Dine Brands Global, Inc.

Hello and welcome to the second quarter 2020 DynBrands Global Earnings Conference call. My name is Patty and I will be your conference operator today. At this time, all participants are in a listen-only mode. If you have any questions, please press star, then 1 on your touchstone telephone. Please note that this conference is being recorded. I will now turn the call over to Mr. Ken Deepti, Executive Director of Investor Relations. Sir, you may begin.

Good morning, and welcome to Dine Grand's second quarter conference call. I'm joined by Steve Joyce, CEO, Tom Song, CFO, Jay Pons, President of IHOP, and John Zawinski, President of Applebees. Before I turn the call over to Steve for open remarks, please remember our tape cover regarding forward-looking information. During the call, management may discuss information that is forward-looking and involves known and unknown risks, uncertainties, and other factors which may cause the actual results to be different from those expressed or implied. Please evaluate the forward-looking information in the context of these factors, which were detailed in today's press release and 10Q file. The forward-looking statements are as of today and it assumes no obligation to update or supplement these statements. You may also refer to certain non-GAAP financial measures, which are described in our press release and also available on Dine Brand's Investor Relations website. With that, I'll turn the call over to Steve.

Thank you, Ken. Well, good morning, everyone, and thank you for joining us. Before we get started, I know the last few months have been challenging for everyone, so I hope you're all safe and doing well. I'd also like to recognize our franchisees and team members for their continued hard work during these difficult times, which has brought out the best in our team across both our organization and system. from creating resourceful ways to drive our business during these times to having a solid focus on our guests and welcoming them back into our restaurants. Our approach has generated some good progress. With that, let's turn to the second quarter results. When we last spoke to you, we provided a look into the sequential improvement in weekly comp sales trends for April. Notably, after reaching lows in late March, the sales trajectory for both brands continued to improve through June as dining restrictions were eased and states began to gradually reopen. Guests who felt more comfortable about restaurant dining were eager to get out after a long period of staying at home, whether that was through off-premise, outdoor, or indoor dining. We set out to bolster this variety of options to meet the different needs of our guests and establish stringent safety protocols that would instill confidence, and keep guests coming back. Despite the impact of COVID-19, our brand showed meaningful progress in recovering, which we believe reflects the successful execution of our off-premise business and the affinity guests have for our brands. While our restaurants have always offered guests respite and a place to enjoy being with friends and family, they've continued to savor our great food increasingly in the comfort of their own homes as the strong growth of our off-premise business demonstrates. We remain optimistic about the overall marked improvement in industry sales and traffic data since April, which would support continued momentum in our business. We're closely monitoring those states that have recently reversed their reopening plans. This situation is obviously fluid at both the state and local levels, so it would be premature to attempt to quantify any impact presently. We're staying nimble in this ever-changing environment and shifting our approaches when warranted, such as refocusing on outdoor dining and off-premise service where it makes sense. We've demonstrated the ability to manage our business during a challenging second quarter, and our franchisees proved their tremendous resiliency in meeting the convenience and safety needs of our guests. We've also leveraged our digital capabilities to support significant growth in our off-premise business. To provide some details, Applebee's online-to-go sales for the second quarter increased sequentially by approximately 18 percentage points to 23% of total sales, with off-premise sales representing 61% of total sales. Similarly, IOP experienced growth of 28 percentage points in online-to-go sales to 35% of total sales during the same period, with off-premise sales representing 54% of total sales. The off-premise business at both brands continued to pose significant growth in the second quarter as guests became more familiar with the platform. We believe our sales will be further supported as dining room restrictions are lowered. John and Jay will provide additional details on their respective brands later. During the reopening process, Dine's crisis management team remains fully engaged with local, state, and federal authorities to obtain the latest information available, enabling us and our franchisees to make well-informed decisions. I'm pleased to say that at the end of the second quarter, 95% of our domestic restaurants are open for either dine-in or off-premise service. This compares to 82% at the end of the first quarter, which primarily consisted of takeout and delivery service. As we reopen dining rooms in accordance with government mandates, the health and safety of our guests, franchisees, and team members are top priorities. In addition to following guidelines provided by the CDC, as well as state and local governments, we've implemented our own operating procedures at both Applebee's and IHOP. These include, but are not limited to, safe food handling procedures in addition to practices to ensure that the restaurants are sanitized, including team members who focus on cleaning and sanitizing common touch points throughout the restaurant. As we continue to welcome guests back, we want to ensure that they feel safe and comfortable whether they choose to dine in restaurant or off-premise. Our research has shown that consumers have a strong desire to return to restaurants. In fact, out of the top five categories that consumers said brought them the most joy, dining out was ranked the highest. As we enter a new normal for dine-in, we know that guests will view health and safety as equal to value and credibility and will continue to serve our guests' needs and desires. Our cross-functional teams have worked relentlessly to ensure our franchisees are equipped with the right information to make sound decisions for their operations and their teams. We're working closely with our franchisees and taking the necessary steps to prepare our restaurants so that we can emerge from this pandemic in a strong competitive position. The coronavirus has had a profound impact on businesses across the country and the globe. As you know, the restaurant industry has been especially hard hit. As a result, industry analysts estimate that a substantial number of independent restaurants that have closed due to COVID-19 will not survive. In contrast, DineGrants has the advantage of scale, a strong cash position and liquidity, experienced restaurant operators, and an asset-like business model. Collectively, this profile has enabled us to withstand the challenges facing our industry, which makes me more optimistic about our future. Looking ahead, We believe that there are potential opportunities to increase our market share due to expected closure of independent restaurants. We'll continue to set the competitive landscape as we focus on our near-term priority, which is returning our core business to sustainable growth. With that, I'll now turn the call to Tom to provide an overview of the first quarter results. Tom? Thank you, Steve. Good morning, everyone. I hope that you and your families are all doing well. Given the circumstances, I'm going to first review the financial initiatives and decisions that Dine has taken during the pandemic. Then I'll discuss our financial results for the quarter. First, we responded by fortifying our financial position during this challenging period for our industry. As a reminder, we borrowed a total of $220 million from a revolving credit facility in March. As of June 30th, the entire amount remains drawn. At the end of the second quarter, we continued to have a strong liquidity position and significant cash on our balance sheet, totaling $342.5 million, of which $278.5 million is unrestricted. I would like to highlight that non-current restricted cash increased by $16.4 million due to DINE voluntarily doubling its interest reserves to enhance our securitization structure. In addition to further support our securitization, we voluntarily accelerated the funding of quarterly interest. And as of today, for example, we have already fully funded interest payments due on September 8th. We did not repurchase our common stock during the quarter and anticipate this will continue for the foreseeable future. Turning to our G&A, we made some very difficult decisions. to furlough approximately one-third of our corporate staff, which led to the sharp decrease in G&A for the second quarter of 2020 to $30.9 million as compared to $39.4 million for the second quarter of 2019. This represents a 22% decline. The decrease was mainly due to lower compensation expenses as well as reductions in other discretionary costs. I would like to clarify that during this quarter of extreme austerity, we were able to reduce our gross cash G&A to approximately $27 million, which includes capital expenditures. However, we are not changing a $30 million per quarter figure that we previously mentioned for G&A and capital expenditures for the remainder of the year, as we have recalled some of our team members from furlough and anticipate resourcing our business to serve our franchisees. To provide financial support for franchisees, we disclosed last quarter that we implemented franchisee assistance measures aimed at enhancing the stability of both brands. The assistance primarily consisted of deferrals of royalty and advertising payments primarily for March and April for both brands and for certain IHOP franchisees, also rent payments. Additionally, we allowed IHOP franchisees to further remodel the new unit development obligations for 2020. Most franchisees did avail themselves of our support. In aggregate, we provided nearly $56 million of deferral for our franchisees. Offsetting these significant deferrals, we received approximately $11 million of deferrals and abatements from our landlords on IHOP properties that are subleased to our franchisees, as well as our other leased properties. While the programs offered, both through Dine and the CARES Act, helped to somewhat mitigate the financial impact of COVID-19 on our franchisees, the effect of dining room closures and restrictions has caused significant deterioration in franchisee cash flows. As a result, we recognized over $5 million of bad debt expense during the second quarter. I would like to note that after the deferral period, both Applebee's and IHOP franchisee collections have been strong, and