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EX-32.1 - SECTION 906 CEO CERTIFICATION - DineEquity, Incdin-2016930x10qxex321.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - DineEquity, Incdin-2015930x10qxex322.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - DineEquity, Incdin-2016930x10qxex312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - DineEquity, Incdin-2016930x10qxex311.htm
EX-12.1 - COMPUTATION OF RATIOS - DineEquity, Incdin-2016930x10qxex121.htm
EX-10.1 - NONQUALIFIED DEFERRED COMPENSATION PLAN - DineEquity, Incdin-2016930x10qxex101.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________ 
FORM 10-Q
 (Mark One)
x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2016
 OR
o      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                  to                
 
Commission File Number 001-15283
appblogonewa05.jpg DineEquity, Inc. ihoplogonewa03.jpg
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or
organization)
 
95-3038279
(I.R.S. Employer Identification No.)
 
 
 
450 North Brand Boulevard, Glendale, California (Address of principal executive offices)
 
91203-1903 (Zip Code)
 
(818) 240-6055
(Registrant’s telephone number, including area code)
 ______________________________________________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding as of October 28, 2016
Common Stock, $0.01 par value
 
18,094,014
 



DineEquity, Inc. and Subsidiaries
Index
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




Cautionary Statement Regarding Forward-Looking Statements
 
Statements contained in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those expressed or implied in such statements. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors” in our most recent Annual Report on Form 10-K, as well as our consolidated financial statements, related notes, and the other financial information appearing elsewhere in this report and our other filings with the United States Securities and Exchange Commission. The forward-looking statements contained in this report are made as of the date hereof and the Company assumes no obligation to update or supplement any forward-looking statements.

Fiscal Quarter End

The Company’s fiscal quarters end on the Sunday closest to the last day of each calendar quarter. For convenience, the fiscal quarters of each year are referred to as ending on March 31, June 30, September 30 and December 31. The first fiscal quarter of 2016 began on January 4, 2016 and ended on April 3, 2016; the second and third fiscal quarters of 2016 ended on July 3, 2016 and October 2, 2016, respectively. The first fiscal quarter of 2015 began on December 29, 2014 and ended on March 29, 2015; the second and third fiscal quarters of 2015 ended on June 28, 2015 and September 27, 2015, respectively.


1


PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.
DineEquity, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
Assets
 
September 30,
2016
 
December 31, 2015
 
 
(Unaudited)
 
 
Current assets:
 
 

 
 

Cash and cash equivalents
 
$
107,823

 
$
144,785

Receivables, net
 
93,935

 
139,206

Restricted cash
 
34,958

 
32,528

Prepaid gift card costs
 
36,728

 
46,792

Prepaid income taxes
 
1,966

 
5,186

Other current assets
 
5,036

 
4,212

Total current assets
 
280,446

 
372,709

Long-term receivables, net
 
145,072

 
160,695

Property and equipment, net
 
205,230

 
219,580

Goodwill
 
697,470

 
697,470

Other intangible assets, net
 
765,773

 
772,949

Deferred rent receivable
 
88,034

 
90,030

Other non-current assets, net
 
18,396

 
18,417

Total assets
 
$
2,200,421

 
$
2,331,850

Liabilities and Stockholders’ Equity
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
32,625

 
$
55,019

Gift card liability
 
104,201

 
167,657

Accrued employee compensation and benefits
 
15,792

 
25,085

Dividends payable
 
16,675

 
17,082

Current maturities of capital lease and financing obligations
 
14,346

 
14,320

Accrued advertising
 
11,875

 
8,758

Accrued interest payable
 
4,314

 
4,257

Other accrued expenses
 
6,565

 
6,251

Total current liabilities
 
206,393

 
298,429

Long-term debt, net
 
1,281,873

 
1,279,473

Capital lease obligations, less current maturities
 
73,603

 
84,781

Financing obligations, less current maturities
 
39,518

 
42,395

Deferred income taxes, net
 
252,907

 
269,469

Deferred rent payable
 
71,574

 
69,397

Other non-current liabilities
 
18,027

 
20,683

Total liabilities
 
1,943,895

 
2,064,627

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value, shares: 40,000,000 authorized; September 30, 2016 - 25,138,172 issued, 18,092,139 outstanding; December 31, 2015 - 25,186,048 issued, 18,535,027 outstanding
 
251

 
252

 Additional paid-in-capital
 
290,365

 
286,952

 Retained earnings
 
378,172

 
351,923

 Accumulated other comprehensive loss
 
(107
)
 
(107
)
Treasury stock, at cost; shares: September 30, 2016 - 7,046,033; December 31, 2015 - 6,651,021
 
(412,155
)
 
(371,797
)
Total stockholders’ equity
 
256,526

 
267,223

Total liabilities and stockholders’ equity
 
$
2,200,421

 
$
2,331,850


 See the accompanying Notes to Consolidated Financial Statements.

2


DineEquity, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 

 
 

 
 
 
 
Franchise and restaurant revenues
 
$
123,259

 
$
128,188

 
$
380,034

 
$
407,774

Rental revenues
 
30,507

 
31,221

 
92,746

 
93,755

Financing revenues
 
2,251

 
3,028

 
7,019

 
8,271

Total revenues
 
156,017

 
162,437

 
479,799

 
509,800

Cost of revenues:
 
 

 
 

 
 
 
 
Franchise and restaurant expenses
 
41,553

 
41,984

 
122,129

 
145,433

Rental expenses
 
22,771

 
23,264

 
69,032

 
70,073

Financing expenses
 
9

 
504

 
155

 
516

Total cost of revenues
 
64,333

 
65,752

 
191,316

 
216,022

Gross profit
 
91,684

 
96,685

 
288,483

 
293,778

General and administrative expenses
 
36,002

 
41,577

 
111,937

 
110,384

Interest expense
 
15,358

 
15,434

 
46,107

 
46,757

Amortization of intangible assets
 
2,500

 
2,500

 
7,480

 
7,500

Closure and impairment charges, net
 
206

 
(72
)
 
3,932

 
2,230

Loss (gain) on disposition of assets
 
113

 
(2,351
)
 
679

 
(2,294
)
Income before income tax provision
 
37,505

 
39,597

 
118,348

 
129,201

Income tax provision
 
(13,232
)
 
(15,340
)
 
(41,703
)
 
(49,635
)
Net income
 
24,273

 
24,257

 
76,645

 
79,566

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(1
)
 
(14
)
 

 
(26
)
Total comprehensive income
 
$
24,272

 
$
24,243

 
$
76,645

 
$
79,540

Net income available to common stockholders:
 
 
 
 

 
 
 
 
Net income
 
$
24,273

 
$
24,257

 
$
76,645

 
$
79,566

Less: Net income allocated to unvested participating restricted stock
 
(338
)
 
(316
)
 
(1,103
)
 
(1,042
)
Net income available to common stockholders
 
$
23,935

 
$
23,941

 
$
75,542

 
$
78,524

Net income available to common stockholders per share:
 
 

 
 

 
 
 
 
Basic
 
$
1.33

 
$
1.29

 
$
4.17

 
$
4.19

Diluted
 
$
1.33

 
$
1.28

 
$
4.15

 
$
4.16

Weighted average shares outstanding:
 
 

 
 

 
 
 
 
Basic
 
17,950

 
18,573

 
18,099

 
18,737

Diluted
 
18,041

 
18,706

 
18,201

 
18,874

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.92

 
$
0.875

 
$
2.76

 
$
2.625

Dividends paid per common share
 
$
0.92

 
$
0.875

 
$
2.76

 
$
2.625

 


See the accompanying Notes to Consolidated Financial Statements.

