentage change(c) (35.0) % 2.2 % 4.4 %
Domestic same-restaurant sales percentage change(d) (32.8) % 1.0 % 1.5 %
Average weekly unit sales (in thousands) $ 25.4 $ 36.7 $ 36.6
Area License:(b)
IHOP sales percentage change(c) (34.2) % 2.7 % 0.5 %
_________________________________
(a)“Global Effective Restaurants” are the weighted average number of restaurants open in a given fiscal period, adjusted to account for restaurants open for only a portion of the period. Information is presented for all Effective Restaurants in the Applebee’s and IHOP systems, domestic and international, which includes restaurants owned by franchisees and area licensees as well as those owned by the Company.
(b)“System-wide sales” are retail sales at Applebee’s restaurants operated by franchisees and IHOP restaurants operated by franchisees and area licensees, as reported to the Company, in addition to retail sales at company-operated restaurants. Sales at restaurants that are owned by franchisees and area licensees are not attributable to the Company. An increase or decrease in franchisees' reported sales will result in a corresponding increase or decrease in our royalty revenue. ales at company-operated restaurants and unaudited reported sales for Applebee's domestic franchise restaurants, IHOP franchise restaurants and IHOP area license restaurants for the years ended December 31, 2020, 2019 and 2018 and were as follows:
Year Ended December 31,
(In millions)
Applebee's domestic franchise restaurant sales $ 2,993.0 $ 3,954.3 $ 4,204.1
Applebee's company-operated restaurants 108.0 131.2 7.1
(c)“Sales percentage change” reflects, for each category of restaurants, the percentage change in sales in any given fiscal year compared to the prior fiscal year for all restaurants in that category.
(d)“Domestic same-restaurant sales change” reflects the percentage change in sales in any given fiscal year, compared to the same weeks in the prior year, for domestic restaurants that have been operated throughout both fiscal years that are being compared and have been open for at least 18 months. Because of new restaurant openings and restaurant closures, the domestic restaurants open throughout the fiscal years being compared may be different from year to year.
(e)The Applebee's franchise sales percentage change for 2019 was impacted by the acquisition of 69 franchise restaurants in December 2018 now reported as company-operated.
(f)IHOP system-wide same-restaurant sales data includes area license restaurants beginning in 2019
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Domestic Same-Restaurant Sales Trends
Applebee’s domestic same-restaurant sales decreased 17.6% for the three months ended December 31, 2020 from the same period in 2019. The decrease primarily was due to a significant decline in customer traffic as a result of the effects of COVID-19, partially offset by an increase in average check. Applebee's same-restaurant sales for the fourth quarter of 2020 outperformed the casual dining segment of the restaurant industry. Based on data from Black Box Intelligence, a restaurant sales reporting firm (“Black Box”), the casual dining segment of the restaurant industry experienced a decrease in same-restaurant sales during the fourth quarter of 2020 resulting from a large decline in customer traffic that was somewhat offset by an increase in average customer check. The primary reason for the performance differential between Applebee's and the casual dining segment during the fourth quarter of 2020 was the increase in average customer check, as Applebee's increase in average customer check was larger than that of the casual dining segment.
For the year ended December 31, 2020, Applebee’s domestic same-restaurant sales decreased 22.4%. This decrease for the full year 2020 was due to a significant decline in customer traffic as a result of the effects of COVID-19, partially offset by an increase in average check. Applebee's same-restaurant sales for the year ended December 31, 2020 underperformed the casual dining segment of the restaurant industry. Based on data from Black Box, the casual dining segment experienced a decrease in same-restaurant sales due to a decline in customer traffic that was slightly offset by an increase in average customer check. The primary reason for the performance differential between Applebee's and the casual dining segment for the year ended December 31, 2020 was the decrease in traffic, as Applebee's decrease in traffic was larger than that of the casual dining segment.
Applebee’s system-wide domestic same-restaurant sales had significant variability over the course of fiscal 2020. This variability was due to several factors. Restrictions on indoor dining were relaxed after the incidents of infection from the initial outbreak of COVID-19 declined, but the restrictions were reinstituted in varying degrees during the fourth quarter of 2020 as incidents of the virus surged in individual geographic areas. Another factor was the Company's return to national media advertising in July 2020 after having temporarily discontinued its national advertising programs in March 2020. Other factors were the resilience of the consumers' desire to patronize restaurants as dine-in restrictions were lifted and the retention of off-premise sales.
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As shown in the following table, prior to the large-scale initiation of restrictions on restaurant operations, Applebee's began 2020 with positive domestic same-restaurant sales. For the first 10 weeks of the first quarter of fiscal 2020, Applebee's domestic same-restaurant sales increased 3.2%, primarily due to an increase in customer traffic as well as an increase in average customer check. During March and April, virtually all Applebee's restaurants were limited to off-premise sales or were temporarily closed. After reaching a low point in same-restaurant sales in April 2020, Applebee's experienced progressive improvement in same-restaurant sales for the months of May through October 2020. However, as incidents of the virus surged in the fourth quarter and restrictions on restaurant operations were reinstituted, the trend of improvement in same-restaurant sales reversed for the months of November and December.
The following table reflects the impact of restaurant dine-in restrictions on Applebee's domestic restaurant operations by month since dine-in restrictions were first instituted:
Restaurant Status Status as of 2020 Fiscal Month Ended
Mar Apr May June July Aug Sept Oct Nov Dec
* In most instances, limited to 50% capacity or less and/or reduced operating hours
While Applebee's off-premise sales as a percentage of Applebee's total sales have declined from the April 2020 peak as restrictions on in-restaurant dining were relaxed, off-premise sales as a percentage of Applebee's total sales have increased compared to pre-pandemic levels.
