DIN – MASKING THE TRUTH

When DIN first announced its intention to acquire Applebee’s in July 2007, it communicated its goal to franchise the majority of Applebee’s company-operated restaurants. In November 2007, the company said it expects to franchise approximately 475 company-operated units by 2010. In February of this year, DIN issued guidance around the expected cash proceeds from these sales and said that for FY08, the company expected to generate $90-$100 million in after-tax cash proceeds from the sale of 100 units (implies an average of $900K-$1M of cash proceeds per unit).

On March 19, DIN appeared to be having some success in achieving these goals when it announced that it had entered into two separate asset purchase agreements to sell 41 restaurants in Southern California and Nevada. Although the company did not disclose the sales dollar amount, DIN did reiterate its expectation to sell 100 restaurants in FY08 for $90-$100 million in proceeds, implying that these 41 units would be sold within the $900K-$1M per unit range. About 4 months later in early July, DIN announced that it did complete the sale of its 26 units in Southern California (26 of the 41 units in which the company had entered into purchase agreements) for $27 million in after-tax cash proceeds. This transaction again signaled that DIN was on track to reach its $90-$100 million goal as these 26 units sold on average for $1.04M, slightly better than the company’s $900K-$1M guided range. Unfortunately, that was when the good news ended.

  • By the end of July, DIN reiterated its guidance to franchise about 100 units in FY08 but lowered its after-tax cash proceeds target to $70-$80 million, which implies an average of $700K-$800K per unit (about a 20% cut in proceeds per unit). Yesterday, DIN reported that it sold an additional 3 units in Delaware in 3Q and 15 units in Nevada subsequent to 3Q’s close. These 15 units in Nevada make up the remainder of the 41 restaurants for which the company had entered into a purchase agreement back in March (took about 7 months to close). Additionally, DIN announced yesterday that subsequent to 3Q’s close, it has entered into asset purchase agreements for the sale of 66 restaurants. The company did not disclose the sales dollar amounts for the 3 units in Delaware, the 15 units in Nevada or the remaining 66 units, but it did say that it expects to generate $63 million in after-tax cash proceeds from all of its already completed and pending sales, which total 110 units (including the 26 units sold in Southern California for $27 million).
  • This $63 million in proceeds implies an average of $573K per unit, a 36%-43% reduction from management’s initial implied guidance in February and an 18%-28% decline from management’s revised guidance in July. We know that 26 of those 110 units sold for $27 million, so the remaining 84 units (18 already completed, 66 pending) are expected to generate only $36 million in cash proceeds, or $429K per unit. Management made a point to say again and again on its 3Q earnings call yesterday, that the units sold/pending thus far are the lowest profit performing restaurants in the Applebee’s system as justification for the lower than expected cash proceeds. The company did not, however, lower its cash proceeds guidance which seemed to be an attempt to not even address the fact that proceeds have come in way below guidance. But remember, according to management, things will get better because these units represent Applebee’s worst performing units. Might the lower proceeds have something to do with the current credit environment and the casual dining segment’s overall performance as of late?
  • That all being said, the cash proceeds forecasts keep getting worse and will likely continue to do so. Although DIN has entered into purchase agreements for the sale of 66 units and has given its projected cash proceeds, a lot could happen before these transactions actually close. Remember the 41 units under purchase agreements announced back in March. At that time, management reiterated its initial guidance, and the 26 units in California met that guidance. The remaining 15 units in Nevada did not close until 7 months later and based on the average $427K per unit in cash proceeds received, those Nevada units fell short of the guidance issued even after purchase agreements were announced. So those 66 units could very well fall short of management’s guidance issued yesterday, which would cause that average $427K per unit to come down again.
  • Management tweaking…
    Yesterday’s press release which announced that DIN had entered into asset purchase agreements for the sale of 66 company-operated units stated that the company expects to generate $63 million in after-tax cash proceeds from the sale of these 110 completed/pending restaurant sales. It went on to say that DIN “expects to assign approximately $50 million of sale-leaseback related rental obligations related to the 110 restaurants sold to the acquiring franchisee as a part of these transactions. Between transaction proceeds and the related reduction of sale-leaseback rental obligations, refranchising activities announced to date will enable the Company to reduce consolidated funded debt and financing obligations by approximately $113 million.”

  • At first glance that $113 million in reduced debt seems right in line with management’s initial guidance to generate $90-$100 million in after-tax proceeds from the sale of 100 units in FY08, but those numbers are not comparable. Instead, DIN is definitely falling short of its initial goal and now expects to generate only $63 million in proceeds (not the $90-$100 million). In its 3Q earnings release the company did not even mention the $63 million number or the $50 million of sale-leaseback related rental obligations. It just stated that the 110 units sold/pending would enable the company to reduce its debt and financing obligations by $113 million. Based on DIN’s initial cash proceeds guidance which again was in the ballpark of that $113 million, I thought this was an interesting way to present the numbers.

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