3


DineEquity, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
 
Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
Cash flows from operating activities:
 
 

 
 

Net income
 
$
76,645

 
$
79,566

Adjustments to reconcile net income to cash flows provided by operating activities:
 
 

 
 

Depreciation and amortization
 
22,924

 
24,134

Non-cash interest expense
 
2,400

 
2,292

Deferred income taxes
 
(14,852
)
 
(12,512
)
Non-cash stock-based compensation expense
 
8,215

 
6,312

Tax benefit from stock-based compensation
 
1,153

 
4,850

Excess tax benefit from stock-based compensation
 
(966
)
 
(4,577
)
Closure and impairment charges
 
1,461

 
2,230

Loss (gain) on disposition of assets
 
679

 
(2,294
)
Other
 
456

 
(1,303
)
Changes in operating assets and liabilities:
 
 

 
 

Accounts receivable, net
 
4,312

 
(95
)
Current income tax receivables and payables
 
(1,138
)
 
5,703

Gift card receivables and payables
 
(30,355
)
 
(11,816
)
Other current assets
 
(824
)
 
(3,304
)
Accounts payable
 
(1,397
)
 
2,147

Accrued employee compensation and benefits
 
(9,293
)
 
(4,915
)
Accrued interest payable
 
57

 
(10,275
)
Other current liabilities
 
2,581

 
(5,554
)
Cash flows provided by operating activities
 
62,058

 
70,589

Cash flows from investing activities:
 
 

 
 

Additions to property and equipment
 
(3,543
)
 
(5,765
)
Proceeds from sale of property and equipment
 

 
10,782

Principal receipts from notes, equipment contracts and other long-term receivables
 
13,969

 
16,498

Other
 
(393
)
 
(274
)
Cash flows provided by investing activities
 
10,033

 
21,241

Cash flows from financing activities:
 
 
 
 

Principal payments on capital lease and financing obligations
 
(10,391
)
 
(9,711
)
Dividends paid on common stock
 
(50,790
)
 
(49,786
)
Repurchase of common stock
 
(45,010
)
 
(50,010
)
Tax payments for restricted stock upon vesting
 
(2,680
)
 
(3,389
)
Proceeds from stock options exercised
 
1,282

 
8,426

Excess tax benefit from stock-based compensation
 
966

 
4,577

Change in restricted cash
 
(2,430
)
 
10,036

Other
 

 
(91
)
Cash flows used in financing activities
 
(109,053
)
 
(89,948
)
Net change in cash and cash equivalents
 
(36,962
)
 
1,882

Cash and cash equivalents at beginning of period
 
144,785

 
104,004

Cash and cash equivalents at end of period
 
$
107,823

 
$
105,886

Supplemental disclosures:
 
 

 
 

Interest paid in cash
 
$
51,940

 
$
64,094

Income taxes paid in cash
 
$
56,734

 
$
51,794

 
See the accompanying Notes to Consolidated Financial Statements.

4


DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

1. General
 
The accompanying unaudited consolidated financial statements of DineEquity, Inc. (the “Company” or “DineEquity”) have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The operating results for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the twelve months ending December 31, 2016.
 
The consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
 
These consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
 
2. Basis of Presentation
 
The Company’s fiscal quarters end on the Sunday closest to the last day of each calendar quarter. For convenience, the fiscal quarters of each year are referred to as ending on March 31, June 30, September 30 and December 31. The first fiscal quarter of 2016 began on January 4, 2016 and ended on April 3, 2016; the second and third fiscal quarters of 2016 ended on July 3, 2016 and October 2, 2016, respectively. The first fiscal quarter of 2015 began on December 29, 2014 and ended on March 29, 2015; the second and third fiscal quarters of 2015 ended on June 28, 2015 and September 27, 2015, respectively.
 
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries that are consolidated in accordance with U.S. GAAP. All intercompany balances and transactions have been eliminated.
 
The preparation of financial statements in conformity with U.S. GAAP requires the Company’s management to make assumptions and estimates that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, if any, at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates are made in the calculation and assessment of the following: impairment of tangible assets, goodwill and other intangible assets; income taxes; allowance for doubtful accounts and notes receivables; lease accounting estimates; contingencies; and stock-based compensation. On an ongoing basis, the Company evaluates its estimates based on historical experience, current conditions and various other assumptions that are believed to be reasonable under the circumstances. The Company adjusts such estimates and assumptions when facts and circumstances dictate. Actual results could differ from those estimates.
 
3. Accounting Policies
 
Accounting Standards Adopted in the Current Fiscal Year
 
Various updates to accounting guidance became effective in the Company's first fiscal quarter of 2016. The majority of these updates either did not apply to the Company's operations or will only apply if the activity addressed in the guidance takes place in the future. Adoption of updates that did apply to the Company's operations did not have a material effect on the Company's financial statements.

Newly Issued Accounting Standards Not Yet Adopted

In August 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance on the classification of certain cash receipts and payments in the statement of cash flows. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The Company will be required to adopt the new guidance beginning with its first fiscal quarter of 2018; early adoption is permitted. The Company is currently assessing the impact that the new guidance will have on its consolidated statements of cash flows.

In June 2016, the FASB issued new guidance on the measurement of credit losses on financial instruments. The new guidance will replace the incurred loss methodology of recognizing credit losses on financial instruments that is currently required with a methodology that estimates the expected credit loss on financial instruments and reflects the net amount

5

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)

3. Accounting Policies (Continued)

expected to be collected on the financial instrument. Application of the new guidance may result in the earlier recognition of credit losses as the new methodology will require entities to consider forward-looking information in addition to historical and current information used in assessing incurred losses. The Company will be required to adopt the new guidance on a modified retrospective basis beginning with its first fiscal quarter of 2020, with early adoption permitted in its first fiscal quarter of 2019. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements and related disclosures and whether early adoption will be elected.

In March 2016, the FASB issued new guidance that addresses accounting for certain aspects of share-based payments, including excess tax benefits or deficiencies, forfeiture estimates, statutory tax withholding and cash flow classification of certain share-based payment activity. The Company will be required to adopt the new guidance beginning with its first fiscal quarter of 2017. Early adoption is permitted as long as all amendments addressed in the new guidance are adopted in the same period. The method of adoption varies based on each specific aspect addressed in the new guidance.