Off-premise sales as % total Applebee's domestic sales
2020 Fiscal Month Ended
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
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* Same-restaurant sales data includes area license restaurants beginning in 2019
IHOP’s domestic same-restaurant sales decreased 30.1% for the three months ended December 31, 2020 from the same period in 2019. The decrease primarily was due to a significant decline in customer traffic as a result of the effects of COVID-19, as well as a slight decrease in average check. IHOP's same-restaurant sales for the fourth quarter of 2020 underperformed the family dining segment of the restaurant industry. Based on data from Black Box, the family dining segment of the restaurant industry experienced a decrease in same-restaurant sales during the fourth quarter of 2020 resulting from a large decline in customer traffic that was partially offset by an increase in average customer check. The primary reason for the performance differential between IHOP and the family dining segment during the fourth quarter of 2020 was the change in average customer check, as IHOP experienced a small decrease in average customer check while the family dining segment reported an increase in average check. The breakfast category, in general, has experienced larger transaction declines than other dayparts.
For the year ended December 31, 2020, IHOP's domestic same-restaurant sales decreased 32.8% due to a significant decline in customer traffic as a result of the effects of COVID-19, partially offset by a slight increase in average check. IHOP's same-restaurant sales for the fourth quarter of 2020 underperformed the family dining segment of the restaurant industry. Based on data from Black Box, for the full year of 2020, the family dining segment experienced a decrease in same-restaurant sales resulting from a large decline in customer traffic that was partially offset by an increase in average customer check. The reason for the performance differential between IHOP and the family dining segment during 2020 was the change in average check as IHOP experienced a smaller increase in average customer check than the family dining segment, partially offset by a smaller decrease in traffic.
IHOP’s system-wide domestic same-restaurant sales had significant variability over the course of fiscal 2020. This variability was due to several factors. Restrictions on indoor dining were relaxed as incidents of infection from the initial outbreak of COVID-19 declined, but the restrictions were reinstituted in varying degrees during the fourth quarter of 2020 as incidents of infection from the virus surged in individual geographic areas. Another factor was the Company's return to national media advertising in July 2020 after having temporarily discontinued its national advertising programs in March 2020. Other factors were the resilience of the consumers' desire to patronize restaurants as dine-in restrictions were lifted and the retention of off-premise sales.
As shown in the following table, prior to the large-scale initiation of restrictions on restaurant operations, IHOP began 2020 with positive domestic same-restaurant sales for the month of January. For the first 10 weeks of the first quarter of fiscal 2020, IHOP's domestic same-restaurant sales decreased 0.6%. During March and April, the significant majority of IHOP restaurants were limited to off-premise sales or were temporarily closed. After reaching a low point in same-restaurant sales in April 2020, IHOP experienced progressive improvement in same-restaurant sales for the months of May through September 2020. However, as incidents of the virus surged in the fourth quarter and restrictions on restaurant operations were reinstituted, the trend of improvement in same-restaurant sales reversed for the months of October, November and December.
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The following table reflects the impact of restaurant dine-in restrictions on IHOP's domestic restaurant operations by month since dine-in restrictions were first instituted:
Restaurant Status Status as of 2020 Fiscal Month Ended
Mar Apr May June July Aug Sept Oct Nov Dec
* In most instances, limited to 50% capacity or less and/or reduced operating hours
While IHOP off-premise sales as a percentage of IHOP total sales have declined from the April 2020 peak as restrictions on in-restaurant dining were relaxed, off-premise sales as a percentage of IHOP total sales have increased compared to pre-pandemic levels.
Off-premise sales as % total IHOP domestic sales
2020 Fiscal Month Ended
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
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Net Franchise Restaurant Development
The total number of Applebee's restaurants open at December 31, 2020 declined 4.3% from the number open at December 31, 2019, as franchisees opened six new restaurants but closed 82 restaurants. The total number of IHOP restaurants open at December 31, 2020 decreased 3.7% from the number open at December 31, 2019, as IHOP franchisees and area licensees opened 27 restaurants in 2020 but closed 96 restaurants.
Internationally, franchisees of both brands opened 11 restaurants and closed 51, a net decrease of 40 international restaurants. This international development activity is included in the total activity for each brand cited above.
In response to the impact of the COVID-19 pandemic on our franchisees, we allowed our franchisees to defer their development obligations for up to 15 months.
Restaurant closures can occur for a variety of reasons that may differ for each restaurant and for each franchisee. Closures generally fall into one of two categories: restaurants in older locations whose retail, residential and traffic demographics have changed unfavorably over time, and restaurants with non-viable unit economics. Our franchisees are independent businesses and their decisions to close restaurants, both temporarily and permanently, can be impacted by numerous factors that are outside of our control, including but not limited to, the impact of COVID-19 on individual franchisees as well as franchisees' agreements with their lenders and landlords.
The following tables present Applebee's and IHOP restaurant development and franchising activity over the past three years:
Year Ended December 31,
Applebee's Restaurant Development Activity
Summary - beginning of period:
Company restaurants (a) 69 69 —
Total Applebee's restaurants, beginning of period 1,787 1,837 1,936
Franchise restaurants opened:
International 3 2 5
Total franchise restaurants opened 6 3 7
Franchise restaurants closed:
Total franchise restaurants closed (82) (53) (106)
Net franchise restaurant reduction (76) (50) (99)
Franchise restaurants acquired by the Company (a) — — (69)
Net franchise restaurant decrease (76) (50) (168)
Summary - end of period:
Company restaurants (a) 69 69 69
Total Applebee's restaurants, end of period 1,711 1,787 1,837
____________________________________________________________________________________________________________
(a) In December 2018, the Company acquired 69 Applebee's restaurants from a former franchisee.