each brand's ad fund is in a stable position at this point. Also, as previously disclosed, an IHOP franchisee that operated 49 locations initiated an assignment for the benefit of creditors and then subsequently filed for bankruptcy. In July, 41 of the 49 units were sold to a new franchisee approved by us, and as part of the transaction, we received $4.6 million dollars which represents a complete recovery in fees. Let's switch gears to our second quarter financial results. For the second quarter of 2020, we reported an adjusted net loss for diluted share of 87 cents compared to adjusted EPS of $1.71 for the same quarter of 2019. While we started the quarter at a very low point with weekly comps down 77% at Applebee's, and down 82% in IHOP for the weekend of April 5th, both brands improved dramatically, with Applebee's down 18% and IHOP down 34% for the last week of the quarter. This represents improvements of 59 percentage points and 47 percentage points for Applebee's and IHOP, respectively. You'll also see in our recorded results that we recorded over $120 million of impairment losses for the quarter. most of which was attributable to Applebee's goodwill and intangibles. Turning to our securitization, our leverage ratio as of June 30th was 6.3 times, up from 4.8 times as of March 31st. Under our securitization structure, we are required to make quarterly principal payments of $3.25 million when our leverage ratio is greater than or equal to 5.25 times. which is our total debt at quarter end divided by adjusted EBITDA for the four preceding quarters. Please note that exceeding the leverage ratio of five and a quarter times does not violate any covenants related to the securitization. We anticipate making a principal payment in the fourth quarter of 2020. I would like to highlight that our debt service coverage ratio, or DSCR, remains robust at 3.34 times as of June 30th. The first key DSCR measurement is tripped when a ratio is below one and three quarters times. So we have ample cushion. Adjusted EBITDA for the second quarter of 2020 was $12.1 million compared to $68 million in last year's second quarter. Turning to our tax rate, our GAAP defective tax rate for the second quarter of 2020 was 8.2% tax benefit compared to 26.4% expense for the second quarter of last year. The primary reason for the variance was due to the non-deductibility of the impairment of Applebee's Goodwill in the amount of $92 million. I'll wrap up on a positive note. Our international business is off to a promising start in the third quarter. We recently opened four new restaurants. These include two IOPs in Canada, one Applebee's in Mexico City, and one Applebee's in Puerto Rico. We also recently entered into a 13-unit development agreement for IOPs in India with a very experienced multi-unit QSR developer. This is a key market for us and complements our prior development agreement for Applebee's in India, which we executed in late 2019. I would also like to welcome Tony Moraleo, President of our International Division, and Justin Skelton, our new CIO, to Dyn's executive team. To close, while our industry remains challenged, we have taken steps to ensure we continue to maintain strong liquidity and remain responsive to franchisees. Our brands have significant scale, as Steve mentioned, and are well positioned to benefit from any potential contractions. restaurant industry competition. We've experienced meaningful improvement in our off-premise business at both brands, which will greatly complement our dine-in sales when restrictions on restaurant operations are further lifted. With that, I'll now turn the call over to John. Thanks, Tom, and good morning, good afternoon, everyone. I've been looking forward to sharing these results, given all that's unfolded since we last spoke about 90 days ago. I plan to provide detail on Q2 as well as a review of what's transpired here in the month of July. Let's start with a bit of context. Pre-COVID, the Applebee's brand had tremendous momentum. We posted a 3.2% comp sales increase through March 8th, meaningfully outperforming the casual dining category and delivering 10 consecutive weeks of positive sales to start the year. Once the pandemic emerged in March, We temporarily closed about 250 restaurants and quickly moved to an off-premise business model. As a result, April comp sales declined 70.4%. May sales declined 54.1% as we began to reopen our dining rooms. In June, sales were down 29.3% as we began to see a real shift in momentum. Four primary factors impacted our Q2 results. The most obvious was the closing of dining rooms, which represented approximately 85% of our business pre-COVID. Once dining rooms began to reopen, government-imposed capacity constraints represented another meaningful variable, with most geographies imposing a 25% to 50% capacity restriction. Another factor limiting our revenue recovery is the understandably cautious nature of the American consumer in this environment, which of course varies depending upon the geography. And finally, we chose to discontinue all national marketing back on March 18th, and we've been on a self-imposed media hiatus through almost all of Q2, In hindsight, this was absolutely the right strategy as we allowed our ad fund to replenish while waiting for the right time to reintroduce Applebee's to America. Now, let's talk about where we are today. I'm very pleased to announce that 1,600 Applebee's restaurants are currently open for business in the U.S., representing 97% of our portfolio. The remaining 56 restaurants are a combination of temporary and permanent closures that that will evolve slightly as we progress through the balance of the year. Of the 1,600 open restaurants, about 1,450 are fully operational with open dining rooms. And given the recent dining room shutdowns in New Jersey, New York, California, New Mexico, South Florida, and Philly, to name most of them, we now have about 150 restaurants operating in an off-premise only mode with some outdoor dining rooms. and we certainly expect these numbers to evolve as local governments modify their guidelines in this very fluid environment. I want to take a moment to talk about our franchise partners, the restaurant teams, and our cross-functional leadership team. Throughout this pandemic, our top priority has always been the safety of our team members and guests, and our partners have simply been exceptional in delivering upon our elevated brand standards. Remember, there was no playbook for this back in March. The pandemic took us all by surprise, yet this adversity has unlocked, from my perspective, a remarkable entrepreneurial spirit of creativity, agility, and resilience. Virtually everything we do in this environment is new and different, and in many cases, better than it was four months ago. And I couldn't be more proud to be associated with this talented team that I am today. I've often stated that Applebee's is at its best in tough times, and that's certainly proving to be the case once again. And the good news is we're now beginning to see genuine momentum return to the business. Thanks to our franchise partners and our Chief Operations Officer, Kevin Carroll, our restaurants were prepared and ready with respect to safety, sanitation, parking lot staging, social distancing, contact-free dining, outdoor dining, as well as all of our food and beverage standards. After an approximate 90-day media hiatus, we returned to national marketing in mid-June with a terrific digital media plan crafted by our Chief Marketing Officer, Joel Yashinsky. That plan was broadened in early July to welcome guests back to our dining rooms while continuing our off-premise messaging, In particular, we received positive feedback around the tonality and authenticity of our current advertising to the music from Welcome Back, Cotter, for those of you not to call old enough to remember that show. I hope you've had a chance to see that ad because it's the perfect message for Applebee's, as though the lyrics were written specifically for us at this precise point in time, and it appears to have really resonated with our guests. In addition, The current product we're featuring, Applebee's Irresistibles, is a great example of abundant value and broadly appealing innovation developed by our Chief Culinary Officer, Stephen Boldarelli. And this also illustrates, importantly, the power of our supply chain team and their ability to move fast and supply the brand with very little notice, as was certainly the case here. Our restaurant P&Ls have also benefited in this environment. from a substantial reduction in our core menu, resulting in the simplification of our operation, better execution, and a reduction in food and labor costs. Of course, some of this benefit is offset by a heavier reliance upon off-premise and its packaging costs, as well as our investments related to safety and sanitation. So let's talk about our business momentum and provide the complete picture as to where we stand today. After steady and sequential progress throughout Q2, we saw a noteworthy change in our comp sales trajectory from minus 37% in early June to an average of minus 18% over the past six weeks, while posting a minus 15.6% result this past week ending July 26th, representing our best comp sales performance since the crisis began. Additionally, and importantly, according to the most recent four weeks of Black Box reporting, Applebee's is once again outperforming the casual dining category. At present, of our 1,450 restaurants with open dining rooms, average weekly sales are about $39,000, with 64% of this volume being dine-in and 36% off-premise. Now, of this off-premise volume, approximately 68% is Applebee's car side to go, and 32% would be delivery. From my perspective, this convenience-oriented and digitally-led business has really thrived under the leadership of Scott Gladstone, and for obvious reasons is more important to us and our guests than ever before. We remain very well positioned in this off-premise segment, and execution has really become a core competency for of the Applebee's brand. Interestingly, as we reopen dining rooms, we appear to be holding most of our off-premise business with only about a 15% to 20% cannibalization rate, suggesting the relevance and staying power of Applebee's to-go and delivery. On another positive note, after the deferral of March-April royalty and advertising payments, I'd like to highlight that Applebee's ad fund is now in a cash flow positive position as we're also beginning to restore our royalty income stream. While we navigate the uncertainties of this environment, we remain 100% aligned with our franchise partners to return our business to its full revenue potential as quickly as market conditions allow. In closing, I believe Americans will choose brands they trust in this environment. And we've been working hard to nurture that long-standing trust in Applebee's over the past several months. Looking forward, I'm confident Applebee's is well-positioned to continue its trajectory, particularly given our momentum and the likely contraction of CDR restaurant supply over time. With that, I'll turn it to Jay.