The Company believes one impact of the new guidance on its financial statements will be the recording of excess tax benefits or deficiencies in its provision for income taxes upon adoption of the new guidance instead of the current recording in additional paid-in capital. The Company is currently evaluating the impact of other aspects of the new guidance on its consolidated financial statements and disclosures.

In February 2016, the FASB issued new guidance with respect to the accounting for leases. The new guidance will require lessees to recognize a right-of-use asset and a lease liability for virtually all leases, other than leases with a term of 12 months or less, and to provide additional disclosures about leasing arrangements. Accounting by lessors is largely unchanged from existing accounting guidance. The Company will be required to adopt the new guidance on a modified retrospective basis beginning with its first fiscal quarter of 2019. Early adoption is permitted.

While the Company is still in the process of evaluating the impact of the new guidance on its consolidated financial statements and disclosures, the Company expects adoption of the new guidance will have a material impact on its Consolidated Balance Sheets due to recognition of the right-of-use asset and lease liability related to its operating leases. While the new guidance is also expected to impact the measurement and presentation of elements of expenses and cash flows related to leasing arrangements, the Company does not presently believe there will be a material impact on its Consolidated Statements of Comprehensive Income or Consolidated Statements of Cash Flows.

In May 2014, the FASB issued new accounting guidance on revenue recognition, which provides for a single, five-step model to be applied to all revenue contracts with customers. The new standard also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts. Companies have an option to use either a retrospective approach or cumulative effect adjustment approach to implement the standard. In August 2015, the FASB deferred the effective date of the new revenue guidance by one year such that the Company will be required to adopt the new guidance beginning with its first fiscal quarter of 2018. During 2016, the FASB issued three clarifications on specific topics within the new revenue recognition guidance that did not change the core principles of the guidance originally issued in May 2014.

This new guidance supersedes nearly all of the existing general revenue recognition guidance under U.S. GAAP as well as most industry-specific revenue recognition guidance, including guidance with respect to revenue recognition by franchisors. The Company believes the recognition of the majority of its revenues, including franchise royalty revenues, sales of IHOP pancake and waffle dry mix and retail sales at company-operated restaurants, will not materially be affected by the new guidance. Additionally, lease rental revenues and financing interest revenue are not within the scope of the new revenue guidance. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements and related disclosures and which method of adoption will be used.
 
The Company reviewed all other newly issued accounting pronouncements and concluded that they either are not applicable to the Company or are not expected to have a material effect on the Company's consolidated financial statements as a result of future adoption.
 

6

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)


4. Stockholders' Equity

Dividends
 
During the nine months ended September 30, 2016, the Company paid dividends on common stock of $50.8 million, representing cash dividends of $0.92 per share declared in the fourth quarter of 2015 and the first and second quarters of 2016. On July 28, 2016, the Company's Board of Directors declared a third quarter 2016 cash dividend of $0.92 per share of common stock. This dividend was paid on October 7, 2016 to the Company's stockholders of record at the close of business on September 16, 2016. The Company reported a payable for this dividend of $16.7 million at September 30, 2016.

On October 31, 2016, the Company's Board of Directors declared a fourth quarter 2016 cash dividend of $0.97 per share of common stock, payable on January 6, 2017 to stockholders of record at close of business on December 16, 2016.

Stock Repurchase Program

In October 2015, the Company's Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to $150 million of DineEquity common stock (the “2015 Repurchase Program”) on an opportunistic basis from time to time in open market transactions and in privately negotiated transactions based on business, market, applicable legal requirements and other considerations. The 2015 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. During the nine months ended September 30, 2016, the Company repurchased 525,550 shares of common stock at a cost of $45.0 million under the 2015 Repurchase Program. As of September 30, 2016, the Company has repurchased a cumulative total of 730,037 shares of common stock under the 2015 Repurchase Program at a total cost of $62.5 million. As of September 30, 2016, a total of $87.5 million remains available for additional repurchases under the 2015 Repurchase Program.

Treasury Stock

Repurchases of DineEquity common stock are included in treasury stock at the cost of shares repurchased plus any transaction costs. Treasury stock may be re-issued when stock options are exercised, when restricted stock awards are granted and when restricted stock units settle in stock upon vesting. The cost of treasury stock re-issued is determined using the first-in, first-out (“FIFO”) method. During the nine months ended September 30, 2016, the Company re-issued 130,538 shares of treasury stock at a total FIFO cost of $4.7 million.

5. Income Taxes
 
The Company's effective tax rate was 35.2% for the nine months ended September 30, 2016 as compared to 38.4% for the nine months ended September 30, 2015. The effective tax rate in 2016 was lower primarily due to application of a lower state tax rate to the deferred tax balances.

 The total gross unrecognized tax benefit as of September 30, 2016 and December 31, 2015 was $3.7 million and $3.9 million, respectively, excluding interest, penalties and related tax benefits. The Company estimates the unrecognized tax benefit may decrease over the upcoming 12 months by an amount up to $1.5 million related to settlements with taxing authorities and the lapse of statutes of limitations. For the remaining liability, due to the uncertainties related to these tax matters, the Company is unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority will occur.

As of September 30, 2016, accrued interest was $1.0 million and accrued penalties were less than $0.1 million, excluding any related income tax benefits. As of December 31, 2015, accrued interest was $4.9 million and accrued penalties were less than $0.1 million, excluding any related income tax benefits. The decrease of $3.9 million of accrued interest is primarily related to resolution of recent audits with taxing authorities. The Company recognizes interest accrued related to unrecognized tax benefits and penalties as a component of its income tax provision recognized in the Consolidated Statements of Comprehensive Income.

The Company files federal income tax returns and the Company or one of its subsidiaries files income tax returns in various state and foreign jurisdictions. The Company is no longer subject to federal, state or non-United States tax examinations by tax authorities for years before 2011. During the third quarter of 2016, the Company resolved the appeals process with the Internal Revenue Service related to its examination of the Company’s U.S federal income tax return for the tax years 2008 to 2010. The reserve previously provided related to the issues under appeal was adequate and did not require any additional adjustment.


7

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)


6. Stock-Based Compensation
 
The following table summarizes the components of stock-based compensation expense included in general and administrative expenses in the Consolidated Statements of Comprehensive Income:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In millions)
Total stock-based compensation expense:
 
 
 
 
 
 
 
Equity classified awards expense
$
2.6

 
$
1.8

 
$
8.3

 
$
6.4

Liability classified awards expense
(0.5
)
 
0.3

 
0.6

 
(0.5
)
Total pre-tax stock-based compensation expense
2.1

 
2.1

 
8.9

 
5.9

Book income tax benefit
(0.7
)
 
(0.8
)
 
(3.3
)
 
(2.2
)
Total stock-based compensation expense, net of tax
$
1.4

 
$
1.3

 
$
5.6

 
$
3.7

 
As of September 30, 2016, total unrecognized compensation expense of $14.7 million related to restricted stock and restricted stock units and $4.5 million related to stock options are expected to be recognized over a weighted average period of 1.55 years for restricted stock and restricted stock units and 1.51 years for stock options.
 