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Year Ended December 31,
IHOP Restaurant Development Activity
Summary - beginning of period:
Total IHOP restaurants, beginning of period 1,841 1,831 1,786
Franchise/area license restaurants opened:
Domestic area license 3 5 3
International franchise 8 13 17
Total franchise/area license restaurants opened 27 51 71
Franchise/area license restaurants closed:
Domestic franchise (56) (27) (15)
Domestic area license (3) (6) (5)
International franchise (34) (8) (6)
International area license (3) — —
Total franchise/area license restaurants closed (96) (41) (26)
Net franchise/area license restaurant (reduction) development (69) 10 45
Refranchised from Company restaurants — — 1
Franchise restaurants reacquired by the Company (3) — (1)
Net franchise/area license restaurant (reductions) additions (72) 10 45
Summary - end of period:
Company 3 — —
The closures presented in the tables above represent permanent closures of restaurants. Temporary closures, which can occur for a variety of reasons, are not reflected as reductions in these tables and temporarily closed restaurants are included in the summary counts at the beginning and end of each period shown. However, temporary closures are reflected in the weighted calculation of Effective Restaurants presented in the preceding Restaurant Data tables.
As previously disclosed, we and certain of our IHOP franchisees evaluated the long-term viability of certain IHOP restaurants in light of individual restaurant-level economics impacted by the COVID-19 pandemic. When we began the evaluation process, we expected it could result in the closure of up to 100 restaurants over the next six months. The evaluation process been completed. As of December 31, 2020, we closed 14 restaurants in the fourth quarter of 2020 and, while the final extent and timing of additional closures remains subject to change, we currently anticipate the completion of the evaluation process could result in the closure of up to 27 additional IHOP restaurants. We have recorded costs of approximately $13.5 million related to these 41 restaurants during the fourth quarter of 2020, primarily charges for impairment and provisions for bad debt and deferred rent.
Closures of Applebee's and IHOP restaurants adversely impact our system-wide retail sales that drive our franchise royalty revenues as well as, in the case of IHOP restaurants, sales of proprietary pancake and waffle dry mix. Further, with certain restaurants, we own or lease the underlying property and sublease it to the applicable franchisee. Thus, our rental income also could be adversely affected due to our obligation to make rental or other payments for such properties.
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Consolidated Results of Operations - Fiscal 2020, 2019 and 2018
The tables in the following section of this Form 10-K present information from our Consolidated Statements of Comprehensive (Loss) Income for our 2020, 2019 and 2018 fiscal years. A detailed discussion of year-to-year comparisons between fiscal 2020 and fiscal 2019 can be found below. For a detailed discussion of year-to-year comparisons between fiscal 2019 and fiscal 2018, please refer to “Management's Discussion and Analysis of Financial Condition and Results of Operations” contained in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Additional Events Impacting Comparability of Financial Information
53rd week in Fiscal 2020
Our fiscal year ends on the Sunday nearest to December 31 of each year. Every five or six years, our fiscal year contains 53 calendar weeks. Our 2020 fiscal year contained 53 calendar weeks, whereas fiscal 2019 and 2018 each contained 52 calendar weeks. The estimated impact of the 53rd week on fiscal 2020 results of operations was additional revenue of $14.4 million, additional gross profit of $4.7 million and a decrease in loss before income taxes of $2.2 million. Our fiscal 2021 will contain 52 calendar weeks.
Loss on Extinguishment of Debt
As discussed under Liquidity and Capital Resources of the Company - Long-term Debt, we refinanced our long-term debt in 2019 and recognized a loss on extinguishment of debt of $8.3 million. There was no similar transaction in 2020.
Financial Review
Favorable(Unfavorable) Variance Favorable(Unfavorable) Variance
(In millions)
(Decrease) increase vs. prior year (24.3) % 16.6 % 6.7 %
Our 2020 total revenue decreased $220.9 million compared to 2019. The decrease in franchise and company restaurant operations revenues primarily was due to a significant decline in customer traffic at our restaurants resulting from measures put in place by various jurisdictions of local, state, national and international governmental entities to mitigate the spread of the COVID-19 virus, as well as changes in consumer behavior resulting therefrom. Rental operations revenue was also impacted by COVID-19 effects, primarily due to a decline in rent paid based on a percentage of franchisees' retail sales. Interest income from financing operations was not impacted significantly by the COVID-19 pandemic, with the expected progressive decline due to repayments of outstanding balances. Total revenue was favorably impacted by approximately $14.4 million due to a 53rd week in fiscal 2020.
Favorable(Unfavorable) Variance Favorable(Unfavorable) Variance
(In millions)
(Decrease) increase vs. prior year (35.0) % 8.4 % 4.2 %
Our 2020 total gross profit decreased $134.1 million compared to 2019, primarily due to the revenue declines related to the pandemic as cited above as well a $13.1 million increase in bad debt expense. Total gross profit was favorably impacted by approximately $4.7 million due to a 53rd week in fiscal 2020.
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(In millions, except number of restaurants)
Effective Franchise Restaurants:(1)
Franchise Revenues:
Franchise Expenses:
Franchise Segment Profit:
Gross profit as % of total revenue 49.1 % 52.0 % 48.7 %
Gross profit as % of franchise fees (2) 86.2 % 91.6 % 83.8 %
____________________________________________________________________________________________
(1) Effective Franchise Restaurants are the weighted average number of franchise and area license restaurants open in a given fiscal period, adjusted to account for franchise and area license restaurants open for only a portion of the period.