Thank you, John. Good morning, everyone. I hope you're all doing well. IOPs performance continued to be impacted by the effects of governmental mandated restrictions on restaurant operations due to COVID-19. This was consistent with the overall family dining category according to industry data. For the second quarter, IOPs comp sales declined 59.1% as traffic remained challenged primarily due to dine-in restrictions, statewide stay-at-home orders, continued high unemployment, and temporary restaurant closures. However, I'd like to highlight that our weekly comp sales for the second quarter improved since the week ending April 5th. In fact, the brand posted 12 consecutive weeks of sequential sales improvement in the second quarter. Additionally, comp traffic improved sequentially every week during the quarter as states began to gradually allow dining rooms to reopen with capacity restrictions, which were generally around 50%. As we entered the third quarter, our performance in July reflected the resurgence of coronavirus cases and dining room restrictions put in place by state and local governments due to the spike. Additionally, we did not utilize national media through the first three weeks of July. As a reminder, we discontinued our marketing late in the first quarter except for some basic local marketing and a brief off-premise campaign. Regarding day part performance, every day parts, sales and traffic improved sequentially month to month in the second quarter. While the overall sales improvement from April to June was fairly even across all day parts, breakfast was approximately 200 basis points behind lunch and dinner respectively. Mainly due to statewide mandates for men at home and rising unemployment, there were essentially less people stopping for breakfast on their way to work. Additionally, the breakfast category in general has faced some pressure compared to other meal periods. According to the NPD group, breakfast or the morning snack occasion has experienced the steepest transaction declines. However, with more people generally staying at home, I'm pleased to report continued strong growth in our off-premise business, even as dining rooms started to reopen. Off-premise comp sales for the second quarter increased by 145%, primarily driven by traffic. Delivery sales accounted for 23.4% of sales mix, and takeout accounted for 33.5% of sales mix for the second quarter. We're successfully leveraging technology to support our to-go business while meeting the convenience needs of our guests. In the second quarter, digital sales grew by approximately 28 percentage points to 35% of total sales. Another facet of our off-premise platform experiencing meaningful growth is curbside pickup, which was launched during the week ending March 29th. The service doubled to 6.3% as a percentage of total off-premise sales for the week ending April 5th compared to the prior week. I'm pleased to say we've seen progressive growth increasing to 8% of off-premise sales for the week ending June 28th. We believe our collective off-premise initiatives will continue to drive sustainable growth as more people are utilizing to-go now than before the pandemic. As a result, a wider range of guests are familiar with the ease and convenience of having their favorite IHOP meals to pick up or be delivered. Now, let's switch gears to the status of reopening our domestic dining rooms. We started reopening on April 21st. As of June 30th, approximately 92% of our domestic system was open for business, of which 88% was open for in-restaurant dining and 4% for takeout and delivery only. Approximately 8% were temporarily closed. As of July 27th, 1,565 domestic restaurants, or 92%, were open for dine-in or off-premise. Undoubtedly, the coronavirus is having a profound impact on our industry. As a result, a significant number of independent restaurants are not expected to survive, as Steve mentioned earlier. This scenario actually provides an opportunity for IHOP to increase its market share as some independents close their doors permanently, and IHOP continues to grow through traditional and nontraditional development. While our growth this year has been adversely affected by COVID-19, our franchisees opened 13 restaurants in the first half of the year, reflecting their continued confidence in the brand and our long-term strategies. Looking ahead, our near-term priorities are to quickly and, most importantly, safely restore sales and traffic to last year's levels. This can be achieved by, first, focusing on the safety of our guests and team members to provide a comfortable environment in our restaurants. Secondly, continue to grow our off-premise business. And third, to provide compelling value propositions to entice guests to come back into our restaurants. While consumers still have some concerns about dining out, there is a strong desire to return to restaurants based on proprietary consumer research. Now, to tie this all together, we have plans to return to marketing broadly and emphasize IHOP's appeal across all day parts, while also focusing on driving off-premise sales. In fact, we recently started national advertising again on the 22nd of this month. To wrap up, Our goal is to return to a sense of normalcy in a way that meets the comfort needs of our guests. We've made some good progress in the second quarter to improve our sales and traffic, but there's more work to be done, obviously. I believe IHOP is well positioned to withstand current industry headwinds and demonstrate why the brand has been ranked the leader in family dining based on domestic restaurant sales for over 10 consecutive years, according to Nation's Restaurant News. I'm very optimistic about the road ahead as state and local government restrictions on restaurant operations are lowered. With that, I'll turn the call back over to Steve for closing comments.