Equity Classified Awards - Stock Options

The estimated fair value of the stock options granted during the nine months ended September 30, 2016 was calculated using a Black-Scholes option pricing model. The following summarizes the assumptions used in the Black-Scholes model:
Risk-free interest rate
1.08
%
Weighted average historical volatility
27.1
%
Dividend yield
4.05
%
Expected years until exercise
4.5

Weighted average fair value of options granted
$13.55


Stock option balances as of September 30, 2016 and related activity for the nine months ended September 30, 2016 were as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
Weighted Average
Remaining
Contractual Term
(in Years)
 
Aggregate
Intrinsic
Value (in Millions)
Outstanding at December 31, 2015
 
504,462

 
$
69.99

 
 
 
 

Granted
 
255,825

 
90.90

 
 
 
 

Exercised
 
(44,813
)
 
28.61

 
 
 
 

Outstanding at September 30, 2016
 
707,550

 
79.90

 
7.4
 
$
6.3

Vested at September 30, 2016 and Expected to Vest
 
661,880

 
78.94

 
7.3
 
$
6.3

Exercisable at September 30, 2016
 
353,126

 
$
65.44

 
5.4
 
$
6.3

 
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the closing stock price of the Company’s common stock on the last trading day of the third quarter of 2016 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2016. The aggregate intrinsic value will change based on the fair market value of the Company’s common stock and the number of in-the-money options.


8

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)

6. Stock-Based Compensation (Continued)

Equity Classified Awards - Restricted Stock and Restricted Stock Units

Outstanding balances as of September 30, 2016 and activity related to restricted stock and restricted stock units for the nine months ended September 30, 2016 were as follows:
 
 
Restricted
Stock
 
Weighted
Average
Grant Date
Fair Value
 
Restricted
Stock Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at December 31, 2015
 
257,594

 
$
89.99

 
35,116

 
$
86.30

Granted
 
85,725

 
89.26

 
12,657

 
90.90

Released
 
(71,876
)
 
77.95

 
(14,027
)
 
72.01

Forfeited
 
(31,472
)
 
92.58

 

 

Outstanding at September 30, 2016
 
239,971

 
$
93.00

 
33,746

 
$
93.97


Liability Classified Awards - Long-Term Incentive Awards
The Company has granted cash long-term incentive awards (“LTIP awards”) to certain employees. Annual LTIP awards vest over a three-year period and are determined using a multiplier from 0% to 200% of the target award based on the total stockholder return of DineEquity common stock compared to the total stockholder returns of a peer group of companies. Although LTIP awards are only paid in cash, since the multiplier is based on the price of the Company's common stock, the awards are considered stock-based compensation in accordance with U.S. GAAP and are classified as liabilities. For the three months ended September 30, 2016 and 2015, a credit of $0.5 million and an expense of $0.3 million, respectively, were included in total stock-based compensation expense related to LTIP awards. For the nine months ended September 30, 2016 and 2015, an expense of $0.6 million and a credit of $0.5 million, respectively, were included in total stock-based compensation expense related to LTIP awards. At September 30, 2016 and December 31, 2015, liabilities of $2.3 million and $1.6 million, respectively, related to LTIP awards were included as part of accrued employee compensation and benefits in the Consolidated Balance Sheets.

7. Segments
 
The Company has four operating segments: franchise operations (an aggregation of Applebee’s and IHOP franchise operations), rental operations, company-operated restaurant operations and financing operations. The Company views all operating segments as reportable segments regardless of whether any segment exceeds 10% of consolidated revenues, segment profit or total assets.
 
As of September 30, 2016, the franchise operations segment consisted of (i) 2,027 restaurants operated by Applebee’s franchisees in the United States, two U.S. territories and 15 countries outside the United States and (ii) 1,699 restaurants operated by IHOP franchisees and area licensees in the United States, three U.S. territories and 10 countries outside the United States. Franchise operations revenue consists primarily of franchise royalty revenues, sales of proprietary products to franchisees (primarily pancake and waffle dry mixes for the IHOP restaurants), franchise advertising fees from domestic IHOP restaurants and international restaurants of both brands and franchise fees.  Franchise operations expenses include advertising expenses from domestic IHOP restaurants and international restaurants of both brands, the cost of IHOP proprietary products, IHOP and Applebee's pre-opening training expenses and other franchise-related costs.

Rental operations revenue includes revenue from operating leases and interest income from direct financing leases. Rental operations expenses are costs of operating leases and interest expense from capital leases on franchisee-operated restaurants. 

At September 30, 2016, the company restaurant operations segment consisted of 10 IHOP company-operated restaurants, all of which are located in the United States. Company restaurant sales are retail sales at company-operated restaurants. Company restaurant expenses are operating expenses at company-operated restaurants and include food, labor, utilities, rent and other restaurant operating costs.

Financing operations revenue primarily consists of interest income from the financing of franchise fees and equipment leases and sales of equipment associated with refranchised IHOP restaurants. Financing expenses are primarily the cost of restaurant equipment associated with refranchised IHOP restaurants.
 

9

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)

7. Segments (Continued)

Information on segments is as follows:
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In millions)
Revenues from external customers:
 
 

 
 

 
 
 
 
Franchise operations
 
$
119.2

 
$
120.1

 
$
366.7

 
$
364.9

Rental operations
 
30.5

 
31.2

 
92.7

 
93.8

Company restaurants
 
4.0

 
8.1

 
13.4

 
42.8

Financing operations
 
2.3

 
3.0

 
7.0

 
8.3

Total
 
$
156.0

 
$
162.4

 
$
479.8

 
$
509.8

 
 
 
 
 
 
 
 
 
Interest expense:
 
 

 
 

 
 
 
 
Rental operations
 
$
2.9

 
$
3.3

 
$
9.0

 
$
10.1

Company restaurants
 
0.1

 
0.1

 
0.3

 
0.3

Corporate
 
15.4

 
15.4

 
46.1

 
46.8

Total
 
$
18.4

 
$
18.8

 
$
55.4

 
$
57.2

 
 
 
 
 
 
 
 
 
Depreciation and amortization:
 
 

 
 

 
 
 
 
Franchise operations
 
$
2.7

 
$
2.6

 
$
7.9

 
$
7.8

Rental operations
 
3.1

 
3.2

 
9.4

 
9.6

Company restaurants
 
0.1

 
0.1

 
0.3

 
0.5

Corporate
 
1.5

 
2.4

 
5.3

 
6.2

Total
 
$
7.4

 
$
8.3

 
$
22.9

 
$
24.1

 
 
 
 
 
 
 
 
 
Gross profit, by segment:
 
 

 
 

 
 
 
 
Franchise operations
 
$
81.9

 
$
86.8

 
$
258.7

 
$
262.0

Rental operations
 
7.7

 
8.0

 
23.7

 
23.7

Company restaurants
 
(0.2
)
 
(0.6
)
 
(0.7
)
 