(2) Total franchise revenue excluding advertising
Our total franchise revenue decreased $181.7 million in 2020 compared to 2019, due to changes in the following components:
•Applebee's franchise revenue decreased 23.7% compared to 2019. Approximately $32.9 million of the decline was due to a decrease of 22.6% in domestic franchise same-restaurant sales primarily caused by the adverse impact on customer traffic of COVID-19-related mitigation measures and changes in consumer behavior. Additionally, revenue decreased $3.8 million due to permanent domestic restaurant closures and $3.2 million due to temporary domestic restaurant closures. Applebee's international revenues declined $3.1 million, primarily due to a decline in same-restaurant sales as well as a $0.6 million decrease due to temporary closures and a $0.2 million due to permanent restaurant closures.These unfavorable changes were partially offset by additional revenue from the 53rd week of approximately $2.4 million, a decrease in domestic delivery credits that reduce royalty revenue and an increase in international franchise fees.
•IHOP franchise revenue decreased 30.0% compared to 2019, primarily due to lower royalty and pancake and waffle dry mix revenues resulting from a 32.8% decrease in domestic franchise same-restaurant sales primarily caused by the adverse impact on customer traffic of COVID-19-related mitigation measures and changes in consumer behavior.Additionally, revenue decreased $7.5 million due to temporary domestic restaurant closures. IHOP's international revenues declined $4.4 million, due primarily to a decline in same-restaurant sales as well as a $0.5 million decrease due to temporary and permanent restaurant closures. These unfavorable changes were partially offset by additional revenue from the 53rd week of approximately $3.0 million, as well as by a $3.5 million increase in franchise fees (primarily termination and forfeited franchise fees). and a decrease in domestic delivery credits that reduce royalty revenue.
•Advertising revenue decreased $81.5 million compared to 2019, as discussed by brand below.
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Our 2020 total franchise expenses decreased $73.8 million compared to 2019, due to changes in the following components:
•Applebee's franchise expenses increased $2.7 million, primarily due to a $3.5 million increase in bad debt expense. Bad debt expense for 2020 was $3.3 million as compared to a bad debt recovery of $0.2 million in 2019.
•IHOP franchise expenses increased $3.3 million, primarily due to a $9.6 million increase in bad debt expense, partially offset by a decrease in purchases of pancake and waffle dry mix.IHOP bad debt expense for 2020 was $9.4 million compared to a bad debt recovery of $0.2 million in 2019. Bad debt expense for 2020 included $2.9 million related to the restaurant closures discussed above under IHOP Restaurant Development Activity.
•Advertising expenses decreased $79.8 million, due to a corresponding decrease in advertising revenue, partially offset by the net change in advertising deficit between 2020 and 2019, as discussed below.
Gross profit as a percentage of total revenue decreased in 2020 compared to 2019, primarily because of the $13.1 million increase in bad debt expense.
Advertising revenue and expense by brand for fiscal 2020, 2019 and 2018 were as follows:
Favorable(Unfavorable) Variance Favorable(Unfavorable) Variance
(In millions)
Advertising Revenues:
Advertising Expenses:
Applebee's advertising revenue and expense for 2020 decreased 24.6% compared to 2019, primarily due to the decrease of 22.6% in domestic franchise same-restaurant sales, as well as a $4.3 million decrease due to permanent domestic restaurant closures and a $3.5 million decrease due to temporary domestic restaurant closures. These unfavorable changes were partially offset by additional revenue from the 53rd week of approximately $2.6 million. IHOP's advertising revenue and expense for 2020 decreased by 34.7% and 33.6%, respectively, compared to 2019, primarily due to the decrease of 32.8% in domestic franchise same-restaurant sales, as well as a decrease due to temporary and permanent restaurant closures. These unfavorable changes were partially offset by additional revenue from the 53rd week of approximately $1.6 million.
It is our accounting policy to recognize any deficiency in advertising fee revenue compared to advertising expenditure, or recovery of a previously recognized deficiency in advertising fee revenue compared to advertising expenditure, in the fourth quarter of our fiscal year. In 2020, international marketing expenditures exceeded revenues by approximately $0.5 million. In 2019, IHOP advertising revenue exceeded advertising expenditures by $1.3 million, due to the recovery of a deficit that previously had been recognized in 2018.
(In millions)
Gross profit as % of revenue 15.5 % 24.8 % 25.6 %
Rental operations relate primarily to IHOP franchise restaurants that were developed under the Previous IHOP Business Model described under Item 1. - Business. Rental income includes revenue from operating leases and interest income from direct financing leases. Rental expenses are costs of prime operating leases and interest expense on prime finance leases on certain franchise restaurants.
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Rental segment revenue decreased in 2020 as compared to 2019, primarily due to a $7.4 million decrease in rental income based on a percentage of franchisees' retail sales, a $2.9 million decrease in base rent due to restaurant closures and lease buy-outs and a progressive decline of $1.6 million in interest income as direct financing leases were repaid. These unfavorable changes were partially offset by additional revenue from the 53rd week of approximately $2.0 million. Rental segment expenses for 2020 decreased compared to the same period of the prior year primarily due to a $1.8 million decrease in rent paid based on a percentage of franchisees' retail sales, $1.4 million decrease in interest expense as finance lease obligations are repaid and a $1.1 million decrease in depreciation expense, partially offset by a $3.4 million provision for losses related to the restaurant closures discussed above under IHOP Restaurant Development Activity.