Thanks, Jay. To recap, both Applebee's and IHOP posted steady improvement in weekly comp sales and traffic during the quarter. Our off-premise business continued to deliver substantial growth as guests became more familiar with the to-go service. We ended the quarter with a strong cash position and ample liquidity. Lastly, we are well positioned to withstand current industry headwinds and stand to benefit from the potential opportunities to expand our market share. Now we'll be pleased to open up the call to any questions you may have. Operator?

Ladies and gentlemen, if you have any questions at this time, please press star, then the number one on your touchstone telephone. If you have your questions, I'm with you. From Mr. Jake Bartlett from SunTrust, your line is open, sir.

Great. Thanks for taking the questions. You know, my first one is about I just want to make sure I understand, you know, how many stores are offering dining currently, you know, after California was shut back down. I think some of the numbers you've given were the end of June. So maybe just to clarify that, And then also in terms of Applebee's, and I'm glad to hear the detail on average weekly sales, you know, at stores with offering dining, I think it was 39,000. How does that compare to, you know, the similar period last year? I'm just trying to get a gauge how those stores really are comping, you know, versus stores with only off-premise. Okay. So let's start with open restaurants and then, John, answer the Applebee's. Yeah. Okay. J.K., this is John. 1,450-plus restaurants have dining rooms open at Applebee's. And that number's fluid. It literally fluctuates on a daily, weekly basis, California being the most recent where we lost, I think, 90-plus restaurants in terms of shutting down dining rooms. And I'll come back on the other question after Jay speaks to IHOP.

Yeah, on the IHOP side, we've got basically 78% of our restaurants are open without restrictions. We have 1,320 plus restaurants. We've got 244 restaurants now that are back to doing off-premise only. It's mainly driven by the California change. That's 14% of our system is off-premise. And like I said, we've stood at about 8% that are closed at the moment. I guess for us in California... We have a larger footprint, I think, than Applebee's does out there. Clearly, it has an impact on us. We've been doing, on average, about 35% of our business in to-go across the nation. So that's picked up in California, obviously, when the dine-in goes down. But in looking at our numbers, just as a comparison, when we have a location that, if you look at all of our restaurants that are open for dine-in, they're running a little less than 30% down in sales. If you look at restaurants where they're only doing on-premise, those restaurants average down about 57%. So it clearly makes a difference, over 20% difference, if you don't have the dine-in.