0.3

Financing operations
 
2.3

 
2.5

 
6.8

 
7.8

Total gross profit
 
91.7

 
96.7

 
288.5

 
293.8

Corporate and unallocated expenses, net
 
(54.2
)
 
(57.1
)
 
(170.2
)
 
(164.6
)
Income before income tax provision
 
$
37.5

 
$
39.6

 
$
118.3

 
$
129.2



10

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)


8. Net Income per Share

The computation of the Company's basic and diluted net income per share is as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In thousands, except per share data)
Numerator for basic and diluted income per common share:
 

 
 

 
 
 
 
Net income
$
24,273

 
$
24,257

 
$
76,645

 
$
79,566

Less: Net income allocated to unvested participating restricted stock
(338
)
 
(316
)
 
(1,103
)
 
(1,042
)
Net income available to common stockholders - basic
23,935

 
23,941

 
75,542

 
78,524

Effect of unvested participating restricted stock in two-class calculation
1

 
1

 
3

 
3

Net income available to common stockholders - diluted
$
23,936

 
$
23,942

 
$
75,545

 
$
78,527

Denominator:
 

 
 

 
 
 
 
Weighted average outstanding shares of common stock - basic
17,950

 
18,573

 
18,099

 
18,737

Dilutive effect of stock options
91

 
133

 
102

 
137

Weighted average outstanding shares of common stock - diluted
18,041

 
18,706

 
18,201

 
18,874

Net income per common share:
 

 
 

 
 
 
 
Basic
$
1.33

 
$
1.29

 
$
4.17

 
$
4.19

Diluted
$
1.33

 
$
1.28

 
$
4.15

 
$
4.16



11

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)


9. Fair Value Measurements
The Company does not have a material amount of financial assets or liabilities that are required under U.S. GAAP to be measured on a recurring basis at fair value. The Company is not a party to any derivative financial instruments. The Company does not have a material amount of non-financial assets or non-financial liabilities that are required under U.S. GAAP to be measured at fair value on a recurring basis. The Company has not elected to use the fair value measurement option, as permitted under U.S. GAAP, for any assets or liabilities for which fair value measurement is not presently required.
 
The Company believes the fair values of cash equivalents, accounts receivable and accounts payable approximate their carrying amounts due to their short duration.
 
The fair values of the Company's Series 2014-1 Class A-2 Notes (the “Class A-2 Notes”) at September 30, 2016 and December 31, 2015 were as follows:
 
 
September 30, 2016
 
December 31, 2015
 
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
 
(In millions)
Long-term debt
 
$
1,281.9

 
$
1,321.2

 
$
1,279.5

 
$
1,306.1


 The fair values were determined based on Level 2 inputs, including information gathered from brokers who trade in the Company’s Class A-2 Notes and information on notes that are similar to those of the Company.

10. Commitments and Contingencies
 
Litigation, Claims and Disputes
 
The Company is 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. The Company is required under U.S. GAAP 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 the Company's litigation are expensed as such fees and expenses are incurred. Management regularly assesses the Company's insurance coverage, analyzes litigation information with the Company's attorneys and evaluates the Company's loss experience in connection with pending legal proceedings. While the Company does not presently believe that any of the legal proceedings to which it is currently a party will ultimately have a material adverse impact on the Company, there can be no assurance that the Company will prevail in all the proceedings the Company is party to, or that the Company will not incur material losses from them.

Lease Guarantees
 
In connection with the sale of Applebee’s restaurants or previous brands to franchisees and other parties, the Company has, in certain cases, guaranteed or has potential continuing liability for lease payments totaling $372.5 million as of September 30, 2016. This amount represents the maximum potential liability for future payments under these leases. These leases have been assigned to the buyers and expire at the end of the respective lease terms, which range from 2016 through 2048. In the event of default, the indemnity and default clauses in the sale or assignment agreements govern the Company's ability to pursue and recover damages incurred. No material lease payment guarantee liabilities have been recorded as of September 30, 2016.

11. Facility Exit Costs

In September 2015, the Company approved a plan to consolidate many core restaurant and franchisee support functions at its headquarters in Glendale, California and communicated the plan to employees. In conjunction with this action, the Company will exit a significant portion of the Applebee's restaurant support center in Kansas City, Missouri. The Company estimates it will incur a total of approximately $7 million in employee termination benefits, primarily severance and relocation costs, associated with the consolidation, of which $5.8 million has been incurred through September 30, 2016. The Company also estimates it will incur approximately $4 million in costs related to the exit of the facility, of which $2.5 million has been incurred through September 30, 2016.


12

DineEquity, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)

11. Facility Exit Costs (Continued)

During the nine months ended September 30, 2016, the Company incurred $1.2 million of employee termination costs, primarily relocation and severance costs associated with the consolidation. These charges were included as general and administrative expenses in the Consolidated Statements of Comprehensive Income.
 
During the nine months ended September 30, 2016, the Company negotiated the termination of its lease on two of four floors of the Kansas City facility and recorded charges of $2.5 million related to this termination that were included as closure and impairment charges in the Consolidated Statements of Comprehensive Income.
 
 
Employee Termination Costs
 
Facility Costs
 
Total Exit Costs
 
 
(In millions )
Accrued exit costs at December 31, 2014
 
$

 
$

 
$

Charges
 
4.6

 

 
4.6

Payments
 
(1.1
)
 

 
(1.1
)
Accrued exit costs at December 31, 2015
 
3.5

 

 
3.5

Charges
 
1.2

 
2.5

 
3.7

Payments
 
(4.4
)
 
(2.5
)
 
(6.9
)
Accrued exit costs at September 30, 2016
 
$
0.3

 
$

 
$
0.3


At September 30, 2016, the $0.3 million of accrued termination costs was included in accrued employee compensation and benefits. At December 31, 2015, $3.3 million of accrued termination costs was included in accrued employee compensation and benefits and $0.2 million was included in other accrued expenses in the Consolidated Balance Sheet.


13


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Statement Regarding Forward-Looking Statements
 
Statements contained in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those expressed or implied in such statements. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors” in our most recent Annual Report on Form 10-K, as well as our consolidated financial statements, related notes, and the other financial information appearing elsewhere in this report and our other filings with the United States Securities and Exchange Commission. The forward-looking statements contained in this report are made as of the date hereof and the Company assumes no obligation to update or supplement any forward-looking statements.

You should read the following Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this report.

Business Overview
 
The following discussion and analysis provides information which we believe is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and MD&A contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015. Except where the context indicates otherwise, the words “we,” “us,” “our,” “DineEquity” and the “Company” refer to DineEquity, Inc., together with its subsidiaries that are consolidated in accordance with United States generally accepted accounting principles (“U.S. GAAP”).
 
Through various subsidiaries, we own and franchise 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, franchise and operate 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 restaurant concepts, whether operated by franchisees, area licensees and their sub-licensees (collectively, “area licensees”) or by us. With over 3,700 restaurants combined, virtually all of which are franchised, we believe we are one of the largest full-service restaurant companies in the world. The June 20, 2016 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 for 2015. This marks the ninth consecutive year our two brands have achieved the number one ranking in their respective categories in Nation's Restaurant News.