(In millions)
Financing revenues $ 5.8 $ (1.3) $ 7.1 $ (0.9) $ 8.0
Financing operations segment profit $ 5.3 $ (1.2) $ 6.5 $ (0.9) $ 7.4
Gross profit as % of revenue 90.9 % 91.9 % 92.5 %
Financing operations relate primarily to IHOP franchise restaurants that were developed under the Previous IHOP Business Model described under Item 1. - Business. Financing operations revenue primarily consists of interest income from the financing of IHOP franchise fees and equipment leases, as well as from several notes receivable from Applebee's franchisees. We also may sell equipment associated with IHOP franchise restaurants we have reacquired when those restaurants are subsequently refranchised to a new franchisee. Financing expenses are primarily the cost of the restaurant equipment sold.
Financing revenues decreased $1.3 million in 2020 compared to 2019. The change was due to a $1.1 million decrease in IHOP interest income due to the decline in interest income from the financing of franchise fees and equipment leases as note balances were repaid as well as a decrease in interest income on Applebee's notes from franchisees.
(In millions, except number of restaurants)
Effective Company Restaurants:
IHOP restaurant expenses(2) 1.9 (1.9) — — —
Company restaurant segment profit (loss) $ (3.5) $ (11.5) $ 8.0 $ 6.8 $ 1.2
Gross (loss) profit as % of revenue(3) (1.5) % 6.1 % 17.1 %
___________________________________________________________________________________________________
(1) Related to 69 Applebee's company-operated restaurants.
(2) Costs associated with IHOP restaurants in the process of being refranchised.
(3) Calculated for Applebee's company-operated restaurants only. Percentages calculated on actual amounts, not rounded amounts presented above.
In December 2018, we acquired 69 Applebee's restaurants in North Carolina and South Carolina from a former Applebee's franchisee. The slight decrease in effective restaurants for 2020 reflects the temporary closure of seven restaurants for a short period of time in April 2020 in compliance with state and local COVID-19-related mitigation measures. The restaurants were limited to off-premise sales at several points during the year. Due in large part to these restrictions, same-restaurant sales decreased 19.1% for 2020 compared to 2019. The comparison of gross profit for Applebee's company-operated restaurants as a percentage of revenue for 2020 as compared to 2019 was adversely impacted by the COVID-19-related operating constraints described above. These unfavorable impacts were partially offset by additional revenue and gross profit from the 53rd week of approximately $2.6 million and $0.2 million, respectively.
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In addition, Company segment restaurant expenses for 2020 include approximately $1.9 million of costs associated with certain IHOP restaurants while in the process of being refranchised. From time to time, we have operated IHOP restaurants reacquired from franchisees on a temporary basis until those restaurants are refranchised and we may reacquire both IHOP and Applebee's restaurants on a temporary basis in the future. There were three such IHOP restaurants under temporary operation at December 31, 2020.
(In millions)
G&A expenses for 2020 decreased 11.1% compared to 2019, primarily due to a $13.0 million decrease in personnel-related costs, a $5.6 million decrease in travel costs and a $0.9 million decrease in consumer research, partially offset by a $1.0 million increase in depreciation primarily related to capitalized software projects. The decline in personnel-related costs was primarily due to lower costs of salaries and benefits, related in large part to the furloughing of approximately one-third of team members across various functional groups in our restaurant support centers for approximately six months, as well as lower costs of equity-based and other incentive compensation. G&A expenses for 2020 included approximately $1.2 million of costs due to the 53rd week. Included in total G&A expenses for 2020 were $4.3 million of expenses related to company-operated restaurants, as compared to $5.3 million in 2019. The decrease primarily was due to lower personnel-related costs.
(In millions)
Impairment of goodwill $ 92.2 $ (92.2) $ — $ — $ —
Impairment of tradename 11.0 (11.0) — — —
Long-lived asset impairment 22.3 (22.3) — — —
Impairment of reacquired franchise rights 3.3 (3.3) — — —
Impairment of favorable leasehold intangible 0.8 (0.8) — — —
The Company evaluates its goodwill and the indefinite-lived Applebee's tradename for impairment annually in the fourth quarter of each year or on an interim basis if events or changes in circumstances between annual tests indicate a potential impairment. Definite-lived intangible assets and long-lived tangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable based on estimated undiscounted future cash flows.
During March 2020, a global pandemic was declared by the World Health Organization related to the rapidly spreading
outbreak of COVID-19. In the second quarter of 2020, we noted that our common stock had recovered less of its early March 2020 (pre-pandemic) market value than the overall U.S. stock market had recovered. We also assessed several months of data as to the impact of the COVID-19 pandemic on our operations and, in turn, assessed the impact that might have on the risk premium incorporated into the discount rate. Based on these developments, we performed an interim quantitative test of goodwill and indefinite-lived intangible assets for impairment in the second quarter of 2020. In determining fair value, the Company utilized valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The fair value technique used in this instance is classified as Level 3, where unobservable inputs are used when little or no market data is available.
In performing the quantitative test for impairment of goodwill, we used the income approach method of valuation that includes the discounted cash flow method and the market approach that includes the guideline public company method to determine the fair value of goodwill. Significant assumptions made by management in estimating fair value under the discounted cash flow model include future trends in sales, operating expenses, overhead expenses, depreciation, capital expenditures and changes in working capital, along with an appropriate discount rate based on our estimated cost of equity capital and after-tax cost of debt, incorporating a risk premium deemed appropriate in light of current conditions. Significant assumptions used to determine fair value under the guideline public company method include the selection of guideline companies and the valuation multiples applied.
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In performing the impairment review of the tradename, we used the relief of royalty method under the income approach method of valuation. Significant assumptions used to determine fair value under the relief of royalty method include future trends in sales, a royalty rate and a discount rate to be applied to the forecast revenue stream.
As a result of performing the quantitative test of impairment, the Company recognized an impairment of Applebee's goodwill of $92.2 million and an impairment of Applebee's tradename of $11.0 million in the second quarter of 2020.