And then, Jake, your final question, the $39,000 weekly volume per restaurant that I referenced is recent, as recent as last week. That would be, to your question, about a $15,000. percent drop from a year ago, average weekly restaurant volumes last year, you know, keep in mind for a brand that's $2.4, $2.5 million annual volume, would be about 46,000 weekly. So we're getting close, and we're seeing sequential improvement each month. I think it's also important to note that those numbers are highly variable depending on market. So we've got some folks that are pretty close to where they were on occasion ahead. We've got some folks, particularly in California, that are obviously, given the restrictions, are struggling. So it's a, you know, those are averages, and it's varying quite significantly across the board. Yeah, I think, Jake, that's an important point. You could look at a state like California where you have a comp sales number of a 50 minus 50 percent, and you can add some other geographies that are positive comp sales numbers. And we certainly have that right now of late. Great. And would you be able to share on the Applebee's side, you know, much like Jay just shared on the IHOP side, the percentage down for dine-in versus off-premise? We can kind of roughly do the math, but if you could help us out, that would be great. The percentage down – look, the delta between – I'll just frame it this way. The delta between total system performance in dining rooms would be about 200 to 300 basis points. In other words, if those dining rooms were open, you'd see a 200 to 300 basis point lift in system comp sales. Great. And the last question was really on the – you shared on the last call some break-even estimates for you know, sales declines, you know, at the store level. Have those changed now that you've had experience with dining rooms being open? Just so you can update us on kind of break-even cash flow sales levels and basically kind of what, I guess, what that would mean for restaurant margins going forward. Tom, why don't you come up with that? Yeah, Jake, as Steve alluded to, there's a tremendous amount of variability. So we did indicate you know, more view on averages as applicable in a highly stressed environment, also benefiting from the fee relief program that we provided in Q2. So at this point, you do have a range where, depending on where our franchisees are located, they're experiencing a variety of different cash flow situations, and we are closely monitoring that. I will speak to our company operating portfolio which we have obviously a lot of visibility. This is our North and South Carolina Applebee's. And so we've obviously experienced dramatic improvements in portfolios performing in line with the entire Applebee's system. And there we anticipate from a four-wall profitability perspective to be either positive for the year. And so hopefully that gives you a little bit of indication just as a data point. Great. Thank you very much. Yeah, and I think the point that Tom made that's important is we are very closely working with our franchisees on their financial health, which obviously has been significantly enhanced by the PPP program. However, we're working very closely with the leadership groups as well as monitoring every single franchisee in terms of where they stand so that we know when people need help and individually we will work with them to help everybody survive. Thank you.

The next question comes from the line of Mr. Nick Satyan from . Your line is open too.

Thanks for taking the questions. It's great to, you know, obviously it's great to see the trends here in July and the cadence of the top line. Tom, just to address a couple of the bigger concerns out there, relative to the Q2 closure rates and relative to the Q2 gross margins, where are we headed in the near term? Can we safely assume that, you know, those gross margin Q2 were as bad as it's going to get? And also just kind of address, you know, what your thoughts are around, you know, unit closures for each brand.

Yeah, so we have an updated guidance. We suspended it, as you know, Nick. But let me give you some context into why some of these. Normally, we wouldn't be able to provide some color on that, but the reason why it's a little tough is simply because you have circumstances, you know, for example, the instance of an IHOP franchisee that had some closures, and then we were able to get a good amount of them transferred to a new franchisee. And so we did have some closures that we deemed permanent during the quarter, but the predictability of that is going to be difficult to determine at this point. With respect to gross margins, a lot of that is obviously by our collections experience. And as I mentioned, the good news there is our collections are getting to be very strong coming out of the relief program, so we believe the relief program had a good intended effect. The PPP program provided a lot of liquidity into the system, and now, as Steve mentioned, we are monitoring our individual franchisees very closely. So one other comment. I've been in this business almost 40 years. I've never seen a quarter like this quarter. I sure hope we're not going to see anything else like this. Yeah. So it's getting better, and it's got to get better from here. So it's a remarkable period. I mean, I just have never seen anything like a quarter like this, and it's just good to have it behind us and good to be moving forward with Simple Metal.

Yeah, absolutely. Fair enough. And then just on the marketing, you know, for both brands, clearly the Applebee's marketing has really worked. How are you thinking about the rest of the year? Are we back to pretty much a normalized cadence? Are there going to be any, you know, periods, short periods or long periods where you're going to go off again? Is menu innovation going to come back with the value focus? How are we thinking about all of those things?

Yeah, let me let both folks address their individual brands. But in general, you know, our view is we're going to make sure that our marketing efforts are sufficient to the opportunity and that we're on air when we need to be. There are some, obviously, as we have every year, some planned gaps, but they're carefully planned so that we don't believe that they're going to cause drops in the momentum. And You know, the interesting thing for Applebee's had a lot of momentum going into this, and so now we want to obviously recoup that. IHOP was doing okay, but we were hoping to pick up from that, and they're showing that they're running neck and neck with competition at this point. Applebee's looks like they're actually running a little ahead of the competition, so obviously we want to maintain that positioning. What you will see is we have significantly increased the level of digital competition. because of the fact that a lot of the efforts that we're doing are about off-premise, and we want to make sure that we're communicating to our 10 or 11 million members between IHOP's program and Applebee's program about specials that we've got available and reasons to come either pick up or come into the restaurant and dine. And so you'll see us shifting a little bit more towards the digital side, as we've done, and had some great success. And then obviously, as we bring additional technology to bear, we're, you know, use your own device and a technology menu that allows us then to continue to grow our ability to communicate with customers. You're going to see us probably step up those digital efforts. And then obviously, we're going to continue to be on air with commercials that we think drive folks either to off-premise or into the restaurant. So, Jay, do you want to talk a little bit about that?