Key Performance Indicators

In evaluating the performance of each restaurant concept, we consider the key performance indicators to be net franchise restaurant development and the percentage change in domestic system-wide same-restaurant sales. Since we are a 99% franchised company, expanding the number of Applebee's and IHOP franchise restaurants is an important driver of revenue growth. Growth in both the number of franchise restaurants and sales at those restaurants will drive franchise revenues in the form of higher royalty revenues, additional franchise fees and, in the case of IHOP restaurants, sales of proprietary pancake and waffle dry mix.
 
An overview of these key performance indicators for the three and nine months ended September 30, 2016 is as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
 
Applebee's
 
IHOP
 
Applebee's
 
IHOP
Net franchise restaurant development (reduction) (1)

 
14

 
(6
)
 
26

% (decrease) increase in domestic system-wide same-restaurant sales
(5.2
)%
 
(0.1
)%
 
(4.4
)%
 
0.5
%
________________________________
(1) Franchise and area license restaurant openings, net of closings
Detailed information on each of these key performance indicators is presented under the captions “Restaurant Development Activity,” “Domestic Same-Restaurant Sales” and “Restaurant Data” that follow.

14


 Restaurant Development Activity
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Applebee's
(Unaudited)
Summary - beginning of period:
 
 
 
 
 
 
 
Franchise
2,027

 
1,993

 
2,033

 
1,994

Company restaurants

 
23

 

 
23

Total Applebee's restaurants, beginning of period
2,027

 
2,016

 
2,033

 
2,017

 
 
 
 
 
 
 
 
Franchise restaurants opened:
 

 
 

 
 
 
 
Domestic
6

 
7

 
13

 
17

International
3

 
2

 
7

 
6

Total franchise restaurants opened
9

 
9

 
20

 
23

Franchise restaurants closed:
 

 
 

 
 
 
 
Domestic
(8
)
 
(6
)
 
(20
)
 
(14
)
International
(1
)
 
(1
)
 
(6
)
 
(8
)
Total franchise restaurants closed
(9
)
 
(7
)
 
(26
)
 
(22
)
Net franchise restaurant development (reduction)

 
2

 
(6
)
 
1

Refranchised from Company restaurants

 
23

 

 
23

Net franchise restaurant additions (reductions)

 
25

 
(6
)
 
24

 
 
 
 
 
 
 
 
Summary - end of period:
 
 
 
 
 
 
 
Franchise
2,027

 
2,018

 
2,027

 
2,018

Company restaurants

 

 

 

Total Applebee's restaurants, end of period
2,027

 
2,018

 
2,027

 
2,018

IHOP
 

 
 

 
 
 
 
Summary - beginning of period:
 
 
 
 
 
 
 
Franchise
1,519

 
1,479

 
1,507

 
1,472

Area license
166

 
166

 
165

 
167

Company
10

 
13

 
11

 
11

Total IHOP restaurants, beginning of period
1,695

 
1,658

 
1,683

 
1,650

 
 
 
 
 
 
 
 
Franchise/area license restaurants opened:
 
 
 
 
 
 
 
Domestic franchise
7

 
11

 
26

 
24

Domestic area license
1

 

 
3

 
2

International franchise
8

 
2

 
11

 
5

Total franchise/area license restaurants opened
16

 
13

 
40

 
31

Franchise/area license restaurants closed:
 

 
 

 
 
 
 
Domestic franchise
(2
)
 
(4
)
 
(10
)
 
(11
)
Domestic area license

 

 
(1
)
 
(3
)
International franchise

 

 
(3
)
 

Total franchise/area license restaurants closed
(2
)
 
(4
)
 
(14
)
 
(14
)
Net franchise/area license restaurant development
14

 
9

 
26

 
17

Refranchised from Company restaurants

 
2

 
1

 
3

Franchise restaurants reacquired by the Company

 

 

 
(3
)
Net franchise/area license restaurant additions
14

 
11

 
27

 
17

 
 
 
 
 
 
 
 
Summary - end of period:
 
 
 
 
 
 
 
Franchise
1,532

 
1,490

 
1,532

 
1,490

Area license
167

 
166

 
167

 
166

Company
10

 
11

 
10

 
11

Total IHOP restaurants, end of period
1,709

 
1,667

 
1,709

 
1,667

Gross development by Applebee's franchisees for the three months ended September 30, 2016 was equal to the same period of the prior year, while gross development by Applebee's franchisees for the nine months ended September 30, 2016 was lower than the same period of 2015. Applebee's net development for both the three and nine months ended September 30, 2016 was lower than the same respective periods of the prior year due to a slight increase in the number of Applebee's restaurant closures.

15


Both the gross and net development by IHOP franchisees for the three and nine months ended September 30, 2016 was higher than the respective periods of 2015. The increases primarily were due to higher gross and net development by international IHOP franchisees. On a combined basis, DineEquity gross and net franchise restaurant development for the three and nine months ended September 30, 2016 was higher than the respective periods of the prior year.
For the full year of 2016, we expect IHOP franchisees to open a total of 65 to 77 new restaurants and Applebee's franchisees to open a total of 25 to 33 new restaurants. The majority of openings for each brand is expected to be in domestic markets. The actual number of openings in 2016 may differ from both our expectations and development commitments. Historically, the actual number of restaurants developed in a particular year has been less than the total number committed to be developed due to various factors, including economic conditions and franchisee noncompliance with restaurant opening commitments in development agreements. The timing of new restaurant openings also may be affected by other factors including weather-related and other construction delays, difficulties in obtaining timely regulatory approvals and the impact of currency fluctuations on our international franchisees.

Domestic Same-Restaurant Sales

We believe that, while the U.S. economy has continued to grow in 2016, the rate of growth has been slower than in 2015 and average wages have grown at a slower pace than the overall economy. In addition, restaurants have been faced with increased competition from prepared food retailers and a widening gap between the cost of food purchased for consumption at home and the cost of food purchased at restaurants. As a result, consumers seem to be allocating less disposable personal income to restaurant visits. Based on data from Black Box Intelligence (“Black Box”), a restaurant sales reporting firm, the third quarter of 2016 was the weakest quarter for the overall restaurant industry since the second quarter of 2010.
 din-2016331_chartx26297a02.jpg
Applebee’s domestic system-wide same-restaurant sales decreased 5.2% for the three months ended September 30, 2016 from the same period in 2015. The decrease resulted from a decline in customer traffic that was only partially offset by a higher average customer check. The decline in Applebee's quarter-over-quarter customer traffic has grown progressively larger from the first quarter of 2015 to the third quarter of 2016. We made an incremental investment of $2.5 million during the third quarter of 2016 to test additional marketing initiatives to help address that trend.

Applebee’s domestic system-wide same-restaurant sales decreased 4.4% for the nine months ended September 30, 2016 from the same period in 2015, also due to a decline in customer traffic that was only partially offset by a higher average customer check. Same-restaurant sales for the first nine months of 2016 are not necessarily indicative of results expected for the full year.