The majority of the impairment was due to an increase in the assessed risk premium incorporated in the discount rate. These assets are at risk of additional impairment in the future in the event of sustained downward movement in the Company's stock price, downward revisions of long-term performance assumptions, increases in the assumed long-term discount rate or an increase in the corporate tax rate.
We performed our annual test of goodwill and intangible assets for impairment on a qualitative basis in the fourth quarter of 2020. In performing that analysis we considered, among other things, the market value of our stock, absolute and relative to peers, and the Company's operating performance compared to forecast results that had been used in performing the impairment analyses during the second quarter of 2020 discussed above. We concluded there were no indicators of additional impairment subsequent to the second quarter of 2020 and therefore, a quantitative test of impairment was not necessary in the fourth quarter of 2020.
The long-lived asset impairment of $22.3 million related to 29 Applebee's company-operated restaurants and 41 IHOP franchisee-operated restaurants for which the carrying amount exceeded the undiscounted cash flows The impairment recorded represented the difference between the carrying value and the estimated fair value. Approximately $15.1 million of the total impairment related to operating lease right-of-use assets that had been recorded in 2019 upon adoption of new accounting guidance for leases codified in Accounting Standards Topic 842, while $7.2 million related to impairments of land, building, leasehold improvements and finance leases. The impairments by individual property varied in amount, ranging from the largest single-property impairment of $1.3 million to less than $5,000.
An impairment of $3.3 million was recognized related to the reacquired franchise rights intangible asset recorded in the purchase price allocation of the December 2018 acquisition of 69 Applebee's restaurants from a former franchisee.
Approximately $1.6 million of the $3.0 million of closure charges for the year ended December 31, 2020 related to seven IHOP restaurants closed during 2020, with the remainder primarily related to adjustments to the reserve for IHOP and Applebee's restaurants closed prior to 2020. Approximately $0.5 million of the $1.5 million of closure charges for the year ended December 31, 2019 related to two IHOP and one Applebee's restaurant closed during 2019, with the remainder primarily related to adjustments to the reserve for IHOP and Applebee's restaurants closed prior to 2019.
(In millions)
Loss (gain) on disposition of assets 2.1 (2.4) (0.3) (0.3) (0.6)
Loss on extinguishment of debt — 8.3 8.3 (8.3) —
Debt refinancing costs — — — 2.5 2.5
Interest Expense, Net
Interest expense, net increased $6.5 million in 2020 compared to 2019, primarily due to increased interest expense on $220.0 million borrowed under our Revolver in March 2020 and additional interest of approximately $1.2 million due to the 53rd week in 2020. See “Liquidity and Capital Resources”for additional discussion related to the Revolver borrowing.
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Amortization of Intangible Assets
Amortizationof intangible assets primarily relates to franchising rights arising from the November 2007 acquisition of Applebee's and reacquired franchise rights arising from the December 2018 acquisition of 69 Applebee's restaurants from a former franchisee. Amortization expense decreased $0.8 million in 2020 as compared to 2019 due to the impairment of reacquired franchise rights noted above. See Note 7 - Other Intangible Assets, of the Notes to the Consolidated Financial Statements for additional information.
Loss (Gain) on Disposition of Assets
The loss on disposition of assets for 2020 primarily related to termination of 12 IHOP restaurant leases and the disposition of capitalized software no longer in use. There were no individually significant gains or losses on disposition of assets during 2019 or 2018.
(In millions)
Income tax benefit (provision) $ 4.6 $ 38.7 $ (34.1) $ (3.9) $ (30.2)
The income tax provision will vary from period to period for two primary reasons: a change in pretax book income and a change in the effective tax rate. Changes in our pretax book income between 2020 and 2019 are addressed in the preceding sections of “Consolidated Results of Operations - Fiscal 2020, 2019 and 2018.”
The 2020 effective tax rate of 4.2% applied to pretax book loss was significantly different than the statutory Federal income tax rate of 21% primarily because of the $92.2 million impairment of goodwill incurred in the second quarter, which is not deductible for income tax purposes and therefore has no associated tax benefit. See Note 16 - Income Taxes, of the Notes to the Consolidated Financial Statements for a reconciliation between our effective rate and the statutory Federal income tax rate.
The 2019 effective tax rate of 24.6% applied to pretax book income was higher than the statutory Federal tax rate of 21% primarily due to tax expense associated with unrecognized tax benefits and state and local income taxes, offset by the recognized benefit from general business credits.
The 2018 effective tax rate of 27.4% applied to pretax book income was higher than the statutory Federal tax rate of 21% primarily due to additional tax expense associated with unrecognized tax benefits related to an IRS audit and state and local income taxes, offset by applying a lower state tax rate applied to the deferred tax balances.
As of each reporting date, we consider new evidence, both positive and negative, that could impact our view with regards to future realization of deferred tax assets. As of December 31, 2020, management determined that it is more likely than not that the benefits from foreign tax credit carryforward and certain state deferred tax assets, including net operating loss carryforwards, from the Applebee’s company-operated restaurants will not be realized. In recognition of this risk, management recorded a valuation allowance of $3.0 million.
Liquidity and Capital Resources of the Company
COVID-19 Pandemic
As discussed in preceding sections of the MD&A, the measures put in place by various governmental entities to help contain the spread of the COVID-19 virus had a significant adverse impact on our restaurant and rental operations over the last ten months of 2020. In response to the numerous uncertainties related to the pandemic, we took several actions to mitigate the effects on our liquidity, as discussed below:
•We drew down a total of $220 million from our revolving credit facility. Including approximately $3 million in letters of credit, $223 million of the total $225 million available under our revolving facility has been utilized. We had no immediate need for additional liquidity, but drew on the revolving facility to maximize our financial flexibility. We plan to repay the $220 million drawn on the revolving credit facility in the month of March 2021.