Yeah. We just went back on the air on the 22nd this month, and I would think for us, without disclosing what we're planning on doing, I think the calendar of user marketing will look more similar to what we would typically do. We intentionally turned off our marketing for a long period of time to save that money for the more appropriate time to start marketing. We think that appropriate time is now. I think the other thing we'll do is, you know, we've already pivoted behind the scenes a couple times as to when we were going to start marketing, what we wanted to market, et cetera. And I think that we'll continue to do that the rest of the year. This is a very fluid situation still, as you can see with them closing down diners in California again. So we don't want to spend a ton of marketing dollars pushing just a get back into the restaurant message. if those restaurants aren't going to be open for dining or if they have too much of a capacity restriction. So we're going to be watching the situation closely. We do have the funds, and we will be doing marketing. What we market, we will pivot as time goes by to think about what's the value play we want to do, what's the innovation we want to talk about, what's the capacity in restaurants, how do you keep supporting the off-premise-to-go message. We'll balance all of that and make good decisions through the balance of a year to market the right things.

And then, Nick, on the Applebee's front, we're pretty good at this. We know how to market effectively in this environment. We've demonstrated that. Our fund is healthy. That's really important. That was the benefit of taking that 90-day hiatus. We'll continue to market. Our objective is to maintain top-of-mind awareness, and we'll have extraordinary sensitivity to the environment. That's everything from how our guests feel about dining out, both from a dine-in perspective and an off-premise perspective, to the variability across the country in terms of government restrictions. We can effectively drive demand. As to the, you know, constraint on that demand, we will actively seek that out. And then to your final question, there will be a balance of value orientation and innovation, probably less innovation, to be quite frank, in this environment, given our reduced menu, which has had some significant operational benefits. And then the final point that I would make is the media landscape is going to be different. America needs its sports. And I'm hopeful that some of those currently restricted media vehicles become available. As a result, I anticipate that the media landscape, generally speaking, as we go into next year, is going to have less demand. and for the first time in a long time, an absence of inflation, which is good news. And then you have the election variable, which will be interesting come November.

Thank you very much.

The next question comes from the line of Mr. Jeffrey Bernstein from Barclays. Your line is open, sir.

Great. Thank you very much. Two questions. One, it seemed like both brands, you talked about independence and potential for significant store closures. I'm just wondering what you've seen already or what your expectation is in terms of the industry as a whole or whether any particular brand is more or less vulnerable. Presumably that creates a market share opportunity for you. And it does raise the question, because I think many people think of franchisees as quote-unquote independent operators. So I'm just wondering whether you guys see yourself vulnerable to more closures in your system, Eddie, the brand. And then I had one follow-up.

So let me start, and we'll cut up. So if you're seeing the same numbers that we're seeing, where people are projecting upwards of 75% or higher of independents closing. So obviously, there's going to be a lot of buildings available for conversion. And you had several brands that went pre-virus were struggling. So obviously, and you've seen some of the numbers, they're closing a lot of restaurants. You know, we're obviously looking at this all very carefully. There are some restaurants that will probably close. A lot of those restaurants were marginal before they started, so this has sort of just hastened the potential loss of a couple more units. We are not viewing this as a major change to either of the systems. and obviously we're prepared to step in and assist where we think it makes sense with individual franchisees. We're also prepared to look at restaurants long-term that probably are on the margin anyway and say, okay, well, do they have a long-term viability or not? Now is as good a time as any to try to figure out a way out of those restaurants, provided we get replacements for them. So it's a combination of efforts that we think is mostly upside for us, And we think at the far end of this episode, I think what you're going to see is the companies that emerge with strong financial capabilities are going to be in a really good position for growth, and that's sort of the way that we're viewing it. Tom, you want to comment on what the brain guys thought? Yeah, I think the one thing independents don't have, and to your point on – To your point on whether or not franchisees are viewed as independent, we view them as independent operators, obviously, but they're affiliated with a national brand with all of our resources. And I did mention we are bringing back resources as appropriate. We also have a very strong liquidity position, and we are willing to step in. We did that in the past. We have our own company operating portfolio, obviously, Jeff. And so... We have a number of levers that we can apply that true independents probably don't have at their disposal.

Yeah, I just think from the IHOP side, you know, keep in mind, like I said, we opened 13 restaurants this year at the beginning of the year. We have a strong desire for growth on the IHOP side and had a lot more restaurants that we're planning on opening this year that we allowed deferrals for franchisees. So, We think our growth engine is going to get going again once this passes. But as Steve said, we have a long history of working with franchisees and trying to find replacement restaurants or finding new owners in some situations because the reasons why restaurants close down are varied. There's a lot of different reasons why those things happen. We assess those situations and figure out, is this restaurant viable with a little different structure, with a new ownership group or not? Or does it just need to be replaced with a new restaurant? So we assess all those things as we're making these decisions. I would expect we will have more closures. How many, though, is just too many variables to even kind of think through what that might look like right now. And any time we get those situations, we're trying our best to save the restaurant through a different franchisee or to not have a permanent closure. That's why we have temporary closures that we talk about because we tend to get those restaurants back. And as you heard Tom say, you know, we lost 49 restaurants in a bankruptcy deal, and we're going to get probably 41 of those back here pretty soon.

And then, Jeff, this is John. The reason I'm bullish on Applebee's is if you look at the categories, you look at QSR and fast casual and casual dining, In particular, the one category that is absolutely disproportionately reliant upon independent restaurants is casual dining. 90-plus percent of all restaurants in casual dining are independent, which means strong, vibrant brands with scale who are well-positioned will benefit significantly. It would be the one category that stands out in terms of opportunity.

And to clarify... I think at the beginning of your comments, Steve, you mentioned something about you were hearing numbers of 75% of independents were potentially closing. I just want to make sure I heard that correctly.

Yeah, yeah, those are the headlines that we've been seeing. I've seen numbers 75% to 85%. I don't know whether that's right or not. I've also seen the Restaurant Association saying, they think the total number for the industry could be a third to 40% of losses, and most of those being in the independent range. So, you know, I think the discussion around scale and brand awareness and the ability to do digital work and the technology we can bring is just out of reach for most independents, and that's why you're seeing them bear the brunt of this. And so our expectation is, There's no question we will close some restaurants, but we don't think the number is going to be a big number. And when people write articles about the industry being under turmoil, they'll throw things in like that bankruptcy. And they say, look, IHOP's closed 49 restaurants. They don't come back and say it, but they reopened 41 of them, which is pretty much the case as we've seen in a couple of these instances so far. So our expectation is we're going to keep most of our restaurants and we'll have some closures, but then we're going to have a lot of growth opportunity afterwards.