Based on data from Black Box, the casual dining segment of the restaurant industry also experienced a decline in customer traffic and an overall decline in same-restaurant sales during the three and nine months ended September 30, 2016 compared to the respective periods of the prior year. Applebee's declines in traffic and same-restaurant sales were larger than those experienced by the overall casual dining segment.

16


din-2016331_chartx27567a02.jpg
IHOP’s domestic system-wide same-restaurant sales decreased 0.1% for the three months ended September 30, 2016 from the same period in 2015, the first quarterly decrease in comparative same-restaurant sales for IHOP since the first quarter of 2013. The decrease resulted from a decline in customer traffic that was nearly offset by an increase in average customer check. IHOP's quarter-over-quarter customer traffic has decreased for the past four quarters after increasing in the five consecutive quarters from the third quarter of 2014 to the third quarter of 2015. IHOP's domestic system-wide same-restaurant sales increased 0.5% for the nine months ended September 30, 2016 from the same period in 2015, due to a higher average customer check, partially offset by a decrease in customer traffic. Same-restaurant sales for the first nine months of 2016 are not necessarily indicative of results expected for the full year.

Based on data from Black Box, the family dining segment of the restaurant industry experienced an increase in same-restaurant sales during both the three and nine months ended September 30, 2016, compared to the same respective periods of the prior year, due to a higher average customer check partially offset by a decrease in customer traffic. IHOP's increase in same-restaurant sales was greater than that of the family dining segment as reported by Black Box for the nine months ended September 30, 2016. IHOP's decrease in customer traffic was greater than that of the family dining segment for the three months ended September 30, 2016, while IHOP's decrease in customer traffic was the same as that of the family dining segment for the nine months ended September 30, 2016.

As reported by Black Box, customer traffic declined for the overall restaurant industry as well as for both the casual dining and family dining segments of the restaurant industry during the three and nine months ended September 30, 2016. With respect to both our brands, a decline in customer traffic may be offset in the short term by an increase in average customer check resulting from an increase in menu prices, a favorable change in product sales mix, or a combination thereof. A sustained decline in same-restaurant customer traffic that cannot be offset by an increase in average customer check could have an adverse effect on our business, results of operations and financial condition due to, among other things, reduced royalty revenues, higher bad debt expense resulting from the failure or inability of franchisees to pay amounts owed to us when due, and a possible decline in the number of franchise restaurants because of reduced development or restaurant closures.

We strive to identify and create opportunities for growth in customer traffic and frequency, average check and same-restaurant sales. We focus on building our brands with a long-term view through a strategic combination of menu, media, remodel and development initiatives to continually innovate and evolve both brands. To drive each brand forward, we seek to innovate and remain actively focused on driving sustainable sales and traffic.


17


Restaurant Data
 
The following table sets forth 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 year. Sales at restaurants that are owned by franchisees and area licensees are not attributable to the Company and, as such, the percentage change in sales at Effective Restaurants is 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.

 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Applebee's Restaurant Data
 
(Unaudited)
Effective Restaurants(a)
 
 

 
 

 
 

 
 

Franchise
 
2,028

 
2,011

 
2,029

 
1,998

Company
 

 
5

 

 
17

Total
 
2,028

 
2,016

 
2,029

 
2,015

System-wide(b)
 
 

 
 

 
 

 
 

Sales percentage change(c)
 
(5.1
)%
 
0.4
 %
 
(4.5
)%
 
2.1
%
Domestic same-restaurant sales percentage change(d)
 
(5.2
)%
 
(0.5
)%
 
(4.4
)%
 
1.2
%
 
 
 
 
 
 
 
 
 
Franchise(b)
 
 

 
 

 
 

 
 

Sales percentage change(c)
 
(4.9
)%
 
1.2
 %
 
(3.7
)%
 
2.3
%
Domestic same-restaurant sales percentage change(d)
 
(5.2
)%
 
0.5
 %
 
(4.4
)%
 
1.2
%
Average weekly domestic unit sales (in thousands)
 
$
43.5

 
$
45.9

 
$
46.2

 
$
48.6

 
 
 
 
 
 
 
 
 
IHOP Restaurant Data
 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
Effective Restaurants(a)
 
 

 
 

 
 

 
 

Franchise
 
1,521

 
1,482

 
1,512

 
1,474

Area license
 
167

 
166

 
165

 
167

Company
 
10

 
12

 
11

 
13

Total
 
1,698

 
1,660

 
1,688

 
1,654

 
 
 
 
 
 
 
 
 
System-wide(b)
 
 

 
 

 
 

 
 

Sales percentage change(c)
 
1.3
 %
 
7.0
 %
 
2.0
 %
 
6.8
%
Domestic same-restaurant sales percentage change(d)
 
(0.1
)%
 
5.8
 %
 
0.5
 %
 
5.6
%
Franchise(b)
 
 

 
 

 
 

 
 

Sales percentage change(c)
 
1.4
 %
 
6.8
 %
 
2.2
 %
 
6.5
%
Domestic same-restaurant sales percentage change(d)
 
(0.1
)%
 
5.8
 %
 
0.5
 %
 
5.6
%
Average weekly domestic unit sales (in thousands)
 
$
37.1

 
$
37.6

 
$
37.5

 
$
37.6

Area License(b)
 
 

 
 

 
 

 
 

Sales percentage change(c)
 
2.4
 %
 
8.0
 %
 
1.1
 %
 
7.6
%
 
(a)   “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, which consist of 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 in franchisees' reported sales will result in a corresponding increase in our royalty revenue, while a decrease in franchisees' reported sales will result in a corresponding decrease in our royalty revenue.Unaudited reported sales for Applebee's domestic franchise restaurants, IHOP franchise restaurants and IHOP area license restaurants were as follows:

18


 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Reported sales
(In millions)
 
(Unaudited)
 
 

 
 

 
 
 
 
Applebee's domestic franchise restaurant sales
$
1,058.9

 
$
1,113.2

 
$
3,382.1

 
$
3,513.8

IHOP franchise restaurant sales
734.3

 
724.5

 
2,208.6

 
2,160.9

IHOP area license restaurant sales
71.0

 
69.4

 
216.5

 
214.2

Total
$
1,864.2

 
$
1,907.1

 
$
5,807.2

 
$
5,888.9

 
(c)   “Sales percentage change” reflects, for each category of restaurants, the percentage change in sales in any given fiscal period compared to the prior fiscal period for all restaurants in that category.
 
(d)   “Domestic same-restaurant sales percentage change” reflects the percentage change in sales in any given fiscal period, compared to the same weeks in the prior fiscal period, for domestic restaurants that have been operated throughout both fiscal periods 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 both fiscal periods being compared may be different from period to period. Domestic same-restaurant sales percentage change does not include data on IHOP area license restaurants.  