•We have stopped repurchasing our common stock and our Board of Directors did not declare a dividend for the second, third and fourth quarters of 2020. Prior to taking these actions, we used cash totaling $53.8 million for dividends and stock repurchases in 2020, as compared to using cash of $156.6 million for dividends and stock
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repurchases in 2019. We will reevaluate our capital allocation strategy as industry conditions improve and normal restaurant operations resume.
•We offered Applebee's franchisees the opportunity to defer payment of their royalty, advertising and other fees, and IHOP franchisees the opportunity to defer payment of their royalty, advertising, equipment rent and sublease rent payments, primarily for the months of March and April. Including a small amount of additional deferrals offered on a case-by-case basis, franchisees deferred a total of approximately $60 million of payments. In general, repayments will take place over nine months and began in the third quarter of 2020. At December 31, 2020, approximately $29 million of such deferred payments were outstanding.
•We voluntarily increased the interest reserve set aside for our securitized debt, from the required $16.4 million to $32.8 million. We also voluntarily accelerated the funding of interest on our securitized debt with the redirection of cash receipts within the securitization structure. As of the date of this report, the interest payments on long-term debt due March 5, 2021 and June 5, 2021 have been fully funded and are included in current restricted cash.
•We have reduced discretionary costs, limited new hiring and significantly reduced the use of independent contractors. At the outset of the pandemic, we temporarily furloughed certain team members across various functional groups in our restaurant support centers and company-operated restaurants and also curtailed the hours of substantially all of the hourly restaurant associates at our company-operated restaurants. Most of the hourly restaurant associates at our company-operated restaurants returned to work following the re-opening of those restaurants, and there were no team members from the restaurant support centers remaining on furlough as of December 31, 2020. Our G&A expenses for the ended December 31, 2020 were $18.0 million lower than the same period of the prior year.
Our total cash balances as of the past five fiscal quarter ends were as follows:
(In millions)
The increase in total cash balances from December 31, 2019 to March 31, 2020 is primarily due to the draw-down of $220 million from our revolving credit facility in March 2020. The decrease in total cash balances from March 31, 2020 to June 30, 2020 is primarily due to the impact on our operations of the COVID-19 pandemic as well as to our offering franchisees the opportunity to defer payments due to us as noted above. The increase in total cash balances from June 30, 2020 to September 30, 2020 reflects the improvement in operations as restrictions on in-restaurant dining became more relaxed and the commencement of collections of amounts deferred by franchisees discussed above. The increase in total cash balances from September 30, 2020 to December 31, 2020 reflects higher sales in the fourth quarter of 2020 compared to the third quarter (including a 14th week in the fourth quarter), a $12.3 million tax refund received and collections of amounts deferred by franchisees discussed above.
We believe that our cash on hand, cash flow from operations, and the actions taken to mitigate the effects of the COVID-19 pandemic discussed above will provide us with adequate liquidity for at least the next twelve months.
Long-Term Debt
On June 5, 2019, Applebee’s Funding LLC and IHOP Funding LLC (the “Co-Issuers”), each a special purpose, wholly-owned indirect subsidiary of the Company, issued two tranches of fixed rate senior secured notes, the Series 2019-1 4.194% Fixed Rate Senior Secured Notes, Class A-2-I (“Class A-2-I Notes”) in an initial aggregate principal amount of $700 million and the Series 2019-1 4.723% Fixed Rate Senior Secured Notes, Class A-2-II (“Class A-2-II Notes”) in an initial aggregate principal amount of $600 million (the “Class A-2-II Notes” and, together with the Class A-2-I Notes, the “2019 Class A-2 Notes”). The 2019 Class A-2 Notes were issued pursuant to an offering exempt from registration under the Securities Act of 1933, as amended.
The Co-Issuers also replaced their existing revolving financing facility, the 2018-1 Variable Funding Senior Notes, Class A-1 (“2018 Class A-1 Notes”), with a new revolving financing facility, the 2019-1 Variable Funding Senior Notes, Class A-1 (the “2019 Class A-1 Notes”), on substantially the same terms as the 2018 Class A-1 Notes in order to conform the term of the 2019 Class A-1 Notes to the anticipated repayment dates for the 2019 Class A-2 Notes. The 2019 Class A-1 Notes and the 2019 Class A-2 Notes are referred to collectively herein as the “New Notes.”
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The New Notes were issued in a securitization transaction pursuant to which substantially all the domestic revenue-generating assets and domestic intellectual property, as further described below, held by the Co-Issuers and certain other special-purpose, wholly-owned indirect subsidiaries of the Company (the “Guarantors”) were pledged as collateral to secure the New Notes.
2019 Class A-2 Notes
The New Notes were issued under a Base Indenture, dated as of September 30, 2014, and amended and restated as of June 5, 2019 (the “Base Indenture”), and the related Series 2019-1 Supplement to the Base Indenture, dated June 5, 2019 (the “Series 2019-1 Supplement”), among the Co-Issuers and Citibank, N.A., as the trustee (in such capacity, the “Trustee”) and securities intermediary. The Base Indenture and the Series 2019-1 Supplement (collectively, the “Indenture”) will allow the Co-Issuers to issue additional series of notes in the future subject to certain conditions set forth therein.
While the 2019 Class A-2 Notes are outstanding, payment of principal and interest is required to be made on the Class A-2 Notes on a quarterly basis. The payment of principal on the 2019 Class A-2 Notes may be suspended when the leverage ratio for the Company and its subsidiaries is less than or equal to 5.25x. Exceeding the leverage ratio of 5.25x does not violate any covenant related to the New Notes.