Understood. Thanks for the call.

The next question comes from the line of Brett Levy from MKM Partners. The line is open.

Thank you for taking my call. Hope you are all doing well. I guess if we could just try to circle back on some of the questions that were asked, try asking them in a different way, see if I get a different answer. When you talk about your break-even propositions for units that have dining rooms versus those that are off-premise only, what do you think the sales gap is? Is it possible that the margins, given the operational improvements you're making, can actually expand beyond where they were, or are these incremental costs that you're – that you're introducing for greater off-premise and safety, are those enough to overwhelm any of the recovery?

So that's a great question. So I'm going to have Tom weigh in a little bit on the margins. So here's the way to think about it. We've got some incremental costs associated with PPE, making sure that guests are safe, associates are safe. But those have been offset and probably benefited from a more tightly grouped menu with a focus on the things that are really moving. So one of the benefits of this is in both brands, we have had extensive menus and have been working with franchisees to try to bring that number down. Obviously, everybody feels their guests, you know, like something different, so hence the proliferation of products on the menu. But this has allowed us to tighten the menu in conjunction with the franchisees in a way that allows better execution in the kitchen and also provides better cost management as a result. So our view is coming out of this, we have the opportunity to maintain that off-premise and return to comparable dining room levels over a period of time. Your guess as to the recovery line is as good as mine at this point. Well, I think we'll know a lot more this fall. But the opportunity on the upside is if we gain back those restaurant sales and we maintain the bulk of the off-premise, that puts us in a better position from a revenue standpoint than before. And with a lower number of different items on the menu, a higher efficiency in the kitchen, we're probably going to be more profitable. Now, that's notwithstanding sort of food cost spikes that we're seeing, whether it's in pork or beef or whatever. But those will presumably settle out as well. So the opportunity going forward for profitability in the restaurants is probably better than it was, provided we return everybody back into the dining room. And so the combination of those two, we feel, is potentially an upside in the long term. So... Brett, let me give some additional data points here. So, with respect to the incremental costs, we did ask both brands' operations teams to assess the one-time cost of reopening the restaurant. So, those are, indeed, costs that are foreign to enhance sanitation standards. And that averaged out to about $3,000 per restaurant. The ongoing costs add up to about approximately $1,000 per week. And so... They're not insignificant. They are incremental to the restaurants. Now, when you look at dining rooms that are open versus that are in off-premise mode only, I'm going to apply this number to both brands because it's about the same. There's a 30-point sales lift if the dining rooms are available to be open. So, again, if you look at our averages that we put out there with respect to comps for both brands, that's a blend. That's a blend of dining rooms are open and dining rooms are closed, and if the dining room's open, you get a 30 percentage point lift. When we think about even those restaurants that are open, let's keep in mind, they're not open 100%. So, using our North and South Carolina restaurants as an example, they're subject to six-foot distancing or 50% restrictions. That's very typical of dining rooms that are open. So, they're capacity constrained, and that puts a tap on some of the sales performance, even in those restaurants that are open. For Applebee's in particular, there's restrictions on late-night operations or the bar past a certain hour. And so, again, we feel as things improve in the country and some of these incremental – it's not a digital function of dining room being open or not. We think there's some room for improvement. as even those restaurants with dining rooms open have additional restrictions lifted.

So I would just say from an IHOP standpoint, if you... If you talk to our franchisees, they will tell you there are puts and takes on this, right? In some ways, having a reduced menu probably reduces some food costs. You get more efficient with what you're managing, et cetera. And some franchisees have seen less prep labor because they're not making as many things that we were doing before. But the takes, the amount of cost for the ongoing sanitizer, gloves, masks, et cetera, are probably outweighing that right now. So if you talk to the franchisees, they would probably tell you, not enough puts, too many takes right now. I think the key thing Steve said, though, was, We have a huge top-line opportunity coming out of this because we have taught people how to use this for to-go and to do off-premise. And as Steve said, we can maintain even half of the increase we've gotten on that and get our dining rooms back to full capacity. Our sales are up, and that flow-through and that leverage is going to lead to higher profits. So there's a big opportunity for us. But if you ask the franchisees right now, while they're still down 35% in sales, they'll tell you it's not working for them right now. We've got to get the top line back.

Nothing to add on my end. Go ahead.

And if you think about the franchise system just in general, if you could bucket it, like what percentage of the system do you think is healthy versus those that are still extremely or significantly challenged and might need some additional help, either hand-holding or financially? And then what kind of bucket of your franchisees are out there saying, you know what, we are interested in buying more. We are interested in building more. We want to get back to the growth algorithm.

Yeah, so obviously there are variances in the health of the franchisees. I will tell you it existed pre-virus, and so the virus may have made some situations a little more intense than before that. I will tell you that because all of the franchisees, or the vast majority, were able to take advantage of the PPP program, that's clearly helped. And then we've got individual franchisees that we're working with who are going to need some assistance from a short-term basis to weather the storm, and we plan on doing that individually with them as opposed to what we've done where the virus started on a programmatic basis, which is what we've always done, by the way. And so our view is, you know, franchisees in general are in a pretty good position, but it also depends on the recovery. And so if you're telling me that we're going to get a relatively rapid bounce back this fall and into the end of next year and then end of this year and then next year looks pretty normal, we're in pretty good shape. If it's an extended period of recovery, then individual franchisees by franchisees, some of them are going to need some assistance, and some of them will end up figuring out what the best long-term solution is for those restaurants. So it is a kind of week-by-week scenario of, you know, look, if you look at our restaurants, We are cash flowing in North and South Carolina. We're not making a lot of money, but we're cash flowing. And so, you know, and that's not – we've got a lot of franchisees in that position, but we've also got some franchisees that are in tougher markets that are not doing as well. And California is a great example of, you know, with dining rooms closed, nobody's going to make any money. So the question is, how long does that last? And, you know, do they have the sufficient funds – to withstand that period of time before they reopen and then recover. And then we're going to assist individually with franchisees to help them either figure out long-term positioning of their assets or to maintain, to sustain into a recovery period.