CONSOLIDATED RESULTS OF OPERATIONS
Comparison of the Three and Nine Months Ended September 30, 2016 and 2015

Events Impacting Comparability of Financial Results
Refranchising of 23 Applebee's Company-operated Restaurants

In July 2015, we completed the refranchising and sale of related restaurant assets of 23 Applebee’s company-operated restaurants in the Kansas City, Missouri market area. As the result of this transaction, we only recognized royalty revenues from these 23 restaurants in 2016, whereas in 2015 we recognized restaurant revenues and operating costs prior to the refranchising and royalty revenues thereafter. The impact of this refranchising on our consolidated revenue and gross profit for the three and nine months ended September 30, 2016 was as follows:
 
 
Three months ended September 30,
 
Favorable
(Unfavorable) Impact
 
Nine months ended September 30,
 
Favorable
(Unfavorable) Impact
 
 
2016
 
2015
 
2016
 
2015
 
Company restaurant revenue
 
$

 
$
3.0

 
$
(3.0
)
 
$

 
$
27.5

 
$
(27.5
)
Royalty revenue
 
0.4

 
0.3

 
0.1

 
1.3

 
0.3

 
1.0

Total revenue impact
 
0.4

 
3.3

 
(2.9
)
 
1.3

 
27.8

 
(26.5
)
Operating costs
 

 
3.1

 
3.1

 

 
26.0

 
26.0

Gross profit impact
 
$
0.4

 
$
0.2

 
$
0.2

 
$
1.3

 
$
1.8

 
$
(0.5
)

Consolidation of Kansas City Restaurant Support Center

In September 2015, we announced a strategic decision to consolidate many core Applebee's restaurant and franchisee support functions and relocate them from Kansas City, Missouri to our Glendale, California headquarters. In conjunction with this action, we estimate we will incur a total of approximately $9 million in employee termination costs and in other personnel-related costs, primarily recruiting costs, associated with this consolidation. We estimate we will incur approximately $5 million in costs related to the reduction in our space requirements at the Kansas City facility, primarily facility exit costs and increased depreciation charges. We expect the consolidation process to be complete by the end of 2016.

During the second quarter of 2016, we negotiated the termination of our lease on two of four floors of the Kansas City facility and recorded charges of $2.5 million related to this termination as part of closure and impairment costs in the Consolidated Statement of Comprehensive Income. Remaining Kansas City employees will be consolidated to a single floor. We expect to record an additional charge of approximately $1 million once the remaining space we will no longer occupy is available for sublease, which is estimated to be in the fourth quarter of 2016.


19


Costs incurred related to the consolidation for the three and nine months ended September 30, 2016, as well as cumulative costs incurred are as follows:
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
Cumulative to September 30,
 
 
2016
 
2015
2016
 
2015
 
2016
 
 
(In millions)
Termination benefits and other personnel-related costs
 
$
0.3

 
$
3.3

 
$
2.6

 
$
3.3

 
$
7.5

Facility costs:
 
 
 
 
 
 
 
 
 
 
Lease termination costs
 

 

 
2.5

 

 
2.5

Depreciation
 

 
0.3

 
0.2

 
0.3

 
1.2

Total facility costs
 

 
0.3

 
2.7

 
0.3

 
3.7

Total consolidation costs
 
$
0.3

 
$
3.6

 
$
5.3

 
$
3.6

 
$
11.2



Adjustment to Deferred Tax Liabilities

As a result of the consolidation action discussed above, our estimated state tax rate that will be effective when temporary book/tax differences are realized in the future will be lower than the effective state tax rate that was used to record net deferred tax liabilities when the temporary book/tax differences arose. Primarily because of this lower rate, we reduced deferred tax liabilities and our 2016 income tax provision by approximately $2.0 million during the second quarter of 2016. This change lowered our combined effective tax rate for the nine months ended September 30, 2016 from what would have been 36.9%, without the adjustment, to 35.2%.
Financial Results
Overview
 
Three months ended September 30,
 
Favorable
(Unfavorable) Variance
 
Nine months ended September 30,
 
Favorable
(Unfavorable) Variance
 
 
2016
 
2015
 
2016
 
2015
 
 
 
(In millions, except per share data)
Gross profit
 
$
91.7

 
$
96.7

 
$
(5.0
)
 
$
288.5

 
$
293.8

 
$
(5.3
)
General and administrative expenses
 
36.0

 
41.6

 
5.6

 
111.9

 
110.4

 
(1.5
)
Other expense and income items, net
 
18.2

 
15.5

 
(2.7
)
 
58.3

 
54.2

 
(4.1
)
Income before income taxes
 
37.5

 
39.6

 
(2.1
)
 
118.3

 
129.2

 
(10.9
)
Income tax provision
 
(13.2
)
 
(15.3
)
 
2.1

 
(41.7
)
 
(49.6
)
 
7.9

Net income
 
$
24.3

 
$
24.3

 
$
0.0

 
$
76.6

 
$
79.6

 
$
(3.0
)
Change vs. prior period
 
0.0
%
 
 
 
 
 
(3.8
)%
 
 
 
 
 
 
 
 
 
 
% increase (decrease)
 
 
 
 
 
% increase (decrease)
Net income per diluted share
 
$
1.33

 
$
1.28

 
3.9
 %
 
$
4.15

 
$
4.16

 
(0.2
)%
Weighted average shares
 
18.0

 
18.7

 
(3.7
)%
 
18.2

 
18.9

 
(3.7
)%
Our net income for the three months ended September 30, 2016 was essentially the same as in the third quarter of 2015. Our general and administrative expenses (“G&A”) and our effective tax rate were lower in 2016, but these favorable items were offset by a decrease in gross profit and a loss on disposition of assets in 2016 compared to a gain on disposition of assets in 2015. The reasons for these changes are discussed in detail in the respective sections that follow. Despite flat earnings, our net income per diluted share for the three months ended September 30, 2016 increased compared with the same period of the prior year due to a smaller number of weighted average shares outstanding.
Our net income for the nine months ended September 30, 2016 declined $3.0 million compared with the same period of the prior year. The decline in net income was due to a decrease in gross profit, costs of $2.5 million incurred to terminate a lease, a loss on disposition of assets in 2016 compared to a gain on disposition of assets in 2015 and an increase in G&A expenses. These unfavorable items were only partially offset by a lower effective tax rate. The reasons for these changes are discussed in detail in the respective sections that follow. However, the percentage decrease in net income per diluted share compared with the same period of the prior year was substantially less than the percentage decrease in net income due to a smaller number of weighted average shares outstanding.
The weighted average shares outstanding for both the three and nine months ended September 30, 2016 decreased primarily due to our repurchase of approximately 800,000 shares of stock pursuant to stock repurchase programs over the past twelve months.

20


Revenue
 
Three months ended September 30,
 
Favorable
(Unfavorable) Variance
 
Nine months ended September 30,
 
Favorable
(Unfavorable) Variance
 
 
2016
 
2015
 
2016
 
2015
 
 
 
(In millions)
Franchise operations
 
$
119.2

 
$
120.1

 
$
(0.9