Our leverage ratio exceeded 5.25x as of June 30, 2020 and has remained greater than 5.25x since then. As of December 31, 2020, the Company's leverage ratio was 7.20x. Accordingly, we made a principal payment in the fourth quarter of 2020 and will continue to make principal payments until the leverage ratio is less than 5.25x.
We may voluntarily repay the New Notes at any time; however, if we repay the New Notes prior to certain dates we would be required to pay make-whole premiums. As of December 31, 2020, the make-whole premium associated with voluntary prepayment of the Class A-2-I Notes was approximately $35 million; this amount declines each quarter to zero in June 2022. As of December 31, 2020, the make-whole premium associated with voluntary prepayment of the Class A-2-II Notes was approximately $74 million; this amount declines each quarter to zero in June 2024. We would also be subject to a make-whole premium in the event of a mandatory prepayment required following a Rapid Amortization Event or certain asset dispositions. The mandatory make-whole premium requirements are considered derivatives embedded in the New Notes that must be bifurcated for separate valuation. We estimated the fair value of these derivatives to be immaterial as of December 31, 2020, based on the probability-weighted discounted cash flows associated with either event.
The legal final maturity of the 2019 Class A-2 Notes is in June 2049, but it is anticipated that, unless earlier prepaid to the extent permitted under the Indenture, the Class A-2-I Notes will be repaid in June 2024 (the “Class A-2-I Anticipated Repayment Date”) and the Class A-2-II Notes will be repaid in June 2026 (the “Class A-2-II Anticipated Repayment Date”). If the Co-Issuers have not repaid or refinanced the Class A-2-I Notes by the Class A-2-I Anticipated Repayment Date or the Class A-2-II Notes by the Class A-2-II Anticipated Repayment Date, then additional interest will accrue on the Class A-2-I Notes and the Class A-2-II Notes, as applicable, at the greater of: (A) 5.0% and (B) the amount, if any, by which the sum of the following exceeds the applicable Class A-2 Note interest rate: (x) the yield to maturity (adjusted to a quarterly bond-equivalent basis) on the applicable anticipated repayment date of the United States Treasury Security having a term closest to 10 years plus (y) 5.0%, plus (z) 2.15% for the Class A-2-I Notes and 2.64% for the Class A-2-II Notes.
In March 2020, in light of the COVID-19 pandemic, Standard & Poor's (“S&P”) placed the Company on “credit watch-negative” with respect to our 2019 Class A-2 Notes. In September 2020, S&P removed the Company from the credit watch and reaffirmed the “BBB” rating of the 2019 Class A-2 Notes.
2019 Class A-1 Notes
The Co-Issuers also entered into a revolving financing facility, the 2019 Class A-1 Notes, that allows for drawings up to $225 million of variable funding notes and the issuance of letters of credit. The 2019 Class A-1 Notes were issued under the Indenture. Drawings and certain additional terms related to the 2019 Class A-1 Notes are governed by the 2019 Class A-1 Note Purchase Agreement, dated June 5, 2019, among the Co-Issuers, certain special-purpose, wholly-owned indirect subsidiaries of the Company, each as a Guarantor, the Company, as manager, certain conduit investors, financial institutions and funding agents, and Barclays Bank PLC, as provider of letters of credit, swingline lender and administrative agent (the “Purchase Agreement”).
The 2019 Class A-1 Notes will be governed, in part, by the Purchase Agreement and by certain generally applicable terms contained in the Indenture. The applicable interest rate under the 2019 Class A-1 Notes depends on the type of borrowing by the Co-Issuers. The applicable interest rate for advances is generally calculated at a per annum rate equal to the commercial paper funding rate or one-, two-, three- or six-month Eurodollar Funding Rate, in either case, plus 2.15%. The applicable interest rate for swingline advances and unreimbursed draws on outstanding letters of credit is a per annum base rate equal to the sum of (a) 1.15% plus (b) the greatest of (i) the Prime Rate in effect from time to time, (ii) the Federal Funds Rate in effect from time to time plus 0.50% and (iii) the one-month Eurodollar Funding Rate plus 1.00%. There is no upfront fee for the 2019 Class A-1 Notes. There is a fee of 50 basis points on any unused portion of the 2019 Class A-1 Notes facility. Undrawn face amounts of
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outstanding letters of credit that are not cash collateralized accrue a fee of 2.15% per annum. It is anticipated that the principal and interest on the 2019 Class A-1 Notes will be repaid in full on or prior to the quarterly payment date in June 2024 (the “2019 Class A-1 Anticipated Repayment Date”), subject to two additional one-year extensions at the option of the Company upon the satisfaction of certain conditions.
Management Agreement
Under the terms of the Management Agreement, dated September 30, 2014, as amended and restated as of September 5, 2018, as further amended and restated as of June 5, 2019 and as amended by that certain Amendment No. 1 to Management Agreement dated November 21, 2019, among the Company, the Securitization Entities, Applebee’s Services, Inc., International House of Pancakes, LLC and the Trustee, the Company will act as the manager with respect to the Securitized Assets. The primary responsibilities of the manager will be to perform certain franchising, distribution, intellectual property and operational functions on behalf of the Securitization Entities with respect to the Securitized Assets pursuant to the Management Agreement. The manager will be entitled to the payment of the weekly management fee, as set forth in the Management Agreement and will be subject to the liabilities set forth in the Management Agreement. The Company, as Manager, voluntarily began waiving its receipt of the weekly management fee in April, 2020 and this waiver remains in place as of December 31, 2020.
Covenants and Restrictions