Thank you very much.

The last question comes from the line of Mr. Brian Vaccaro from Raymond James. Your line is open, sir.

Yeah, thanks for taking my questions. So back to the last one you were just talking about on franchisee health. In the past, I guess a few years ago, you did a nice job disclosing sort of how many franchisees you were working with, you know, the nine and the three. That obviously healed from there. But would you be willing to maybe just frame a little bit more how many franchisees or what percent of units at each brand are operated by franchisees that are on your radar of receiving additional relief or help?

Yeah, well, and the reason we're not doing that is because it's a very different situation. So the answer is there's a handful that we may or may not begin talking with, but it's nothing like the previous downturn for the Applebee's franchisees. Obviously, everybody's hurting and everybody's looking for profitability. One of the reasons we're doing a dramatically stepped-up cooperative effort with the franchisees is to take a deep look into the sustainability longer term. If this thing runs at this level's through the end of the year and next year starts out slow, that changed the picture dramatically. But we're not – there's no major program underway at this point. And, Brian, I guess the other point that I'd make is an obvious one, but the one thing, you know, that we're working hard to do is return – each business for full revenue as quickly as possible considering market conditions. So Q3 is important. Q3 is going to give us some visibility to that rate of return towards positive sales. Yeah, and I think the two you've heard about were problems pre-virus. They had nothing to do with the virus. And those both turned out pretty well for us.

Yeah, yeah, understood. Okay. And I guess just to be clear on the status of franchisee release, more recently as the business has recovered? Are essentially all franchisees now paying royalties and advertising fees in the case of IHOP rental payments? And if not, what percent of each brand are still receiving some level of deferrals?

Hey, Brian. So for all intents and purposes, we're back to kind of a normative rate of collections on both brands. And with respect to IHOP, actually, there were many of our franchisees that you saw the numbers. They were struggling. Having said that, one of the conditions of PPP was that the money was used to pay not only employees but also rent. And so we had a good rate of payment on the rents as well after the deferral period.

Okay, all right. And then I wanted to ask on Applebee's side, back to some of the operational changes that were made, in terms of streamlining the menu, could you help frame what percent of the items you've removed, and how do you plan to manage adding back items to the menu, and where could that land ultimately compared to the historical menu?

Hey, Brian, that's a good question. This is John. Proliferation of a menu, you know, in any mature brand is something that has taken place over a couple of decades. So we've taken about a third directionally of our menu items off the menu. It'll stay off that, you know, we have focused on items that are in high demand, high velocity, low complexity. And we've removed, you know, the third that we've removed represent, you know, probably 10% of dollar volume, but we easily move guests to like items. Our franchisees are very enthusiastic about that. And in terms of adding items back, I don't anticipate additional proliferation. We'll be smart and strategic. If we decide to add items, we're going to take other items off. And so that discipline... has been in place for a while here. The pandemic has accelerated our movement to a simplified operation, which has guest benefits and financial benefits.

Yeah, this is Jay. On the IHOP side, we did a very similar thing. We cut the menu by a percentage, and we intend to leave most of that off as well. We think there will be some items that may come back, and more importantly, we leave ourselves a little bit of space for some new innovation as time goes by. But it's not going to get back to the level that it was.

Okay, and then also on the operational side, could you provide more color on the measures that franchisees have taken to expand capacity during COVID, whether it be expanded outdoor seating or adding plastic barriers in the restaurants to optimize booth seating? Just kind of frame or quantify how important those factors have been.

Hey, Brian, John here. You know, we have 30 partners at Applebee's. They're naturally entrepreneurial. They've been successful and efficient. What we see both in – now, of course, this assumes, you know, they are permitted to have outdoor dining, which is its own complexity, but significant creativity around that. And then the, you know, whether it's a barrier or anything that can be introduced inside of a restaurant that allows additional capacity, there's been a lot of creativity there around – plexiglass items that can separate adjacent booths and eliminate the need for six-foot distancing. Those tend to be branded. They tend to be high quality. As Tom referenced, cost. Some of that is initial, kind of out-of-pocket, one-time cost that won't be recurring, but allows these guys to maximize their capacity in the face of constraints. All good. I mean, there's a whole lot of creativity taking place right now on a daily basis.

On the IHOP side, we're doing very similar things. This is where it's great to be in a franchise system because franchisees are much more entrepreneurial. That is where they are similar to independents. When their survival is at stake, they find creative ways to solve problems. They've done some very interesting things. What we do is When we get the things that they have done locally, oftentimes we'll share those as best practices out to the system. In fact, we do regular town hall calls with our franchisees. We actually had our architect on the call with them on one of our recent calls to walk them through how to execute this if your local municipalities will allow it and what are the steps to do it and how to make it look and what are the specs to do that. So, yeah, it's been very, very successful where they've done it.

All right, thank you. I'll pass it along.

Thanks, Brian. Thank you. So just for the question about sort of the overall industry, there's a National Restaurant Association statement out that says, The restaurants have lost more revenues and jobs than any other industry. And they estimate that in June, for the first three months of the pandemic, it was $120 billion in lost revenue, which is why we're working with the National Restaurant Association, International Franchise Association, National Retail Federation for more assistance for the industry and our franchisees. And then according to the Restaurant Coalition, the Independent Restaurant Coalition, they They were the ones that put out the number that 85% of independent restaurants may go out of business by the end of 2020. So, sobering numbers. However, you know, one person's crisis is another person's opportunity. And our view is we're going to emerge from this thing with a lot of strength and capital. And that's going to put us in a position to resume a significant growth trajectory for the company. And we are... excited about seeing that momentum build and we get a recovery and full opening of all the restaurants and then take the lessons learned and have higher revenues and higher profitability as a result. It looks like a long road to that at this point, but there is a road and a vision to get there over time. So with that, I just want to close, say thank you for your time. I hope everyone's staying safe and healthy. Visit our restaurants. We do a good job of creating a safe, healthy environment with great food. So thank you again for your time, and we'll look forward to speaking with you next quarter.